UNIT 1

INTRODUCTION TO AUDITING

MEANING

The word Audit is derived from the Latin word audire, which means to hear. Originally, it was
customary for person responsible for maintenance of accounts go to some impartial and
experienced persons, ordinarily judges who used to hear these accounts and express their opinion
about their correctness or otherwise such persons were known as ―Auditors‖. Thus the term
auditors mean literally hearer i.e., one who hears and is used ever since the days when public
accounts were accepted and approved on the basis of hearing the accounts read.
Auditing is an important professional task carrying heavy responsibility and calling for
commensurate skill and judgement.

Keeping in view the definitions of various authors we may define the word auditing as:

Auditing is an examination of the accounting books and the relative documentary evidence
so that an auditor may be able to find out the accuracy of figures and may be able to make
report on the balance sheet and other financial statements that have been prepared from
there.
Definitions of Audit

The following are the some of the definitions of audit given by some writers:

Spicier and Pegler

An audit is such an examination of the books, accounts and vouchers of a business as it enable
the auditor to satisfy that the Balance Sheets is properly drawn up, so as to give a true and fair
view of the state of the affairs of the business and whether the profit and loss accounts gives a
true and fair view of the profit or loss for the financial period according to the best of his
information and explanations given to him and as shown by the books, and if not, in what
respects he is not satisfied.

Montgomery
Auditing is a systematic examination of the books and records of a business or other
organization, in order to ascertain or verify and report upon the facts regarding its financial
operation and the result thereof.

Lawrence R. Dicksee
An audit is an examination of records undertaken with a view to establishing whether they
correctly and completely reflect the transactions to which they relate. In some circumstances it
may be necessary to ascertain whether the transactions are supported by authority.

A.W. Hanson
An audit is an examination of such records to establish their reliability and the reliability of
statement drawn from them.

R.B. Bose
Audit may be said to the verification of the accuracy and correctness of the books of accounts by
independent person qualified for the job and not in any way connected with the preparation of
such accounts.

Taylor and Perry

An audit is an investigation by an auditor into the evidence from which the final Revenue
Accounts and Balance sheet or other statement of an organization have been prepared, in order to
ascertain that they present a true and fair view of the summarized transactions for the period
under review and of the financial state of the organization at the ending-date, so enabling the
auditor to report thereon.

OBJECTIVES OF AUDITING

1. Reporting
the objective of an audit of financial statement is to enable the auditor to express an opinion
whether the financial statements are prepared, in all material respects in accordance with an
identified financial reporting frame work. The phrases used to express the auditor‘s opinion are
given a true and fair view or present fair in all material respects, which are equivalent terms.
2. Purpose of Audit
The purpose of audit is to check the proper accounting to policies. For the better accounting
system it is necessary to follow the accounting policies. Only by this way we can get the
effective result. The auditor‘s purpose is to check that accounting policy has been followed or
not.
3. Law which is prescribed
another objective of the auditor is to check that the accountant has used the prescribed law. There
are so many laws related to working of business. The auditor can indicate whether the proper law
has been applied or not.
4. Opinion
The purpose of the audit is to get the correct opinion about the business so for this the auditor
should be honest, confident and he must have the ethical standard for his work.
5. True and Fair View
The purpose of the auditing is to determine the correctness of statement. After auditing the
financial statement has the correct and true view about the business.
6. Prevention of Errors
the audit is committed for the prevention of errors. These errors can be prevented through
internal check also.
7. Detection of Errors
another purpose of audit is to detect the errors. The auditor uses different ways and means to find
your errors.
8. Prevention of Fraud
The prevention of fraud is another purpose of auditing. It consists of the omission of the effect of
transaction, recording or transaction without substance etc.
9. Detection of Fraud
The detection of fraud is also the purpose of the audit. It is the responsibility of the management
to detect the fraud.
10. Cost Audit
to verify the correctness of cost accounting is the main purpose of the cost audit. The
management had a duty to follow the cost objectives in maintaining the records of business
transaction.
11. Property Audit
The examination of the proper use of money is the main purpose of the property audit. How and
where the money of business is used must be mentioned in this audit.
12. Management Audit
the management audit refers to the audit of the management structure either these are according
to the requirements of the business or not. It is a voluntary audit.
13. Tax Audit
Tax audit is conducted to satisfy the income tax officer. This type of audit is conducted to
determine the income. Usually the partnership and the sole proprietorship conduct this type of
business.
14. Social Audit
The measurement of social performance of the business is the main object of social audit.
15. Profit Verification
Audit is concern to check the profit verification in a business concern. Profit has to main position
in any type of business, only the expert auditors can check the fluctuation of the Profit.
16. Admission of Partners
For the admission of the new partner the audit plays an important role. It provides information to
new as well as old partner for the settlement of the new terms according to the volume of assets
and liabilities.
17. Purchasing Price
for the buyers and sellers of a certain business concern it is necessary to know the real value of
the business assets and liabilities. The audit is helpful in finding out the real value of the
business.
18. Loan from Lenders
Audit is also very helpful and it is also its purpose to find the value of the assets and liabilities or
its financial position. From which the management can approach the banks and all the financial
institutions for the loan. Auditor report is a proof for the business concern.
19. Operations
it is a part of social audit. The main purpose is to prevent the misuse of resources.
20. Moral Check
Moral check is in fact or more clearly a psychological check. Its object is to create a fade mind to
the staff of the business that after a particular period of time a specific person has duty to check
the books of accounts.

DIFFERENCE BETWEEN ACCOUNTING AND AUDITING

When accounting process ends, auditing begins, for the purpose of determining the true and fair
picture of books of accounts. It is an activity of record keeping and preparation & presentation of
the financial statement. Accounting is used by the firms for keeping a track of their monetary
transactions. It is the language the business understands, as it is the tool for reporting financial
statement of the business entity.

Conversely, Auditing is an activity of verification and evaluation of financial statement. It aims

at checking and confirming the authenticity of financial books prepared by the accounting staff
of the enterprise. Thus, it determines the validity and reliability of accounting information.

Definition of Accounting

Accounting is a specialized language of business, which helps to understand the economic

activities of the entity. It is an act of orderly capturing the day to day monetary transactions of
the business and classifying them into various groups along with that, the transactions are
summarized in a way that they can be easily referred at the time of urgency, thereafter analyzing
and understanding the results of the financial statement and finally communicating the results to
the interested parties.

Definition of Auditing

THE AUDIT is a methodical procedure of independently examining the financial information of

an entity with the aim of giving an opinion on true and fair view. Here organization refers to all
the entities, regardless of their size, structure, nature and form.

Auditing is a critical, unbiased investigation of each and every aspect of the transaction, i.e.
vouchers, receipts, account books and related documents are verified, in order to spot the validity
and reliability of the financial statement. Moreover, errors and frauds or deliberate manipulation
in accounts or misappropriation etc. can also be detected through detailed scrutiny.
SL. Basis for Comparison Accounting Auditing
No.

1 Meaning Accounting means systematically Auditing means inspection of the

keeping the records of the books of account and financial
accounts of an organization and statements of an organization.
preparation of financial
statements at the end of the
financial year.

2 Governed By Accounting Standards Standards on Auditing

3 Work performed by Accountant Auditor

4 Purpose To show the performance, To reveal the fact, that to which

profitability and financial extent financial statement of an
position of an organization. organization gives true and fair
view.

5 Start Accounting starts where Auditing starts where accounting

bookkeeping ends. ends.

6 Period Accounting is a continuous Auditing is a periodic process.

process, i.e. day to day recording
of transactions are done.
Appointment
7 Accountant is appointed by the Auditor is appointed by the
management. shareholders.

8 Nature of Job Accountant job is a mechanical Auditor job is not so mechanical in

nature. that sense.

9 Qualification For the accountant no specific For the auditor specific

qualification is required qualification is required.

10 Responsibility Accountant responsibility is fixed Auditor responsibility is fixed by

by the management law.

11 Submission of Report Accountant is not required to Auditor is required by law to

 submit any report. submit the report.

12 Fixation of Rights Rights and duties of accountant Rights and duties of an auditor are
are fixed by the management. fixed by the law.

13 Time In case of accounting, period is The period of auditing is usually

usually one year. less than one year

14 Record / Data Accounting is related with the Auditing is related with the past
present record. record.

15 Employment Accountant is a permanent Auditor is not a permanent

employee. employee.

16 Reward Accountant reward is called Auditor reward is called free.

salary.

17 Reward Accountant reward is called Auditor reward is called free.

salary.

18 Liability After preparing the final accounts Auditor has liability after
accountant has no liability. presenting the audit report.

19 Importance Accounting is necessary for Auditing is not necessary for every

every business. business

20 Rules Accounting is not governed by Auditing is governed by the

code of conduct laid down by the charted accountant code of
institute. conduct

21 Evaluation The accountant cannot determine Auditor also cannot determine the
the efficiency of its own efficiency of its own function but
function. he can determine the efficiency of
 all the business.

22 Methods Accounts use the method of The auditor uses manual and
valuation and depreciation. computerized method

23 Knowledge Accountant must have the Auditor must have the knowledge
knowledge of accountancy. of accounting as well as auditing.

24 Removal Accountant can be removed from Auditor cannot be removed till the
his job at any time. completes his period of
appointment.

Auditing begins where Auditing begins where accounting

25 End and Start accounting ends. ends.

TYPES OF AUDITS

In general, an audit is an investigation of an existing system, report, or entity. There are a

number of types of audits that can be conducted, including the following:

1. Compliance audit. This is an examination of the policies and procedures of an entity or

department, to see if it is in compliance with internal or regulatory standards. This audit
is most commonly used in regulated industries or educational institutions.
2. Construction audit. This is an analysis of the costs incurred for a specific construction
project. Activities may include an analysis of the contracts granted to contractors, prices
paid, overhead costs allowed for reimbursement, change orders, and the timeliness of
completion. The intent is to ensure that the costs incurred for a project were reasonable.
3. Financial audit. This is an analysis of the fairness of the information contained within an
entity's financial statements. It is conducted by a CPA firm, which is independent of the
entity under review. This is the most commonly conducted type of audit.
4. Information systems audit. This involves a review of the controls over software
development, data processing, and access to computer systems. The intent is to spot any
issues that could impair the ability of IT systems to provide accurate information to users,
as well as to ensure that unauthorized parties do not have access to the data.
5. Investigative audit. This is an investigation of a specific area or individual when there is a
suspicion of inappropriate or fraudulent activity. The intent is to locate and remedy
 control breaches, as well as to collect evidence in case charges are to be brought against
someone.
6. Operational audit. This is a detailed analysis of the goals, planning processes, procedures,
and results of the operations of a business. The audit may be conducted internally or by
an external entity. The intended result is an evaluation of operations, likely with
recommendations for improvement.
7. Tax audit. This is an analysis of the tax returns submitted by an individual or business
entity, to see if the tax information and any resulting income tax payment are valid. These
audits are usually targeted at returns that result in excessively low tax payments, to see if
an additional assessment can be made.

ADVANTAGES /IMPORTANCE OF AUDITING

For Business
1. Errors are Located
Auditing is helpful for business. The error can be located through it. The location and correction
of error is possible through auditing. The true and fair information about business is available.
2. Frauds are discovered
Auditing is helpful for business. The discovery of fraud is possible through it. The guilty persons
can be held responsible. The auditing accounts show fair about business.
3. Loans Become Easy
Auditing is useful for business. Lenders for granting loans accept the auditor‘s accounts. The
reputation of borrowers increases due to auditing. Thus auditing accounts help the businessman
to expand his activities.
4. Advise about Weakness
Auditing is useful for business. The people can seek advice from auditors. The auditors are
professional and they know their work very well. They can spotlight the grey area. It is the duty
of the business man to act upon the advice of the auditors.
5. High Moral Values
auditing is essential for business. There is moral check on the management and other staff.
Auditing puts the pressure on the staff of work honestly. There is no pending work so there is
less chance of errors and frauds.
6. Tax Payments
auditing is useful for business, tax authority accept audited accounts for assessment of taxes.
There is no further inquiry or investigation from department. The audited accounts lessen the
worries of business people.
7. Tax Owners
auditing is useful for business. The tax authorities accept audited accounts for assessment of
taxes. There is no further inquiry or investigation from tax department. The audited accounts
lessen the worries of business people.
For Owners
1. Efficiency Improves
Auditing is beneficial for business. The auditing determines the efficiency of employees. The
training and qualifies management is an asset for any business. Such management can play
dynamic role in framing and implementing the policies.
2. Dispute is settled
Auditing is essential for business. The audited accounts are helpful to settle the disputes. The
audited accounts become the basis of making decisions. The dispute may relate to
infringement of patents or trademarks.
3. Planning Becomes Possible
Auditing is helpful for business. The audits accounts present true and fair view of business
activities. The facts and figures can be used to prepare budge and estimates for the next
years. The projected cash receipts and payments, income statement and balance sheet can be
prepared.
4. Improvement of Internal Control
Auditing is helpful for business. The auditor can point out the weakness of internal control
system. The business management can take steps to remove these weaknesses. The effective
control systems are essential for large-scale business enterprises.
5. Fluctuation in Profits
auditing is helpful for business. The auditor can make the detailed study to find of fluctuation
in profits. There are various reasons for changes in profits. The auditor can determine the true
cause of such changes.
6. High Credit Rating
the auditing is beneficial for business. The auditing accounts increase the credit standing of
any business house. The lenders can rely on audited accounts for granting credit facility. In
fact auditing is a screening test of business entity.
7. Listing at Stock Exchange
the auditing is beneficial for business. The listing of securities at stock exchange is optional.
The public limited companies can get registration at stock exchange. Stock exchange
management for registration purpose accepts the audited accounts.
8. Shareholders Protection
Auditing is beneficial for owners. The shareholders feel that their rights are protected through
auditing. They can know the performance of management. Audited accounts help to
determine the value of shares.
9. Partner Satisfaction
Auditing is helpful for partners. The sleeping partner feels satisfaction when there is audited.
The managing partners can use business property for their personal benefit. There is moral
check on managing partners.
10. Proprietors
auditing is useful for proprietors. The audited accounts help the sole traders that their
 business is going on properly. The error and fraud are pointed out auditors. The owners can
determine the efficiency of their employees or assistants.
11. Beneficiary
Auditing is valuable for beneficiaries. The auditor of a trust can nominate any person as
trustee to look after the property of a trust. Auditing can safeguard the right of beneficiaries.
There is a moral check on the trustee to follow the by – laws of trust.
12. Deceased Estate
the auditing is helpful for dependents of decreased person. The audited accounts present true
and fair view of financial statements. The family can rely on audited accounts for distributing
the estate of deceased person.
13. Insolvency
the auditing is beneficial for creditors. The audited accounts show true and fair view of state
of affairs of sole proprietorship or partnership. The creditor can get their money first and then
owners can get refund of capital. The audited accounts help to settle the cases at an early
date.

