AUDITING

Unit 1

Meaning of Auditing
The term audit is derived from a Latin word “audire” which means to hear
authenticity of accounts is assured with the help of the independent review. Audit is
performed to ascertain the validity and reliability of information.
Examination of books and accounts with supporting vouchers and documents to
detect and prevent error, fraud is the primary function of auditing. Auditor has to
check the effectiveness of internal control systems for determining the extent of
checking out the audit.

Initially its meaning and use were confined merely to cash audit, and the auditor has
to ascertain whether the persons are responsible for the maintenance of accounts had
adequately accounted for all the cash receipts and the payment on behalf of this
principle.

But the word audit has an extensive usage, and it now means a thorough scrutiny of
the books of accounts and its ultimate aim is to verify the financial position disclosed
by the balance sheet and profit and loss accounts of a company.
In short, an audit implies an investigation and a report. The process of checking and
vouching continues until the study is completed and the auditor enables himself to
report under the terms of his appointment.

Definition of Auditing
“An audit is an examination of accounting records undertaken with a view of
establishing whether they correctly and completely reflect the transactions to which
the purport to relate.” –Lawrence R. Dickey

“Audit is defined as an investigation of some statements of figures involving

examination of certain evidence, so as to enable an auditor to make a report on the
statement.” –Taylor and Perry

Characteristics of Auditing
1. There must be an institution.
2. An auditor must be an independent person.
3. To examine the truthness and fairness of the books.
4. Use of vouchers.
5. To get necessary clarifications.
6. To follow the principles.
7. Collection and evaluation of evidences.
8. Certain period
9. Tactfully
10. Report

Objectives of Auditing

The main objective of auditing is to ensure the financial reliability

of any organization; detection of fraud is just an incidental object.
Independent opinion and judgement form the objectives of auditing. The job of an
Auditor is to ensure that the books of accounts are kept according to the rules
stipulated in the Companies Act; an Auditor also needs to ensure whether the books
of accounts show a true and fair view of the state of affairs of the company or not.

The following are the three distinct types of fraud −

A. Misappropriations of cash
B. Misappropriations of goods
C. Manipulations of accounts

Misappropriation of Cash : Misappropriation of cash is the easiest way of fraud

especially in large business houses where there is limited or no communication
between the owner of an organization and the cashier.

Misappropriation of Goods :Misappropriation of goods can be done

in the following ways −

 Goods may be stolen by employees or with the help of employees.

 By issuing false credit notes to customer on account of goods return.

Detection of misappropriation of goods is more difficult rather

than detecting misappropriation of money, especially where
management is not much vigilant and sound system of book-
keeping, internal control and adequate system of securities are not
available. To keep control on the physical verification of goods,
reconciliation of physical stock with books and careful checking of
sale and purchase is must.
Manipulation of Accounts :Two types of manipulation of accounts
are mainly done by top management to mislead some parties for
some specific purpose.

 Showing higher profit

 Showing low profits.

Auditors should be very careful about the detection of errors

because manipulation in accounting may also appear as error or it
may be a result of carelessness on part of a bookkeeper.

Errors may be broadly classified as follows −

A. Errors of principles.
B. Errors of omissions.
C. Errors of duplication.
D. Errors of commission.
E. Compensating errors.

Error of Principle

Where the recording of the items of transactions are not done

according to the Principle of Accounting, it is known to be an
error of principle. These errors are not traceable from trail
balance; these errors may be committed unintentionally or for the
purpose of manipulation of accounts to inflate or deflate profit.

Following are the examples of such type of errors −

A. Providing excessive or inadequate depreciation.

B. Where the provision for outstanding expenses or prepaid
expenses is wrong.

Errors of Omission
There may be two types of omission of entry while recording the
transactions in the books of accounts;

A. Where transaction is totally omitted from the books of

accounts, it will not affect the trial balance and the detection of
such error is difficult. Following are the examples of such errors;

# Omission of purchase or sale from the purchase day book or the

sale day book respectively.

# Omission of outstanding or unpaid expenses.

B. Examples of the transactions which are partially omitted from

the books of accounts are −

# Where total of purchase day book or sale day book omitted to be

posted in purchase or sale account respectively.

# Where payment or receipt transaction omitted to be recorded in

ledger account from cash book.

