UNIT-I

Introduction

Auditing means to inspect, examine, checking, investigate, scrutinize, company accounts.

Auditing is a systematic examination and verification of firms books of accounts, transactions

records, other relevant documents and physical inspection of inventory by qualified accountants

called auditors.

Origin

The term audit is derived from Latin word ‘audire’ which means to hear. Auditing is as old as

accounting. It was used in all ancient countries such as Greece, Egypt, Rome, U.K, India.

The main objective of auditing is to ascertain the accounts were true and fair and to detect and

prevent errors and frauds.

The International Accounting Standard Committee and the Accounting Standard Board of the

Institute of Chartered Accountants of India have developed standards accounting and auditing

practices to guide the accountants and auditors in the day to day work.

Definition

1. 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 of which

they relate.”

2. R.K.Mautz,” auditing is concerned with the verification of accounting data determining

the accuracy and reliability of accounting statements and reports.”

Functions

1. Study The Accounting System :- It is the basic function of auditing. In order to determine the

nature, timing and extent of the audit procedures auditor should study the accounting system.

2. Internal Control System :- It is a process which determines that management policies are

carried out according the accounting principles. This system is very useful to safeguard the

interest of the enterprise. The auditor determines the effectiveness of this system.

3. Vouching :- This function is essential to determine the accuracy of accounting record.

Through audit those documents can be checked which support and prove the business

transactions. All entries in books of accounts are made on the basis of relevant vouchers.

4. Verification Of Assets :- It is the function of auditing that it should verify the assets of the

business. It is concerned with the determination of value, ownership and possession of business

asset. The auditor can check the existence of asset.

5. Legal Requirement :- It is the function of auditing to verify that statements are prepared

under the legal requirements or not. There are various laws like company and income tax

ordinance which are introduced by the govt.

6. Liabilities Verification :- The liabilities of the business can be verified from the books of

accounts. The auditor can write a letter to the creditors for the verification of liabilities. The

auditor must receive the certificate from the management in this regard.

7. Capital And Revenue :- Auditing should make difference between capital and revenue items.

The capital items are compared to note the financial position of the business. The revenue items

are compared to determine the income. The income and expenses related to many years can be

divided in current and coming year.

8. Valuation Of Liabilities :- Through auditing value of liabilities can be checked from the

books of accounts and other papers. The auditor can also confirm the value from outside sources.

The value of liabilities is given in the balance sheet by the management but it is the function of

auditing which confirms this value.

9. Valuation Of Assets :- The management gives the value of assets and auditor can apply the

accounting principles to assess the value of assets. The auditor critically examines and takes help

from the expert.

10. Reporting :- Auditing important function is reporting. Auditor is an independent person and

it is his duty to submit his report in writing. If he is satisfied he can present clean report

otherwise he can give qualified report.

Objectives

1. Primary Objective

The main objectives of the audit are known as primary objectives of the audit. They are as

follows:

1. Examining the system of internal check.

2. Checking arithmetical accuracy of books of accounts, verifying posting, casting,

balancing etc.

3. Verifying the authenticity and validity of transactions.

4. Checking the proper distinction between capital and revenue nature of transactions.

5. Confirming the existence and value of assets and liabilities.

Verifying whether all the statutory requirements are fulfilled or not. Proving true and fairness of

operating results presented by income statement and financial position presented by the balance

sheet.

2. Subsidiary Objective

These are such objectives which are set up to help in attaining primary objectives. They are as

follows:

(A) Detection and prevention of errors

Errors are those mistakes which are committed due to carelessness or negligence or lack of

knowledge or without having vested interest. Errors may be committed without or with any

vested interest.

So, they are to be checked carefully. Errors are of’ various types. Some of them are:

1.Errors of Accounting principle- When principles of book keeping and accountancy are not

followed in recording of business transactions ,it is known as error of principle.

• Wrong posting of income transaction

• Wrong posting of expenditure

• Wrong allocation of expenditure between capital and revenue. Revenue expenditure may

be treated as capital expenditure and vice-versa.

Such errors are not disclosed in trial balance, debit and credit sides of transactions are same.

Such errors can be detected by thorough checking of each and every transaction.

Error of principle affect the reliability of financial statement. it is an accounting mistake in which

entry is recorded in the incorrect account, the value recorded was the correct but placed

incorrectly.

2. Errors of omission- When a transaction is omitted fully or partly from books of accounts,

such type of errors are known as error of omission. Usually it arises due to mistake of clerk.

• Omission of purchases from purchases book

• Omission of sales from sales book

• Omitting the entry for charging depreciation in the books.

• Rent or interest paid for 11 months, the remaining amount which is unpaid or outstanding

has not been entered in the books.

3. Errors of commission- When the entries made in the books of original entry or ledger are

incorrect wholly or partly, such are called error of commission. Usually these error arise due to

negligence in recording of some business transactions.

➢ Ex:-wrong recording in the books of original entry wholly or partly. Goods purchased for

Rs.10,000 recorded in purchases book as Rs.1000

➢ Rs.500 purchased from m and co, recorded as from n and co.

➢ Wrong totaling of original entry, while totaling sales day book or purchase day book

mistake is made in the total sales. Sales day book is totaled Rs.100 short and posted to

ledger. This error will affect trial balance, the credit side total will be short by Rs.100. it

will lower the profit by Rs.100.

➢ Wrong subsidiary book used for recording a transaction .

For ex:-credit sales to x and co. Were recorded in purchase day book or credit purchases to y and

co. were recorded in sales day book.

4. Compensating errors- When an error offsets the effect of another error, such error is known

as compensating error. These errors don’t affect trial balance.

Sometimes under casting of one account is compensated by over casting of another account, such

as ‘X’ a/c is under totaled by Rs.100 and’ Y’ a/c is over totaled by Rs.100.

5. Errors of Duplication- When a transaction is recorded twice and also posted twice in the

ledger. Such an error will not affect trial balance. It is more difficult to locate such errors. Only

thorough checking and comparing of vouchers with entries in the books. If two entries on the

same side are appearing with the same amount.

(B) Detection and Prevention of frauds

Frauds are those mistakes which are committed knowingly with some vested interest in the

direction of top level management. Management commits frauds to deceive tax, to show the

effectiveness of management, to get more commission, to sell a share in the market or to

maintain the market price of share etc. Detection of fraud is the main job of an auditor. Such

frauds are as follows:

1. Misappropriation of cash- Misappropriation of cash is done by theft of cash receipts, petty

cash, cheques, negotiable instruments, showing fictitious (false, fake) payments to workers,

creditors, purchases etc; misappropriation of cash is very easy. With the increase in size of

business, the opportunities of committing fraud also increase because the owners of the business

have no direct control over receipts and payments of cash.

Examples of misappropriation of cash:-

• Recording fictitious purchases and thereby cash involved there in is

misappropriated.

• Omitting credit note received from the supplier and discount allowed

by them.

• Showing payment of wages to dummy workers in wage sheet.

• Various receipts like bad debts recovered ,sale of scrap or rejected

stock etc;

• Omitting the records of donations receipts or recording lower

amounts.

• The credit sales may not be recorded and money received from

customers pocketed.

2. Misappropriation of goods- The misappropriation of goods is easy in case of a business

which produces or deals in goods of high value and less bulky.

• Issuing false credit note to customers for sales returns and such goods are

misappropriated.

• Goods may be stolen by employees from the godowns.

It is not easy to detect the misappropriation of goods. Only the efficient system of record

keeping, periodical checking, internal check etc; will be helpful to avoid misappropriation of

goods.

3. Manipulation of accounts or falsification of accounts without any misappropriation- This

type of fraud is committed by upper level of management with the different objectives to mislead

certain parties within or outside the business. Whenever such fraud is committed, it usually

involves large amounts and it is intentional. This type of fraud is usually committed by

Managers, Directors, Board of directors etc;

(a) Showing low profits than the actual ones:-

To give wrong impression about success of business to competitors. To reduce or avoid

payment of income tax.

To purchase shares at a lower price in the market.

(b) Showing more profits than what actually are:-

-The manager may get more commission if such commission is calculated on the basis of profits

earned.

-To sell the shares at high prices by declaring higher dividends, this is done when such person

hold shares of the company.

-The services of such person may be retained by showing more profits to the shareholders

thereby the confidence of shareholders is maintained.

-To mislead financial institutions for obtaining further credit, the financial position of the

business is shown better than what actually it is.

-When the company is in the process of issuing shares to the public, to attract more subscribers

for such shares.

Manipulation of accounts may be resorted /use the following devices:-----Purchases/expenses

may be inflated / suppressed.

-Sales or other incomes may be inflated /suppressed.

-Stocks may be over or under valued.

-Omission of adjustment of expenses outstanding or prepaid expenses.

-Depreciation of assets may be over or under charged or omitted altogether.

-Assets or liabilities may be over or under valued.

-Treating capital expenditure as revenue expenditure or vice-versa.

Window dressing

The financial position of the business is shown in such a way that it seems better than what

actually it is window dressing is more of misrepresentation than fraud. it is done in the following

ways:-

(a) Purchases of current year may be shown as next year.

(b) Income of previous year may be shown as current year.

(c) Expenses of current year may be shown as next year.

(d) Showing short-term liabilities as long term liabilities.

(e) Charging revenue expenses as capital expenditure.

(f) Over-valuation of closing stock.

(g) Over-valuation of assets or undervaluation of liabilities.

Merits

Assurance of true and fair accounts: An audit provides an assurance to the investors,

government, lenders, creditors, owners, management etc. That the final account presented shows

the true and fair picture of the profit and losses and financial position of the concern

True and fair balance sheet: The user of final accounts can be sure that the assets and liabilities

disclose true and fair view of financial position of the concern, it’s neither more nor less, and it’s

free from window dressing or secret reserve.

True and fair profit and loss account: The user of final accounts should be sure that the profit

and loss account show true amount of profit or less as it is.

Tally with books of accounts: The audited final accounts should tally with the books of

accounts of the concern. So it can be easy to calculate the taxable income without going through

all the transactions.

As per law: The audited final accounts should be prepared as per the rules and guidelines laid

down by law.

Disclose all material facts: The audited final accounts should disclose all material facts, thus

users can rely on them for making useful decisions of lending, investing etc.

Detection of errors and frauds: It is assumed that the audited final accounts are free from errors

and frauds, the auditor with his expertise knowledge would detect the errors and fraud so as to

show the true figure of final accounts.

Moral check on employees: Auditing techniques such as verification, vouching of cash, assets,

stock etc. act as a moral check on the employees, this forces them to keep the accounts up-to-

date and free from errors and frauds.

Advice to concern: Auditor can also advise the client about internal control, taxation, finance,

accounting system etc.

Demerits

All transactions cannot be checked: It is not possible for an auditor to check each and every

transaction; he has to check them on sample basis

Evidence is not conclusive: Audit evidence is not conclusive in nature the confirmation of

debtors is not conclusive evidence that all amount will be collected, the conclusions are

persuasive rather than conclusive.

Not easy to detect some frauds: It’s not easy for an auditor to detect the deeply laid frauds

which involves acts designed to conceal them such as forgery, false explanation, and not

recording transaction and so on.

Audit cannot assure about profitability or efficiency of management: Even though the

accounts are audited it doesn’t mean that the user can take granted the future profitability or

prospects of concern as audit don’t comment on efficiency of the management.

Rely on experts: The auditor has to rely on experts like lawyers, engineers, valuers etc. for

estimation of contingent liability and valuation of fixed assets.

Accounts and Auditing

• Definition: Accounting is keeping records of the financial transactions and preparing

financial statements; but auditing is critical examination of the financial statements to

give an opinion on their fairness.

• Objective: Objective of accounting is to determine the financial position, profitability

and performance; while objective of auditing is to add credibility to the financial

statements and reports of the company.

• Status: Accounting is usually carried out by an internal employee of the company; but

auditing is carried out by an external person or independent agency. Accounting is

governed by Accounting Standards with some degree of discretion; but auditing is

governed by Standards on Auditing and does not provide much flexibility.

• Appointment: Accountant is appointed by the management of the company; while the

auditor is appointed by the shareholders of the company, or a regulator.

• Qualification: Any specific qualification is not compulsory for an accountant; but some

specific qualification is compulsory for an auditor.

• Scope Determination: The scope of accounting is determined by the management of the

company; while the scope of auditing is determined by the relevant laws or regulations.

• Commencement: Accounting starts usually where book-keeping ends; while auditing

always starts where accounting ends.

• Remuneration :Accounting is carried out by a company employee who gets a salary;

while a specific auditing fee is paid to the auditor. Accountant’s remuneration, i.e., salary

is fixed by the management; while auditor’s fee is fixed by the shareholders.

• Period: Accounting mainly concentrates on the current financial transactions and

activities; while auditing concentrates on the past financial statements. Accounting is

carried out on continuous basis with daily recording of financial transactions; while

auditing is basically a periodic process and carried out after the preparation of final

accounts and financial statements, usually on yearly basis.

• Compulsion: Accounting covers all transactions, records and statements having financial

implications; while auditing mainly covers final financial statements and records.

• Report Submission: Accounts are submitted to the management of the organization;

while audit report is submitted to the shareholders.

• Knowledge :- Accountant must have the knowledge of accountancy whereas an Auditor

must have the knowledge of accounting as well as auditing.

Types Of Audit:

(A) On The Basis Of Scope:-

(1) Management audit

(2) Cost audit

(3) Tax audit

(4) Operational audit

(5) Proprietary or Performance audit

(B) On The Basis Of Forms Of Organization :-

1. Sole trader

2. Partnership accounts

3. Hindu undivided family

4. Audit of Association of persons

5. Audit of non-trading concerns

(C) On The Basis of conduct/Method/Approach:

(1) Independent (external)

(2) Internal

(3) Balance sheet audit

(4) Partial audit

(5) Interim audit

(6)Continuous audit

(7)Periodical/ completed annual audit

(A) On The Basis Of Scope:-

An audit examination can be general or specific. A general audit can be independent. On the

other hand, specific audit concentrates on a particular areas, object or may be period.

(1) Cost audit:- Cost audit was first introduced in 1965 in India, when the central govt.

added clauses (d) to section 209 and 233B to section 233 of Companies Act,1956 . Cost audit is

the effective means of control in the hands of management and it is a check on behalf of the

shareholders of the company , consumers and the govt. The cost audit helps in maintaining and

effective control of cost. The cost accountant helps in maintaining proper cost records and

suggests the means for reducing the cost of production.

(2) Management Audit:- Management audit is to evaluate various management functions

and processes. 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 organizations.”

(3) Performance audit:- It is to determine whether the various activities of the organization

are being carried out efficiently. It is to ensure effective control in the organisation. It examines

the relationship between production and sales to maximize the profits of the organization.

(4) Operational audit: This audit aims at improving the operations of business.

• To make recommendations for the improvement of profitability of the organization.

• To help in achieving other objectives of business such as workers satisfaction,

improvement in company’s image.

(5) Tax audit :-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. This profit differ due to various reasons. Profits for accounting

are ascertained as per accounting policies and standards but profits for tax purpose are

computed as per the provisions and rules of Income Tax Act.

