~AUDITUNIT 4) Chap apter lryB BA introduction to Auditing Vv = The term ‘Audit’ is derived from the Latin audire, which literally means, “to hear” Tn the olden days whenever the proprietor of a business enterprise would suspect a fraud, some independent persons were appointed to hear verbal explanations from those responsible for keeping the books of account, judge the facts, and thereafter on the basis of their examination announce the results of the enterprise to the owner(s). This practice was known to have existed in the ancient Egyptian, Greek, and the Roman civilizations. Scope of audit was quite Timiled as during those days most businesses” were small and owner-operated. Since these owners-managers had extensive first-hand knowledge of the business and its operations, they had little need for independent audit) The owners were chiefly interested in ascertaining whether all cash receipts and payments had been properly accounted for and checking the records for possible employee fraud. Put differently, initially, the aim of audit was to know whether any cash had been embezzled end if so, who embezzled it and what amount was involved. But as the businesses grew both in size and complexity, the owners found it more difficult to maintain complete knowledge of all aspects of their business. Especially, since the birth of a company form of business organization, a need was felt to appoint an independent authority whe would examine the company's affairs on. behalf of the shareholders, whe have no hand in actual running of the business. Consequently. there arose a demand for independent auditors to examine business undertakings’ financial statements and to report on their correctness. The scope of (financial) audit, therefore, as it exists today, cannot be confined to cash verification. The principal object of independent financial! audit is to report on the financial position of s business undertaking as depicted by its balance sheet and profit and loss account where’ detection of errors ‘ind frauds is an incidental object. Thus, over a period of time, the work of independent financial auditors switched in emphasis from searching for just errors and frauds to judging the fairness in presentation of financial statements DEFINITION OF AUDIT Tt is bit difficult to give a single and precise definition of the term ‘audit’, Many well-known authors have defined it and everyone of them attempted to highlight one aspect or the other. Nevertheless, for the purpose of our understanding of the subject, dinggean 2y 2 we may rel on the \_ Abaditing is a systematic examination of the bo ‘A special committee ‘Audit’ in the Acco Principles and Practice —— aaa « given bY distinguished authorities giv fer to some of the definitions of “audit qunts and vouchers Of rbject: Balance Shee! 1s such an examination of the books, accoun the auditor to satisfy hmsell wheter oe ints, ‘a true and fair view of the atate of affai eae ‘rue and foir view Of the profit os Fr formation and the explanations the is not satisfied. _ Spicer and Pegler of the books of account ich they ave written UP, for the yeriod as shown the business 05 cose responsible ‘An audit may be said to be a business, as shall enable properly drawn up, 30 as to xive pnd that the Profit and Loss account gives @ the financial period, according to the best of his in to Im as shown by the books; and if not, in what respec ‘Auditing may be defined as an intelligent ond a critical scrutiny Of a business with the documents and vouchers from wh purpose of ascertaining whether the working resulis for a particular P by the Profit and Loss Account and also the exact financial condition of reflected in the Balance Sheet are truly determined and presented by th for their compilation. | — JR. Batlibor unting records-underraken with a view 10 ictions to which ‘Ay audit is an examination of acco etely reflect the transac U'etabtishing whether they correctly ond comp they purport to relate. — Lawrence R. Dicksee “An audit is an examination of such records tg establish their reliability and the reliability of statements drawn from them. — A.W. Hanson fa Balance Sheet and Profit and Loss Account prepared by others together with the books, accounts and vouchers relating there in crcl a manner that the auditor may be able;to satisfy himself and-honestly report thet, 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. Gnd explanations given to him and as shown by the books ‘An audit denotes the examination of — FRM. De Paula cks and records of a business or other “organization, in order to ascertain or verify fo report upon the facts regarding its financial operation and the result thereof. ; — Moutgomery of the American Institute of Accountants h# defined the term ting Research Bulletin No. $ a3 iollows: “() An examination of a claim for payment or credit and of supporting evidence for the purpose of determining whether the expenditure is properly authorized, wy hae been duly made, and how it should be treated in the accounts of the