AUDITING
C lass: B.ComCourse Instructor: Mr .Tahir Abbas
Before Mid-Term Outline:
Audit
- Introduction
- Nature & scope
- Objectives of an audit
- DISTINCTION BETWEEN ACCOUNTING AND AUDITING
- Advantages and Disadvantages of audit
Internal Control
- Internal Audit
- Internal check
- Internal control for cash, store, purchases & sales department
Types of Audit
- Continuous, Interim & Final audit
- Features, Advantages and Disadvantages of each type of audit
- Auditing Programs, Test checking, Audit working papers, Audit Notes Book
Vouching
- Techniques & Application
Verification
- Verification of assets & Liabilities
Auditor
- Appointment & Qualification
- Rights, Duties & Liabilities
- Professional Ethics
1. INTRODUCTION -AN OVERVIEW OF AUDITING:
As society become more complex, there is an increased likelihood that unreliable information will be provided to decision makers. There are several reasons for this: remoteness of information, voluminous data and the existence of complex exchange transactions.As a means of overcoming the problem of unreliable information,
The decision-maker must develop a method of assuring him that the
Information is sufficiently reliable for these decisions. In doing this he must
Weigh the cost of obtaining more reliable information against the expected Benefits.
A common way to obtain such reliable information is to have some type of verification (audit) performed by independent persons. The audited information is then used in the decision making process on the assumption that it is reasonably complete, accurate and unbiased.
ORIGINAND EVOLUTION
The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days an auditor used to listen to the accounts read over by an accountant in order to check them.
Auditing is as old as accounting. It was in use in all ancient countries such as Greece, U.K. and India.
The original objective of auditing was to detect and prevent errors and frauds.Auditing evolved and grew rapidly after the industrial revolution in the 18th century with the growth of the joint stock companies the ownership and management became separate.
The International Accounting Standards Committee and the
Accounting Standard board of the Institute of Chartered Accountants of
India have developed standard accounting and auditing practices to guide the accountants and auditors in the day to day work
DEFINITION
The term auditing has been defined by different authorities.
According to Prof. L.R.Dickse:
"Auditing is an examination of accounting records undertaken with a view to establish whether they correctly and completely reflect the transactions to which they relate”.
R. K. Mautz:
"concerned with the verification of accounting data, with determining the accuracy and reliability accounting statement and reports."
- Nature & Scope of Audit
SCOPE OF AUDIT:-
The term "Scope of Audit" means the audit procedure which is considered necessary for the achievement of desired objectives. The auditor should keep in view the following points :
1. Legal Conditions :-
While determining the scope of audit and auditor should follow the rules and regulations applicable on the audit work.
2. Validity ofData:-
The auditor should use various methods to test the validity of data. He should confirm that data provided in the financial statement is reliable.
3. Cover All theAspects:-
The auditor should cover all the functions of business, know all its working any aspect related to financial statement may not be ignored. A business is small or large auditor should cover all the areas.
4. Comparison:-
The auditor can compare the accounts record with the financial statement to know the true picture. He determines whether the relevant information is properly communicated or not.
5. Apply His Skill:-
While preparing the report, an auditor should apply his professional skill and experience to prove that figures and facts.
6. Sufficient Record:-
The auditor checks that record and relevant data is sufficient. He also uses other tests and verification procedure.
7. Judgement:-
The auditor also considers the judgement of the management made in preparing the financial statements. The auditor must have the quality of judgement when he fails to find the data in the books of account.
8. Internal Check:-
It is not possible for the auditor to check each and every voucher and transaction, so he should try to rely on internal check system. He is also bond to make guess work on the basis of available data.
9. Persuasive Evidence:-
The auditor his opinion as true fair instead of cent percent correct because the available evidence is persuasive. The personal judgement also affects the value of any items.
10. Misstatement Problem:-
Due to the limitations of audit sometimes some material misstatements remain undiscovered. So statement does not show the exact view of operations.