(B) On The Basis Of Forms Of Organization or Statutory:-

(a) Audit of sole traders :- In case of proprietary concern, the owner himself takes the

decision to get the accounts audited. The auditing work will depend upon the

agreement of audit. It will be safe for the auditor to get the agreement in writing from

the trader.

(b) Audit of accounts of partnership firms:-To avoid any misunderstandings and

doubts, partnership firms recognize the advantage of audit of financial statements.

Partnership deed on mutual agreement between the partners may provide for audit of

final statements. Auditors are appointed by the mutual consent of all the partners.

Rights, duties and liabilities of the auditors are defined in the mutual agreement and

can be modified by the partners.

(c) Audit of accounts of individuals:-Many of the individuals derive from income from

property, shares, investments and other sources. They may be incurring heavy expenses for

earning such incomes. Like insurance agents earn a commission. Auditor may be appointed to

audit the accounts and to verify the accuracy. He must get clear instructions from his client. His

scope of work will depend upon the agreement with his client.

(d) Audit of companies:-Under Companies Act, audit of accounts of companies in India

is compulsory. Independent Chartered Accountant who is professionally qualified is

required for audit of accounts of companies. Indian Companies, Act 1913 for the first

time made it compulsory for joint stock companies to get their accounts audited by a

qualified accountant. A number of amendments have been made in Companies Act, 1956

regarding appointment, duties, qualifications, power and liabilities of a qualified auditor.

(e) Audit of accounts of trust:-Accounts of trust are maintained as per the conditions and

terms of the trust deed. The income of the trust is distributed to the beneficiaries. There

are more chances of frauds and mis-appropriation of incomes. In the trust deed as well as

in the trust by a qualified auditor. The audited accounts of the trust nsure true and fair

view of accounts of trust.

(f) Audit of accounts of Co-operative Societies:-co-operative societies are established

under the Co-operative Societies Act, 1912. It contains various provisions for regulation

and working of these societies. The auditor of co-operative society should have an expert

knowledge of the particular Act. Companies Act is no applicable for co-operative

societies.

(g) Audit of accounts of other institutions:-other corporate bodies like banks, insurance

companies, electricity companies etc. formed under the Special Acts of the parliament

shall get their accounts audited as per the provisions of the respective Act.

(C) On The Basis Of Conduct/Method/Approach:-

It is classified into external and internal audit. An independent or external audit is conducted

by an independent, professionally qualified person who is not an employee of the organization.

An independent audit enjoys better credibility in the eyes of public. Indian companies Act, and

Chartered Accountants Act contain number of provisions to ensure the independence of the

auditor. On the other hand, i internal audit is conducted by employee of the organization to

enable better exercise of managerial control.

(1) Internal audit implies the audit of accounts by the staff of the business. The staff may or

may not have professional qualification for audit of accounts. The internal audit staff is

permanent in nature and helps the business in detection of errors and frauds. Partial audit:-

When an auditor is asked to audit certain category of transactions or transactions made during a

post of period, it is called as partial audit.

(2) Partial audit:- It is conducted as a special event, normally in those organizations where

routine audits are not taking place. For ex,in a partnership firm when a new partner is to be

admitted or where govt. orders a special audit to investigate in to certain matters.

(3)Interim audit:-When an audit is conducted between two annual audits, such audit is known

as interim audit. It may involve complete checking of accounts for a part of the year. Sometimes

it is conducted to enable the Board of Directors to declare an interim dividend.

(4) Continuous audit: It is a detailed examination when an audit is done at certain levels but

from where it is left . The reasons may be where there are large volumes of transactions or

internal control or check is weak.

(5) Balance sheet audit: It is an in depth examination of all items of balance sheet, profit and

loss account, original entries etc.. Vouchers are examined only to a necessary extent.

Basic Principles Governing an Audit

The Auditing and Assurance Standard 1 (SA 200) on “Basic Principles Governing an Audit”

issued by the Institute of Chartered Accountants of India describes the basic principles which

govern the auditor’s professional responsibilities and which should be complied with whenever

an audit of financial information of an entity is carried out. The basic principles as stated in this

statement are:

(i) Integrity, Objectivity and Independence: The auditor should be straightforward, honest

and sincere in his approach to his professional work. He should maintain an impartial attitude

and both be and appear to be free of any interest which might be regarded, whatever its actual

effect on being incompatible with integrity and objectivity.

(ii) Confidentiality: The auditor should respect the confidentiality of information acquired in

the course of his work and should not disclose any such information to a third party without

specific authority or unless there is a legal or professional duty to disclose.

(iii) Skill and Competence: The audit should be performed and the report prepared with due

professional care by persons who have adequate training, experience and competence in auditing.

(iv) Work Performed by Others: When the auditor delegates work to assistants or uses

work performed by other auditors and experts, he will be entitled to rely on work performed by

others provided he exercises adequate skill and care and is not aware of any reasons to believe

that he should not have so relied. The auditor should carefully direct, supervise and review work

delegated to assistants and obtain reasonable assurance that work performed by other auditors or

experts is adequate for his purpose since he will continue to be responsible for forming and

expressing his opinion on the financial information.

(v) Documentation: The auditor should document matters which are important in providing

evidence that the audit was carried in accordance with the basic principles.

(vi) Planning: Planning enables the auditor to conduct and effective audit in an efficient and

timely manner. Primarily, planning should be based on the knowledge of the client’s business.

Plans should be further developed and revised as necessary during the course of the audit.

(vii) Audit Evidence: The auditor should obtain sufficient appropriate audit evidence through

the performance of compliance and substantive procedures to enable him to draw reasonable

conclusions there from on which to base his opinion on the financing information.

(viii) Accounting System and Internal Control: The auditor should reasonably assure

himself that the accounting system is adequate and that all the accounting information which

should be recorded has in fact been recorded. Internal controls normally contribute to such

assurance. The auditor should gain an understanding of the accounting system and related

internal controls and evaluate the same to determine the nature, timing and extent of other audit

procedures.

(ix) Audit Conclusions and Reporting: The auditor should review and assess the

conclusions drawn from the audit evidence obtained and from his knowledge of business of the

entity as the basis for the expression of his opinion on the financial information. This review and

assessment involves forming an overall conclusion as to whether:

(a) the financial information has been prepared using acceptable accounting policies

which have been consistently applied;

(b) the financial information complies with relevant regulations and statutory

requirements;

(c) there is adequate disclosure of all material matters relevant to the proper

presentation of the financial information, subject to statutory requirements, where applicable.

The auditor should contain a clear written expression of opinion on the financial information and

if the form or content of the report is laid down in or prescribed under any agreement or statute

or regulation, the audit report should comply with such requirements. When a qualified opinion,

adverse opinion or a disclaimer of opinion is to be given or reservation of opinion on any matters

is to be made, the audit report should state the reasons therefore.

Audit Planning

Proper implementation of any plan depends upon a good programme me. While preparing audit

programme me, the auditor must keep in mind size and composition of the organization and

nature and extent of internal control. An auditor prepares a plan after the selection of senior and

junior staffs allocating the jobs to them, mentioning when to start, how to do the work etc; this

plan is known as audit programme.

An auditor should include all the procedures in written form, objectives of each sector and all the

directions which are to be given to the staff, which helps to control their work and helps to

implement such programmes in to action.

Preparation before commencement of audit

It means that when an organization is going to start final audit

before commencement of audit the following instruction must be given by the auditor to his

client.

1. To ascertain nature and scope of his duties.

2. An engagement letter called audit contract should be procured from the client in which it

contains all the terms and conditions between auditor and his client.

3. A list of book in use, list of employees, their duties and internal control should be provided to

the audit staff.

4. Books of original entry, ledgers, trial balance and Final accounts should be provided to the

auditor to know the internal control system.

5. All supporting document should be properly arranged.

6. List and schedule of assets and liabilities should be arranged properly for the examination to

the audit staff managed properly for the examination to the audit staff.

7. The auditor of the newly established company should also carry out the following primary

work before commencing the audit.

8. To understand the nature of transaction of the client the auditor should acquire technical

knowledge.

Audit Programme

Audit programme is a detailed work plan which includes the time of doing work and how to

do the work which includes audit procedures. It also estimates the duration to complete the

audit task. Senior staffs prepares audit programme to junior staff on the basis of nature of

business. Auditor has to keep in mind the size and composition of organisation nature and

extent of internal control for audit program.

Advantages

(1) Audit programme saves time and labour:- All the directions which are to be given to

assistant are clearly stated in the audit programme which helps to complete the task in

time.

(2) Audit programme increases efficiency:- The responsibilities of auditor are divided

among the number of staffs considering their skill and intelligence which helps to

complete the work of audit properly.

(3) Audit programme helps to control:- An auditor can compare the work performed by

the assistants on the basis of audit programme which helps to control their wok.

(4) Audit programme helps to maintain uniformity:- work is divided among the assistant

staffs, so there is no chance of leaving non-audited statements. If the work of audit is

performed every year, uniformity can be maintained in the work of audit which helps to

compare the report of various years.

(5) Audit programme help to make responsible:- work of assistant is clearly defined in the

audit programme and assistant puts signature in the completed work. So, if any work is

left out, assistant can be made liable for such work.

(6) Audit programme helps to maintain continuity:- Audit programme clearly shows the

completed task and procedures of doing work. So, if any staff leaves the job or remains

absent, new staff can easily continue the job of audit.

(7) Audit programme helps to present as proof:- Auditor can present audit programme as

proof. If he/ she done negligence or misfeasance, can get clearance from such accusation.

Audit programme can be presented in court also.

Disadvantages

Even though audit programme has number of advantages it is not free from limitations. Some of

the major disadvantages of audit programme are as follows:-

(1) Audit programme harasses staff:-All the staff should perform task within the limitation

given in audit programme. So, staff can’t use their knowledge and calibre which harasses

to them.

(2) Possibility of being unsuitable:- Nature and size of business differs. So, the programme

which is prepared at the beginning of the year remains unsuitable. Different organisations

may have their own problems.so, similar type of programme may not be applicable to all.

(3) Audit programme increases the chance of fraud:- Staff of the client got information

about the audit programme in advance which increases the chance of committing frauds.

Similarly, it harasses the audit staff, so they perform the work of audit carelessly which

also increases the chance of committing frauds.

(4) Audit programme is unsuitable to small concerns:- Small concerns has less

transactions and work of audit can be completed in short period of time. So, audit

programme is not essential to audit such concern.

(5) Exclusion of problems of new technology:- New techniques and technologies are used

in the work of accounting. Such technology creates the problem in the work of audit.

Audit Note Book:-

Audit note book is a diary or register maintained by audit staff to note errors, doubtful queries

and difficulties. The purpose is to note down various points which need to be either clarified with

the client o the chief auditor. The audit note book is also used for recording important points to

be included in the auditor’s report. It is a complete record of doubts and their clarification.

Contents of Audit Note Book:-

(1) A list of books of accounts maintained.

(2) The names, duties and responsibilities of principal officers.

(3) The particulars of missing receipts and vouchers.

(4) Mistakes and errors detected.

(5) The points calling for clarification and explanations.

(6) The points deserving the attention of the auditor.

(7) Various totals and balances.

(8) Extracts from minutes and contracts.

(9) Points to be part of auditor's report.

(10) Date of commencement and completion of audit.

Audit papers or Audit Working Papers:-

Audit working papers are the documents which record all audit evidence obtained during

financial statements auditing, internal management auditing, information system auditing and

investigations. These papers contain essential facts about accounts which are under audit.They

show the audit was:

• Properly planned;

• Carried out;

• There was adequate supervision;

• That the appropriate review was undertaken; & finally and most importantly;

• That the evidence is sufficient and appropriate to support the audit opinion.

Purpose of Audit Working Papers

1. Working papers represent the volume of work performed by the auditor and his staff. Hence,

they enable the easy drafting and preparation of a detailed audit report.

2. The various minute details and aspects of the audit report can be well substantiated based on

the findings summarized in the report.

3. They become a valuable documentary evidence for the auditor on the occasions when he has

to defend himself against the charges of negligence, etc. leveled against him.

4. They enable auditor to coordinate and organize the work of audit clerks.

5. They enable the auditor to advice his client regarding the improvement of the system of

internal check and efficiency of the accounting system.

6. They serve as a guide to the auditor in subsequent examinations and help the auditor to plan

for the succeeding year.

7. They serve as a means to give training to the audit clerks to summarize the work done by

them.

8. The purpose of audit working papers is to prepare written record as a proof of audit work

done.

9. Audit staff keeps audit working papers so long these are needed for future use such record is

the property of an auditor. He can keep it as long as he thinks necessary.

10. The auditor can be assisted in forming an opinion about financial statements.

Latest Trends in audit

The AC (Audit Committee) plays a critical role in helping organizations navigate today’s

challenging business environment, providing guidance and oversight on a wide range of complex

issues. This means audit committees must focus on ensuring the right skills are at the table and

that all members continue to expand their knowledge in key areas. Encouragingly, more than 70

percent of respondents indicated that their board assesses its skills on an annual basis with an eye

to facing evolving challenges.

1. Talent and human capital: So much data gathering work is being automated now in internal

audit and finance. Talent-wise, that means internal audit will be looking for people who are more

astute on the levels of data and information analysis – people who can use data strategically to

help the organization realize its vision and goals. We’re really seeing the emergence of a

different capability in internal audit, where it’s moving from a ‘doing’ function to a ‘leading/

influencing’ function.

2. Technology and cyber security: Businesses really need to think harder about technology

infrastructure, as it appears to be moving from one model to another model. Organizations are

unsure what their capital investment should look like going forward, as a pay-as-you go

approach is becoming more practical. This is an area that is changing at a tremendous rate and it

just isn’t as well understood as it should be. For those that get it right, it could create significant

innovation differentiation.

3. Disruption to business models: It is clear that the innovation agenda will continue to be a

core focus for organizations, whether to optimize cost, differentiate the customer experience or

grow new products and services. It is critical to move past the buzzwords and for ACs to truly

understand the existing and future risks and opportunities posed through innovation disruption,

which is occurring at an exponential rate.

4. Evolving regulatory landscape: In our globalized economy, organizations should start

thinking not just about complying with regulations in other countries, but about whether their

operations in those countries are living up to home country standards and regulations. This is

particularly relevant given the rapid rise of social media and its use to highlight what individuals

believe to be inappropriate corporate behaviour. Companies have a social responsibility to think

about these issues, and their brand can be damaged if they are not properly addressed.

5. Political and economic uncertainty: For ACs to address risk issues around uncertainty –

whether political or economic – they need access to, and engagement with, leading insights.

Those insights can come from a variety of places: subject matter experts, experience gleaned

from other boards, or external advisors who can assess the business and understand how the

broad range of uncertainty-based risks applies.

6. Changing reporting expectations: The importance of operational and non-financial metrics

will only continue to increase. As a result, the finance function’s responsibilities will expand

beyond traditional financial reporting and controls. Audit committees should ensure their finance

function is taking the full range of externally reported KPIs(Key Performance Indicators) into

account and leveraging them to give external stakeholders more assurance around the accuracy

of all reports.