payer—hence ‘audited voucher’. (i) An examination of similar character and purpose of an account purporting & deal with actual transactions only, such as receipts and payments ete, Comparison between Auditing and Accounting ™~ Chapter 1_Introduction to Auditing 3 (iii) By extension, an examination of accounts which purport to reflect not only actual transactions but valuations, estimates, and opinions for the purpose of determining whether the accounts are properly stated and fairly reflect the matters with which they purport to deal (iv). An examination intended to serve as a basis for an expression of opinion regarding the fairness, consistency and conformity with accepted accounting principles, of statements’ prepared by a corporation or other entity for publication—in this case, more generally’ called ‘examination’ According to Standard on Auditing (SA) 200 (Revised), Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, issued by the Institute of Chartered Accountants of India (ICA): “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.” To conclude, auditing as such (i.e. in relation to financial information) may be defined as “checking somebody else’s accounting and reporting thereon.” ESSENTIAL CHARACTERISTICS OF AUDITING From the foregoing discussion, it is clear that: 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 beer properly drawn up, and exhibit a true and fair view of the financial state of affairs of the business for the accounting period 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. 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. Many financial information users and members of the public often think of auditing as being part of accounting. The confusion results because most auditing is concerned with accounting information (i.e., examination thereof) and almost all auditors are accountants also, Giving the title “chartered accountants” to individuals performing a major portion of the audit function increases the confusion. Therefore, in order to understand the true nature and role of auditing as a discipline, one must know how auditing is different from accounting besides what relationship it maintains with thé latter.information for decision making, The person wh accountant. His job includes following 4 = AUDITING: Principles and Vracuce - ,, classify’ Accounting Accounting is the process of reconlings _classily ; iermis Accounting aims business transactions in monetary terms. Ac C viding f : ho performs this function is called ay, ing,and summarizing at. providing financia) (a) Recording business transactions in monetary terms (b) Classifying and summarizing them (c) Preparing financial statements (@) Communsicating the final information in a summary form to management and other users to make decisions. Auditing ‘Auditing begins where accounting ends. This implies that an auditor comes into the picture only when the accountant has done his job. While auditing accounting data; the auditor has to determine whether the recorded information properly reflects the economic events thal occurred during the accounting period. Thus auditing is basically a review function. An auditor examines the final product of the accounting system and, on the basis of his examination and audit evidence, accumulated by him, expresses (through a formal repott) his impartial opinion—whether the. accounting information is properly recorded and fairly reflects the state of affairs of firm's business. From the above discussion, it should be clear that auditing is not a part or subset of accounting; albeit the two maintain a close relationship. Auditing, being primarily a review of accounting information, a thorough knowledge of accounting is a prerequisite to carry out an audit effectively. This, however, does not mean that to be an effective auditor, the person concerned should involve himself in the process of accounting for, in that case; the audit cannot be an independent assessment. In the words of Mautz and Sharaf, “The relationship of auditing to accounting is close, yet their nature are very different; they are business associates, not parent and child ...”. The main points of difference between accounting and auditing may be summarized as below: 4. Subject matter Accounting is concerned with collection, classification, and summarization of economic events in a logical manner for the purpose of providing financial information fer decision-making. Auditing, on the other hand, is-concerned with examination or review of financial information so furnished. 2 Object The main object of accounting is to know the trading results or state of affairs of a business durmg the accounting period. Whereas the object of audit is to “ulge the correctness and reliability of financial statements prepared by the internal staff of the business enterprise. 