For Government
1. Better Performance of Tax Department
Auditing is beneficial for government. Tax officers accept the audited accounts. The
assessment order can be issued without further clarification. There is saving of money and
time due to audited accounts. The performance of tax officers is improved.
2. Exact Revenue Amount
Auditing is beneficial for government. The collection of revenue is possible at an early date.
The people are allowed to deposit various kinds of taxes. The recovery of income is made at
the start of the year. The government can start welfare project on the basis of total revenue
collected.
3. Progress of Economy
Auditing is essential for government policies. The true fair view is stated in audited accounts.
The stage of economic progress can be determined. The government can take measures to
raise the rate of economic growth.
4. Purchase of Private Business
Auditing is helpful for government. The private business houses may not work in favor of
general public. The government can take over such business units. The purchase price is
decided on the basis of auditing of accounts.
5. Sale of Government Business
Auditing is useful for government. The policy can be framed on the basis of audition
accounts. The management comes to know the value of business. The government can sell
state – owned unit to private sector. The bid price is settled on audited accounts.
6. Inspectors
the auditing is helpful for government. The auditing accounts show the fair value of all
 assets. The value of assets. The value of assets is the basis of tax. This issue can be settling
through audited accounts. The auditors are experts in their field. They know all methods of
property valuation. They can issue certified the government agencies for valuation of
property.

For General Public

1. Insurers can settle Claims
auditing is essential for insurers. The settlement of fire or marine insurance claims is easy
through audited accounts. The policy holders and insurance company can settle actual loss of
property.
2. No Loss to Lenders
auditing is essential for lenders. The banks and other lenders ask the borrowers to submit
audited accounts before granting loans. The audited accounts are helpful to check the trust
worthiness of customers.
3. Creditor are Protected
Auditing is essential for creditors. They can know the true performance of their debtors. The
creditor can accept this promise only when he feels that debtor is reliable businessman.
Auditor accounts provide basic information about reliability.
4. Bidders Can Offer High Rate
Auditing is helpful for bidders. Audited accounts provide information about net worth of any
business. The people interested in purchasing the business can rely on such information.
They know the fair value of business. They can offer reasonable price through open bidding.
5. Better Pay to Employees
auditing is helpful for employees. They are interests in profits. Auditing accounting proves
true and fair view of profit. The employees can demand higher pay, fringe benefits and
participating in profits. Audit of accounts with the independent person help the employees to
make settlement with the employers.
6. Investors Can Take Decisions
auditing is helpful for inventors. The audited accounts can be used to calculate value of
shares and other securities. The bargains power is given to the people who have money and
they want earn income. They can protect their rights through reliable information.

PREPARATION BEFORE COMMENCEMENT OF AUDIT

Commencement of Audit
Commencement of audit means that when an organization is going to start final audit
Before commencement of audit the following instruction must be given by the auditor to his
client.
1. A list of book in use, list of employees, their duties and internal control should be provided to
the audit staff.
2. Books of original entry, ledgers, trial balance and Final account should be provided to the
auditor.
3. All supporting document should be properly arranged.
4. List and schedule of assets and liabilities should be arranged properly for the examination to
the audit staff managed properly for the examination to the audit staff.
The auditor of the newly established company should also carry out the following primary
work before commencing the audit.

Commencement of Audit

1. Appointment of the auditor:

The auditor can examine his appointment the shareholder have right to appoint an auditor .a
copy of resolution shows the decision of management for appointment.
2. Previous auditor:
The auditor can write a letter to old auditor for obtaining his consent. He must have no
objection to such appointment. It is moral duty of new auditor to inform old auditor for
appointment.
3. Time of Audit:
The audit can consult the management for fixing time of audit the stating data is fixed with the
consent of management. The time allocated utilized for proper audit work.
4. Time required:
The auditor can decide the time required for completion of audit work he can engage sufficient
audit clerks to complete work in time otherwise the cost of audit increases.
5. Audit staff:
The auditor can arrange audit staff on the basis of work load. The number of audit Clerks can
be engaged on the basis of audit work. There should be no extra burden of work on audit staff.
6. Audit duties:
The auditor cannot fix audit duties such duties are usually stated in audit engagement letter.
The duties stated in company‘s ordinance cannot be overlooked.
7. Nature of business:
The auditor can check the nature of business. The nature may relate to manufacturing, trading
or services. The auditor must know the nature of activities in order to conduct audit.
8. Business History:
The auditor should record the history of business. He can record year of establishment nature
and number of products available in market.
9. Types of product:
The business may produce different products of successful working. One product or service is
not sufficient to compete in the market the auditor should note the types of product.
10. List of officers:
 The auditor can ask for list of officer their duties and specimens signature he must know
authority and responsibility of officer.it is essential for completion of audit work.
11. Copies of documents:
The auditor can collect copies of document like memorandum of association and articles of
association. He can examine all such document for the purpose of audit.
12. Books of account:
The auditor can obtain lists of books of account he can check that legal requirement are
followed in preparing books of account.
13. Internal control:
The internal control system is tested to rely on it. Audit sampling is possible if it is
effective the business work flow under proper accounting and administrative control.
14. Certificates of clients:
The auditor can obtain certificate from client, the confirmation of accounts from debtors
and creditor is possible. The client can issue stock valuation certificate for the auditor.
15. Old reports:
The auditor should examine old audit report. he can note the weakness stated in previous report
he can check that weak point stated in old report are net repeated during this year.
16. Analytical review:
The auditor can check the ration and percentage for a number of years he can examine the
trend of various items in order to note the usual items.
17. Prepare report:
The auditor can prepare report for work done by him. When he is fully satisfied there is
clean report. In case of bad working he can submit qualified report to the shareholders.

AUDIT NOTE BOOK

Definition of Audit Note Book

Audit notebook is a diary on which auditor scribble down all important inquiries to avoid the
possibility of unquestioned material facts.
Importance
Justice William throws light on the importance of audit notebook in the following words,
the audit notebook that contained detailed information proved to be very helpful to the auditor in
every critical moment.
For preparing the audit report it is very useful for that auditor.
In case of negligence charge against the auditor, but note book good evidence can be presented.
It may be also used for future guidance and reference. It also enables to auditor to know that
what work his assistant at each audit has done.
Advantages of Audit Note Book
1. Audit Report
The audit notebook is helpful to prepare audit report. The auditor can record the weakness of
accounting records. The queries not properly answered are started in the audit report when the
auditor is satisfied he can submit a clear report.
2. Staff Honesty
The audit notebook is used to determine the integrity and honesty of audit clerks. The moral and
ethical value can be examined through audit work. When a person completes his work in time.
Time period auditor can appreciate him. If there is pending work after the expiry of time period,
he can be held responsible for it. The audit staff must be honest in his work.
3. Helpful for Memory
The audit notebook is help to keep things fresh in memory. The auditor can read the book on
daily basis. He can note the weakness on fingertips. The auditor can retain the data in his
memory for a longer period of time. He can ask the management to clear the doubtful points
before preparing audit report.
4. Reference
The audit notebook is useful for reference. In future it can provide information to the audit staff.
The past data gives an insight into business matters. The auditor can note the changes. He can
form an opinion about the changes in the nature and size of the business.
5. New Auditor
The audit notebook is useful for new auditor. They can see the weakness of previous years. The
old weak points may not be repeated this year.
6. Court Cases
the audit notebook is helpful to defend an auditor in court cases. The people can go to court of
law in order to fix liability for negligence of duty. The audit notebook is a written proof of work
performed by an auditor.

AUDIT WORKING PAPERS

Audit Working Papers

Audit working papers include those papers and documents, which consist of details about
accounts, which are under audit. They are the written, private materials, which an auditor
prepares for each audit. They describe the accounting information, which he obtained from his
client, the method of examination used, his conclusions and the financial statements.
Definition

The Institute of Chartered Accountants of India insists on the preparation and keeping of
adequate working papers. According to the Institute of Chartered Accounts of India,

―Working papers must include audit program, queries, explanations given for the queries,
schedules of important items like depreciation, inventories, confirmation from third parties,
certificates issued by the management, banks, etc.‖

Thus, the standard requires an auditor to maintain adequate working paper. Working papers
provide basic evidence of audit conducted in accordance with standard audit practices. They help
the auditor in writing the report. The quality of audit work performed by the auditor can be
judged by the character and contents of working papers prepared and maintained by the auditor.

According to Prof. Meigs,

―The term working papers is a comprehensive one and includes all the evidences gathered by the
auditor to show the work he has done, the methods and procedures he has followed and the
conclusions he has developed ―.

From an analysis of above two definitions, it is clear that the working paper should specify

1. How the work was planned and supervised?

2. How the internal control system was reviewed and its reliability was assessed?
3. How the evidence was collected and what procedures were adopted to collect the
evidence?
4. Whether the testing performed provided sufficient competent evidential matter to enable
to form a reasonable basis for an opinion or recommendation?

Thus the working papers constitute a valid evidence of the work done in the current audit.

Importance of Audit Working Papers

Working papers are necessary in all audit assignments. The Institute of Chartered Accountants in
its Statement on Auditing Practices mentions,

―It is necessary to prepare and keep adequate working papers‖.

Similarly, the Institute of Chartered Accountants of England and Wales suggests,

―Working papers are used to an auditor in controlling the current years audit work and planning
the audit for next year‖.
The third Standard of Field Work pronounced by the AICPA requires that the auditor should
accumulate sufficient competent evidential matter on the financial statements.From this it clear
that there should be sufficient working papers to support independent auditor‘s opinion. Apart
from the basic objectives, the working papers serve the following objectives and provide several
benefits.

Objectives of audit working papers

1. The working papers serve the auditor both as useful audit tool as well as a permanent record of
the audit work performed.

2. They are useful to the auditor to control the current year‘s audit work.

3. They constitute a reliable guidance for planning the future audit assignments.

4. A review of the audit working papers gives an assurance that the audit work is both accurate
and complete.

5. The auditors arrange the data properly in the working papers. Hence, the data become more
meaningful and useful for the purpose of the, audit.

6. Working papers are necessary to corroborate the work and the findings of all the audit staff.

7. The chief auditor is assured that the opinion is supported by the findings of their audit staff.

8. The working papers constitute complete and conclusive evidence in future as to the entirety
and completeness of the audit work.

Contents of audit working papers

AAS 3 states working papers should record the auditor‘s plan, the nature, timing and extent of
the audit procedures performed; and the conclusions drawn from the evidence obtained.

Generally, audit working papers consist of the following details:

1. Schedule of debtors and creditors.

2. Trial Balance.
3. Certificate of officials regarding certain important matters like bad debts, valuation of
stock, unpaid expenses, accrued incomes, etc.
4. Statement of depreciation.
5. Correspondence between the auditor and the debtors, creditors, etc. of the client.
6. Investment Schedules.
 7. Confirmation by the bank regarding the bank balances of the client.
8. Bank Reconciliation Statement.
9. Important extracts from the minute books such as agreement with vendors, hire
purchasers, selling agents, etc.
10. Detail of cash balance checked.
11. Adjustment entries.
12. Contingent liabilities certified by the management.
13. Draft financial accounts.
14. Details of clarifications made during the course of audit.
15. A copy of the auditor‘s book.
16. Letters of representation.
17. Correspondence from legal advisors
18. Pertinent memoranda relating to the audit.
19. Data relating to the review of internal control.
20. Stock holder equity and the minutes.
21. Test of transactions.

