Ministry of higher education

Kandahar university
Economics faculty

Auditing
Principles and practice
Instructor: Mohammad Idrees Rounaq

M.I.R 1
Introduction to Auditing ( ‫) د بررسي او کنترول پیژندنه‬

• The term ‘Audit’ is derived from the Latin (Audire), which

literally means. “to hear”.

• This practice was known to have existed in the ancient

Egyptian, Greek, and Raman civilizations.

M.I.R 2
 Definitions of Audit: )‫)د بررسي او کنترول تعريفونه‬
1. An audit may be said to be such an examination of the books,
accounts and vouchers of a business, as shall enable the auditor to
satisfy himself whether the Balance Sheet is properly drawn up, so
as to give a true and fair view of the state of affairs of the business,
and that the profit and loss account give a true and fair view of the
profit or loss for the financial period, according to the best of his
information and the explanations given to him as shown by the
books; and if not, in what respect he is not satisfied?

(Spicer and Pegler)

M.I.R 3
2. Auditing may be defined as an intelligent and critical scrutiny

of the books of account of a business with the documents and

vouchers from which they are written up, for the purpose of

ascertaining whether the working results for a particular period

as shown by the profit and loss account and also exact financial

condition of the business as reflected in the Balance Sheet are

truly determined and presented by these responsible for their

compilation. (J.R Batliboi)

M.I.R
3. An audit is an examination of accounting records
undertaken with a view to establishing whether they
correctly and completely reflects the transactions to which
they purport to relate.

(Lawrence R. Dicksee)

M.I.R 5
4. An audit is an examination of such records to
establish their reliability and the reliability of
statements drawn from them.
(A.W.Hanson)

M.I.R 6
5. An audit denotes the examination of Balance Sheet and profit
and loss account prepared by others together with the books,
accounts and vouchers relating thereto in such a manner that
the auditor may be able to satisfy himself and honestly report
that, in his opinion, such Balance Sheet is properly drawn up so
as to exhibit a true and correct view of the state of affairs of a
particular concern according to the information and
explanations given to him and as shown by the books.

(F.R.M. De Paula)
M.I.R 7
6. Auditing is a systematic examination of the books and
records of a business of other organization, in order to
ascertain of verify to report upon the facts regarding its
financial operation and the result therefore.
(Montgomery)

M.I.R 8
According to auditing and assurance standard 1 (AAS1)
:‫د برسی اوکنټرول او د تضمین د معیار له آنده‬

• ‘Basic principles Governing an Audit’, issued by ICAI:

• “An audit is the independent examination of financial

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

M.I.R 9
 Essential characteristics of Auditing
:‫د برسی او کنټرول مهمی ځانګړتیاوی‬
1. Audit is an independent, scientific, intelligent and critical
examination of the books of account or accounting records of a
business.

2. Such examination enables the auditor to satisfy himself that the

financial statements have been properly drawn up, and exhibit a
true and fair view of the financial state of affairs of the business
for the accounting period.

M.I.R 10
Continue…

3. Detection of errors and frauds is an integral part of auditing.

4. The job of auditing is performed by an independent person or

body of persons qualified for the job.

M.I.R 11
5. In order to report on the financial health of the business, the
auditor has to go through vouchers and other related
documentary evidence (both internal as well as external).

6. The auditor has to satisfy himself about the correctness,

authenticity, and reliability of accounting information and
submit his report accordingly.

M.I.R 12
Comparison between auditing and accounting :
.‫د برسی او کنټرول او محاسبې مقايسه‬

1. Accounting : is the process of recording, classifying, and

summarizing business transactions in monetary terms.
Accounting aims at providing financial information for
decision making.

M.I.R 13
The person who performs this function is called
accountant. His job includes:

a. Recording business transactions in monetary terms

b. Classifying and summarizing them
c. Preparing financial statements
d. Communicating the final information in a summary
form to management and other users to make decisions.

M.I.R 14
Continue…

2. Auditing: “Auditing begins where accounting ends.”

this implies that an auditor comes into the picture only
when the accountant has done his job.

• The auditor has to determine whether the recorded

information properly reflects the economic events that
occurred during the accounting period.

M.I.R 15
The main points of difference between accounting and
auditing may be summarized as bellow:
:‫د برسی او کنټرول او محاسبې تر منځ د توپیر اصلی نقطی په الندي ډول خالصه سوي دي‬

1. Subject matter: Accounting is concerned with

collection, classification, and summarization of economic

events in a logical manner for the purpose of providing
financial information for decision-making . Auditing on the
other hand, is concerned with examination or review of
financial information so furnished.