3. Hierarchy Auditing begins where accounting ends. There gin be no auditing without the prior éxistence of accounting data. a y 4. Nature Accounting is constructive in nature as it measures business events Y fit or Toss and communicates the financial condition of the business as ia terms of pro Tepisted by financial statements. Auditing on the other hand, is referred as analytical “val critical aspect of accounting since it reviews the measurement and communication Of financial results and condition of business. of financial results and corti 5. Expertise required An accountant may not be comfortable with audit techniques rinciples and techniques and procedures, but an auditor must be well versed witl =F accounting. It is this expertise that distinguishes auditors from accountants,Chapter 1 Introduction to Av 5 6. Process Accounti classification, summariz: is_a four-step process that involves collection a: on and communication of accounting information and ws thereof. Auditing, on the other hand, includes thzee principal steps, viz planning, ‘performing the audit work, and reporting the findings. However, of these steps is not always clear. liminary SELECTIVES OF AUDIT, The objecta.< of an ‘Audit’ may broadly be cate, 1. Primary objewive 2, Secondary objectives _- 3. ‘Speeific objectives, Primary Objective ; the main.concern is to determine whether the recorded information appropriately reflects the economic events that occurred during the accounting period. The dominant principle of aud it is the examination of financial information produced by an accountable party with a'view to reporting to the person to whom the information is rendered on its truth or otherwise. The Act (The Companies Act, 2013) requires that the auditor of a company has to state in his audit report whether in his opinion the accounts and financial statements examined by—give a “true and fair view" of the. flate of company’s affairs at the end of its nancial year and profit or loss cash flow for the year. In technical terms, this is called expression of expert opinion. Therefore, the primary objective of an independent financial audi to determine whether the financial statements present a factual and impartial view of the financial Position and Working results of an enterprise-Fhe di iscovery of errors and frauds although appears fo be the central cbject of audit,itis jist-an- incidental jist an incidental object. In the Act, nowhere the question of Uecovery of wrorand fraud ‘in Yelation to THE auditor's responsibility 's discussed although his failure to discover manipulations, whether fraudulently or otherwise would normally render him liable for damages, Re Kingston Cotton Mills Co. Ltd: Case (1896), Lord Justice hela, “An auditor is not bound to be detective arid to work with their suspicion, that there is something wrong. He is a watchdog not a blood hound.-He is justified in believing tried servant of the company and is eni ‘ovides he takes Teasonabies care: = When an undertaking whose accounts are being audited is large, g to be placed on the accountis i S and frauds. Thus, the auditor resorts to test-checking te the accounting system adopted is reliable and how effi auditor should also disclose in his audit report the adeqi of the accounting system so employed to record busings: fed to rely upon thoir representation py -chnique to ascertain whether ‘ently it was put to use. The tacy and weaknesses, if s transactions, any,AUDITING: Principles and Practice _ Secondary Objectives As discussed above, in financial audit, an auditor has lo examine the books eee and relevant supporting documents with a view to express his opinion 0" tne financial state of affairs of the company. During the process of such an examination of accounts, certain errors and frauds may be discovered eventually. These can be discussed under the following two heads: , . . aaeeT _aung refers to (a) Detection and sreventiol sors The term ‘error in acco F B of errors: The Mental and of various Unintentional misstatement cl @ fact. Errors are normally 2” types, which are discussed below: . e errors “ich arise due to negligence 27 the part of the clerical staff in the-ordinary course of business. These are of five types: () Errors of omission Thuse errors occur oF account of transactions not heing~ recordin the BE ara partially. Detection of such 7° iS bit difficult, as they do not affect the arrangement of trial balance. sesrever, 2 searching eye and a critical scrutiny of the ‘acquurnes -veny CATT HTCOVEL, such errors. For example, scrutiny- ries account in the general ledger may indicate trav salaries for only 11 months have been accounted for and the outstanding amount for the 12th ‘month has, not been provided for. (i) Errors of commission These errors consist of incorrect additions, postings and entries. Some of the examples of these aire: : tions, camry forwards in the books of original entrieS or ledgers. sea ae detit amount posted to credit, wrong Geterical errors Those-are th wrong + Errors in « Errors or incorrect postings ‘posted twice, omission to post an amount posted to afiaoiiint, an amiunt pares nce, aunt Hom a book of oniinal entry to the ledger — « Gerors in taking out balanoes of