CH - 0 - Audit - Basics

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Chapter 0
Basics of Auditing, Nature, Scope and Objective of Audit
Introduction
ICAI
The Institute of Chartered Accountants of India (ICAI) is the national professional accounting body of India.
● It was established on 1 July 1949 as a statutory body under the Chartered Accountants Act, 1949 enacted
by the Parliament (acting as the provisional Parliament of India) to regulate the profession of Chartered
Accountancy in India.
● ICAI is the second largest professional Accounting & Finance body in the world.
● ICAI is the only licensing and regulating body of the financial audit and accountancy profession in India.
Emblem of ICAI
Rules and Regulation For Accounting and Auditing
● __________________________
● __________________________
Practical Subject
Auditing is, perhaps, one of the most practical-oriented subjects in the C.A. curriculum. This paper aims to
provide knowledge of generally accepted auditing procedures and of techniques and skills needed to apply
them in audit engagements. A good knowledge of the subject would provide a strong foundation to students
while pursuing the Chartered Accountancy course. A good understanding of the theoretical concepts,
particularly, in the context of auditing standards would make practical training an enriching and enjoyable
experience. While studying this paper, students are advised to integrate the knowledge acquired in other
subjects, specifically, accounting and corporate laws in a meaningful manner. Such learning would only help a
student to become a better professional.”
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A brief About Audit

● Genesis
● The person who conducts audit is known as auditor
● General Meaning
○ Evaluation Process
○ Undertaken to establish
○ Adherence to certain norms
● कोई भी काम उसके बनाए गए तरीके से हुआ है या नहीं, इसे चेक करने को ही ऑडिट कहते है ।
● As a Chartered Accountant we are concerned with mostly with Financial Audit (Audit of Financial
Information)
● Why we need Audit of Financial Information (among many reasons)
○ Emergence of Limited Liability Organisations
○ Increasing complexities in Financial reporting
Following things must be clearly understood before we start studying audit

1. Meaning of Auditing
2. Objective of Auditor
3. Reasonable Assurance
4. Misstatement
5. Material
6. Types of Opinion
7. Those charged with governance
8. Management
9. Pre-Conditions for an audit
10. Internal Control
11. Test Checking
12. Professional Judgement
13. Audit Procedures
14. Assertions
15. Audit Risk
16. Audit Evidence
17. Independence
18. Steps in Auditing

Meaning of Audit
An Audit is
● independent examination of
● Financial information of
● any entity, whether profit oriented or not , and irrespective of its size or legal form, when such an
examination is conducted
● with a view to expressing an opinion thereon.


0.1 Q1. Define Audit.

(SELF)
0.1 Q2. Correct / Incorrect

Audit is required to be conducted only in case of profit oriented entities
(SELF)
Overall Objectives of Auditor

In conducting an audit of financial statements, the overall objectives of the auditor are
● To obtain reasonable assurance about
○ whether the financial statements as a whole
○ are free from material misstatement,
■ whether due to fraud or error,
○ thereby enabling the auditor to express an opinion on
■ whether the financial statements are prepared,
■ in all material respects,
■ in accordance with an applicable financial reporting framework; and
● To report on the financial statements, and communicate as required by the SAs, in accordance with the
auditor’s findings.
Reasonable Assurance
● A high, but not absolute, level of assurance.
For auditor's opinion, reasonable Assurance is an absolute level of assurance (T/F)
Misstatement
A difference between
● the amount, classification, presentation, or disclosure
○ of a reported financial statement item
● and the amount, classification, presentation, or disclosure
○ that is required for the item to be in accordance with the applicable financial reporting
framework.

Misstatements can arise from error or fraud.
● The distinguishing factor between fraud and error is whether the underlying action that results in the
misstatement of the financial statements is intentional or unintentional.
● Fraud’ deals with intentional misrepresentation but, ‘error’, on the other hand, refers to unintentional
mistakes in financial information.
Question - Fraud is more difficult detect than error (True or False)

Answer - Statement is true, fraud is more difficult to detect than error. This is because fraud generally involves
sophisticated and carefully organized schemes to conceal it such as forgery, deliberate failure to record
transactions, intentional misrepresentations to the auditor.
The risk not detecting a material misstatement from fraud is higher than risk of not detecting one resulting
from error (T/F)
Material
Misstatements, including omissions, are considered to be material

● if they, individually or in the aggregate,
● could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements;
0.2 Q1. Define Audit and State the objective of the auditor
(SELF)

