UNIT 1

Introduction

1.1 Introduction: meaning and objectives of Auditing; Types of

audit; Internal audit, Audit Process: Audit programme; Audit and
books Working papers and evidences; consideration for
commencing an audit, Routine checking and Test checking Intern
Check System: Internal Control, Internal auditing.

Introduction: meaning and objectives of Auditing

The term auditing is derived from the Latin word ‘Audrie’ which means to
hear. The original objective of auditing was to detect and prevent errors.
In India the companies act 1913 made audit of company accounts
compulsory.

According to Spicer and Pegler “Auditing is such an examination of

books of accounts and vouchers of business, as will enable the auditors to
satisfy himself that 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 gives true and fair view of the profit/loss for the financial
period, according to the best of the information and explanation given to
him and as shown by the books; and if not, in what respect he is not
satisfied”.

Prof. L.R.Dicksee. "auditing is an examination of accounting records

undertaken with a view to establish whether they correctly and
completely reflect the transactions to which they relate”.

OBJECTIVES OF AUDITING

There are two main objectives of auditing. The primary objective and the
secondary or incidental objective.

a. Primary objective – as per Section 227 of the Companies Act 1956, the
primary duty (objective) of the auditor is to report to the owners whether
the balance sheet gives a true and fair view of the Company’s state of
affairs and the profit and loss A/c gives a correct figure of profit of loss for
the financial year.

b. Secondary objective – it is also called the incidental objective as it is

incidental to the satisfaction of the main objective. The incidental
objective of auditing are: i. Detection and prevention of Frauds, and
ii. Detection and prevention of Errors. Detection of material frauds and
errors as an incidental objective of independent financial auditing flows
from the main objective of determining whether or not the financial
statements give a true and fair view.

As the Statement on auditing Practices issued by the Institute of Chartered

Accountants of India states, an auditor should bear in mind the possibility
of the existence of frauds or errors in the accounts under audit since they
may cause the financial position to be mis-stated. Fraud refers to
intentional misrepresentation of financial information with the intention to
deceive.

Frauds can take place in the form of manipulation of accounts,

misappropriation of cash and misappropriation of goods. It is of great
importance for the auditor to detect any frauds, and prevent their
recurrence. Errors refer to unintentional mistake in the financial
information arising on account of ignorance of accounting principles i.e.
principle errors, or error arising out of negligence of accounting staff i.e.
Clerical errors.

Types of audit

Audit is the examination or inspection of various books of accounts by

an auditor followed by physical checking of inventory to make sure that
all departments are following documented system of recording
transactions. It is done to ascertain the accuracy of financial statements
provided by the organisation.
• Continuous Audit

According to spicer and pegler “A continuous Audit which is also known

as detailed Audit is one where the auditors staff is occupied continuously
on the accounts the whole year round, or where the auditor attends at
intervals, fixed or otherwise, during the currency of the financial year,
and performs an interim audit; such audits are adopted where the work
involved is considerable, have many points in their favour, although they
are subject to certain disadvantages.” Thus, a continuous audit involves
the conducting of audit of accounts throughout the year at regular
intervals, fixed or otherwise, of say, one month or months. The accounts
in such a case are subjected to audit as and when they are prepared. Such
an audit is necessary only for big business houses.

Continuous Audit is applicable in case of following business concerns:

(i) Where final accounts are prepared just after the close of the financial
year, as in the case of a bank.

(ii) Where the transactions are many in number and thus it becomes
necessary to get them audited at regular intervals.

(iii) Where the system of internal check in operation is not satisfactory.

(iv) Where the statements of accounts are prepared after every month or
quarter to be presented.

(v) Where sales effected are very large.

2. Interim Audit

Interim audit is one which is conducted in between the two annual audits
for some interim purpose, say, to enable a company to declare an interim
dividend. This kind of audit involves a complete checking of the accounts
prepared by a company for a part of the year to the date set of interim
accounts, say, quarterly or half-yearly accounts.
3. Balance Sheet Audit

A balance sheet audit is an evaluation of the accuracy of information found

in a company's balance sheet. After a balance sheet audit, you can use
the analyses to detect irregularities or weaknesses in your company's
accounting system.

Under such an audit, the auditor checks capital, reserves, assets,

liabilities, etc., given in the Balance Sheet. Those items of Trading and
Profits and Loss Account are also checked which have a bearing on the
Balance Sheet items. For example, the purchase of goods on credit will
increase the liabilities to creditors, increase the stock and will be shown
in the Trading Account as an increase in purchases and closing stock. So
this item will have to be verified. This type of audit can be successful in
those business concerns where efficient system of internal check and
control is in operation. Such an audit is popular in U.S.A.

Concurrent audit:

Usually concurrent audit is conducted for bank branches, depending

upon the quantum of advances given. It also depends upon bank to bank
and their risk taking capability. Concurrent audit is conducted to monitor
day to day bank operations so that all the compliances and security
measures are being followed. Concurrent audit involves daily account
opening checking, cash balance, income leakage, BCP & DRP analysis,
NPA tracking, laws compliance compliance, various authorisations and
all.

In some particular banks, scope of concurrent audit is very well defined

to focus on the areas they are most concerned with. Now a days more and
more branches are coming under the review of concurrent audit due to
alarming rise of NPAs in all banks. So now banks are hiring more and
more concurrent auditors to ensure their operational efficiency and
profitability.

Annual Audit
Kind of audit whether the author verifies the account at the end of every
financial year. This is a common audit and is mostly used by small
organisations.
Internal audit

MEANING

SA 610 issued by the Institute of Chartered Accountants of India (ICAI)

defines Internal Audit as follows: Internal audit is a separate component
of internal Control established to determine whether
other Internal controls are well designed and properly operated.

OBJECTIVES

• Review of accounting system and Internal controls

• Examination of Accounting controls
• Examinations of Operational controls
• Physical verification

SCOPE / FUNCTIONS OF INTERNAL AUDIT

• Monitoring of internal control

• Examination of financial and operating information
• Review of operating activities
• Review of compliance with laws and regulations
• Risk management
• Governance

BASIC PRINCIPLES GOVERNING INTERNAL AUDIT

Standard on Internal Audit (SIA) 2, Basic principles Governing

Internal audit, issued by the Council of the Institute of Chartered
Accounts of India lays down the following:

(SAME AS THE PRINCIPLE OF AUDIT)

INTERNAL AUDIT VS. EXTERNAL AUDIT

TOPIC INTERNAL AUDIT (IA) STATUTORY AUDIT (SA)
Voluntary / IA is Voluntary SA is compulsory under law
Compulsory e.g. under Companies Act.
Appointment Internal Auditor is appointed Statutory Auditor is
by the management itself. appointed by the
shareholders of a Company.
Status Internal Auditor is an Statutory Auditor is an
employee of the concern. independent outside expert.
Responsible & Internal Auditor is Statutory Auditor is
reports to responsible and reports to responsible and reports to
management. shareholders.
Scope of duties Management decides the Duties of statutory auditor
scope of duties of internal are laid down by law (e.g.
Auditor. It includes non Companies Act) its scope
accounting matters. limited to accounting
matters.
Removal Internal auditor can be Statutory Auditor can be
removed by the removed by shareholders
management on its own. only if approved by central
Government.
Objectives IA aims to review the SA aims to report to
internal control system of shareholders whether the
concern. accounts are true and fair.
Period IA is continuous. SA is normally periodical or
annual.
Qualifications No qualifications are Qualifications are
prescribed by law for an prescribed by law for
Internal Auditor. Statutory Auditor.
Liability for Internal Auditor is liable Statutory Auditor is liable to
Negligence only to management and not shareholders and in some
to shareholders or third cases to third parties also.
parties.
INTERNAL AUDIT VS. INTERNAL CHECK

TOPIC INTERNAL AUDIT INTERNAL CHECK

Aims Aims to determine whether Aims to distribute responsibilities
other internal controls are and work to help cross-checking.
working properly.

Part of Part of internal control. Part of Internal control.

Separate Separate staff is appointed to No separate staff is appointed to
staff carry out internal audit. carry out Internal Check.
When Internal audit is done after the Internal Check is done during the
work is complete. work.
Purpose Internal audit may detect Internal check may prevent errors
errors or frauds. or frauds.

Audit Process: Audit programme

Audit process

1. One must take care to ensure that nothing is missed in the process
which needs to be followed to achieve the audit objective. The
following audit process in that order may be taken as a specimen:

2. Formulating audit plan and laying down broad framework for

conducting the work and method to ensure control over the quality of
work.

3. Examination and evaluation of the nature, extent and efficacy of the

system of internal control. The nature, extent and timing of substantive
procedures, would depend upon the extent of satisfaction an auditor
obtains after evaluating the internal control system. The determination
of extent of test checking would also depend upon the same.

4. Ascertaining the arithmetical accuracy of the books of account by

checking posting, casting, crass-casting, carry forwards, opening and
closing balances, etc.
5. Examining the documentary evidence (both internal and external)
and the authority in support of the transaction, i.e. vouching.

6. Checking the validity of transactions with reference to:

a) Provisions affecting the accounts and audit in any Act or Rules;

b) Rules and regulations governing the constitution and management

of the organisation i.e., the memorandum and articles of association in
the case of a company, partnership deed in the case of a firm, trust deed
in the case of a trust and bye-laws in the case of a co-operative society;

c) Minute books for appropriate sanction of the transactions by

competent authority;

d) Other legal documents such as the prospectus, returns submitted to

legal authorities, contracts and agreements e.g., vendors’ agreement,
lease agreement, selling agency agreement, collaboration
agreements, etc; and

e) Well recognized accounting principles and practices e.g.,

distinction between capital and revenue, accrual system of accounting,
valuation principles, etc.

7. Ensuring that there is adequate disclosure of information and, in

particular, the annual accounts are prepared in such a manner as to
convey the real picture about the assets and liabilities and of the
operating result (profit or loss) of the organisation. For this purpose,
the auditor must conform to the prescribed legal requirement, if any,
as to the form of accounts and have due regard to the best current
accounting practice. Reference to Schedule III of the Companies Act,
2013 in case of companies and compliance with accounting standards
will have to be seen.

8. Verification of existence, ownership, title and value of the assets and

determination of the extent and nature of liabilities.
9. Scrutiny of the accounts to establish reasonableness, consistency
and compliance with the legal requirements.

10. Application of various overall checks in order to test the overall

reliability of the accounting records and the statements and to see
whether the results of overall checks corroborate the findings already
made.

11. Determination of the significant accounting ratios and subjecting

the accounts to ratio analysis to locate the areas showing departure
from the expected state of affairs .Audit and books Working papers and
evidences consideration for commencing an audit, Routine checking
and Test checking Intern Check System: Internal Control, Internal
auditing.

Audit programme

It is desirable that in respect of each audit and more particularly for

bigger audits an audit programme should be drawn up.
Audit programme is nothing but a list of examination and verification
steps to be applied and set out in such a way that the inter-relationship of
one step to another is clearly shown and designed. In other words, an
audit programme is a detailed plan of applying the audit procedures in
the given circumstances with instructions for the appropriate techniques
to be adopted for accomplishing the audit objectives.

1. To start with, an auditor having regard to the nature, size and

composition of the business and the dependability of the internal
control and the given scope of work, should frame a programme which
should aim at providing for a minimum essential work which may be
termed as a standard programme. This programme may be altered in
case of any abnormal situations.
2. The assistant engaged in the job should be encouraged to keep an
open mind beyond the programme given to him. He should be
instructed to note and report significant matters coming to his notice,
to his seniors or to the partners or proprietor of the firm engaged for
during the audit.
3. There should be periodic review of the audit programme to assess
whether the same continues to be adequate for obtaining requisite
knowledge and evidence about the transactions.

4. The utility of the audit programme can be retained and enhanced only
by keeping the programme as also the client’s operations and internal
control under periodic review so that inadequacies or redundancies of
the programme may be removed.

5. As a basic feature, audit programme not only lists the tasks to be

carried out but also contains a few relevant instructions, like the extent
of checking, the sampling plan, etc. So long as the programme is not
officially changed by the principal, every assistant deputed on the job
should unfailingly carry out the detailed work according to the
instructions governing the work.

6. An audit programme consists of a series of verification procedures to

be applied to the financial statements and accounts of a given company
for the purpose of obtaining sufficient evidence to enable the auditor to
express an informed opinion on such statements.
For the purpose of programme construction, the following points
should be kept in view:

a) Stay within the scope and limitation of the assignment.

b) Determine the evidence reasonably available and identify the best
evidence for deriving the necessary satisfaction.
c) Apply only those steps and procedures which are useful in
accomplishing the verification purpose in the specific situation.
d) Consider all possibilities of error.
e) Co-ordinate the procedures to be applied to related items.
Advantages of an Audit Programme:

• It provides the assistant carrying out the audit with total and clear set
of instructions of the work generally to be done.
• It is essential, particularly for major audits, to provide a total
perspective of the work to be performed.
• Selection of assistants for the jobs on the basis of capability becomes
easier when the work is rationally planned, defined and segregated.
• Without a written and pre-determined programme, work is
necessarily to be carried out on the basis of some ‘mental’ plan. In such
a situation there is always a danger of ignoring or overlooking certain
books and records. Under a properly framed programme, the danger is
significantly less and the audit can proceed systematically.
• The assistants, by putting their signature on programme, accept the
responsibility for the work carried out by them individually and, if
necessary, the work done may be traced back to the assistant.
• The principal can control the progress of the various audits in hand
by examination of audit programmes initiated by the assistants
deputed to the jobs for completed work.
• It serves as a guide for audits to be carried out in the succeeding
year.
• A properly drawn up audit programme serves as evidence in the
event of any charge of negligence being brought against the auditor. It
may be of considerable value in establishing that he exercised
reasonable skill and care that was expected of professional auditor.

Disadvantages of Audit Programme

The work may become mechanical and particular parts of

the programme may be carried out without any understanding of the
object of such parts in the whole audit scheme.

• The programme often tends to become rigid and inflexible following

set grooves; the business may change in its operation of conduct, but
the old programme may still be carried on. Changes in staff or internal
control may render precaution necessary at points different from those
originally decided upon.
• Inefficient assistants may take shelter behind the programme i.e.
defend deficiencies in their work on the ground that no instruction in
the matter is contained therein.
• A hard and fast audit programme may kill the initiative of efficient
and enterprising assistants.
• All these disadvantages may be eliminated by imaginative supervision
of the work carried on by the assistants; the auditor must have a
receptive attitude as regards the assistants; the assistants should be
encouraged to observe matters objectively and bring significant
matters to the notice of supervisor/principal.