M.I.R 16
2. Object: the object of accounting is to know the trading
results of a business. Whereas the object of audit is to judge the
correctness and reliability of financial statements.

3. Hierarchy: Auditing begins where accounting ends. There

can be no auditing without the prior existence enterprise.

M.I.R 17
4. Nature: Accounting is constructive in nature as it measure
business events in term of profit or loss and communicate the
financial condition of the business. Auditing on the other hand,
is referred as analytical and critical aspect of accounting.

5. Expertise required: an accountant may not be

comfortable with audit techniques and procedures, but the audit
must be well versed with the principles and techniques of
accounting.

M.I.R 18
6. Process: accounting is a four-step process that involves:
a. collection and record,

b. classification,

c. summarization and communication of accounting information.

d. and results thereof.

M.I.R 19
Auditing, on the other hand, includes three principal steps, viz
a. preliminary planning,
b. performing the audit work, and
c. reporting the findings.
However, separation of these steps is not always clear.

viz.,(that is or in other words ‫)لکه یا په بل عبارت‬

M.I.R 20
 Objectives of audit
‫د برسی او کنټرول اهداف‬

1. Primary objectives.

2. Secondary objectives.

3. Specific objectives.

M.I.R 21
1. Primary objective : ‫لومړنی اهداف‬

• Expression of independent opinion on accounts: in auditing

accounting data, the main concern is to determine whether
the recorded information appropriately reflects the
economic events that occurred during the period.

M.I.R 22
The main objectives of the audit are known as the primary
objectives of audit. They are as follows:
1. Examining the system of internal check.
2. Checking arithmetical accuracy of books of accounts,
verifying posting, casting, balancing etc.
3. Verifying the authenticity and validity of transactions.
4. Checking the proper distinction between capital and
revenue nature of transaction.
5. Confirming the existence and value of assets and liabilities.

M.I.R 23
2. Secondary objectives : ‫دوهمی اهداف‬:

As discussed above, an auditor has to examine the books of

account and relevant supporting documents with a view to
express his opinion on the financial state of affairs of the
company. Certain error and frauds may be discovered.

A. detection and prevention of errors ‫د غلطیو کشف او مخنیوی‬:

the term ‘error’ in accounting refers to unintentional
misstatement of a fact. Error are normally accidental and of
various types. Which are discussed below:

M.I.R 24
 Types of errors: ‫د تقصیر(غلطیو) ډولونه‬

1.Clerical errors :‫دفتری غلطیانی‬ these are the

error which arise due to negligence on the part of the
clerical staff in the ordinary course of business.
These are of five steps:
I. Error of omission: ‫ د غفلت په اساس را منځته شوی غلطیانی‬these
occur on account of transactions not being recorded in the
book of account either wholly or partially.
II. Error of commission: ‫ د کمیسون اړوند غلطیانی‬these consist of
incorrect additions, wrong posting and entries. Some of
the example of these are:

M.I.R 25
➢ Error in additions, carry forwards in the books of original
entries or ledgers.

➢ Errors or incorrect posting such as debit amount posted to

credit, wrong amount posted to an account, and amount
posted twice, omission to post an amount from a book of
original entry to the ledger.

➢ Errors in taking out balances of the ledger accounts.

M.I.R 26
Continue…

III.Compensating error: ‫د معاویضی یا جبران او غرامت وړ غلطیانی‬

these are the error which counter-balance each other
in such a manner that there are remains no difference
between two sides of the trial balance. For example, a
cash sale of $1000 may be recorded in the cashbook,
as $100, whereas another cash sale of $100 may be
recorded as $1000. therefore the trail balance would
still agree.

M.I.R 27
III.Error of duplication: ‫تکرار غلطیانی‬
errors of duplication arise when and entry in a book of original
records has been made twice. Or/and due to double posting of
a journal entry in ledger accounts.

III. Trail balance errors: ‫د ازمایښتی بیالنس اړوند غلطیانی‬

these may be consist of casting errors in the trail balance ,
omission of a balance while extracting balance from the
books of account, or entering an amount incorrectly or on
the wrong side.

M.I.R 28
2. Errors of principle: ‫اوصولی غلطیانی‬

• Error of principle are those which result from miss-

application of or overlooking accounting principles.