Errors of Duplication

The detection of error of duplication is very difficult. It might be

detected with proper and minute observation of accounts; for
example, purchase may be recorded twice with original and
duplicate copy of purchase invoice, etc. It is also possible to post
the total of any ledger account twice in the trial balance.

Errors of Commission

Error of commission occurs the entry made in the books of the

original entry or the ledger account is wrong. Let us see the
following examples −
A. Purchase of goods for Rs. 25,000 wrongly entered as Rs. 2,500 in purchase book..
B. Credit purchase from AB Company wrongly credited to BA Company’s account.
Compensating Errors

When the effect of an error compensates with another error; it is

known to be a compensating error. Such errors do not affect the
trial balance; for example, total of a debit account as well as credit
account totaled short by Rs. 7,500. This type of error will
compensate both.

“AN AUDITOR IS A WATCH DOG NOT A

BLOOD HOUND .”
This statement draws the attention of the people about the duties
of the auditor relating to the discovery or detection of errors and
frauds.

In this two things have been stated :

First, “An auditor is a watch dog”

The term watch dog implies that the dog is kept and maintained
by his master. Dog is faithful animal and always sees the interest of
his master. No damage should be made to his master due to the
loss of attention of the dog.if any person tries to put the owner
any loss, it barks and inform the owner about the unforeseen act
of the third party. It is clear from the statement, that the watch
dog neither cries nor bark on each and every person. It also does
not intend to create any terror around the place. The watch dog
barks upon a person only when it sniffs that a person has came to
create nuisance or loss to its master. Therefore, a watch dog
remains faithful to its owner and discharges duty with honesty and
efficiency.

Seconds, “An auditor is not a blood hound”

The characteristics of a blood hound is to see with suspicion and

treat as an enemy any person who come near to his master.
Therefore, it not only bark upon a person but also tries to injure
him.thus the auditor should not act and follow the blood hound.
He only finds out the errors and frauds , but not to treat the
employees responsible for those errors and frauds as enemies ,
rather show love and co operation towards them. He must be
honest , sincere, and methodical in his approach to detect errors
and frauds.

Principles of Auditing
The Webster’s New International Dictionary, defined the word
‘principle’ as a “fundamental truth”, a primary law , a settled rule
of action”.
Applied to auditing , principle is the fundamental truth necessary
for the effective accomplishment of the ocbjective of auditing.
THE FOLLOWING FUNDAMENTAL PRINCIPLES OF AUDITING ARE
:-
1. Principle of independence
2. Principle of objectivity
3. Principle of full disclosure
4. Principle of materiality
5. Confidentiality
6. Skills and competence
7. Principle of true and fair
8. Work performed by other
9. Accounting system and internal control
10. Report

ACCOUNTING IS A NECESSITY WHILE

AUDITING IS LUXURY.

According to some businessmen,accountancy is necessary while

auditing is luxury.but this statement does not come true in every
business.This statement is accepted only in those businesses who
have their businesses in small scale and with little capital as they
have self control over the operations of the businesses , auditing is
not very beneficial to these smale scale businesses.
However,there are another group of businesses who have their
businesses in large scale with high amount of capital involved and
employing more number of people . for these group of people
auditing is not luxury and the statement does not come true .

Now we will discuss in detail about this situation

“ACCOUNTING IS A NECESSITY”
The argument given ahead can be palced in the favour of the
statement ‘accounting is necessity’.
1. Limited memory power of the human being.
2. Knowledge about profit and loss.
3. Knowledge about economic position of business.
4. Proof in the court of law .
5. Need on admission of a new partner.
6. Necessity on the death or retirement of the partner.
7. Helpful for adjudication as insolvent.
8. Helpful in determination of various taxes.
9. Safety from fraud
10. Helpful in getting loans .
11. Helpful in preparing future plans.
12. Helpful in getting licence.
CONCLUSION : On the basis of above discussion, it can be said that
accountancy is requirement for every business for its effective
operation and control.Therefore,accounting is necessity.

“AUDITING IS A NECESSITY”
Whether auditing is luxury or not , we have 2 options in this
regard-
i. option of small scale business
ii. Option of large scale business
We will discuss about both of them.

Option of small scale business -

From this point of view auditing is luxury.The argument given
below is in support of this statement:
1. More expensive
2. Alternative procurement of the advantage of auditing
3. Difficulties in fulfilling the formalities
4. Wastage of time.
5. Fulfillment of prestige only
6. Decrease in efficiency of employees.