Audit and books Working papers and evidences

Audit notebook

An audit note book is usually a bound book in which a large variety of

matters observed during the course of audit are recorded. It is thus a part
of the permanent record of the auditor available for reference later on, if
required. The audit note book also provides a valuable help to the auditor
in picking up the links of work when the concerned assistant is away or
the work is stopped temporarily because in it are recorded along with
observations, the various queries, explanations obtained and evidence
seen, while queries remaining undisputed of would be noted for follow
up. It is more satisfactory in some ways, however, to use loose sheets for
entering queries and notes which, subsequently, on being punched, may
be filed in a special query file maintained for each client or along with the
clients’ accounts and papers, separately for each year.

Significant matters observed during the course of audit, a record of

which should be kept in the Audit Note Book:

• Audit queries not cleared immediately e.g. missing receipts, vouchers,

etc.
• The mistakes or irregularities observed during the course of audit
e.g. cases of failure to comply with the requirements of the Companies
Act, 2013 or the provisions contained in the Memorandum or Articles; a
change in the basis of valuation of finished inventory and work-in-
progress or in the computation of depreciation; failure to provide
adequate depreciation, etc.
• Unsatisfactory book-keeping arrangements, costing method, internal
or financial administration or organization.
• Important information about the company which is not apparent
from the accounts.
• Special points requiring consideration at the time of verification of
final accounts.
• Important matters for future reference.

Specimen of entries in an Audit Note Book to indicate the manner in which

entries in those books ought to be made:

Queries-Vouchers-Cash Book Payment

Voucher Account Query How disposed of

Debited
38 Advertisement 2,01,600 Managing Sanction obtained
Director’s sanction
required
107 Rent 81,500 Rent bill & receipt Receipt & bill
required obtained
306 Das & Co. 5,23,474 Receipt required Party reminded
42 Machinery 15,49,160 Board’s sanction Sanction obtained
required minute dated 10-1-
15
89 Stores 37,403 Invoice required Party reminded
128 Raw material 83,457 Rates for items (I) Items of the quality
& ordered not
being available, a
better quality was
 accepted under
(ii) are different purchase officer’s
from those on the approval.
purchase order

The making of intelligent enquiries on the accounts under audit is an

important part of the work of an auditor. However, to guard against the
client’s staff being required to provide explanation and information
which are unnecessary or which could be ascertained otherwise junior
members of the audit staff should be allowed to raise audit queries only
after obtaining the prior approval of the senior in charge.

The audit notes constitute important evidence of matters considered by

the auditor during the course of the audit, some of which may not find a
place in his report submitted to the shareholders or directors, for the
reason that on the basis of an explanation given to him by the
management, he, on being satisfied, decided to drop them. As such, audit
notes can be an important defense for the auditor in the event of an action
for negligence in the discharge of his duties being subsequently brought
against him.

Audit notes can also serve as a guide in framing audit programmed in the
future as they indicate the weaknesses in the system of the client which
specially need to be watched.

Also, it is desirable that the audit notes, whether they are kept in a book
or in loose sheets, should bear a reference to the particular item of work
in the audit programmed, and as far as practicable, all notes relating to
the particular work in the programmed should be kept together in the
systematic order.

Audit evidence

The Auditing Standard on Audit Evidence SA(500) issued by the Institute

of Charted Accounting of India (ICAI) deals with the nature of audit
evidence and the procedures and techniques used to obtain evidence.
Auditor needs to obtain evidence is respect of the following basic
matter-

1. Internal controls

2. Transactions during the year and

3. Balance of Assets and Liabilities at the end of the Year.

Such evidence must be sufficient, relevant and reliable.

1. Evidence about Internal Controls:

• Existence:- Auditor should ascertain whether Internal Control exist in

the concern or not.
• Effective:- Auditor should obtain evidence whether the internal
control are effective or not.
• Operative:- Auditor should obtain evidence whether the internal
control actually operated during the relevant accounting years.

2. Evidence about Transactions During The Year

• Occurrence:- Auditor should obtain evidence proving that a

transaction actually took place.
• Complete: - Auditor should obtain evidence to ensure that there are
no unrecorded transaction assets or liabilities.
• Amount: - Auditor should obtain evidence to ensure that a
transaction is recorded in the books for the right amount.
• Disclosure: - Auditor should obtain evidence to ensure that a
transaction is recorded in the books and disclosed in the final account
as per the recognized accounting policies and practices and the
provision of law.

3. Evidence about Year-End Balances Of Assets & Liabilities

• Existence:- Auditor should obtain evidence to ascertain whether an

assets or a liability actually exists as at the year end.
• Right and Obligations:- Auditor should obtain evidence to ascertain
whether an asset is legally owned and a liability is legally owned by the
concern at the year end.
• Valuation:- Auditor should obtain evidence to ensure that an asset or
a liability is shown in the balance sheet at the right value.
• Diclosure:- Auditor should obtain evidence to ensure that the assets
and liabilities are disclosed in the balance sheet as per
the recognised accounting policies and practices, and the provision of
law.

Essentials Of Good Audit Evidence:-

• Sufficient Evidence:- Sufficient evidence means adequate evidence in

terms of its quantity or extent.

• Relevant Evidence:- Audit evidence must be relevant to the matter

being checked. Thus ,if transactions in stock book for receipt and issue
are being checked, relevant evidence would be Goods Received Notes,
Delivery Chalans ,etc.
• Reliable Evidence:- No evidence can be 100% reliable or conclusive . It
is said audit evidence is normally persuasive rather than conclusive in
nature. Auditor must see whether the evidence obtained is reliable or
not. Reliability of audit evidence depends upon its source and its
nature.

Internal Evidence V/S External Evidence.

Feature Internal Evidence External Evidence

Nature Internal evidence is one which External evidence, on the other
has been created within the hand is one which originates
client’s organization. from outside the client’s
organization. A document
issued by a person with whom
some business transactions had
been entered into or who was
 paid or was advance an amount
constitutes such evidence.
Example Examples are sales invoices, Examples are payee’s,
employees time reports, purchase invoices, lease
inventory reports, wages agreement, bank statement,
sheets, counterfoil of receipts, cancelled cheques, insurance
purchase requisition, minute policies, mortgage deeds etc.
books etc. These documents are prepared
in the normal course
of business activities of the
organization an form part of its
records.
Sources Internal evidence is created External evidence is obtained
and retained within the from outside parties.
organization.

Reliability Internal evidence is External evidence is

considered less reliable considered more reliable than
considered less reliable than internal evidence.
external evidence.

Audit working papers

The audit working papers constitute the link between the auditor’s report
and the client’s records. According to SA-230 , Audit Documentation
refers to the record of audit procedures performed, relevant audit
evidence obtained, and conclusions the auditor reached (terms such as
“working papers” or “work papers” are also sometimes used). The
objects of an auditor’s working papers are to record and demonstrate the
audit work from one year to another.

Audit documentation serves a number of purposes:

a) Assisting the engagement team to plan and perform the audit.

b) Assisting members of the engagement team responsible for
supervision to direct and supervise the audit work, and to discharge their
review responsibilities in accordance with SA 220.
c) Enabling the engagement team to be accountable for its work.
d) Retaining a record of matters of continuing significance to future
audits.
e) Enabling the conduct of quality control reviews and inspections in
accordance with SQC 1.
f) Enabling the conduct of external inspections in accordance with
applicable legal, regulatory or other requirements.
Working papers are varied in nature. They may be recorded on paper
or on electronic or other media. Examples include:
a) Audit programmers.
b) Analyses.
c) Issues memoranda.
d) Summaries of significant matters.
e) Letters of confirmation and representation.
f) Checklists.
g) Correspondence (including e-mail) concerning significant matters.

The auditor may include abstracts or copies of the entity’s records (for
example, significant and specific contracts and agreements) as part of
working papers. Working papers, however, is not a substitute for the
entity’s accounting records. The auditor need not include in audit
documentation superseded drafts of working papers and financial
statements, notes that reflect incomplete or preliminary thinking,
previous copies of documents corrected for typographical or other
errors, and duplicates of documents. Oral explanations by the auditor, on
their own, do not represent adequate support for the work auditor
performed or conclusions the auditor reached, but may be used to
explain or clarify information contained in the working papers.
The foundation of all working paper can be traced to:

a) The basic constitutional documents like Memorandum and Articles of

Association, Partnership Deed, Trust Deed, etc.;
b) The contents of the minute books;
c) The contents of the balance sheet and the statement of profit and loss;
and
d) The letter of engagement.
Form and Content of Working Papers: Working papers should record
the audit plan, nature, timing and extent of auditing procedures
performed, and the conclusions drawn from the evidence obtained.

The form, content and extent of working papers depend on factors such
as:

• The size and complexity of the entity.

• The nature of the audit procedures to be performed.
• The identified risks of material misstatement.
• The significance of the audit evidence obtained.
• The nature and extent of exceptions identified.
• The need to document a conclusion or the basis for a conclusion not
readily determinable from the documentation of the work performed
or audit evidence obtained.
• The audit methodology and tools used.

Working papers should be designed and properly organized to meet the

circumstances of each audit and the auditor’s needs in respect
thereof. Working papers should be sufficiently complete and detailed for
an auditor to obtain an overall understanding of the audit. The extent of
the documentation is a matter of professional judgment since it is neither
necessary nor practical that every observation, consideration or
conclusion is documented by the auditor in his working papers. All
significant matters which require the exercise of judgment, together with
the auditor’s conclusion thereon, should be included in the
working papers. The auditor should satisfy himself that these working
papers have been properly prepared. Examples of such working papers
are detailed analysis of important revenue accounts, receivables etc. In
the case of recurring audits, some working paper files may be classified
as permanent audit files which are updated currently with information of
continuing importance to succeeding audit, as distinct from current audit
files which contain information relating primarily to the audit of a single
period.

A permanent audit file normally includes:

• Information concerning the legal and organizational structure of the

entity. In the case of a company, this includes the Memorandum and
Articles of Association. In the case of a statutory corporation, this
includes the Act and Regulations under which the corporation
functions.
• Extracts or copies of important legal documents, agreements and
minutes relevant to the audit.
• A record of the study and the evaluation of the internal controls
related to the accounting system. This might be in the form of narrative
descriptions, questionnaires or flow charts, or some combination
thereof.
• Copies of audited financial statements for previous years.
• Analysis of significant ratios and trends.
• Copies of management letters issued by the auditor, if any.
• Record of communication with the retiring auditor, if any, before
acceptance of the appointment as auditor.
• Notes regarding significant accounting policies.
• Significant audit observations of earlier years.

The current file normally includes:

• Correspondence relating to acceptance of annual reappointment.

• Extracts of important matters in the minutes of Board Meetings and
General Meetings as relevant to audit.
• Evidence of the planning process of the audit and audit programmed.
• Analysis of transactions and balances.
• A record of the nature, timing and extent of auditing procedures
performed, and the results of such procedures.
• Evidence that the work performed by assistants was supervised and
reviewed.
• Copies of communication with other auditors, experts and other third
parties.
• Letters of representation or confirmation received from the client.
• Conclusions reached by the auditor concerning significant aspects of
the audit, including the manner in which exceptions and unusual
matters, if any, disclosed by the auditor’s procedures were resolved or
treated.
• Copies of the financial information being reported on and the related
audit reports.

Consideration for commencing an audit:

Steps:- Before Commencing an Audit, the auditor must take the following
steps and procedures.

1. Ascertain the type of audit i.e. statutory, continuous etc.

2. Obtain necessary document such as list of books , employees etc., and

3. Give instruction for preparation to be made by the client.

This will help the auditor to-

1. Develop the overall audit plan.

2. Prepare the Audit Programme and

3. Identify areas of audit requiring special emphasis.

Type Of Audit:-

• Statutory or Voluntary:- The auditor should ascertain whether the

audit is statutory or voluntary. If the audit is statutory, e.g. financial
audit under the companies Act, the audit must be conducted in
accordance with the provisions of the companies act. If the audit is
voluntary, e.g. audit of a sole trader or a partnership firm, the auditor
must know why the audit is being conducted e.g. for valuation of
business at the time of sale, admission of partner and so on. This helps
in defining the scope and procedure of audit.

2. Continuous or Final:- The auditor should ascertain whether the audit

is continuous or final. This enables the auditor to decide the extent of
checking and the types of audit procedures to be adopted.

Documents To Be Obtained From Client :-The auditor should obtained

the following documents from the client before commencing the audit-

• Letter to Appointment.
• Memorandum and Articles of Association in case of a Company.
• Partnership deed in case of a firm.
• Organisational chart showing different departments and sections in
the organisation and the persons in change.
• Organisation Chart of the Accounts and Internal Audit department.
• List of directors, partner and officers entitled to sanction payment,
sign cheques and offer explanation to auditor.
• List of places of businesslike. offices, branches and factories.
• List of bocks of account and other relevant records.
• Internal Control Manual and Internal Auditor's Reports.
• Draft Final Account, Trail Balance, Groupings and Schedules.
• Past Annual Account and Annual Reports.
• Extracts from minute Books.
• List of products manufactured and raw materials purchased.
• List of relatives of directors, interested persons etc.

Instruction Of Clients To Prepare Documents :-Before actually

commencing the audit ,the auditor should issue detailed instruction to the
client to prepare and keeps ready-

• All registers such as Cash Book, Bank Book, Sale Register, Purchase
Register, Journal etc. along with voucher Files.
• All ledgers duly posted and balanced.
• Trail balance duly tallied.
• Draft Final Account with schedules and groupings.
• Schedule of Fixed Assets and Commutations Of Deprecations.
• Details Of investment.
• Details so cash-in-hand, cheques in transit at year end.
• Bank Reconciliations and Bank Balance Confirmations.
• Confirmation of balance from parties, lender, etc.
• Bill-wise statement of debtors and creditor balance.
• Quality Reconciliations and Statement of Closing Stock.
• Details of pre-paid and outstanding expenses.

Routine checking and Test checking Intern Check

System: Internal Control, Internal auditing

Test check

SA 700 (Audit Report) mentions that an audit includes examination, on a

test basis, of evidence supporting the amounts and disclosures in
financial statements.