Types of Opinion
● Clean Opinion
● Modified Opinion
○ Qualified Opinion
○ Adverse
○ Disclaimer of Opinion
Meaning of Pervasive
The term pervasive is used to describe the effect of misstatements on the financial statement.
Whether the effect of material misstatement is pervasive or not it depends on auditors judgement.
While deciding that the effect is pervasive or not auditor must keep the following things in mind
● Effect is pervasive when it is not confined to a specific element

● Even if it is confined to a specific element the effect can be considered as pervasive if it represent a
substantial proportion of financial statements
● In relation to disclosures, The effect can be considered as pervasive if It is fundamental to users
understanding of the financial statements.
Those charged with governance

The person(s) or organisation(s) with responsibility for
● overseeing the strategic direction of the entity and
● obligations related to the of the entity

0.3 Q1. The persons with responsibility for overseeing the strategic direction of the entity and
obligations related to the accountability of the entity are :
a. Management
b. those charged with governance
c. audit committee
d. board of directors
(RTP, May 2021, NA) (MTP1, May 2021, 1 Mark ) (RTP, Nov 2021, NA)
Management
● The person(s) with executive responsibility for conduct of entity's operation
0.4 Q1. Management and TCWG can be same Correct / Incorrect

(SELF)
Pre- Conditions for an audit

In order to establish whether the preconditions for an audit are present, the auditor shall:
● Determine whether the financial reporting framework is acceptable; and
● Obtain the agreement of management that it acknowledges (मानती है ) and understands (जानती है ) its
responsibility:
○ For the preparation of the financial statementsin accordance with the applicable financial
reporting framework;
○ For the internal controlas management considers necessary; and
○ To provide the auditor with:
■ Access to all information such as records, documentation and other matters;
■ Additional information that the auditor may request from management for the purpose
of the audit; and
■ Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.

0.5 Q1. Discuss the pre-conditions of an Audit

(SELF)
Internal Control
The Process designed, implemented and maintained by
➔ Those charged with governance
➔ Management
➔ Other personnel
To Provide Reasonable Assurance with regard to
● Reliability of financial reporting
● Effectiveness & Efficiency of operations
● Safeguarding of assets
● Compliance with applicable law & regulations

It is a means by which an organization's resources are directed, monitored, and measured. It plays an
important role in detecting and preventing fraud and protecting the organization's resources, both physical
(e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks).
Early Examples - One set of bureaucrats charged with collecting taxes and another with supervising them.
Other Examples
● Locks
● Segregation of duties
○ Separating responsibility for physical custody of an asset from the related record keeping is a
critical control.
○ Persons who can authorize purchase orders (Purchasing) should not be capable of processing
payments (Accounts Payable)
● Authorisation
○ An employee who only needs to view computer information should be restricted to Read and
File Scan access and should not be granted Write and Create access.
● Reconciliations
Auditor’s Responsibilities / Role

● RAP
● FAP
● Opinion?
0.6 Q1. Define Internal Control

(SELF)
Test Checking
● Application of Audit Procedures to less than 100% of the Transaction. It is also known as Sampling.
● Should be done in such a way that every item must have an equal chance of selection.
Judgement
The application of relevant
➔ training, knowledge & experience, (TKE)
➔ in making informed decisions
➔ about the courses of action that are appropriate in the circumstances of the audit engagement.

Professional judgment is essential to the proper conduct of an audit.
(Study this part while revising Chapter 1 For the first time after completion of syllabus) - Professional
judgment is necessary in particular regarding decisions about:
● Materiality and audit risk.

● The nature, timing, and extent of audit procedures used to meet the requirements of the SAs and
gather audit evidence.
● Evaluating whether sufficient appropriate audit evidence has been obtained, and whether more needs
to be done to achieve the objectives of the SAs and thereby, the overall objectives of the auditor.
● The evaluation of management’s judgments in applying the entity’s applicable financial reporting
framework.
● The drawing of conclusions based on the audit evidence obtained, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.
Other Points
● May differ from person to person
● Can also be formed after consultation
"Professional judgment is essential to the proper conduct of an audit." Discuss. MTP May 2021
0.7 Q1. "Professional judgment is essential to the proper conduct of an audit." Discuss.
(MTP1, Nov 2020, 3 Marks)
How Audit Is Conduct
Framework to conduct audit
➔ Engagement
➔ Planning
➔ Materiality
➔ Risk assessment; and
➔ Tests of controls, when required by the SAs or when the auditor has chosen to do so; and

➔ Substantive procedures (Checking of Assertions), including

◆ Tests of details and
◆ Substantive analytical procedures.
➔ Audit Evidence
➔ Conclusions and Reporting
Risk Assessment and Risk Assessment Procedures
● Risk assessment is done to assess the risk of material misstatement. (ROMM)