CONCLUSION : on the basis of above argument, it can be said that

for small businesses auditing is luxury .

Option for large scale business -

From big businessmen point of view ,auditing is not luxury because:
1. It increases the efficiency of employees .
2. Less probability of fraud.
3. Increase in the efficiency of management.
4. Helpful in the development of the business.
5. Prompt decision at the time of insolvency.
6. Base of the future planning.
7. To protect the interests of the shareholders.

CONCLUSION : On the basis of the above arguments, it can be said

that accounting is necessary for businessmen of all size and levels
and auditing is luxury for all small businessmen but necessity for
big industrialists and businessmen .

Scope of auditing
The scope and dimensions of auditing has greatly increased in the
seventies . the evolution of the new concept such as cost audit,
management audit, social audit, tax audit and operational audit
has laid emphasis on its adoption on wide scale. The primary audit
objective of detection of frauds has now been shifted to the
determination of the fairness and authenticity of reported financial
position together with the detection and preevention of errors and
frauds .
This vastly enhances the scope of auditing.
The scope of audit is clear from the following duties of an auditor:
1. Checking the arithmetical accuracy of the accounts .
2. Checking the books of accounts with the help of all the relevant
vouchers , invoices , correspondence , minute books etc.
3. Verifying the assets and liabilities shown in the balance sheet.
4. Reporting to the clients on the basis of findings .

Qualities of an auditor
An auditor must have all the qualities of head and heart as he
required to perform a variety of functions.
In particular he must possess the following qualities.
1. knowledge of book keeping , accountancy and auditing.
2. Knowledge about working of business .
3. Knowledge of economics .
4. Knowledge of audit case laws.
5. Knowledge of industrial management.
6. Technical knowledge .
7. Knowledge of tax laws.
8. Honesty
9. Tactful
10. Impartial.

Types of auditor
1. Amateur audit : These are the persons who are not competent
to discharge the work of audit efficiently because they only do the
work of audit only for entertainment not for money. Therefore,
these persons are not appointed as an auditors.
2. Government auditors : auditors , who audit the books of
accounts of government companies or institutions are known as
government auditor.the top most authority of audit department of
the government of India is called “auditor general of India”.
3. Professional auditor : in fact , professional auditor are
competent and efficient . they are the auditors who audit the books
of accounts of different companies. They are not the employees
rather they are paid remunerations on the basis of contract for
the work of audit performed by them.

Types of audit
ORGANISATION STRUCTURE BASED CLASSIFICATION :

1. Statutory audit : It is the one which is prescribed under the

statue of law and is conducted as per the requirement laid down
by the statue/law. The appointment of auditors, qualifications and
disqualifications,remunerations , rights ,liabilities etc are prescribed
under the law. The companiesv and corporations ,LLPs, cooperative
societies , public and charitable trust and other statutory bodies are
compulsory required to conduct their statutory audit.
The main features of statutory audit are:
A. It is compulsory under the law.
B. The scope of the audit is governed by the law .
C. The rights , duties and liabilities of statutory auditor are
governed by the law.

2. Private audit : it is an audit which is optional in nature and is

done as per the preference of the owner. Such type of audit is
conducted by the proprietorship concern where the requirement of
audit is not mandatory. A proprietorship concern may like to
access the accuracy of books of accounts and with such an idea in
background , auditor is appointed, who may not necessarily be the
member of ICAI to get his accounts audited .
Generally following entities undergoes under the private audit:
A. Sole trader
B. Partnership firm
C. Individuals and institutions
D. Non profit Organisations

3. Government audit : it is the audit of receipts as well as

payments done by the government. It is done basically to achieve a
high degree of financial administration.
It is done with the following objectives in mind.
A. To ensure that the given expenditure has been judiciously
incurred for which it is sanctioned.
B. To verify stock and its valuation.
C. To ensure that the payments has been correctly made to the
concerned persons.
D. To ensure that the proper system has been laid down to record
and incur expenditure.

SPECIFIC OBJECTIVE OR DIMENSION BASED CLASSIFICATION

1. Independent / external audit : this audit is conducted to

ascertain the true and fair view of the results of financial
operations and financial positions of the company. It is conducted
by professionally qualified auditor who are independent of the
entity or client.

