Principles and Practice of Auditing V Sem B.

Com

Syllabus
Module No. 1: Introduction to Auditing
Introduction – Meaning and Definition – Objectives– Types of Audit– Merits
and Demerits of Auditing – Relationship of audit with other disciplines.
Preparation before commencement of new audit - Working Papers -Audit Note
Book, Audit Programme Qualities of an Auditor – Audit planning – Audit
strategy ––Audit Engagement -Audit Documentation - Audit Evidence –
Written Representation.

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Pooja A R (Lecturer, VVFGC)
 Principles and Practice of Auditing V Sem B.Com

Module-01
Introduction to Auditing
Introduction:

Auditing originates from the Latin term “Audire”, which means “to hear,”
- just as in ancient times auditors used to listen to officers and people of
authority to confirm the validity of their words. Over the years, the role of
auditing evolved to verifying written reports: specifically, the financial records
of individuals and businesses.

An audit is an "independent examination of financial information of any

entity, whether profit oriented or not, irrespective of its size or legal form when
such an examination is conducted with a view to express an opinion
thereon." Auditing also attempts to ensure that the books of accounts are
properly maintained by the concern as required by law. Auditors consider the
propositions before them, obtain evidence, and evaluate the propositions in their
auditing report.

Meaning:
Auditing, or a financial audit, is an official examination and verification
of a business’s financial records.

Auditing is the process of checking the financial statements along with

other accounting information of a business entity. It is a systematic procedure
where the economic condition of the entity is analysed. The person taking up
the responsibility of the process is called an “Auditor”.

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

According to R. K. Mautz, "Auditing is concerned with the verification of

accounting data, in order to determine the accuracy and reliability of the
accounting statement and reports"

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Pooja A R (Lecturer, VVFGC)
 Principles and Practice of Auditing V Sem B.Com

Objectives: The objective of an audit is to express an opinion on financial

statements. The auditor has to verify the financial statements and books of
accounts to certify the truth and fairness of the financial position and operating
results of the business. Therefore, the objectives of audit are categorized as
primary or main objectives and secondary objectives.

A. Primary Objectives: The primary or main objective of audit is as follows:

1. To Examine the Accuracy of the Books of Accounts

An auditor has to examine the accuracy of the books of accounts, vouchers and
other records to certify that Profit and Loss Account discloses a true and fair
view of profit or loss for the financial period and the Balance Sheet on a given
date is properly drawn up to exhibit a true and fair view of the state of affairs of
the business. Therefore the auditor should undertake the following steps:

 Verify the arithmetical accuracy of the books of accounts.

 Verify the existence and value of assets and liabilities of the companies.
2. To Express Opinion on Financial Statements
After verifying the accuracy of the books of accounts, the auditor should
express his expert opinion on the truthiness and fairness of the financial
statements. Finally, the auditor should certify that the Profit and Loss Account
and Balance Sheet represent a true and fair view of the state of affairs of the
company for a particular period.

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Pooja A R (Lecturer, VVFGC)
 Principles and Practice of Auditing V Sem B.Com

B. Secondary Objectives: The secondary objectives of audit are: (1) Detection

and Prevention of Errors, and (2) Detection and Prevention of Frauds.

1. Detection and Prevention of Errors: The Institute of Chartered

Accountants of India defines an error as, “an unintentional mistake in the books
of accounts.” Errors are the carelessness on the part of the person preparing the
books of accounts or committing mistakes in the process of keeping accounting
records. Errors which take place in the books of accounts and the duty of an
auditor to locate such errors are discussed below:

1. Clerical error: Errors that are committed in posting, totalling and balancing
of accounts are called as Clerical Errors. These errors may or may not affect the
agreement of the Trial Balance.
Types of Clerical Errors:

(A) Errors of Omission: When a transaction is not recorded or partially

recorded in the books of account is known as Errors of Omission. Usually, it
arises due to the mistake of clerks. Error of omission can occur due to complete
omission or partial omission.

(1) Error of Complete Omission: When a transaction is totally or completely

omitted to be recorded in the books it is called as “Error of Complete
Omission”. It will not affect the agreement of the Trial Balance and hence it is
difficult to detect such errors.
Example – 1: Goods purchased on credit from Mr. X on 10.5.2016
for Rs. 20,500, not recorded in Purchases Book.
Example – 2: Goods sold for cash to Ram for Rs. 10,000 on 1.7.2016 not
recorded in Cash Book.
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Pooja A R (Lecturer, VVFGC)
 Principles and Practice of Auditing V Sem B.Com

(2) Errors of Partial Omission: When a transaction is partly recorded, it is

called as “Error of Partial Omission”. Such kind of errors can be detected easily
as it will affect the agreement of the Trial Balance.
Example – 1: Credit purchase from Mr.C for Rs. 45,000 on 10.12.2016, is
entered in the Purchases Book but not posted in Mr.C’s account.
Example – 2: Cash book total of Rs. 1, 10,100 in Page 5 is not carried forward
to next page.