7. Environment and climate change: Many of Canada’s leading industry sectors could well

suffer negative consequences from climate change if they don’t take action. The cost of recent

catastrophic weather events and the potential negative impact of climate change on business

models and asset valuations are increasingly driving home this realization. To play an effective

role, ACs have a responsibility to understand and ensure that management has addressed the

potentially material impacts of climate change and related disclosure requirements.

UNIT-2

AUDIT AND AUDIT PROCEDURE

AUDIT EVIDENCE:

Auditing is primarily concerned with the verification and examination of the accounting data. The auditor

should give his opinion on the financial statements and should investigate into the accounts of the company to

establish a basis for his opinion.

During the process of investigation, the auditor should collect and evaluate the evidence to establish the facts

and to draw conclusions and opinions.

The auditor should obtain sufficient and competent evidence before expressing any opinion on the financial

statements.

The term evidence includes all influences on the mind of an auditor which affects his judgment about the

truthfulness of the proportions submitted to him for review.

In simple words an auditor must gather sufficient and appropriate audit evidence and test them to make judgment

of opinion.

Audit evidence is information obtained and recorded by the auditor is arriving at the conclusions on which he

bases his opinion on the financial statements. Main source of audit evidence includes:

1 Accounting system and underlying documentation of the

enterprise.

2 Tangible asset.

3 Management and employees of the organization.

4 Customers, suppliers and other third parties who have dealing with or knowledge of the enterprise or it’s

business.

Thus with the help of the evidence the auditor can form an opinion whether the financial statements show a

true and fair view of the affairs of the company.

CONCEPTOF MATERIALITY:

Materiality determines which information should be presented in the financial statements. There is no definite

criterion for determining the materiality of information. Information is said to be material if its omission or

misstatement would influence the economic decisions taken by the users based on the financial statements.

Thus it can be said that information is material if it is relevant to the decision of the users. Hence, materiality

and relevance have much in common as both defined by the reference to the needs of users in making economic

decisions.

Kohler’s defines Materiality as the characteristic attaching to a statement, fact or item where by its disclosure

or the method giving it expression would likely to influence the judgment of a reasonable person.

According to this concept only those events should be recorded which have a significant bearing and

insignificant things should be ignored. The avoidance of insignificant things will not materially affect the

records of the business. There is no formula in making a distinction between material and immaterial events. It

is a matter of judgment and it is left to the accountant or auditor for taking a decision.

The principle of materiality is and has always been fundament6al to the whole process of accounting. An

auditor has also to be quite concerned with regard to the concept of materiality. In fact, he has analyze and take

decision regarding various items whether they are material or not during the course of an audit. This would

require thorough knowledge, competence and experience on his part. In case, he finds that an item is quite

material in nature, he would have to give careful consideration to its checking & would call for more evidence

in support. In fact, he would have to undertake an ‘audit in depth’ to satisfy himself regarding such material

item.

Accounting standard 1 defines material items as relatively important and relevant items i.e items ‘the

knowledge of which would influence the decisions of the users of the financial statements’.

In companies act 2013, the word material has been used in schedule 3, part 2 of schedule 3 requires the financial

statements and profit and loss account to disclose all material items, features. Similarly schedule 2 of chartered

accounts act 1949 clause 5,6,8 and 9 of part 1 refer to material facts, material misstatement, material exceptions

and material departure. It’s importance is also been in the statement on auditing practices.

It has been stated that “the concept of materiality is fundamental to the process of recognition, aggregation,

classification and presentation of financial information. It is also an important consideration for an auditor who

has constantly to judge whether a particular item of transaction is material or not”.

INTERNAL CONTROL: Internal control means controlling the whole management system financial or non-

financial. It means internal control involves a number of checks and controls exercised in a business to ensure its

efficient and economic working.

SPICER AND PEGLER: Define the internal control as “internal control is best regarded as the whole system

of controls, financial and otherwise, established by the management is the conduct of a business including

internal check, internal audit and other forms of control.

MEANING:

1 The internal control is a system of controls.

2 Controls are established over financial and non-financial areas.

3 The mechanism of control may manifest itself in the forms of internal check or internal audit or other firm.

According to The American Institute of Certified Public Accountants:

“Internal control comprises of the plan of organization and all the co-ordinate methods and measures

adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data

to promote operational efficiency and to encourage adherence to prescribed managerial policies.

SCOPE OF INTERNAL CONTROL:

1 FINANCIAL CONTROL: It is concerned with an efficient system of accounting, adequate supervision,

recording and duplicating system.

2 CASH CONTROL: It includes controlling of the receipts, payments and balances remaining. Proper steps

should be taken to avoid misappropriation of cash.

3 CONTROL OVER TRADING TRANSACTIONS: This deals with the system of controlling purchases

and sales transaction. Proper procedures should be made for handling, acquiring and accounting of goods

purchased and for recording and handling of goods sold.

4 CONTROL OVER EMPLOYEES REMUNERATION: The preparation and maintenance of records for

remuneration to employees, methods of payments etc have to be properly dealt with. This should be done to

avoid defalcation and misappropriation of cash payments to be made to the employees.

5 CAPITAL EXPENDITURE CONTROL: The expenditure on capital assets must be kept under proper

control. It should be properly used and sanctioned and feedback reports must be prepared and submitted.

6 OTHERS:

a) Stock maintenance

b) Control over investments

c) Maintenance of staff

relationship

OBJECTIVES:

Before depending upon the internal control system, the auditor should ensure that the following objectives have

been achieved by the organization.

1. Assets Protection: The purpose of internal control is to protect assets of the business entity, The assets

are used in the business. These assets are in the custody of responsible officers. So assets are not

destroyed or misused.

2. Accurate Record: The purpose of internal control is to maintain accurate accounting record. The

business transactions are processed under generally accepted accounting principles after authorization of

competent person.

3. Follow Policies: The purpose of internal control is to follow policies management. The policies are broad

guidelines for obtaining business objectives. All employees try their best to follow rules of the game.

4. Prevention of Errors: The purpose of internal control is to prevent errors. There may be an unintentional

mistake due to overwork or carelessness. There is normal workload with every person. The senior person

checks the work of a junior person.

5. Prevention of Frauds: The purpose of internal control is to prevent frauds. It is an intentional

misrepresentation of financial information by one or more individuals among management, employees

or third parties.

6. Best Use of Resources: The purpose of internal control is the best use of resources. There is a need for

an optimum combination of resources for maximizing profits. Internal control can point out a weakness

that can be removed.

7. Nature of Test Audit: The purpose of internal control is to determine the nature and extent of audit test.

When there is effective internal control there will be few audit tests otherwise there will be a need for

thorough checking.

8. Reliable Record: The purpose of internal control is to maintain reliable accounting record. The equal

distribution of work among the employees provides the complete and reliable record, as it is free from

errors and frauds.

9. Reduce Workload: The purpose of internal controls is reduction of workload. The effective internal

controls can be useful for auditors. They can check few items remaining items will be treated as checked

by the auditor.

10. Location of Errors and Frauds: The purpose of internal controls is to locate frauds and errors. There

are many types of errors and frauds that may be found in the accounting record. The compliance and

substantive tests may be applied to detect the frauds.

INTERNAL CHECK:

It is an arrangement of the duties of members of staff in such a manner that the work performed by one person is

automatically and independently checked by the other.

Spicer and Pegler “Internal check is an arrangement of the duties of the staff members of the accounting

functions in such a way that the work performed by a person is automatically checked by another”.

Ronald A Irish “Internal check refers to the organization of office duties in such a way as to prevent or disclose

both errors or frauds”.

INTERNAL AUDIT:

It is the independent appraisal activity within an organization for the review of accounting, financial and other

business practices.

DEFINITION: Watter B Meigs “Internal auditing consists of a continuous and critical review of financial and

operating activities by a staff of auditors functioning as full time salaried employee”.

DISTINCTION BETWEEN INTERNAL AUDIT AND INTERNAL CHECK

Basis Internal check Internal audit

1.Meaning It is an arrangement ai duties allocated in

such a way that the work of one person is

checked by another.

It is an independent appraisal of the operations

and records of the company.

2.Object Is to prevent on minimize the of errors,

frauds

or irregularities.

It is to detect the errors and frauds which have

already been committed.

3. Separate staff

required

no new appointment is required. It is

arrangement of duties of staff in a

particular

way.

A separate staff of employees is appointed for

this.

4.Nature of work It is a process under which the work goes

on uninterruptedly & the checking is more

or

less automatic.

The internal auditor has to report to the

management about the inefficiencies and

suggest

improvements.

5.Timing of work It is in operations during the course of

transactions.

It starts when the accounting process of different

transactions is finished.

6.Device It is a device for doing the work. It is a device for checking the work.

7.Errors& frauds Errors and frauds are discovered during the

course of work.

Errors and frauds are detected after the

completion

of work.

8.Scope of work Scope is very limited. Scope is broad.

9.Involment A Large number of employees are needed

for implementation.

A Much smaller number is needed

for implementation.

INTERNAL CHECK WITH REGARD TO CASH TRANSACTIONS

The risk of misappropriation of cash and chances of frauds are numerous in cash transactions. Hence the

following points should be taken into consideration while devising a good and proper system of internal check

for cash transactions.

CASH RECEIPTS.

1. The cashier should have no access to the ledgers and other books of original entry except the cash book.

2. The printed receipts books, serially numbered, should be used when cash is collected and should me

countersigned by the responsible manager.

3. All cheques should be marked not negotiable and A|c payee only.

4. All the receipts should be acknowledged by means of a printed receipt.

5. Incoming correspondence and remittances should be opened by the cashier in the presence of responsible

officer.

6. Account collections both cash and cheque should be deposited into the bank daily. The counter –foil of the

pay-in-slip should be filled by the clerk and the portion to be retained by the bank should be filled by the

cashier.

7. Bank reconciliation statement (B.R.S) should be prepared at regular intervals by the cashier to know the

actual position of bank balance.

8. Any spoiled slips should be cancelled but not removed from the receipt book. Overwriting should be

discouraged and fresh writing with proper initials is encouraged.

9. Copies of the receipts previously issued must be marked duplicate.

10. Some responsible person from the firm should verify the balance of cash by carrying out a surprise physical

check.

CASH SALES.

Cash sales in of three types.

1. Sales at counter: The following procedure should be followed for cash sales.

a. The sales man should be properly named and a specific number to each salesman should be allocated.

b. Cash memo should be printed in numerical sequence every salesman should be given a separate book of

bank copies of cash memos.

c. The salesman sells goods to customers and prepares 4 copies of cash memos, 3 to be given to customers and

4th to be retained by the salesman.

d. All those copies are checked by another official.

e. The customers carries the 2 copies to the cashier, who after collecting the amount and after recording the

sale, returns 2 copies marked cash paid.

f. Goods are handed over to the customer by the gate keeper and ‘1’ copy of cash memo is retained by the gate

keeper.

g. At the end of the day, the salesman, cashier and gatekeeper prepare summary of the cash separately.

h. Receipts from cash sales should be deposited in the bank on the same day, if sales are made after banking

hours Kama the same may be deposited the next day.

i. Where cash recording machines are used, the total of cash received has given by the machine, should be

checked with the amount actually banked.

2. Travelling salesman: These salesmen collect debts from the old customers and accept advance from the

new ones. The following measures should be adopted to check the salesman.

a. Travelling salesman should be given pre numbered rough receipts books. Hence they issue a rough receipt

to the customers for cash received and the final receipt is issued by the head office.

b. The customer can directly contact the head office if they do not receive the final receipt within a period of time.

c. No travelling salesman is instructed to deposit all the cash receive to the head office, without making any

deductions from commissions or any expenditure.

d. Head officer regularly statement of accounts to their old customers to appraise them of their debts and balance.

e. Special attention should be given to defaulters.

f. Salesman should be transferred from one area to another to avoid fraud and increase efficiency of the

salesman.

3. postal sales:

a. There should be a separate register to Record sales by post or V.P.P.

b. When cash is received against a V.P.P sale, it should be entered in the separate register.

c. Separate bank pay in slips should be prepared to deposit cash received against postal sales.

d. An officer should be deputed to check the register and special attention should be given to those goods which

have been returned.

CASH PAYMENTS.

a. All the payment should be made by account payee cheque.

b. The person in-charge of making payment should have no connection with the person receiving cash.

c. It should be seen that all the cheques have been signed by the authorized person.

d. All the unused cheques should be kept in proper safe custody.

e. Payment always by reference to appropriate documentary evidence.

f. Payment for Rs.20000/- or more always by A/C payee cheques.

g. Use of revenue stamps for cash payments exceeding Rs.5000/-

h. Continuous serial numbering of all cheques/cash vouchers.

i. Recording all payments in cash book.

j. Vouchers supporting payment should not be presented twice. Such vouchers should be stamped as 'paid'

before the cheques are signed.

k. An official should check the statement received from creditors and verify within the invoice and ledger

account. Only after verification the cheque should be drawn in favor of the creditor. Confirmation of account

should also be made with the credit card through check correspondence.

l. No payments against ‘LOU and On account’ without sanction of an appropriate authority.

m. B.R.S should be prepared to reconcile bank and cash balance from time to time by some authorities other

than the cashier.

INTERNAL CHECK WITH REGARD TO PURCHASES

Purchase is of two types. cash purchases and credit purchases. The internal check has regard cash and credit

purchases are given as follows.

a. No purchase should be made without purchase requisition slip issued by store department. The details about

the quantity, quality and the time by which the goods must be supplied be clearly mentioned in the requisition

slip.

b. In order to purchase the required item, the purchase department makes an enquiry about the terms and

conditions of purchase from different suppliers. Tenders one also invited and the one with the lowest prices

accepted.

c. The purchase manager should be given the authority to issue purchase order 1 original and with '3' copies of

the order should be prepared. The original copy sent to the suppliers, one copy sent to the account department,

1 to the store department and 1 is retained by the purchase department for reference.

d. All the goods received should be checked with the purchase order from and with the challenge of the

suppliers. After the goods have been inspected for quality and quantity, a goods receipts register is to be

maintained for recording the same at the store department or centralized warehouse.

All the invoices (bills) received from the supplier’s one to be entered in the purchase day book.

e. The purchase department should properly check the invoices and send the same to the account department for

payment. The accounts department compares its invoice with the purchased order, and also verify the bill

amount. An A/c payee cheque is then to be issued and these cheques should be marked as 'paid'.

INTERNALS CHECK WITH REGARDS TO SALES:

Sales are the important source of revenue in a business. The system of internal check regarding sales should be

extremely efficient otherwise frauds might take place. Hence the whole system of credit sales should be kept

under proper control and supervision.

1. When an order is received, it should be recorded in the other received book. With the details like date of

receiving the order, name of the customer, particulars about goods, date of delivery, mode of transport etc. If

it is a verbal order, a confirmatory written order should be obtained.

2. The copy of the order should be sent to the dispatch department with necessary particulars. It should see

that the order is executed according to specification.

3. The dispatch department should take step to pack the goods as part of the order. Another clerk should

compare the goods so dispatched with the order, to see that the whole order is met and another list in prepared

showing the goods in package and this list is sent to the counting house.