2. Internal audit : according to the institute of internal auditors , “

internal audit is an independent appraisal activity initiated within
an organisation for review of accountancy , financial other
operations , as a basis for services to the organisation”. The main
characteristics of internal audit are :
A. It is to be conducted by an independent entity .
B. It helps in locating and identifying errors in the initial stage.
C. It helps in formulation of policies in the interest of the
organisation.
D. It is optional in nature and the period of audit is not defined.
E. It helps in improving operational efficiency of the organisation.

3. Cost audit : according to the institute of cost and work

accountants of England, “ cost audit is the verification of
correctness of cost accounts and of adherence to cost accounting
principles and plans.”
the idea of this audit is to access the accuracy of cost accounting
system of the organisation and also to ascertain the extent to
which cost accounting system are being followed in the organisation
.
The main objective of cost audit :
A. To ensure that the cost accounts are properly maintained .
B. To ensure the arithmetical accuracy of the cost accounts.
C. To ensure that the cost accounts detect all errors and frauds.
D. To assess the utility of cost accounts for management decesion
making.
4. Management audit : It is the critical evaluation of all the aspects
of the management. It is done to examine in details the various
plans , policies and actions of the management. It covers the audit
of both management process as well as management functions .
this audit is not at all compulsory under the law.

5. Tax audit : There is always a difference between the profits

reportable to shareholders and taxable profits shown to the
taxation department due to a different provision under companies
act 2013 and the income tax act 1961 . tax audit is done to
ensure the accuracy of the taxable profits calculated by the entity
so that the tax liability is calculated properly.

6. Environment audit ( green audit ) : This audit is conducted with

a view to access the performance of the company towards
safeguarding the environment . it is only required for the industries
specified in the environment protection act 1986 as they have to
submit environment audit reprt to state pollution board .

7. Forensic audit : The term forensic means investigation of crime.

So forensic audit means the audit which is done to check whether
any fraud has occurred or not. Hence, it involves critical
examination of books of accounts .

8. Special audit : Central government may order special audit of

company in the following situation :
A. When the affairs of the company has not being managed in
accordance with sound business principles or prudent commercial
practices;
B. When the company is being managed in a manner likely to cause
serious damage to interest of trade ; industry or business;
C. When the financial position of the company is such as to
endanger its solvency.

9. Propriety audit : The term propriety means meering the tests of

public interests or standard of conduct. In simple word it means
propriety audit is done to ensure that expenditure done is not
more than what is required. It means expenditure should be done
in such a way as a man of ordinary prudence would have done in
his own case .

10. Efficiency-cum-performance audit (EPA) : It includes :

A. Economy audit
B. Efficiency audit
C. Effectiveness audit

TIME BASED CLASSIFICATION

1. Continuous audit : It is conducted throughout the year at regular

or irregular intervals by the auditor.
“ A continuous audit is one where the auditor or his staff is
constantly engaged in checking the accounts during the whole
period or where the auditor or his staff attends at regular or
irregular intervals during the period.”

2. Periodical/final/annual audit : Under this type of audit , the

auditor undertakes audit work of the organisation at the end of
the financial or accounting year.
“Periodical audit is one where the auditor does not attend until the
completion and closure of the financial accounts by the undertaking
or client and the auditor takes the audit task as a whole and the
checking is done at one time.”
3. Interim audit : This audit is conducted between 2 annual audit
to enable the company to declare interim dividend . it covers only
part of the accounting period .

4. Balance sheet audit : In this type of audit , each of the item of

assets and liabilities appearing in the balance sheets such as share
capital, capital reserve , plant and machinery ,etc is verified this
type of audit has American origin . The term is not commonly used
in India .

SCOPE BASED CLASSIFICATION

1. Complete audit : In this audit , the auditor is required to check

all the transactions , each and every account and report with the
help of documentary evidence. However , now a days auditors go
for test checking as it is not feasible to complete audit owing to a
avery large number of transactions.

2. Partial audit : Sometimes, the clients may ask the auditor to

audit only some of the books instead of all the books or to audit all
tyhe book for part of the year . such an audit is called partial audit.

3. Detailed audit : As a name suggests a detailed audit means

thorough examination . It is difficult to differentiate between
complete audit and detailed audit . the main difference is that the
few transactions or accounts are examined in detail is called a
detailed audit.