the ledger accounts. trial balance. Checking the arithmetical «phe above errors will affet the agreement ofthe trial PAE o z Checking the ari-nme accuracy of books of GFiginal entries and ledger ‘and postings from the books of original @ntries to the tedgers may “ancover such types of errors. ——— 7 Aina), Compensating errors ‘These azo the errors-which counter balsoce each other iin such a manner that there remains no difference between two sides of the trial balance, Fox-exarapie, a cash sale <1) aay be recorded in the cashl cashbook, as *190, Sree sale of €100 may be recorded as €1,000. These errors would fore, mu: ss thorough knowledge s qd ec cen pe out an audit effectively. It would furnished by others ion of the accounts prepared. Moreover,pea the accounting information is properly recorded, the auditor dedling with these date must also thoroughly understand the rules. In nutshell, an auditor should bea skillful accountant. . 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. Besides, he should be familiar with various relevant laws of the country governing a business such as tax laws, corporate laws, and economic laws, ete. _.3. Intelligence and tactfulness He must be capable of making intelligent and exhaustive enc ill he ascertains the information required to understand the state of affairs of client’s business. getion Gith gf ony BER hogy fof the 4, Responsible and prudent An auditor should be prudent enough. When asked by the client to offer suggestions or advice on matters relating to financial policy or to put forth suggestions for improvements in the accounting system and internal controls prevailing in the organization, an auditor must be prudent, He should be responsible in in terms of his attitude as well as-approzetyto work. ‘work, 5. Familiarity with the latest developmentsfamendments affecting audit He should be familiar with the latest developments/amendments as to techniques S of auditing/accounting and Jaws affecting him and his work. This will help him to modify the procedure of audit work and carry out an effective audit. 6. Integrity An aucitor should be honest and possess high moral standards. Lord Justice Lindley very aptly described the honesty on the part of auditor-re London and General Bank in the following words: “... he must not certify what he does not. believe to be true and he must take reasonable care and skill before he believes what. he certifies is true.” If an auditor differs from his client on a matter of importance, he must have the courage of his convictions and should menticn his viewpoint in his report. 71. Objectivity, independency and transparency An auditor should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. He should carry out his duties cheerfully, conscientiously and independently. He must show transparency in his approach. He should prove himself to be an independent person and must not compromise on important issues with his client in case of difference of opinions between two. cor ont Be aaVinilarcotauyeuiditnr should inevelandpand’os\ voueireteted ieee "detect errors and frauds. An auditor should remember that one of his main duties is to spot errors and frauds so that their re-occurrence can be prevented and it is possible only when he remains constantly vigilant. 9. Positive attitude and reliance upon client’s staff He should not be unduly suspicious. In the words of Lord J detective or to epee his work with Fu12 AUDITING: Principles and Practice ___ ical and critical in nature and require. ‘The auditor should work diligently <5 40. Diligence Auditing job is an auditor's time, energy, attention and patience as to set an example before his professional peers _-11. Confidentiality and loyalty Maintaining confidentiality is an integral part of professional ethics. An auditor should maintain complete secrecy of the.business of his vrent and should not disclose any confidential information gathered during the course of his work to an outsider unless there is a legal or professional duty contrary to it) 42. Communication skill It is quite essential for an auditor that he could” communicate well with all the concerned. He should be able to write audit report properly and without ambiguity. He should be competent to convey his message in a clear, concise and precise manner. DVANTAGES OF AUDIT ‘There are numerous advantages to have accounting records audited, ne matter whether there is any legal requirement of audit. Nowadays business people get their accounts, audited by a professional auditor with a view to make the accounting information transparent and reliable. Audit is useful for every business organization. Some of the) important advantages associated with auditing are given below: 4. Detection and prevention of errors and frauds become easier Audit helps a_ business to detect and prevent the frauds and errors. Errors and frauds can be located and rectified at an early. and initial stage. 