Audit Process

A) Basic Preparations

Audit Plan
The auditor should so plan his work that audit work may be conducted in an effective and
efficient manner. The plan should be based on the clients' accounting system, policies and
control procedures, the extent of reliance to be placed on the internal control system, and proper
coordination of work. The auditor should determine what work is to be done, how it is to be
done, when it is to be done, by whom it is to be done.
Preliminary arrangements in respect of a new audit will necessarily be more elaborate than in the
case of a repeat audit. In a new audit, the auditor is required to seek information and secure the
client's confirmation in regard to many matters such as purpose of audit, nature of examination,
period to be covered, nature of the business, organisation structure, key personnel, condition of
records, and the place of work. As against this, in a repeat audit, there will be many papers and
records from the previous audit to help in the planning of the current audit. In fact, the work may
continue based on old audit programmes unless any new situation has arisen to warrant a
modification.
An audit plan is a brain child of wisdom, foresight, professional knowledge, previous experience,
knowledge about the industry, knowledge about the entity, its management and the operating
system.

Steps in Audit Planning

1) Terms of Engagement and any Statutory Responsibilities: These would be specified
in the letter of appointment/engagement and/or in the relevant statutory provisions, if any.
The audit plan should be such that the auditor can discharge his responsibilities in an
effective manner. For example, in the case of an independent financial audit, the auditor
must primarily report whether the financial statements present a true and fair view of the
financial position and working results. However, in the case of independent financial
audit of companies in India, the auditor has also to give a detailed report on certain other
matters specified by the Companies Act. Obviously, such a requirement has an impact on
the scope of work of the auditor and should be considered while developing the overall
audit plan.

2) Nature and Timing of Reports or Other Communications: What are the reports to be
given because of the audit? When are these to be given? Answers to these questions
would help the auditor in determining the scope and time schedule of his audit.

3) Applicable Legal or Statutory Requirements: It is important to consider the legal or

statutory requirements that may affect the scope or conduct of the audit. For example, in
the case of an independent financial audit of an insurance company, the relevant Act
itself requires the auditor to physically verify the cash balances, securities relating to the
insurer's loans, etc., and investments.

4) Accounting Policies Adopted by the Enterprise and Changes in those Policies: There
are several accounting aspects where an enterprise can choose one of the alternative
 accounting policies. For example, generally, a company may choose either the straight-
line method or the written-down value method for providing depreciation. Also, if there
is a-change in an accounting policy, the auditor may have to extend his audit programme
in that area in the year of change, particularly to ensure that the new accounting policy
has been applied properly.

5) Effect of New Accounting or Auditing Pronouncements: Financial statements are

prepared in accordance with standards of accounting, which are generally issued by
professional accountancy bodies (e.g., the Institute of Chartered Accountants of India).
Similarly, audit is conducted as per the auditing standards and guidelines enunciated by
professional accountancy bodies. Any changes in the accounting or auditing
pronouncements since the conduct of the previous year's audit may affect the scope of the
audit or the way it is conducted. Therefore, these should be carefully considered by the
auditor while drawing up his audit plan.

6) Identification of Significant Audit Areas: In any auditing situation, some audit areas
involve greater audit risk than the others, i.e., there is a greater possibility of the auditor
forming an inappropriate opinion in respect of those areas. It is, therefore, important for
the auditor to identify such areas so that he can pay special attention to them during the
audit. For example, in an independent financial audit of a company manufacturing and
exporting computers, the auditor may identify the following as significant audit areas,
among others.
(a) Foreign exchange transactions-if exchange rates change frequently, errors or manipulations in
recording the dates of transactions may significantly affect the financial statements.
(b) Changes in technology that may render the products of the company obsolete.
(c) Collectability of debtors situated in countries which have imposed restrictions on remittances.

