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What is Auditing ? | Definition, Objectives, Advantages & Disadvantages

audit


What is Audit ?


Audit is performed to ascertain the validity and reliability of information. Examination of books of accounts with supporting vouchers and documents in order to detect and prevent error and fraud is the main function of auditing. The goal of an audit is to express an opinion on the financial or non-financial areas. Audit safeguards the financial interest of persons not associated with the management like partners or shareholders, acts as a moral check on the employees and prevents from committing fraud. However, due to constraints, an audit seeks to provide only reasonable assurance that the statements are free from material error. In case of financial audit, a set of financial statements are said to be true and fair when they are free of material misstatements. But recently, argument that auditing should go beyond just true and fair is gaining momentum in view of recent frauds by high profile organizations in connivance with the reputed audit firms.

Meaning of Auditing


Summary of Auditing :

Auditing implies the examination of books of accounts and related documents of an organisation in order to correctly estimate their accuracy, completeness and regularity. Such an examination is carried out by a competent and unbiased person with the help of evidences, documents, information and explanations given to him. For example, if a person goes to a doctor to have himself examined, the doctor, only after a thorough examination of his body, gives his report as to whether he is healthy or not, and if not, what is the ailment he is suffering from. 
In the same manner, a businessman gets his books of accounts examined by a doctor of books of accounts (i.e. the auditor) who, after a thorough examination of the books, gives his report as to whether or not they give a true and fair view of the state of affairs of the business, and not then what are the errors, deficiencies and faults in them.

Definition of Auditing by Different Authors


Lawrence R. Dickee :
"An audit is an examination of accounting records undertaken with a view to establishing whether they correctly and completely reflect the transactions to which they relate. In some instances it may be necessary to ascertain whether the transactions themselves are supported by authority".

Speicer and Pegler :
"An audit may be said to be such an examination of the books, accounts and vouchers of a business as will enable the auditor to satisfy that the Balance Sheet is properly drawn up so as to give a true and fair view of the state of affairs of the business, and whether the Profit and Loss Account gives a true and fair view of the profit or loss for the financial period according to the best of his information and the explanations given to him, as shown by the books, and U not, then in what respects he is not satisfied."

J.R. Batliboi :
"Auditing may be defined as an intelligent and critical scrutiny of the books of accounts of a business, with documents and vouchers from which they are written up, for the purpose of ascertaining whether the working result for a particular period as shown by the Profit and Loss Account, as also the exact financial condition of that business as reflected in the Balance Sheet are truly determined and presented by those responsible for their compilation."

Objectives of Auditing


The original object of an audit was principally to see whether the personnel involved in accounting had properly accounted for the receipts and payments of cash. In other words, the object of audit was to find out whether cash had been embezzled and if so, who embezzled it and what amount was involved. Thus, it was only an audit of cash book. But, at present, the main object of audit is to find out, after going through the books of accounts, whether the balance sheet and profit and loss account are properly drawn up accordingly and whether they represent a true and fair view of the state of the affairs of the concern. This is possible when he verifies the accounts and the statements. While performing his duties, the auditor has also to discover errors and frauds. There are two main objectives of auditing, Primary and Subsidiary Objectives of Auditing.

A) Primary Objective of Auditing : 


Expression of Independent Opinion on Accounts :
In auditing accounting data, the main concern is to determine whether the recorded information appropriately reflects the economic events that occurred during the accounting period. The dominant principle of audit is the examination of financial information produced by an accountable party with a View to reporting to the person to whom the information is rendered on its truth or otherwise. The Companies Act requires that the auditor of a company has to state in his audit report whether in his opinion the accounts disclose a "true and fair view" of the state of company's affairs or not. In technical terms, this is called expression of expert opinion. Therefore, the primary objective of an independent financial audit is to determine whether the financial statements present a factual and impartial view of the financial position and working results of an enterprise. 
The discovery of errors and frauds although appears to be the main object of audit, it is just an incidental object. In the Companies Act, nowhere the question of discovery of error and fraud in relation to the auditor's responsibility is discussed although his failure to discover manipulations, whether fraudulently or otherwise would normally render him liable for damages. When an undertaking whose accounts are being audited is target, greater reliance is to be placed on the accounting system in use for the detection and prevention of errors and frauds. Thus, the auditor resorts to test-checking technique to ascertain whether the accounting system adopted is reliable and how efficiently it was put to use. The auditor should also disclose in his audit report the adequacy and weaknesses, if any, of the accounting system so employed to record business transactions.