4. A responsible official will mark the rate at which the goods are to be charged, the terms and conditions of

the order so that there is no complaints from the buyer.

5. with the help of the copy of the invoice, entries should be made in the sales day book.

6. On dispatch of the goods records should be made in the goods outward book.

7. Two copies of the invoice are rent to the customer, who will return one of them after signing it. It acts as a

delivery note. Third copy is retained for future reference.

8. Entry should be made inwards book, for goods returned by customers (sales returns). credit note should be

prepared and checked and signed by the responsible official.

9. With the help of credit note, record should be made in the sales returns

book.

INTERNAL CHECK WITH REGARD TO STORES (STOCK)

1. The store room should be located at a convenient place. It should have proper stores facilities so that goods

may not be misplaced, misused or wasted.

2. On receiving the goods, it should be properly recorded by the store keeper on goods received sheets in

triplicate. One copy to be given to account department, one to buying (purchase) department and third to be

retained by the stores.

3. All the items in the stores should bear a reference number and should be stored at their allotted rack and bins.

Bin cards should be used in the stores which should hang outside each bin. Stock- taking should be carried out

at regular intervals it should be done by an independent person who is not involved in any way with purchase,

issues or maintenance of stores.

4. No item from the store should be issued to any person without formal requisition from some authority. Only

authorized person should be allowed to remove articles from the stores according to requisition. For

material or stores returned from the job of department. Material return notes should be written and properly

accounted for. Material transfer note should be issued for transferring material from one department to

another. The gatekeeper should be instructed not to allow any material out of the factory without permit from

the store keeper.

5. After the issue of materials from the stores, the issue requisition should be sent to the stores. Account section

for proper record. The bin cards should be checked and compared from time to time with stores records.

Routine checking:

Routine checking means checking of arithmetical accuracy of book of original entry and ledger with a view to

detect clerical errors and frauds of a very simple nature.

The main objectives of routine checking are

1. To verify the arithmetical accuracy of the entries made in the book of accounts.

2. To verify that posting from journal to ledger have been made to the correct accounts and balancing of these

accounts have been correctly done.

3. To ensure that after the routine checking is over, the figures have not win erase or altered. This is done by

special 'ticks' for checking.

Test checking:

In large organizations the number of transactions are very large. Hence it is physically impossible to verify all

the entries. If the firm has a good system of internal check and control, it is not necessary for the auditor to do

a detailed checking. Test checking is a substitute of detailed checking.

The auditor makes use of the test checks, which implies limiting his examination of every transaction entered

by his client in the books to certain test of the internal control and the data in the financial statement. It involves

a more intensive checking of a limited number of transactions selected on random basis from the total

accounting data as against a detailed checking of all the transactions.

The following points need special attention of the auditor:-

1. The pattern of test checking should be changed frequently so that the staff of the client cannot understand it.

2. The test checking applied in one year can take as a base for preparing the audit program for next year.

3. Over the years, each section and period must be covered.

4. There cannot be pre-determined sample size.

5. The risk of error and fraud has to be kept into consideration.

6. The materiality concept may be applied in deciding the

sample.

UNIT-III

VOUCHING

Meaning

• Vouching is concerned with examining documentary evidence to ascertain the authenticity of entries in

books of entries in books of accounts. It is an inspection by the auditor of an evidence supporting and

substantiating the transaction made in the books. It is a technique used by the auditor to judge the truth of

entries appearing in the books of accounts. All accounting entries must be supported by a document. It is

not only examining the documentary evidence but sometimes auditor has to go behind recorded evidence

to eliminate any possibility of fraud.

DEFINITION

• “Vouching is the examination of the evidence offered in substantiation of entries in the book including in

such examination the proof, so far as possible, that no entries have been omitted from the books” -Taylor

and Perry.

OBJECTIVES OF VOUCHING

• To ensure recording of all transactions.

• To verify that all transactions recorded in the books of accounts are supported by a

documentary evidence.

• To verify the validity of the vouchers which support the entries and to ascertain whether

these are authentic, addressed to the business and properly dated.

• To verify that no fraud or error has been committed while recording the transactions in the

books of accounts.

• To ensure that the vouchers have been processed carefully through various stages of internal check

system.

• To verify whether every transaction recorded has been adequately authenticated by a responsible

person.

• To know that while recording the transaction whether distinction has been made between capital and

revenue items.

• To ensure whether accuracy has been observed while totaling, carrying forward and recording and

amount in the account.

• To verify that all the transactions connected with the business have been recorded in the books of

accounts.

• To check vouchers which support entries are legal, valid, authentic, addressed to the business and

properly dated.

• To have greater precision in reporting the financial information as true and fair.

• To ensure reliability of figures entered in the books of accounts.

• To confirm that no transaction has been recorded in the books of accounts which are not related to

the entity under audit.

POINTS TO BE NOTED WHILE VOUCHING

1. Auditor must verify the authenticity of transactions, accuracy of amount recorded and proper

classification of account.

2. All the vouchers are numbered serially and dated. To avoid wasting of time in locating a voucher,

they have to be arranged serially.

3. The voucher checked by the auditor should be stamped or tick marked with a special sign, to avoid its use

again.

4. The amount in the receipt must be shown in words and figures. If there is a difference, it should be

investigated.

5. The receipt should indicate the period for which the payment has been made. It will show the payments

made in advance.

6. If the voucher is in the personal name of the partners, manager, director or any other person, it should be

properly treated in the books of accounts.

7. The auditor should proceed cautiously and use special ticks for the vouchers which are doubtful.

8. Every voucher should be certified by a responsible officer of the business.

9. All expenses pertaining to the business should be examined by the auditor.

10. A receipt obtained from a party for Rs.20/- or more should bear the revenue stamp.

11. The auditor should see that proper account is debited or credited and proper classification of accounts

has been done.

12. Distinction is made between capital and revenue items while vouching.

13. Alterations in the vouchers must be supported by the concerned officer’s initials.

14. Auditor should use specific ticks for vouching cash payments, receipts, purchases, sales etc.

A) VOUCHING OF TRADING TRANSACTIONS

1. VOUCHING OF PURCHASE BOOKS.

1 . The main aim of vouching of purchases book is to see that all purchases invoices are entered in

purchases book and the goods are entered in the purchases book are actually received by the business.

2. Payment is made for only those goods which are delivered by the supplier.

3. Vouching normally depends on the frequency of purchases, size of the organization and the staff

employed.

4. If the internal control system for purchases is inadequate, the auditor has to exercise a greater care in

vouching the purchase transactions.

Auditor’s Duties While Vouching Credit Purchases

1. a) There should be proper record for all the purchase orders. A duplicate copy of order is kept in the office

for record.

b) A copy of purchase order shall be sent to Accounts Department.

c) All goods received should be recorded on goods received note; a copy of it should be sent to Accounts

Department.

d) Payment of supplier is made only after verification of receipt of goods and the price quoted in purchase order.

2) The auditor should see that only credit purchases of goods are recorded in purchase book.

3) The purchases book can be verified from purchase invoices, copies of orders placed, goods received note,

goods inward book, copies of challans from suppliers.

4) The quantity mentioned in the invoice must be the same as in shown in the Purchase order.

5) The price charged by the supplier must be as per quotation/price list of supplier.

6) The supplier bill must in the name of the business and for the period under audit.

7) The goods purchased must not be for the personal use of Directors or officers.

8) While vouching the purchase vouchers, each voucher should be stamped or initiated after examination, so

that it cannot be produced again.

9) The totaling and casting of purchases book should be verified. It should also be seen that all Taxes,

octroi, and freight are added to the purchases and trade discounts allowed are deducted.

10) In certain cases, statement from the suppliers may be obtained to verify his purchases

records.

11) The auditor should be more careful while vouching the purchases made in the first and the last month of the

accounting period, because sometimes the purchases of the last year may be included in the purchases of

first month of the current year or purchases of the last month of the current year may be recorded in the

next.

12) Duplicate invoices must not be entered in the purchases book if original invoices have already been recorded

2. VOUCHING OF PURCHASE RETURNS

Sometimes the purchased goods are returned back to the supplier for the various reasons. The goods

purchased may not correspond to the quality or the specifications ordered. The auditor should see

that there exists a proper system to record such returns. In such cases, the purchaser sends back the

invoice or alternatively a credit note may be obtained from the supplier. The credit note should

include the amount which was originally included in the invoice. A separate returns book is

maintained to record the returns. If the supplier replaces the goods returned, the information must

be sent to both departments.

AUDITOR’S DUTY

o He should see that a Debit note has been sent to the supplier or Credit note has been received from

the supplier.

o The quantity returned must correspond with the store-keeper’s record, return outward register

and gatekeeper’s outward register.

o The amount shown in Credit note should be verified.

o The auditor should be careful about the recording of purchases return in the current year.

Sometimes the profits of current year may be manipulated by recording current year’s

purchases returns in the subsequent years.

o The purchases return of the first month and last month of the accounting year should be vouched

carefully, to detect any manipulation of amounts.

3. VOUCHING OF CREDIT SALES

In big organizations sales are made on credit basis. The client himself prepares the sales invoices and

records credit sales in the sales book. The auditor can depend on sale invoices, and internal control

system for credit sales in operation.

INTERNAL CONTROL OF CREDIT SALES

• Any order received or booked should be recorded in a separate register, giving full details of the goods

ordered. The details are: a) Name of the customer b) Quantity ordered c) Selling Price d) Reference

number e) Date of delivery f) Mode of delivery g) Particulars regarding sales tax, excise duty and

insurance.

• After receiving the order, a copy of the same is sent to dispatch section, where the clerk will keep the

goods separate for the purpose of dispatch.

• Another clerk will prepare the list of goods and verify the goods dispatched with the customer’s order.

• Three copies of the challan should be prepared giving the full details of goods dispatched. One copy will

be kept by the dispatch Department and other two copies will be sent along with the goods.

• One copy will be received back duly receipted, which serves as the proof of dispatch of goods. The

original copy of invoice is sent the customer, and another copy to Accounts Department.

• If the orders are received through agent, a copy of sales invoice will be sent to the agent for sales

commission and execution of sales order.

• If agent collects the payment from customers, necessary information shall be provided.

• For collection of amount of Sales Invoice either Sales or Accounts Department may make cautious efforts

to collect the amount after expiry of credit period.

• Up-to-date record shall be maintained by Departments.

AUDITOR’S DUTIES

• He should examine the internal control system to assess the efficiency of the system by test checking. If not

satisfied, thorough vouching will be necessary.

• The sales register should be examined with copies of sales invoices. The sale of capital items shall not be

recorded in the sales book.

• Test checks should be applied on the calculations made in sales invoices.

• The totaling and castings of sales book should be verified.

• The sales tax, duties collected through sales invoices must be recorded under separate accounts.

• It should be verified that all sales invoices are prepared on the basis of challans and entered in the respective

accounts. No sales invoice should be left unrecorded.

• Sales made in the current year must be recorded under that year only. Similarly sales of the preceding or

subsequent years shall not be recorded as sales of the current year.

• All cancelled sales invoices must be kept together for verification by auditor, and see that they are properly

treated in the books of accounts.

• Trade discounts allowed to the customers should be checked. No separate entry for discount should be

passed in the books. If the trade discounts are high, the possible reasons should be located.

4. VOUCHING OF SALES RETURNS

They are the returns made by the customers, on which a credit note is issued only after obtaining

sanction from the responsible officer. Before a Credit note is issued, return inward register and

stores records should be verified. If sales returns occur frequently, it is preferable to use separate

sales return book in returns will be recorded. The auditor should be careful about the sales return in

the beginning of the year to detect the fictitious sales. The quality and quantity of goods returned

must be verified by the person preparing return note. Sometimes the customer sends a Debit note

on returning the goods; it should be taken as external information for verification and duplication in

recording of sales returns.

The auditor should pay special attention while vouching sales returns:

• Date on which the goods are actually returned.

• Credit or Debit Note of sales returns.

• Gate-keeper’s receipt book.

• Stores Records.

• Corresponding entry for the return of goods in customer’s account.

• Goods returned should form the part of closing stock at cost price or market price whichever is less.

5. VOUCHING OF GOODS ON SALE OR RETURN BASIS

A separate record should be maintained for goods sold on approval basis. It should not be treated

as sales unless the customer has sent his approval or after the expiry of the time limit. On the

receipt of approval from customer or expiry of time limit, sales invoice will be prepared, a copy

of which will be sent to the customer. If the customer informs about the return of goods,

necessary arrangement should be made to get back the goods. The goods sent on sale or return

basis should be taken in the closing stock as stock with customer. The auditor should get a

statement from customer that goods are lying with him on approval basis.

6. VOUCHING OF GOODS SENT ON CONSIGNMENT BASIS

• The goods sent on consignment basis by the principal to his agent should not be considered as sale.

• Only when such goods are sold by the consignee, entry for sale should be made in the books.

• The goods sent on consignment still lying with the consignee should be taken into closing stock.

• A Separate book should be maintained to show the record of goods sent on consignment basis.

• At the end of the year, an account sale is received from consignee, indicating the goods sold by him and

balancing of closing stock of goods sent on consignment basis.

• The auditor should verify the goods sent on consignment basis from proforma invoices, goods outward

register correspondence with consignee and account sales.

(B) VOUCHING OF CASH TRANSACTIONS

INTRODUCTION:

Cash book is maintained to account for receipts and payments of cash. Auditor should see

that all receipts have been recorded in cash book and no fictitious payment appears on the

payment side of cash book. The auditor should study the internal control in existence and

verify its effectiveness and adequacy.

He should find out chances of frauds in the system and the circumstances for concealment of incomes,

introduction of fictitious payments, manipulation of accounts etc. He should look into the accounting

routines and financial authority of different officials. Vouching must be arranged in serial and

chronological order. If any voucher is in the personal name of an official, it should be verified that it

related to the organization.

AUDIT OF CASH TRANSACTIONS:

1) INTERNAL CONTROL SYSTEM EVALUATION: It should have the characteristics like:

a) It shall not leave any cash receipts unaccounted for and permit any cash payment without goods and services

being received.

b) The person authorizing the payment must have financial power. It should be verified under what

conditions it can be exercised.

c) All receipts shall be immediately recorded and acknowledged.

d) All cheques must be crossed “Account payee only” immediately on receipt.

e) Cash receipts issued and amount credited to debtors shall be reconciled daily.

2) CORRECTNESS OF ACCOUNTING RECORDS:

It involves checking of records to verify that entries have been made as per the accounting system which is

regularly followed. The checking of records may disclose mistake or manipulations e.g.

a) Omission or commission of a transaction which may be accidental or incidental.

b) Errors of principle

c) Compensating errors.

I. VOUCHING OF CASH RECEIPTS

The auditor should keep in mind the following points in regard to risk of errors, frauds or

manipulation while vouching the cash receipts;

▪ False particulars of cash deposited in bank may be entered in counterfoils of pay-in-

slips.

▪ Cash received may not be entered in cash book particularly bad debts recovered,

sale of assets, over payments to creditors.

▪ Duplicate receipts may show sum less than the original receipts.