Meaning

SA 500 issued by the institute of Chartered Accounts of India (ICAI) states

that in forming an opinion an auditor may obtain audit evidence on
selective basis. The selection may be based on auditor’s personal
judgment or statistical sampling technique.
TEST CHECKING VS. STATISTICAL SAMPLING

When items are selected and checked on the basis of the personal
judgment of auditor, it is called Test Checking. When items are selected
by applying statistical techniques of sampling, random selection etc., it is
called Statistical Sampling.

UNSUITABLE

The following transaction/balances are not suitable for test checking.

• Opening and closing entries.

• Bank Reconciliation statements.
• Item recurring calculations/estimates e.g. depreciation, royalty etc.
• Very important/material transactions/ balances etc.

IMPORTANCE

• Full Checking Impossible

When the number of transactions is large auditor cannot check all the
transactions 100%. In such cases auditor has to resort to test checks.

2. Full Checking Unnecessary

In most cases, 100% checking is unnecessary. Statements on Auditing

Practices issued by the ICAI states that where an adequate system of
internal control is in force, the auditor is entitled to apply test checks.

3. Extent of Checking

The extent of checking should be based on the following factors:

a) Possibility of errors and frauds.

b) Nature and materiality of item being checked.

c) Nature of the business and size of the company.

d) The system of accounting.

e) Internal controls.

f) Internal audit.

ADVANTAGES

• Reduces the cost of audit.

• It helps to speed up the audit work.
• It helps to decide whether the financial records are reliable and to
what extent.
• It is a labor saving technique.
• It helps auditor to arrive at a conclusion regarding the true and fair
view.

DRAWBACKS

• Arbitrary Selection

The selection depends upon the personal judgment of the auditor.

2. Ignores Statistical Techniques

Test checking ignores statistical techniques of sampling, random

selection, risk assessment etc. Thus, auditor cannot be confident that he
has selected the right sample.

3. Ignores Quality

An audit instruction regarding, say 25% checking of purchase entries,

does not indicate how those 25% entries are to be selected.

4. Risks

Risk means the possibility that conclusions from test checks may be
different from those based on 100% checking. Risks are of the following
types –
(a) Reliance on Internal Controls

(b) Wrong Conclusions

PRECAUTIONS

• Classify Transactions under proper heads

• System and Procedures for a transaction right from the beginning
to the end should be studied in their sequence.
• The whole of the system of internal control in the areas of accounts
and finance should be studied and evaluated.
• A properly thought-out test check plan should be prepared.
• The transactions falling under each tests-check plan should be
selected in such a manner that bias cannot enter in the selection.
• Auditor should identify the areas where test check may not be
suitable.

AUDITOR’S LIABILITY

The test checking does not reduce auditor’s liability. If an auditor is

accused of negligence, he cannot say that the items for test checking were
free of errors. It is the duty of the auditor to take reasonable care and
exercise his skill during an audit. Auditors must keep proper record of
the test checks carried out, to help him defend his conclusions later on.

Routine checking

Routine Checking means checking of arithmetical accuracy of books of

original entry and ledgers with a view to detecting clerical errors and
simple frauds. It involves the

a) Checking of casting, sub casting (total, sub-totals), carry-forward,

extension and calculation etc. in subsidiary books,

b) Checking of postings into the ledgers, casting of ledger account and

c) Extraction of their balance into the trial balance.

Feature;

1. Detailed Checking

Routine chewing involves detailed checking of each and every

accounting step-entry in the original books, postings into the ledger and
preparation of the trial balance.

2. Traditional system

It is the traditional system of audit also known as ‘vouch and post’ audit.

3. Juniors

The work is usually done by junior members of the auditor’s staff.

4. Ticks

Distinctive ‘ticks’ are used in routine checking for different purposes e.g.
for totals, for posting etc. hence ‘routine checking’ is also called ‘tick-
work’.

5. Routine Errors / Frauds

Routine Checking can reveal routine clerical errors / frauds.

Objectives-

The main objects of routine checking are:

1. Verification of the arithmetical accuracy of the entries,

2. Verification of the accuracy of posting of ledgers.

3. Verification of the balancing of the ledger accounts, and

4. Ensuring that no figures have been altered after checking.

Advantages

1. It is the simplest form of audit work.

2. Errors and frauds of simple nature can be very easily detected.

3. the books of accounts can be thoroughly checked.

4. It helps in checking castings and postings.

5. Arithmetical accuracy of all the transactions can be confirmed by this

method.

6. It offers an opportunity to train the junior auditors.

Disadvantages

Routine Checking has the following disadvantages:

• It is a mechanical and boring work

• It can detect only simple arithmetical errors and small frauds.
• It is time consuming and expensive.
• It is unnecessary in case of a large business using information
technology.

Internal control

SA 400 issued by the Institute of Chartered Accountants of India (ICAI)

deals with the study and evaluation of Internal Control in connection with
an audit. It defines internal Control as “all the policies and procedures
adopted by the management of a concern to ensure the orderly and efficient
conduct of its business.”

PURPOSE, ADVANTAGE AND OBJECTIVES

The objective of internal control i.e. accounting Controls and Operational

Controls are as follows.

• Accounting controls
 1. All transactions are duly authorized, properly recorded and
recorded promptly.
2. The accounting policies adopted by the management in respect of
stock valuation, depreciation etc. are implemented.
3. The assets of the concern are safeguarded; the assets are not
used or sold without proper authorization and are verified
regularly.
4. Errors and frauds are prevented and detected.
5. The books of accounts are complete and accurate.
6. The final accounts are reliable and ready in time.

2. Operational or Administrative Controls

Operational Controls aim to ensure that the management policies in

respect of the operations and administration of the concern are
implemented. This in turn ensures that the business is conducted in an
orderly and efficient manner. Examples of operational controls are
Quality Control, Budgetary Control, Internal Check, Internal Audit,
Quantitative Controls etc.

AUDITORS DUTIES

SA 400 makes the following recommendations in this regard:

• Responsibility of Management

Basically, the management is responsible for establishing and operating

the Internal Control system.

2. Auditor’s Duty

The auditor’s duty is to study system, check whether the system was
actually in operation during the year and evaluate the system to ascertain
how much he can rely upon it.

3. Need for Evaluation

An auditor needs to evaluate internal control system to achieve the
objectives.

4. Steps in evaluation

a) Understand the System: In the first stage, the auditor should

understand the system of Internal Control. He can understand the system
with the help of manuals, discussions with managers or the technique of
Flow Charts.

b) Test Application: He should check whether the controls were actually

applied in practice. He can check some transactions in depth. Thus he can
take up some sales transactions and check all the documents right from
the sales order to the receipt from debtors.

c) Evaluate the system: He should judge, on the basis of above tests,

whether he can rely on the system and if so to what extent.

5. Communicate Weakness to Management

a) The material weakness in internal controls should be communicated to

the management by the auditor. Material weakness means the absence of
adequate controls that increase the possibility of errors and frauds in the
financial statements.

b) Such communication should be in writing.

INHERENT LIMITATIONS OF INTERNAL CONTROL

All the objectives of internal control, listed above, may not be actually
achieved, because of its following limitations.

• Costs

Cost of implementing control procedure may be much more than its

benefits.
2. Human Error

A control procedure may not prove effective due to human errors e.g.
carelessness of employees, mis-understanding of instructions, wrong
judgments etc.

3. Collusion

Even if duties are divided among different employees, they may collude
(work together fraudulently).

4. Misuse

An employee responsible for a particular function may misuse his

authority.

5. Manipulation by Management

Manipulation and misappropriation by top management will defeat the

very purpose of internal control.

INTERNAL INTERNAL INTERNAL

CONTROL FOR CONTROL CONTROL
SALARIES AND FOR FOR SALES
WAGES PURCHASE
Division of Work relating to Work relating Work relating to
Work payment of to purchase sales and
salaries and should be debtors should
wages should be divided among be divided
divided among different among different
different departments departments
employees. and employees. and employees.
Different person Thus sales and Thus sales and
should employ the Debtors would Debtors would
staff and workers, involve the involve the
 record the Sales Sales
attendance, Department, Department, the
prepare the pay the stores and stores and the
Sheet, check the the account account
Pay Sheet, make department. department.
the payment and
record the entries.

Procedures The employees Purchase Sales

should sign in the department department
Pay sheet or should invite should obtain
Vouchers in tenders on the sales Orders
acknowledgment basis of and issue
of payment purchase Dispatch Orders
received. requisitions to the stores.
Payment to received from Material should
representatives of the factory or be dispatched
absent employees stores. Material from
should be made should be the godown onl
only after received in y on the basis of
verifying their the godown and such dispatch
authorization. If property orders and after
salaries are paid inspected preparing
by cheques, they before delivery challan
should be crossed acceptance. s. The Sales Bills
“A/C payee” to Payments should be
prevent misuse. should be made raised and the
by the Account cash
department or cheques from
only after debtors should
verifying the be received by
Goods the Accounts
Received Note department.
and the
 Inspection
report.

Cross-Check The work should The work The work

be divided in such should be should be
a way that the divided in such divided in such
related a way that the a way that the
documents are related related
prepared by documents are documents are
different persons prepared by prepared by
and automatically different different
checked by persons and persons and
another automatically automatically
employee. checked by checked by
another another
employee. employee.
Change in The security Staff, The duties of The duties of the
Duties the Personnel Staff the concerned concerned
and the Cashier employees employees
should be (purchase (salesman,
changed from officer, storekeeper)
time to time. storekeeper) should be
should be rotated from
rotated from time to time.
time to time. They may be
They may be transferred to a
 transferred to a different
different location. One
location. employee
should not do
same work for a
long time.
Annual The security staff The concerned The concerned
Leave and the cashier employees employees
should be asked (especially the (especially the
to go on leave at storekeeper) storekeeper)
least once every should be should be asked
year, to enable asked to go on to go on leave at
detection of errors leave at least least once every
or frauds. once every year, to enable
year, to enable detection of
detection of errors or frauds.
errors or
frauds.
Access to The security staff The purchase The sales staff
Books should not have officer or should not have
access to the pay Storekeeper access to the
sheets. The should not have books of
personnel Staff or access to the account, such as
Cashier should books of sales Journal or
not have access to account, such ledgers.
the books of as sales Journal
accounts. or ledgers.
Proper The attendance All goods All goods
Recording should be should be should be
recorded in the properly properly
Attendance recorded i.e. recorded i.e.
Records properly. the right the right
Mechanical Time quantity should quantity should
Clocks should be be entered, be entered,
 used to prevent against the against the right
errors and frauds. right party and party and on the
All payments on the right right date.
should be date.
properly
recorded.
Prompt The attendance The transaction The transaction
Recording and payments should be should be
should be recorded recorded
recorded promptly in the promptly in the
promptly in the relevant books relevant books
relevant books. of accounts. of accounts.
Accounting The payments The purchase The sales should
policies should be should be be recorded on
recorded on the recorded on the the basis of the
basis of the basis of the accounting
accounting accounting policies
policies adopted policies adopted by the
by the adopted by the management.
management. management.
Safeguarding The cheques sign The stock in The stock in
ed but not handed hand should be hand should be
over to the safeguarded safeguarded i.e.
employees who i.e. stored stored safely
may be absent safely and and properly.
should be kept in properly. Stock Stock in hand
safe custody. Such in hand should should be
as cheques or be verified verified
cash vouchers for regularly. regularly.
unpaid salaries
should be verified
immediately after
the ‘pay-day’
Errors and Pay sheets, cash Stock books Stock books
Frauds Book and bank should be should be
book should be checked to checked to
checked to detect detect errors in detect errors in
errors in recording recording sales.
recording purchase. e.g. E.g. errors of
payments of errors of commission,
salaries and commission, errors of
wages e.g. errors errors of omission or
of commission, omission or errors of
errors of omission errors of principle etc.
or errors of principle etc. stock books
principle etc. stock books should be
these books should be frequently
should be frequently reconciled with
checked to detect reconciled with the physical
frauds by inflating the physical stocks to detect
payments, by stocks to detect frauds e.g.
showing frauds e.g. misappropriatio
payments to misappropriatio n of goods by
dummy workers n of goods by inflating
etc. Payments to inflating dispatches.
dummy persons dispatches.
may be detected
by checking the
attendance
record, making
surprise check on
attendance.
Reconciliatio --- The Creditors The Debtors
n and accounts should accounts should
confirmation be reconciled be reconciled
s regularly. regularly.
Confirmation of Confirmation of
 balances balances should
should be be obtained
obtained from from them at
them at least least once
once during during year.
year.

Internal Control for Internal Control for Debtors

Creditors

Credit
Limits
a) Fixed on a basis which is clearly laid down

b) Approved by an officer independent of the sales department

c) Checked before accepting orders from customer, and

d) Reviewed from time to time.

Prompt The procedures should
Recording ensure prompt recording
of the amounts due to
creditors and the amounts
paid to creditors.
Prompt The amount paid to a
Adjustment creditor should be
promptly adjusted against
the relevant bill.
Unadjusted amounts should
be reconciled regularly.
The procedures should ensure
prompt recording of the amounts due
from debtors and the amounts
received from debtors.
The amount received from a debtor
should be promptly adjusted against
the relevant bill. Unadjusted amounts
should be reconciled regularly.
Age-wise There should be a
Schedule procedure for preparing
age wise schedule of
creditors. The schedules
should be reviewed by a
senior officer.
Statements Statements of accounts
of Accounts should be prepared and
periodically to all
creditors. They should be
prepared by a person
other than the ledger-
keeper and sent by yet
another person.
Discounts All materials adjustments
& write- such as discounts,
offs allowances and rebates
received, amount not
payable written back etc.
should be approved by a
senior manager.
Reconcile There should be a system
Control of periodic reconciliation
Accounts of creditors’ balances with
related control accounts.
There should be a procedure for
preparing age wise schedule of
debtors. The schedules should be
reviewed by a senior officer.
Statements of accounts should be
prepared and periodically to all
debtors. They should be prepared by
a person other than the ledger-keeper
and sent by yet another person.
All materials adjustments such as
discounts, allowances, rebates, and
debts written off etc. should be
approved by a senior manager.
There should be a system of periodic
reconciliation of debtors’ balances
with related control accounts.

Internal audit-

SA 610 issued by the Institute of Chartered Accountants of India (ICAI)

defines Internal Audit as follows: Internal audit is a separate component
of internal Control established to determine whether
other Internal controls are well designed and properly operated.