2. Audited accounting information: Greater reliability and authenticity Manage- ment exercises a great deal of subjectivity in preparing financial statements and allocating resources entrusied to it in operating the entity. An audit provides reasonable assurance that management's representations on these activities are authentic. Thus, audited accounts carry a greater reliability and authenticity in comparison of unaudited accounts. “3, Acceptability by the authorities Audited accounts are readily acceptable by the Income Tax, Sales Tax, and such other statutory bodies. 4, Professional advice available Independent auditors also render services other than auditing. They do tax work, act as management consultants, advise on internal control system in operation, and prepare reports required by government agencies and. so on so forth. ! 5, Speedy processing of loan. Financial institutions consider counts] ceniond tna enti MRE sce tn ot ocn con clcal 6. Settlement of dispute over such matters as of a partner may can easily trust atChapter 1 Introduction to Auditing reliability to deciding out the net worth of the business and goodwill. A perspective purchaser of a business may place more confidence in audited accounts as evidence of Past profitability. The auditing function therefore plays an important role in verifying whether an organization is profitable or not or whether its financial position is sound or not 8. Settlement of insurance claims Audited accounts are likely to have more credibility and this he!ne ‘> ear'y and easy settlement of insurance claims in case of losses by fire, misappropriation, einbezzlement or any other reason. 9. Useful to compare the financial performance Audited financial statements are considered more reliable to compare the financial performance of a business concern over the years. ‘ at 10. Keeps accounts department vigilant A regular audit of accounts keeps the accounts department not only up-to-date but also careful and vigilant. 11. Identifies the weak areas Audit reviews the internal control system of the auditee and identifies the weak areas, which helps management to get over the weaknesses and achieve their goal within stipulated time and at reasonable cost. LIMITATIONS OF AUDIT Auditing has numerous advantages but has certain limitations too. An auditor has to depend on the books of account and records produced before him by the management — of the organization. Managetnent could have an incentive to bias the informztion presented in financial statements, as financial statements are one of the means used to evaluate menagement’s performance. Auditor may not be in a position to uncover all sorts of manipulations. In other words, audit may not trace out all types of errors, misappropriations or manipulations, especially those ingeniously perpetrated. ‘As per the Companies Act, some responsible officer must give true and correct information to the auditor who has to base his opinion on the inputs so provided. If such officer intentionally does not part with true and correct information to the auditor, the audit report will not exhibit a true and fair view. Most of the time auditor has to take the information and explanation from the management and its staff such as details regarding the stock in hand including finished, semi-finished, raw material, scrap, etc. Such information may be incorrect as valuation.of stock may be greater or less from the actual value, Influence of management is another major limitation of audit. Though, an indepen- dent auditor is appointed by the shareholders, he depends wpon the management for his fees and obviously has a close working relationship with the latter. So, an auditor is subject to conflicting pressures and some time he intentionally ignores the actual facts and reports as desired by the management. Every auditor suffers from a pre- conceived notion that he has been appointed to safeg instead of to work as a financial police iC PK14 AUDITING: Principles and d Pri ae A CRITICAL APPRAISAL OF AUDITING minds of business people wh that accounting is 4 ne ether auditing is a luxury ‘A question often arises in the ee or necessity. They frequently comment wastage of resources. 7 oe ‘| 7 The expenditure on accounting can be justified on the following gro ; 8: be recalled by businessmen for i It 1. Large number of unrecorded transactions canno! / a tee time. Therefore, bsiness transactions are recorded in books of account is to remember them. ’ . It is quite necessary for a businessman to know the correct profit, which only the written records can furnish. 3. Accounting reflects the financial position of a business on a given. date. _ Written records are necessary to know the debtors and creditors of the organization. Written accounting recerds 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. 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. y s a Arguments Against Auditing Auditing may be a Inxury in the opinion of businessmen on the basis of following arguments: 1. The remuneration payable to the auditor unnecessarily burdens the profit and » «dos account and reduces the net profit. 