▪ Cheques received from customer may be deposited in bank without being entered in cash

book and later on an equivalent amount may be withdrawn.

▪ Incorrect totaling of cash book and thereafter false bank statements may be prepared.

▪ Overstatement of discount allowed and excess of cash received may be

misappropriated.

▪ Cash in hand may include personal cheques without any intention to deposit these

cheques into bank for collection.

▪ Cheques received may be credited to suspense account and then later on cash may be

withdrawn and misappropriated.

The vouching of cash receipts will depend to a large extent on the strength of internal control system.

Test checks can be applied to the audit of cash receipts if internal control system is satisfactory and

adequate. Auditor may check a few receipts at random if everything is in order.

VOUCHING OF VARIOUS CASH RECEIPTS (DEBIT SIDE)

• OPENING BALANCE: Closing cash balance of the last year becomes opening cash balance of the

current year. It can be verified from the last year’s audited balance sheet.

• CASH SALES: There are more misappropriation of cash sales. In vouching cash sales, cash

register should be fully checked with carbon copies of cash memos. The auditor should verify the

daily deposits of cash received in the bank.

• Dates of cash memos and date on which the receipts are recorded in cash book must be same

• If cash memos are cancelled, all copies including the original copy duly cancelled, should bekept in

the book.

• If the company has a discount policy, it must be approved by a responsible officer.

• (Vouchers-Duplicate cash memo, Salesman’s abstracts, Cashier summaries).

CASH RECEIVED FROM DEBTORS

When cash is received from customers, a cash memo is issued; a counterfoil is retained by the receiving

clerk.

Sometimes shortage is concealed, by delaying the recording of receipts of cash from a debtor.

Sometimes payment received from a customer is misappropriated without making entry in his account and

later on when cash is received from another customer, it is posted to the account of former customer. This

is known as “teeming and lading”.

• The auditor should verify amount received from debtors from the counterfoils issued to customers.

• All receipts should be serially numbered.]

• Amount should be entered in the cash book on the day when received.

• Discount allowed to customers should be authorized by a responsible officer.

(Vouchers-Counterfoils, Correspondence etc).

Loans

All business concerns have to borrow, from banks or other financial institutions.

Auditor should enquire whether the client is empowered borrow.

A company is required to maintain a separate register for the public deposits accepted and should

follow legal provisions imposed by the Companies Act.

While vouching the received, the terms and conditions contained in the agreement should be verified.

If the loan is secured it has to be disclosed in the Balance Sheet.

BILLS RECEIVABLE

• It may be verified because the various details regarding bills matured and discounted are available in

it.

• Auditor should check the amount received with bank statement.

• An enquiry may be made from party regarding due amounts and dishonor of bills. It may lead to

detection of a fraud, as the amount may be received and misappropriated by the cashier.

• A verification of the bills discounted should be made. Such bills be entered and appeared as contingent

liability in the Balance Sheet; if the date of maturity is after the date of Balance Sheet.

• (Vouchers-Bill receivable Book, Cash Book, Pass Book)

RENT RECEIVABLE

The auditor has to examine the following points:

• Terms and conditions of agreement and lease deed.

• Rent received should be compared with the list of properties maintained. If the rent is collected by

agent, then it should be compared with the account submitted by the agent.

• Check the counterfoils of receipts issued to the tenants.

• In case of heavy arrears of rent outstanding, auditor should confirm the arrears from tenants with the

consent of client.

• Auditor should obtain a certificate from the responsible officer regarding the period for which

the property remained vacant.

• (Vouchers-Lease Deed and Agreement, Counterfoils, Correspondence)

SALE OF INVESTMENTS

• The auditor should examine the bank advice to know the various details about the investments sold

through broker.

• Broker’s Sold Note or Commission Note should be examined to verify the sale proceeds and

commission charged by the broker.

• If the investments are sold at cum-dividend price, auditor should see that proper apportionment

has been made between capital and revenue receipt.

• If the investments are made against specified funds, they must be transferred to Profit or Loss

Account.

(Vouchers-Bank Advice, Broker’s Sold Note)

INCOME FROM INTEREST AND DIVIDEND

• The auditor should check dividend warrant counterfoil land covering letter received along with the

cheques.

• If the dividend is collected through bank, amount should be verified with the bank statement.

• If the dividend warrant has been received and is not yet collected, it should show as yet to be

collected.

• Interest received on the securities can be vouched from covering letters and schedule of

securities.

• Interest on fixed deposits can be verified from the bank pass book and interest on loan granted can be

checked from the agreement made and counterfoil of receipt issued.

• It should be ensured that al interest received and accrued have been accounted for in the books and

properly shown in the balance sheet.

(Voucher-For dividend counterfoils, Dividend warrants, Pass Book.

For Interest-Pass Book-Agreement, Counterfoils).

COMMISSION RECEIVED

The following points should be examined by the auditor:

• Study the agreement for receiving commission.

• Verify the commission received with counterfoils of receipts.

• Check the calculations of commission according to the terms of agreement.

• List of names of the parties should be verified from whom the commission is receivable.

• In case of commission received on sale of goods on consignment basis, amount of commission should be

verified form the copy of account sale sent to consignor.

(Voucher-Agreement, Counterfoils)

PROCEEDS FROM THE SALE OF FIXED ASSETS

• It should be vouched with minute book of Board of Directors, Correspondence, agents sale account and

sale contract.

• It should be credited in proper account.

• Any profit arising on the sale of asset shall be credited to revenue account which is not available

for distribution of dividends.

• If any expense on the sale assets is paid, the amount should be reduced and balance should be credited to

asset account.

• Sale of fixed assets is to be sanctioned by the authorized person or committee.

(Voucher-Sale Deed, Broker’s Sold Note, Correspondence)

INSURANCE CLAIMS

• It can be vouched with copy of insurance claim lodged, correspondence with the insurance company

counterfoil of the receipt issued.

• It should be verified that insurance claim recovered has been recorded in the proper account.

(Vouchers-Accounts, Correspondence)

II VOUCHING OF CASH PAYMENTS (CREDIT SIDE)

• The internal control system for payments should be evaluated before vouching credit side of cash book.

• While vouching various payments auditor should see that:

▪ Payment is made to right person.

▪ Payment is for the purpose of business

▪ Amount recorded in the cash book is the amount appearing in the voucher.

▪ Payment is duly sanctioned by the authorized officer.

▪ Proper account has been debited with the payment.

▪ Provisions of Companies Act has been complied with while recording the payment.

▪ Rough cash book should be compared with the cash book to locate the fictitious payment.

i) CASH PURCHASES

• In emergency, cash purchases may be made.

• Purchases of stores and stationery are made usually on cash basis.

• An adequate internal control system will be helpful in controlling manipulation of cash

purchases.

• It should be seen that goods purchased are actually received by the store-keeper.

• Cash memos can be compared with goods inward book to verify the goods received.

• Only the net amount should be entered in the books (after trade discount).

(Vouchers-Cash Memos, Goods Inward Note).

ii) BIILS PAYABLE

• If honored on the date of maturity and are returned by the payee after receiving the payment.

• These bills should be cancelled after being paid.

• Bills payable paid can be vouched with bills book.

• If the payment is made by bank, bank statement or pass book can be examined to verify the payment of bill.

(Vouchers-Receipts, Bills Payable Returned, Pass Book, Bills Payable Book)

iii) WAGES

• There are many chances of fraud and misappropriation in wages payment.

• The auditor should study the system of internal control in operation.

• Fraud and misappropriation in wage payment can arise in the following ways:

a) Inclusion of dummy workers in the workers’ register.

b) Payment of wages for the time or the work for which worker was not present at the work place.

c) Payment of wages at higher rate than allowed.

d) Including in the records the name of those workers who have left the organization.

e) Less amount of deductions is taken for calculation of wages.

iv) SALARIES

• Auditor should see that salaries bill is prepared with the sanction of responsible officer.

• He should also check attendance records, salary bill of earlier months and appointment letters of new

employees.

• If there is an abnormal increase in salaries of a month over the salaries of previous month, he

should inquire into the reasons for such change.

In vouching the payment of salaries, following points are important:

a) Auditor should check salary register with the entries made in cash book.

b) He should examine carefully alterations in the amount of deductions on account of fines, funds, loans,

insurance etc.

(Voucher-Salary Registers, Counterfoils, Appointment Letters)

v) INSURANCE PREMIUM

The auditor should examine the following for the vouching of the insurance premium:

a) Insurance policy or the cover note issued by the insurance company.

b) Insurance policies in case the policies are more than one.

c) Insurance premium receipts.

vi) TRAVELLING EXPENSES

• The staff of the company is paid travelling expenses according to the rules.

• The voucher and receipt of travelling expenses will serve as an evidence for vouching these expenses.

• If the allowance is fixed as per rules, auditor can verify the amount from the rules.

• If actual expenses are reimbursed, the calculation of travelling expenses should be verified.

• The Bill of travelling expenses should be sanctioned by a responsible officer.

(Vouchers-Receipts, Bills)

vii) PETTY CASH BOOK

▪ Verification of actual cash balance with the balance appearing in Petty cash book.

▪ Whether the internal control system is effective in detection of frauds and

misappropriations.

▪ Determining the validity and accuracy of transactions recorded in the Petty Cash

Book.

• All vouchers are serially numbered and sanctioned by a responsible officer.

• Petty cash received from the head cashier is recorded on the same day on which it is actually

received.

• Appropriate expense account is debited.

• All the payments must be verified from the supporting evidence

viii) LOANS

• He should see that the loan voucher should be supported by the receipt given by the party.

• Details regarding terms and conditions of loan can be verified from the loan agreement.

• It should be seen that instalments of loan along with interest are received on time.

• Mortgage deeds, other documents should also be examined.

ix) Freight, carriage, Customs duty

• Freight-- Heavy goods transported through ship/train/truck/aircraft for which charges are collected

called as freight charges.

• To check freight invoice

• Consignment note if any given by transporter, which gives you an evidence of the amount paid and

whether actual transport is happened or not.

• Whether transporter has PAN or not.

• If freight is subjected to TDS and no PAN is submitted, then TDS to be charged @20%.

• If payment is through cash –cash book, vouchers to be verified.

• If payment is through bank- cheque register, bank statement to be verified.

• Also bills, validity, mileage, duplicate payments, and use of correct tariffs.

• Carriage --Verify carriage inward voucher with delivery challan.

• Verify mode of payment- cash or bank.

• Bills received immediately to be recorded properly.

• In some case companies adopt self-billing process to pay freight bills.

• Customers calculate their freight costs and instruct the freight forwarder to invoice using credit notes.

• If still auditor is unable to calculate because of software usage and no knowledge can ask for third

party experts.

• Customs duty –Tax imposed on imports and exports of goods, rates are either specific or based on

value of goods.

• If customs duty is directly paid, auditor should check receipt bill entry.

• Checking of monthly accounts and bill entry.

• To see that all charges are treated as capital or revenue items.

• Orders

• Accounting ledgers

• Bills of lading

• Airway bills

• Permits

• Invoices

• Contracts

• Packing list

• Correspondence

• Evidence of payment made or received.

Sources: Any document based upon which a financial transaction is recorded in books of accounts is

known as ‘source document’.

1. Cash memo

2. Cheques

3. Invoices and bills

4. Credit note

5. Debit note

6. Pay- in –slip

7. Receipt

8. Miscellaneous

Importance:

Vouching is the act of checking evidential documents to find out errors and frauds and to know the

authenticity, accuracy and reliability of books of accounts. Thus, it is important for an auditor due to

the following reasons:

1. Vouching Is the Backbone of Auditing

Main aim of auditing is to detect errors and frauds for proving the true and fairness of results presented

by income statement and balance sheet. Vouching is only the way of detecting all sorts of errors and

planned frauds. So, it is the backbone of auditing.

2. Vouching Is the Essence of Auditing

Auditing not only checks the accuracy of books of accounts but also checks whether the transactions

are related to business or not. All the transactions are performed after the prior approval of concerned

authority or not, transactions are real or not because an accountant may include fictitious transactions

to commit frauds. All these facts can be found with the help of vouching. So, vouching is essential for

auditing.

3. Vouching Is Important to See Whether Evidences Are Correct or Not

An auditor checks the books of accounts to detect errors and frauds. Frauds may be committed

presenting duplicate vouchers. All the small and big amounts of frauds can be detected with the help of

vouching. So, all the evidential documents and records are to be checked carefully and in detail by an

auditor which is the scope of vouching.

Therefore, it can be said that vouching is the heart of auditing because without the work of vouching,

the work of auditing cannot be performed.

UNIT-IV

VERIFICATION AND VALUATION OF ASSETS AND LIABILITIES

Meaning of Verification

Verification means proving the correctness. One of the main works of auditor is

verification of assets and liabilities. Verification is the act of assuring the

correctness of value of assets and liabilities, title and their existence in the

organization. An auditor should be satisfied himself about the actual existence of

assets and liabilities appearing in the balance sheet is correct. While verifying the

assets, an auditor should consider the following points:

* Ensuring the existence of assets.

* Acquiring the assets for business.

* Ensuring the proper valuation of assets.

* Ensuring that the assets are free from any charge.

Meaning of Valuation

Valuation is the act of determining the value of assets and critical examination of

these values on the basis of normally accepted accounting standard. Valuation of

assets is to be made by the authorized officer and the duty of auditor is to see

whether they have been properly valued or not. For ensuring the proper valuation,

auditor should obtain the certificates of professionals, approved values and other

competent persons. Auditor can rely upon the valuation of concerned officer but it

must be clearly stated in the report because an auditor is not a technical person.

An auditor should consider the following points regarding the assets while making

valuation off assets:

* Original cost

* Expected working life

* Wear and tear

* Scrap value

Audit of Land and Building Assets like land, building, etc. can be divided into two categories such as

1. Freehold Property, and

2. Leasehold Property.

Audit of Freehold Property – Verification

Procedure As land is a non-depreciable asset, it is better if it is shown

separately in the Balance Sheet. In other words, it should not be

shown along with buildings because building is a depreciable asset

whereas land is a non-depreciable asset. The verification procedure

is as follows:

1. The auditor should examine the title deeds in order to ensure

that they are in the name of the client.

2. In case the property is mortgaged, he should obtain a certificate

from the mortgagee or his solicitor to the effect that the title deeds

are in their possession. He should also enquire whether there is any

second or subsequent mortgage or not.

3. If it is purchased, correspondence and broker’s note should be

examined. If the purchase is effected through auction the

auctioneer’s account should be checked.

4. If the client has constructed the building, the auditor should

examine the certificates received from the builder, contractor,

architect and other necessary papers and documents.

5. If the building is a newly purchased one, the value of building can be

ascertained by vouching the amount paid to the contractor. If it is partly

constructed, by obtaining architect’s certificate, its value can be

determined.

6. If the client’s own staff members are also engaged in its construction,

the auditor should see that a reasonable basis of allocation of wages,

supervisor charges, etc. has been adopted.

2. Audit of Leasehold Property – Verification

procedure If the land or building is acquired by the business for a fixed duration on

lease, the property is said to be leasehold. Auditor should see that

separate accounts are maintained both for freehold and leasehold

properties.