(B) Errors of Commission: Errors which are not supposed to be committed or

done by carelessness is called as Error of Commission. Such errors arise in the
following ways:
(1) Error of Recording,
(2) Error of Posting,
(3) Error of casting or Error of Carry-forward.
(1) Error of Recording: The error arises when any transaction is incorrectly
recorded in the books of original entry. This error does not affect the Trial
Balance.
Example – 1: Goods purchased from Shyam for Rs. 1000 wrongly recorded in
Purchases Day Book as Rs. 100.
Example – 2: Goods purchased from Ram for Rs. 1,000, instead of entering in
Purchase Day Book wrongly entered in Sales Day Book.

(2) Error of Posting: The error arises when a transaction is correctly

journalised but wrongly posted in ledger account.
Example – 1: Rent paid to landlord for Rs. 10,000 on 1.5.2016 is wrongly
posted to debit side of Repairs account instead of debit side of Rent account.
Example – 2: Rent paid to landlord for Rs. 10,000 on 1.5.2016 is wrongly
posted to credit side of Rent account instead of debit side of Rent account.
(3) Error of casting or Error of Carry-forward: The error arises when
a mistake is committed in carrying forward a total of one page on the next page.
This error affects the Trial Balance.

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 Principles and Practice of Auditing V Sem B.Com

Example – 1: Purchases Book is totalled as Rs. 10,000 instead of 1,000.

Example – 2: Total of Purchases Book is carried forward as Rs. 1,000 instead

of Rs. 100.
2. Error of duplication: Errors of duplication arise when an entry in a book of
original entry has been made twice and has also been posted twice. These errors
do not affect the agreement of trial balance, hence it can’t locate easily.
Example: Amount paid to Anbu, a creditor on 1.10.2016 for Rs. 75,000
wrongly accounted twice to Anbu’s account.
3. Error of compensation (or) Compensating errors: When one error on
debit side is compensated by another entry on credit side to the same extent is
called as Compensating Error. They are also called as Off-setting Errors. These
errors do not affect the agreement of trial balance and hence it cannot be
located.
Example: A’s account which was to be debited for Rs. 5,000 was credited
as Rs. 5,000 and similarly B’s account which was to be credited for Rs. 5,000
was debited for Rs. 5,000.
4. Error of principle: An error of principle occurs when the generally
accepted principles of accounting are not followed while recording the
transactions in the books of account. These errors may be due to lack of
knowledge on accounting principles and concepts. Errors of principle do not
affect the trial balance and hence it is very difficult for an auditor to locate such
type of errors.
Example – 1: Repairs to Office Building for Rs. 32,000, instead of debiting to
repairs account is wrongly debited to building account.
Example – 2: Freight charges of Rs. 3,000 paid for new machinery, instead of
debiting to Machinery account wrongly debited to Freight account.
2. Detection and Prevention of Frauds: Fraud is the intentional or wilful
misrepresentation of transactions in the books of accounts by the dishonest
employees to deceive somebody. Thus detection and prevention of fraud is of
great importance and constituents an important duty of an auditor. Fraud can be
classified as:

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Pooja A R (Lecturer, VVFGC)
 Principles and Practice of Auditing V Sem B.Com

1. Misappropriation of cash: This is a very common method of

misappropriation of cash by the dishonest employees by giving false
representation in the books of accounts intentionally. In order to detect and
prevent misappropriation, the auditor should verify the system of internal check
in operation and by making a detailed examination of records and documents.
Cash may be misappropriated in the following ways:
(1) By omitting to enter cash which has been received.
Example: Cash received on account of cash sales for Rs. 35,000 is not
accounted in the debit side of the cash book.

(2) By accounting less amount on the receipt side of cash book than the actual
amount received.
Example: Cash received on account of cash sales for Rs. 35,000 is accounted in
the debit side of the cash book as Rs. 25,000. The difference of Rs. 10,000 may
be defrauded by the cashier.
(3) By recording fictitious entries on the payment side of cash book.
Example: Cash book is credited for Rs. 44,000 as amount paid to Mr.X for
goods purchased on credit but actually no amount is paid. Hence, cashier
misappropriates Rs. 44,000 of cash as paid to Mr.X.