- OBJECTIVES OF AUDITING
There are two main objectives of auditing. The primary objective and the secondary or incidental objective.
1. Primary objective:
As per Section 227 of the Companies Act
1956, the primary duty (objective) of the auditor is to report to the owners whether the balance sheet gives a true and fair view of the Company’s state of affairs and the profit and loss A/c gives a correct figure of profit of loss for the financial year.
- Examining the system of internal check.
ii. Checking arithmetical accuracy of books of accounts, verifying posting, costing, balancing etc.
iii. Verifying the authenticity and validity of transactions.
iv. Checking the proper distinction of capital and revenue nature of transactions.
v. Confirming the existence and value of assets and liabilities.
vi. Verifying whether all the statutory requirements are fulfilled or not.
vii. Proving true and fairness of operating results presented by income statement and financial position presented by balance sheet.
2. Secondary objective:
It is also called the incidental objective as it is incidental to the satisfaction of the main objective. The incidental objective of auditing is:
i. Detection and prevention of Frauds, and
ii. Detection and prevention of Errors.
I.Detection and prevention of errors
Errors are those mistakes which are committed due to carelessness or negligence or lack of knowledge or without having vested interest. Errors may be committed without or with any vested interest. So, they are to be checked carefully. Errors are of various types. Some of them are:
* Errors of principle
* Errors of omission
* Errors of commission
* Compensating errors
II.Detection and prevention of frauds
Frauds are those mistakes which are committed knowingly with some vested interest on the direction of top level management. Management commits frauds to deceive tax, to show the effectiveness of management, to get more commission, to sell share in the market or to maintain market price of share etc. Detection of fraud is the main job of an auditor. Such frauds are as follows:
* Misappropriation of cash
* Misappropriation of goods
* Manipulation of accounts or falsification of accounts without any misappropriation
- DISTINCTION BETWEEN ACCOUNTING AND AUDITING
Points of difference / Accounting / Auditing
- Meaning
- Nature
- Objects
- commencement
- Scope
- Staff
It is concerned with finalisation of accounts.
The object is to ascertain the trading results.
It involves various financial statements. It involves maintenance of books of accounts. It does not go beyond books of accounts.
Accounting prepares profit and loss account and balance sheet and other statements as per the instruction of auditor
An accountant is a staff of an organization and draws the salary from the business / It is the critical examination of the transactions recorded in the books of accounts.
It is concerned with establishment of reliability of financial statements.
The object is to certify the correctness of financial statements.
It depends upon the agreement or upon the provisions of law. It goes beyond books of accounts.
Auditor checks the books of accounts considering their fairness as well as complying with the provision of company act or not.
An auditor is an independent person who is appointed for specific period and gets a sum of remuneration.
- Preparation Of Report
- Responsibility
An accountant remains responsible to the management
Auditor needs to prepare and present report after the completion of his work to the concerned authority.
An auditor is responsible to the owners or shareholders.
- ADVANTAGES AND DISADVANTAGES OF AUDIT
Advantages of Auditing
Assurance of true and fair accounts
An audit provides an assurance to the investors, government, lenders, creditors, owners, management etc. That the final account presented shows the true and fair picture of the profit and losses and financial position of the concern
True and fair balance sheet
The user of final accounts can be sure that the assets and liabilities disclose true and fair view of financial position of the concern, it’s neither more nor less, and it’s free from window dressing or secret reserve.
True and fair profit and loss account
the user of final accounts should be sure that the profit and loss account show true amount of profit or less as it is.
Tally with books of accounts
the audited final accounts should tally with the books of accounts of the concern. So it can be easy to calculate the taxable income without going through all the transactions.
As per law
the audited final accounts should be prepared as per the rules and guidelines laid down by law.
Disclose all material facts
the audited final accounts should disclose all material facts, thus users can rely on them for making useful decisions of lending, investing etc.