OBJECTIVES

• Review of accounting system and Internal controls

• Examination of Accounting controls
• Examinations of Operational controls
• Physical verification

SCOPE / FUNCTIONS OF INTERNAL AUDIT

• Monitoring of internal control.

• Examination of financial and operating information.
• Review of operating activities.
• Review of compliance with laws and regulations.
• Risk management.
• Governance.

INTERNAL AUDIT VS. EXTERNAL AUDIT

TOPIC INTERNAL AUDIT (IA) STATUTORY AUDIT (SA)

Voluntary / IA is Voluntary SA is compulsory under law
Compulsory e.g. under Companies Act.
Appointment Internal Auditor is Statutory Auditor is
appointed by the appointed by the
management itself. shareholders of a Company.
Status Internal Auditor is an Statutory Auditor is an
employee of the concern. independent outside
expert.
Responsible & Internal Auditor is Statutory Auditor is
reports to responsible and reports to responsible and reports to
management. shareholders.
Scope of Management decides the Duties of statutory auditor
duties scope of duties of internal are laid down by law
 Auditor. It includes non (e.g. Companies Act) its
accounting matters. scope limited to accounting
matters.
Removal Internal auditor can be Statutory Auditor can be
removed by the removed by shareholders
management on its own. only if approved by central
Government.
Objectives IA aims to review the SA aims to report to
internal control system of shareholders whether the
concern. accounts are true and fair.
Period IA is continuous. SA is normally periodical or
annual.
Qualifications No qualifications are Qualifications are
prescribed by law for an prescribed by law for
Internal Auditor. Statutory Auditor.
Liability for Internal Auditor is liable Statutory Auditor is liable to
Negligence only to management and not shareholders and in some
to shareholders or third cases to third parties also.
parties.

INTERNAL AUDIT VS. INTERNAL CHECK

TOPIC INTERNAL AUDIT INTERNAL CHECK

Aims Aims to determine whether Aims to distribute responsibilities
other internal controls are and work to help cross-checking.
working properly.

Part of Part of internal control. Part of Internal control.

Separate Separate staff is appointed to No separate staff is appointed to
staff carry out internal audit. carry out Internal Check.
When Internal audit is done after the Internal Check is done during the
work is complete. work.
Purpose Internal audit may detect Internal check may prevent errors
errors or frauds. or frauds.

Key takeaways –
• Auditing is defined as the on-site verification activity, such as
inspection or examination, of a process or quality system, to ensure
compliance to requirements.
• Test checking in Audit means checking a few transactions selected at
random from a large number of transactions.
• An internal audit offers risk management and evaluates the
effectiveness of a company's internal controls, corporate governance,
and accounting processes

UNIT 2

Audit Procedure

2.1 Audit Procedure: Vouching; Verification of assets and liabilities.

Vouching

Vouching is the examination of transactions of a business together with

documentary and other evidence of sufficient validity to satisfy an auditor
that such transactions are in order, have been properly authorized and
are correctly recorded in books.

Objects of Vouching -

• Authentication of accuracy and truth of book keeping entries.

• Satisfaction of entries of business transactions.
• Knowing the transactions unrelated with business.
• Authentication of transactions.
• Essence of auditing.

The auditor must take care of following while vouching

• Proper filing of vouchers in serial order.

• Adoption of test check methodology for examining vouchers.
• Comparison of evidences with accounting entries.
• Voucher must be in name of the person or business whose account is
audited.
• It must be related with business transactions.
• Voucher should relate to period under audit.
• It must be in printed form.
• The amount and calculations in voucher must be checked.
• Voucher must be signed, authenticated and duly stamped.

Vouching of Cash Book -

Cash Receipts :

(i) Internal check should be examined.

(ii) Issue of receipts and use of receipt books should be checked.

(iii) System of depositing the receipts into bank should be checked.

(iv) Auditor must obtain the list of all memorandum books like cash
diary, Kuchi Rokar Bahi, Pucci Rokar Bahi, etc.

(v) Vouchers must be serially numbered and the name, amount date in
vouchers must tally with the accounting records.

(vi) Accounting records unsupported by vouchers must be probed.

(vii) Soiled, unissued or cancelled receipts should not be torn but

checked along with counterfoils.

Important points while vouching Cash Payments

• Actuality of payment.
• Payment relates to audit year.
• Payment for business.
• Payment to right person.
• Right amount to be paid.
• Payment must be due with regard to date.
• Authorization of payment.
• No payment for ultravires acts.
• Legitimacy of payment.
• Correct accounting.

Vouching sales book

a) On the basis of copies of sales invoices.

b) Help from other books like orders received book, goods outward
book, correspondence, etc.

c) Intensive examination of goods sold of the end of the year and

beginning of new year.

d) Recording of only actual sales.

e) Help from statements of accounts of debtors.

f) Audit of totals and postings of sales book.

Vouching of Sales Returns Book-

• Vouching the records on the basis of copies of credit notes.

• Checking of goods inward book and correspondence.
• Examination of the records at the commencement of the next year.
• Totals and ledger posting of sales returns to be carefully examined.

Vouching Purchases

• Examination of purchase book on the basis of invoices.

• Record of lost vouchers.
• Help from goods inward book, challan form and packing notes.
• Checking of totals & postings on the basis of invoices goods inward
books, purchase order, challan form, goods receipt notes.

Vouching of Purchases Returns Book -

• Checking entries of purchases returns book on the basis of credit

notes.
• Tallying with goods outward book.
• Checking the totals and postings in ledger.

Vouching of Journal

• Opening entries shall be vouched with the balance sheet of previous

year.
• Closing entries to be vouched by checking the ledger postings.
• Rectification entries must be checked thoroughly and must be
countersigned.
• Adjustment entries relating to outstanding and prepaid expenses,
unearned income and accrued income must be vouched on the basis of
relevant documents.
• Transfer entries must be backed by proper authority.
• Bad debts must be vouched on the basis of authorization and
relevant correspondence with the debtors.
• Consignment transactions must be checked by the account sale
received from the agent.

Vouching Ledger Postings -

• Methodology of vouching, i.e., checking the ledger postings on the

basis of entries in books of original entries.
• Persons vouching the accounts.
• Recording the errors.
• Vouching the balances of accounts
• Test checking of ledger postings.
• Vouching of different ledgers – purchase ledger, sales ledger, etc.

Vouching of various receipts -

• Cash Sales & Credit Sales : Voucher, date, serial no., account head,
sales invoices, charging of sales tax and excise duty, copy of delivery
order, sales order, rates, quantity and authorization by sales/ marketing
manager.
• Receipt from debtor : Cash/Bank receipt voucher, date, serial no.,
account head, copy of invoice, sales order, rates quantity party ledger,
bank statement, sales register.
• Other Income (Interest dividend, etc) : Bank receipt voucher, date,
serial no., account head copy of dividend warrant, interest warrant. TDS
certificate, rates paid up value, investment register, bank book, bank
statement.
• Loan received: Receipt voucher, date, serial no., account head,
(secured/unsecured) loan agreement, hypothecation or pledge deed,
rates of interest, principal amount, resolution of board of directors,
bank statement, ledger.
• Rent Received: Cash/Bank receipt voucher, date, serial no., account
head, rent agreement, rent receipt, TDS certificate, prepaid or
outstanding rent, bank statement, ledger.
• Sale of Investment: Voucher, account head, broker’s note, copy
of demat account, rate, quantity, bank statement, investment ledger.
• Bills Receivable Discounted: Voucher date, account head,
discounting charges, copy of B/R, bank advice, noting charges, bank
statement/book, BR register.
• Sale of Fixed Assets: Receipts voucher, sale agreement, sale value
and wdv, authorization by BOD, fixed assets register, bank statement.
• Royalty Received: Receipt voucher, account head, copy of
agreement, TDS certificate, rates and quantity explored, produced or
sold, royalty register, ban statement.
• Insurance Claim : Receipt voucher, account head, copy of intimation
of claim copy of sanction, loss assessors report, verify the amount of
claim, insurance claim register, bank statement.
• Recovery of Bad Debts : Voucher, account head, debtors control
account, commission to factor, bank book, statement or list of bad
debts written off in previous years.
• Miscellaneous receipts (subscriptions amount received from,
agents etc) : Voucher, counter fails of receipts, bank pass book,
membership register, statements of agents, etc.

Vouching of Payments :

1. Purchase of Goods : Payment voucher, purchase order, builty,

material received note, inspection report, bank statement, rates, quantity
and terms of purchases, stores ledger, goods inward register,
authorization, cash purchase register.
2. Payment to Creditors : Receipt by customer, statement of account,
invoice copy, discount and allowances, and other deeds.

3. Salaries & Wages : Payment voucher, attendance register, salary

sheet, wage roll, time keeping record, bank statement, PF, ESIC,
overtime sheets, cash book or bank book, ledger,

4. Payment for Acquisition of Assets : Payment voucher, account head,

sale/purchase agreement, title deed, bank statement, transfer
deed, valuer certificate, stamp duty, broker’s statement, auctioneer’s
note, fixed asset register, cash/bank book, authorization by BOD, Articles
of association, etc.

5. Payment of Taxes (Income Tax, Sales Tax) : Computation of tax,

copy of challan of advance tax, TDS certificates, challan of self
assessment tax, return, etc.

6. Travelling Expenses : Voucher tour program, schedule, TADA rules,

expense voucher, receipts,etc.

7. Preliminary Expenses : Memorandum & Articles of association,

registry, Cheque no., bills & receipts, rate of stamps, vouchers, etc

Verification of Assets & Liabilities

Verification is the process of substantiation involved in proving that a

statement account or item is accurate and stated properly. It is an enquiry
into the value, ownership & title, existence and possession, and presence
of any charge on the assets as stated in the balance sheet.

Objects of Verification –

• Picture of true position.

• Correct valuation.
• Not exceeding the actual.
• Not less than actual.
• Existence and possession.
• Ownership and title.
• Without fraud or irregularity.
• Arithmetical correctness.
• Correct presentation in the balance sheet.

Position of Auditor as regards valuation of assets –

An auditor is not a valuer or a technical expert. So he has to rely upon the

valuation made by directors, partners, technical experts, surveyors, etc.
However he must ensure that the valuation is fair and reasonable and
based upon some accepted principles.

Verification of fixed assets -

(i) Goodwill -

(a) Existence : Whether purchased or acquired. Self generated

goodwill is not said to be in existence.

(b) Records : Check the fixed asset register.

(c) Right of Ownership : Check purchase agreement, purchase

consideration and MOU between the parties.

(d) Valuation and proper amortization as per AS-14, i.e. 5 years.

(e) Proper presentation and disclosure.

(ii) Freehold Properly :Which is in the name and title of owner.

(a) Ownership:Check the sale deed.

(b) Mortgage: Check the mortgage deed.

(c) Change in asset due to sale, purchase or construction work should be

enquired and duly recorded.

(d) Revenue expenses regarding repairs and maintenance should be

written off in P & L Account.
(e) The auditor must enquire into the existence, valuation and
presentation in balance sheet.

(iii) Leasehold Property :

It has two owners and both have qualified rights over it. The following
points to be considered :

(a) Ownership : Lease deed should be examined.

(b) Mortgage : Relevant deed should be perused.

(c) Revenue expenses : To be charged to P & L.

(d) Existence, valuation and presentation B/S to be checked.

iv) Plant & Machinery :

(a) Existence : Physical verification to be conducted, additions and

deductions to be checked.

(b) Records : Check the fixed asset register.

(c) Ownership : Invoice receipt and purchase order to be checked.

(d) Revenue and capital expenditure should be properly accounted for.

(e) Proper presentation and disclosure under the schedule of fixed

assets.

(v) Furniture, fixture and fittings :

The auditor has to verify the existence, records, changes ,ownership,

valuation, presentation and disclosure in the balance sheet, along with
depreciation.
(vi) Motor Vehicles :

The auditor has to verify the existence, fixed asset register, log books,
invoices, registration book, incidental charges like insurance and road
tax, depreciation, licences etc.

(vii) Copyrights, patents, trademarks, loose tools

Check the existence ownership, valuation, presentation in balance sheet,

respective registers, write off etc.

(viii) Investments :

a) Ownership: name of client, pledge or lien of investments,

Classification: trade or non trade, long term, short term, stock in trade.

b) Physical verification: obtain relevant certificates, etc.

c) Changes: broker’s purchase note or sale note should be checked.

d) Valuation and disclosure :Current investments should be valued at

lower of cost or fair market value. Long term investments should be
valued at historical cost of acquisition.

(ix)Inventory :

a) Classification of inventory : Stores and spare parts, loose tools, raw

materials, material in process, finished goods, waste or by products.

b) Existence and records in the stock register to be verified.

c) Right of ownership : Invoices, documentary evidence to be checked.

d) Valuation : According to AS-2, valuation is done on cost or NRV

whichever is lower.Method is FIFO or weighted average and method
is not changed, unless required.

e) Presentation and disclosure in Balance Sheet.

(x)Debtors, Loans and Advances:

a) List of debtors to be obtained.

b) Correspondence with debtors.

c) Inquiry into discount and bad debts, provision for bad debts.

d) Securities.

e) Presentation and disclosure in Balance Sheet.

f) Classification of debtors according to age, security and reliability,

bad and doubtful.

(xi) Loans and Advances.:

a) Names & Amounts involved.

b) Terms and Conditions of loan.

c) Regularity of repayment.

d) Steps for recovery/repayment of overdues.

Verification of Liabilities

Steps for verification

• Examination of records .
• Direct confirmation procedure.
• Examination of disclosure.
• Analytical review procedure.
• Obtaining Management Representations.

The nature, timing and extent of substantive procedures to be

performed is a matter of professional judgement of the auditor which is
based on the auditor’s evaluation of the effectiveness of the related
internal controls.
Key takeaways –

• Verification means to validate the resemblance of facts regarding the

assets and liabilities, with those appearing in the Balance Sheet.
• Vouching is done on the basis of documentary evidence i.e. vouchers,
invoices, bills or statements.

2.2 Audit of Limited Companies: Company Auditor – Appointment,

Powers, Duties and Liabilities.

Modes of Appointment of AuditorsThe First Auditor:

a) The first auditor of a company shall be appointed by the board of

directors within one month of the date of registration of the company. If
the Board fails to appoint within the said period of one month, the
company in general meeting may appoint the first auditors.

b) The first auditors shall hold office from the date of appointment to the
conclusion of the first annual general meeting of the company.