The amount of premium paid in order to acquire the lease, the expenses

incurred on the improvement of the building, etc. should be capitalized

and written off over the life of the lease.

The royalty paid every year should be treated as revenue expenditure

and debited to the Profit & Loss Account. The cost of leasehold property

should be written off on straight line basis.

The auditor should take the following steps to verify the leasehold

property:

1. The auditor should inspect the lease agreement to find out value of the

property and its duration. He should see that the lease agreement is

registered with the Registrar and certificate testifying the validity of the

same has been obtained from the client’s legal advisor.

2. He should see that the terms and conditions of the lease are duly

complied with.

3. The annual charge for depreciation will be arrived at by dividing the

total cost by the term of the lease. The auditor should see whether

amount written off is sufficient to provide for depreciation at the end of

the term.

4. If the property is sub-let, the auditor should examine the agreement

entered into with the sub-lessee.

5. If the asset is of building, the tax paid, and repair expenses made for it

should be treated as operating expenditure. The auditor should see

whether they are treated so.

2. Plant and Machinery

A plant is an asset with a useful life of more than one year that is used in producing

revenues in a business’s operations. Plant is recorded at cost and depreciation is

reported during their useful life.

Auditor's Duty

1. When the machines are purchased in the current accounting period, the invoices

and the agreement with the vendors should be verified.

2. The auditor should ` examine the plant register in which particulars about the

cost, records about sales, provision for depreciation, etc., are available.

3. He should prepare a list of each machine from the plant register and should get

the list certified by the works manager as he is not a technical person and therefore

he has to depend upon the advice of the works manager regarding their valuation,

etc.

4. He should see that plant and machinery account is shown in the Balance Sheet at

cost less depreciation after making proper adjustment for purchases and sales

during the year under audit.

5. In case any plant and machinery has been scrapped, destroyed or sold, he

should ascertain that the profit or loss arising thereon has been correctly

determined.

3. Furniture, Fixtures and Fittings

They are items of movable equipment that are used to furnish an office. Examples

are chairs, desks, shelves, book cases, filing and other similar items.

Auditor's Duty

1. Verify Invoices: When assets have been acquired during the current accounting

period, the auditor should examine the purchase invoice of the dealers.

2. Verify Furniture Stock Register: He should verify furniture stock register and

ask the management to prepare an inventory to reconcile it with the stock register.

3. Verify Schedule of Previous Year: He should compare furniture schedule of

previous year with that of current year to ascertain the existence, purchase or sales

of asset during the year.

4. Disclosure of Profit or Loss on Sale: He should examine that any profit or loss

on sale of furniture during the year is properly disclosed in books of accounts.

VALUATION OF FIXED ASSETS

1. Valuation of Land: Land which does not have depreciated value, is valued at

cost price.

2. Valuation of Other Fixed Assets: Other fixed assets like Buildings, Plant,

machinery, office equipment, furniture and fixtures should be valued at going

concern value.

3. Depreciation: Auditor should ensure that adequate amount of depreciation has

been provided, taking into account the working life and usage of the asset.

4. Disclosure in Balance Sheet: He should verify that furniture, fittings and

fixtures are disclosed in Balance Sheet at cost less depreciation.

Verification and Valuation of Current Assets

We will now discuss the verification and valuation of a few important current assets, cash and bank balance and sundry debtors.

Cash-in-hand

Cash-in-hand is verified by actual counting of cash. Cash-in-hand should be verified at the close of the business or on the date of the balance sheet. Counting of cash must be done in the presence of cashier. If physically verification of cash is not feasible for an Auditor due to branch located abroad or in remote area, the Auditor should ask the cashier to deposit all his Cash-in-hand in bank account on the last date.

It is the primary duty of an Auditor to verify the cash-in-hand and in case of non verification, the Auditor will be held responsible for breach of his duty. If there is heavy cash balance in hand at any time, the Auditor should immediately inform the management beforehand.

If the cashier is made accountable for payment to employees or others, the Auditor should carefully verify the same.

Cash at Bank

The Auditor needs to consider the following points for verification of cash at bank −

• The Auditor should prepare a bank reconciliation of account as on date. With the help of it, the Auditor will clearly come to know the status about the cheque issued but not yet presented in the bank and cheques deposited in the bank but not yet cleared. There are many kinds of frauds which are detectable through preparation of bank reconciliation of account.

• The Auditor should obtain different certificates from banks for different types of accounts like current account, fixed deposit account, savings account, overdraft account or cash credit account, etc.

• The Auditor should obtain a letter of confirmation of bank balances directly from banks.

• The Auditor should compare the bank balance as per the bank book and the pass book.

• If payments are deposited in foreign banks under exchange control regulation it should be verified by the Auditor.

Sundry Debtors

The Auditor is concerned with obtaining sufficient audit evidence to corroborate the management’s assertion regarding the following −

• All amounts are recorded in respect of outstanding debtors as at date of Balance sheet.

• Valuation of debtors is appropriate and properly applied.

• That all the debtors are disclosed, classified and described in accordance with recognize accounting policies and practices.

The verification process of the debtors involves the following −

Examination of Records

• Auditor should satisfy himself about the validity, accuracy and recoverability of debtors’ balance.

• Excessive discount allowed or bad debts written off should be verified.

Direct Confirmation Procedure

• Direct communication with debtors is the best way to ascertain whether the balances are accurate, genuine and undisputed.

• Debtors from whom confirmation of balances is required, the method of requesting confirmation is to be determined by the Auditor.

• Confirmation procedure may be carried out within a reasonable period from the end of the year.

• Replies received from debtors should be carefully gone through and in case, where balances do not agree, client should be asked to investigate.

• The Auditor must pay special attention to those balances for which confirmation is not received. They might be fictitious or made to conceal a fraud.

Steps for Verification

• Book debts can be verified by the books of accounts and those should be supported by sale documents.

• Book balances should be sent to debtors directly for confirmation. It will establish the existence of book debts.

• Ownership of book debts can be verified with the sales documents and the sales ledger.

• Debtors should enquire about any type of dispute with customers about discount, claim etc.

Steps for Valuation

• Debtor’s ledger should be supported by sales ledger.

• Auditor should obtain list of book debts, bad debts written off and for provision for doubtful debts.

• Sundry debtors should be valued at realizable value.

• Confirmation of balances shows that valuation of debtors is correct.

Verification and Valuation of Liabilities

Let us now understand the verification and valuation of liabilities −

Trade Creditors

Auditor should take the following important steps for the verification and valuation of Trade Creditors −

• Auditor should collect schedule of creditors and that should tally with ledger balances.

• Purchase ledger should be checked and verified with purchase register, purchase invoices and debit notes etc.

• Auditor should verify the discount received or receivable from creditors.

• Auditor should minutely check the purchase of first month and last month of the financial year to avoid any possibility of booking purchases of current year to next year or last year purchase to current financial year.

• Auditor should pay special attention on any unpaid amount stands in ledger of creditor since long. It might be possible that amount has misappropriated by the any official and balance stands as it is in books of accounts.

• Confirmation of balances should be done directly by the Auditor and if there is any kind of discrepancy that might be sorted out.

• Auditor should carefully study the hire purchase agreement to verify the purchases made on the basis of Hire-Purchase.

Loans

The Auditor should verify the following important points for verification and valuation of Loans −

• The Auditor should verify the amount of loan, type of loan, rate of interest and repayment terms, etc.

• He should collect and examine the agreement and certificate from bank in case loan is granted by any Bank or financial institutions.

• He should obtain balance confirmation from party from whom loan is accepted by the organization other than bank.

• Interest calculation should be duly checked by the Auditor according to agreement.

• Amount of interest due but not paid during the current financial year should be duly accounted for in books of accounts and should be shown as current liabilities.

• In case of company, the Auditor examines the borrowing power, register of charges and created charge should be registered with the Registrar of Companies.

Stock

Goods are easily subject to misappropriation and manipulation. Very

often firms use stock in trade as one of the methods to inflate or deflate

profit by understating or overstating the value of stock.

Stock- in- trade – verification procedure

The audit procedure, which the auditor should follow while verifying the

stock-in-trade, is as follows:

1. The auditor should examine the internal check system in operation.

2. He should study and make himself familiar with the stock taking

system followed in the organization. He should also see whether the

system is proper.

3. He should check the Stock Sheets with the Stock Registers.

4. He should examine how the management controls the receipts and

issues of stock.

5. He should check the prices of stock with the help of catalogues,

invoices, and price lists.

6. He should check the totals, balances, and extensions of stock sheets.

7. He should get a copy of the physical stock taking instructions given

by the client beforehand and see whether they are proper and possess

adequate safeguards against possible errors or frauds.

8. If possible he can send one of his staff to observe the physical stock

taking.

9. He should see whether the job of stock sheet preparation is allotted to

a responsible official of the organization and also should insist that a

top-level executive like director should sign it.

10. If there is any alteration in stock sheet, he should see whether the

responsible official attests such alteration. Besides, he should also find

out the intention for such alteration.

11. He should test check some of the items of the stock with the stock

records with regard to their quantity and value. If there is any material

difference it must be enquired into.

12. He should test check the physical existence of at least 5% of the

items to determine whether records represent correctly the stock in hand.

13. He should see whether all the goods purchased during the year

included in the stock.

14. He should see whether all old, and damaged stocks have not been

included in the stock, and they have been written off.

Auditor's Duty in Valuation

Stock-in-trade is a Current Asset and the auditor should ensure that stock-in -trade

is valued at cost price or market price whichever is lower. The Institute of

Chartered Accountants of India Accounting Standards - 2 (AS 2) “Valuation of

Inventories” states that, stock of material is valued at cost or market price (Net

Realizable Value) whichever is lower on the date of Balance Sheet.

Verification of Bills Receivable by Auditor

1. The auditor should verify Bills Receivable Book with bills receivable

in hand for which he should call for a certified Schedule of bills in hand.

2. The totals of the Schedule should be checked by reference to the

accounts in the General Ledger.

3. He should examine each bill to see that it is properly drawn, signed by

the acceptor and is also properly stamped.

4. He should verify the bills met after the close of financial year but

before audit by vouching the cash received and entered in the Cash

Book.

5. Bills discounted should be examined by verifying the entries made in

the Cash Book with those in the Bills Receivable Book.

6. The auditor should see that a note for the contingent liability in

respect of bills discounted appears on the Balance Sheet.

In case bills deposited with a bank for safe custody or for security of a

loan, they should be verified with the help of a certificate obtained from

the concerned bank, in order to confirm their existence.

In case bills have been retired before the date of the Balance Sheet, the

proceeds received there from should be checked by reference to the Cash

Book.

FURNITURE & FIXTURES:

VERIFICATION:

1. It should be verified with the help of invoices obtained from the supplier as personal

inspection may not always be possible.

2. The auditor should check the furniture stock register, date of B/S and should check the balance

is shown clearly or not.

3. Expenditure incurred for obtaining for these assets should be capitalized freight and carriage

spent on bringing the furniture to the shop of factory should be charged to the furniture account

but not to profit and loss account.

4. Auditor should properly inspect the stock register maintained by the firm

VALUATION:

1. They are subject to heavier wear and tear and should adequately provide for.

2. The auditor should enquire into the methods of charging depreciation because amount of

depreciation will depend upon use of assets. For eg: furniture used in canteen, hotel or

cinema hall will require more depreciation than the furniture used in office.

3. The adequacy of depreciation on the furniture must be properly looked into by auditor

MOTOR LORRIES & VANS: Its account is to be separately maintained if the no. of vehicles

is very large, a separate register as plant register can be maintained.

VERIFICATION:

1. It should be verified with the help of the invoices from the suppliers

2. Vehicles should be inspected by the checking the registration number.

3. He should check certificate of registration, registered no. with particulars in ledger. He

should also checked insurance premium paid to ensure that all vehicles are insured.

4. Any addition made during the year should be scrutinized.

VALUATION:

1. These assets are valued at cost less depreciation.

2. The motor vehicles are written off over the mileage they are expected to run.

3. In case of carts and vans the auditor should allow depreciation at a lower rate.

4. He should see that expenditure on repairs have been charged to revenue account and not

added to their cost.

GOOD WILL: It has no physical existence. It is the value of reputation of firm. It appears as an

asset on balance sheet only when it is purchased. It is the difference between the total

purchase price less assets acquired when a company revalues its assets, when a partner is

admitted or retired or dies.

VERIFICATION:

1. G/W is brought into accounts books only when it is purchased for valuable

consideration.

2. When good will is purchased along with a running business the value should be

verified from the price paid for it.

3. The auditor should examine the purchase agreement or the partnership deed to

ascertain the cost of good will.

VALUATION:

1. The auditor should see that goodwill is never appreciated in the books of a company.

2. It is valued at cost less any amount written off.

3. The auditor should confirm himself that goodwill appearing in the balance sheet

has not been shown in excess of its cost price.

4. The value changes with the changes in the earning capacity, so the auditor should

be concerned with the fluctuations in its value.

PATENT: It is an official document which gives the investor exclusive right for years to make

or use or sell his invention. Examples –pen with scanner, articles, any new inventions.

VERIFICATION:

1. He should verify it with the help of certificate which grants patents rights and also

ensure that the patents are registered in the name of the client.

2. Original fee paid for purchase of patents must be capitalized. Renewal fees must be

treated as revenue expenditure and depreciation must be written off.

3. If no. of patents is large, Auditor can ask his client to prepare a list of details mentioning

dates of acquisition, registration no., and unexpired period

VALUATION:

1. Patents should be valued at cost less depreciation. Causes for depreciation are: a. Lapse of time b. Obsolescence c. The patented article going out of fashion

2. They should be written off over a period of 14 yrs. after which the

right automatically lapses

TRADE MARK: It is a distinctive mark attached to goods offered for sale in order to

distinguish them from other goods or identify them with a particular trader. They can

be in any form like symbols, letters, figures, logos, marks. Examples- airtel, mc

Donald’s, KFC, Nike… etc.

VERIFICATION:

1. It is verified by examining assignment deed duly endorsed by Registrar of Trade

Marks.

2. In case they have been purchased from others the auditor should vouch the

expenditure incurred in connection with acquisition like registration fee, payments

made to designers etc. VALUATION:

1. It should be seen that trade mark is properly valued and shown in the B/S. 2. Research expenses to be capitalized. 3. Differentiation to be made between capital and revenue expenditure.

COPYRIGHT: It is an exclusive right to produce or reproduce literary works. It is a legal

protection provided to author prohibiting other from publishing his work. The period of

work copyright is for lifetime of an author or 60 years after his death. Examples- music, graphics, dramas, poetry, novels, songs, movies, sculptural works. VERIFICATION:

1. The procedure is more or less same as patent rights 2. In verifying copyrights, auditors should inspect the agreement between the auditor

and the publisher. 3. If there are many copyrights with a business, the auditor should call for a schedule

from the client to verify them. VALUATION:

1. The value is not stable because copyrights lose their value by passage of time. 2. In the B/S copyright must be shown at cost less amounts written off from time

to time.