B) Secondary/ Subsidiary Objectives of Auditing


As discussed above, an auditor has to examine the books of account and relevant supporting documents with a view to express his opinion on the financial state of affairs of the company. During the process of such an examination of accounts, certain errors and frauds may be discovered. These can be discussed under the following two heads :

1) Detection and Prevention of Errors and Mistakes :
The term 'error' in accounting refers to an unintentional misstatement of financial statements. Errors and mistakes are of various kinds, which are discussed now.

A) kinds of Errors :
I) Clerical Errors :
These errors arise because of mistakes committed by the clerical staff in ordinary course of accounting work. These are of five types :

a) Errors of Omission :
These occur on account of transactions not being recorded in the books of account either wholly or partially. Detection of such errors is bit difficult, as they do not affect the arrangement of trial balance. However, a searching eye and a critical scrutiny of the accounts only can uncover such errors. For example, scrutiny of salaries account in the general ledger may indicate that salaries for only 11 months have been accounted for and the outstanding amount for the 12th month has not been provided for.

b) Errors of Commission :
These consist of incorrect additions, wrong postings and entries. Some of the examples of these are;
(i) Errors in additions carry forwards in the books of original entries or ledgers.
(ii) Errors or incorrect postings such as debit amount posted to credit, wrong amount posted to an account, an amount posted twice, omission to post an amount from a book of original entry to the ledger.
(iii) Errors in taking out balances of the ledger accounts. 
The above errors will affect the agreement of the trial balance. Checking the arithmetical accuracy of books of original entries and ledger and postings from the books of original entries to the ledgers may uncover such types of errors.

c) Compensating Errors :
These are the errors which counter-balance each other in such a manner that there remains no difference between two sides of the trial balance. For example, a cash sale of Rs. 1, 000 may be recorded in the cashbook, as Rs.100, whereas another cash sale of Rs. 100 may be recorded as Rs. 1,000. These errors would offset each other and, therefore, trial balance would still agree if these were the only errors. Checking of the arithmetical accuracy of books of account and postings would help detect such errors.

d) Errors of Duplication :
Errors of duplication arise when an entry in a book of original record has been made twice, or/and due to double posting of a journal entry in ledger accounts.

e) Trial Balance Errors :
These may consist of casting errors in the trial balance, omission of a balance while extracting balance from the books of account, or entering an amount incorrectly or on the wrong side. These errors can be spotted during routine checking.

II) Errors of Principle :
Errors of principle are those in which result from mis-application of or overlooking accounting principles. By and large, there are three types of errors generally considered to be errors of principle. These are :

a) Incorrect Allocation :
This occurs when the distinction between revenue and capital is not strictly maintained, e.g., capital expenditures charged to revenue and vice versa.

b) Omission of outstanding assets and liabilities :
These arise when prepayments are ignored and the amount charged from the profit and loss account and outstanding expenses in respect of rent, salaries, commission, etc. are ignored and not accounted for.

c) Incorrect valuation of assets :
This occurs when, for example, fixed assets are not valued at cost less depreciation; closing stock is not valued at cost or market price, and whichever is lower. An intelligent vouching and a complete verification (including checking of valuations) of the assets and liabilities can easily detect such errors. Other examples of errors of principle: Apart from the foregoing errors the following kinds of errors also fall in this category;
1) Excess or inadequate provision for depreciation
2) Excess or wrong provision for bad and doubtful debt
3) Over valuation or undervaluation of closing stock, etc.

B) Location of Errors :
To locate errors and discover the difference in the trial balance, the auditor should take the following steps :

I) Trial Balance Checking :
  • Check casts of the trial balance, lists of debtors and creditors.
  • Establish the amount of difference.
  • Check balances from personal and impersonal ledger into the trial balance.
  • While checking the balances, care must be taken to ensure that the closing balances are correctly entered in the right column.

II) Short-cut Method :
  • Look for an item of half that amount which might have been entered on the wrong side.
  • If the difference is divisible by nine, it may mean an error of transposition of figures (e.g., 69 written as 96 or 86 written as 68 etc.)
  • If the difference is a round figure, it is probable that the mistake has been made in totals of trial balance or carry forward of its figures.
  • If the difference is that of a large amount, it is advisable to compare the trial balance with the previous year's, in order to ascertain whether the figures under the different heads of account are very near to the same as those of the previous year, and whether the balances fall on the same side of the trial balance.
  • If the difference happens to be of an amount which constantly recurs in the books, all postings of this amount is to be checked.