M.I.R 29
They are three types:
i. Incorrect allocation: ‫غلط تخصیص‬ this occurs when the

distinction between revenue and capital is not strictly

maintained, e.g., capital expenditures charged to revenue and
vice versa.
ii. Omission of outstanding assets and liabilities: these arise
when prepayments are ignored and the amount charged from
the profit and loss account and outstanding expenses in
respect of rent, salaries, commission, etc. are ignored and not
accounted for.
M.I.R 30
Continue…. Error of principle.
iii. Incorrect valuation of asset: ‫ دشتمنی غلطه ارزونه‬this occurs
when, for example, fixed assets are not valued at cost less
depreciation, closing stock is not valued at cost or market price,
whichever is lower.

kinds of errors also fall in this category

a. Excess or inadequate provision for depreciation

b. Excess or wrong provision for bad debts

c. Overvaluation or undervaluation of closing stock, etc.

M.I.R 31
Location of errors. ‫د غلطی محل يا ځای‬

To locate errors and discover the difference in the trial balance, the
auditor should take the following steps.

Trial balance checking: ‫د ازمایښتی بیالنس کتل‬

i. Check casts of the trial balance, lists of debtors and creditors.
ii. Establish the amount of difference.
iii. Check balances from personal and impersonal ledger into the trial
balance.
iv. While checking the balances, care must be taken to ensure that the
closing balances are correctly entered in the right column.

M.I.R 32
 Short-cut method: ‫لنډه طريقه‬

i. Look for an item of half that amount which might have been entered on the
wrong side.

ii. If the difference is divisible by nine, it may mean an error of transposition of figures (
e.g., 69 written as 96 or 86 written as 68 etc.)

iii. If the difference is a round figure, it is probable that the mistake has been made in totals
of trial balance or carry forward of its figures.

iv. If the difference is that of a large amount, it is advisable to compare the trial balance
with the previous year’s, in order to ascertain whether the figures under the different
heads of account are very near to the same as those of the pervious year, and whether
the balances fall on the same side of the trial balance.

v. If the differences happens to be of an amount which constantly recurs in the books, all
postings of this amount is to be checked.

M.I.R 33
 Extensive checking : ‫پراخه کتنه‬

if all the above shortcuts do not result in locating the difference, the
following work should be done:

i. Ascertain that all opening balances have been correctly brought forward
in the current year’s book.

ii. check casts, cross casts and carry forward of the various books of original
entries and ledgers.

iii. If the ledgers were self-balancing, the work would be restricted to

checking the balances, posting and casts of only that ledger the trial
balance of which does not agree.

M.I.R 34
 Extensive checking… ‫پراخه کتنه‬
iv. The journal and subsidiary books should be scrutinized to see that the total
debits and credits of each entry tally and there were no unticked items.

v. The posting from the various subsidiary books should than be checked into
the impersonal ledger.

B. Detection and prevention of fraud: ‫د درغلی کشف او مخنیوی‬

The term ‘fraud’ may be defined as internal irregularities aimed at cheating

or causing injury to another. As opposed to error. Frauds are intentional.

Fraud are also committed by two or more persons.

M.I.R 35
 Forms of fraud: ‫د درغلی شکلونه‬
1. Misappropriations and defalcations:

2. misrepresentation of accounts
1. Misappropriations of defalcations ‫ غلطه استفاده او اختالس‬:
i. Embezzlement of cash ‫ دپیسو اختالس‬: embezzlement of cash refers to falsification or
misappropriation of cash, which is very common especially in case of big business concern, as
the proprietor has very little control over the receipts, and payments of cash. Cash may be
misappropriated in a number of ways as follows:

• By omitting to enter receipts.

• By entering fictitious payment:

a. Under casting the receipt side of cashbook by entering fewer amounts than what has been
actually received

b. Overcasting the payment side of the cashbook by entering excess amount.

M.I.R 36
Continue…. Misappropriations and defalcations:

ii. Misappropriation of goods further, ‫ د اجناسو څخه غلطه استفاده‬: fraud

may also be committed through misappropriation of goods, it is very
difficult to detect misappropriation of goods, which is very common
especially when good are not bulky and are of higher value. Such
detection can be possible only if proper records of stock inward and
outward are maintained.

M.I.R 37
 2. Misrepresentation of accounts ‫ د اکاونټ غلطه راپور ورکونه‬:
• The accounts of a firm may be falsified or manipulated by making false
entries. This type of fraud usually involves very large amount and cannot be
detected easily by the auditors because it is usually committed by those
responsible persons who are in top management, viz.,Director, Managers,
etc.
accounts can be falsified by various means. Some of the tools are as under:
• Undervaluation and overvaluation of closing stock and other assets.

• Overvaluation and undervaluation of liabilities.

• Creating excess or less provision for depreciation or not providing for depreciation.

M.I.R 38
Continue…

• Charging capital expenditure to revenue and vice versa.

• Providing for excess or less doubtful debts.
• Writing off excess or less bad debts.

