Auditing Fundamentals

UNIT 1

Meaning of Auditing

Auditing originates from the Latin term “Audire”, which means “to hear,” - just as in ancient times
auditors used to listen to officers and people of authority to confirm the validity of their words. 

The main goal of auditing is to make sure that a company’s financial statements are accurate and are
following regulatory guidelines. Auditing also gives investors, creditors, and other stakeholders
reasonable assurance that they can rely on a company and its integrity.

Objectives of Auditing

The Indian Institute of Chartered Accountants (ICAI) in its Auditing and Assurance Standard-2
(AAS-2) specifies the following objectives of auditing:

Advantages of Auditing

The job of an auditor is of great significance for all affected parties. The auditor should produce
his audit report accurately and efficiently based on the information and real figures. If this is
concluded, the subsequent advantages may be anticipated from the auditing:
From Legal Point of View

 Income Tax Return Filling

Income tax experts usually affirm the profit and loss statement that has been processed by
a certified auditor, and they don’t go into specifics of the statement.
 Financing Money from Outside Sources
Money can be financed conveniently on the basis of audited books of accounts from the
outside sources. Nearly all financial institutions approve a loan on the basis of audited
financial statement.
 Settlement of Insurance Claim
In the event of flood, fire and alike unanticipated circumstances, the insurance company
pays the claim for loss or destructions based on audited accounts of the preceding years.
 Payment of Sales Tax
Sales tax experts may often acknowledge the audited financial statement.
 Action Against Bankruptcy
The audited financial statement provides a base to decide the action in bankruptcy and
deterioration cases.
From Internal Control Point of View

 Fast Revelation of Errors and Frauds

Errors and frauds are positioned at an initial date so that eventually no effort is made to
carry out such frauds, as one will be moderately attentive not to carry out an error or a
fraud as the financial statement are accountable to regular audit.
 Moral Check on the Personnel
The auditing of financial statement manages the accounting clerk regular and aware as
they realize that the auditor would object adjacent to them if the appropriate accounts are
not inclined or if there is any distortion.
 Advice to the Management
The management can ask the auditor for a consultation on certain technological points,
despite the fact it is not the responsibility of an auditor to provide such consultation.
 Uniformity in the Accounts
If the books of accounts have inclined on a consistent base, accounts of one year can
correlate with the accounts of other years, and if there is any conflict, the origin of conflict
may be investigated.

From External Affairs Point of View

 Settlement of Accounts
The audited financial statement would expedite the arrangement of accounts of a departed
or dead partner.
 Valuation of Assets and Goodwill
If the business is getting bankrupt, there may not be much difficulty regarding estimation
of assets and goodwill as the financial statement is audited earlier by an auditor.
 Future trend of the business
The expected flow of the business can determine with assurance from the audited financial
statement.

Qualification of an Auditor

According to law, no specific qualification is recommended for the auditor in case of the
proprietary concern, but in the case of the companies, the following qualification is must:

1. According to the Companies Act, 2013, a chartered accountant having a certificate of

practice from the Institute of Chartered Accountants of India can be a qualified auditor of a
company.
2. As per “Part B” of the State Law Act, 1953 a person holding a certificate stating that he is
designated to act as an auditor.

Qualities of an Auditor

Some relevant qualities that an auditor should possess are as follows:

  Sovereignty: The auditor should not make his decisions to the will of his clients or any
other person and should keep himself free from any sympathy allegedly and prepare
financial statement of the management in an impartial way.
 Honesty: The auditor should always maintain sincerity while operating his duties.
 Conversation Skills: In the course of managing a process of audit, the auditor has to
collaborate with numerous officers and parties; thus, he should have excellent conversation
skill.
 Maintain Confidentiality: The auditor should maintain the privacy of the books of
accounts unless authorized by the client or enforced by the law.
 Expertise: The auditor must have an awareness about the client’s business and the current
economic conditions, and a consciousness about the laws such as taxation laws, companies
act and partnership act.
 Sensitivity: The auditor has to deal with different persons while performing his duties; he
has to handle his sub-ordinates as well as various clients; thus, he should have the
intelligence to handle them in any situations.
 Coherent Skills: The auditor must have the ability to analyze and illustrate the problems
so that he can appropriately handle them when faced.