III) Extensive Checking :
If all the above shortcuts do not result in locating the difference, the following work should be done :
  • Ascertain that all opening balances have been correctly brought forward in the current year's books.
  • Check casts, cross casts and carry forwards of the various books of original entries and ledgers.
  • If the ledgers were self-balancing, the work would be restricted to checking the balances, postings and casts of only that ledger the trial balance of which does not agree.
  • The Journal and subsidiary books should be scrutinized to see that the total debits and credits of each entry tally and there were no unticked items.
  • The postings from the various subsidiary books should then be checked into the impersonal ledger.

2) Detection and Prevention of Frauds :
The term fraud' may be defined as internal irregularities aimed at cheating or causing loss to another. Frauds are often committed by two or more persons, acting in collusion with one another. The auditor's responsibility for uncovering frauds deserves special mention. A fraud may take the following forms :

A) Misappropriations and Defalcations :

I) Embezzlement of Cash :
Embezzlement of cash refers to falsification or misappropriation of cash, which is very common especially in case of big business concern, as the proprietor has very little control over the receipts and payments of cash. Cash may be misappropriated in a number of ways as follows :
a) By omitting to enter receipts.
b) By entering fictitious payment :
i) Under-casting the receipt side of cashbook by entering fewer amounts than what has been actually received
ii) Overcasting the payment side of the cashbook by entering excess amount.
In order to detect such fraud of misappropriation of cash, the auditor should check the cashbook with original records, counter foils of receipt book, bills register, salesmen's report, invoices, wage sheets, salary book, vouchers, etc. In a big business enterprise strict control should be exercised over the receipts and payments of cash. Such control can be exercised through a system, devised specifically for the purpose, known as internal check system.

II) Misappropriation of goods :
Further, fraud may also be committed through misappropriation of goods. It is very difficult to detect misappropriation of goods, which is very common especially when goods are not bulky and are of higher value, such detention can be possible only if proper records of stock inward and outward are maintained. Only accurate stock recording through proper accounting for purchases and sales and periodical checking of stock can minimize the possibility of such misappropriation.

B) Misrepresentation of Accounts :
Misrepresentation of accounts refers to Fraudulent Manipulation or Falsification of Accounts. With a view to conceal the true picture and to reveal the distorted picture, the accounts of a firm may be falsified or manipulated by making false entries. This type of fraud usually involves very large amount and cannot be detected easily by the auditors because it is usually committed by those responsible persons who are in top management, viz., directors, managers, etc. Accounts can bee falsified or manipulated by various means. Some of the tools or devices adopted for this purpose may be mentioned as under :
  • Undervaluation and overvaluation of closing stock and other assets.
  • Overvaluation and undervaluation of liabilities.
  • Creating excess or less provision for depreciation or not providing for depreciation.
  • Charging capital expenditure to revenue and vice versa.
  • Providing for excess or less doubtful debts.
  • Writing off excess or less bad debt.
Basically there are two different objects behind the manipulation of accounts done through the above-mentioned devices. Firstly, showing more profit than the actual ones so as to earn more commission on profits when payable on the basis of performance and to win the confidence of shareholders by claiming that the firm is able to generate high profit under their leadership. 
Secondly, showing less profit than the actual ones so as to mislead income tax authorities and to buy-back shares in the open market at lower price besides cheating shareholders by declaring less dividend and to conceal the true position of state of affairs of the business. It must be noted that by adopting the above-mentioned devices, accounts would either reveal much better financial position or disclose worse financial position than actual ones. The former is technically known as Window Dressing and latter is referred to as Secret Reserves. A brief description of both is given as follows :