7) Setting of Materiality Levels for Audit Purposes: The auditor plans and performs an
audit to have a reasonable expectation of detecting misstatements that are material in
relation to the information on which he is reporting. For this purpose, at the planning
stage, the auditor sets materiality levels. In an independent financial audit, the auditor
usually sets materiality levels for individual account balances and classes of transactions
(such as debtors, stocks, sales, etc.) for applying specific audit procedures. For example,
the auditor may decide that in the case of audit of sales, he will examine all transactions
above Rs 5,000 and will conduct a selective examination of transactions below Rs 5,000.
It may be emphasised that this is only an illustration and the actual materiality level will
differ from case to case, depending upon factors like the amount of total sales, whether
the sales are against cash or on credit, whether the customers are related to the
management of the enterprise under audit, etc.

8) Conditions requiring Special Attention: In developing his audit plan, the auditor
should carefully identify conditions that require special attention, such as the possibility
of material error or fraud or the involvement of parties in which directors or substantial
owners of the enterprise are interested and with whom transactions are likely. It is
obvious that an independent financial auditor will have to pay special attention to such
areas as these are more likely to result in misstatement of financial information. For
 example, if many transactions occur at contract sites in remote areas where the
accounting function is also carried on by the engineering staff, the possibility of material
errors and frauds would be greater. The auditor must take this factor into account in
determining the scope and conduct of the audit. Similarly, the auditor should also pay
special attention to transactions between the enterprise and third parties in which
managerial personnel or major shareholders or owners of the enterprise have an interest,
e.g., purchases from a firm in which a director of the company is a partner.

9) Degree of Reliance expected to be placed on Accounting System and Internal

Controls: On the basis of his preliminary assessment of the effectiveness of the
accounting system and related internal controls, the auditor can make a judgement about
the extent to which he can rely upon the same. If his preliminary assessment is that the
accounting system and the related internal controls in the enterprise under audit are
effective, he can decide to limit the extent of detailed checking of transactions and
balances. If, on the other hand, he finds that the accounting system and the related
internal controls are weak, he will have to carry out a more extensive examination of
transactions and balances. Thus, the planned degree of reliance on accounting system and
related internal controls also affects the scope and conduct of the audit.

10) Possible Rotation of Emphasis on Specific Audit Areas: In the case of recurring audits,
it is usual for the auditors to plan each audit in such a manner that some areas come under
much deeper scrutiny in one year, some others are examined in depth in the next year,
and so on. It must, however, be mentioned that no auditor can afford to completely ignore
any area in any one year. The purpose of rotating the audit emphasis on different areas is
to ensure that all important areas are examined in depth over a period, say, three years or
so. It is obvious that in case the auditor decides upon the rotation of emphasis on specific
audit areas, he will have to frame his audit programme accordingly. The programme
should, therefore, list the areas of emphasis of the particular year. However, the auditor
should never disclose to the management or employees of the enterprise the areas on
which he intends to place greater emphasis in any one year.

11) Nature and Extent of Audit Evidence: If the accounts are maintained on computers, the
audit programme will have to be suitably modified to consider the nature of audit
evidence available in a computerised system. On the other hand, if the accounts are
maintained manually, the nature and extent of audit evidence will be different. Similarly,
the nature and extent of audit evidence in the case of a building contractor having
contract sites at various places would be different as compared to the case of an
enterprise which is engaged in publishing textbooks. The auditor must consider the nature
and extent of the audit evidence likely to be available in each situation and accordingly
select the audit techniques. For example, in one situation he may rely more on physical
examination, confirmation and analytical procedures, whereas in another situation, he
may rely more on examination of documentary evidence.
 12) Work of Internal Auditors: Many enterprises have an internal audit system whereby
specially assigned personnel conduct an internal audit of transactions, activities and
performance-often on a continuous basis throughout the year. The work of the internal
auditor is, in some ways, like the work of the independent financial auditor. In some
cases, a part of the internal audit programme itself may have been designed in
consultation with the independent financial auditor. It is, therefore, often useful for the
independent financial auditor to review the work of the internal auditor to take a decision
about the extent to which he can rely on the same. The extent of reliance to be placed on
the internal auditor's work obviously affects the scope of examination of the independent
financial auditor.