AUDIT PROGRAM (AUDIT PLAN)

An audit program, also called an audit plan, is an action plan that documents what procedures an
auditor will follow to validate that an organization is in conformance with compliance
regulations.

The goal of an audit program is to create a framework that is detailed enough for any outside
auditor to understand what official examinations have been completed, what conclusions have
been reached and what the reasoning is behind each conclusion. The framework should explain
the audit's objectives, its scope and its timeline. The audit program should also describe how
working papers -- the documented evidence of the audit -- will be collected, reviewed and
reported.

Objectives of audit programs

When developing an audit program, the internal auditor and its associated audit team should start
with outlining the audit's objectives, goals and obligations.

Audit program objectives help direct planning of the audit report and are based on the policies,
procedures and guidelines unique to the company. These objectives may relate to and outline
how the auditors will maintain efficiency, professionalism and a specific code of conduct during
audit procedure.
In addition to relevant regulatory compliance mandates, objectives for audit programs should
consider aspects such as management priorities, business intentions, system requirements,
business structure, legal and contractual mandates, the expectations of customers and other
interested parties, potential risk management vulnerabilities, and any corrective action taken
based on previous audits.

Preparing an audit program

Audit program details are specific to individual organizations based on their unique needs, but
audit plan preparation will consider the audit's relevant regulatory deadlines, staff requirements
and reporting structure, and overall goals. In particular, these goals will consider how the
company will maintain regulatory compliance via risk assessment and management procedures.
The audit program should also include a timeline detailing when specific aspects of the audit
program should take place and how they should be prioritized.

Audit program planning is usually a continual and iterative process. During audit planning and
development, companies can build on lessons learned from previous audits by implementing
newly learned best practices that alleviate risk and maintain compliance. Audit development
guidelines and best practices vary by industry, but local and regional auditing certifications are
available, as are internationally recognized audit certifications. These certifications include
Certified Internal Auditor and Certified Information Systems Auditor, and membership in the
International Register of Certificated Auditors.

Types of audit programs

Different types of audit programs include standardized audit programs, tailored audit programs
and compliance audit programs. Standardized audit programs, which are available for many
different industries, can be used proactively to help an organization create its own
internal compliance framework and internal audit program. For example, the International
Federation of Accountants publishes financial audit standards called the International Standards
on Auditing. A standardized audit program is different than a fixed audit program, which is
defined as an audit program that cannot be changed during the course of an audit.

Tailored audit programs are different from standardized audit programs in that they cater audit
procedures to match specific needs of the auditing entity. These audit programs are "tailored" to
reference specific areas such as business procedures, legal documents and assets. By targeting
these specific requirements through tailored audit programs, the company can more quickly
identify potential compliance lapses and develop internal controls to offset these vulnerabilities.

A compliance audit program outlines how an organization will adhere to regulatory guidelines.
The details of compliance audit program will vary depending upon factors such as whether an
organization is a public or private company, what kind of data it handles and if it transmits or
stores sensitive financial data. For instance, Sarbanes-Oxley Act requirements state that
electronic communication must be backed up and secured with disaster recovery infrastructure,
while financial services companies that transmit credit card data are subject to Payment Card
Industry Data Security Standard (PCI DSS) requirements. In the Unites States, publicly traded
companies must report results of internal control audits to the Securities and Exchange
Commission (SEC). In each case, an organization's audit program outlines how the company will
maintain compliance with regulatory compliance rules

Recent Trends in Auditing

Traditionally, audits were mainly associated with gaining information about financial systems
and the financial records of a company or a business. However, recent auditing has begun to
include non-financial subject areas, such as safety, security, information systems performance,
and environmental concerns. With nonprofit organizations and government agencies, there has
been an increasing need for performance audits, examining their success in satisfying mission
objectives. As a result, there are now audit professionals who specialize in security audits,
information systems audits, and environmental audits. In cost accounting, it is a process for
verifying the cost of manufacturing or producing of any article, on the basis of accounts
measuring the use of material, labor or other items of cost. In simple words the term, cost audit,
means a systematic and accurate verification of the cost accounts and records, and checking for
adherence to the cost accounting objectives. An audit must adhere to generally accepted
standards established by governing bodies. These standards assure third parties or external users
that they can rely upon the auditor's opinion on the fairness of financial statements, or other
subjects on which the auditor expresses an opinion.

Key trends in auditing today

Based on the growing demands of global organizations as well as new expectations of investors
and boards in recent years, five important trends:

1. Change the role of internal auditors and expanding the scope of the audit.
2. Assessment of the quality of operations.
3. Accountability and transparency.
4. Moving to a revision on the basis of risk.
5. Upgrading infrastructure audit in accordance with technological progress.

Internal audits in organizations have evolved from the financial audit. The traditional functions
of audit: audits of operations, systems audits, fraud investigations and audits of special project
became less important than urgent needs of regulatory compliance and business process
optimization. Today, looking properly structured internal audit function which affects not only
legislation but also operational. The role of an internal auditor is now changed from mere
financial reporting to the control of risk management, priorities, objectives and activities,
eliminate complexity and redundancy, ease of doing business, as well as the protection and
enhancement of shareholder value.

Management and the Audit Committee, rely on internal audit to provide assurance and trust in
the organization in the form of assessing the effectiveness and efficiency of the performance
functions and quality. In today's environment there is a need for greater cooperation and a strong
relationship between the auditor and the audit at all levels. The trend is moving towards the
development of a structure that facilitates a healthy environment that will encourage the free
flow of information in regard to all matters of auditing and auditor. The organization must be
structured in a manner that ensures that responsibility is not limited to the Audit Committee.

In recent years, internal auditors devote their time, energy and resources, primarily towards
harmonization activities. Now is the time for internal auditors to review their activities and
improve the expectations of stakeholders in the framework of the audit based on risk. Risk
management organization and fraud thus gain an advantage during the audit, especially because
these risks can greatly affect the organization. Activities relating to fraud detection and audit IT
security are the today focus of internal audit strengthen the internal audit

Large organizations with complex audit requirements, which include not only financial audits
but also audits, assessments and inspections related to operations, quality, safety, trade and
information technology, have led to improvements in the technology infrastructure that is used to
perform the audit. More used integrated management audits on Web-based systems.
Technological progress makes it possible to simplify and strengthen the internal audit function so
that it brings strategic value and reduce its operating costs. The expected benefits are improved
data transparency, shared environment and decision-making.

In conclusion, the role of audit in public finance is an integral part of the institutional framework
to support good governance and the implementation of financial policies of one country and
eradicate poverty. Social protection programs and other targeted programs of poverty eradication
in developing countries are characterized by their limited access to resources. In this context, the
role of public auditors in monitoring the use of resources is essential. A good auditor will greatly
contribute to social development by limiting corruption and strengthen accountability of state
organs.

Tax Audit: Meaning, nature and significance

To discourage tax avoidance and evasion, the requirement of a tax audit was introduced by the
Finance Act of 1984, by inserting a new section ―44AB‖ w.e.f Assessment Year 1985-86. A Tax
Audit involves an expression of the tax auditors' opinion on the truth and correctness of certain
factual details, given by assesse to the Income Tax Authorities to enable an assessment of tax.
The provisions for an Income Tax audit are covered under section 44AB of the Income Tax Act
of 1961. The Income Tax audit is an examination of an individual‘s or organization‘s tax returns
by any outside agency to verify that all the income, expenditure and deduction information are
filed correctly. Tax audits have been made mandatory by the Income Tax Act that states that all
taxpayers are required to get the accounts of their business or organization audited according to
the provision of the act.

Under section 44AB, the audit aims to ascertain the factual veracity of returns filed and the
accomplishment of other requirements as per applicable rules. The Chartered Accountant
performing the tax audit has to submit all his/her findings and observations in the form of an
audit report. The audit report is given as per format available in the form numbers 3CA/3CB and
3CD.

Objectives / Purpose of Tax Audit

The objectives of Tax Audit are as follows:

 A proper system of tax audit would ensure that all the businesses maintain the books of
accounts and all other revenue/expense records properly.

 A proper tax audit would also ensure that the total income and the claims for deduction
are correctly and accurately entered by the businessmen.

 Tax audit restricts the chance of fraudulent practices.

 Tax audit facilitates the administration of tax laws by proper presentation of accounts
before tax authorities and save the time of assessing officers engaged in carrying out
routine verifications- facilitates the administration of tax by a proper presentation of
accounts before the tax authorities and considerably saving the time of assessing
officers in carrying out routine verifications like checking correctness of totals
and verifying whether purchases and sales are properly vouched or not, thereby their time
could be utilized for attending to more important investigational aspects of the case.

 All applicable tax legislation have been complied with;

 Provision of an avenue to educate taxpayers on various provisions of the tax laws;

 Discourage tax evasion;

 Detect and correct accounting and/or arithmetic errors in tax returns;

Nature and Need.

•Tax Audits are required to be performed ONLY by a Chartered Accountant u/s 44AB of
Income tax act.
 •Tax Audits include the issuance of Tax Audit Report in Form 3CA or Form 3CB.

•Form 3CA is used when the accounts of the business or profession of a ―person‖ have been
audited under any other law.

•The tax audit report shall include a statement of particulars in Form 3CD

Nature Criteria Is a Tax Audit Required?

Business Revenue > 100 lacs Yes

Profession Receipts > 25 lacs Yes

Special application to deemed profits and gains deemed U/s. 44AD, 44AE, 44BB or 44BBB

Cost Audit: Meaning, Advantages and Types

Meaning and Definitions:

Cost Audit is a critical review undertaken to verify the correctness of Cost Accounts and to
check that cost accounting principles and planning have been efficiently followed. It is
noteworthy that India is the only country which has introduced statutory cost audit to regulate
about 45 vital industries of the country. Cost Audit has been defined by the Chartered Institute of
Management Accountants (CIMA) of Landon as ―the verification of cost accounts and a check
on the adherence to the cost accounting plan.‖

This definition implies the following:

(i) The objects of cost accounting with reference to which the cost accounting plan must have
been drawn up have to be kept in mind to see whether or not the plan itself and the figures
collected will lead to the achievement of the goal or objective set. For instance, if the objective is
to achieve maximum efficiency, the plan and the analysis of data will be different from the case
where the only objective is to fix prices.

(ii) It has to be examined whether the methods laid down for ascertaining costs and other
relevant decisions are being implemented. Treatment and determination of abnormal losses of
gains or treatment of certain expenses as direct or indirect are cases in point.
(iii) The correctness of the figures has to be vouched.

‗Statutory Cost Audit is a system of audit introduced by the Government of India for the review
examination and appraisal of the cost accounting record and added information required to be
maintained by specified industries‘ (ICWA of India).

The concept of cost audit has been elaborated by ICWA as ‗an audit of efficiency of minute
details of expenditure, while the work is in progress and not a post mortem examination.
Financial audit is a ‗fait accompli‘, cost audit is mainly a preventive measure, a guide for
management policy and decision in addition, to being a barometer of performance‘.

Cost Audit can be called efficiency audit. It is evidenced by amendment in section 209 which
reads. ‗The object of the amendment of the section is to ensure specified company proper records
relating to utilization of material labor are available which would make efficiency audit (cost-
audit) possible‘.

Advantages of Cost Audit:

The chief advantage of a cost audit will be that management will be sure to get reliable data for
its objectives — price fixing, decision-making, control, etc. Existence of such a system of audit
will also be of great use for maintaining internal check and control and will be of great help to
even financial audit. But it must be understood that the aims of financial and cost audit are
different.

The former aims at prevention of frauds and errors and with presentation of Profit and Loss
Account and Balance Sheet which exhibit a true and fair view of the state of affairs (of profit
earned during the year and of financial position at the end of the year).

It is concerned with totality of expenditure and revenue rather than its functional analysis. Cost
Audit will establish the accuracy of cost of each product, job, activity, etc., and is concerned with
proper analysis of information and its estimation so that management gets the necessary
information promptly. Apart from reliability of data, cost audit should afford certain incidental
advantages. Rather, it should be said that cost audit will help consolidate and realize advantages
expected from a system of costing. Following statement of the HR Gokhale Ex-minister of Law,
Justice and Company Affairs emphasizes the social advantage of cost audit.

‗The objective of this measure (cost audit) is to protect consumers from unwarranted increase in
prices. Reasonableness of the prices charged can only be ensured by correct determination of
costs and the margin charged by producers and their retailers. Another object underlying this step
is to make the industries covered by such rules alert and efficient and also to make them know
their rational cost with a view to reducing it to the extent possible. Thus by resorting to this
method, the interest of consumer is safeguarded and it is definite step towards removal of social
injustice‘.

The advantages, briefly, are as follows:

(i) A close check will be maintained on all wastages—materials in store, labor, etc.—and they
will be promptly located and reported.

(ii) Inefficiencies in production (or efficiencies) will be located and converted into monetary
terms.