(4) By accounting more amount on payments side of cash book than the actual
amount paid.
Example: Amount paid to Gopal for Rs. 5,000 is accounted on the credit side of
cash book as Rs. 15,000. The difference of Rs. 10,000 may be defrauded by the
cashier.

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Pooja A R (Lecturer, VVFGC)
 Principles and Practice of Auditing V Sem B.Com

(5) Teeming and Lading of Fraud which means cash received from one
customer is misappropriated and remittance received from another debtor is
posted to the first debtors account.

2. Misappropriation of goods: Fraud which takes places in respect of goods is

Misappropriation of Goods. Such a type of fraud is difficult to detect and
usually takes place where the goods are less bulky and are of high value.

 By showing less amount of purchase than actual purchase in the books of

accounts.
 By showing issue of material more than actual issue made.
 By showing good materials as obsolete or poor line of goods.
 By showing fictitious entries in the books of accounts.
Example – 1: Goods purchased amounting to Rs. 58,000 is wrongly accounted
in Purchases Book as Rs. 50,000. Hence, showing less amount of purchases
than the actual and misappropriating goods worth Rs. 8,000.
Example – 2: Goods issued from stores for 1000 units is wrongly accounted in
the Ledger accounts as 3000 units issued. The difference of 2000 units may be
misappropriated by the storekeeper.

Example – 3: Entries in the Purchases Book may be suppressed or inflated to

show more or less profit.

Detection of Misappropriation of goods is a difficult task for an Auditor.

Only through efficient system of inventory control, periodical stock verification,
internal check system and adequate security arrangement the scope for such
frauds can be eliminated or minimized.

Auditor has to thoroughly scrutinize the inward and outward registers, invoices,
sales memos, audit notes, etc., to detect the goods-related frauds.

3. Manipulation of accounts: There is a very common practice almost in

every organization; some dishonest employees have intention to commit this
type of fraud. Manipulation of accounts is the procedure to alter books of
accounts in such a way that there will be an increase or decrease in the amount
of profit to achieve some personal objectives of the high officials. It is very
difficult for the auditors to identify such frauds which may be due to
manipulation of accounts.

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 Principles and Practice of Auditing V Sem B.Com

Merits and demerits of Auditing:

Merits of Auditing:
1. Assurance to Stakeholders: This comes as one of the biggest advantages of
auditing is that the final report of the audit is accepted by all and provides a
clear picture of the business's position. The owners or investors get a proper
idea of the accuracy of the books of accounts and, eventually, the performance
of the business. This also provides them with satisfaction about the functioning
of their employees and various departments. They get an idea about the overall
profitability and efficiency of the business; this helps them be assured of their
stake holding.

2. Fair Evaluation: This process helps a business' evaluation be done fairly

without any chance of manipulation as the auditor responsible for examining the
books of account gives their viewpoint as an independent authority. The audit
officer's remark is much valued among the owners and investors of the business
entity. All the documents, financial statements, and inventory inspections are
closely inspected and verified for getting a fair report and do not involve any
biasness.
3. Fraud Identification: Fraud is intentional misconduct on the part of the
individual. At the same time, there is always a chance of unintentional mistakes
by an individual. Both situations can be easily noticed after an audit, and
accountability can be sought in both cases. Employees taking care of them
might get examined for any of these cases. So, this creates a responsibility
among them to do their tasks honestly and efficiently. The auditing process
decreases the chance of committing fraud and errors in the functioning of the
business entity.

4. Moral Policing: This process does the task of teaching a sense of moral
accountability towards the firm in the employees. They know their mistakes will
be discovered, so this generates the responsibility for being honest and always
avoiding irregularities and irresponsibility in their work.

5. Credibility: Audit of the books of a firm allows their stakeholders, like

creditors, investors, banks, and debenture holders, to have more confidence in
them. These are important connections of a business entity as they help raise
money, loans, and capital accumulation, a much-needed resource for their

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 Principles and Practice of Auditing V Sem B.Com

growth. As the auditing body has no agenda or biasness, the reports thus
produced after analysis of the financial statements, accounts, etc., have high
credibility for the stakeholders.