Responsibilities of an Auditor

Following are the responsibilities of an auditor:

 Examination: Cross-examination of the company’s accounting system and internal
control system is necessary to safeguard the record’s appropriateness.
 Checking of Books: The books of accounts should be checked thoroughly by an auditor to
ensure its arithmetical accuracy.
 Documentation: Proper documentation of the records should be maintained by the auditor
after investigating documentary pieces of evidence. It helps him in gathering the
appropriate information about the transactions of the business.
 Full Incorporation: An auditor should properly analyze whether all entries have been
recorded in the books of accounts or not while preparing the financial statement.
 Conventionality: Examining that the books of accounts or financial statement should not
contain any fraudulent or faulty entry.
 Authentication of Assets and Liabilities: Verification of assets and liabilities for
checking their existence, valuation, completeness and disclosure in financial statements.
 Statutory Consent: In case of audit of general insurance companies and banks, the auditor
secures the compliance of financial statements with the compatible decree.
 Disclosure: Auditor examines whether the data in the financial statement acknowledged
adequately or not. He discloses his point of view by way of the audit report after the
completion of the audit process.
 Facts and Integrity: Auditor ensures financial statement as a whole and serves an
accurate and fair view of profit/loss, assets and liabilities of a company in the appropriate
forms.
Duties of an Auditor

Along with the responsibilities the auditor has to perform certain duties; they are as follows:

1. Duty to Produce an Audit Report

 Description to members: An auditor must generate a statement to the members, yet he is

not enforced to send a report to every member.
 Review of the auditor’s report: The report prepared by the auditor intends to read in the
general meeting of the company. The report shall be open to any member for inspection.
 Capacity of audit report: The audit report should reveal the accounts maintained by the
auditor, i.e. profit and loss statement, balance sheet of the company and the chronicles
annexed with these accounts.
2. Duty to Produce Competent Disclosures in an Audit Report

 Report on Appropriate and Impartial View: The auditor shall state whether in his
impression and to best of his knowledge and bestow to the description given to him, the
balance sheet and profit and loss account give:

 The instruction prescribed by the law; and

 An authentic and fair view of the state of affairs of the company.
 Report on Principal Allegation: The audit report should state:
 Whether he has gathered all the material and justification.
 Whether from his point of view, appropriate books of accounts have been conserved.
 Whether in his view, all accounting standards have assembled.
 Whether any director who has disqualified from being appointed as a director.
 Report on CARO: The auditor has to address all the elements specified in CARO.
 Report on Precise Inquisition: This report describes:
 Whether loans and advances built by the company in support of security have been
perfectly captured, and the circumstances on which they have been formed are not
biased to the concern of the company or the members of the company.
 It states whether the book of entries is unfavourable to the interests of the company.
 Report on specific inquiries should state whether the retail price of the shares,
debentures, and other guarantees held by the company is below its purchase price.

3. Duty to Give a Sense for Accomplishment

 The aspect in which competence is made in the auditor’s report should be as such that no
allowance for doubt in the public minds. A qualification should deliver the full description
and not simply create grounds for the impression of enquiry.
 The auditor should appraise, wherever possible, the enact of the financial statement’s
capabilities, if the same is material.
 It states whether it is not achievable to accurately quantify the consequence of the
qualifications he may use the authority estimates or indicate the sense for not appraising
the requirement’s effect.

4. Duty to Endorse the Audit Report

The audit report or any other chronicle mandatory to be signed or validated by the auditor may
be endorsed by:

 A person selected as an auditor of the company.

 A firm selected as an auditor or by a partner of the firm exercising in India.

Conclusion

An individual who regulates an audit process is known as an auditor. He is the one who takes the
responsibility of analyzing the books of records of the firm or the company, whether they are
showing accurate and generous values or not. Based on these records, he prepares the audit
report signed by him stating that the business activities are investigated and verified by him.

Basic Principles Governing an Audit

SA- 200 describes the nine basic principles that govern the procedure of auditing. It lists out the
roles and responsibilities of the auditor and his general code of conduct during an audit. We will
look into these principles in brief.

1] Integrity, Independence and Objectivity

The auditor has to be honest while auditing, he cannot be favoring the organization. He must remain
objective throughout the whole process, his integrity must not allow any malpractice.