13) Involvement of Other Auditors: In many independent financial audits, there is

involvement of other auditors apart from the principal auditor. For example, a company
having several branches at different locations may appoint local auditors to audit its
various branches. These auditors would give their reports on the accounts of the branches
to the principal auditor. The principal auditor must consider the involvement of other
auditors to decide about the steps to be taken to ensure that the other auditors' works is
adequate for his purpose and to co-ordinate their work.

14) Involvement of Experts: Sometimes, an auditor has to use the work of certain experts in
the course of an audit. For example, if a company has revalued its buildings based on the
current construction costs, the auditor may have to consider the architect's estimates
about the current construction costs. This is because the auditor himself may lack the
expertise in this regard. Similarly, while examining the amount of the provision for
gratuity, the auditor may consider the certificate given by the actuary (an expert in such
valuations) about the liability of the enterprise in this regard.

15) Allocation of Work to be undertaken among Joint Auditors and the Procedures for
Control and Review: In many cases, especially in the case of large enterprises, several
auditors are appointed to perform the audit jointly. The joint auditors divide the work
among themselves on a rational basis. The division of work may be based, for example,
on geographical units of the enterprise or on some other basis. In such a case, it becomes
necessary to design procedures whereby the overall audit work can be co-ordinated and
controlled. Each auditor has to accordingly plan the work to be performed by him.

16) Establishing and Co-ordinating Staffing Requirements: The auditor should estimate
the exact requirements of the staff along with a broad estimate of the time required by
each staff member.

Audit Programme
Audit programme is the auditor's plan of action. Prof. Meigs defines it as "a detailed plan of the
auditing work to be performed, specifying the procedure to be followed in verification of each
item in the financial statements, and giving the estimated time required”.
An audit programme is a written scheme designed by the auditor to identify the work to be done
during the audit and to distribute the same among his staff. It indicates-(a) what work is to be
done during the audit; b) by which member of his staff any particular portion of the work is to be
done and (c) within what time-frame any particular work is to be accomplished.
An audit programme, enables the auditor-(a) to maintain a close vigil over the performance of
audit work; (b) to ensure that the work is performed in an orderly manner; (c) to fix
responsibility as regards individual staff members for the work done; and (d) to detect
shortcomings and lapses in the distribution and performance of work such that the same do not
occur again in the audit programmes in future.

Objectives of Audit Programme

1) To integrate and coordinate the different parts of audit work.
2) To ensure the uniformity in the performance of audit work and to avoid duplication of
work.
3) To have a fair allocation of audit job amongst audit staff.
4) To ensure the completion of audit work within a time frame.
5) To fix the responsibility of each member of the audit staff.
6) To provide a proof of completion of a particular audit work, the dates on which it was
completed, who performed it and how it was done.

Contents of Audit Programme

It is somewhat difficult to mention all the items to be incorporated while drafting an audit
programme as it varies from company to company and depends on the type of audit work to be
carried out. A fresh audit programme is required for each audit. Generally, preparation for an
audit programme needs the following information:
1. Name of the company
2. Nature of operations of the company
3. A review of the system of internal check
4. Date of commencement of audit
5. Tentative period of audit exercise
6. Accounting system followed by the company for recording its financial transactions
7. Preparation of the audit report
8. Instructions or points of caution as mentioned by previous year's auditor in his audit report
9. Schedule of checking of various subsidiary books including journal proper
10. Schedule of checking of ledger accounts including profit and loss account items and balance
sheet items.

Advantages
1) Provides clear-cut instructions - A written audit programme provides the assistants
with a clear set of instructions about the work to be done by them.
2) Provides a total perspective - A written audit programme reduces possibility of ignoring
or overlooking certain books and records. Without it, assistants cannot get a perspective
 of the work to be performed and may also end up repeating unnecessarily much of the
work carried out at the previous audit.
3) Provides a tool for efficient distribution of work - An audit programme is prepared
keeping in mind the level of competence and experience of individual members of an
audit team. The junior members are given routine work and senior members handle the
more complex assignments.
4) Assists in fixing responsibility for work done - An audit programme incorporates the
details of allocation of duties among the members of audit team. The work done may be
traced back to the individual staff member.
5) Helps in assessing progress of work - An auditor can assess the progress of all audits by
examining the audit programmes and ascertaining what part of audit work has been
completed and what remains to be done.
6) Serves as evidence against charge of negligence - An audit programme is of immense
evidentiary value for defending lawsuits charging auditor of negligence. A properly
drawn and duly initialled audit programme can easily establish the exercise of reasonable
skill and care by the auditor.
7) Serves as a basis for subsequent revision - The audit procedures may be modified in
the light of any changes taking place within an enterprise especially in the system of
internal control and accounting procedures and also experience gained during the course
of conducting past audit.