(iii) Through fixation of individual responsibility, management by exception will be possible.

(iv) The system of budgetary control and standard costing will be greatly facilitated with cost
audit at the hands of a qualified cost accountant.

(v) Records will be up-to-date and information for various purposes will be available.

(vi) Cost audit may unearth a number of errors and frauds which may not be revealed otherwise.
This is because a cost auditor examines expenditure minutely and compares it with standards and
ascertains exact reasons for discrepancy.

Cost audit offers many advantages to management, cost accountant, shareholders, statutory
auditor, consumers and the government.

These advantages are summarized below:

Advantages to Management:

(i) Errors in following costing principles and techniques are detected. Inconsistencies and frauds
can also be detected. This keeps everyone alert and promotes efficiency.

(ii) Cost audit can serve to measure performance of managers and better performance can be
rewarded.

(iii) It helps to prepare accurate cost reports and this business planning can be more accurate.

(iv) Inter-firm comparisons can be made with ease and this might be a very useful proposition if
industrial intelligence is good.
(v) Cost audit can give an idea about the comparative operational efficiency of each department
of division; and may thus pin-point deficiencies and also encourage operating in a competitive
spirit.

Advantages to Management/Cost Accountant:

Important advantages are:

(i) His task is facilitated since errors, deficiencies, etc., are pointed out. Costing plans can be
prepared to take care of these things.

(ii) Cost audit may help in easier reconciliation of cost and financial accounts.

(iii) If the cost auditor is an outsider and is an expert, he can certainly give some practical and
sound advice to streamline costing systems and organization.

(iv) Cost audit helps to focus attention of management on the problems faced by the cost
accountant. This helps him to realize his goals and objectives with ease.

Advantages to Statutory Auditor:

Important advantages are:

(i) Audited cost data helps him to determine the value of stocks, remuneration of managerial
personnel, etc., with ease and accuracy.

(ii) Data and statements of cost audit help him to prepare his audit program and plan so that he
concentrates more on those aspects which have not been adequately covered by cost audit.

Advantages to Consumers:

(i) The direct benefit accrues where a statutory cost audit has been done to fix a reasonable price
for the consumers.

(ii) Since cost audit aims at ensuring efficiency in the organization, this may also get reflected in
reduced prices to the consumers.

Advantages to Labor:

(i) If cost audit is done thoroughly labor also stands to gain through increased profitability in the
shape of bonus and other benefits.
(ii) Also it brings into focus the role of labor in improving efficiency in term of increased
productivity.

Advantages to Shareholders:

(i) There is correct valuation of all kinds of inventories. This may project a true picture of the
organization before shareholders and other investors and help them to assess its performance.

(ii) External cost audit highlights efficiency or inefficiency, utilization of manpower and other
resources, adequacy of return, etc.

Advantages to Government and Economy:

(i) It helps the government to settle accounts where cost-plus contracts have been made.

(ii) The government can intervene to protect the interests of the consumers, labor, shareholders
and investors from exploit-age or inefficient managements.

(iii) At the national level, cost audit promotes cost consciousness and overall efficiency. This
means that every rupee invested produces the maximum quantity of goods and services.

Types of Cost Audit:

The main types of Cost audit are the following:

(i) Cost Audit as an Aid to Management:

The aim is to see that all information placed before management is relevant, reliable and prompt
so that management can discharge its duties well. It must also be seen that no relevant or
pertinent information is suppressed.

(ii) Cost Audit on Behalf of a Customer:

Often contracts are placed on ―Cost Plus‖ basis. In other words, the customer will determine the
final price to be paid on the basis of exact cost plus an agreed margin of profit. The customer, in
such a case, usually gets cost accounts of the product concerned audited to establish correct cost
and, therefore, price.

(iii) Cost Audit on Behalf of Government:

Sometimes the Government is approached with request for financial help or protection. Before
taking a decision on the request, the Government may choose to get cost accounts of the
applicant audited to establish whether the need for help is genuine or is a result of mere
inefficiency.

(iv) Cost Audit under Statute:

The Amendment Act of 1965 has inserted a new section, 233B, in the Companies Act, 1956
whereby the Central Government may order that certain classes of companies will get their cost
accounts audited by a member of the Institute of Cost and Works Accounts of India. Only such
companies as are required to maintain proper records regarding materials consumed, labor and
other expenses under Section 209 (as amended to date) and may be required to get their cost
accounts audited.

The powers and duties and manner of appointment of the cost auditor are the same as that of
external financial auditor and the same disqualifications will apply. The cost auditor will submit
his report to the Company Law Board with a copy to the company. The right to investigate all
aspects of cost accounts is presumably granted to the cost auditor.

The aim of cost audit under statute seems to be that the Government wishes to know, as an
instrument of control, the costs of various goods. Government has the power to prescribe the
forms in which cost audit reports are to be made out. These are designed not only to verify
information, but also to convey good deal of information to Government.

(v) Cost Audit on Behalf of the Trade Association:

Sometimes trade associations seek to maintain prices at a certain level. For this purpose, the
accuracy of costing information submitted by various concerns has to be checked. The trade
associations may seek to have full information about production capacity and the relative
efficiency of productive processes.

MANAGEMENT AUDIT

Management audit is audit of the management. It is similar to operational audit in several

aspects. However, management audit concentrates more on the inefficiencies and weaknesses of
the management.

Management Auditing is the process of ―auditing the quality of managers through appraising
them as individual managers and appraising the quality of the total system of managing in an
enterprise.‖ Thus management audit aims at assessing how managers perform different functions
of management, e.g., planning, coordinating, motivating, etc.
Objectives of Management Audit

The following are the important objectives.

1. To identify the weaknesses and inefficiencies of management in different functional areas,

such as production, sales, finance etc.

2. to analyses the different ways to overcome the inefficiencies, or weaknesses.

3. To critically review the organization structure.

4. To evaluate the ways for improving the management efficiency and to select the best are the
some of the objectives of management audit.

Scope of Management Audit

Management audit may cover a specific functional area or all the functional areas such as. Sales,
Inventory, Production, Purchase, Personnel, Finance, Administration, etc.

In management audit, experts from various fields –

 Examine the organizational structure, Plans and Objectives, Policies, Systems and
Procedures, Methods of control, Standards fixed for performance and the method of
evaluation of results.
 Report on the defects, weaknesses and irregularities observed by them during their
examination.
 Make suggestions to improve the efficiency and performance of the management.

Advantages of Management Audit

1. Management audit helps in decision making areas such as make or buy, closing down of a
unit, acquisition of a business, etc.

2. It also helps in assessing the efficiency of the executives. It serves as a moral check on the
executives.

3. Management audit suggests ways to utilize the resources of the organization effectively.

4. Management audit helps in rehabilitation of sick units.

5. Management audit report is jointly reported by experts from various fields.

6. The opinions and suggestions of a group of experts on the functioning of the organization are
possible only through management audit.

Disadvantages of Management Audit

1. Management audit involves high cost and it is suitable only to big organizations.

2. Management audit may create a fear in the minds of the executives and may curb their
initiative and innovation.

3. The management auditor may lack independence and may simply take instructions from the
top management.

However, an organization can utilize management audit effectively to improve its various
functional areas.
 UNIT-2

INTERNAL CONTROL

Internal Control
Internal control, as defined in accounting and auditing, is a process for assuring achievement of
an organization's objectives in operational effectiveness and efficiency, reliable financial
reporting, and compliance with laws, regulations and policies.

The plan of organization and all the methods and procedures adopted by the management of
an entity to assist in achieving the management‟s objective of ensuring, as far as practicable,
the orderly and efficient conduct of its business, including adherence to management policies,
the safeguarding of assets, prevention and detection of fraud and error, the accuracy and
completeness of the accounting records and the preparation of reliable financial information.

Objectives of Internal control

1. Transactions are executed in accordance with management‟s general or

specific authorizations.
2. Transactions are carried efficiently & effectively.
3. All transactions are promptly recorded so as to permit preparation of
financial information within a framework of recognized accounting policies
and practices and relevant statutory requirement if any, and to maintain
accountability for assets.
4. Assets are safeguarded from unauthorized access, use or disposition
5. The recorded assets are compared with the existing assets at reasonable
intervals and appropriate action is taken with regard to any differences.
6. To minimize the possibility of error, fraud and irregularity
7. To prevent the misappropriation….
8. To allocate duties and responsibility...
9. To ensure an accurate recording of all business transaction.
10. To enhance the efficiency of the clerk in the organization.
11. To exercise moral influence over the staff member.
12. To prepare final account with an ease and efficiency.
13. To detect errors and frauds promptly which helps to minimize their effects in
long term?
14. To ensure the reliability of information produced by the accounting system.

Scope of Internal control

It extends beyond accounting controls. Basically internal controls can be classified into two
broad categories:

(i) Accounting controls

(ii) Administrative controls

Accounting controls primarily aim at provision and timely preparation of reliable

financial information by strictly following the procedures and broad policies envisaged by the
management. Whereas administrative controls include all other managerial controls concerned
with the decision making process. e.g. Preparation and maintenance of approved /registered
Vendors‟ register.

Limitations of Internal control

1. The organizational structure of the entity may not be such as to have an effective system.
2. Lack of Management supervision, frequent follow-up measures and so on.
3. Management‟s perception of cost related to internal control
4. Lack of integrity, interest on the part of the personnel bound to follow the systems.
5. Abuse of power, like a member of management overriding a control.
6. Control system may become redundant with passage of time.
7. Collusion between two or more persons may not be prevented.
8. Manipulation by management itself with respect to transactions or estimates, judgements
in preparation of financial statements.
9. The potential for human error.
10. Most controls tend towards transaction of usual nature.

Internal control are the whole system of controls established by the

management in order to carry out the business of organization in an
orderly and an efficient manner, ensure adherence to management
policies, safeguard the assets and secure as for as possible, the
completeness and accuracy of records.
.

Essential Charteristics/Priciples Of A Good System Of Internal Check

1. Responsibility
2. Completion
3. Rotation of employees
4. Automatic check
5. Reliance
6. Safeguards
7. Supervision
8. Formal sanction
9. Periodical review

Internal Check and its Objectives

Meaning: 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 it self, 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.
9.To eliminate the frauds and errors which may be committed by the staffs.
10.To prevent misappropriation of cash or stock.
11. To ensure the reliability of information produced by the accounting system.
12. 4. To detect errors and frauds promptly which helps to minimize their effects in long
term.
13. 5. To exercise moral pressure over the staffs.

PRINCIPLE OF INTERNAL CHECK:

 The should be allocated among the staff of the business according the duties,
responsibility and rights in such a, there is no room for interference.
 No single person should have an independent control over all important aspect of the
business.
 The duties among the staff of the business should be changed from time to time so that no
staff should be engaged in a particular job for a long time.
 Every member of the staff should be encouraged to go on leave at least once in a year
.this will help in detecting the concealed fraud.
 An efficient system of internal check should provide for an automatic checking of the
work of an assistant by other.
 The division of work should not be much expensive.
 Self-balancing system should be invariably used.
 The financial and administrative power should be assigned very judiciously to different
officer.
 Person having physically custody of asset must not be permitted to have an access to the
books of account .

ADVATAGES OF INTERNAL CHECK:

 Proper Division of Work.