● Risk of material misstatement is defined as ‘the risk that the financial statements are materially
misstated prior to audit
● Risk assessment procedures are
○ used to
■ obtain an understanding of the entity and its environment,
■ including its internal control
○ in order to
■ assess the risk of material misstatement and
■ determine the nature, extent and timing of further audit procedures.
● After RAP, the Auditor can assess the level of ROMM.
● Once the ROMM is assessed, we can decide NET of FAPs
○ Nature - (Compliance or Substantive)
○ Extent - (Sample size, Less work or more work)
○ Timing - (Interim period and some transaction at the year end OR all year end in detail)
● Risk assessment procedures alone do not provide audit evidence sufficient to support audit opinion.
● They are required in all financial statement audits.
0.8 Q1. Correct / Incorrect

Risk assessment procedures involve testing of accounts for checking of assertions.
(SELF)
Further Audit Procedures
Compliance Procedure
● Auditor test internal control in order to
○ to decide whether to rely on them or not .

● We will (For testing IC)

○ Check design (SoD, Approvals, Reconciliations etc)
■ No - Leave it go for SP
■ Yes test efficiency (Operation and Continuity)
○ Test of Efficiency (Operation and Continuity) If internal controls are efficient then it is going to
have a direct impact on the nature, extent and timing of substantive procedures.
○ If because of efficiency of internal control we decided to rely on internal control then we will
do more compliance procedures and less substantive procedures.
Substantive Procedure
● Auditor will check transactions, account balance presentation and disclosure
○ Analytical Procedures
○ Test of Details (Vouching and Verification)
0.9 Q1. Correct/Incorrect

‘Test of Control’ may be defined as an audit procedure designed to detect material
misstatements at the assertion level.

Assertions
Representation by Management, Explicit or otherwise, Embodied in the financial statements.

Example on Assertion
Plant and Machinery (at cost) ₹ 4,00,000
Less: Depreciation till the end of ₹ 1,40,000

previous year
Depreciation for the year ₹ 26,000 ₹ 1,66,000
₹ 2,34,000
The assertions are as follows
● the firm owns the plant and machinery;

● the historical cost of plant and machinery is ₹ 4 lacs;
● the plant and machinery physically exists;
● the asset is being utilised in the business of the company productively;
● total charge of depreciation on this asset is ₹ 1,66,000 to date on which ₹ 26,000 relates to the year in
respect of which the accounts are drawn up; and
● the amount of depreciation has been calculated on a recognised basis and the calculation is correct.
● The above assertions are implicit (Obvious)
Explicit assertions are made when otherwise the reader will be left with an incomplete picture; it may even be
misleading.
● Secured Loans ₹ 4,00,000

● The description does not give us a complete picture. We do not know:
○ the name of the lender, if it is relevant;
○ the nature of security provided; and
○ the rate at which interest is payable.
Assertions may also be positive or negative. Further these positive or negative assertions may be explicit or
assertions.
For example, if it is stated that there is no contingent liability it would be an expressed negative assertion;
On the other hand, if in the balance sheet there is no item as “building”, it would be an implied negative
assertion that the entity did not own any building on the balance sheet date.
Assertions about transactions and events for the period relating to PPE.
1. Occurrence—transactions and events relating to PPE have been recorded, have occurred and pertain to
the entity.

2. Completeness—all transactions and events relating to PPE that should have been recorded have been
recorded.
3. Accuracy—amounts and other data relating to recorded transactions and events have been recorded
appropriately.
4. Cut-off—transactions and events have been recorded in the correct accounting period
5. Classification—transactions and events have been recorded in the proper accounts.
0.10 Q1. Which of the following is not an assertion about presentation and disclosure?
a. Occurrence and rights and obligations
b. Completeness
c. Classification and understandability
d. Existence
(Sample MCQs)
0.10 Q2. Which of the following Assertion is not related to assertion about presentation and disclosure:
a. Occurrence and rights and obligations
b. Completeness
c. Classification and understandability
d. Valuation and allocation
(Sample MCQs)
0.10 Q3. Name the assertions for the following audit procedures:
i. Year end inventory verification.
ii. Depreciation has been properly charged on all assets.
iii. The title deeds of the lands disclosed in the Balance Sheet are held in the name of the
company.
iv. All liabilities are properly recorded in the financial statements.
v. Related party transactions are shown properly.
(SA, May 2018, 5 Marks) (MTP2, May 2021, 5 Marks)
0.10 Q4. State assertions that are implied in the extract of financial statement given below:
Plant & Machinery (At Cost) 4,00,000
Less: Depreciation