Basically there are two different objects behind the manipulation

of accounts done through the above-mentioned devices.

Firstly, showing more profit than the actual ones so as to earn more
commission on profits when payable on the basis of performance
and to win the confidence of shareholders by claiming that the firm
is able to generate high profit under their leadership.

M.I.R 39
Continue…
• Secondly, showing less profit than the actual ones so as to
mislead income tax authorities and to buy-back shares in the
open market at lower price besides cheating shareholders by
declaring less dividend and to conceal the true position of state of
affairs of the business.

A brief description of both is given as follows:

i. Window dressing: when accounts are prepared in such a

manner that they seem to indicate a much better and sound
financial position of the business enterprise, it is known as
‘window dressing’. The principal objectives behind window
dressing are as follow:

M.I.R 40
i. Window dressing…
• To attract potential investors to subscribe for the shares in
order to procure further capital.

• To obtain further credit.

• To enjoy better reputation in the market by showing more

sound financial position than in actual term.

• To win the confidence of shareholders.

• To arise the price of shares (i.e., artificially) in the market by

paying higher dividends.

M.I.R 41
i. Window dressing…
ii. Secret reserves: ‫پټی زیرمی‬ when account are prepared in such a
manner that they seem to disclose worse financial position of the
company than actual ones, it is known as ‘secret reserve’ thus the real
picture of the business is concealed and a distorted picture is revealed.

The main objectives behind showing less profit than actual ones are:

• To avoid or reduce income tax liability.

• To buy back shares from the open market through reducing the price of
shares by paying less or no dividends.

• To conceal the true position of company’s state of affairs from the

competitors.

M.I.R 42
 3. Specific Objectives of Audit
‫د تفتیش او کنترول خاص اهداف‬
1. Review of cost.
2. Operations.
3. Efficiency.
4. Management.
5. Tax Liability
6. To provide information to income tax authority.
7. To satisfy the provisions of the companies Act. And…
8. To have a moral effect, etc. which fall under the purview of Audit.

M.I.R 43
 Qualification and qualities of an auditor
‫د برسی کوونکي صالحیت او کیفیت‬
• An auditor must be professionally qualified, and should possess certain
traits and qualities discussed bellow:

1. Knowledge of accounting ‫ په اکاونټنګ پوهاوی‬: audit, begin primarily and

examination of the accounting data, cannot exist independent of
accounting. An auditor, therefor, must possess thorough knowledge of
accounting to carry out and audit effectively.

2. Knowledge of theory and practice of auditing and relevant laws:

He should possess thorough knowledge of theory and practice of auditing. He

should have mastery in his field. And he should be familiar with the relevant
laws of country.

M.I.R 44
Qualification and qualities of an auditor…
3. Intelligent and tactfulness

4. Responsible and prudent

5. Familiar with the latest development/amendments

affecting audit

6. Integrity: an auditor should be honest and possess high

moral standard.

M.I.R 45
Qualification and qualities of an auditor…
7. Objectivity, independency and transparency

8. Vigilance: an auditor should be vigilant and cautious.

9. Positive attitude and reliance upon client’s staff

10. diligence(‫)زیارکش‬

11. Confidentiality and loyalty

12. Communication skills

M.I.R 46
Advantages of audit… ‫ د برسی او کنټرول ګټی‬:
some of the important advantages associated with auditing
are given bellow:

1. Detection and prevention of errors and fraud become easier

2. Auditing accounting information: greater reliability and

authenticity

3. Acceptability by authorities

4. Professional advice available

5. Speedy processing of loan

M.I.R 47
Continue….. Advantages of audit
‫د برسی او کنټرول ګټی‬
6. Settlement of disputes
7. Facilitates calculations of net worth and goodwill of
business
8. Settlement of insurance claims
9. Useful to compare the financial performance
10. Keeps accounts department vigilant
11. Identifies the week areas

M.I.R 48
 Limitations of audit :
‫د برسی او کنټرول محدوديتونه‬
• Sometimes accountable officer does not give true and correct
information to auditor, then the auditor report will never show
a true and fair view.

• Influence of management is another major limitation of audit.

M.I.R 49
Generally following are the limitations of auditing
1. Non-detection of errors/ frauds.

2. Dependence on explanation by others.

3. Dependence on opinions of others.

4. Conflict with others.

5. Effect of inflation.

6. Corrupt practice to influence the auditors.

7. No assurance.

8. Inherent limitations of the financial statements.

9. Detailed checking not possible.

M.I.R 50
 A critical appraisal of auditing
‫د برسی او کنټرول انتقادي یا قطعي ارزونه‬

a question often arises in the minds of business people

whether auditing is a luxury or necessity. They frequently
comment that accounting is a necessity while auditing is
wastage of resources.