 Efficiency and Economy
 Early Detection of Error and frauds
 Minimization of Error and Frauds
 Moral Influence on Staff
 Early Preparation of Final Account
 Increased Profitability
 Convince to Auditor

DISADVATAGES OF INTERNAL CHECK:

 Decreased in Quality of Work

 Complacency among High Officials
 Costly for the Small Business
  Create Confusion
 Chance of Collusions

Internal Check
Internal check is a method of organising the accounts system of a business
concern or a factory where the duties of different clerks are arranged in
such a way that the work of one person is automatically checked by another
and thus the possibility of fraud, or error or irregularity is minimised unless
there is collusion between the clerks. For example, the receipt of cash is
entered by the cashier on the debit side of the cash book; this entry is
carried to the ledger by another clerk; the statement of account relating to
this transaction is sent to the customer by a third clerk and so on. Thus the
same transaction has passed through three different hands and the work of
one is checked automatically by the other. It is a kind of division of labour.
This minimises the possibilities of frauds and errors unless all the three join
hands in defrauding their employer.
According to the special committee on Terminology, American Institute of
Accountants, 1949 "Internal check-a system under which the accounting
methods and details of an establishment are so laid out that the accounts
procedures are not under the absolute and independent control of any
person - that, on the contrary, the work of one employee is complementary
of that of another, and that a continuous audit of the business is made by
the employees."
The essential elements of an internal check are :
(a) Instituting of checks on day-to-day transactions.
(b) These checks operate continuously as a part of routine system.
(c) Work of each person is made complementary to the work of another.
The objective of such allocation of the duties is that no one has an exclusive
control over any transaction.
Internal check system in the various aspects of the accounting is given below
:
Internal check as regards cash
There should be a proper system of internal ^heck in respect of all
transactions because majority of the frauds arise in connection with cash.
The auditor must familiarise himself with the system of internal check in
operation. Duties in respect of cash should be divided in such a manner that
there is automatic check on the various functionaries connected with cash
section. It is necessary that employees of the cash are encouraged to go on
vacation. Rotation of duties relating to cash section should also be enforced.
Internal check as regards Cash Receipts
1. The cashier should not have access to the incoming mail books (which do
not concern him), petty cash funds and the ledgers.
2. Remittances should be opened by the cashier in the presence of a
responsible person. All cheques and bank drafts received should be marked -
`Not negotiable A/c Payee only.'
3. All the receipts of the day should be deposited in the bank at the end of
the day or the next morning.
4. On receiving cash, it should be acknowledged by issuing a printed receipt.
This receipt should have a counterfoil. These receipts should be
consecutively numbered. The receipt should be kept under lock and key.
5. Cash registers should be used.
6. The cashier should prepare the paying-in-slips to be retained by the bank.
However, the counter-foils of the paying-in-slips should be entered by some
other clerk and not by the Cashier.
7. Cash sales should be so organised as to reduce the chances of
misappropriation to the minimum.
8. As far as possible the system of collection by travellers should be
discouraged. However, if they are authorised to collect debts on behalf of
the business, there should be proper rules and regulations.
9. Bank reconciliation statement should be made by cashier and someone
else frequently.
Internal check as regards cash payments
1. As far as possible, all payments should be made by cheques authorised by
a responsible person and signed by responsible persons. Cheques should be
marked' A/c Payee only' before they are despatched. Unused cheque books
should be kept under lock and key by a responsible person.
2. Employees authorised to sign or countersign cheques should not have any
other duty connected with cash. Otherwise, it will provide them with
opportunity to influence entries in the ledgers.
3. Petty cash should be maintained under the imprest system.
 4. There should be an efficient system of internal check as regards wages
(discussed elsewhere in this chapter).
5. Vouchers should be numbered properly and filed in order. The cashier
should not be asked to do this.
6. There should be a proper internal check system of cash sales (discussed in
this chapter).
7. Castings of cash book should be independently checked.
Internal check as regards wages
In case of manufacturing concerns wage bill is of great magnitude. The
system of internal check is of great importance in such concerns as regards
wages. Any system of internal check as regards wages much counteract the
following dangers -
(i) Inadequate time records. This may result in the workers receiving wages
for time not devoted.
(ii) Inadequate piece work records. This will result in workers receiving
wages for work not done.
(iii) Errors in preparation of wage-sheets or pay rolls,
(iv) Manipulation of wage sheet by inserting dummies.
The system of internal check to be suggested will vary according to each
particular case.
However, to counter-act the above dangers, the following system of internal
check is suggested :
1. Time Records : Where the wages are to be paid according to the
time basis, the times of employees entering and leaving the work
should be recorded. This may be done either by a gatekeeper or
time recording clock. Further, the foreman of each department
should take the time of entering and leaving the department. This
will not only act as a counter-check on the original records but also
as a deterrent to wasting to times by the workers.
2. Piece work records : Where wages are paid on piece-wages basis,
an efficient system of recording piece work is essential. When the work
is given, it should be entered in the concerned piece worker's card. On
completion, this card should be signed by the worker and foreman.
Where necessary, it should be signed by the store-keeper.
3. Preparation of wage-sheets : Separate wage-sheets should be used for
time workers and piece workers. They should be ruled to record all the
essential particulars. Special columns should be provided for the gross
amount payable, deductions for employees, state insurance, provident fund
contribution, loans, fines etc. and the net amount payable. Columns should
also be provided showing the employers' contribution under the Employees
State Insurance Act.
For time workers, the gate-keepers records and departmental time records
should be compared by two clerks in the wage office. Discrepancy, if any,
should be enquired into. A third clerks should record on the wages sheet,
the name of the employees, rate of wages and other particulars. These
entries should be checked by another clerk. Net amount payable to each
worker should be calculated by another clerk. Similarly, wage sheets should
be prepared for the piece workers following the above procedure. It should
be remembered that each wage clerk should initial for that portion of work
connected with wage sheet undertaken by him. All the wage sheets should
be counter signed by the Works Manager, a Director or a Partner.
4. Payment of wages : Wages should be paid by Cashier. The cashier
should not have any hand in the preparation of wage sheets. A separate
cheque should be drawn for the precise amount of the wages. The workers
should attend personally to receive their wages in the presence of their
foreman to avoid impersonation. Wages of the absentees should be paid to a
worker only when he has brought letter of authority. The Works Manager or
some responsible officer should be present at the time of payment.
Internal check as regards purchases
For this purpose the system of internal check to be adopted by any concern
will depend on its size and resources. However, the following system of
internal check for purchases is suggested -
1. All the orders for purchases should be recorded in the Purchases Order
Book. They should be properly authorised. A carbon-copy of every order
placed should be kept.
2. On receipt of the goods, the gate-keeper or store-keeper should make a
record in the Goods Inwards Books.
3. Invoices received from the sellers should be checked with the Orders
Books and Goods Inwards Books as to its quality, quantity, prices and
calculations. The clerks checking them should also initial the invoices. After
this invoices should be entered in the Bought Day Book and filed.
4. In case, there are a number of departments, each placing its order, the
invoice should be sent to the concerned department for checking.
5. Entry for all goods purchased should be made by an independent person
in the stores ledger.
6. The payment of every invoice should be authorised by a responsible
official.
7. A proper system of internal check for cash purchases should be in
operation. As far as possible, cash purchases should be discouraged.
Internal check as regards sales
Chances of errors and frauds are greater in the case of sales. Goods sent on
approval being treated as actual sales or entering of fictitious sales in the
sales book is possible. Further, it is possible that the next year's sales may
be taken as this year's or sale of fixed assets recorded as sale of goods. The
object of internal check should be to counteract the above.
1. All orders received should be recorded properly and in writing.
Orders received on telephone or verbally should be confirmed in
writing.
2. All goods supplied should be recorded in the Goods Outward Book.
3. Invoice should be prepared in duplicate - one copy sent to the customer
and other carbon copy should be kept. Details of every invoice should be
checked before sent out. Entries in Goods Outwards Book should be
compared with invoices.
4. Entries should be made in the sales Book on the basis of invoices.
5. Goods returned by the customer should be entered in the returns inwards
book and a credit note be prepared.
6. In case of cash sales, cash should be received by a person other than
salesman. Goods should be delivered on the basis of the receipt cash memo.
Internal Check and Auditor
How far an auditor can rely on the internal check system ? This is not an
easy question to answer. The answer to this question will depend upon the
size and nature of the business. Before he can decide upon the reliance on
internal check system, he will have to take the following steps :-
1. Seek a statement from his client in this regard.
2. Examine the system taking into account the size and nature of the
business.
3. Examine the system especially from its weakest point to assess the
possibilities of errors and frauds.
If the auditor finds that the system of internal check is defective, he should
carry on detailed checking.
An efficient system of internal check can reduce to a great extent the work
of the auditor but does not reduce his liability. On the other hand, a
defective system makes his work difficult.
INTERNAL AUDIT
Internal audit is the review of operations and records undertaken within a
business by specially assigned staff on a continuous basis. Internal audit has
been defined as "the independent appraisal of activity within an
organization for the review of accounting, financial and other business
practices as a protective and constructive arm of management. It is a type
of control which functions by measuring and evaluating the effectiveness of
other types of controls." Therefore it is clear that internal audit not only
includes the verifications of accounting matters but also financial and other
matters.
DEFINITIONS:
According to WATTER B. MEIGS, “Internal auditing consists of continuous critical review of
financial and operating activities by a staff of auditors functioning as full-time salaried
employees.

Objects of Internal Audit

1. To verify the correctness of the financial accounting and statistical
records presented to the management.
2. To comment on the effectiveness of the internal control system and the
internal check system in force and to suggest means to improve them.
3. To facilitate the early detection and prevention of frauds.
4. To ensure that the standard accounting practices to be followed by the
organization are strictly followed.
5. To confirm that the liabilities have been incurred by the organization in
respect of its legitimate activities.
6. To examine the protection provided to assets and the uses to which they
are put.
7. To undertake special investigation for the management.
8. To identify the authorities responsible for purchasing assets and other
item as well as disposal of assets.
9. To comment on the effectiveness of the internal control system in
force and to suggest ways and means
to improve upon the system.
10. To verify the correctness, accuracy and authenticity of the financial
accounting records presented to the
management.
11. To facilitate the early detection and prevention of frauds.
12. To ensure that the international accounting standards or the
standard accounting practices are followed by the organization.
13. To take up an investigation at the special request of the
management.
14. To ensure that the assets of the organization are adequately
safeguarded and properly accounted for.
15. To ensure that the organization incurs liabilities in respect of its
valid legitimate activities.
16. To ensure that the acquisition and disposal of assets are under
proper authority.
17. To ensure as to whether or not each unit of the organization follows
the policies and procedures as laid
down by the top management.

INTERNAL CHECK Vs INTERNAL AUDIT

Similarities: Both Internal Check and Internal Audit are part of the whole system of internal
control, as
such both are complementary and go together.
Dissimilarities: There is a lot of difference b/w Internal Check and Internal Audit. Both differ
from each
other in the following respects.
a. Meaning: Internal Check is an arrangement of duties allocated in such a way that the work of
one person is
automatically checked by another. Internal Audit is an independent appraisal of the operations
and records
of the company.
b. Object: the purpose of Internal Audit is to detect the errors and frauds which have already
been
committed.
i. The purpose of Internal Check is to prevent or minimize he possibilities of errors, frauds or
irregularities.
c. Need for separate staff: for carrying out Internal Audit, a separate staff of employees is
engaged for the
purpose.
For internal check, no new appointment is made. It, in fact represents only the arrangement of
duties of
the staff in a particular way.
d. Nature of work: the work involved in the Internal Audit is just like that of a watch man.
Internal auditor has to report, from time to time, to the management about the various in
efficiencies and suggest
improvements. It is also his duty to see that the internal check system does not become static.
Internal Check, on the other hand, represents a process under which the work goes on
uninterruptedly
and the checking too is more or less automatic.
e. Timing of work: Internal Audit starts when the accounting process of different transactions is
finished. Internal Check is an operation during the course of transaction.
f. Internal audit: It is a device for checking the work, whereas internal check is a device for
doing the work.
g. In Internal Audit Errors and Frauds are detected after the completion of work, whereas in
Internal Check the Errors and Frauds are discovered during the course of work.
h. Scope of work: The scope of Internal Check is very limited. The scope of Internal Audit is
comparatively board.
i. Involvement: A large number of employees are needed for the implementation of Internal
Check System. Whereas, a much smaller number of persons are needed for implementing
Internal Audit implementation.

Distinction Between Internal Check and Internal Audit

1. Internal check is an arrangement of as duties allocated in such a way that
the work of one clerk is automatically checked by another while internal
audit is an independent review of operations and records undertaken by the
staff specially appointed for the purpose.
2. In Internal audit, a separate salaried staff of internal auditors is entrusted
with the audit
work but in internal check, there is no separate staff appointed especially
for this purpose. Different clerks are assigned with various tasks with which
they proceed and carry on checking at the same time.
3. In Internal audit, the work of a clerk is checked by an internal auditor
after the former has finished the work while in case of internal check, the
work of one clerk is automatically and independently checked by another
simultaneously.
4. In internal audit, errors and frauds which have already been committed
can be discovered but the system of internal check is so devised that the
possibilities of errors and frauds are reduced to the minimum.
Internal control
Internal control has been defined as being "no only internal check and
internal audit but the whole system of controls, financial and otherwise,
established by the management in order to carry on the business of the
company in on orderly,manner, safeguard its assets and secure as far as
possible the accuracy and reliability of its records."
Therefore internal control is a broad term with a wide coverage. Its scope
extends beyond those matters which relate directly to the functions of
accounting and financial records. In its modern sense, audit control includes
two types of controls:
(a) Accounting Controls : These comprise primarily the plan of
organization and the procedures and records that are concerned with and
directly related to the safeguarding of assets and reliability of financial
records. These include budgeting control, standard costing, control
accounts, bank reconciliation, self balancing ledgers and internal auditing
etc.
(b) Administrative Controls : These comprise the plan of organization
that are concerned mainly with operational efficiency. They may include
controls, such as time and motion studies, quality controls through
inspection, performance reports and statistical analysis.
From the point of view of the auditor, the distinction between these two
controls, is very significant. An auditor has to make a careful review of the
accounting controls in order ensure the accuracy and adequacy of financial
statements. He is not expected to review the administration controls
because they have only a remote relationship with financial records.
However he may evaluate only those administrative controls that have a
bearing on the reliability of financial statements.