INTERNAL AUDIT

Internal audits evaluate a company’s internal controls, including

its corporate governance and accounting processes. These audits
ensure compliance with laws and regulations and help to maintain
accurate and timely financial reporting and data collection.
Internal audits also provide management with the tools necessary
to attain operational efficiency by identifying problems and
correcting lapses before they are discovered in an external audit.

Understanding Internal Audits

Internal audits play a critical role in a company’s operations and
corporate governance, especially now that the Sarbanes-Oxley Act
of 2002 (SOX) holds managers legally responsible for the accuracy
of their company's financial statements. SOX also required that a
company's internal controls be documented and reviewed as part
1
of their external audit. Internal controls are processes and
procedures implemented by a company to ensure the integrity of
its financial and accounting information, promote accountability,
and help prevent fraud. Examples of internal controls are
segregation of duties, authorization, documentation requirements,
and written processes and procedures. Internal audits seek to
identify any shortcomings in a company's internal controls.

Internal audits may take place on a daily, weekly, monthly, or

annual basis. Some departments may be audited more frequently
than others. For example, a manufacturing process may be audited
on a daily basis for quality control, while the human resources
department might only be audited once a year. Audits may be
scheduled, to give managers time to gather and prepare the
required documents and information, or they may be a surprise,
especially if unethical or illegal activity is suspected.

Internal control
Internal controls are the mechanisms, rules, and procedures
implemented by a company to ensure the integrity of financial and
accounting information, promote accountability, and prevent
fraud.

Besides complying with laws and regulations and preventing

employees from stealing assets or committing fraud, internal
controls can help improve operational efficiency by improving the
accuracy and timeliness of financial reporting.

Understanding Internal Controls

Internal controls have become a key business function for every
U.S. company since the accounting scandals in the early 2000s. In
their wake, the Sarbanes-Oxley Act of 2002 was enacted to
protect investors from fraudulent accounting activities and
improve the accuracy and reliability of corporate disclosures. This
has had a profound effect on corporate governance, by making
managers responsible for financial reporting and creating an audit
trail. Managers found guilty of not properly establishing and
1
managing internal controls face serious criminal penalties.

Internal audits evaluate a company’s internal controls, including its

corporate governance and accounting processes. They ensure
compliance with laws and regulations and accurate and timely
financial reporting and data collection, as well as helping to
maintain operational efficiency by identifying problems and
correcting lapses before they are discovered in an external audit.
Internal audits play a critical role in a company’s operations
and corporate governance, now that the Sarbanes-Oxley Act of
2002 has made managers legally responsible for the accuracy of
1
its financial statements.
Internal check system
In the opinion of Spicer and Pegler, “A system of internal check is an arrangement of
staff duties, whereby no one person is allowed to carry through and to record every
aspect of a transaction so that without collusion between two or more persons, fraud is
activated and at the same time the possibilities of errors are reduced to the minimum.”

Internal check means practically a continuous internal audit carried on by the staff
itself, using which other members of the staff independently check the work of each
individual.

An internal check is a continuous process and is part of the day-to-day routine. It

relates to all the transactions that take place every day. An internal check is achieved
by a complimentary allocation of duties and by independent verification of the work
of one person by another.

Essential Characteristics of Internal Check System

1. Division of work
2. Provision of check
3. Uses of devices
4. Self balancing system
5. Job rotation

Unit 2

Audit programme
An audit program is a set of directions that the auditor and its team members need
to follow for the proper execution of the audit. After preparing an audit plan, the
auditor allocates the work and prepares a program which contains steps that the
audit team needs to follow while conducting an audit. Thus, an auditor prepares a
program that contains detailed information about various steps and audit
procedures to be followed by the audit.

An audit program provides a basic plan for the audit team regarding the entity’s
business, its size, how to conduct the audit, allocation of work among team
members and the estimation of time within which it should complete the work.
It contains details regarding the relevancy of evidence, materiality level, risk
tolerance, measure of the sufficiency of the evidence. Thus, programs enhance the
accountability of the audit team and its members for the work performed by them.

An audit program covers various steps of auditing in an audit program like the
assessment of internal control, ascertaining accuracy and reliability of books of
accounts, inspection, vouching and verification, valuation of assets and liabilities,
scrutiny of accounts, presentation of financial statements, and submission of
reports and related disclosures.