2. Too many formalities attached to auditing create difficulties for th one staff-of the client. © eae . The entrepreneurs take auditing as a means of wasta i i reprel e of tim: obstructions in the smooth functioning of busincss saul sicnaad 4. Audit.is not a foolproof method of detecting errors and frauds. a foarte the auditor. He may ctors and the managementChapter 1_Introduction to Auditing 15 Arguments in Favour of Auditing Though, 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 luxuzy for small entrepreneurs but for a large and complex business organization, it is a necessity for the under-mentioned reasons/advantages associated with audited accounting records: 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 8. Auditor can render his advice and opinion to the management for improving the performance of the enterprise. 4. A regular audit of accounts keeps the accounts department not only up-to-date but careful and vigilant as well. 5. Audit safeguards 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. ~ SCOPE OF AUDIT Scope of audit refers to its subject matter. It includes its area of cperations, various aspects to be covered u:ider the audit and the requirements of the relevant legislations As per SA 200 (Revised), issued by ICAI, the auditor's opinion on the financial statements deals with whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. Such an opinion is common to all audits of financial statements. The auditor's opinion therefore does not assure, for example, the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity. In some cases, however, the applicable laws and regulations may require auditors to provide opinions on other specific matters, cuch as the effectiveness of internal control, or the consistency of a separate management report with the financial statements. Accordingly, the scope of an audit is determined by the auditor, with regard to: (a) the terms of the engagement; (b) the requirements of the relevant legislation; and (c) the pronouncements of the Institute of Chartered Accountants of India. However, the terms of the engagemeni cannot restrict the scope of an audit in respect of matter, which are prescribed by the relevant legislation, and the pronouncements of the Institute. The audit should adequately cover all aspects of the enterprise, which are relevant to the financial statements under audit. The auditor should be reasonably satisfied that the information contained in the accounting records, etc. is reliable and sufficient for the preparation of financial statements in respect of which he is to form his opinion. He should also see that the disclosure of information is as per the legal requirements, if any, a ‘ ‘The reliability and suffici evaluation of the accountinga ——— i dures; and (b) carrying oy so as to decide the nature, extent and timing of audit Li 0 : verificati races 5 eae ec ctancial statements will be determined perly summarize the trang. tc.; and (b) considering the 16 AUDITING: Principles and Practice other necessary tests, enquiries, Propriety of disclosure of information in the fina hy—(a) examining whether the financial statements prol actions and events recorded in the accounting records, & eet GU management's judgements as regards preparation of finan oe lection and application of accounting polictes, involve an assessment of a Hn of classification of-information, and adequacy of disclosure. nay ‘The auditor, with a view to form his opinion on the financial ee ie procedures so as to satisfy himself that the financial statements reflect ee fats view of the financial position and operating results of the enterprise. He recognizes that because of the limitations inherent in the test checks, audit and any system of internal control, some material misstatement may still remain undiscovered. It is true that in many situations a material misstatement by management may be discovered in the course of an audit, but such discovery, is not the main objective of audit and the auditor's programme of work is also not specifically designed for the purpose. However, while an audit does not ensure the discovery of fraud or errors, it is the duty of the auditor to extend his procedures if he has any indication that some fraud or error, which is likely to result in material misstatement, may have taken place. ‘The audit is primarily concerned with the items, which, whether individually or as @ group, are material in relation to the affairs of an enterprise. Material items are those which might influence the decision of the user of the financial statements. However, in the absence of any definite standard to Judge materiality, the auditor should make a decision about it on the basis of his professional experience and judgement. The auditor is not expected to perform duties, which are outside the scope of his competence, such as determining physical conditicn of certain assets, If there are any constraints as. regards the scope of audit, which impair the auditor's ability to