Appointment of Subsequent Auditors [Sections 224 (1), (IB) and (1C)]:

At every annual general meeting, the auditor are appointed or

reappointed by every company by passing an ordinary resolution. The
appointment of auditors at an annual general meeting is an item of
ordinary business. Such auditor holds office from the conclusion of the
meeting in which they are appointed to the conclusion of the next annual
general meeting.

Appointment of Auditors by Central Government [Section 224(3)]:

Where at any Annual General Meeting, no auditors are appointed or

reappointed, in that case within 7 days of such a meeting, the company
shall intimate this to the central government who may appoint a person to
fill the vacancy.
Compulsory Reappointment of Retiring Auditor (Section 224(2)]: At
an annual general meeting, a retiring auditor by what so ever authority
appointed, shall be reappointed except under any of the following
situations:

(a) Where he is not qualified for reappointment

(b) Where he has given the company notice in writing of his

unwillingness to be reappointed.

(c) Where a resolution has been passed at that meeting appointing

somebody instead of him or providing expressly that he shall not be
reappointed.

(d) Where notice has been given or an intending resolution to appoint

some person in the place of a retiring auditor passed, but by reason of the
death, incapacity or disqualification of that person the resolution cannot
be proceeded with.

Appointment in case of Causal Vacancy [Sec. 224 (6)]:

Where a vacancy is caused by the resignation of an auditor, the company

in a general meeting shall only fill the vacancy. The Board of Directors
may fill casual vacancy in the office of an auditor caused by any other
reason than a resignation, while any such vacancies continues the
remaining auditor or auditors, if any, may continue to act the auditor or
auditors. Any auditor appointment in a casual vacancy shall hold office
until the conclusion of the next annual general meeting.

Appointment by special Resolution (Sec. 224 A):

In case of a company in which not less than 25% of the subscribed share
capital is held, whether singly or in any combination, by

a. A public financial institution, or a government company or the Central

Government or any state government, or
b. Any financial or other institution established by any provincial or State
Act, in which a State Government holds not less than 51 % of the
subscribed share capital, or

c. A nationalised bank or an insurance company carrying on general

insurance business,

The appointment or reappointment at each annual general meeting of the

company, an auditor or auditors shall be made by a special resolution. It
the company fails to pass such a special resolution for making the
appointment of an auditor or auditors

it shall be deemed that no auditor or auditors had been appointed by the

company at its annual general meeting. In such a case, the Central
Government may appoint a person to act as the auditor of the company.

Appointment of Auditors of Government Companies (Sec. 619):

Appointment of auditors in case of a government Company is subject to

the provisions of Sec 619 which overrides Sec 224 to Sec 233 dealing with
appointment, etc., of the auditors in the case of nongovernment
companies. The auditor of a Government Company shall be appointed or
reappointed by the Comptroller and Auditor General of India; however
the appointment shall be subject to ceiling limits as per Sec 224 (1B).

Removal of Auditor

Different modes of removal:

(a) Removal of first auditors before expiry of term [Section 224(5)]:

The company may remove the first auditor by passing an ordinary
resolution at a general meeting (usually extra ordinary general meeting.
No special notice is required for such removal under s. 225. However,
procedure prescribed under section 225(2) and (3) shall be followed.
Although Nomination notice is required to given to the members of the
company at least 14 days before the date of the meeting by this way only
any other person may be appointed in place of removed auditor.

(b) Removal of subsequent auditor before expiry of their term:

The company may, after obtaining the previous approval of the Central
Government, remove the auditors before the expiry of their term by
passing an ordinary resolution. No special notice is required for such
removal. However, procedure prescribed under section 225(2) and (3)
shall be observed.

(c) Removal at an AGM of first or subsequent auditor: The company may,

at an annual general meeting, provide expressly that a retiring auditor
shall not be reappointed or appoint an auditor other than a retiring
auditor. Special notice shall be required for such. The remaining
procedure prescribed under section 225(2) and (3) shall be followed for
his removal.

Procedure prescribed under section 225(2) and (3) :

(b) The notice for removal of an auditor shall be sent forthwith by the
company to the auditor.

(c) After receiving notice auditor has the following rights :

(i) Right to be heard orally at the meeting.

(ii) Right to make a representation in writing to the company (not

exceeding reasonable length).

(iii)Right to get his representation circulated among the members.

(d) Where a request is made by the auditor to circulate the

representation, it shall be the duty of the company :

(i) to send a copy of the representation to every member of the company;

and
(ii) to state the fact of the representation having been made in the notice
given to the members.

(e) When representation is not sent by the company:

If a copy of the representation which was not sent as aforesaid because

the representation was received too late or because of the company’s
default, the auditor may require that the representation shall be read out
at the meeting by himself.

(f) Intervention by Central Government:

The copies of the representation need not be sent out and the
representation need not be read out at the meeting if the Central
government is satisfied that this right is being abused by the auditor to
secure needless publicity for defamatory matter. The Central
government may order the company’s costs on such an application to be
paid by the auditor, notwithstanding that he is not a party to the
application. The application to the Central government may be made
either by the company or by any other remember or director or other
person.

Rights of Auditors [Section 227]-

1. Rights of Auditors to access books of accounts An auditors of a company

shall have a right of access at all times to the books and accounts and
vouchers of the company, whether kept at the head office of the company
or elsewhere.

2. Right to obtain information and explanations [227(1)]:

An auditor of the company is entitled to require from the officer of the

company such information and explanation as he may think necessary for
the performance of his duties as an auditor.

3. Right to visit branch offices and access to branch account [Sec. 228(2)]:
Where the accounts of any branch office are audited by a person other
than the company’s auditor, the company’s auditor is entitled to visit the
branches, if he deems it necessary to do so for the performance of his
duties as an auditor.

4. Right to receive notice and attend general meeting [Sec. 231]:

The auditor has the right of

a) receiving all the notices and other communication relating to any

general meeting of a company which any member of the company is
entitled to have

b) He is entitled to attend any general meeting and

c) He is entitled to be heard at any general meeting which he attends on

any part of the business which concern’s him as an auditor.

5. Right to make representation [Sec. 225]:

The retiring auditor is

a) Entitled to receive a copy of the special notice intending to remove

him or proposing to appoint any other person as auditor.

b) Further, the retiring auditor sought to be removed has a right to make

his representation in writing and request that the same be circulated
amongst the members of the company.

c) In case, the same could not be circulated, the auditor may require that
the presentation shall be read out at the general meeting. The auditor
also has the right to be heard at the general meeting.

6. Remuneration of the Auditor [Section 224(8)]:

Auditor is entitled to receive remuneration as follows-

a. Where appointed by the Board of Director

When an auditor is appointed by the Board of Directors, remuneration is
also fixed by them.

b. Where appointed by shareholders:

In this case the remuneration is determined by the share holders at the

AGM.

c. If appointed by the Central Government.

In this case the remuneration is fixed by the Central Government.

d. If appointed by the Comptroller and Auditor General of India: the

remuneration should be fixed by the co. in general meeting.

7. Right to correct any wrong statement.

8. Right to have legal and technical advice.

Duties of Auditors:

1. Duty as to enquiry [Sec. 227(1A)]:

Without prejudice to the rights given under s. 227 (1) auditor must
enquire into following matters:

(a) Whether loans and advances made by the company on the basis of
security:

(i) have been properly secured and

(ii) whether the terms on which they have been made are not prejudicial
to the interest of the company or its members;

(b) Whether transactions of the company which are represented merely

by book entries are not prejudicial to the interests of the company;

(c) Whether the company is an investment company or a banking

company, whether so many of the assets of the company as consists of
shares, debentures and other securities have been sold at a price less
than at which they were purchased by the company;

(d) Whether loans and advances, made by the company have been shown
as deposits;

(e) Whether personal expenses have been charged to revenue account;

and

(f) Where it is stated in the books and papers of the company that any
shares have been allotted for cash, whether the cash has actually been so
received, whether the position as stated in the accounts books and the
Balance Sheet is correct, regular and not misleading.

2. To report to members.

3. To specify a few things in the report.

4. Duties under section 227(4A).

5. To report for inclusion in prospectus.

6. To certify the Statutory Report.

7. Duties regarding Investigation.

8. To submit report on the Balance Sheet and P. & L. Account appended to

the declaration of solvency at the time of voluntary winding up.

Liabilities of an Auditor:

A. Civil Liabilities B. Criminal Liability

(A.) Civil Liabilities:

1. Liability for Negligence:

If the auditor owes some duty towards the plaintiff (the person who files a
suit in the court), and he does not discharge his duties with reasonable
skill and care, resulting in a loss to the plaintiff, the auditor is guilty of
negligence.

2. Liability for Misfeasance:

If the auditor does not approach and perform his duties it is misfeasance
an auditor is liable to indemnity only if the following things are proved
against him:

• The auditor owned duty to the plaintiff:

• He failed to discharge his duty;
• The plaintiff suffered loss due to non-performance of duty by the
auditor.\

3. Civil Liability under Indian Companies Act:

a. Under section 62: If an auditor who can also be the auditor of the
company gives untrue statement as expert in the prospectus issued by
the company, he is liable to indemnify to each person who, believing the
prospectus applied to purchase any shares or debentures and who has
suffered loss due to the untrue statement.

b. According to Section 543 of Indian Companies’ Act: The Court can

compel an auditor to indemnify the company an amount deemed fit by the
Court with regard to the being wound up, if he is held guilty of
misfeasance and breach of trust.

Civil Liability towards Third Party:

1. Not liable for negligence: In regard to civil liabilities an auditor can be

compelled to indemnify only if the auditor owed duty towards the plaintiff.
Regarding company audit, as already stated, an auditor is appointed
by company, therefore, he owes duty only to the company. If loss is
suffered by third party due to negligence or misfeasance of the auditor,
the auditor cannot be liable for it. It is only just because there is no
contract between the auditor and third party.
2. Liability for fraud: An auditor is not liable to third party for negligence
or misfeasance but if he is guilty of fraud, he shall be held liable to the
third party also.

B. Criminal Liability :

Criminal Liability under Companies’ Act1. Violation of section 57.

• Not signing authenticating as per the Act.

• For not rendering help to the Inspector.
• Fraud in books. (Sec. 539).
• Filing a suit for a criminal action.
• For false statement in a report.
• For untrue statement in the prospectus.
• For prompting a person to invest.
• For false evidence.
• Arresting and producing the auditor in the court.

Key takeaways –

• An auditor is appointed to detect frauds, errors etc. He is responsible

on account of negligence in performance of his duties.
• Any clause in the agreement between the company and the auditor
whereby the auditor is freed from liability has been declared void.

UNIT 3
Auditing Standards
3.1 Auditing Standards- Appointment, Powers, Duties and
Liabilities of Auditors

All the government and non-government organizations have to keep track

of their accounts and audit reports as the financial year approaches. The
financial statements of these firms need to be thoroughly analyzed and
assessed before submitting them to the authorized departments. This
assessment of financial documents is done by an Auditor. In case of any
discrepancy in the reports, the auditor is held responsible. Thus, the
requirement of an auditor is a must for every organization.
Appointment of Auditor

Within 30 Days:

Every company must appoint its first auditor or an auditing firm within 30
days of registration of the company during the annual general meeting or
within 90 days, in an Emergency General Body Meeting by the Board of
Directors. The first auditor (or the auditing firm) appointed will hold office
from the conclusion of the meeting (in which the appointment of auditor
has been made) to the time when the sixth annual general meeting is held
(five years). Therein, the auditor appointments are reviewed every sixth
year.

Written Consent:

A written consent from the auditor, with sufficient proof to suggest that the
person (or firm) qualifies the criteria provided in Section 141 of the Act,
needs to be submitted before an appointment.

Appointment Notice:

The company should issue an appointment notice to the auditor, and a

Form, ADT- 1 is required to be submitted with the registrar within 15 days
of the meeting in which the auditor is appointed.

Section 139:

The companies listed in Section 139 (belonging to the class or classes of

companies as mentioned in the section) and Rule 5 of the companies
(audit and auditor) rules, 2014, will not:

1. Appoint an individual as auditor for more than one consecutive five-

year tenure;

2. Appoint an auditing firm for more than two terms of five consecutive
years
Provided, the auditor who has finished his term will not be eligible for
reappointment in the same company or the auditing firm who has
completed a two-year tenure is not eligible for appointment in the same
company for five years.

A three-year transition period is given to comply with this requirement.

Although, according to the rules, the five years is calculated with the
retrospective effect.

Sections 139 to 148 of the Companies Act, 2013 give a complete and
detailed summary of the role of an auditor as well as the other
requirements, such as their appointments or removal from the company
payroll.

Rights and Powers of auditors

According to Section 227(7) of the Companies Act, a company auditor has

the following rights:

1. Right of Access Books of Accounts: As per Section 227(1) of the

Companies Act every auditor of the company has the right to access at all
times to the books of accounts and vouchers of the company, whether
kept at the head office of the company or elsewhere. Under section 209(1)
(d), a company auditor has the right to examine the cost records also
which are required to be maintained by certain companies relating to
production sales, stores etc.

2. Right to Obtain Information and Explanations: An auditor can call

for any information or explanation from different officers of the company
which he may think necessary for the performance of his duties.

Apart from the auditor’s right to obtain information and explanation it is

the duty of every officer of the company to furnish without delay the
information to the company auditor. If the directors or officers of the
company refuse to supply some information on the ground that in their
opinion it is not necessary to furnish it, then the auditor has the right to
mention that in his audit report.

3. Right to Receive Notices and Other Communication Relating to

General Meetings and to attend them: According to section 231, of the
companies act an auditor of a company has the right to receive notices
and other communications relating to the general meetings in the same
way as that of the members of the company.

Similarly an auditor also has the right to attend any annual general
meeting and also to be heard at those meetings which he attends and
which concerns him as an auditor.

The auditor also has the right to make a statement or explanation with
regard to the accounts he has audited. But he auditor is not expected to
answer questions in the general meeting.

4. Right to Visit Branches: According to section 228 of the companies

act the auditor of the company has the right to visit the branch office or
offices of the company.

He can also audit such accounts of eh offices of the company provided that
there is not qualified auditor to audit the accounts of the branch office or
offices of the company, in such cases, the auditor has the right to access
at all times to the books of accounts and vouchers that the company
maintains at branch office or offices.