Advantages of the Audit Programme

A. An audit program helps in ensuring that all-important areas are considered while
conducting the audit.
B. An audit program helps an auditor in the allocation of work among its team
members according to their skills and competency.
C. It enhances the accountability of audit team members towards work performed
by them
D. It helps the auditor in checking the status of audit work, its progress, how much
it is left for performance while conducting the audit.
E. Audit program enables the auditor to keep a record of useful information
specifically for future audit and references.

Disadvantages of Audit Programme

A. Rigidity: There is no set standard audit program that can be applied in the case
of every entity. However, programs differ for different types of entities. Every
entity has its own problems. Therefore, we cannot apply for a single audit program
in the case of all business entities.
B. Reduces the Initiative of Efficient Staff: – A program reduces the initiatives of
efficient and competent staff. Thus, staff members cannot make changes to
the audit plan and cannot make suggestions for it.
C. Audit Work becomes Mechanical: The program becomes mechanical when it
ignores other aspects like internal control.
D. Overlooking New Areas: A program may overlook the new areas. With the
change in time and technology, new problems may arise that an audit program may
not consider.

Types of Audit Programs

The two main types of audit programs are:

A. Fixed Audit Program

B. Flexible Audit Program

Fixed Audit Program

A fixed audit program is a set of standardized instructions that need to be

followed by the auditor while conducting the audit. It includes all possible audit
procedures to be followed during the audit although all of them may not be
applicable in a situation. A fixed audit program aims to take care of every
possible audit situation that may arise during an audit.

Flexible Audit Program

A flexible audit program is one that does not prescribe the exact audit procedure
to be followed by the auditors while conducting an audit. It simply gives an
outline of the scope, nature and limitations of the audit assignment to be
conducted. Also, the nature of work to be performed by each person of the audit
staff is not predetermined under it. The auditors decide most of the things as the
work proceeds and the reliability of procedures and internal control system
become known to the auditor.

Audit notebook

What is an Audit Note Book?

During the course of audit the audit clerk experiences several

difficulties. He cannot remember everything at all time. So he
maintains a book with him in which he makes note of important
points and queries, which he has to refer to the client’s staff or
clarify with the chief auditor. Such a book is called Audit Note
Book. It is an essential book used to note important points that
shall be included in the Auditor’s report. It is a complete record of
doubts and their clarification. It helps the auditor in his subsequent
audits. It is also used as a guide to the other audit clerks.

To sum up audit note book is nothing but a dairy, maintained by

the audit staff for the purpose of recording certain points which
require further clarification, explanation and investigation. This
book generally includes the errors found out during the course of
audit, difficulties observed and doubtful queries of various
accounting records, etc. This note book usually forms a part of the
permanent audit file.

Audit note book is also called as a remembrance book. It contains

all matters that come to the notice of the auditor in the course of
audit. It also plays an important part in defending the auditors if
any legal action is brought against them. Audit note book can be
used as authentic evidence in support of the work done by them.

Contents of Audit Note Book

An audit notebook generally consists of the following information:

1. The nature of the business and summary of important

documents relating to the constitution of the business such as
Memorandum of Association, Articles of Association or Partnership
Deed, etc.

2. A list of the books of accounts maintained.

3. Particulars as to the system of accounts followed and the system

of internal check in force.

4. Names of principal officers, their duties and responsibilities.

5. Progress of audit work together with the dates on which the

work was undertaken and completed.

6. Extracts from correspondence with different authorities.

7. Audit programme.

8. Allocation of work among different audit staff.

9. All queries which have not been clarified so far.

10. Lists of missing receipts, vouchers, bills, etc.

11. Any special point arising during the course of audit to which
the attention of the auditor must be drawn.

12. Particulars of cash balances, investments, fixed deposits, and

the reconciliation statements of principal bank accounts.

13. Extracts of the minutes and contracts affecting the accounts.

14. Record of audit work done with dates of commencement and

of completion.

15. Particulars regarding the financial policies followed by the

business.

16. All mistakes and errors discovered.

17. Points to be incorporated in the audit report.

18. Points, which need further explanations and clarifications.

19. All important matters for future reference at subsequent

audits.

20. Information of permanent nature relating to the business and

notes of all important technical transactions.

These matters are very useful in preparing the audit programmes

for subsequent audits.

