Auditing Introduction meaning objectives Dr Manish Dadhich Contents

Auditing: Introduction, meaning, objectives Dr. Manish Dadhich

Contents 1. 2. 3. 4. 5. 6. Introduction to Auditing Origin & Development of Auditing Meaning, Definition & Characteristics of Auditing Scope & Principles of Auditing Functions & Limitations of Auditing Objects of Auditing

Introduction Economic decisions in every society must be based upon the information available at the time the decision is made. Unreliable information cause inefficient use of resources to the detriment of the society and to the decision makers themselves. As society become more complex, there is an increase likelihood that unreliable information will be provided to decision makers.

Cont. There are several reasons for this: remoteness of information, voluminous data and the existence of complex exchange transactions. As a means of overcoming the problem of unreliable information, the decision-maker must develop a method of assuring him that the information is sufficiently reliable for these decisions. In doing this he must weigh the cost of obtaining more reliable information against the expected benefits.

Cont. A common way to obtain such reliable information is to have some type of verification (audit) performed by independent persons. The audited information is then used in the decision making process on the assumption that it is reasonably complete, accurate and unbiased.

Origin And Development The term audit is derived from the Latin term ‘audire, ’ which means to hear. In early days an auditor used to listen to the accounts read over by an accountant in order to check them. Auditing is as old as accounting. It was in use in all ancient countries such as Greece, Egypt, Rome, U. K. and India. The Vedas contain reference to accounts and auditing. Arthasashthra by Kautilya detailed rules for accounting and auditing of public finances.

Cont. Auditing evolved and grew rapidly after the industrial revolution in the 18 th century with the growth of the joint stock companies the ownership and management became separate. The shareholders who were the owners needed a report from an independent expert on the accounts of the company managed by the board of directors who were the employees. The original objective of auditing was to detect and prevent errors and frauds.

Development In India the companies Act 1913 made audit of company accounts compulsory. With the increase in the size of the companies and the volume of transactions the objective of audit shifted and audit was expected to ascertain whether the accounts were true and fair rather than detection of errors and frauds. Hence the emphasis was not on arithmetical accuracy but on a fair representation of the financial efforts the companies Act 1913 also prescribed for the first time the qualification of auditors.

Cont. The later developments in auditing pertain to the use of computers in accounting and auditing. In conclusion it can be said that auditing has come a long way from hearing of accounts to taking the help of computers to examine computerized accounts.

Meaning The general meaning of an audit is a planned and documented activity performed by qualified personnel to determine by investigation, examination, or evaluation of objective evidence, the adequacy and compliance with established procedures, or applicable documents, and the effectiveness of implementation.

Definition Simple Definition: “Audit is an examination of accounts & records which is carried out by vouching the evidences, supporting various transactions; by such an examination it is ascertained that the Balance Sheet gives a true & fair view of the state of affairs of business & the Profit & Loss Account gives a true & fair view of the profit or loss of business.

Cont. Spicer and Pegler: "Auditing is such an examination of books of accounts and vouchers of business, as will enable the auditors to satisfy himself that the balance sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and that the profit and loss account gives true and fair view of the profit/loss for the financial period, according to the best of information and explanation given to him and as shown by the books; and if not, in what respect he is not satisfied. "

Cont. Prof. L. R. Dicksee: “Auditing is an examination of accounting records undertaken with a view to establish whether they correctly and completely reflect the transactions to which they relate. ”

Characteristics of Auditing 1. Systematic & Scientific Procedure 2. Essential Documents are integral part 3. It is done with the help of vouchers, documents, information and explanations received from the authorities. 4. Undertaken by an Independent person or Body 5. Analytical approach

6. Art & Science Both Cont. 7. Verification of the results 8. The Auditor has to satisfy himself with the authenticity 9. Compliance 10. The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions and examine correspondence, Memorandum of Association and Articles of association etc. , in order to establish correctness of the books of accounts.

Scope of Auditing The scope of audit is increasing with the increase in the complexities of the business. It is said that long range objectives of an audit should be to serve as a guide to the management future decisions. Today most of the economic activities are largely conducted through public finance. The auditor has to see whether these larger funds are properly used. The scope of audit encompasses verification of accounts with a intention of giving opinion on its reliability. Hence it covers cost audit, management audit, social audit etc. It should be remembered that an auditor just expressed his opinion on the authenticity of the account. He has no power to take action against anybody, in this regard its said that “an auditor is a watch dog but not a blood hound”.