Moreover section 226 of the companies act provides that in case of the
company gets the branch accounts audited by some of the local auditors,
even the auditor has access at all times, to the books, accounts an
vouchers of the company and he can also visit the branches, if he feels
necessary.
5. Right to Correct Any Wrong Statement: The company auditor is
required to make a report to the members of the company on the accounts
examined by him of the final accounts and the related documents which
are laid down before the company in the general meeting.

6. Right to sign the Audit Report: As per section 229 of the companies
act only the person appointed as auditor of the company or where a firm
is so appointed, only a partner in the firm practicing in India, may sign the
audit report or authenticate any other document of the company required
by law to be signed.

7. Right to Being Indemnified: Under Section 633 of the Companies Act,

an auditor is considered to be an officer of the company and he has the
right to be indemnified out of the assets of the company against any
liability incurred by him in defending himself against any civil and
criminal proceedings by the company if it is proved that the auditor has
acted honestly or the judgment is delivered in his favour.

8. Right to seek Legal and Technical Advice: The company auditor has
the full right to seek the opinion of the experts and to take their legal and
technical advice so as to discharge his duties efficiently.

9. Right to Receive Remuneration: As per Section 224(8) of the

Companies Act, the company auditor has the right to receive
remuneration provided he has completed the work which he has
undertaken to do so.

Duties and Liabilities of a Company Auditor (Section 227):

Duties towards the shareholders:

1. Report shareholders about true and fair state of affairs of the company

2. State that balance sheet and profit and loss a/c give all information
required by law.
3. State that balance sheet and profit and loss a/c agree with the books of
account.

4. State that balance sheet and profit and loss a/c agree with accounting
standards.

5. State that he has obtained all the necessary information.

6. State whether the company has maintained all books as required by

law;

7. State the reasons of qualification in his report.

8. State that he has received the audit report on the branch accounts
audited by other auditor and how he has dealt with the same in preparing
his report.

9. Auditor shall state in his report whether:

a) The loans taken are properly secured and the terms of loans are not
against the interests of the company.

b) Loans given are shown as fixed deposits and the terms of loans are not
against the interests of the company.

10. Transactions recorded as book entry are not against the interests of
the company.

11. Personal expenses of directors have not been charged to revenue a/c
of company;

12. The company fulfills the requirements of CARO 2003.

Duties towards Company:

1. Prospectus: According to Sec 56, the auditor is required to certify

profits or losses, assets & Liabilities and dividend paid etc in the
prospectus.

2. Statutory Report: Section 165 requires that the auditor has to certify
the statutory report.

3. Public Deposits: Section 58AA requires the auditor to report about

whether the company has followed all rules and guideline of RBI in regard
to public deposits or not.

4. Signature on Audit Report: Section 229: It is duty of auditor to sign on

his report.

5. Insolvency (Section 488): If the company wants itself to be declared

insolvent, it is duty of auditor to prepare profit and loss a/c for the current
period.

Duties towards Government:

1. CARO-2003: The auditor has to report para-wise that the company has
fulfilled all the requirements of CARO-2003.

2. Assist the Investigation u/s 237: It is duty of auditor to assist the

investigation ordered by the CG u/s 237.

Duties towards General Public:

1. His office is of confidence and faith. He must be reliable in all respects.

2. He should reveal all material information regarding the state of affairs

of the company to the company as well as to the general public.

3. While issuing prospectus u/s 56, he should see that the prospectus
does not include any misleading information or material.
Key takeaways –

The auditor has a right to access, at all times the books of accounts &
vouchers of the company, whether kept at head office or elsewhere. It
is an absolute right & is not subject to any restriction, exception or
qualification.

3.2 Board Outlines of Company Audit and Auditor’s Report.

Company Audit

A company is said to be an artificial person created by law having a

separate legal entity distinct from its members. It cannot be directly
managed by its owners because they are very large in number have
small holding and also scattered over a wide area. As such the
management and control of the affairs of the company is done by
directors but an absolute faith put in directors is not considered to be
desirable on social and moral grounds. Hence, it becomes essential for
a company to appoint an independent and qualified person i.e. an
auditor, to verify and certify the truth and fairness of the financial
statements.

Further, the companies usually work with a large staff and auditing
serves a very useful purpose of locating all errors and irregularities in
their work.

In order to achieve the above objectives, The Indian Companies Act

1956 has made it a statutory obligations for joint staff companies,
whether public or private, to get their accounts audited by qualified
auditor.

Statutory requirements governing the Company Auditors

Before commencing the audit work of company, the auditor should go

through the following
• Ensuring whether his appointment is in order: Before
commencing the audit work of a company the auditor shall ensure that
all legal provisions relating to his appointment have been duly compiled
with to ensure is appoint is in order. If his appointment is made in
general meeting of the company, he should obtain the resolution of his
appointment passed in such meeting. In case he has appointed in place
of retiring auditor, he shall find out a due notice has been given to the
retiring auditor in this regard. In case if the casual vacancy is due to
resignation of the auditor, he shall obtain the copy of the resolution
passed at general meeting making his appointment. He shall ensure
that his remuneration has been fixed by the company as per the
provisions of the Act.

2. Inspection of Statutory Books and Documents: Before the

auditor commences the work of audit, he should examine the following
documents

a. Memorandum of Association.

b. Articles of Association.

c. Prospectus.

d. Certificate of in cooperation and certificate to commence

business

He should also examine the following statutory books and registers-

a. Register of Members. (Sec 88)

b. Index of Members. (Sec 88)

c. Register and Index of Debenture holders. (Sec 88)

d. Register to Mortgages and charges (Sec 85)

e. Register of Investment [sec 187(3)]

f. Foreign Register ( Sec 88)

 g. Register of Contracts (Sec 188, 184 and 189)

h. Register of Directors, managing Director , Manager and

Secretary (170)

i. Register of Director’s Shareholdings (170)

j. Register of Deposits (73)

k. Register of Loans (Sec [186(9)]

l. Minute books (118)

3. Inspection of Contracts: The auditor should inspect and examine

the contracts which have been entered into by a company with other
e.g.

a. Contracts with the vendors of any property.

b. Contracts with brokers and under writers for their commission.

c. Contract with the promoters for the preliminary expenses, etc.

If any statement regarding these contracts has been made by the

company in the prospectus, the auditor should see that such statement
is correct and that entries relating to such contracts are correctly
recorded in the books of account.

4. Study of Previous year’s balance Sheet and Auditor’s report: The

auditor should inspect the previous year’s balance sheet to verify the
opening balances of the current year. Moreover, according to
Companies Act, the corresponding figures of the previous year have to
be given in the balance sheet.

The last audit report is inspected by the auditor mainly for two
purposes.

a. To formulate a rough idea about the company and its working.

b. To see whether the recommendations made there in have been
carried out or not.

5. Study of the Internal Control System in Operation: The study and

evaluation of the internal control system in operation is important it
serves as a basis there on. It helps the auditor in determining the extent
of the tests to which auditing procedures can be restricted.

Audit Report /Auditor’s Report

An auditor’s Report is the format of result of all the effort that goes into
the audit. Communicating the Auditor’s findings to interested users is
part of all audits. Thus, the Final phase of an Audit involves preparing
that communication, which is known as auditor’s report.

According to Lancaster, “Audit report is statement of collected and

considered facts, so drawn up as to give clear and concise information
to persons who are not already in possession of full facts of subject
matter of the report.”

Contents of Audit Report

Under section 227 (2) every auditor is required to make report to the
shareholders on the accountants examined by him and every balance
sheet and profit and loss A/c and every document declared by law to
be part of or annexed to the balance sheet and profit or loss A/C which
are placed before the shareholders of the company at the general
meeting during tenure of his office. The report has to state whether, in
his opinion and to the best of his information and according to the
explanations given to him, the said accountants give the information
required by the Companies Act in manner so required and give a true
and fair view.

i. In the case of the balance sheet, of the state of the company’s affairs
as at the end of its financial year; and
ii. In the case of profit and loss account, of the profit or loss account for
its financial year.

Sub-section (iii) of the section 227 required that the auditor’s report
shall also state.

a. Whether he has obtained all the information and explanations which

to the best of his knowledge and belief were necessary for the purpose
of his audit;

b. Whether in his opinion, proper books of account as required by law

have been kept by the company so far as appears from hiss
examination of these books, and proper returns adequate for the
purposes of his audits have been received from the branches not
visited by him .

c. Whether the report on the accounts of any branch office audited

under section 228 by a person other than the company’s auditor has
been forwarded to him and how he has dealt with the same in preparing
the auditor’s report.

d. Whether the company’s balance sheet and profit and loss A/C dealt
with by the report are in agreement with the books of accounts and
returns.

If any of the matters as referred to in section 227 (2) and (3) is answered
in the negative or with the qualification the auditor has to state in his
report the reasons for such answer.

The Auditor’s report shall also include a statement on such additional

matters as specified by the Central Government under section 227 (4-
A) of the Companies Act, This section empowers the Central
Government to order the inclusion of certain matters in the auditor’s
report.
The Institute of Chartered Accountants of India requires the auditor’s to
ensure that the accounting standards are implemented in the
presentation of financial statements covered by their audit reports. The
deviation should be reported in the report.

Key Takeaways-

A company is said to be an artificial person created by law having a

separate legal entity distinct from its members.

3.3 Special Audit of banking companies, Audit of educational

institutions, Audit of insurance companies, Audit of non-profit
companies, When Fraud is suspected and . When a running a
business is proposed.

Special Audit of a Bank

Auditor will begin his work by carrying out a thorough verification of

the assets and liabilities of the banking company. Points to which he
must pay his special attention in the performance of this work with
regard to each individual asset and liability are discussed below:

1- Cash in hand / with other banks – Auditor will attend on the last
date of the period under audit and will verify cash in hand or bullion
by actual counting or weighing. He will compare and tally the
balance with the Cash Book, the Day Book. Balances with the State
Bank or other banks shall be verified.

2- Investments – Auditor shall obtain a list of the investments of the

bank. He shall verify these investments at the close of the year by
carrying out an actual inspection of the scripts or other documentary
evidence available with the bank. He must take utmost care to see
that the same investments are not shown to him twice.

3- Advances, Overdrafts, Loans and Cash Credits – Auditor shall

obtain a schedule of all loans, advances, cash credits and overdrafts
 etc from the bank and will then proceed to verify them with the
balances of respective leaders. The totals will be compared and
checked up with the respective total accounts maintained in the
general ledger.

The responsibilities of the auditor with regard to the verification of

loans and advances etc are very heavy. He will have to pay special
attention with regard to the different kinds of advances such as:

a) Advances against government securities;

b) Advances against stock in trade;

c) Advances against properties;

d) Advances against Life policies;

e) Advances against fixed deposits;

f) Advances against bullion.

4- Bills Discounted and Purchased – Auditor will verify bills

discounted and purchased as recorded in the books with those
which are in the actual possession of the bank. He shall see that the
limits fixed by the Board of Directors have not been exceeded and
that the total of the Bills Discounted Ledger agrees with the balance
of the control account in the General Ledger. He will examine the
date of maturity of each bill in order to verify the amount of overdue
bills.

5- Contra Accounts – Usually they relate to the following types of

accounts (a) Bills for collection (b) acceptances,
guarantees, letters of credit etc, opened on behalf of the customers.
These items appear on both sides of the balance sheet as they
constitute both the assets and liabilities of the bank.
6- Branch adjustments – This item discloses the combined effect of
the differences in the inter-branch balances. Auditor shall verify this
item from the certificates of balances received from branches
preparing reconciliation statements.

7- Other Assets – Other assets of the bank shall include premises,

furniture and fixtures, stock of stationary, interest accrued on
investments etc. Auditor shall examine the title deeds or any other
type of documentary evidence in order to ascertain that the assets
of the bank, on the date of the Balance Sheet, do exist in the name of
the bank and that they have been properly valued.

8- Liabilities – Important items which usually appear on the

liabilities side of the Balance Sheet of a bank are the customer’s
deposits, borrowings from other banks or agents etc, bills payable,
branch adjustments, liabilities for outstanding expenses and
contingent liabilities etc. Auditor will try to check up the
understatement or overstatement of liabilities.

Audit of Educational Institutions

Audit of books of educational institutions like school, college,

universities etc. or other such institutions which are engaged in the
educational field is known as audit of educational institutions. Auditor
should check income and expenditure account and balance sheet of
such institutes in order to verify and report the true and fairness of
results presented by income statements and financial position
presented by the balance sheet. Generally, the methods and
procedures for vouching and auditing is same even though an auditor
of educational institution should perform following tasks:

• The auditor should go through the University Act. Trust deeds and
should note the rules and regulations relating to accounts. The
governing body may pass resolutions from time to time in respect to
accounts. A copy of minutes books should be made available to him so
that he may be able to confirm whether the decision of the government
body have been compiled with.
• Auditor should obtain a copy of budget or financial statements to
study of different heads of income and expenditure.
• Auditor should thoroughly assess the strength of internal check.
• Auditor should vouch the grant-in-aid from the government carefully.
• Auditor should verify the receipts of monthly fees from students,
from counterfoils or carbon copy of the receipts. He should also see
whether cash received has been banked daily or not.
• Other charges from the students such as examination fees,
laboratory fees, fines etc. should be carefully verified.
• Any fees received in advance should be properly adjusted.
• The concession of fees and other charges should be
duly authorised by the proper authority. Any charges becoming
irrecoverable should be written off only after proper authority has
recommended.
• Any grant-in-aid or funds received for a particular purpose must
be utilised for the same.
• The donations and other subscriptions from the various authorities
have been accounted for and acknowledged.
• The income from property, investment etc., should be properly
verified from the vouchers.
• Auditor should vouch the amount of salaries paid with the Salary
Register. Any increment given to an employee shall be duly sanctioned.
• The staff provident fund should be verified and it should be seen that
it is invested as per the rules.
• The establishment expenses must be carefully vouched and it should
be seen that capital expenditure has not been treated as revenue
expenditure or vice versa.
• The payment of scholarship should be verified with the receipt from
students and Scholarship Register.
• All the assets and liabilities should be properly exhibited in the
balance sheet.
• The stock of equipment, stationary, furniture should be carefully
verified.
• While making payment of staff salaries, income tax should be
deducted at source and shall be duly deposited with the Income Tax
Department.