STOCK IN TRADE: The correct recording and auditing of stock or inventories are of paramount importance. It comprises the items such as stores and spare parts, loose tools, raw materials, scrap or by- products etc.

VERIFICATION:

1. If stock in trade is incorrectly recorded, v4rified or evaluated the result profit or loss for the period will be incorrect. It also affects the B/S and the net worth will present a wrong picture.

2. He should review and be familiar with the procedure and arrangements for the maintenance of stock records and find out discrepancy therein.

3. He should check how management controls the receipts and issues of stock and physical stock taking.

4. He should test check the physical existence of at least 5% of items to

ascertain whether records correctly represent the stock in trade.

5. He should ensure that no goods belonging to the client (goods sold on

consignment or sale or return basis) have been including in stock.

VALUATION: The valuation of stock is made on the basis of cost price or market price whichever is less. The valuation is of two methods:

1. Pick and choose method: it is also known as individual method. This method implies that we deal with each item of stock separately and find out the cost or market price, whichever is lower of each item.

2. Global method: under this method each item of stock is not taken separately. First the aggregate cost price of all articles and their aggregate market price is calculated. Then the lower of the two valuations becomes the basis for the valuation of stock.

TRADE DEBTORS (SUNDRY DEBTORS):

VERIFICATION:

1. Verification of the book debts involves detailed checking of the schedule of all

debtors with the ledger and statements of accounts received from debtors. 2. Balance of book debts should be sent to the debtors for their confirmation,

which will also establish the existence of book debts. 3. Existence of book debts can be verified by examining the books of account and

satisfying that entries therein are supported by proper documents. VALUATION:

1. The auditor should call for the lists of book debts and debts written off and arrive at the conclusion about adequacy of write off and provision for doubtful debts.

2. The confirmation of balances by debtors will help establish the valuation of book debts.

3. It should be ensured by the auditor that sundry debtors are valued only at realizable value,

BILLS RECEIVABLE:

VERIFICATION:

1. The auditor should examine the B/R book and prepare a schedule of all those B/R which have not yet matured before the date of preparation of B/S.

2. The auditor should get a detailed certificate from the bank to ascertain the clear position about the bills.

3. The bills which have been dishonored before the due date of the balance sheet should not be included in B/S.

4. The bills those are discounted or endorsed but remain outstanding at the time of audit any contingent liability in respect of such bills should be maintained as a foot note of the B/S.

VALUATION:

1. The auditor should see that the bills are properly drawn, stamped and duly accepted and they are not overdue.in case of renewal he should check new bill with old bill.

2. Sometimes the bills might have matured and honored subsequent to the date of the balance sheet, but prior to the date of audit the auditor should check the cash book.

3. If the bills have been retired before the date of balance sheet the proceeds thereof should be checked by reference to the cash book.

CASH IN HAND:

VERIFICATION:

1. The auditor should verify the cash in hand with the close of the business on the date of balance sheet.2

2. As far as cash in transit is concerned, the auditor should verify this balance with help of proper documentary evidences and correspondence.

VALUATION:

1. If the cash in hand is not in agreement with the balance as shown in the books, it should be the duty of the auditor to call for an explanation.

2. He should also check the system of making payments. 3. In case if cash is maintained at local branches the auditor can ask

bank manager to deposit the balance of cash on th balance sheet date.

CASH AT BANK:

VERIFICATION:

1. The auditor should compare the balances as shown in passbook with the balances of cash book.

2. He should prepare BRS or should check the statement prepared by the client in order to ascertain the correct bank balance.

3. He should obtain a balance confirmation certificate from the bank at the close of the year.

4. He should get separate certificates for FD account, current account and savings bank account from different banks to confirm total deposits in different banks.

VALUATION:

1. Any deposits in foreign banks under exchange control regulations the fact is to b disclosed.

2. Amounts are kept in different reserves account in the banks , in order to avail deductions under Income Tax act the fact should be disclosed.

3. In order to ascertain current position with regard to cheques issued but not yet presented or cheques deposited but not collected, the auditor should confirm through cash book and pass book figures.

VERIFCATION AND VALUATION OF LIABILITIES.

DEBENTURES:

1. The auditor should refer MOA and AOA in order to determine the extent borrowing power and to check power to issue debentures.

2. The auditor should verify the terms of prospectus complied with. 3. The auditor should examine a copy of the debenture bond to

ascertain th terms and conditions on which the debentures have been issued.

4. If the debentures are mortgaged debentures, the debenture trust deed

should be studied by the auditor. When issued at par but redeemable

at premium: Loss is charged to P/L account.

5. When they are issued at premium: Auditors should ensure

that the premium collected must be shown separately and not

utilized for distribution of dividends.

6. If issued at discount: They are shown at face value in Balance sheet

and deduct the amount of discount allowed.

7. If profit is made on redemption: It has to be transferred to capital reserve.

LOANS: A company can obtain loan from bank and other financial institutions based on the

credibility and security provided.

1. He should scrutinize the loan account in the ledger and documents relating to fixed assets.

2. The auditor should check whether the interest due has been paid or not. If the interest is

due but not paid till the date of B/S it should be shown as liability.

3. Secured and unsecured loans should be shown separately.

4. The auditor should check the MOA and AOA to examine its power of borrowing.

5. Loans should be verified with help of agreement with lenders and in case if loans or OD

is taken from bank, agreement with bank and certificate to the effect should be obtained

and examined.

TRADE CREDITORS (SUNDRY CREDITORS)

1. The balances should be verified with the purchase ledger balances

2. The purchase ledger should be checked with help of purchase invoices, credit notes,

Goods inward and outward books etc.

3. If the client maintains provision in respect of discount on creditors he should check the

same with reference to the creditors account.

4. If a debt is unpaid for a long period of time he should enquire whether there is a genuine

delay or is there any misappropriation of funds.

5. He should compare the % of gross profits earned with that of previous year to trace

omission of invoices if any.

BANK OVER DRAFT:

1. The auditor should examine the overdraft agreement with the bank in order to ascertain the terms and conditions of overdraft and maximum limit thereon

2. The auditor should check whether interest on OD has been duly accounted for.

3. He should get confirmation from bank in respect of amount of OD at the close of the year.

4. The MOA in case of a company should be examined to ascertain the borrowing power of the company and any limitations.

5. It is to be seen whether any security was offered for the OD in terms of agreement, depending on which the OD is to be classified as secured or unsecured.

Drawings: They are money or other assets taken out of a business. This might be by the owner or partner for personal use, or as dividends if the company has been made public.

1. Auditor has to check whether the MOA or AOA of the company permits for drawings by the partners/owners.

2. He has to verify the amount of drawings and check if interest on drawings is been received and how will be the amount reverted back by the person.

3. Bank statement to be verified. 4. Authorized person to issue drawings to be verified.

Provision for taxation:

1. Auditor should ascertain the tax liability. 2.Computation of assessable taxable income. 3.Check the computation of assessable P and L account. 4.Verify past completed assessment to know how the adjustments were made. 5.To verify Any advance tax paid 6.Verify proper IT returns are filed. 7.Obtain a certificate from tax practitioner 8.To check for overall provision. (provision for the year, advance tax paid, past provision made, assessment order, pending appeals, refunds)

Bills Payable: 1. The auditor should obtain a list of outstanding obligations on account of bills payable. This should be checked with the bills payable books and bills payable account and any variation b/w two should be reconciled. 2. with the permission of his client, the auditor should obtain should the statement 3. the bills paid after the balance sheet date should be verified with the entries passed in the cash book 4. he should ensure that the bills which have been paid are not recorded as outstanding

Valuation of liabilities:

Reserve fund method:

They are created to strengthen the financial position of balance sheet, raise working capital, to meet future contingencies or loss. Example- general reserve, capital reserve, contingency reserve.

1. Auditor has to verify the amount is transferred and debited to p&l appropriation account.

2. It is shown on liabilities of balance sheet separately. 3. To see that fund created to be used only for ear marked purpose only. 4. To see that amount invested in reserves is in easily realizable securities.

Difference b/w Verification & valuation

Verification and valuation are interlinked and interdependent. It is a combined process by which

the position of different assets appearing in the Balance Sheet is examined. Valuation and

verification of assets are complementary to each other. Until and unless the valuation of assets is

made, verification is impossible.

Particulars Verification Valuation

Meaning Verification means proving

the truth or confirmation

Valuation implies critical

examination and testing of

determined values of assets on

the basis of its utility during a

particular period.

Function It deals with assessment of the

genuineness of the ownership

title

It deals with only the

assessment of rightness of the

methods of valuation at which

different assets & liabilities

are valued

Scope It has broader concept which

includes among different

aspects, valuation is a part of

assets & liabilities

Valuation is a narrow concept

as compared to verification,

because it is only the part of

the whole process of

verification

Objective It is to ascertain whether the

assets & liabilities owned by

entity are correctly disclosed

in FS at the proper value.

It is to ensure that assets &

liabilities of an entity are

correctly valued by following

the prescribed norms of

competent authority.

Nature Nature of the work involves in

verification process is some

extent complicated as it

involves assessment of the

ownership as well as

possession of the assets by the

entity

It involves determines the

values of assets & liabilities as

per the prescribed norms &

guideline.

Term Verification is made at the end

of the year.

Valuation is made throughout

the year

Based upon Verification is based on

individual check.

Valuation is based on

evidence.

Interdependence Without proper valuation, the

verification process can’t be

completed. So , verification is

dependent on valuation

Valuation is a process which

facilitates proper verification

of A&L. without valuation ,

verification can’t be

completed

Services from other experts It doesn’t require services

from other expert by auditor

It requires services of other

experts because the auditor is

not a valuer in the true sense.

Certificate for the work Auditor is supposed to issue a

separate certificate for

verification of asset &

liabilities of an entity

If an experts service is sought

for the proper valuation of

assets & liabilities, the

concerned expert is supposed

to give a certificate for the

valuation he has done.

UNIT-V

Auditor Qualifications and Disqualifications

Qualifications--Section 226 of the Companies Act, prescribes the qualifications and

disqualifications of the company auditors. According to Section 226, “ A person shall not be

qualified as auditor of a company unless he is a Chartered Accountant within the Accountant can

be appointed as an auditor of a company.

A person shall be appointed as an auditor if he is Chartered Accountant within the meaning of

Chartered Accountants Act, 1949 and holding valid certificate of practice and acting in capacity

as

(a) Individual

(b) Partnership firm

(c) Limited liability partnership

Dis-qualifications--Sec 226 provides disqualifications of company auditor:

(1) A body corporate

(2) An officer or employee of the company

(3) Any partner or employee of the company

(4) A person who himself is relative to partners holding any security or interest in the

company.

The term relative as defined under the Companies Act,2013, means anyone who is related to

another as Hindu Undivided Family, husband or wife, father (incl. step father), mother (incl. step

mother), son (incl. step son) , son’s wife, daughter, daughter husband, brother(incl. step brother),

sister(incl. step sister).

Example--Mr. ‘P’ is a practicing chartered accountant and Mr.’Q’, the relative of Mr. ‘P’ is

holding securities of ABC co. having value of Rs. 90,000. Whether ‘P’ is qualified from being

appointed as an auditor of ‘ABC co.?

The relative of auditor may hold the securities of interest of Rs. 100,000 face value in the ABC

ltd.

In the present case, Mr.Q, relative of Mr.P an auditor is having securities of Rs.90,000. Face

value in the ABC co., therefore, Mr.P will not be disqualified to be appointed as an auditor of

ABC ltd.

(5) A person or firm, whether directly or indirectly has business relationship with the

company, or its subsidiary or holding or associate company.

(6) A person whose relative is a director or key managerial person.

(7) A person who has convicted by a court of an offence involving fraud and a period of 10

years.

Appointment of auditor in a company

Audit of Joint Stock Company is a statutory audit. Sec.224 of the Act deals with the

appointment of a company auditor.

(a) First auditor: - First auditor is appointed by directors within one month of its

registration. The first auditor holds office till the first annual general meeting is held. He

may or may not continue after the AGM. If he is to be removed at least 14 days’ notice

has to be given to him before the meeting. If the directors don’t appoint the first auditor

the shareholders may appoint him in their general meeting.

(b) Subsequent auditor: - According to Sec. 224 every subsequent auditor is appointed at

the Annual General Meeting(AGM). He holds office from the AGM in which he is

appointed until the next AGM. The auditor has to inform his acceptance or otherwise if

he doesn’t accept the offer the vacancy can be treated as neither as casual vacancy nor as

vacancy resignation. The company has to appoint a new auditor in AGM.

(c) Appointment by central government: - When the AGM fails to appoint an auditor the

central government may appoint an auditor within 7 days of being informed by the

company.

(d) Appointment by special resolution: - In case of companies where more than 25% of

capital is held by a nationalized bank, insurance company, government company or state

government etc; the auditor of such a company must be appointed by passing a special

resolution.

(e) Auditors of government companies: - Auditors of all government companies are

appointed by the central government on the advice of Comptroller and Auditor General

of India (C&AG). In such a case the report is to be submitted to C & AG.

(f) Appointment by company: Every company shall at each annual general meeting,

appoint auditors to hold office from conclusion of that meeting until the conclusion of

next annual general meeting. Within 7 days of appointment intimation given by company,

the auditor has to intimate registrar of companies within 30 days of the receipt from the

company about his acceptance or refusal of appointment.

(g) Reappointment of auditor: A retiring auditor may be reappointed at AGM by passing a

resolution.

Reappointment of a retiring auditor is not automatic. A resolution at the Annual General

Meeting is required.

However, a retiring auditor shall not be reappointed.

(a) When he doesn’t qualify for reappointment.

(b) When he is not interested or willingness to accept reappointment.

(c) When a resolution is passed in the AGM appointing some other auditor requires a

special resolution.

(d) When opted not to reappoint him.

(h) Appointment in case of casual vacancy: Casual vacancy arises for an auditor due to

disqualification, resignation, death etc; Any casual vacancy of the auditor must be

filled by the Board of Directors within 30 days. If the casual vacancy is on account of

a resignation of an auditor, then the appointment of the auditor must be approved at

an Extra-Ordinary General Meeting convened within 3 months of the

recommendation of the Board. Board of director may appoint an auditor to fill the

casual vacancy.

(1) Where there are more than one auditor, the remaining auditor may act as the auditor

during the vacancy period.

(2) Where the casual vacancy is due to resignation, the vacancy can be filled up only at a

Annual General Meeting.

(i) Appointment of Auditor by Special Resolution

In the case of companies mentioned below, appointment and reappointment of auditors at the

annual general meeting shall be made only after passing a special resolution.

1. A company in which not less than 25% of the subscribed share capital is held as on the date of

annual general meeting, jointly or singly, by,

a. a nationalized bank or a general insurance company or

b. any institution, financial or otherwise, established under State or Provincial Act, in which,

not less than 51% of the subscribed capital is held by the State Government or

c. a central Government or a state government or a company or a public financial institution.

Here, the following are to be noted:

1. Subscribed share capital includes preference share capital.

2. Special Resolution for the appointment of auditor is necessary even if a nationalized bank

holds shares of the company in its name as security for loans advanced by it.