M.I.R 51
 The expenditure on accounting can be
justified on the following grounds:

1. Large number of unrecorded transactions cannot be

recalled by businessmen for a long time. Therefor, business
transactions are recorded in books of account to
remember them.

2. It is quite necessary for a businessman to know the correct

profit, which only the written records can furnish.

M.I.R 52
3. Accounting reflects the financial position of a business on a
given date.
4. Written records are necessary to know the debtors and
creditors of the organization.
5. Written accounting records are the source of documentary
evidence in case of a legal dispute.
6. Accounting records facilitate valuation of goodwill.
7. Written accounting records are needed to measure the

productivity and growth of a business.

M.I.R 53
8. Written records furnish the required data to calculate the
tax liability and facilitate revenue authorities in this regard.

9. Comparative study of two accounting periods of various

firms can be done only with the help of written accounting
records.

10. Loans can be easily granted on the basis of financial

position of the enterprise as reflected by accounting records.

M.I.R 54
 Arguments against auditing
‫د برسی او کنټرول په وړاندی استـدالل‬
Auditing may be a luxury in the opinion of business on the
basis of following arguments:

1. The remunerations payable to the auditor unnecessary

burdens the profit and loss account and reduces the net
profit.

2. Too many formalities attached to auditing create difficulties

for the accounting staff of the client.

M.I.R 55
Arguments against auditing…
3. The entrepreneurs take auditing as a means of wastage of time
and creating obstructions in the smooth functioning of business.

4. Audit is not a foolproof method of detecting errors and frauds.

5. Management being appointing authority may influence the

auditor. He may attempt to safeguard the interest of the Board
of Director and the management instead of working as
financial police force. Therefore, sometimes he is unable to

prevent the misuse of power and other financial irregularities.

M.I.R 56
 Arguments in favor of auditing
‫د برسی او کنټرول ګټو ته متوجه داليل‬

Tough, auditing has certain limitations but it would be

irrational to consider auditing a waste of resources or
redundant. Auditing offers numerous advantages. Auditing
may be luxury for small entrepreneurs but for a large and
complex business organizations, it is a necessity for the
undermentioned reasons.

M.I.R 57
1. Audited accounts carry a greater reliability and authenticity
in comparison of unaudited ones.

2. Audit helps to detect and prevent the errors and frauds.

3. Auditor can render his advice and opinion to the

management for improving the performance of the
enterprise.

M.I.R 58
Arguments in favour of auditing …
4. A regular audit of accounts keeps the accounts department
not only up-to date but careful and vigilant as well.

5. Audit safeguard the interest of the investors, owners,

employees, financial institutions, creditors and the
management.

6. Public funds invested in private sector need to be thoroughly

examined so as to ensure their optimum utilization. This is
possible through auditing only.

M.I.R 59
 Scope of audit
‫د برسی او کنټرول ساحه‬
As per statement on ‘auditing and assurance standard 2 (AAS2)
the scope of audit is mentioned below:
The scope of audit is determined by the auditor, having regard to:
a. The terms of the engagement;

b. The requirement of the various legislation;

c. the audit should adequately cover all the aspects of the enterprise, which
are relevant to the financial statements under audit.

d. He should also see that the disclosure of information is as per the legal
requirements, if any.

M.I.R 60
 Scope of audit…
The reliability and sufficiency of the information will be assessed by:

a. Study and evaluation of the accounting systems and internal

control s which are to be relied upon so as to decide the
nature, extent and timing of audit procedures; and

b. Carrying out other necessary tests, enquires, and verification

procedures.

M.I.R 61
Continue…
Property of disclosure of information in the financial statements will
be determined by:

a. Examining whether the financial statements properly

summarize the transactions and events recorded in the
accounting records.

b. Considering the management’s judgments as regards

preparation of financial statements which will involve an
assessment of selection and application of Accounting
policies, the manner of classifications of information, and
adequacy of disclosure.

M.I.R 62
 Independence of the auditor
‫د برسی او کنټرول د استازي يا څېړونکي خپلواکی‬
• The concept of ‘independence’ refers to the necessity of the
auditor being not under the influence of his client or
appointed authority.

• Expression of “Independent Opinion” on financial statements

by appointed auditor is the most basic objective of an auditor.

M.I.R 63
An auditor may also render his services in other areas
of work , such as:
➢ provision of accounting services.
➢ Advising the clients on taxation matters.
➢ Management consultancy.
➢ Financial advice.
➢ Investigation, etc.

M.I.R 64