Detection of errors and frauds
it is assumed that the audited final accounts are free from errors and frauds, the auditor with his expertise knowledge would detect the errors and fraud so as to show the true figure of final accounts.
Moral check on employees
Auditing techniques such as verification, vouching of cash, assets, stock etc. act as a moral check on the employees, this forces them to keep the accounts up-to-date and free from errors and frauds.
Advice to concern
Auditor can also advise the client about internal control, taxation, finance, accounting system etc.
LIMITATIONS OF AUDITING
All transactions cannot be checked
it is not possible for an auditor to check each and every transaction; he has to check them on sample basis
Evidence is not conclusive
Audit evidence is not conclusive in nature the confirmation of debtors is not conclusive evidence that all amount will be collected, the conclusions are persuasive rather than conclusive.
Not easy to detect some frauds
it’s not easy for an auditor to detect the deeply laid frauds which involves acts designed to conceal them such as forgery, false explanation, and not recording transaction and so on.
Audit cannot assure about profitability or efficiency of management
Even though the accounts are audited it doesn’t mean that the user can take granted the future profitability or prospects of concern as audit don’t comment on efficiency of the management.
Rely on experts
the auditor has to rely on experts like lawyers, engineers, valuers etc. for estimation of contingent liability and valuation of fixed assets.
Chapter no. 2
Internal Control
Internal Audit
DEFINITION of 'Internal Audit'
The examination, monitoring and analysis of activities related to a company's operation, including its business structure, employee behaviour and information systems. An internal audit is designed to review what a company is doing in order to identify potential threats to the organization's health and profitability.
Function of Internal Audit
Step 1: Establish the Authority of Internal Audit
Establish the authority of the internal audit activity and review the definition of internal auditing.
Step 2: Interview Leadership
Interview senior management and board of directors/audit committee chairmen to build rapport, to ensure those at the top have a clear picture of the internal audit function, and to clarify expectations of all. Use this opportunity to quickly learn and address what management and the board view as the greatest risks to the organization, while keeping in mind issues, problems, and opportunities that have already been identified. Develop a system for cataloguing such information, including date and name of person interviewed for quick reference in the future.
Step 3: Understand Benchmarking Needs
Understand "benchmarking" needs, i.e., industry, specialty groups, organizations with same staff size, etc. Ask senior management who they consider to be leaders and laggards in your organization's market niche.
Step 4: Review Policies and Procedures
Obtain and review your organization's written policies and procedures, especially the policy pertaining to management's responsibility to control the organization.
Step 5: Discuss Control Issues
Discuss with external auditors open and closed internal control issues, which they may have identified during their reviews.
Step 6: Develop the "Audit Universe"
Start to develop the "audit universe," or the list of all auditable entities.
Step 7: Develop Risk Assessment
Develop a risk assessment for your organization. This should be a macro-level assessment, which includes both external and internal risk factors.
Step 8: Develop Charter for Internal Audit
Develop a charter for internal audit. Ensure that both senior management and the audit committee review and approve the charter.
Step 9: Build the Budget
Build the budget, including personnel and travel.
Step 10: Hire Staff and Develop Training Plan
Hire your staff and develop a plan for staff training. Ensure your staff covers the range of expertise needed based on your risk assessment.
Step 11: Ensure Complete Cooperation
Ensure that senior management notifies other departments of your existence and calls for complete cooperation.
Internal Check
It is an arrangement of duties of members of staff in such a manner than the work performed by one
person is automatically and independently checked by the others.
According to ‘F.R.M.De PAULA’,
“Internal check means practically a continuous internal audit carried on by the
staff itself, by means of which the work of each individual is independently checked by other members of the
staff.”
According to ‘D.R. DAVAR,’ “Internal check is a system or method introduced with defined instructions given to
staff as to their sphere of work with a view to control and verification of their work and also maintenance of
accurate records as the ultimate aim.”
OBJECTIVES OF INTERNAL CHECK
1.To exercise moral pressure over staff.