Importance of Audit Note Book

1. Audit note book shall be taken as reliable evidence even by the
Court of law in case of dispute or if the auditor is charged with
negligence.

2. It is useful for drawing the audit programmes.

Disadvantages of Audit Note Book

1. Very often, it creates misunderstanding between the client staff
and the audit staff.
2. If it is not properly and carefully prepared it cannot be used as
evidence against the auditor for negligence.
3. It develops a fault finding attitude in the minds of the staff of
the audit.

Audit working papers

Audit working papers are the outcome of the documentation process. Working
papers are the record of various audit procedures performed, audit evidence
obtained, allocation of work between audit team members etc. Audit working
papers are the documents and evidence that an auditor collects and retains with
himself during the audit.

Audit working papers support the work that the auditor performs for providing
assurance that he conducts the audit in accordance with all the applicable
standards on auditing (SA’s). They constitute all the audit evidence that an
auditor obtains. Also, it contains various procedures that he applies to indicate
that the audit is performed by him.

The auditor and his audit team members prepare the audit working papers while
performing the audit. Working papers are connecting link between the client’s
records and audited financial statements.

Also, the working papers help audit team members to understand

entity’s business, points which they need to check on a priority basis, queries and
actions against them in previous audits. Working papers helps auditor in future
cases to protect himself if the client files a suit against auditor for auditor’s
negligence while conducting the audit.

Working papers provide information on the following matters :

A. Information about audit team members and work allocated to them. Information
regarding unallocated work.
B. Whether he follows all the applicable standards on auditing (SA’s) or not
C. He properly plans the audit or not
D. An auditor undertakes an appropriate review or not
E. Whether the evidence is relevant, sufficient and appropriate to support the
opinion of the auditor
We can divide the working papers into two parts:

A. Permanent audit file

B. Current audit file

- A permanent audit file contains information which is of continuous interest and

is relevant in future audits. Information like articles of association, loan
agreements, leases, documents related to internal control of the entity, record of
accounting policies followed by the entity on a continuous basis, significant
observations of previous audits etc.

- A current audit file contains information regarding audit conducted for the
current period. It includes information like financial statements and audit report
of the entity, trial balance and worksheets, records regarding internal control risk
of an entity, external confirmations received, queries of auditor and reply received
from the management.

Consideration of commencing audit

Routine checking
Test checking
What is Test Checking?
Test checking in Audit means checking a few transactions selected
at random from a large number of transactions. It is also known as
“Selective Verification” or “Sampling Process“.

In simple words in test checking a representative number of entries

of each class is selected and checked and, if they are found correct,
the remaining entries are also taken to be correct. Test checking is
an accepted substitute of detailed checking, which in most of the
cases from the economic point of view is unwarranted.

Advantages of Test Checking

Test checking enjoys the following advantages:

1. It saves time and energy.

2. If the selection of transactions is done intelligently, test checking
is useful and purposeful.

3. The volume of work is reduced. So the auditor can carry on

many audit simultaneously.

4. It helps in reducing the cost of audit.

Disadvantages of Test Checking

Test checking suffers from the following disadvantages:

1. It is not possible to detect all the errors and fraud.

2. The clerks of the client may become careless because they know
that their work will not be checked in detail.

3. It is of no use if proper and effective systems of internal checks

and controls are not being adopted in business.

UNIT 3
Vouching
Definition: Vouching, widely recognized as “the backbone of
auditing,” is a component of an audit seeking to authenticate the
transactions recorded in a firm’s book of accounts. When an
accounting transaction is vouched, it is tested and verified by
presenting relevant documentary evidence.

What is Vouching?
Vouching means inspection by an auditor of documentary evidence
supporting & substantiating transactions. Vouching is the process of
checking documentary evidence that the transactions are properly
recorded & accounted for.

The main aim of vouching is to inspect all receipts & payments are
properly accounted for & no fraudulent transactions are recorded.
Vouching is a substantive audit procedure to obtain evidence as to
completeness, accuracy & validity. With the help of vouching
auditor come to know the genuineness of the transactions.

The duty of auditor is to see substantial accuracy of vouchers &

then make a report thereon. Vouching is also the basis for assets &
liabilities. The auditor should be careful while vouching the
transactions & entries in the books of accounts. It is the backbone
of the auditing process. Thus, vouching may be considered as the
essence of auditing.