Disadvantages
1) Audit work becomes mechanical - The audit procedures are listed in detail. As a result,
work becomes mechanical. Parts of the programme may be executed without proper
understanding of their significance to audit process.
2) Rigidity - The listed procedures are carried out by audit assistants despite changes in
business operations such as changes in internal control system or staff.
3) Shields inefficient staff - Inefficient audit assistants may take shelter behind the
programme i.e. defend their deficiencies in their own work on the plea that no fixed
instructions in the matter were contained therein.
4) Reduces the initiative of efficient staff - It may put fetters on the initiative of efficient
and intelligent staff members. They may not be able to decide upon the audit procedures
themselves.

Audit Evidence
Audit evidence is a fundamental constituent of an audit process. It is defined as any document,
record or information which is available to substantiate any assertion made in financial
statements or transactions recorded in the books of account. The auditor applies his professional
judgment to the evidence gathered and obtained during the audit process. He forms his opinion
as to the truthfulness and fairness of financial statements on the basis of review of such evidence
and expresses his opinion through an audit report.

Procedures to obtain evidence

1) Compliance procedures: The compliance procedures are audit tests designed to obtain a
reasonable assurance as to the reliability of the internal control system. They seek to test:
a) that the internal control exists, i.e, existence,
b) that the internal control is operating effectively, i.e., effectiveness and
c) that the internal control has so operated throughout the period under audit i.e., continuity.
For example, an auditor wants to see whether payments are properly authorized by a designated
person before issuing the check, and that the check is signed by two approved signatories. He
would check the compliance of this prescribed procedure by test check of a few transactions.
This is called compliance testing.

2) Substantive procedures: Substantive Tests - Substantive tests are designed to obtain

evidence as to the completeness, accuracy, and validity of the data produced by the
accounting system. These are of two types:
 tests of detailed transactions and balances, and
 analysis of significant ratios and trends.
The auditor undertakes substantive test procedures in order to obtain reasonable assurance about
the following assertions that:
 An asset or a liability existed on a given date.
 Assets/liabilities were in the client entity's name.
 Transactions recorded related to the period under audit.
 There were no unrecorded transactions.
 No transaction has been omitted to be recorded in books.
 The assets/liabilities have been shown at proper values.
 Expenses and income have been stated at proper value.
 The transactions have been recorded/classified under proper heads of account.
 Complete and unambiguous disclosure of all relevant information, whether statutorily
required on not, has been made in respect of all the items appearing in the accounting
statements.
Further to the aforesaid transaction specific assertions, there also exist few general assertions
The generally accepted accounting principles including fundamental assumptions have
been followed in the preparation of the accounting statements and statutory disclosure
requirements have been complied with.
The significant accounting policies have been disclosed along with changes, if any.

Sources of audit evidence

1) Accounting system
The system of accounting followed by a business constitutes the basic support evidence.
Business transactions, documents, etc., are inputs of this system. Account balances are its output,
based on which figures as shown in the financial statements are verified.
Information about operation of the system may be gathered from instructions or manuals, if any,
specifying the procedures to be followed by each employee involved in the system. Based on
this, the auditor may prepare flow charts depicting the course followed by each transaction and
resulting documents, through all processing steps taking place in the system.

2) Physical evidence
The best evidence in the case of tangible assets e.g., cash, stock-in-trade, plant and machinery,
etc. is their physical existence. As for the scrutiny of money-value of these assets as shown in the
Balance Sheet, the auditor must guard against over-or under-valuation. There may be cases
where it is not possible to inspect physical assets because of distant location. Actual inspection is
also not possible in case of cash deposited with banks, etc. In such cases, documentary evidence
will be the only reliable evidence in support of the auditor's opinion.