6. Overall Improvement: An audit is the best way to get an idea about the
functioning of the sustaining system and opportunities that can be grabbed for
more development and business performance. Auditing also helps implement
changes in the present situation as regular reports are obtained with overall
performance.
7. Compliance with Rules and Standards: The main objective of an audit lies
in ensuring that all the policies and procedures comply with the standard norms.
Also, with the help of the process, a proper analysis can be done to evaluate the
company's conduct with that of good practices, and affectivity can be measured
against the expected one.
8. Helps in Building a Good Reputation: Audit reports at regular periods
ensure the stakeholders about the firm's conduct. This builds a reputation for the
firm in terms of teamwork, ethical working, and conduct. This also helps in the
further development of a firm.
9. Legal Proof: The report obtained after auditing a business firm acts as legal
proof. This record can be used for the sake of insurance. Many firms like LIC,
HUDCO, etc., consider the previous year's audit report more reliable for their
services.
10. Dispute Settlement: This helps settle disputes and claims between
management. This contains independently done assessments about every
transaction with defined all details. This becomes a source for the identification
of any claim or disputes involved.
Demerits of Auditing:
1. Expensive: This process puts a heavy monetary cost on a firm for execution.
This requires a cost of examination of all financial statements and records,
which may include duplication of records for easy access and availability, by an
auditor. Auditing firms charge a high fee for their services.

2. Not Suitable for Small Businesses: An audit may not turn out to be of use
for small-scale organizations, which include very limited business transactions.

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 Principles and Practice of Auditing V Sem B.Com

3. Chances of Uncertainty in the Report: There can be cases where errors can
be found in audit reports if the staffs involved are not careful or inexperienced
and biased. The report helps in the future planning for the business entity, so
any mistake may turn out to be a disaster.

4. Lack of Certainty in Standards: There are no rules or general standards

followed in the audit process. For every other firm, there must be a newly
defined audit plan.

5. Lack of Participation: The planning of an audit program does not include

participation in terms of suggestions by efficient and competent staff. So this
prevents their application of knowledge and calibre. Instead, turns into their
harassment in a way.

6. Ignorance of Technology: In modern times, the use of technology has been

introduced in the process of accounting. The audit process still depends on
manual examinations and ignores the internal control based on the particular
technology used in the firm. The difference in technology creates a problem, but
this audit system does not include prevention measures for these issues.
7. Less Guaranteed: The report does not disclose any details about the data or
figures involved in the analysis. So the report does not guarantee any
explanations. Most of the components are based on information and disclosures
made by departmental personnel of concerned departments.
Characteristics of auditing:

1. Independence: Auditors must maintain an independent stance, free from any

bias or influence that could compromise their professional judgment and
objectivity. Independence is crucial to ensure an impartial assessment of the
organization's financial statements and processes.

2. Systematic Approach: Auditing follows a structured and methodical

approach, involving planned and organized procedures to gather sufficient and
appropriate evidence. This systematic approach ensures a comprehensive
examination of financial records and operations.

3. Objective Evaluation: Auditors conduct their examinations objectively,

based on evidence and facts, without allowing personal beliefs or opinions to

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 Principles and Practice of Auditing V Sem B.Com

influence their assessments. The objective evaluation is vital for providing

credible and unbiased opinions.

4. Professional Skepticism: Auditors maintain a skeptical mind set throughout

the audit process, critically thorough scrutiny and helps uncover potential errors,
irregularities, or fraudulent assessing the information and evidence obtained.
This skepticism encourages activities.

5. Evidence-Based: The audit process relies on gathering and evaluating

relevant and reliable evidence to support the conclusions and opinions provided
by auditors. The strength of the audit opinion is directly linked to the quality
and sufficiency of the evidence collected.

6. Risk Assessment: Auditors assess risks associated with financial reporting

and internal controls to tailor their audit procedures. This allows them to focus
on areas with higher risks and allocate resources effectively to mitigate those
risks.

7. Professional Standards and Guidelines: Auditing is guided by established

professional standards and guidelines, such as those set by organizations like the
International Auditing and Assurance Standards Board (IAASB) and the
Generally Accepted Auditing Standards (GAAS). Compliance with these
standards ensures consistency, quality, and ethical conduct in auditing.
8. Verification and Vouching: Auditors verify the accuracy and completeness
of financial statements by vouching transactions, examining supporting
documentation, and ensuring compliance with accounting principles and
policies.
9. Communication and Reporting: Auditors are required to clearly
communicate their findings, conclusions, and the board of directors, and other
stakeholders, providing transparency and recommendations in a formal audit
report. This report is shared with management, accountability.