Characteristics of Good Internal Control System

1. There should be a well-developed plan of organization with delegation of
proper responsibilities at various levels of operational hierarchy.
2. These should be a scientifically developed system of record procedures
with a view to maintain reasonable control over assets, liabilities, revenues
and expenses.
3. A system of healthy practices and traditions is also necessary for the
performance of duties and activities of various departments of the
organization.
4. The personnel engaged in the business should be of high quality and
character with a deep understanding of their responsibilities and a proper
background of training and ability. This is necessary because controls are
exercised by personnel engaged in the business.
5. There should be managerial supervision and reviews of the company's
financial operation and positions at regular and frequent intervals by means
of interim accounts and reports and operating summaries etc.
Divisions of Internal control
Depending upon the nature of business and the environment in which it
works, the main divisions of an overall internal control system are:
1. General Financial Control: This control includes a proper efficient
system of accounting, adequate supervision, recording and duplicating
systems, good efficient staff and the maintenance of healthy relationships
amongst the staff.
2. Cash Control: The system includes certain important aspects of
control for receipts, payments and balances held. A proper system of
internal check must operate at all stages. There may be specially deputed
officials including the internal audit staff to exercise checks at regular and
irregular intervals. Effort should be made to avoid misappropriation of cash.
3. Employee Remuneration: The system must cover all sections of
employee remuneration and maintenance of records for remuneration, their
preparation and methods of payment should be brought under tight control.
So pacific instructions must be issued to the staff concerned.
4. Trading Transactions: These refer to the purchases, sales etc. So in
respect of these transactions, effective procedure should laid down for
acquisitions, handling and accounting of goods purchased or sold.
5. Fixed Assets: Capital expenditure on fixed assets should be kept under
strict check and supervision. The authority right from sanctioning of capital
expenditure to its use should be clearly defined so that any type of
misappropriation by officials of the organization can be reduced to the
minimum.
6. Stock maintenance: Stocks of raw materials, work-in-progress and
finished goods should be properly maintained and accounted for. Regular
stock taking procedures are quite helpful as means of independent, checks
and reconciliation of records.
7. Investments: The procedures of control in regard to investments
cover such measures as authorisation, recording and maintaining record of
investments held and safeguarding the documents of title.
Internal control and the Auditor
An auditor is mainly concerned with the evaluation of the internal control
system in force so that he may be able to know:
(i) whether mistakes, errors and frauds are likely to be located in the
ordinary course of business.
(ii) Whether an effective internal auditing department exist or not.
(iii) How far and how adequately the management is discharging its function
in so far as correct recording of transaction is concerned.
(iv) How extensive examination he should carry out in different areas of
accounting.
(v) How far administrative control has a bearing on his work.
(vi) What should be the appropriate audit programme in existing
circumstances.
(vii) To what extent reliability can be placed on the reports, records and the
certificates of the management.
(viii) Whether some suggestion can be given to improve the existing control
system.
Therefore we can conclude by saying that internal control is a broad term
which includes internal check, internal audit, and other forms of control
 UNIT-III
LECTURE-19
Vouching
The act of examining documentary evidence in order to ascertain the accuracy and authenticity
of entries in the books of account is called "Vouching".
In other words vouching means a careful examination of all original evidences that is invoices,
statements, receipts, correspondence, minutes, contracts etc. With a view to ascertain the
accuracy of the entries in the books of accounts and also to find out, as far as possible that no
entries have been omitted in the books of accounts.
According to Dicksee. "Vouching consists of comparing entries in books of account with
documentary evidence in support thereof.
The vouching is an important tool in the hands of auditor provided he handles this work with
intelligence, observation and commonsense. Vouching is a sort of preliminary work which forms
an important part of audit work. Since accounts of a business begin with the passing of entries,
hence it becomes a basis for further scrutiny to be made at a later stage. The auditor, after
satisfying himself with regard to the authority and authenticity of transactions, can only then say
specifically that the books of account are correct and the Balance sheet and Profit and Loss
Account exhibit the true and fair state of the financial affairs of business. This is why vouching is
said to be the backbone of auditing.
But all this depends upon the efficiency of the auditor. He, besides checking the arithmetical
accuracy of the books or comparing the entries with the available documentary evidence, should
also go to the source of a transaction. He should also see that the transaction has been properly
authorized. Frauds can be detected only by proper vouching conducted in an intelligent and
searching manner. The importance of proper vouching was emphasized in the case of "Armitage
Vs. Brewer and Knott . In this case auditors were found guilty of negligence because of their
failure to detect defalcations committed by manipulating wage records and petty cash book.
Objects of Vouching
1. To see that all transactions connected with the business have been recorded in the books of
account.
2. To establish that no transaction which is not connected with the business has been recorded.
3. To verify that all recorded entries are genuine.
Objectives: Main objective of vouching is to find out the regularity or irregularity of
transactions, frauds and errors. Regularity means maintaining record and performing the work
compliance with the rules, regulation and law. But irregularity means doing the work crossing to
the line of rules, regulation and laws. Some of the major objectives of vouching are given below:
1. To Detect Errors and Frauds
All transactions are to be supported by evidence. Each document should be proved
By authorized authority. With the help of vouching we can detect errors and frauds by verifying
each transaction. Planned fraud can be detected through vouching.
2. To Know the Truth of Account
Each and every transaction is checked and ratified on the basis of support document. So, we can
easily know the truth of account.
3. To Find the Unrecorded Transactions
Each and every transaction is checked and ratified on the basis of document. Vouching helps to
find out the unrecorded or missing transactions. If any voucher is found unrecorded, auditor can
suggest to record such transactions.
4. To Know That All the Transactions Are Authorized
If the transactions are made on the consent of concerned authority, such transactions are known
as authorized transactions. If transactions are not authorized, such transactions can be fictitious
transactions. So, such fictitious transactions ca be found with the help of vouching.
5. To Know That Only the Business Transactions Are Recorded
Sometimes, transactions are performed for individual purpose but payment is made out of
business. Such transactions should not be recorded in account of business. If such transactions
are recorded, we can find it with the help of vouching. To know the real profit or loss of
business, such transactions are to be separated.
Importance:
Vouching is the act of checking evidential documents to find out errors and frauds and to know
the authenticity, accuracy and reliability of books of accounts. Thus, it is important for an auditor
due to the following reasons:
1. Vouching Is the Backbone of Auditing
Main aim of auditing is to detect errors and frauds for proving the true and fairness of results
presented by income statement and balance sheet. Vouching is only the way of detecting all sorts
of errors and planned frauds. So, it is the backbone of auditing.
2. Vouching Is the Essence of Auditing
Auditing not only checks the accuracy of books of accounts but also checks whether the
transactions are related to business or not. All the transactions are performed after the prior
approval of concerned authority or not, transactions are real or not because an accountant may
include fictitious transactions to commit frauds. All these facts can be found with the help of
vouching. So, vouching is essential for auditing.
3. Vouching Is Important To See Whether Evidences Are Correct or Not
An auditor checks the books of accounts to detect errors and frauds. Frauds may be committed
presenting duplicate vouchers. All the small and big amounts of frauds can be detected with the
help of vouching. So, all the evidential documents and records are to be checked carefully and in
detail by an auditor which is the scope of vouching.
Therefore, it can be said that vouching is the heart of auditing because without the work of
vouching, the work of auditing cannot be performed.
 UNIT-III
LECTURE-20

Principles or Techniques of Vouching:

At the time of vouching auditor should keep in view the following important principles:

1. Arranged Vouchers:
First of all auditor should check all the vouchers provided by the client are properly arranged.
These are in the same order as the entries are made in the books.

2. Checking Of Date:
The auditor should compare the date of the voucher with the date recorded in the cash book.

3. Compare the Words and figures:

The auditor should satisfy himself amount written numbered consecutively. All the vouchers
should be properly filed. On the vouchers, its figures and words are same or not.

4. Checking Of Authority:
The auditor should examine that all the vouchers are passed by the authorized officer. If the
voucher is passed by unauthorized person it will not be correct.

5. Cutting or Change:
If there is any cutting or change on the receipts and vouchers figures it should be signed by the
authorized officer. The auditor should satisfy himself by inquiring about it.

6. Transaction Must Relate To Business:

The auditor should carefully examine that the entries must relate to the business.

7. Case of Personal Vouchers:

The auditor should not accept the voucher in personal name. There is a chance that an officer of
the company has purchased any item in his personal capacity.

8. Checking Of Account Head:

Auditor must be satisfied about the head of account on which cash is deposited and drawn. He
should examine the documentary evidence in this regard.

9. Revenue Stamp:
The auditor should also check that voucher bears a required revenue stamp or not?

10. Case of Cancelled Voucher:

The auditor should not accept the cancelled voucher. Because it has already served the purpose
of payment. There will be a danger of double payment if it is accepted.
11. Important Notes:
The auditor should take some important notes about those items which need further evidence or
explanation.

12. Payment:
The auditor should check that whether payment is described partially or for complete transaction
of sale.

13. Agreements:
These provide the basic information to the auditor. He should check the agreements,
correspondence and other relevant papers.

14. Printer Vouchers:

Printer vouchers are considered true and these are legally acceptable. If these are not printed then
these are useless.