3) Documentary evidence
Documentary evidence in possession of the client may be of four kinds:
a) Evidence originating outside but held by client -- Examples of such evidence are share
certificates, debentures, bonds, etc., held by the client. These documents are issued after a
great deal of checking and cross-checking. The auditor may therefore accept them as
reliable evidence of investment by the client. But certificates as to account-balances
issued by banks or purchase invoices received from suppliers, which also fall under this
category, are not equally reliable because these may easily be altered or forged while in
the client's possession.
b) Evidence originating inside but circulating through third parties -- Examples of such
evidence are cheques drawn by the client and circulating through payees and the banking
system. Evidence falling under the present category has an element of reliability due to
its circulation through third parties. However, it should be checked carefully.
c) Evidence originating inside but subject to effective internal control -- If evidence is
subject to effective internal control, it may be relied upon even if it originates internally.
For example, records as to wage payment can be reliable evidence if time-card in the case
of each worker is prepared on the basis of information supplied by the personnel
department, time of his daily arrival and departure is noted by automatic time recorders,
and the worker is checked at the shop floor by a time-keeper.
d) Evidence originating inside but not subject to effective internal control -- Internal
evidence which is not subject to effective internal control should not be accepted at its
face value. Miscellaneous expenses recorded in the petty cash register are a case in point.
Sums shown as advance against travelling or postal expenses should not be relied upon
unless confirmation has been secured from the recipients as to the purpose and amount of
the advance.

4) Ratio and trend analysis

Analysis of ratios and trends between different periods of the same company, and between the
company under audit and other companies, will also constitute evidence for the auditor to form
his opinion. Ratios can be worked out between gross profits and direct production expenses,
gross and net profits, and debt and equity for different periods, to determine whether the data
presented in the financial statements meet the test of logic and reasonableness.

5) Oral evidence
Question-answer sessions with the officers and employees of the company under audit, may
sometimes throw up important clues to test the veracity of documentary and other evidence. Oral
evidence helps an auditor to satisfy himself as to the reasonableness of the existence of certain
procedures and accounts.

6) Subsequent events
Events after the preparation of financial statements may also serve as evidence to test the
authenticity of the accounting data. For example, sundry debtors or bills receivable appearing in
the financial statements may be confirmed with documentary evidence as to subsequent
collections.
But the fact that collections or payments have subsequently been made, do not automatically
confirm the existence of sums receivable or payable as shown in the financial statements.
Documents relating to later events will have to be independently examined to determine their
evidentiary value.

7) Circumstantial evidence
Circumstantial evidence is intended to prove a fact by proving other events or circumstances, so
as to afford a basis for a reasonable inference of the occurrence of the fact in issue, or otherwise.
It may be conclusive or presumptive. It is conclusive when it proves a fact by proving other, but
directly relevant, events. It is presumptive when the fact itself is not proved by direct testimony
but the same is to be inferred from circumstances which are either necessarily or usually related
to such facts. However, a presumption can be relied upon only if the contrary is not actually
proved.
The circumstances under which accounting figures are prepared may affect their authenticity.
For example, the operation of the system of internal control. In the case of an organisation with
effective internal control system, the accounting data will naturally be more reliable than if it has
little or no internal control. Internal control is thus a circumstantial evidence to evaluate the
authenticity of accounting data.
Other forms of circumstantial evidence are: (a) logical reasonable relationship between figures;
(b) general reliability of financial statements of the same organisation in previous years; (c)
overall economic condition within the country and of the industry to which the enterprise under
audit belongs, etc.

8) Computerised records
There is no change in the basic approach to audit in the case of an enterprise operating computer-
based accounting systems. The main difference is that evidence in such a case is in the form of
electronic records, for the examination of which different tests and procedures are called for.
Accordingly, the auditor should adapt his tests and procedures in conformity with the control
techniques in the computer system. He may also use techniques to ensure that the programme
procedures are operating properly and the tests and procedures are carried out more effectively.