a) Window Dressing :
When accounts are prepared in such a manner that they seem to indicate a much better and sound financial position of the business enterprise, it is known as window dressing'. The principal objectives behind window dressing are as follows :
  • To attract potential investors to subscribe for the shares in order to procure further capital.
  • To obtain further credit.
  • To enjoy better reputation in the market by showing more sound financial position than in actual term.
  • To win the confidence of shareholders.
  • To raise the price of shares (i.e., artificially) in the market by paying higher dividend
b) Secret Reserves :
When accounts are prepared in such a manner that they seem to disclose worse financial position of the company than actual ones,t is known as "Secret Reserves"? Thus the real picture of the business is concealed and a distorted picture is revealed. The main objectives behind showing less profit than actual ones are :
  • To avoid or reduce income tax liability.
  • To buy back shares from the open market through reducing the price of shares by paying less or no dividend.
  • To conceal the true position of company's state of affairs from the competitors.
On the basis of above discussion, it can be concluded that auditing has the principal objective of seeing whether or not the financial statements exhibit a true and fair view of state of affairs of a firm's business and reporting accordingly, Detection of errors and frauds and making recommendations so as to prevent their re-occurrence is incidental and secondary objective of auditing but by no means less significant as compared to the former.

C) Specific Objectives of Auditing


From the analysis of various definitions given by the distinguished authorities on the subject and latest developments in the field of auditing. it should be clear that the term audit should not be confined to financial audit alone. The area of operation of audit is quite wide and such other areas like review of cost, operations, efficiency, management, and tax liability, etc. fall under the purview of audit. Accordingly, there will be specific objectives in respect of each type of such specified audit. For example, in cost audit this is concerned with verification of cost records and examination of cost accounting procedures, the object of audit is to verify the truth, accuracy and fairness of costing data and to serve as an effective tool of cost control. Similarly, in a management audit, the aim of audit shall be to promote the efficiency of managerial functions and to enhance the operational efficiency besides identifying areas of weaknesses in internal control. Thus, depending upon the nature and subject matter of specific audit, specific and different objectives in respect of each specific audit is required.

What are the Advantages and Disadvantages of Auditing ?


Advantages / Importance of Auditing


In today's age when businesses and industries are operating on such a large scale, it is obvious that the importance of audit has increased. With the increase in capital invested in business and industry, and the separation in ownership and management, the need of audit has come out even more clearly. Every external party, whether he is a lender, or a income tax or sales tax officer, or a perspective buyer of the business, considers audited accounts to be more reliable than unaudited ones. Apart from this, audited accounts are also better acknowledged by courts as evidence as compared to unaudited accounts, and are also helpful in obtaining licence. Hence, all big business whether they are sole proprietorship concerns or partnership firms, get their accounts audited. The audit of the accounts of a company has been made mandatory by law. In business, auditing is equally important for every kind of business, and that is why even those businessmen for whom it is not compulsory to get their accounts audited, are getting their accounts audited. The following advantages of auditing notes must be kept in mind 

1) General Advantages

The general advantages of auditing are as follows :

a) Knowledge of the Actual Position of the Business :
Through an audit the actual position of the business comes to light. The owners of the business are assured that the results being shown by the Profit and Loss Account and Balance Sheet are correct.

b) Detection of Frauds and Errors :
During the examination of accounts in the course of the audit, the frauds and errors contained therein also come to light. This also reduces the chances of frauds and errors being committed in the future.

c) Moral Pressure on Employees :
When the employees are aware of the fact that their work is going to be examined by an independent person, there is an indirect fear among them, and they do their work with much greater regularity, competency and caution. They do not have to do anything wrong or be negligent. As a result of this the possibilities of frauds and errors being committed are also reduced.

d) Alertness among Employees and Management :
Audit makes the employees and the management more alert as it results in healthy criticism of their work. The employees become more disciplined and adopt better policies and procedures.
Work gets completed as per schedule. The control exercised through the audit also helps in reducing corruption and judging the honesty and capability of employees.

e) Proper Valuation of Business :
If any business is to be sold or in case a firm is to be converted into a company, then audited accounts are helpful in proper valuation of the business and the valuation of goodwill. In fact, audited accounts are considered more dependable than unaudited ones.

f) Increase in Goodwill :
Public puts greater faith in accounts of organisations who get their accounts audited, which enhances the goodwill of the business. The increase in goodwill makes it very easy for the organisation to obtain loans from banks and other financial institutions.

g) Helpful in Receiving Compensation :
In case of accidents such as fire, theft, etc., audited accounts are more helpful in receiving compensation from insurance companies.

h) Helpful in Assessment of Tax :
Assessment of tax is much easier on the basis of audited accounts otherwise officers usually define tax liability arbitrarily. Hence, audited accounts are helpful in preventing arbitrary assessment of tax.