Cont. 1. Legal Requirements 2. Entity Aspects 3. Reliable Information 4. Proper Communication 5. Evaluation 6. Test 7. Comparison 8. Judgments 9. Work 10. Evidence 11. Misstatement

Accounting vs Auditing 17 Accounting Auditing 1. It’s a continuous process carried out throughout the year. 1. No prescribed qualification is required to be an accountant. 1. It’s a one time activity after the closure of accounting year. 2. He must be the member of Institute of Chartered Accountants of Pakistan to become an auditor. 1. An accountant is a employee of the 3. An auditor is an independent professional. company. 1. An accountant gets regular salary for his work. 1. Accounting is concerned with recording of business transactions systematically. 2. Accounting precedes, auditing. 4. He gets remuneration for his professional work. Audit fees. 5. Its concerned with verification of accounts prepared by the accountant. 6. Auditing succeeds accounting.

Qualities required in an Auditor � Professionally Competent : - It is a basic quality of an auditor. He must have a complete and thorough knowledge of the accountancy. To understand the accounting details he can apply his knowledge and skill. It is only possible if he has a sound background in accountancy and he is professionally competent. 2. Honest : It is also very important quality of an auditor. Justice Hindley says "An auditor must be honest. He must not certify what he does not believe to be true and he must take a reasonable care and skill before he believes that what he certifies is true. 3. Auditing : An auditor's knowledge of auditing must be upto date. He must know the techniques of auditing. He must have the knowledge of other subjects relating to auditing. 4. Accounting Knowledge : The auditor should be at home in all the management accounting cost accounting and general accounting.

Qualities required in an Auditor 5. Knowledge Of Business Law : 6. Knowledge Of Taxation Law : 7. Computer Expert : 8. Knowledge Of management System 9. Preparation Of Budget 10. Intelligent

Qualities required in an Auditor 11. Qualification : For a professional auditor it is necessary that he should be charted accountant. According to companies ordinance it is essential qualification for auditor. 12. Tactful : In a particular situation auditor should deal tactfully. He should ask the questions in such a manner that it does not show about his ignorance or weakness. 13. Maintain Secrecy : The auditors nature of work is confidential. He should maintain secrecy from others about the affairs of his client. 14. Patience : There should be a quality of patience in the auditor. Before signing on any paper he should check the evidence and then sign it. He never checks the papers in hurry. 15. Critical Attitude : It is also very essential quality of the auditor. He should examine the statements critically. He should ask the various questions from the client and try to find contradictions.

Qualities required in an Auditor 21 16. Bold And Courageous : Auditor should be bold and courageous person. He should not be influenced by any authority. He should possess the courage to face the difference of opinion between him and client on any issue. 17. Courteous : It is an important quality which the auditor should possess. His attitude towards the staff of client should be very humble and polite. He should also stress on his own staff to be courteous with the client. 18. Independent : The auditor should be impartial. He should not have such relations with the organization which may affect his independence. He should give his opinion independently. 19. Common Sense : The auditor must have the quality of common sense and judgement. He may be able to assess the value of depreciation and bad debts.

Principles of. Auditing 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Integrity, Objectivity and Independence Confidentiality Skill & Competence Responsibility of work performed by others Documentation Planning Audit Evidence Accounting system & Internal Control Audit Conclusions Audit Report

Functions of Auditing 1. Accounting control Audit is an instrument of accounting control. The truth and fairness of the accounting information is controlled and checked by auditing activities. 2. Safeguard Audit acts as a safeguard on behalf of the proprietor/s (whether an individual or a group of persons) against control, carelessness or fraud on the part of the proprietors’ agents or servants in the realisation and utilisation of his/their money and other assets.

Cont. 3. Assurance Audit assures on the proprietors’ behalf that the accounts maintained truly represent facts and expenditure has been incurred with due regularity and propriety. 4. Assessment Audit assesses the adequacy of the accounting system in order to ascertain its effectiveness in maintaining accounting records of an organization. 5. Review Audit carries out a review of the financial statements to know whether the accounting records are in agreement with those statements.

Cont. 6. Reporting tool Audit is a tool for reporting on the financial statements as required by the terms of the auditors’ appointment and in compliance with the relevant statutory obligations. 7. Practical subject Auditing is a practical subject. It is something that people do. How it is done today is a result of long history of marginal changes and responses to new commercial and legal developments over the centuries with the most rapid progress in the last few years.

Advantages of Auditing A. Businessman's point of view: 1. Detection of errors and frauds 2. Loan from banks 3. Proper valuation of investments 4. Proper valuation of assets 5. Government acceptance 6. Suggestions for improvement 7. Better Reputation 8. Uniformity in accounts B. Investor's point of view 1. Protects interest 2. Moral check 3. Builds reputation 4. Good security

Cont. C. Other Advantages 1. Audited account are detected as an authentic record of transaction. 2. Errors and frauds are detected and rectified. 3. It increases the morale of the staff and thus it prevents frauds and errors. 4. Because of his expertise the auditor may advise on various matters to his clients. 5. An auditor acts as a trustee of his shareholders. Hence he safeguards their financial interest. 6. For taxation purpose auditing of account is a must.