Objectives of vouching
Verification of assets and liabilities

Q.1. What is meant by verification of assets and liabilities? State the

object of such verification.

Ans. The verification of assets and liabilities involves the

consideration of the following points:

1. That each asset/liability is correctly stated in the balance sheet.

2. That each asset/liability is correctly valued according to the
generally accepted valuation principles.
3. That the assets actually exist on the date of balance sheet, and
are the property of the company.
4. That the assets are free from any charge except that disclosed
on the balance sheet.
5. That no liabilities on the date of balance sheet have been
omitted.

The verification of assets and liabilities achieves two main objects:

1. Propriety of transactions recorded.

2. Expressing an opinion on the financial statements, i.e., whether

the balance sheet reflects a true and fair view of the state of affairs
of the company.

Unit 4
Company auditor
Liabilities of an auditor
Divisible profit
Dividend
Auditor’s report
Types of auditors report
Investigation
Investigation is a detailed examination of accounts and
enquiry into the state of affairs of the business or for a
specific purpose. It involves the process of analysing,
collecting and presenting facts in a manner which enables
the parties to know the essential facts regarding the
matter under enquiry. Investigation covers more than one
financial period and the programme depends on each
type of investigation.

Definition of investigation
· According to Spicer and Pegler,
“The term investigation implies an examination of
records for some special purpose”.
· According to Taylor and Perry,
“Investigation involves and enquriy into the fact beyond
the books of accounts into the technical, financial and
economic position of the organisation”.

CHARACTERSTICS OF INVESTIGATION
1. It relates to a special and specific objects only.
2. Its scope may be extended or curtained according to
the objective.
3. It is a critical examination and verification of specific
record for a specific period.
4. Its report is analytical, descriptive and exhaustive.
Duties of an investigator
1. Obtaining written instruction about scope of work, objects and

period to be covered.

2. Formulation of investigation programme.

3. Collection of relevant details about the business.

4. Enquiry about reputation.

5. Nature of business.

6. Opinion of specialists.

Special audit of Banking Company

As per provisions of Section 30 (1B) of BR Act, RBI can order

special audit of the banking company’s accounts if it is of opinion
that it is necessary in the public interest or in the interest of the
banking company or its depositors by a person duly qualified under
any law to be an auditor of companies. The auditor has to submit
the special audit report to RBI and forward a copy to the banking
company concerned. Any expenses incidental to the special audit
have to be borne by the banking company.

Audit for insurance company

The purpose of insurance is generally created to share or spread
the risk among the people or entities with the insurance business is
called the “insurer”. which the insurer provides the renter
insurance to the people or entities through issuing the insurance
policy.
The insurance business is to sell rights the prevent bad things
happen through the coverage of financial compensation for people
or entities at a specific time.

The insurer is typical as the legal entities that are registered and
surveillance for complying with internal regulatory or relevant law
and regulations to the country. Insurers provide the financial
coverage and insured amount of payment to cover occurred
unexpected or bad events that occur in the insurance time.

In any case of the catastrophes are occurred to the people or

entities who are purchased or covered by insurance policy, the
insurer will start to evaluate the risks and whether how the events
occurred and how much amount should be claimed to cover the
financial compensate outlined in the insurance policy.

There are 3 types of insurance companies:

1. The life insurance company, in short, is the so-called “Insurance company”: provides
the financial compensation to cover life or permanent disability for those who are stated as
the beneficiary by the policyholder.

2. Health insurers: provide insurance to cover in term claiming on financial compensation for
the current illness (accident, and health insurance) when there is any occurrence of illness
happen in the insured event.

3. Property and liability insurance company: provide the protection on the damages or loss
of the property caused by theft, fire and so on which are stated in the property and liability
insurance contract between the insurer and property owner.

Audit of non - profit companies

An audit for nonprofit organization involves examining the
organization's financial records to make sure they are complying
with the requirements of a tax-exempt entity. If the auditor finds
that these requirements are not being met, the organization will
most likely lose its nonprofit status.

Audit help to protect the organization as they uncover unnecessary

charges and discover financial carelessness or misappropriations in
handling funds, and can guide the organization back on track
before its too late.
Audit also encourages good habits of fiscal responsibility that
ensures all employees follow accountability principals that are put
into place.