. If any of the above mentioned companies fails to appoint the auditor by passing a special

resolution in its annual general body meeting, the Central Government has the power to appoint

the auditor of the company.

The term Public financial institution means

a. any institution constituted under any Central Act or

b. any institution in which not less than 51% of the paid up share capital is held or controlled

by the Central government

c. The official gazette of the Central government mentioning the names of the Public

Financial Institutions.

Removal of auditor--Section 140 of Companies Act deals about removal of auditor. The section

seeks to provide for the provisions for removal of auditor before the expiry of his term.

The Board of Directors of the company has no power to remove an auditor (individual/ firm)

appointed by the company in General Meeting before the expiry of the term. Removal only by

special resolution and previous approval of the Central Government. Here a long term

relationship is built for 5 years, since removal before 5 years would be considered as removal

before the expiry of his term. And for removal before the expiry of an auditor’s term requires

strict formalities to be followed.

Example: - M/S ABC &co.is an auditor of Tata ltd. Company wants to remove M/S ABC &co.

in dec.2017, company has to obtain previous approval of Central Government and also has to

follow other procedures prescribed under section 140.

(1) Company must disclose clearly indicating the grounds for removal of auditor.

(2) Whether the accounts have been qualified during last three years.

(3) Whether any civil or criminal proceedings are pending between the company and the

concerned officers.

(4) Whether any special notice has been received for removal of auditors.

(5) Whether all due audit fees has been paid to the concerned auditors.

(6) Details for other services been rendered by such auditors to the company.

(7) Whether there is any dispute with regard to the book of accounts in the possession of

auditors.

Rights of auditor

1. Right to Access to Books of Accounts

The auditor has a right of access to books of account, vouchers, and relevant documents of the

company at all times during his term of office. Therefore, the auditor can even pay a surprise

visit and check the entries in the books of accounts. But usually the auditor does not make such

visits.

2. Right to Obtain Information and Explanations

The auditor has a right to obtain whatever information or explanation he requires in performing

his duty. The person from whom the auditor requires such explanation must provide the same.

The person may be the Managing Director, Director, Manager or any other officer or employee.

If any information sought by the auditor is refused, he should report the matter to the members.

3. Right to make Suggestions to the Board

The auditor is also having a right to suggest suitable modifications in the method of accounting

followed by the management. The directors, if a suggestion is made, should comply with it. If

not, the auditor should report the same to the members. But he has no right to make any

alteration in the accounts of the company on his own accord.

4. Right to Visit Branches

The auditor is also entitled to visit the branches of the company. However, if a qualified auditor

audits the accounts of the branch, he can get copies of the accounts certified by the branch

auditor, and always has access over such documents. The auditor has no statutory right to visit

foreign branches.

5. Right to Receive Notice and Attend Meetings

The auditor has a right to receive all notices and communications relating to all general meetings

during his term. Even if the accounts audited by him are not discussed, the company should send

a notice to the auditor. The auditor is also entitled to attend the meetings. He can also speak at

the meeting if any clarification is needed from him.

6. Right to Sign the Audit Report

Only the auditor can sign the Auditor’s Report. If a firm is appointed, any partner practicing in

India can sign. The first auditor should sign and authenticate a particular part of the Statutory

Report. Besides he has a right to sign and authenticate any other document, which the Act

requires to furnish.

7. Right to Remuneration

He has a right to receive the remuneration fixed by the appointing authority. In the event of

winding up, he can also rank as a creditor for the amount due. However, he can claim the amount

only after completing the work fully and entirely.

8. Right to be Indemnified

The company under certain circumstances can take both civil and criminal proceedings against

the auditor. If legal action is taken against him, he will generally defend himself against the

proceedings. If the judgement goes to his favor or he is acquitted, the company should

compensate the loss incurred by him in defending the suit.

9. Right to take Legal and Technical Advice

The auditor has a right to take advice or opinion of legal and technical experts if there is a need

for it.

Duties of Auditor

Report to members [SEC. 227 (2)] - The auditor is required to make a report to the

members of the company on the following matters:

a. Whether in his opinion the Profit and Loss Account shows a `true and fair’ view of the profit

or loss.

b. Whether in his opinion the Balance Sheet is properly drawn up so as to show a `true and fair’

view of the state of affairs of the business.

c. Whether he has obtained all the information and explanations, which were necessary for the

purpose of audit.

d. Whether proper books of accounts as required by law have been maintained by the Company.

e. Whether the company’s Balance sheet and Profit and Loss Account are in agreement with

books of accounts and returns.

Duty as to inquiry [SEC.227 IA] - It is the duty of auditor to inquire on various points,

whether the loans and advances have been properly secured , whether any personal expenses

have been charged to revenue account to mis-utilise the funds of the company. The auditor is

also required to see whether any investments are sold by the concern at a price lower than the

purchase price.

Duty to sign report (SEC.229) - It is the duty, as well as right of the auditor to sign the

report prepared by him.

Duty as to certify statutory report [SEC. 165(4)] - After the statutory report has been

certified as correct by the required number of directors, the auditor of the company must certify

it as correct to the extent it relates to:

a. share allotted by the company;

b. cash received in respect of such shares;

c. receipts and payments of the company.

Duty to give a report upon the Prospectus (Section 56 (1) ).-The auditor is required to give

his report upon the Prospectus issued by an existing company. He should also give his report on

the assets, liabilities and Profit and Loss of such company.

Duty to assist the Investigators (Section 240 (v) (b))- In case the affairs of the company are

to be investigated, the auditor should assist the Investigators in every possible manner. He should

produce his working papers relating to audit when asked for by the Investigators.

Duty as to report voluntary winding up of company (sec 488(2))-Where a a company has

been wound up voluntarily then a required number of directors has to make a declaration as to its

solvency, such declaration will not have effect unless it is accompanied by a report of the auditor

relating to profit and loss account and the balance sheet.

Types of Audit

Special Audit--It is the type of audit assignment and normally done by internal auditor. Special

audit is done when there is problem in the organization like fraud or other special case. For

example, fraud took place in the payroll department and the concerned department raises this

issue to audit committee or board of director or sometime there is request from CEO to have

special audit on this area. Special audit is done by internal staff of entity.

Joint Audit-- Practice of appointing more than one auditor to conduct the audit of large entities.

Such auditors, known as Joint Auditors. Joint Auditors conduct audit jointly & report on the

financial Statements.

Example: Reliance Industries Limited has three auditors namely Chaturvedi & Shah, Deloitte

Haskins & Sells LLP, Rajendra & Co. These three audit firms conduct audit of Reliance

Industries Limited. So Above three audit firms are known as Joint Auditors. The concept of Joint

audit is very common in Nationalized banks. A typical joint audit has audit planning

performed jointly and fieldwork allocated to the auditors.

Branch Audit-- Sec 143(8) says that where a company has a branch office, the accounts of that

office shall be audited either by

• The company’s auditor; or

• Any other person, qualified to be and appointed as an auditor as per the provisions of the

Act to act as branch auditor under section 139.

• where the branch office is situated in a country outside India, the accounts of the branch

office shall be audited either by the company’s auditor or by an accountant or by any

other person duly qualified to act as an auditor of the accounts of the branch office in

accordance with the laws of that country and the duties and powers of the company’s

auditor with reference to the audit of the branch and the branch auditor, if any, shall be

such as may be prescribed.

• Duty of Branch Auditor is to prepare a report on the accounts of the branch examined by

him and send it to the statutory auditor of the company who shall deal with it in his report

in such manner as he considers necessary.

Audit Report

An audit report is a written opinion of an auditor regarding an entity's financial statements.

The report is written in a standard format, as mandated by generally accepted auditing

standards (GAAS).

GAAS requires or allows certain variations in the report, depending upon the circumstances

of the audit work in which the auditor engages. An audit report is an appraisal of a small

business’s complete financial status.

Completed by an independent accounting professional, this document covers a company’s assets

and liabilities, and presents the auditor’s educated assessment of the firm’s financial position and

future. Audit reports are required by law if a company is publicly traded or in an industry

regulated by the Securities and Exchange Commission (SEC).

Parts of Report

(1) Title:- An appropriate title such auditor’s report, helps the reader to identify the report

and to distinguish it from report issued by others.

(2) Addressee: - The report should be appropriately addressed like in the case of statutory

audit of a company, the report is addressed to the shareholders and in the case of special

audit it is addressed to the government.

(3) Identification of financial statements: - The financial statements can be identified by

including the name of the entity and the date and period covered by the financial

statements.

(4) Reference to auditing standards and practises: - Such a reference ensures the compliance

of the resolution of the Institute of Chartered Accountants of India and assures the readers

that the accounting and auditing standards have been complied with.

(5) Opinion on the financial statement: -The report should clearly state the auditor’s opinion

on the entity’s financial position and operational results, i.e the financial statements give

a true and fair view.

(6) Signing of audit report: - Section 229, of the Act lays down that, the persons appointed as

the auditor of the company, or a partner in the firm of auditors may sign the auditor’s

report, or may sign the auditor’s report, or any other document of the company required

by law to be signed or authenticated by the auditor.

(7) Address of the auditor: -. The auditor has to mention his details of address in the audit

report.

(8) Dating of the report: - An auditor’s report is issued on a date later that the end of the

period being reported on because it takes time for the books to be closed, financial

statements to be prepared and audit to be completed.

(9) Reading and inspection of auditor’s report: - Report of the auditor must be read before

the shareholders in general meeting and kept open for inspection of every member of the

company.

Types of report

Unqualified Opinion--Often called a clean opinion, an unqualified opinion is an audit report

that is issued when an auditor determines that each of the financial records provided by the small

business is free of any misrepresentations. In addition, an unqualified opinion indicates that the

financial records have been maintained in accordance with the standards known as Generally

Accepted Accounting Principles (GAAP). This is the best type of report a business can receive.

Typically, an unqualified report consists of a title that includes the word “independent.” This is

done to illustrate that it was prepared by an unbiased third party. The title is followed by the

main body. Made up of three paragraphs, the main body highlights the responsibilities of the

auditor, the purpose of the audit and the auditor’s findings. The auditor signs and dates the

document, including his address.

Qualified Opinion--In situations when a company’s financial records have not been maintained

in accordance with GAAP but no misrepresentations are identified, an auditor will issue a

qualified opinion. The writing of a qualified opinion is extremely similar to that of an unqualified

opinion. A qualified opinion, however, will include an additional paragraph that highlights the

reason why the audit report is not unqualified.

Adverse Opinion-- The worst type of financial report that can be issued to a business is an

adverse opinion. This indicates that the firm’s financial records do not conform to GAAP. In

addition, the financial records provided by the business have been grossly misrepresented.

Although this may occur by error, it is often an indication of fraud. When this type of report is

issued, a company must correct its financial statement and have it re-audited, as investors,

lenders and other requesting parties will generally not accept it.

Disclaimer of Opinion--On some occasions, an auditor is unable to complete an accurate audit

report. This may occur for a variety of reasons, such as an absence of appropriate financial

records. When this happens, the auditor issues a disclaimer of opinion, stating that an opinion of

the firm’s financial status could not be determined.

Computer Aided Tools and Techniques(CATT)

Computer-assisted audit techniques (CAATs) or computer-assisted audit tools and

techniques (CAATTs) is a growing field within the IT audit profession. CAATs is the practice

of using computers to automate the IT audit processes. CAATs normally includes using basic

office productivity software such as spreadsheet, word processors and text editing programs and

more advanced software packages involving use statistical analysis and business

intelligence tools. Now a day's these are becoming more popular throughout our profession,

these tools are being used throughout the industry to assist internal auditors in their search for

irregularities in data files, to help internal accounting departments with more detailed analysis

and to support the forensic accountant with extrapolating large amounts of data for further

analysis and fraud detection.

Applications of CATTs

• Tests of details of transactions and balances, for example , the use of audit software for

recalculating interest or the extraction of invoices over a certain value from computer

records.

• Analytical procedures, for example, identifying inconsistencies or significant

fluctuations.

• Test of general controls for example, testing the set up or configuration of the operating

systems or access procedures to the program libraries or by using code comparison

software to check that the programme in use is approved by the management.

• Sampling programs to extract data from audit testing.

• Tests of application controls for example, testing the function of the programmed control

and reperforming calculations performed by the entity's accounting systems.

CATTs Techniques: They fall into two categories:

----The first involves examinations of computerised data. Within this context data files

may hold either transaction data or standing data files. CATTs are not confined to

accounting data alone but also used for processing non-accounting files such as journals

or logs.

Two types of CATTs are commonly used for reviewing file data. They are

a) Data file interrogation

b) Embedded audit module

----The second one involves test controls within the system . you can judge how reliable

the controls are and how accurate the accounting and other records may be. Techniques

used to review and verify system controls are :

a) Test data

b) Integrated test facilities

c) Parallel simulation

d) Program code comparison

e) Program code review.

The first category are

Data file interrogation: It is about using audit software to review information held in

computer files and to use computer speed and reliability helps you to cope with the

massive volumes of data often involved. It includes

-selecting records that conform to particular criteria.

-printing selected records for detail examination.

-Printing totals and subtotals from an accounting file.

-reporting on file content by value bands.

-searching for duplicate transaction.

-searching for gaps in sequence.

-comparing the contents of two files.

-sorting and merging files.

Embedded Audit Modules-It's a technique that is generally used with computer

system that handles very high volumes of data. as name implies it's an audit

application that is permanently resident within the main processing system . it

examines each transaction as it enters the system . the audit log file is periodically

scanned , analysed and reports are printed for follow up.

Test Data- It is generally used to confirm the operation of a new or amended

program or programs that generate output that cannot be easily predicted or reconcile

with input, it can be used to test and verify

• input validation routine

• error detection capabilities

• processing logics and calculations

• the accuracy of reports

• any manual procedures surrounding the system

advantages of this technique are : it requires limited technical knowledge ;

usually fairly simple to operate ; helps the auditor learn how the system

operates.

Integrated test facilities- It is a technique that is sometimes used in auditing

complex application system. Provides an inbuilt testing facility through the creation

of dummy department within the normal accounting system . advantages are:

It allows regular comprehensive testing of live system ;

Testing can be unscheduled and unknown to other staff ;

Small operational costs are involved once it is set up;

It can be used for system testing and user training etc .

Parallel simulation application- the objective is to generate an independent program

to simulate part of an application.

for example : an auditor wants to prove that an interest calculation program works

properly but due to excessively high data volumes you are unable to do this easily ,

auditor may decide that to test real data he may use his own interest calculation

program . if an auditor uses simulation program against the same source data file that

is submitted to the operational interest calculation , he should obtain the same result .

since the program will only be concerned with one or two aspects of the operational

program it will usually be smaller and less complex.

Program code comparison- utility programs are available that will compare two

versions of a program and report differences between the two. this approach

sometimes used by configuration managers to compare programs returned after

amendment with the previous data held in definitive program libraries . configuration

managers carry out similar test but between definitive versions are those in actual use

. this activity is referred to as "configuration audit" .

Program code review-it involves a detail examination of program coding. It

generally involves fair degree of programming skills and a thorough knowledge of

program specification.