15. List of Missing Vouchers:

Auditor should prepare the list of missing vouchers. This list will be helpful in detecting the
fraud and errors.
Voucher:
A voucher is a documentary evidence in support of a transaction in the books of account.
Types of Vouchers
A voucher is a written paper or document in support of an entry in the books of account. They
may be of two types:
1. Primary: A written evidence in original is said to be the primary voucher, for example, invoice
for a purchase.
2. Collateral: When the original voucher is not available, copies thereof are produced in support
or subsidiary evidence in order to remove doubt from the mind of auditor. Such a voucher is
usually known as a collateral voucher.
A voucher may be a receipt, invoice wage-sheet, an agreement, correspondence, bank paying-in-
slip, minute books recording resolutions of directors or shareholders, and so on.
 UNIT-III
LECTURE-21
While examining vouchers the following points should be noted by the auditor:
1. All vouchers have been properly filed, serially numbered and arranged in order as it saves time
in finding out a particular voucher in checking.
2. The voucher is properly stamped as normally every receipt for more than five hundred rupees
requires a revenue stamp unless legally exempted.
3. The date and the year of the receipt or the voucher corresponding with the cash book. The
name of the party to whom the voucher is issued, the name of the party issuing voucher and the
amount etc. are correct.
4. Those vouchers which have been inspected by him are stamped so as to avoid the possibility
of their being produced again.
5. Every voucher is passed "as in order" by some responsible person whose signature should be
noted.
6. Amount paid appears both in words and figures. If they differ, the matter should be
investigated.
7. For missing vouchers, the auditor should satisfy himself with regard to the reasons of their
being lost. If he is not satisfied with the explanations, he should state this fact in his report.
8. No help from any member of the staff of the client has been taken while vouching the entries
and checking the vouchers.
9. Any alteration in the voucher is duly signed by the invoice clerk.
10. In case of vouchers for insurance, rent, rates and taxes etc., the period for which the payment
has been made should be noted.
11. Special attention should be paid to those vouchers which are in the personal name of one of
the partners, Directors, manager, Secretary or any other official of a business and which may or
may not relate to the business itself. In case of purchase, original invoice, inward book and order
book etc. should be examined to ensure that the goods were purchased for the business only.
Vouching of Cash transactions
Vouching of cash transactions is by far the most important job in every business irrespective of
its size and type of business etc. Before setting the programmer for vouching the cash book, an
auditor should examine carefully the whole system of internal check in operation in respect of
cash transactions. (Internal check has already been explained in detail previously).
Vouching of receipts of the debit side of the cash book
It is rather very difficult to vouch the receipt of cash than to vouch payments as some entries
might have been omitted altogether and therefore only an indirect evidence like counterfoils of
receipts issued, carbon copies of receipts, contracts and letter from debtors etc. are available. He
should check a few items at random and if he finds them to be in order, he may assume that the
others will be correct but he must not forget to compare the rough cash book or the diary with the
cash book. If he fails to do so and later on a fraud is detected, he might be held responsible. If he
finds that there is a time gap between the two dates, he should go deeper into the matter as it is
possible that money might have been received in between the two dates and misappropriated.
Some of the important items which usually appear on the debit side of the cash book and the duty
of an auditor in that connection are given below:
1. Opening balance: This can be vouched by comparing it with the balance shown in the duly
audited balance sheet of the previous year. By doing this, it is verified that the actual balance has
been brought down.
2. Cash sales: Under this head, the chances of fraud are comparatively greater, for example the
salesman may sell goods but may not record the same in the cash book thus misappropriating the
money. Therefore the auditor should examine the effectiveness of the internal control system in
operation in regard to cash sales. Assuming an effective internal check system in operation, the
auditor should take the following steps to verify the correctness of the amount of cash sales.
(a) Check the counterfoils of the cash sales books with the salesman's summaries or
abstracts.
(b) Note that each salesman's abstracts agrees with the analysis of the cash received by the
receiving cashier.
(c) Check the details of cash received with the cash sales counterfoils.
(d) Compare the daily totals of the receiving cashier's memorandum cash books with their
corresponding entries in the main cash book. If the auditor fails to do so and later on fraud is
discovered, he will be held liable.
Cash received from debtors
The cash received from customers to whom good have been sold on credit in the past can be
vouched with the help of the counterfoils of the receipts issued to them. But it is often noted that
a smaller amount than actually received is shown on the counterfoils or receipts are issued to the
debtors from old but unused counterfoil receipt books, the auditor should take the following
steps in vouching receipts from debtors:
1. Check the internal check system with regard to the sales as a whole.
2. Ensure that the unused counterfoil receipts are kept in safe custody.
3. See that all spoiled receipts are attached to the counterfoils and he has cancelled them.
4. Verify the dates on the counterfoils with those in the cash book.
5. The practice being followed with regard to receipts through cheques should be noted and if no
official receipts are being issued, he should verify the daily lists of such receipts with the entries
in the cash book.
6. In respect of discount allowed to debtors, the auditor should ascertain the terms on which
discount is allowed and test check a certain number of entries to ascertain whether the discount
allowed is in order.
7. Special attention should also be paid to the amount shown as bad debts written off as cash can
be misappropriated by writing off the whole or a part of the debit balance as bad. He has to
ascertain as to who is responsible for writing off debts as bad. He should, with the permission of
the client, establish direct contracts with the debtors by sending them the statements or
verification slips from time to time and asking them to send their confirmation directly to him.
With regard to receipts from debtors fraud may be committed by the process of "teeming and
lading” that is not entering cash in the cash book received from a debtor and entering it only
when a similar amount is received from another debtor and so on. Of course, no
misappropriation is committed but the practice should be checked because there is the loss of
interest for the period money is misappropriated and the cashier may be tempted to commit such
a fraud of bigger amount and may not be able to replace the same. To detect such a fraud the
auditor should:-
1. Examine the accounts of those debtors which show part payments from time to time.
2. Check the amount and date on the counterfoil receipts to compare it with the date and
amount deposited in the bank.
3. Should send verification slips to the debtor requesting them to send the confirmation
directly to him.
4. Bills receivables:
All details about bills receivable can be made available in the Bills receivable book. The auditor
should take the following steps:
(I) ascertain the due dates of the various bills.
(ii) Note that the amount due on bills was received on maturity. This can be ascertained by
comparing the bills receivable book with the cash book and the pass book.
(iii) Special attention should be given to those bills which have been matured but the amount in
respect thereof has not been received. Such bills might have been dishonored or retired. But there
is a possibility of their proceeds being misappropriated by the cashier.
(iv) In case, of discounted bills, the cash received should be properly entered in the cash-book
and the discount deducted should be separately shown in the discount account.
(v) He should note that in case of bills discounted but not matured at the date of the balance
sheet, contingent liability has been shown in the balance sheet.
5. Rents Receivable :
The auditor should proceed keeping in view following points:
(I) examine the leases agreement with the tenants and ascertain the exact amount receivable.
(ii) Check the amounts due with the rent-foil.
(iii) Compare the amounts as per rent roll with the cash book.
(iv) Check the counterfoils of rent receipt issued to tenants. If agents are appointed to collect
rent, the accounts or statements submitted by them should be carefully checked.
6. Interest and dividends:
Interest and dividends received from investments should be vouched in the following manner:
(I) receipts on this account should be checked with the counterparts of the interest and dividend
warrants or the letters along with the cheques.
(ii) In case of bearer bonds the bonds themselves should be inspected along with the torn off
coupons to note as to what interest should have been received.
(iii) If the banker is authorized to collect interests or dividends the entries in the bank pass book
or statement should be inspected.
(iv) In case of Interest on fixed deposits, the bank pass book has to be checked.
(v) In case of interest received on a loan granted to a borrower, the agreement between the
borrower and the business should be referred to for the rate of interest, date of payment etc.
(vi) The auditor should ensure that all dividends or interest in respect of investments, deposits or
lendings etc. have been received and accounted for.
7. Sale of fixed assets:
The points to be considered are given below:
(i) It is possible in case of sale of fixed assets, the sale deed is not executed for the full purchase
consideration. To detect such a fraud, the auditor should examine the correspondence made with
the parties willing to purchase them.
(ii) In case, sale has been made through a broker, the broker's sold note should be examined,
(iii) He should see that the sale has been duly sanctioned.
(iv) He should note that the profit earned on the sale of fixed assets should be credited to the
capital reserve account and not to the general profit & loss account.
8. Insurance Claims:
Amounts received under an insurance policy should be verified by means of the correspondence
with and accounts rendered by the insurance companies.
9. Sale of investments:
In this connection, the auditor should consider the following points:
(i) As investments are usually sold through brokers, so the broker's sold note should be examined
to note the date of sale, the amount received and the commission changed.
(ii) In case the sale has been made through the bank, the bank advice should be examined.
(iii) He should note as to whether the sale has been cum-dividend and if so, the dividend has
subsequently been received and the sale proceeds have been proportioned between capital and
revenue. If investments are sold ex-dividend, he has to see that the dividend has been received if
declared.
10. Subscriptions:
Subscriptions received by a club or society should be checked with counter-foils of receipt books
and with the published list of subscribers.
11. Commission received:
For this, the agreements between the client and the parties from when it is receivable should be
examined to verify the terms of commission, its rate etc. Counter-foils of receipts should be
compared with the particulars entered in the cash bank. In case of goods received on
consignment, the amount of commission should be vouched with reference to the copy of the
account sent to the consignor or the auditor should calculate the amount himself, if necessary.
12. Receipts from hire purchase:
The hire purchase agreement should be checked in order to ascertain the duration of the
agreement, the amount of instalments, total number of instalments, and payment by the close of
period the accounts of which are under audit. He should also note that the instalment includes
interest also and also the whole amount of an instalment is properly apportioned between sales
and interest.
 UNIT-III
LECTURE-22
Vouching of Cash Payments
The object of vouching the credit side of cash or bank of cash payments is not merely to
ascertain that money has been paid away but to ensure that the payments have been made:
(a) To the proper and right party,
(b) On behalf of the business for a proper purpose,
(c) For the accounting period under audit,
(d) After proper authorization,
(e) Against a proper voucher, and
(f) Correctly recorded in the books of account.
Some of the important items on the credit side of the cash book and the duty of an auditor in that
connection are given below:
(A) Capital Expenditure:
According to Spicer and Pegler "Capital expenditure is all expenditure incurred for the purpose
of acquiring, extending or improving assets of a permanent nature, by means of which the
business may be carried on or for the purpose of increasing the earning capacity of the business".
Such expenditure is normally heavy and therefore require special attention. The type of
documents required depends upon the nature of the payment. Some of the items of capital nature
and the duties of an auditor in each case are given below:
1. Land & Building: The auditor should take the following steps:
(i) The documents of title of the property purchased should be examined.
(ii) The auditor should find out as to whether land or buildings purchased are on freehold or
leasehold basis. In latter case, he should examine the terms of the lease.
(iii) If the properties are purchased through an auctioneer, the account submitted by the
auctioneer should be checked.
(iv) In case the property has been purchased through the broker, the broker's note should be
examined.
(v) Where the property is got erected through a contractor, he should examine the receipts issued
by the contractor, for payments made. If the buildings have been constructed by engaging labor,
he should vouch the expenditure on building materials purchased, cartage paid, wages paid to the
workers etc. and also see that the expenditure has been properly capitalized.
(vi) The expenses incurred, for example, auctioneer's commission, brokerage, architect's fee,
registration fee etc. can be vouched with the help of the receipts obtained and it should be seen
that they are capitalized.
2. Plant, Machinery, Furniture, Fixtures etc.:
In this connection, the auditor should take the following steps:
(i) Examine the invoices and the receipts obtained from the supplier and see that the items have
been properly authorized.
(ii) In case, machinery has been purchased on hire-purchase basis the auditor should examine the
contract of hire-purchase with the vendors to find out the purchase price, the amount of
instalment and interest. Here, he should note that only the principal amount has been capitalized.
3. Investments:
Investments should be vouched in the following manner:
(i) In case, these have been purchased through a stock-broker, payments should be vouched with
reference to the brokers sold note.
(ii) In case of a new issue for which application has been made and if the share certificates have
not yet been received, the allotment letter and banker's receipts for the instalments paid should be
inspected. But if share certificates or debentures have been received, they should be examined.
(iii) The actual investments should be examined.
(iv) In case of cum-dividend purchase, he should see that the expenditure has been properly
apportioned between capital and revenue.
(v) He should see that the investments have been made in accordance with the provisions of the
Companies Act and Investments are registered in the name of the company required under
section 49 of the Companies Act.
4. Patents:
The auditor should take the steps as given below:
(i) Examine the patent.
(ii) If the patent has been purchased, the assignment should be inspected together with the receipt
for the purchase consideration.
(iii) In case patent has been purchased through some agent, the agent's receipted amounts should
be examined to note the agent's fees and verify the amount so included in the asset account.
(iv) He should note that the patent renewal fees has not been charged to the patent account, as
these fees represent revenue expenditure.
5. Loans:
In order to vouch the figure of loans, the auditor should:
(i) Inspect the loan agreement, the security held if any, receipt given by the borrower etc.
(ii) Examine that the loan has been properly authorized.
(iii) If the loan has been advanced against mortgage he should examine the receipt mortgage, the
receipt from the borrower, the mortgage, deed, title deeds and other documents.
(iv) In case of loans to directors, the managing directors and other officials of a company, he
must see that the provisions of the companies act are followed.
 UNIT-III
LECTURE-23

(B) Revenue Expenditure:

(i) Wages: In case of concerns employing a considerable number of workers, vouching of wages
forms a very important part of the auditor's job. He should first of all satisfy himself in regard to
the efficiency of internal check system so far as it relates to the maintaining of wage records,
preparation of wages sheets and payment of wages. Besides this, he should note the following
points:
(i) the totals and calculations involved in the wage sheets should be checked.
(ii) He should check a few items, for example, deductions in the form of rent, fire insurance,
provident fund, etc. and the method of deducting them should also be examined.
(iii) He should see that the amount of the cheques drawn for payment of wages tallies with the
net amount as shown in the wages sheets.
(iv) Names of workers given in the wages sheets should be well compared with those given in
the wages record like job cards, foremen's register, etc.
(v) He should see that the wages sheets have been properly initialed by those responsible for
their preparation.
(vi) He should carefully check the payments made to the casual labor.
2. Salaries:
For this, salaries book containing the details of the employee's salary should be maintained. The
auditor should take the following steps:
(i) He should compare the cheques drawn with the salaries book.
(ii) Any change in the salary list should be verified with an official source.
(iii) Special attention should be paid to the deductions in respect of provident fund, life insurance
premium, income tax, etc.
(iv) Independent information as regards employees leaving the service of the concern should be
obtained from the staff departments and compared with the salaries book to find out persons
already left being included in the salaries book.
(v) He should ensure that the payment has been made to the correct person. This he can do by
comparing the signature on the salaries book with the specimen signature of the employees.
3. Petty Cash:
Vouching petty cash is another problem for the auditor as normally there are no proper vouchers
and therefore chances of misappropriation of cash exist. As a first step, the auditor should
examine the soundness of internal check system in this regard and in case he finds it to be
satisfactory, he should take the following steps:
(i) He should see that imprest system is being followed and if not he should recommend the same
to the client.
(ii) He should check the payments made to the petty cashier with the entries in the cash book.
(iii) For those expense for which vouchers are not available he should ask the petty cashier to
give a summary which should be duly signed by a responsible officer.
(iv) He should examine the totals and balances of the petty cash book.
(v) He should see that the petty cash book is periodically checked and initialed by some
responsible official.
(vi) The auditor should, without notice and occasionally, count the cash in hand and agree it with
the balances shown by the petty cash book.
4. Travelling expenses
These are paid for the travel in connection with the business. Where a fixed amount is payable,
there is no difficulty in checking it. But in other cases, the auditor has to check very carefully.
His duty in vouching such payments shall consist of:
(i) Vouching the cheques drawn according to the cash-book with the traveler’s receipts.
(ii) Checking the figures in some of the traveler’s accounts with the vouchers submitted by them.
(iii) Seeing that all unpaid commissions and expenses have been brought into account at the end
of the financial period.
5. Insurance premiums
In case of new policies, the auditor should inspect the cover note or the receipt from the
insurance company and in case the policy has been received, it should be examined. In case of
renewals, the renewal receipt should be checked. If the number of policies is large, he should
require a schedule of various particulars like number of the policy, the amount, the date of
maturity, the amount of the premium payable etc. He should examine these particulars. In case
some policy has lapsed, he should find out as to under whose authority it has been allowed to
lapse.
6. Bank Charges
In order to vouch this item as shown in the cash book the auditor should tally the figures with the
bank pass book and if necessary he should check their calculations.
7. Postage
The auditor should compare the postage book with the cash book and petty cash book and count
the stamps in hand. He should see that postage includes only the postal expenses connected with
the business and not with any private account.
8. Director's Fee:
The auditor should take the following steps in vouching the payments under this head,
(i) Examine the articles to find out the fee payable to the directors.
(ii) The director’s minute book, the attendance register should be examined to ascertain the
number of meetings attended by them.
(iii) Examine the receipts obtained from directors for this payment.
(iv) Examine the resolutions of the shareholders to calculate the amount payable as director's fee
and compare this figure with the amount actually paid.
9. Cash Purchases
In vouching this item, the auditor should take the following steps:
(i) Test the entries in the cash book with the cash memos.
(ii) See that the goods paid for have actually been received which can be done by checking the
entries in the goods inward book or purchases book.
(iii) See that only net amounts, that is, purchases minus trade discount, has been carried to the
books of account.
10. Payments to Creditors
(i) The receipts issued by the creditors acknowledging the receipt of money should be checked.
(ii) The money paid should be compared with the money due as per the accounts of the
creditors and the invoices received from them.
(iii) He should scrutinize the method of comparing the statement of accounts with their actual
accounts.
(iv) Before passing an entry in this regard, he should refer to minutes, contracts and other
documentary evidence in support of it.
 UNIT-III
LECTURE-24
11. Bills Payable
In this connection, the auditor should:
(i) Examine the duly cancelled returned bills as an evidence of the amount having been paid.
(ii) Inspect the bills payable book.
(iii) See the bank pass book and the banker's advice in case the payments on certain bills have
been made through the bank.
12. Freight and Carriage
The auditor should vouch the payment on this account with the help of the statements rendered
by the shippers or carriers together with the receipts. He should also see that allowances in
respect of rebates have been properly accounted for. 13. Rents Payable
The agreement with the landlords and receipts from them should be examined.
14. Payment of taxes
In order to vouch this item, the auditor should refer to the copy of the assessment order,
assessment form, notice of demand and the receipted challan etc. The advance payment of
income tax and interest allowed on it should also be verified. Payment of sales tax can be
vouched by reference to the return submitted by the dealer and Treasury or bank receipt every
month or quarter.
15. Commission
The conditions relating to the payment of commission should be examined with reference to the
agreements between the client and the agents. The statements of account submitted by the agents
should also be seen.
 Verification and Valuation of Assets and Liabilities