Cont. 7. In case of any claim is to be made from the insurance company only audited account should be submitted. 8. Even in case of partnership firm auditing of accounts helps in the settlement of claim at the time of retirement/death of a partner. 9. Auditor account helps in managerial decisions. 10. They are useful to secure loan at the of amalgamation, absorption, reconstruction etc. 11. Auditing safeguards the interest of owners, creditors, investors, and workers. 12. It is useful to take certain financial decisions like issuing of shares, payment of dividend etc.

Limitations of Auditing Truly speaking, an audit should have no limitations of its own. It is designed to protect the interest of all parties who are interested in the affairs of the business. If there be any shortcoming arising there from, it may be due to its narrow scope of application in its related field of operation and unextended definition of the concept. Auditing suffers from the following shortcomings: 1. Want of complete picture The audit may not give complete picture. If the accounts are prepared with the intention to defraud others, auditor may not be able to detect them.

Cont. 2. Problems of dependence: Sometimes the auditor has to depend on explanations, clarification and information from staff and the client. He may or may not get correct or complete information. 3. Post-mortem examination: Auditing is a post-mortem examination. There is no use of such examination when events have already been occurred. 4. Existence of errors in the audited accounts: It is not possible for the auditor in all cases, to check each and every transaction of an organization. As a result, there may be error in the audited accounts even after the checking by the auditor.

Cont. 5. Lack of expertise: Auditor has to seek opinion of experts on certain matters on which he may not have experts knowledge. The auditor has to depend upon such reports which may not always be correct. 6. Diversified situations: Auditing is considered to be a mechanical work. Auditors may not be in a position to frame audit programme, which can be followed in all situations. 7. Quality of the auditor: Success of audit depends on the sincerity with which the auditor has performed his duties. The same audit work can be done by two different auditors with difference in sincerity.

Cont. 8. Existence of defective policies The auditor can only report on the truth and fairness of the financial statements. But other defects, i. e. defects relating to management and control may not be possible to be covered by the auditor.

Objectives of Auditing Primary Objective Secondary Objective Varification of a/c Detection& Prevention of Errors Moral Check B/s shows true & fair state Detection& Prevention of Frauds Complaince of Co. 's Act P & L a/c showstrue & fair state Other Objectives to create trust in govt.

Objectives of Auditing. Auditors are basically concerned with verifying whether the account exhibit true and fair view of the business. The objectives of auditing depends upon the purpose of his appointment. � Primary Objective. �The primary objective of an auditor is to respect to the owners of his business expressing his opinion whether account exhibits true and fair view of the state of affairs of the business. It should be remembered that in case of a company, he reports to the shareholders who are the owners of the company and not the director. The auditor is also concerned with verifying how far the accounting system is successful in correctly recording transactions. He had to see whether accounts are prepared in accordance with recognized accounting policies and practices and as per statutory requirements.

Objectives � Secondary Objective: Detection and prevention of errors: Errors are mistakes committed unintentionally because of ignorance, carelessness. Errors are of many types: Errors of Omission: These are the errors which arise on account of transaction into being recorded in the books of accounts either wholly partially. If a transaction has been totally omitted it will not affect trial balance and hence it is more difficult to detect. On the other hand if a transaction is partially recorded, the trial balance will not agree and hence it can be easily detected. Errors of Commission: When incorrect entries are made in the books of accounts either wholly, partially such errors are known as errors of commission. Eg: wrong entries, wrong Calculations, postings, carry forwards etc such errors can be located while verifying.

Objectives Compensating Errors: when two/more mistakes are committed which counter balances each other. Such an error is know an Compensating Error. Eg: if the amount is wrongly debited by Rs 100 less and Wrongly Credited by Rs 100 such a mistake is known as compensating error. Error of Principle: These are the errors committed by not properly following the accounting principles. These arise mainly due to the lack of knowledge of accounting. Eg: Revenue expenditure may be treated as Capital Expenditure. Clerical Errors; A clerical error is one which arises on account of ignorance, carelessness, negligence etc.

ERRORS Errors are mistakes committed unintentionally because of ignorance, carelessness on the part of those responsible for the preparations of the accounts, while fraud involves some intention to gain out of manipulating records. . Types of Errors: Errors of Omission Errors of Commission Compensation Errors of Principles

Detection & Prevention of Errors Error of Omission Error of Commission Clerical Error • trasanction is to be left out to register, partial entry of one transaction • Rs. 1500 recorded as Rs. 5100 • ommission to post, posting wrong side & amount to an a/c, double posting, totalling mistake, balance b/d & c/f Error of Principle • fundamental principle of Accountancy & Auditing Compensating Error • two errors togather which will be resulted in trial balance sheet will agree

Detection & Prevention of Frauds Of Cash By Employees Misappropriation Of Goods Showing more Profits Manipulation of A/c Showing less profit By Top Management