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MF0013 SLM Unit 01
MF0013 SLM Unit 01
Unit 1
Unit 1
Financial Audit
Structure:
1.1
Introduction
Objectives
1.2
Evolution of Financial Audit
1.3
Development of Financial Audit in India
1.4
Definitions
1.5
Objectives of Financial Audit
1.6
Scope of Financial Audit
1.7
Philosophy of Auditing
1.8
Qualifications of an Auditor
1.9
Qualities of an Auditor
1.10 Advantages of Financial Audit
1.11 Limitations of Financial Audit
1.12 Summary
1.13 Glossary
1.14 Terminal Questions
1.15 Answers
1.16 Case Study
1.1 Introduction
Financial Audit is a specialized discipline with its own principles, standards,
postulates, procedures and techniques. It is said that auditing begins where
accounting ends. As a student of Finance, you know that every economic
unit maintains books of accounts to record the financial transactions and
prepares financial statements based on the accounting records.
The International Accounting Standards Committee defines the term
Financial Statements to cover Balance Sheet, Profit and Loss Account or
Income Statement, Cash Flow Statement and Statement of Changes in
Equity. Financial Statements reflect the performance of an organization
during an accounting period, usually a year, and the financial position at the
end of the period.
Generally, users of financial statements fall into two categories:
(a) Internal stakeholders, viz. the managers of the company who use the
information for day-to-day operating decisions
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Financial audits are of two types: statutory audits and internal audits. An
audit which is authorized, governed and mandated under anenactment of
law is called statutory audit. Audit of limited companies incorporated under
the Companies Act, 1956 are examples of statutory audit. Internal audit is
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and many
an internal
and risk
getting an
Objectives:
This introductory unit will help you to get familiar with the basic concepts of
auditing. After studying this unit, you should be able to:
discover the evolution of financial auditing
study how auditing has developed in India
define financial audit
state the objectives, scope and philosophy of auditing
explain the requisite qualifications and qualities of an auditor
describe the advantages and limitations of financial audit.
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recognition after the British Companies Act was passed in 1862. The main
objective of auditing came to be finding of fraud. In the United States,
financial audit was introduced in 1900 and ascertaining of actual financial
conditions and earning of an enterprise was set out as the main objective.
Self Assessment Questions
1. Financial statements reflect the financial position and performance of
an organization. (True/False)
2. Why did the evolution of joint stock company system make financial
audit of businesses necessary?
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1.4 Definitions
The International Auditing Practices Committee defines auditing as the
independent examination of financial information of any entity, whether
profit-oriented or not and irrespective of its size, or legal form, when such an
examination is conducted with a view to expressing an opinion thereon.
Montgomery has defined Auditing asa systematic and orderly check on the
books and records of a business or other organization in order to ascertain
or verify and to report the facts regarding the financial operations and the
result thereof.
According to Ronald Irish Auditing in its modern concept is a scientific and
systematic examination of books, vouchers and other financial and legal
records in order to verify and report upon the facts regarding the financial
condition disclosed by the balance sheet and the net income revealed by
the profit and loss account.
In the above definitions, the focus is on examination of the financial records
and reporting thereon. But over time auditing has extended to costing
records, operational data and performance metrics as well. Efficiency audit
is a new dimension of auditing today.
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Assessment Questions
Audit is only concerned with checking of financial records. (True/False)
____________ audit has become a buzzword in modern Auditing.
The stated objective of auditor is to express an opinion as to the
____________ and __________ of the financial statements.
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a true and fair view in the case of Balance Sheet of the state of
companys affairs as at the end of the financial year and in the case of
the Profit & Loss Account, of the profit or loss for the financial year.
According to SA 200A, the objective of audit of financial statements is to
allow the auditor to voice their views regarding the truth and fairness of
assertions made in those statements. The user must not assume that
this belief is an assurance as to the future possibility of the enterprise or
the efficiency or the effectiveness with which the management has
conducted the affairs of the enterprise.
2. Secondary objective: The secondary objective of audit is to track,
detect and prevent any possible errors and frauds.
An error may be defined as any unintentional mistake or wrong
description in the books of accounts or records whether by way of:
(a) Arithmetical or clerical mistakes in the books of records and data;
(b) Inaccuracy or misconception of facts; or
(c) Mismanagement of accounting guidelines/policies.
An error is generally taken to be innocent and not deliberate. Where it
appears to be wilfully made, it assumes the character of a fraud.