Reliability of audit evidence

The reliability of audit evidence means the credential value of the assurance the evidence
provides about the assertions. When audit evidences collected from different sources and in
different forms or nature, point to same assurance without conflict, the cumulative effect of
effect of assurance level is high. Where they point to inconsistent assertions, the reliability of the
evidences is doubted, and more evidence needs to be gathered to resolve inconsistency.
Generally-
1. The external evidences are more reliable than internal evidence.
2. Internal evidence is more reliable when related internal control is satisfactory.
3. Evidence in the form of documents and written representations is more reliable than oral
representation.
4. Evidence obtained by the auditor himself is more reliable than that obtained through the entity.
External evidence is the one which originates from external sources, such as:
• customers,
• suppliers and third parties having some dealings with the client.

Methods of collecting audit evidence

1) Physical Verification - The main objective of physical examination by the auditor is to
satisfy himself about the existence of an asset or a document. It provides the auditor,
what is normally called 'eye witness' evidence. Physical examination procedure provides
utmost satisfaction to the auditor because it convinces him about the existence of the
thing he is to verify. This method is applicable to those assets which are tangible and
have evidence of existence, such as cash, stocks, furniture, building and machinery,
investments, etc. Existence of an asset alone is not enough, there are certain implied
considerations also which should be borne in mind while making physical examination.
These considerations are: verification of ownership, determination of quality and
specifications, ascertaining of genuineness, and verification of quantity.

2) Direct Confirmation - implies verifying records by obtaining agreement on some given

facts in the accounting records of the client from appropriate outside persons having
dealings with the client. This technique generally supplies quite reliable evidence and
very often used in the following cases:
 Confirmation of outstanding balances of sundry creditors/debtors which is
referred to as circularisation.
 Bank balances
 Security deposits
 Existence of lawsuits
 Goods stored in public warehouses
 Contingent liabilities
 Assets with sub-contractors, fabricators.

3) Documentation - The implication of the word examination in the context of auditing

techniques means examination of original documents. According to audit terminology,
the examination of documents in support of transactions recorded in the books, is often
called 'vouching’. For every transaction, documentation is prepared based on which the
entries are made in the financial books. Such documents are purchases and sales invoices,
cash receipts in payment for goods or services, etc. These documents provide prime
evidence in support of transactions. In order to assure himself about the satisfactory
evidence, the auditor should examine as far as possible, the original documents. While
examining the documents, (vouching) the auditor should look for the following points:
 Authenticity of the document: i.e. whether the related document is genuine or fake.
 Relevance of the transaction: It should be, supported by a document which relates to
the client company and pertains to the period under audit.
 Arithmetical accuracy of the document in support of any payment or income: The
amount payable or receivable should be correctly computed.
 Approval of the transaction: The document should have the approval of appropriate
official of the entity, authorising the transaction supported by the approved document.
  Classification of the transaction: It should be seen that the transaction has been
correctly classified and recorded in the books of account. This is to ensure that items
of revenue nature have not been capitalised or vice versa.
4) Re-computation – Re-computation technique is applied to prove arithmetical accuracy
of a transaction only. To satisfy himself, the auditor should prove the totals and
extensions. The areas where re-computation technique is applied includes totalling of the
books of original entry, ledger balances, stock sheets, depreciation computation,
schedules attached to balance sheet, bonus calculations, write-off of bad debts and many
other matters. Inexperienced auditors are likely to underestimate the need for this type of
verification. Until one becomes accustomed to the idea that any total or the result of any
combination of figures may be incorrect, it is difficult to remember that any such result
requires verification.

5) Analytical Review - It implies studying important ratios and trends and investigating into the
unusual fluctuations. While auditing financial statements, the auditor can correlate various
figures to establish financial soundness of the company. During the audit, the auditor can
scan various unusual transactions and examine them thoroughly. Proper scanning of the
transactions requires greater degree of skill on the part of the auditor. Examples of review
techniques are
 Analyse and compare previous year amounts and current years amounts.
 Gross profit Ratio -- Compare + Analyse difference
 Net profit Ratio -- Compare + Analyse difference.
 Using different tools and techniques for analysis of financial statements
 Critical analysis
 Ratio analysis
 Taxation analysis – Provision/ Assessment
 High value transactions

6) Representation by management - It is used to let the client's management declare in writing

that the financial statements and other presentations to the auditor are sufficient and
appropriate and without omission of material facts to the financial statements, to the best of
the management's knowledge. It serves to document management's representations during the
audit, reducing misunderstandings of management's responsibilities for the financial
statements.