Audit of Non –Profit Institution:

• Examine the constitution, rules and regulations or the Trust Deed if

any.
• Examine that the fund for specific purpose have been used
accordingly.
• Vouch the donations and Receipts.
• Vouch the Income from Investments.
• Vouch the Receipt of Rents.
• Vouch the payment with the minute book of the trustees or the
managing committee regarding important payments.
• Verify the purchase of Investments.
• Verify the cash and bank balance.
• See the accounts are drawn up according to the regulations.
• If any special Act has been passed by the State relating to the
Charitable Institutions, see that the form of accounts and auditor’s
report are drawn up according to the regulation.

Audit of Insurance Companies:

• Vouch the premiums received with the copies of insurance policies,

cover notes or premium receipts.
• Interest and dividends are to be checked.
• The Claims paid or payable by the company to be checked.
• Commission payments should be vouched.
• Management Expenses should be examined.
• All the reinsurance in detail should be checked.
• All the investments made and cash balanced should be verified.
• Scrutinize carefully the outstanding branch and agency balances to
determine that they are recoverable.
• See that the sufficient amount has been set aside as reserve for
unexpired risks.
• Make sure that all the contingent liabilities are ascertained and
provided for.
• Make sure that the code of conduct has been duly observed as it is
required to be observed by the insurance companies in India.
• See that the annual accounts of insurer have been prepared in
accordance with the prescribed forms and regulations.

3.4 Investigation; Divisible Profit and Dividend

Investigation

It implies an enquiry into the accounts and records of a business

undertaking. It is a sort of special audit with a particular object in view.

Investigation involves inquiry into facts behind the books and accounts,
into the technical, financial and the economic position of the business
or organisation.

Investigation is an examination of books and records preliminary of

financing or for any specified purpose, sometimes differing in scope
from the ordinary audit.

Investigation implies an examination of and record for some special

purpose.

Nature of Investigation

Investigation is an enquiry into the financial statements of a number of

past years with a view to know the real financial position or earning
capacity. It is in fact a kind of special audit with predetermined scope
depending upon the purpose to be achieved. Investigation is neither
accounting nor auditing. Investigation is carried out not in substitution
of audit, but in addition to audit. The investigating auditor may even
have to investigate the audited accounts.

Scope of investigation

No general principle can be laid down with regard to the scope of

every type of investigation. Scope of investigation, in each case, would
be limited to the period or area to be covered by the investigator. An
investigation on behalf of a person intending to purchase running
business of a sole trader will be restricted to the determination of value
of assets, liabilities, reserves, existing potential and future prospects.
An investigation to settle suspected irregularities in cash or stock
would normally cover a period from three to six months.

Objectives of Investigation

The real objective of conducting an investigation by an auditor on

behalf of his client is to provide him the desired information in the form
of a report about the matter specified. Normally the objective of
investigation is to collect, analyze and evaluate facts in respect of
desired field of activity with a view on some special purpose as
determined by the person on whose behalf the investigation is
undertaken. In short investigation is to ascertain the financial position
and earning capacity of a business on behalf of a certain person

The common objectives of investigation are listed below:

1) Proposed purchase of business.

2) Proposed sale of business.

3) Reasons for low profitability.

4) Cause of high employee turnover.

5) Reliability of business data.

6) Proposed investment in particular securities.

7) Suspected fraud.

8) Joining in existing partnership business.

9) Borrowing funds.
 10) Lending funds.

11) Proposed purchase of controlling shares in a company.

12) Suspected misfeasance against directors.

13) Detection of undisclosed income for tax purposes.

14) Suspected misappropriation by trustees.

Process of Investigation

• Receiving of Mandate of Investigation.

• Planning of Investigation.
• Execution of Investigation.
• Summarizing and Report Making.
• Submitting the Report to the authority.

Divisible profits and dividends

Divisible Profit is that profit for the disbursement of which as dividend

a company has legal right. Direct interest of shareholders of a company
is in dividend, therefore, the management of the company
always endeavours to disburse dividend to the shareholders but it
cannot do so in such style as may result into the bankruptcy of the
company, e.g. out of capital.

Divisible Profits under the Indian Companies Act 1956:

Section 205 lays down law on the following points :

• Sources of Dividend [Section 205(1)]

• Current Depreciation [Section 205 (2)]
• Transfer to Reserves [Section 205 (2A)]
• Arrears of Deprecation [Section 205 (1)(a)]
• Past Losses [Section 205(2)(b)]

It would be useful to elaborate the provisions:

(i) Sources of Dividend: As per Section 205(1), a company can disburse
dividend for a certain year from the following sources:

(a) Profits of the year;

(b) Profits of the previous year;

(c) The two (a) and (b) together, that is, total thereof;

(d) Amount received for disbursement of dividend from the Central

Government or any State Government for the payment of dividend in
pursuance of a guarantee given by that government.

Dividend can be disbursed from the sources after making the following
deductions from the profits of the company:

(a) Current Deprecation [Section 205(2)]

(b) Transfer to Reserves [Section 205(2A)]

(c) Arrears of Deprecation [Section 205(1)(a)]

(d) Past Losses [Section 205(b)]

The following points need consideration in respect of divisible profits :

(1) Section 205 of the Companies’ Act must be abided by:

(2) The rules as provided in the Articles of Association must be kept in

mind.

(3) The excess of income over the current expenditure may, after
deducting depreciation on current assets, as required under sections
205 and 350 of the Companies Act, and creating adequate funds for
payment of liabilities, be divided as dividend among the shareholders.

(4) The capital profit can be disbursed as dividend if (i) they have
been realised in cash, (ii) there is surplus after writing off capital
losses, and realised in cash, (ii) there is surplus after writing off capital
losses, and (iii) the company is authorised to divide it as dividend by
its Articles.

(5) It is compulsory to write off revenue losses before distribution of

revenue profits as dividend and, similarly, it is also required to write
off capital losses before disbursement of capital profit as dividend but
it is not compulsory to write off capital losses before disbursement of
revenue profits as dividend.

(6) It is not obligatory to write off the existing loss of paid up capital of
the company or the past debit balance of P & L. Account
(before deprecation) prior to distribution of dividend, if the company
has adequate funds to discharge liabilities.

Preliminaries before starting Audit-

1. Appointment of Auditor.

2. Nature of Business of the Company.

3. Accounting Year.

4. Board of Director

5. Acquaintance with Management.

6. Knowledge of the byelaws regarding Memorandum of Association

and Articles of Association.

7. Study of prospectus.

8. To receive the List of Books.

9. Obtaining the List of Employees and job description.

10. Knowledge of Internal Control.

11. Acquisition of Previous Final Accounts and Audit Report

Audit of Share-Issue

• Checking the right to issue.

• Checking the Procedure of issue.
• Checking Books of original entry.
• Checking Ledger Posting.
• Presentation in Balance Sheet.
• Audit of Calls in Advance.
• Audit of Calls in Arrears.
• Underwriting Commission and Brokerage.
• Audit of Issues at premium
• Audit of Issues at Discount

Audit of Share Transfer -

1. Under the Companies’ Act.

2. Under agreement:

(i) Checking the Articles.

(ii) Checking the Transfer Registrar.

(iii) Checking the Transfer Deed.

(iv) Checking the intimation to Transferee.

(v) Action by Directors’ Meeting.

(vi) Checking the Share Certificates.

(vii) Checking the Register of Membership.

Audit of Debentures -

• Checking the Articles

• Looking into commission.
• Compliance of Section 293.
• Checking the restrictions on allotment.
• Checking Debenture Register.
• Checking of Transfers.
• Checking the Charges.
• Audit of Financial Books-

(i) Cash Consideration.

(ii) Other consideration.

(iii) Commission and Discount.

(iv) Application forms and Allotment.

(v) Premium.

(vi) Collateral security.

(vii) Entries of interest.

Key takeaways –

Divisible Profit is that profit for the disbursement of which as dividend

a company has legal right.

UNIT 4

Recent Trends in Auditing

4.1 Recent trends in Auditing- Nature and Significance of Cost Audit,

Tax Audit; Management Audit and Computerized Audit

Nature and significance of cost audit

Cost Audit is mainly a preventive measure, a guide for management

policy and decisions, in addition to being the barometer of
performance.
Cost Audit is an audit of efficiency of minute details of expenditure
while the work in progress and not a post mortem examination.

Cost audit can be defined as verification of correctness of cost accounts

and a check on adherence to the cost accounting principles, plans and
procedures.

According to Institute of Cost Accountants of India cost audit is “

a system of audit introduced by the government of India for the review,
examination and appraisal of the cost accounting records and
attendant information, required to be maintained by specified
industries.”

According to (CIMA) Chartered Institute of Managemnt Accountanta,

London, “Cost audit is verification of the correctness of cost accounts
and cost accounting plans.”

Objectives-

• To establish the accuracy of costing data. This is done by verifying the

arithmetical accuracy of cost accounting entries in the books of
accounts.
• To ensure that cost accounting principles are governed by the
management objectives and these are strictly adhered to in preparing
cost accounts.
• To ensure that cost accounts are correct and also to detect errors,
frauds, and wrong practice in the existing system.
• To check up the general working of the cost department of the
organization and to make suggestions for improvement.
• To help the management in taking correct decisions on certain
important matters
• to determine the actual cost of production when the goods are ready.
• To reduce the amount of detailed checking by the external auditor, its
effective internal cost audit system is in operation.
• To find out whether each item of expenditure involved in the relevant
components of the goods manufactured or produced has been
properly incurred or not.
Advantages of cost audit

Advantages to management-

• It provides necessary information for prompt decision decisions.

• It helps management to regulate production.
• Errors, omission, fraud, and mistakes can be detected and prevented
due to the effective auditing of cost accounts.
• It reduces the cost of production through plugging loopholes relating
to wastage of material, labor, and overheads.
• It can fix the responsibility of an individual wherever irregularities or
wastage are found.
• It improves the efficiency of the organization as a whole and costing
system in particular by constant review, revision, and checking or
routine procedures and methods.
• It helps in comparing actual results with budgeted results and points
out the areas where management action is more needed.
• It also enables comparison among different units of the factory to
find out the profitability of the different units.
• It exercises a moral influence on employees, which keeps them
efficient and alert.
• It ensures that the cost accounts have been maintained under the
principles of costing employed in the industry concerned.
• It ensures effective internal control.
• It helps to increase the overall efficiency of productivity.
• Inefficiency can be eliminated by suitable corrective actions.
• It facilitates cost control and cost reduction.
• It assists in the valuation of stock of materials, works in progress, and
finished goods.
• It ensures maximum utilization of available resources,
• It enables the management to choose economic methods of
operations and thus earn profits to satisfy the shareholders and the
investing public.
• It enables the management to chalk out the future policy based on
the report by the cost auditor, especially regarding labor, raw material,
plant, etc. to maximize production and reduce the cost of production.
• It tests the effectiveness of cost control techniques and to evaluate
their advantages to the enterprise.

Advantages to the shareholders-

• It ensures that proper records are maintained as to purchases,
utilization of materials, and expenses incurred on various items i.e.,
wages and overheads, etc. It also makes sure that the industrial unit
has been working efficiently and economically.
• It enables shareholders to determine whether or not they are getting
a fair return on their investments. It reflects managerial efficiency or
inefficiency.
• It ensures a true picture of the company’s state of affairs. It reveals
whether resources like plant and machinery are properly utilized or
not.
• It creates an image of the creditworthiness of the concern.

Advantages to society-
• It tells the true cost of production. From this, the consumer may
know whether the market price of the article is fair or not. The
consumer is saved from exploitation.
• It improves the efficiency of industrial units and thereby assists in the
economic progress of the nation.
• Since the price increase by the industry is not allowed without
justification as to an increase in the cost of production, consumers can
maintain their standard of living.

Advantages to the customers-

• Helps in Fixation of Fair price
• Timely and proper Information

Advantages to the government-

• It assists the tariff board in deciding whether tariff protection should
be extended to a particular industry or not.
• It helps to ascertain whether any particular industry should be given
any subsidy to develop that industry.
• It provides reliable data to the government for fixing up the selling
prices of the various commodities.
• It helps in fixing contract prices in a cost-plus contract.
• It determines whether differential pricing within the industry is
desirable.
• It helps the government to take necessary measures to improve the
efficiency of sick industrial units.
• It can reveal the fraudulent intentions of the management.
• Cost statements may be helpful to authorities in imposing tax or duty
at the cost of finished products.
• It facilitates settlement of trade disputes of the companies.
• It imposes an automatic check on inflation.
• It assists the Tariff Board to consider the extension or removal of
protection.

Disadvantages of cost audit-

• Shortage of cost accountants.
• Unrealistic regulations.
• Expensive and luxury.
• It leads to duplication of work.
• Unnecessary interference of government in the working of
companies.

Tax Audit-

Now-a-days tax audit has become very important to ascertain the

accuracy of tax related documents. Tax audit mostly covers income
returns, invoices, debt and credit notes and various current and fixed
assets. Tax audit is an innovation of 21st century. It has added one more
chapter to the procedure of auditing. Tax audit ensures the validity and
credibility of tax related documents.

The financial statements are certified by the auditor for truth and
fairness of operating results and financial position of the business.
These are meant for general purpose being used by the owners,
creditors, banks and other interested parties. Sometimes a specific
information my required by certain people which may not be available
in these statements

Under Income Tax Act, profits shown by profit and loss A/c have to be
adjusted as per the provisions of the Act. In this way profits for
accounting and profits for taxation are not the same. These profits differ
due to various reasons. Profits for accounting are ascertained As per
accounting policies and standards but profits for the tax purpose are
computes as per the provisions and rules of Income Tax Act.

The Income Tax Department cannot verify each and every detail of
provisions compiled by the assessee. In this regard expertise of
auditors is utilized, who certify the compliance of the provisions of
Income Tax Act.

• How to conduct tax Audit-

1. The tax auditor shall be guided by the auditing standards and

guidance notes as issued from time to time by Institute of
Chartered Accountants of India.
2. Obtaining books of accounts, financial statements and other
statements of particulars duly authenticated.
3. Evaluation of internal control system on the basis of which
extent of vouching and verification can be determined.
4. While conducting tax audit the provisions and objectives of sec,
44 AB shall be kept in mind.
5. The auditor shall have thorough knowledge of taxation
provisions and judicial pronouncements.
6. The Central Government has notified the following ‘accounting
Standards’ in respect of audit of financial statements under
section 44 AB.
Compulsory Tax Audit

Following are provisions relating to compulsory audit under Section

44(AB) of income Tax Act.