express an unqualified opinion on financial statements, he should set them out in his report and render a qualified opinion or a disclaimer of opinion, as deemed a ‘propriate. INDEPENDENCE OF AUDITOR ‘The concept of ‘Independence of the Auditor’ refers to the necessity of the auditor being not under the influence of his client or appointing authority. Expression of ‘Independent Opirion’ on the financial statements by an appointed auditor is the most basic objective of Udit. The primary duty of an auditor is report to his client on the financial informatien exomined by him, The Companies Act requires the auditor of a company to state whether in his opinion the financial statements Profit and loss account and balance sheet disclose a ‘true and fair view’ of the state of company’s affairs. An auditor is supposed” to'be an independent person hence should not compromise on material discrepancy detected by him during the course of audit, if any, with his appointing authorities. His reports lend credibili ty to the financial information upon which reliance can be placed by’ Various sectio st N ‘areholders), creditors, trade union, govern: s and 0 Sessi timate int Sea the business. Re London ry 7 " ‘ must be honest, thatmivuucun w eauucing ag In view of the auditor's extensive responsibilities to third parties, the auditor must be independent of his client. He should not get influenced by the management of the enterprise under audit Further, although auditing may be an important part of the work of a practising chartered accountant, he may, if approved by the Board of Directors or the audit committee, as the case may be, render his services in other areas of work, such as: (a) advising the client on taxation matters; (b) financial advice; and (©) investigations, ete As a matter of fact it is quite essential for auditors to maintain their independence and only to accept or continue a professional appointment if they are satisfied that to do so will not reflect adversely upon their integrity and objectivity in relation to that appointment. The auditor should not subordinate his judgment to that of the management of the undertaking under audit. With a view to maintain the independence of an independent financial auditor, the Moreover, the Companies Act, 2013 specifically provides under Section 144 that an auditor shall not render any of the following services whether such services are rendered directly or indirectly to the company (under audit) or its holding or subsidiary company, namely: (a) accounting and book keeping services; () internal audit; (©) design and implementation of any financial information systera; (d) actuarial services; (e) investment advisory services; (fH investment benking services; (g) rendering of outsourced financial services; (h) management services; and (i)'ahy other kind of services as may be prescribed ‘That is, an auditor is under statutory obligation not to render any non-audit service which is likely to impair his professional independence and integrity. It can be concluded, thus, an auditor should approach his work independently and be free from bias and prejudice. Independence is also an attitude of mind and independent thought and action are equally as important as the independent relationship between the auditor and his client. OS welch 1. State whether the following statements are ‘True’. fi) Auditing is critical examination of books of account to establish their accuracy and correctness. (ii) Auditing of accounts is compuls (iii) Auditing of accounts is op oct—s ion of the accuracy and correctness of th, erson qualified for the job and not in any f such accounts. + errors and frauds, if any, in the 18 AUDITING: Principles and Practice _ oes a e verificatt v) Audit may be said to be the veri! ie ee Ht necount by an independent P books of account way connected with the preparaticn 0 (v) The primary objective of auditing is to detec books of account. of errors end fravids, (wi) Audit renders financial statements free from all sorts ny act . ‘ he balance sheet of the company as thejy (vii) Compensating errors do not affect the bast! eement of trial balance. presence does not affect the agreeme f jderable importa) (viii) An auditor who does not. compromise on matters of Sons nee. ‘rith the Board of Directors is designated as independent aur” 0. , (ix) The ultimate responsibility for detection and prevention of errors and frauds rests with the auditor. ae Ae (x) Incorrect totaling of ledger accounts is an example of error of principle. 