UNIT-IV

LECTURE-25

Verification

Verification means `proving the truth' or `confirmation'. One of the most important duties of an
auditor in connection with the audit of the accounts of a concern is to verify the assets and
liabilities appearing in the balance sheet. The fact that there is an entry regarding the purchase of
an asset and has been be correctly recorded, is not a proof that the asset is in the possession of
the concern at the date of the balance sheet. It is possible that after purchase and passing the
entries, the asset might have been disposed of or pledged and no entry has been made concerning
this before the closing of these books. Therefore, he has to see whether a particular asset as
recorded in the balance sheet on the day of the closing of the books of account exists or not. If he
fails to verify the asset, he will be liable for any damage suffered by the client as it was decided
in the case of London Oil Storage Co. Ltd. Vs. Sear Haslock and Co. (1904).

According to Spicer and Pegler—“The verification of assets implies an inquiry into the
value, ownership and title, existence and possession, the presence of any charge on the
assets.”

Thus we can say that verification is a process by which the auditor satisfies himself not only
about the actual existence, possession, ownership and valuation but also ensures that the assets
are free from any charge or lien.

Objectives

Objectives of Verification are:

a) To show correct valuation of assets and liabilities.
b) To know whether the balance sheet exhibits a true and fair view of the state of affairs of the
business
c) To find out the ownership and title of the assets
d) To find out whether assets were in existence
e) To detect frauds and errors, if any
f) To find out whether there is an adequate internal control regarding acquisition, utilization and
disposal of assets.
g) To verify the arithmetic accuracy of the accounts
h) To ensure that the assets have been recorded properly
The verification of assets involves the following points:
a) Comparing the ledger accounts on the date of the balance sheet.
b) Verifying the existence of the assets on the date of the balance sheet.
c) Satisfying that they are free from any charge of mortgage.
d) Verifying their proper value.
e) Assets were acquired for the business.
Difference between Vouching and Verification
1. Vouching is based only on documentary evidence whereas verification is based on physical
inspection as well as documentary examination.
2. Vouching examines the entries relating to the transaction recorded in the books of account
whereas verification examines the assets and liabilities appearing in the balance sheet.
3. Vouching of books of account is done for the transactions for the whole year. Verification,
on the other hand is done at the end of the year when the balance sheet has been prepared.
4. Vouching indicates though a particular asset must be in possession of the concern whereas
verifies certifies the existence of the asset.
The auditor should as far as possible, inspect the assets personally on the date of the balance
sheet like cash, bills receivable and investments etc.

Verification of assets is important as it will avoid the possibility of the improper inflation of
values, or of the existence in the books of record of an asset which does not exist or which in fact
never existed. This may be done in most of the cases to inflate the profits, and to show a better
position of the business than what is actually is. An example of this is inflation of the value of
stock. If the auditor is negligent is performing his duties in respect of verification, he may not be
in a position to detect misappropriation of assets, inflation of profits and falsification of the
balance sheet. In such case he may be held liable for damages.

The auditor has to give a certificate on the accounts examined by him that the Profit
and Loss Accountant shows as a true and fair view of the profit or loss of business and
the Balance Sheet shows a true and fair view of the state of affairs of the business. Hence it
becomes the duty of the auditor not only to vouch the expenses and incomes, but also to verify
and check the valuation of the assets and liabilities of business. He has to satisfy himself that
the assets and liabilities do in fact exist, and they are properly valued.
 UNIT-IV

LECTURE-26

Concept and Meaning of Verification

One of the main works of auditor is verification of assets and liabilities. Verification is the act of
assuring the correctness of value of assets and liabilities, title and their existence in the
organization. An auditor should be satisfied himself about the actual existence of assets and
liabilities appearing in the balance sheet is correct. If balance sheet incorporates the incorrect
assets, both profit and loss account and balance sheet do not present true and fair views.

Thus, verification means to confirm the truth or accuracy and to substantiate. It is a process by
which the auditor satisfies himself not only about the actual existence, possession, ownership and
the basis of valuation but also ensures that the assets are free from any charge. While verifying
the assets, an auditor should consider the following points:

 Ensuring the existence of assets.

 Acquiring the assets for business.
 Ensuring the proper valuation of assets.
 Ensuring that the assets are free from any charge.
Thus, verification includes verifying:

 The existence of the assets and liabilities.

 Legal ownership and possession of the assets
 Correct valuation, and
 Ascertaining that the asset is free from any charge
Valuation

Valuation of assets is an important part of their verification. The correct profits cannot be
calculated unless the assets are properly valued. Only then the balance sheet will reveal the true
and fair position of the financial affairs of the business. The valuation as such is to ensure the
correct valuation of the assets while in verification, the auditor has to verify the authority, and
the existence of the property also besides its valuation. Thus valuation means to test the exact
value of an asset on the basis of its utility. Normally, valuation is done after deducting the
depreciation for the value of an asset. If proper depreciation on assets is not provided for, the
profits will be overstated or understated which will have adverse effect on the company's
solvency. The auditor should consider the following points while valuing the assets:
a) Original cost of the assets.
b) Expected working life of the assets.
 c) Wear and tear of the assets.
d) Break-up value of the assets.
e) The chances of the assets becoming obsolete.
Concept and Meaning of Valuation

Valuation is the act of determining the value of assets and critical examination of these values on
the basis of normally accepted accounting standard. Valuation of assets is to be made by the
authorized officer and the duty of auditor is to see whether they have been properly valued or
not. For ensuring the proper valuation, auditor should obtain the certificates of professionals,
approved values and other competent persons. Auditor can rely upon the valuation of concerned
officer but it must be clearly stated in the report because an auditor is not a technical person.

Auditor's position as regards valuation of assets:

It is not an auditor's duty to determine the values of various assets. It has been judicially held
that he is not a value or a technical man to estimate the value of an asset. But he is definitely
concerned with values set against the assets. He has to certify that the profit and loss account
shows true profit or loss for the year and balance sheet shows a true and fair view of the state of
affairs of the company at the close of the year. Therefore he should exercise reasonable care and
skill, analyze all the figures critically, inquire into the basis of valuation from the technical
experts and satisfy himself that the different classes of assets have been valued in accordance
with the generally accepted assumptions and accounting principles. If the market value of the
assets are available i.e., in the case of share investment then he should verify the market value
with the stock exchange quotations. If there is any change in the mode of the valuation of an
asset, he should seek proper explanation for it. If he is satisfied with the method of valuation of
the assets he is free from his liability.
 UNIT-IV

LECTURE-27

Importance of Verification and Valuation of Assets and Liabilities

Assets and liabilities are very important aspects of business. Balance sheet is prepared on the
basis of them and an auditor should prove the true and fairness of information provided by
balance sheet. So it is very important for an auditor. Its importance can be highlighted as follows:

1. To Show the Actual Financial Position

Balance sheet is prepared to show the actual financial position of a business. If proper valuation
is not made, such balance sheet does not provide true and fair information. So, to provide
information about the real financial position, verification and valuation of assets are essential.

2. To Know the Real Position of Profit And Loss

Depreciation and other expenses on assets will be incorrect if proper valuation of assets is not
made. So, to calculate the actual amount of profit and loss, proper valuation of assets and
liabilities is necessary.

3. To Increase Goodwill

Proper valuation gives fair information about profitability and financial position of a business.So,
people can get information which creates positive attitude towards company. Positive attitude of
public increases goodwill.

4. To Assure Shareholders

Valuation and verification provide actual information about assets and liabilities to the
shareholders which assure the safety of their investment.

1. Easy For Sale

At the time of sale of the company, it can be sold at the price which is enlisted in the balance
sheet, but the assets whose valuation is not made need valuation before selling the company.

6. Easy To Get Loan

Company discloses the balance sheet proved by auditor for public knowledge which increases
the trust of the company. Financial institutes provide loan easily to such companies.
 7. Easy To Get Compensation

Whenever the loss occurs due to any incident, insurance company provides compensation on the
basis of valuation of assets. So, the company can easily get compensation.

The mode of valuation of different types of assets differs depending upon the nature of the
business and the purpose for which the assets are held. The basis of valuation for different types
of assets is given as below:

Mode of Valuation of Different Types of Assets.

The mode of valuation of different types of assets differs depending upon the nature of the
business and the purpose for which the assets are held. The basis of valuation for different types
of assets is given as below:

1. Land & Building: Assets like land, building, etc. can be divided into two categories such
as:

a) Audit of Freehold Property – Verification Procedure

As land is a non-depreciable asset, it is better if it is shown separately in the Balance
Sheet. In other words, it should not be shown along with buildings because building is a
depreciable asset whereas land is a non-depreciable asset. The verification procedure is as
follows:
 The auditor should examine the title deeds in order to ensure that they are in the name
of the client.
 In case the property is mortgaged, he should obtain a certificate from the mortgagee
or his solicitor to the effect that the title deeds are in their possession. He should also
enquire whether there is any second or subsequent mortgage or not.
 If it is purchased, correspondence and broker’s note should be examined. If the
purchase is effected through auction the auctioneer’s account should be checked.
 If the client has constructed the building, the auditor should examine the certificates
received from the builder, contractor, architect and other necessary papers and
documents.
 If the building is a newly purchased one, the value of building can be ascertained by
vouching the amount paid to the contractor. If it is partly constructed, by obtaining
architect’s certificate, its value can be determined.
 If the client’s own staff members are also engaged in its construction, the auditor
should see that a reasonable basis of allocation of wages, supervisor charges, etc. has
been adopted.
b) Leasehold Property: Audit of Leasehold Property – Verification procedure
If the land or building is acquired by the business for a fixed duration on lease, the
property is said to be leasehold. Auditor should see that separate accounts are maintained
 both for freehold and leasehold properties. The amount of premium paid in order to
acquire the lease, the expenses incurred on the improvement of the building, etc. should
be capitalized and written off over the life of the lease. The royalty paid every year
should be treated as revenue expenditure and debited to the Profit & Loss Account. The
cost of leasehold property should be written off on straight line basis.
The auditor should take the following steps to verify the leasehold property:

 The auditor should inspect the lease agreement to find out value of the property and its
duration. He should see that the lease agreement is registered with the Registrar and
certificate testifying the validity of the same has been obtained from the client’s legal
advisor.
 He should see that the terms and conditions of the lease are duly complied with.
 The annual charge for depreciation will be arrived at by dividing the total cost by the
term of the lease. The auditor should see whether amount written off is sufficient to
provide for depreciation at the end of the term.
 If the property is sub-let, the auditor should examine the agreement entered into with the
sub-lessee.
 If the asset is of building, the tax paid, and repair expenses made for it should be treated
as operating expenditure. The auditor should see whether they are treated so.

2. Plant and Machinery: In case the machines are purchased in the current accounting period,
the invoices and the agreement with the vendors should be verified. The auditor should `
examine the plant register in which particulars about the cost, records about sales, provision
for depreciation, etc., are available. He should prepare a list of each machine from the plant
register and should get the list certified by the works manager as he is not a technical man
and therefore he has to depend upon the advice of the works manager regarding their
valuation, etc. He should see that plant and machinery account is shown in the balance sheet
at cost less depreciation after making proper adjustment regarding purchases and sale of
some parts effected during the year under audit. In case any plant and machinery has been
scrapped, destroyed or sold, he should ascertain that the profit or loss arising thereon has
been correctly determined.