The term fraud refers to an intentional act by one or more individual(s) of
management, employees or outsiders, severally or jointly, involving the use
of fraud to obtain an undeserved or illegal advantage. The distinguishing
factor between error and fraud is the underlying motive.
Examples of errors:
1. Goods purchased on credit were not entered in the Journal.
2. A purchase of ` 20,000 was entered in the purchases book as ` 2,000.
3. Goods were sold to X for ` 50,000 but posted to the account of Y instead
of X.
Examples of frauds:
1. Fictitious purchases were recorded to misappropriate cash.
2. Unearned incomes were recorded in the current year or expenses of
current year shown as of next year deliberately, to boost profits for the
current year.
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3. Internal financial audit assists the CEO and his team of operating
managers regularly and much more frequently in understanding the
financial performance of the company and taking corrective actions
necessary.
4. Financial audit is an invaluable tool for prevention and early detection of
fraud and errors.
5. Audited financial report together with the auditors report is necessary for
a company in sourcing funds from banks and other financial institutions.
6. The audited balance sheet of a company read with the auditors report is
often the base document for valuation of companies in case mergers,
acquisitions or outright sales.
Self Assessment Questions
17. Audit keeps management more alert and vigilant. (True/False)
18. The Income Tax Act does not contain a provision for holding tax audit.
(True/False)
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1.12 Summary
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1.13 Glossary
Postulates: fundamental truths or assumptions of a theory
Principles: broad generalizations inferred from postulates
Standards: quality of performance criteria
Procedures: specific acts to be performed
Techniques: methods used for carrying out a procedure
Financial Statements: Balance sheet and Profit and Loss Accounts etc.
Error: any unintentional mistake or wrong description in the books of
accounts or records
Fraud: An intentional act by one or more individuals of management,
employees or outsiders, severally or jointly, involving the use of deception to
obtain an unjust or illegal advantage.
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1.15 Answers
Self Assessment Questions
1. True
2. The advent of the joint stock company form of business organisation
gave rise to the concept that owners of a business and managers were
not the same. The owners therefore needed an independent review
and audit of the accounts, and a forewarning if the managers indulged
in any acts that would be detrimental to their (owners) interests.
3. True
4. False
5. True
6. False
7. Efficiency
8. True and fair
9. Reliability and validity
10. As per SA 240, Auditors responsibility to consider fraud and error in
an audit of financial statements, subsequent discovery of undetected
material misstatements of financial information resulting from errors
and frauds does not necessarily mean that the auditor has been
negligent in performing his duties if he had adopted adequate audit
procedures as per auditing standards.
11. True
12. The directors are ultimately responsible for maintaining adequate
records and preparation of annual accounts showing a true and fair
view. Directors are also responsible for safeguarding the assets of the
company, and they should not depend upon the auditor to protect them
from any deficiency in carrying out these responsibilities.
13. The auditor is authorised to rely upon the safeguards and internal
controls established by the management. However, in forming and
expressing professional opinion on the companys books of accounts,
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14.
15.
16.
17.
18.
19.
20.
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Terminal Questions
1. Auditing is a systematic and independent examination of data,
statements, records, operations and performance (financial or
otherwise) of an enterprise for a stated purpose. In any auditing
situation, the auditor perceives and recognizes the propositions before
him for examination, collects evidence, evaluates the same and on this
basis, formulates his judgment which is communicated through his audit
report. For more details, refer to section 1.4.
2. The learned judge Lopse summed up auditors duty by stating Auditor is
a watchdog, not a bloodhound. For more details, refer to section 1.5.
3. According to De Paula, The main object of an audit is to ascertain that
the Balance Sheet and Profit & Loss Account of an undertaking shows a
true and fair view of its financial position and earnings. For more details,
refer to section 1.5.
4. Apart from the professional qualification required of an auditor by law, he
must have certain personal qualities without which he may not be able to
give satisfactory performance. For more details, refer to section 1.9.
5. Statutory financial audit gives the owners of a company and other
stakeholders the assurance that annual financial reports provide a true
and rational view of the companys financial performance. For more
details, refer to section 1.10 and 1.11.
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by
the
Menon
family
comprising
Answers
1) The Indian Companies Act, 1956 stipulates that every private or public
limited company shall appoint an auditor who shall report to the
members of the company. Thus, getting the accounts of the company
audited by a qualified auditor is an essential legal requirement
regardless of size or family holding.In addition to the legal requirement,
an independent audit of the accounts of the company would give
credibility to its financial statements and confidence to outsiders to deal
with the company in whatever capacity.
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