2. Fill in the blanks with the most appropriate word/expression given > the bracket, (i) Audit of accounts of a company is compulsory under the (Chartered Accountants Act, 1949/Companies Act, 2013). (i) In the ancient period audit was confined to frand. (stock/eash) Gii) An auditor who examines the books of account with due audit care . ‘ escape liability for a subsequent discovery of misstatements arising from an error or fraud. (can/cannot) (iv) Detection of errors and frauds is ... (v) When two or more errors are committed in such a manner that thc ultimate effect of these errors on the debits and credits is nil, they are known as nes (errors of commission/eompensating errors). (vi) Expression of independent opinion by the auditor on correctness and reliabilit of financia! statements and supporting accounting documents for a particular of an audit. (primary objectivefsecondary objective) ‘ine is to avoid or reduce the tax liability. audit and not to detect _ the purview of an audit. (within/ovtside) financial period is .. (vii) The primary objective of .. (window dressing/secret reserves) (viii) An audit carried on by an independent auditor is known as (internal audit/external audit). . of accounts refers to fraudulent manipulation or falsification of accounts. (Misappropriation/Defalcation/Misrepresentation) is to win the confidence of shareholders. (ix) (s) The main objective of .... (secret reserves/ivindow dressing) 3. Each of the following questions comprises four answers. Select the most appropriate answer for each. (i) Which of the following best describes the primary object: i Ponce primary objective of an independent (a)"Détection and prevention of frauds (b) Detection and i f preventi (©) Both (a) and (b); (d) Expression of independent opinion by the aoe the truth and fairness of financial information examined by him. aChapter 1 Introduction to Auditing 19 (ui) In a conventional partnership firm the scope of audit and duties of auditor are determined by: (a) Partnership Act, 1932 (b) Partnership Deed (c) Agreement between partnership firm and the auditor (d) Partnership Agreement. (iii) “An auditor is a watchdog and not a bloodhound.” This was observed in (a) London Oil Storage Company (b) Kingston Cotton Mills Co. Lid. (c) London and Ceneral Bank (A) Delightful Cigarette Co. Ltd. (iv) Transposition of figures is an error of (a) principle (b) compensating nature (¢) omission (d) commission (v) The wrong allocation of amount between capital and yevenue cxpenditure is a/an (a) error of principle (b) compensating error (c) error of commission (d) trial balance error. (vi) “An auditor is not an insurer and all that he is required to do is to exercise with reasonable care and skill.” This decision was given in the court case of: (a) Kingston Cotton Mills Co. Ltd. (b) Allen Craig and Co. (©) London and General Bank (d) Westminster Road Construction Co. (vii) For which of the following types of enterprises an independent financial audit is required statutorily? 4sf Companies (b) Partnership firms (c) Hindu Undivided Families (d) Registered firms. (viii) The Chartered Accountants Act was enacted in the year: (a) 1951 (b) 1955 (c) 1959 (d) 1949 pee My MPL . Define auditing. Distinguish between auditing and accounting . Discuss the objectives of auditing. 3. Give the main classes of errors and frauds that an auditor may come across while auditing a firm’s accounts. Give illustrations. Can an auditor prevent the occurrence of such errors and frauds completely? Describe the qualities desired of a competent auditor. . Discuss in brief the advantages and limitations of auditing. . “Auditing though useful, is not free from an Elaborate. ne > other organization, in order to ascerts regarding its financi: | openChapter 2 2 440.43 Classification of Audits Auditing is a broad discipline. The entire process of auditing depends upon the kind cof audit required in particular circumstances. Therefote, it is logical to discuss various kinds of audits before outlining the precise procedure for any audit. For this purpose, an audit examination can broadly be classified on the following three bases: 1. Classification on the basis of the organizational structure I. Classification based. on the timing and scope of audit procedures UI, Classification on the basis of specific objectives behind audit. CLASSIFICATION BASED ON ORGANIZATIONAL STRUCTURE ‘Thistype of classification is based on the organizational structure of business undertaking under audit. A business undertaking may be owned, managed and centrolled by government or private individuals, and may be operated in a corporate form or non- corporate form. The types of audits to be conducted for various organizations, therefore, should fall under the following categories. Statutory Audit ‘Where undertakings are formed under the statute or laws, audit for such undertakings js made compulsory under the statutes that govern them. An audit undertaken under sti or law is called statuvory audit. A qualified exiemnal auditor can conduct any statute. 2 statutory audit. Audit is compulsory under statute in the following cases: 4. Joint stock companies incorporated under the Companies Act, 2013 The audit of 4 joint stock company is compulsory under the provision of Companies Act, 2013. The shareholders are the actual owners of a company and they appoint the directors to supervise overall affairs of the company. ‘The day-to-day working of the company is left company’s state of affairs. All andited by an independent