I. Tax audit is compulsory for a business if its total sales, turnover or

gross receipts in a previous year exceed Rs 1 crore.

II. In case of a profession, Tax audit is compulsory if gross receipt

exceed Rs. 25 lakhs.

III. If the profits of a business are determined on presumptive basis, the

audit of accounts shall be on compulsory basis if he assessee claims
that their profits are less then profits computed under the following
sections.

A. Sec 44 (AD) Profit from any business (whether it is retail trading or

civil construction or any other business).

Provisions are as follows

• Assessee should be resident individual or resident HUF or resident

partnership.
• Assessee has not claimed exemption under section 10 (A), 10 (AA), 10
(B), 10 (BA), 80 (HH) or 80 (RRB).

The following persons are not eligible

a. Person carrying on profession under [section 44 (AA) (1)]

b. The person earning commission or brokerage or carrying on agency

business or plying, hiring or leasing goods carriage.

c. Turnover/gross receipt in the previous year should not exceed

1 crore
B. Profit from the business of carriage of goods [section 44 (AE)]

This sec is applicable to only those persons who are engaged in plying,
hiring or leasing goods carriages and own not more than 10 such goods
carriages.

C. Profit and gains of a non resident from shipping business [sec.

44 (B)]

A sum equal to 7.5% of the aggregate receipts in India shall be deemed

to be the profit

If the assessee does not opt for the above scheme he will have to get
accounts audited.

D. Profit and gain of business of Oil exploration of non-

resident assessee [sec. 44 (BB)]

A sum equal to 10% of amount payable in India or outside India

to assessee shall be deemed to the profit

If the assessee does not opt for the above scheme he will have to get
accounts audited.

E. Profit and gains of business of operation of Aircraft by

Non- resident[ sec. 44 (BBA)]

A sum equal to 5% of amount payable in India or outside India

to assessee shall be deemed to the profit

If the assessee does not opt for the above scheme he will have to get
accounts audited.

F. Profit Of Foreign Company Engaged in Business of civil

Construction or Erection of plant and machinery or/and
Commission thereof[ sec. 44 (BBB)]
A sum equal to 10% of amount payable in India or outside India
to assessee shall be deemed to the profit . If the assessee does not opt
for the above scheme he will have to get accounts audited. If Gross
receipts or sales or turn over exceed a specified amount in a business
only then audit is required.

G. Persons covered under section 44 (AB)

a. The persons who are not covered by Income Tax Act need to get their
accounts audited for the purpose of this section like a person having
agricultural income exceeding 40 lakhs.

b. The persons who are covered by this section but their income is
exempted shall get their accounts audited as in case of charitable Trust,
co-operative societies etc.

c. Persons, who are covered under this section, having income below
the taxable limit, they have to get their accounts audited if the specified
limit under section 44 AB has exceeded.

d. In case of non-resident assessee, if his global or receipts exceed the

specified limit, then h has to get Indian operations accounts audited.

H. Persons not covered under section 44 AB

a. A non-resident assessee carrying business of operation of ship U/S

44 B.

b. A Non-Resident assessee having income from operation of aircraft

u/s 44 BBA

I. Specified date

The audit of accounts must be conducted and audit report must be

submitted by the assessee by October 31.
J. Penalty sec. 271 B

If any person fails to get his accounts audited as required u/s 44 AB, the

assessing officer may direct such person shall pay a penalty equal to or
.5% total sales, turnover or gross receipts in business or gross receipts
in profession or Rs. 100000, whichever is less.

Management Audit-

Management audit is attempt made to evaluate various management

functions and process. A detailed and critical review of all the
objectives, policies, procedures and functions of management is made
with a view to bring about an overall improvement in managerial
efficiency.

According to Leslie R. Howard, “ An investigation of a business from

the highest level downward in order to ascertain whether sound
management prevails throughout, thus facilitating the most effective
relationship with outside world and the most efficient organization and
smooth running of internal organization.”

According to W.P. Leonard, “A comprehensive and constructive

examination of an organization structure of a company, institution or a
branch of government or of any component thereof such as division or
department, and its plans and objectives, its means of operations, and
its uses of human and physical facilities.”

Thus it can be simply stated that management audit, on the basis of

established standards, examines, reviews and appraises the various
policies and actions of management.

Objectives/Aims of management Audit-

1. To ensure that sound objectives are set by the management.

2. To reveal any irregularity or defect in the process of management
and to suggest improvements to obtain the best results.

3. To ensure that the management objectives are achieved.

4. To help various levels of management in the effective discharge of

their duties.

5. To assist management in achieving coordination among various

departments.

6. To help to achieve the efficiency of management.

7. To assist management in establishing good relations with the

employees and to elaborate duties, rights and liabilities of entire staff.

8. To evaluate the performance by comparing inputs with outputs

(human and physical both).

9. To ensure most effective relationship with the outsiders and the most
efficient internal organization.

10. To recommend changes in the policies and procedure for a better

future.

Advantages of Management Audit-

1. It helps management in preparation of plans, objectives and policies

and their efficient achievement.

2. It helps management in taking vital decisions for maximization of

profits.

3. It helps the management in strengthening its communication systems

within and outside the business.

4. It helps in evaluating the performance of management in various

areas and measures to improve it.
5. It can help management in preparation of budgets and resource
management.

6. It can help management in training of personnel and marketing

policies.

Need/importance of Management Audit:

The statutory auditor is not required to examine the policies of

management and their implementation or whether any improvement
in the efficiency of management can be made. In these days a report
on all these matters is very important to the business. The management
auditors are appointed to advise the management on various matters
related to management. These persons examine the various aspects of
management and evaluate the actual performance by comparing it
with predetermined standards. Such auditors may or may not be from
the field of accountancy. They advise management on the matters
relating to performance of various departments as well as of the
organization as a whole.

The management may conduct management audit periodically to

review the efficiency of managers. The results may be used to provide
incentives to staff.

The management audit reveals irregularities and defects in the

working of management and suggests the ways to improve the
efficiency of management. It concentrates on the results and does not
examine whether procedures have been followed or not.

The government may ask for management audit of sick industrial units
with a view to examine the efficiency of management. It may be
conducted to find whether the sickness is due to functioning of
management or the circumstances beyond the control of management.
On the basis of report of management auditor, the government may
decide to take over to sick units.
 It can be said that management audit is a guide which helps in
improving the efficiency of management

Appointment of Management Auditor-

A team of experts should be appointed to conducted management

audit. It can’t be expected that an individual can possess expertise in
all management’s fields; therefore, an expert in each field of
management should be included in the team of management auditors.
Such team should have full cooperation from the top level management
to enable it to conduct the audit smoothly.

The members of management audit team should have a proper

training and expert knowledge of science of management. A wide
experience of actual work situations will be added to the advantage.
The audit of the management involves an appraisal of activities of
organization; the auditor must study the organization and its plan in
detail.

The internal auditors may be regarded as suitable persons for conduct

of management audit because they are familiar with the internal
workings of management. Sometimes it is desirable to have O & M
experts as management auditors. All will depend on the scope of
management audit which the management has to decide.

Qualities of a Management Auditor

The area of activities of management audit is wide; no specific qualities

can be narrated for management auditor. He must possess enough
qualities to fulfill his professional obligations. Some of the qualities of
the management auditor can be described as follows.

1. He should have a good knowledge of managerial functions.

2. He should be familiar with the various principles of management,
planning, control, management by objectives, and management by
exception.

3. He should have a good understanding of financial statements and

their preparations.

4. He should understand the working of organization and its problems.

5. He should be able to understand the objectives of organization.

6. He should be able to assess and critically examine the internal

control systems.

7. He should be able to understand the nature of the product and its

production process.

8. He should understand plans, budgets, rules and the procedures

applied in the organization.

9. He should have a good knowledge of financial statement analysis

techniques like standard costing, budgetary control, ratio analysis,
fund flow statements etc.

10. He should be familiar with the human resources accounting, social

accounting, etc.

11. He should have a good knowledge of economics, business laws,

etc.

Management Auditor’s Report

In the end, the management auditor prepares a report. On the basis of

findings and definite information, the auditor prepares a report making
suggestions for improvement in the working of the management. His
report should give a correct assessment of the working of organization.
He should not hesitate in criticizing the management. His
recommendations should be constructive and not merely condemning
in nature. His report may include the following matters:

1. Whether the management; and the staff relations are healthy.

2. Whether the return to shareholders is adequate.

3. Whether the methods of production are out-dated.

4. Comparison of operating efficiency of the organization with other

concerns.

5. Rate of the return on investment.

Conduct of Management Audit

Following points need careful attention before he commences his

work.

• The auditor should ensure that various objectives and goals are
properly established which are likely to help to achieve the desired
results.
• He should see that the plan laid down by management is practicable
and helpful to achieve objectives.
• He should see that whether the organization has a well defined
structure, authority lines and responsibility areas are clear, decision
making is centralized or decentralized.
• He should verify the efficiency of information system operating in the
organization.
• To collect necessary information he should prepare a questionnaire
such as:
• Whether the resources are efficiently employed,
• Whether plans, policies , procedures and systems are strictly followed
• Whether the objectives are split up into target of each department.
• Whether management by exception is possible.
• Whether the planned and actual performance are compared at
regular intervals of time.
• Whether irregularities arise frequently, if so, who is responsible?
• Whether the methods used in organization are satisfactory.

6. The information obtained with the help of above questions should be

counter checked from the various records and statements available in
the organization.

7. To arrive at definite conclusions, the management audit has to

correlate the information collected through various means

Computerized Audit-

Information Technology (IT) is integral to modern accounting and

management information systems. It is, therefore, essential that auditors
should be aware of the impact of IT on the audit of a client’s financial
statements. Information Technology auditing (IT auditing) began as
Electronic Data Process (EDP) auditing and developed largely as a result
of the rise in technology in accounting systems. The last few years have
been an exciting time in the world of IT, auditing as a result of the
accounting scandals and increased regulations. Regardless of the
computer systems used, the audit objectives and approach will remain
largely unchanged from that if the audit was being carried out in a non-
computer environment. Information Technology (IT) is integral to modern
accounting and management information systems. It is, therefore,
essential that auditors should be aware of the impact of IT on the audit of
a client’s financial statements. Information Technology auditing (IT
auditing) began as Electronic Data Process (EDP) auditing and developed
largely as a result of the rise in technology in accounting systems. The last
few years have been an exciting time in the world of IT, auditing as a
result of the accounting scandals and increased regulations.

Regardless of the computer systems used, the audit objectives and

approach will remain largely unchanged from that if the audit was being
carried out in a non-computer environment. Audit Approach
in Computeriszed Environment Assuming that an enterprise that has
acquired a computerised information system during the current period.
To carry out the audit, the auditor will usually consider the
following features and risks of the CIS at the planning stage.

Information Technology (IT) is integral to modern accounting and

management information systems. It is, therefore, essential that auditors
should be aware of the impact of IT on the audit of a client’s financial
statements. Information Technology auditing (IT auditing) began as
Electronic Data Process (EDP) auditing and developed largely as a result
of the rise in technology in accounting systems. The last few years have
been an exciting time in the world of IT, auditing as a result of the
accounting scandals and increased regulations. Regardless of the
computer systems used, the audit objectives and approach will remain
largely unchanged from that if the audit was being carried out in a non-
computer environment.

Audit Approach in Computeriszed Environment

1. Auditing Around the Computer: It is the type of auditing done in a

traditional method. The auditor summarises the input data and ignores
the computer’s processing but ensures the correctness of the output data
generated by the computer, this approach is generally referred to as
“auditing around the computer”. This methodology was primarily
focused on ensuring that source documentation was correctly processed
and this was verified by checking the output documentation to the source
documentation

2. Auditing Through the Computer: Due to the “real time” computer

environments, there may only be a limited amount of source
documentation or paperwork hence the auditor may employ an approach
known as “auditing through the computer”. In this approach, the
reliability and accuracy of the results are analysed through the computer.
This involves the auditor to perform tests on the information technology
controls to evaluate their effectiveness like Compliance test, Test Packs,
Reprocessing.

3. Auditing with the Computer: The utilization of computer by the

auditor for some audit work and he uses some general software for the
purpose of calculating depreciation, printing letters, and duplicate
checking and files comparison.

The computer is not used for all the audit work and it is done manually.

Audit Process for Computerized Accounting System- The audit

process for a computerized accounting system involves the following
five majorsteps..

1. Conducting Preliminary Survey: This is a preliminary work to plan

how the audit should be conducted. The auditors gather information
about the computerized accounting system that is relevant to the audit
plan. This includes an understanding of how the computerized accounting
functions are organized, identification of the computer software
used, understanding accounting application processed by computer and
identification applicable controls.

2. Reviewing and Assessing Internal Controls: There are two types

of controls namely general controls and application controls.

a) General Controls: General controls are those that cover the

organization, management and processing within the computer
environment. They should be tested prior to application controls,
because if they are found to be ineffective, the auditor will not be able to
rely on application controls. General controls include proper segregation
of duties, file backup, use of labels, access control, etc.

b) Application Controls: Application controls relate to specific tasks

performed by the system. They include input controls, processing
controls, and output controls. They should provide reasonable assurance
that the initiating, recording, processing and reporting of data are
properly performed.

3. Compliance Testing: Compliance testing is performed to determine

whether the controls actually exist and function as intended. This can be
performed by comparing the results to predetermined results or by
processing dummy transactions.

4. Substantive Testing: This is performed to determine whether the data

is real. Substantive tests are tests of transactions and balances and
analytical procedures designed to substantiate the assertions. Auditors
must obtain and evaluate evidence concerning management’s assertions
about the financial statements. The auditor must obtain sufficient
competent evidential matter to provide a basis for an opinion regarding
the financial statements under audit. If sufficient competent evidence
cannot be obtained then an opinion cannot be issued.
5. Audit Reporting: The audit report will contain detailed information on
various aspects of their findings in the process of audit in a computerized
environment.

Key takeaways –
• Computer auditing is a systematic and logical process that follows a
risk based approach to determine whether the information systems of
an entity, including its detailed information technology processes,
controls and activities, will achieve its IT objectives and will thereby
ultimately enable the organisation to achieve their organisational goals.
• A management audit is an assessment of how well an organization's
management team is applying its strategies and resources.
• Tax audit refers to the examination of a taxpayer's accounts.