i) Helpful In Getting Declared as insolvent :
When the state of the business becomes so bad, that its liabilities exceed its assets, then the businessmen often wants to be declared ass insolvent so that he may be relieved of his liabilities. In such cases, the description provided by audited accounts serves as better evidence in courts.

j) Helpful in Formulating Dividend and Bonus Plan :
The audit of accounts certifies the truthfulness of the Profit and Loss Account, and as a result it becomes easier to declare and distribute dividends as well as proper disbursement of bonus is facilitated. This is because the shareholders and the workers consider the audited accounts as correct and have faith in them.

k) Availability of Valuable Suggestions :
The auditor from time to time keeps on giving suggestion to his client regarding book-keeping and accountancy, so as to prevent frauds and errors. Apart from this, the suggestions of the auditor are also useful in other business matters.

2) Advantages to Various Organisations 


A) To Sole Proprietorship Concerns :
Apart from the above benefits, audit has the following advantages in case of a sole proprietorship concern :

a) Proof In Court :
If in any business dispute any fact is to be established through the books of accounts, then audited accounts can be produced as evidence in courts. The former Chief Justice of India, M. Hedayatullah, observed, "When accounts certified by an auditor are produced in court, then the judge is assured that the accounts are true."

b) Helpful In Conversion of Business into Partnership :
in case a sole proprietor wants to convert his business into a partnership firm, i.e. wants to take in another person as a partner in his business or himself wants to become a partner in another firm, then audited accounts prove very helpful.

c) Comparative Study Possible :
In case the accounts for a number of years need to be compared, on the basis of the audit reports of the said years the accounts of one year can be compared with those of another. This makes a comparative study of profits and losses or income and expenditure possible.

d) Helpful in Assessment of Wealth Tax :
If the sole proprietor has a lot of assets, and upon his death taxes are to be paid upon his wealth, audited accounts prove very helpful.

e) Helpful In Assessment of Income Tax and Sales Tex :
While determining the liability for income tax and sales tax the concerned officers lay much greater reliance upon audited accounts.

B) To Partnership Firms :
Apart from the above described general advantages, audit has the following advantages In case of a partnership firm:

a) Mutual Confidence among Parties :
Normally, all the partners do not participate in the day-to- day running of the business of the firm. If the accounts of the partnership firm have been audited, it helps in building mutual confidence among the partners. In case the firm also has sleeping partners, the audit of the accounts of the firm becomes even more necessary since the sleeping partners do not have complete information about the business of the firm. Hence, audited accounts reduce the chances of disputes at the time of division of profits among the partners, and the work of the firm can proceed without any hindrance.

b) Helpful in Valuation of Business and Goodwill:
in case of admitting a new partner into the business of the firm, or at the time of retirement or death of a partner, the valuation of the business, and the valuation of its assets and liabilities and the goodwill of the firm, is greatly facilitated if the accounts have been audited.

c) Peaceful Settlement of Accounts :
At the time of dissolution of the firm, the assets and liabilities of the firm can be divided among the partners in a peaceful manner on the basis of audited accounts.

C) To a Joint Stock Company :
The advantages of audit to a joint stock company, apart from the general advantages mentioned above, are as follows :

a) Confidence among Shareholders in Management :
A company has a system of representative management. The management of the company is in the hands of a few selected shareholders (the directors). The remaining shareholders do not participate in the management of the company. Hence, the managers of the company with the help of getting the accounts audited assure the shareholders that they have been working properly and that they have not misused their position in the company in any manner.

b) Easy Availability of Investment :
A company accumulates capital by issuing shares and debentures to the public. The public has faith on audited accounts and it is on the basis of the same that it invests capital in the company.

c) Helpful in Declaration of Dividends :
Since audit certifies the profits of the company, hence at the time of declaration and distribution of dividends no suspicious are aroused. The auditor certifies in his report that the dividend has been declared and distributed at an appropriate rate.

d) Facilitates Amalgamation, Absorption and Reconstruction of Companies :
When ever, companies are amalgamated, absorbed or reconstructed, then deciding the purchase consideration is greatly facilitated by audited accounts. in such situations, audited accounts are considered to be more reliable.