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 Principles and Practice of Auditing V Sem B.Com

Types of audit:
I. On the basis of the conduct of audit
1. Continuous Audit
2. Final Audit
3. Balance Sheet Audit
4. Interim Audit
5. Partial Audit
6. Occasional Audit
II. On the basis of specific objective
1. Cash Audit
2. Cost Audit
3. Management Audit
4. Special Audit
5. Operational Audit
6. Performance Audit
7. Propriety Audit
III. On the basis of degree of independence
1. Independent or External Audit
2. Internal Audit
IV. On the basis of organizational structure

1. Statutory Audit
2. Private or Voluntary Audit
3. Government Audit

I. On the basis of the conduct of audit, audit may be classified into the
following types

1. Continuous Audit: Continuous audit is an audit, where the books of

accounts are verified throughout the year, either at regular or irregular intervals
and the financial statements of the business are examined at the end of the year.
Suitability: Continuous audit is suitable for the following types of business:
1. in concerns, where the internal check system is not satisfactory.
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 Principles and Practice of Auditing V Sem B.Com

2. in big concerns, where the volume of transactions are numerous.

3. In concerns, where monthly accounts are required to be presented to the
Management

4. in concerns, where final accounts are to be published immediately after the

close of the accounting period.
Advantages of Continuous Audit:
1. Detection of errors and frauds: Auditor gets sufficient time to check all the
books of accounts in detail, in case of continuous audit. This facilitates auditor
to detect errors and frauds easily and quickly.
2. Moral check: Frequent visits of the auditor to the client’s business impose a
moral check on the accounting staff to keep the books of accounts up-to-date
and accurate.
3. Early presentation of accounts: As accounts are checked throughout year, it
becomes possible for the accountant to present the audited financial statements
to the owners of the business immediately after the close of the accounting year.

4. Valuable suggestions: In case of continuous audit, auditor gets an

opportunity to familiarize himself with all the aspects of the clients business.
This will help the auditor to give valuable suggestions for the improvement of
operational efficiency of the business.
5. Preparation of interim accounts: If the directors of a company decide to
declare an interim dividend, continuous audit will help them in preparing
interim accounts without much delay.

6. Work efficiency: As auditor has constant touch with the client's business and
sufficient time, he can plan his work properly and carry out his work more
efficiently.
Disadvantages of Continuous Audit:

1. Very expensive: Continuous audit is very expensive, as more audit fees is

required to be paid to the auditor for his continuous visits.

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 Principles and Practice of Auditing V Sem B.Com

2. Time consuming: Continuous audit involves much time. The time spent on
audit will be a sheer waste, if the size of the business is small.

3. Alteration of figures: In case of continuous audit, figures may be altered by

the dishonest accountant, after the auditor has checked the books of accounts for
a particular period.

4. Losing link in the audit work: If proper notes of the work done on previous
visits are not correctly made, the auditor may lose the link of the work and will
fail to clear up the outstanding queries

5. Monotony: As audit is carried out throughout the year in case of continuous

audit, there is the danger of the audit work becoming mechanical.
6. Inconvenience: Frequent and unexpected visits of the auditor to the client's
business may cause inconvenience to the client's staff and dislocation of clients
work.
Precautions: The disadvantages of continuous audit can be minimized, if the
auditor takes the following precautionary measures:

1. By a judicious allocation of audit work among his staff, the auditor can
prevent the audit work from becoming mechanical.

2. There should be strict instructions from the auditor to the client's staff, not to
make any alterations in the books of accounts without his knowledge.

3. The auditor should prepare a flexible audit program to prevent any loose
ends.
4. Before commencing the work at each subsequent visit, the auditor must
carefully glance over the work done at the previous visit, in order to find out the
alterations in the figures, if any.
5. The auditor should complete the checking of a book, as far as possible, in one
sitting. If that is not possible, he should complete the checking up to certain
stage and note that down. This will help him to avoid the possibility of any
omission. As continuous audit is very expensive and time consuming, it is not
widely adopted. It is more suitable for large units, which have numerous
transactions.

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 Principles and Practice of Auditing V Sem B.Com

2. Final Audit: Final audit is an audit, where the auditor takes up his work of
checking the books of accounts at the end of the accounting period, when the
transactions for the whole year are completely recorded and financial statements
have been prepared.

Suitability: Final audit is adopted by almost all concerns. This type of audit is
more suitable for small concerns.

Advantages of Final Audit:

1. Final audit is not very expensive. Therefore, more suitable for small
concerns.
2. Final audit involves less time.
3. There is no scope for the auditor may to lose the link of the work.
4. There is less danger for the audit work becoming mechanical.
5. In case of final audit, there is less scope for alteration of figures.
6. It does not cause inconvenience to the client's staff.
Disadvantages of Final Audit:

1. Auditor does not get sufficient time to check all the books of accounts in
detail.

2. In case of final audit, auditor does not impose a moral check on the
accounting staff to keep the books of accounts up-to-date and accurate.

3. It is not possible for the accountant to present the audited financial statements
to the owners of the business immediately after the close of the accounting year.
4. Auditor does not get an opportunity to familiarize himself with all the aspects
of the clients business.
5. Final audit does not help them in preparing interim accounts in time.