Up to Previous Year 1,40,000

For the Year 26,000 (1,66,000)
2,34,000
(i) Indicate assertions in respect of transactions and events for the period relating to PPE.
(ii) State specific assertions relating to the above extract of financial statements.
(MTP2, May 2019, 6 Marks) (MTP1, May 2021, 6 Marks)
0.10 Q5. What are the obvious assertions in the following items appearing in the Financial Statements?
(i) Statement of Profit and Loss
Travelling Expenditure Rs. 50,000
(ii) Balance Sheet

Trade receivable Rs. 2,00,000
0.10 Q6. Correct/Incorrect

Assertions refer to the representations by the auditor to consider the different types of the
potential misstatements that may occur.
(MTP1, Nov 2020, 2 Marks) (SA, July 2021, 2 Marks)
0.10 Q7. ……………. refer to representations by management, explicit or otherwise, that are embodied in the
financial statements, as used by the auditor to consider the different types of potential
misstatements that may occur.
(a) Assertions
(b) Positive Confirmation
(c) Written representation
(d) Audit Evidence.
(MTP1, May 2021, 1 Mark)

Audit Evidence
Audit Procedures to Obtain Audit Evidence
1. Inspection
2. Observation
3. External Confirmation
4. Recalculation
5. Reperformance
6. Analytical Procedure
7. Enquiry
0.11 Q1. Define Audit Evidence.

(SELF)


Audit Risk

0.12 Q1. The auditor is expected to, and can, reduce audit risk to zero and can therefore obtain absolute
assurance.
Steps In Auditing (Not For Exams)
NOTE: It is easy to write the sequence of these steps in theory, but in the practical world the sequence is not
followed strictly or some of the steps are of continuous nature.
For example planning starts with engagement and ends with opinion and it again starts shortly after the
completion of the audit, for next year’s audit.
So for theory purposes we will study them in a sequence but one needs to understand that practically no clear
starting line and finish line is there for all the steps.
1. Engagement
2. Planning
3. Materiality
4. Risk assessment; and
5. Tests of controls, when required by the SAs or when the auditor has chosen to do so; and
6. Substantive procedures (Checking of Assertions), including
a. Tests of details and
b. Substantive analytical procedures.
7. Audit Evidence
8. Conclusions and Reporting


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These notes are incomplete without our videos. We keep on updating our books, notes and videos.

Rules and Regulation For Accounting and Auditing

To get the best out of these notes visit www.edu91.org Chapter 0 | 1

Lines Taken From ICAI Study Mat - www.icai.org

A brief About Audit

Following things must be clearly understood before we start studying audit

To get the best out of these notes visit www.edu91.org Chapter 0 | 2

To get the best out of these notes visit www.edu91.org Chapter 0 | 3

To get the best out of these notes visit www.edu91.org Chapter 0 | 4

0.1 Q1. Define Audit.

0.1 Q2. Correct / Incorrect

Overall Objectives of Auditor

For auditor's opinion, reasonable Assurance is an absolute level of assurance (T/F)

To get the best out of these notes visit www.edu91.org Chapter 0 | 5

Misstatements can arise from error or fraud.

Question - Fraud is more difficult detect than error (True or False)

Misstatements, including omissions, are considered to be material

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● Effect is pervasive when it is not confined to a specific element

Those charged with governance

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0.4 Q1. Management and TCWG can be same Correct / Incorrect

Pre- Conditions for an audit

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0.5 Q1. Discuss the pre-conditions of an Audit

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Auditor’s Responsibilities / Role

0.6 Q1. Define Internal Control

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Professional judgment is essential to the proper conduct of an audit.

● Materiality and audit risk.

How Audit Is Conduct

Framework to conduct audit

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➔ Substantive procedures (Checking of Assertions), including

Risk Assessment and Risk Assessment Procedures

● Risk assessment is done to assess the risk of material misstatement. (ROMM)

0.8 Q1. Correct / Incorrect

Further Audit Procedures

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● We will (For testing IC)

0.9 Q1. Correct/Incorrect

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Less: Depreciation till the end of ₹ 1,40,000

Depreciation for the year ₹ 26,000 ₹ 1,66,000

The assertions are as follows

● the firm owns the plant and machinery;

● Secured Loans ₹ 4,00,000

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Up to Previous Year 1,40,000

(ii) Balance Sheet

0.10 Q6. Correct/Incorrect

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Audit Procedures to Obtain Audit Evidence

0.11 Q1. Define Audit Evidence.