D) To Other Parties :
Audit has the following advantages for other parties :

a) When any property is placed in a trust for the benefit of a particular person then the trustee, in order to present in front of others that he has done the work of the trust honestly, gets the accounts of the trust audited.

b) Audited accounts of a business are helpful for an insurance company when the amount of loss is to be estimated in case of a fire. The insurance companies on the basis of the audited accounts of the organisation can find out whether the claim tiled by the organisation is correct or not. This becomes very difficult in case the accounts have not been audited.

c) Banks and other money lending institutions can take decisions as to whether or not to lend money to a particular organisation on the basis of audited accounts.

d) If any external person wants to purchase an organisation, then audited accounts are very helpful in deciding the purchase consideration. In case the accounts have been audited and certified they serve as a basis for the purchasers to decide upon the purchase consideration.

e) Audited accounts are very helpful for government employees. While levying sales tax, income tax, wealth tax and expenditure tax.

f) The court, in any case, can also rely upon audited accounts as evidence. One can present one's case better in front of courts by presenting audited accounts as evidence.

Disadvantages / Limitations of Audit 


The work of the auditor is to certify the accounts prepared by the client or his employees. He is appointed in order to examine the books of accounts and to certify as to whether they have been prepared as per rules and regulations and that the Profit and Loss Account and the Balance Sheet depict a true and fair view of the financial position of the business. Hence, if the auditor is satisfied as to the Profit and Loss Account and Balance Sheet of an organisation and during the course of the audit does not come across anything to the adverse, and then he certifies the fairness and correctness off the Profit and Loss Account and the Balance Sheet. Despite the exercise of utmost diligence, caution and competence on the part of the auditor, some frauds and errors in the books of accounts may escape getting detected Hence, before reaching any conclusions on the basis of the auditor's report, the following disadvantages of auditing notes must be kept in mind :

1) Auditing Is not a Conclusive Proof of the Honesty of Employees :
if the organisation has a system of internal check in place, and the auditor is satisfied with the working of the same, then he may certify the accuracy; of the accounts by resorting to test checking. In a system of internal check also, two or more people can team up and commit fraud, and such frauds may not come to light during the audit. Hence, getting the accounts audited doesn't certify that the employees of the organisation have worked honestly throughout the period under review.

2) Auditing Doesn't Guarantee Cent-Per-Cent Accuracy :
Normally, large organisations have a very large number of transactions during the financial year. Hence, it is not possible for the auditor to examine each and every transaction in detail, nor is it viable in terms of wastage of time, effort and money. In such cases the auditor resorts to test checking and hence it is only natural that some frauds and errors may remain undetected.

3) Minor Things are not Paid Attention :
The auditor, during the course of his examination, gives full attention only to matters related to Profit and Loss Account and Balance Sheet. He does not pay much attention to small transactions or transactions entered into by the lower staff of the organisation. Hence, it is possible that a few irregularities may remain undetected at the lower levels, despite the audit.

4) Certain Frauds May Remain Undetected :
Despite the exercise of due diligence, competency and efficiency on the part of the auditor, intentional and pre-planned frauds committed by the top managers or other responsible employees of the organisation may escape getting detected.

5) Auditor does not Understand the Nature of all Business Transactions :
Even though the auditor examines the accounts of organisation in a variety of fields, it is not necessary for him to understand the nature of each and every transaction. Hence, it is not possible for the auditor to certify as to whether a particular transaction makes business sense or not. During the course of audit, transactions are examined from the legal point of view and not from the point of view of appropriateness.

6) Auditor Merely Expresses his Opinion :
The auditor merely expresses his opinion on the accounts of the organisation. By his expressing his opinion that the Profit and Loss Account and Balance Sheet are correct does not mean that there can be no irregularity in the books of accounts. Even though he gives his opinion after due examination, he is also human, and human beings make mistakes.

7) Auditor Does not Enjoy Practical Freedom :
Even though an auditor is considered to be an independent person, since his rights, duties and responsibilities have been specified by the Companies Act, 1956, in practice, the managers of the company always appoint their own persons as the auditors of the company. The auditor is influenced by the management of the company, and hence is not able to conduct a completely independent examination of the books of accounts and gives his report on the same.

Principles of Auditing


The institute of Chartered Accountants of India (ICAI) has laid down the basic principles which govern an audit [SA 200; erstwhile: AAS-1]. Basic principles of audit guide an auditor as to how to conduct am audit and give an audit report. These basic principles govern the auditor's professional responsibilities and must be observed whenever an audit is carried out. 9 Fundamental Principles of Auditing are as follows :

1) Integrity, Objectivity & Independence :
a) Auditor should be straightforward, honest and sincere in his professional work.
b) He should be fair and must not be biased.
c) He should maintain impartiality. He should be free of any interest.