3. Balance Sheet Audit: Balance sheet audit is a type of audit, which

concentrates mainly on the verification of the items in the Balance sheet, such
as capital, reserves and provisions, profit and loss account balance, assets and
liabilities of the business. I may be noted that in case of Balance sheet audit,

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 Principles and Practice of Auditing V Sem B.Com

audit work commences from the Balance sheet, working back to the books of
original entry and documentary evidences.

Suitability: Balance sheet audit is quite suitable for small and medium sized
business units. It is also quite effective in those big concerns, which have a good
internal control system and qualified accountants.

4. Interim Audit: It is a kind of audit, which is done between the two annual
audits. It is suitable for those companies, which wants to declare interim
dividend.
Advantages of Interim Audit:
1. The final audit can be completed very soon, if there has been an interim audit.
2. Errors and frauds can be detected easily and quickly.
3. It imposes a moral check on the staff of the client.
Disadvantages of Interim Audit:
1. Figures may be altered in the accounts, which have already been audited.
2. Even in case of interim audit, auditor is required to take extensive notes of
the figures audited. This would increase the work of the auditor.

3. Interim audit is comparatively expensive, as it involves additional financial

burden to the organization.

5. Partial Audit: It is a kind of audit, where the work of the auditor is curtailed.
For instance, auditor may be asked to check only the cash book to detect
misappropriation of cash. It may be noted that partial audit is not permitted in
case of companies.

6. Occasional Audit: It is a kind of audit, which is not conducted on a regular

basis and it is not suitable for Joint stock companies.

II. On the basis of specific objective, audit may be classified into the
following types

1. Cash Audit: It is a type of audit under which only the cash receipts and
payments are audited in detail by the auditor. It may be noted that partial audit
is not permitted in case of companies.
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 Principles and Practice of Auditing V Sem B.Com

2. Cost Audit: Cost audit is an independent and critical examination of the

various records maintained by the company by the cost auditor to ascertain
whether cost of the product manufactured by the company have been correctly
determined in accordance with the correct costing principles.

3. Management Audit: The auditor examines the policies and the actions of the
management to ensure that there is proper and maximum utilization of available
resources.

4. Special Audit: When the affairs of the company are not being managed,
according to the sound business principles, the central government is
empowered to appoint a special auditor to audit the company's working and its
state of affairs. Such audit is known as special audit.

5. Operational Audit: It involves intelligent examination of the various

operations of the different functional areas of a business, and observing the
weaknesses, lapses, inefficiencies in operations and suggesting ways for
strengthening the system.

6. Performance Audit: Performance audit is a procedure for analysing the

profits and losses of different economic activities carried on by a business unit,
examining the relationship between production and sales and discovering the
avenues for maximizing profits.
7. Propriety Audit: Propriety audit is carried out with the objective of
ascertaining that contracts entered into with third parties are in the best interest
of the concern and there is a system, which ensures the safety of the assets of
the concern.
III. On the basis of degree of independence, audit may be classified into the
following types

1. Independent or External Audit: External auditors are independent firms

that inspect the accounts of an entity and render an opinion on whether its
statements conform to GAAP and present fairly the financial position of the
company and the results of operations. The external auditors’ primary
obligation is to users of financial statements outside the organization. External
auditors are required to register with ISO 9000.

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 Principles and Practice of Auditing V Sem B.Com

2. Internal Audit: Internal auditing considers the examination, monitoring and

analysis of activities related to a company’s operation, including its business
structure, employee behaviour and information systems. Although accounting is
an important skill for an internal auditor, the focus for internal auditors is the
evaluation of operational, risk management, internal control and the governance
processes of the organization. An internal audit is designed to review what a
company is doing in order to identify potential threats to the organizations
health and profitability and to make suggestions for mitigating the risk
associated with those threats in order to minimize costs.

IV. On the basis of organizational structure, audit may be classified into

the following types

1. Statutory Audit: Statutory audit refers to the audit of accounts of a business

unit compulsorily under the provisions of a statue or law. Further, statutory
audit is carried out in number organizations, such as, Joint stock companies,
Banking companies, Insurance companies etc.
Features of Statutory Audit:
1. Statutory audit is compulsory under law.
2. It is an independent audit.
3. It is an external audit.
4. It can be complete audit or full audit. It cannot be partial audit.

5. Statutory auditor is required to serve the interest of the owners and not the
interests of the management.

6. The rights, duties and liabilities of an auditor are governed by statute.

Therefore, they cannot be curtailed or restricted.
7. It should be conducted by the qualified auditor.