2. To ensure that the accounting system produces reliable and adequate information.
3. To provide protection to the resources of the business against fraud, carelessness and inefficiency.
4. To distribute the work in such a business transaction is left unrecorded.
5. To allocate duties and responsibilities of each clerk in such a way that he may be held responsible for particular fraud or error.
6. To minimize the chances of errors, frauds or irregularities in the business based on the principle of division of labour.
7. To detect errors and frauds easily if it is committed, because in an efficient internal check system, there is based on the principle of division of labour.
8. To detect errors and frauds easily if it is committed, because in an efficient internal check system, there is a provision for independent checking.
ESSENTIAL CHARTERISTICS/PRICIPLES OF A GOOD SYSTEM OF INTERNAL CHECK
1. Responsibility:
Responsibility of each individual must be properly defined and fixed. The work of the
business should be allocated amongst various clerks in such a manner that their duties and responsibilitiesare clearly and judiciously divided.
2. Completion:
The work should be divided in such a way that no single person is allowed to complete the work
solely by himself from the beginning to the end. However, there should be no duplication of work.
3. Rotation of employees:
A good system of internal check should not allow person having custody of assets to have access to the books of account. A system of transfer or rotation of employees from one seat of work to anther must be followed by the business.
4. Automatic check:
A good system of internal check must provide for an automatic checking of the work of
one clerk by the other.
5. Reliance:
No clerk of the business should be relied upon too much.
6. Safeguards:
Safeguards should be prescribed to keep un-used cheque books, files and securities etc.
7. Supervision:
A strict supervision should be exercised to ensure that the prescribed internal checks and
procedures are fully operative.
8. Periodical review:
The system of internal check be reviewed from time to time to introduce improvements.
ADVANTAGES OF INTERNAL CHECK
some of the widely accepted advantages of an efficient system of internal check are as follows.
1. FOR THE BUSINESS
a. Proper division of work: Internal check entails a proper and rational distribution of work among the members of staff of the enterprises keeping in view their individual qualifications, experience and area of specialization.
b. Detection of errors and frauds: since no individual worker is allowed to handle a job completely from the beginning to the end, and the work of each clerk is automatically checked by the other, this heaps in the early detection and discovery of errors and frauds and the possibilities of the commission of errors and frauds can be minimized.
c. Increased efficiency coupled with economy: A good system of internal check increase the efficiency of work among the staff and leads to overall economy.
d. Moral check: knowledge of subsequent checking of each employees work by others, acts as a great check to commission of errors and frauds.
2. FOR THE AUDITOR
a. Quick preparation of final accounts: The Profit & Loss Account and the Balance Sheet are
prepared without any loss of time.
b. Convenience to Auditor: Where an organization is operating system internal check, the statutory auditor may conveniently avoid detailed checking of the transactions. He may apply a few tests here and there and can relieve himself from detailed checking.
3. FOR THE OWNER
a. Accuracy of the accounts can be relied upon: if there is a system of internal check the owner of the concern may rely upon genuineness and accuracy of the accounts.
b. Increase in profits: Overall efficiency and economy in operations result in more profits—thus
ensuring larger dividends for the owners or shareholders.
DISADVANTAGES OF INTERNAL CHECK.
Following are some of the disadvantages of a system of internal check.
1. Costly for small business: A system of Internal check system quite expensive especially for small business houses.
2. Quality is sacrificed for Promptness: In an internal check system quality of work declines because the clerks of the business attach greater importance to become quick and do not care if in the process their work gets sub standardised.
3. Carelessness among high officials: The possibility of some of the responsible and high officials being complacent, increases as they believe, though not always rightly, that under a sound system of internal check nothing can go wrong.
4. Disorder in the working of a business. In the absence of a proper organized system of internal check there will be chaos and disorder in the working of business.
5. Risky for an auditor: If the auditor does not apply tests and procedure his own and if he relies on the output of the system his work cannot be free from irregularities if the system itself proves to be defective.