Another important principle is independence. So the auditor cannot have any interest in the
organization he is auditing, which allows him to be independent and impartial at all times.

2] Confidentiality

The auditor has access to a lot of sensitive financial information of the organization. It is important
that he respect the confidential nature of such information and documents.

He cannot disclose any sensitive information to any third party unless it is a requirement by law.
And he must also be very careful with documents, certificates etc. that the organization entrusts to
him.

3] Skill & Competence 

The auditor must be experienced and trained in the procedures of auditing, i.e. must be qualified as
an auditor. And as a professional, he must be up to date on recent changes, announcements, rules
etc.

If necessary he can undergo training and workshops to stay up to date with the recent auditing and
accounting procedures. For example, after GST was introduced, auditors had to update their
knowledge.

4] Work Performed by Others

The scope of audit at times can be very vast. So an auditor has employees, delegates and other
people who work under him.
 However, the auditor will continue to be fully responsible for the work done by these people
working for him. So the auditor must carefully supervise and review such work and be reasonably
sure of the accuracy of such work.

5] Documentation

In most cases the auditor maintains an audit notebook, an audit plan and auditing file. It is important
the auditor keeps a record of important documents with respect to his audit work, as it is evidence of
the work the auditor has done. And the client is inclined to these documents and files if he wishes to
inspect the work.

6] Planning

An audit plan allows the auditor t plan out his work and enables him to be more efficient and timely.
Every audit plan is different as it has to be customized according to the type of organization, the
kind of business they conduct, the scope of the audit, the efficiency of the internal controls etc.

7] Audit Evidence

The auditor must collect enough evidence to support his final opinion. This collection of such
evidence is done by compliance and substantive procedures. There are two sources of this evidence
– internal and external. Also, external sources of evidence are always more reliable.

8] Accounting Systems and Internal Controls

The auditor has to assure that the accounts of the organization are accurate and represent a true and
fair picture of the financial status of the company. Also, the auditor must ensure that all material
information has been recorded in the accounts. Testing the internal controls system is also important
as it helps determine the same.

9] Audit Conclusions and Reporting

After the auditor collects all evidence he must now form his opinion on the basis of the following
criteria,

i. all relevant accounting standards were applied at all times

ii. financial statements are in compliance with all regulations and statutory requirements

iii. all material information has been disclosed

Ethical Principle
Rule Principle
The integrity of internal auditors establishes trust and thus provides the basis
Integrity
for reliance on their judgement.
Internal auditors exhibit the highest level of professional objectivity in
gathering, evaluating, and communicating information about the activity or
Objectivity process being examined. Internal auditors make a balanced assessment of
all the relevant circumstances and are not unduly influenced by their own
interests or by others in forming judgements.
Internal auditors respect the value and ownership of information they receive
Confidentialit
and do not disclose information without appropriate authority unless there is
y
a legal or professional obligation to do so.
Internal auditors apply the knowledge, skills and experience needed in the
Competency
performance of internal auditing services.

Relationship of Auditing with other Disciplines

 
Disciplines Relationship
 

1. Accounting
Auditor has to review and evaluate the financial statements by providing an
opinion. Therefore, he should have thorough knowledge about accounting
concepts and principles.
 

2. Mathematics and Statistics

Auditor deals with financial data and the amount that appears in financial
statements. Hence, it requires knowledge of calculation procedure involved in
computing various items, for example., depreciation, provision for bad debts, tax
etc.
Auditor is also expected to have knowledge of statistical sampling for making
meaningful conclusion.
 

3. Economics
Auditor requires knowledge regarding business and economic environment
affecting the client. Thus, economic concepts are required to perform auditing in
a meaningful way.
 

4. Law
Audit of a business concern has to be undertaken with respect to conformity with
law. Thus, an auditor should have sound knowledge of laws affecting the client.
 

5. Computer Information System

In recent times, clients maintain their accounts in computer information system.
Thus, working knowledge on computer is required for auditors to conduct audit in
an effective way.
 
6. Financial Management
Auditor to understand and evaluate the financial statements in a better way
should have knowledge of financial techniques.
 

7. Behavioural Science
Auditor has to deal with many personnel to conduct the audit efficiently. Hence,
he should have the tact of getting along with people.