2. Private or Voluntary Audit: Where the audit is not compulsory under any
statue, but is undertaken by the owners voluntarily to get the benefits of audit,
such audit is known as private or voluntary audit. Further, the organizations,
which adopt private audit, are: sole trading concerns, partnership firms and
other individuals.

19 Prepared by,
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 Principles and Practice of Auditing V Sem B.Com

3. Government Audit: Government audit refers to the audit of accounts of

government departments and offices, government companies and statutory
corporations.
Features of Government Audit:

1. Government audit is undertaken either by the comptroller and auditor general

of India and his staff or professional chartered accountants approved by the
comptroller and auditor general of India.
2. Government audit can be considered as an internal audit.
3. It is a sort of continuous audit, as it is conducted continuously throughout the
year.

4. Government auditor checks the existence of stocks and stores and their
valuation and ensures that there is proper system of stock taking.

5. He also examines whether the payment has been sanctioned by the competent
authority and such payment is not excessive and it is made to the right person.
6. He makes suggestions to the proper authority for improvements in the rules
and regulations for greater efficiency and economy.
Relationship of audit and other disciplines:

The field of auditing as a discipline in simple words involves review of

various assertions; both in financial as well as in non-financial terms, with a
view to prove the veracity of such assertions and expression of opinion by
auditor on the same. Thus, it is quite logical and natural that the function of
audit can be performed if and only if the person also possesses a good
knowledge about the fields in respect of which he is conducting such a review.
1. Auditing and Accounting: It has been pointed out earlier that both
accounting and auditing are closely related with each other as auditing
reviews the financial statements which are nothing but a result of the overall
accounting process. It naturally calls on the part of the auditor to have a
thorough and sound knowledge of generally accepted principles of
accounting before he can review the financial statements. In fact, auditing as
a discipline is also closely related with various other disciplines as there is
lot of linkages in the work which is done by an auditor in his day-to-day

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 Principles and Practice of Auditing V Sem B.Com

activities. To begin with, it may be noted that the discipline of auditing itself
is a logical construct and everything done in auditing must be bound by the
rules of logic. Ethical precepts are the foundations on which the foundation
of the entire accounting profession rests. The knowledge of language is also
considered essential in the field of auditing as the auditor shall be required to
communicate, both in writing as well as orally, in day-to-day work.

2. Auditing and Law: The relationship between auditing and law is very close
one. Auditing involves examination of various transactions from the view
point of whether or not these have been properly entered into. It necessitates
that an auditor should have a good knowledge of business laws affecting the
entity. He should be familiar with the law of contracts, negotiable
instruments, etc. The knowledge of taxation laws is also inevitable as entity
is required to prepare their financial statements taking into account various
provisions affected by various tax laws. In analysing the impact of various
transactions particularly from the accounting aspect, an auditor ought to have
a good knowledge about the direct as well as indirect tax laws.

3. Auditing and Economics: As, it is well known, accounting is concerned

with the accumulation and presentation of data relating to economic activity.
Though the concept of income as put forward by economists is different as
compared to the accountant’s concept of income, still, there are lot of similar
grounds on which the accounting has flourished. From the auditing view
point, the auditors are more concerned with Micro economics rather than
with the Macro economics. The knowledge of Macroeconomics should
include the nature of economic force that affect the firm, relationship of
price, productivity and the role of Government and Government regulations.
Auditor is expected to be familiar with the overall economic environment in
which his client is operating.

4. Auditing and Behavioural Science: The field of auditing as a discipline

involves review of various assertions; both in financial as well as in non-
financial terms, with a view to prove the veracity of such assertions and
expression of opinion by auditor on the same. Thus, it is quite logical and
natural that the function of audit can be performed if and only if the person
also possesses a good knowledge about the fields in respect of which he is

21 Prepared by,
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 Principles and Practice of Auditing V Sem B.Com

conducting such a review. The discipline of behavioural science is closely

linked with the subject of auditing. While it may be said that an auditor,
particularly the financial auditor, deals basically with the figures contained
in the financial statements but he shall be required to interact with a lot of
people in the organisation. As against the financial auditor, the internal
auditor or a management auditor is expected to deal with human beings
rather than financial figures. One of the basic elements in designing the
internal control system is personnel. Howsoever, if a sound internal control
structure is designed, it cannot work until and unless the people who are
working in the organisation are competent and honest. The knowledge of
human behaviour is indeed very essential for an auditor so as to effectively
discharge his duties.