2) Confidentiality :
a) He should maintain confidentiality of information acquired during his work.
b) He should not disclose any such information to a third party without specific permission of client or legal or professional duty to disclose.

3) Skill & Competence :
a) He should perform work with due professional care.
b) Audit should be performed by persons having adequate training, experience and competence.

4) Work Performed by Others :
a) The auditor can delegate work to assistants or use work performed by other auditors and experts.
b) But he will continue to be responsible for his opinion on financial information.
c) The Auditor is entitled to rely on work performed by others, provided:
i) He exercises adequate skills and care.
ii) There is nothing to doubt.

5) Documentation :
a) He should document matters relating to the audit (maintain working papers).
b) Working papers are maintained to demonstrate that the audit was carried out in accordance with the basic principles.

6) Planning :
a) He should plan his work to conduct audit in effective and timely manner.
b) Plans should be based on knowledge of the client's business.
c) Plans should be further developed and revised during audit if circumstances require so.

7) Audit Evidence :
a) Auditor should obtain sufficient and appropriate audit evidence by performing compliance and substantive procedures.
b) Evidences enable the auditor to draw reasonable conclusion.
c) Compliance procedures mean the sets designed to obtain reasonable assurance that internal controls have been properly designed & operating effectively throughout the year.
d) Substantive Procedures are performed to obtain evidence as to the completeness, accuracy and validity of data produced by the accounting system.

8) Accounting System & Internal Control :
a) Internal control system ensures that the accounting system is adequate and that all the accounting information has been duly recorded.
b) The auditor should understand the accounting system and related internal controls adopted by the management.
c) He should study and evaluate internal controls system to determine the nature, timing and extent of other audit procedures.

9) Audit Conclusions & Reporting :
a) The auditor should review and assess the conclusions drawn from the audit evidences obtained through performance of procedures.
b) The audit report should contain clear written expression of opinion on the financial statements.
c) His report is on whether :
i) The financial information has been prepared using acceptable accounting policies which have been consistently applied;
ii) The financial information complies with relevant regulation and statutory requirements, and
iii) There is adequate disclosure of all material matters.
d) The report should be as per legal requirement. When other than clean opinion is given, the audit report should state the reasons thereof.

Basic Concepts of Auditing


The basic concepts of auditing serve as the background to auditing. As per Martz and Sharaf, the following are the basic concepts of auditing:

1) Independence :
The auditor should be completely free of any pressure from the management and should do his work competently and with a free mind. He should examine the accounts and documents without any personal bias and in an impartial way; while conducting the examination he should neither neither favor nor be biased against anybody.

2) Evidence :
Evidence is the foundation of auditing. The auditor does his work and examines and certifies the books of accounts only on the buts of evidence produced before him. Hence evidence should be correct, sufficient and reliable. Usually, evidences are derived from the vouchers and other documents relating to the accounts. Apart from these, an auditor can also assimilate appropriate and sufficient evidence through inquiry, observation and explanation.

3) Due Audit Care :
While performing the work of auditing the auditor should always be on the alert and should exercise due diligence in order to detect frauds and errors. Hence, the auditor is expected to display proper competence, caution and alertness while doing his work. This concept is the yardstick for measuring the work of the auditor and serves as a guide to him in dispensing his duties.

4) Ethical Conduct :
Like other professions, auditing also has its own code of conduct which contains rules for its practice. Hence, every auditor should adhere to the code of conduct so that he cannot be held guilty of professional misconduct. In this way the code of conduct protects the people in the auditing profession against moral turpitude and misconduct towards each other.

5) Fair Presentation :
This includes the following concepts :

a) Accounting Propriety :
This implies that the financial statements have been prepared according to the universal concepts of accounting and that they depict a true and fair view of the financial position of the business.

b) Adequate disclosure :
This implies that the financial statements and the auditor's report provide complete and correct information about the financial situation of the organisation to the owners as well as other parties.

c) Audit Obligation :
This implies to the actual responsibility of the auditor towards his client and his implied responsibility towards other parties. The auditor is responsible and answerable only to the client, but his work and report is also used by other people, and hence, he should present his views appropriately, so that there is no ambiguity in deriving any conclusions on the basis of his report.

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