5. Auditing and Statistics & Mathematics: With the passage of time, test
check procedures in auditing have become part of generally accepted
auditing procedures. With the emergence of test check procedure, discipline
of statistics has come quite close to auditing as the auditor is also expected to
have the knowledge of statistical sampling so as to arrive at meaningful
conclusions. The knowledge of mathematics is also required on the part of
auditor particularly at the time of verification of inventories. The use of data
analytics is advancing rapidly in auditing where many organizations are
using continuous auditing and continuous monitoring of data to identify risks
as part of their system of internal control.

6. Auditing and Data Processing: Today, organisations are witnessing

revolution in the field of data processing of accounts. Many organisations are
carrying out their financial accounting activities with the help of computers
which can document, record, collate, allocate and value accounting data and
information in very large quantity at very high speed. The dependence on the
accuracy of the programmed instructions given today, the computer is able to
carry out each of these activities with complete accuracy. With such a
phenomenal growth in the field of computer sciences, the auditor should
have good knowledge of the components, general capability of the system
and the related terms. In fact, Computerised Information System auditing in
itself is developing as a discipline in itself.

22 Prepared by,
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 Principles and Practice of Auditing V Sem B.Com

7. Auditing and Financial Management: Auditing is also closely related with

other functional fields of business such as finance, production, marketing,
personnel and other general areas of business management. With the
overgrowing field of auditing, the financial services sector occupies a
dominant place in our system. While in general terms, the auditor is expected
to have knowledge about various financial techniques such as working
capital management, funds flow, ratio analysis, capital budgeting etc. The
auditor is also expected to have a fair knowledge of the institutions that
comprise the market place. The knowledge of various institutions and
Government activities that influence the operations of the financial market
are also required to be understood by an auditor.

8. Auditing and Production: Regarding production function, it may be stated

that a good auditor is one who understands the client and his business. While
carrying out the audit activity, the auditor is required to evaluate transactions
from the accounting aspect in relation to the process through which it has
passed through as accounting for by-products; joint- products may also
require to be done. The knowledge of production process shall become more
essential in case of an internal auditor. The auditor shall also require
understanding the cost system in operation in the factory and assessing
whether the same is adequate for the particular company. The understanding
of the terminology of the production shall enable an auditor to communicate
with production employees in connection with his work. On the similar
pattern the auditor is also expected to have good understanding about the
marketing, personnel and other general business management areas.
Multiple choice question (MCQ)
1. What is the primary purpose of an audit?
[a] To maximize profits
[b] To ensure regulatory compliance
[c] To detect fraud
[d] To provide assurance on financial statements
Answer: [d]

23 Prepared by,
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 Principles and Practice of Auditing V Sem B.Com

2. Which type of audit is conducted by an independent auditor to express an

opinion on the fairness of financial statements?
[a] Internal audit
[b] External audit
[c] Tax audit
[d] Operational audit
Answer: [b]
3. Which of the following is NOT a key principle of auditing?
[a] Independence
[b] Integrity
[c] Objectivity
[d] Profit maximization
Answer: [d]

4. Which audit procedure involves examining a sample of transactions to assess

their accuracy and completeness?
[a] Analytical review
[b] Substantive testing
[c] Compliance testing
[d] Risk assessment
Answer: [b]
5. What is the primary focus of a performance audit?
[a] Financial statement accuracy
[b] Compliance with laws and regulations

[c] Effectiveness and efficiency of operations

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 Principles and Practice of Auditing V Sem B.Com

[d] Detection of fraud

Answer: [c]
6. Who typically hires an external auditor to perform an audit of a company's
financial statements?
[a] The company's management
[b] The company's shareholders
[c] The external auditor themselves
[d] The government
Answer: [b]
7. Which of the following is an example of an operational audit?
[a] Reviewing payroll records for accuracy
[b] Evaluating the efficiency of a manufacturing process
[c] Confirming compliance with tax laws
[d] Assessing the reliability of financial statements
Answer: [b]

8. What is the primary difference between a financial statement audit and a

compliance audit?
[a] The timing of the audit
[b] The scope of the audit
[c] The qualifications of the auditor
[d] There is no difference; they are the same
Answer: [b]

9. What is the primary purpose of an audit notebook or working papers in the

auditing process?
[a] To record personal notes of the auditor

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 Principles and Practice of Auditing V Sem B.Com

[b] To provide evidence of the audit work performed

[c] To list the auditor's qualifications
[d] To serve as a journal for financial transactions
Answer: [b]

10. Which of the following is NOT a common type of working paper used in
auditing?
[a] Audit program
[b] Trial balance
[c] Analytical review
[d] Bank reconciliation
Answer: [b]

26 Prepared by,
Pooja A R (Lecturer, VVFGC)