Audit Working Papers

According to SA-230, "Documentation", issued by the Institute of Chartered Accountants of
India, audit working papers consist of-
(a) evidence obtained during the audit examination;
(b) details of the methods and procedures followed by the auditor during such examination; and
(c) conclusions reached by him as regards the objects of the audit.
Working papers are the medium through which the auditor expresses his technical knowledge of
accounting principles and procedures as applied in the production of reports, statements and
analysis of business information. To form his opinion as regards the representations in the
financial statements, the auditor has to select, analyse and examine adequate evidence which
stands the test of logic and veracity. The evidence may be physical or documentary, and in the
form of books of accounts, records, or the system of internal control operated by the enterprise
under audit. The working papers serve as the proof of how the relevant evidence was obtained,
analysed, examined and pieced together to reach reasonably logical and verifiable conclusions.

Purpose
1) Planning, organisation, control, and review of audit work: Working papers provide a
means of planning, organising, controlling, administering and review of the work. They
are an evidence that the audit was conducted as per the generally accepted auditing
standards and practices.
2) Support for auditor's opinion: Working papers provide the principal support for the
report of the auditor. They also provide a proof that generally accepted auditing standards
and practices have been duly followed in the conduct of the work. If the validity of the
auditor's opinion, assertion, or recommendation as to the financial statements is later
questioned, working papers can be produced as an evidence to establish the said opinion
or assertion. The auditor should therefore ensure that the working papers are conclusive
and complete in every respect, leaving no question raised therein unanswered.
3) Division of labour: Working papers help in appropriate division of work among the audit
staff, in the sense that different working papers may be made the responsibility of
different audit clerks under the supervision of a senior clerk or the auditor himself. The
progress of the work can thus be effectively monitored. Even where the audit work
extends to different offices or branches of the client, the audit programmes may be
divided into so many parts, or separate audit programmes may be prepared for each place,
and then working papers prepared at each place may be compiled at the central office to
have an overall view of the work.
4) Use as permanent record: Working papers constitute a permanent record of the auditing
procedure employed, and the financial records examined. The client can make use of
these in case his own records are altered or lost.
5) Bridge between original transactions and financial statements: Working papers
provide an important link between original transactions and the financial statements. This
is because an auditor's work mostly consists in tracing the business transactions, though
on a sample basis, from the original records to the financial statements, and vice versa.
Working papers also constitute the basis for making rectification and adjustment entries.
6) Basis for review and revision of internal control: Internal control questionnaires form
part of the working papers. Comments as to the working of the internal control system
will also be found in working papers relating to audit tests in respect of each aspect of the
enterprise. Thus, working papers facilitate an in-depth review of the internal control
system, which forms the basis of recommending suitable changes therein.
7) Basis for evaluation and training of audit staff: Working papers provide a means to
test whether the auditor and his staff have done their job as per the required standards.
They serve as an index to the auditor's ability to plan and organise the audit, because at
each stage of audit, he has to take decisions as to the nature of evidence to be obtained
and the tests to which each evidence should be subjected. Review of the past year's
working papers and reports submitted by senior audit clerks can also be used as a basis to
provide the required training to the staff.
 8) Basis for further work: In the course of his examination, the auditor may come across
certain situations or conditions in the pattern of management of the client's business
which, though not directly connected with his work and, therefore, being outside the
purview of his report, may nevertheless be useful in future planning. Thus, the notes and
analysis prepared by the auditor as part of his working papers, may also prove useful to
the client in several other areas.

Form and Contents of Working Papers

1. Working papers should record the auditor's planning, the nature, timing and extent of the
auditing procedures performed, and the conclusions drawn from the evidence obtained.
2. Working papers should be sufficiently completed and detailed to enable an auditor to obtain
an overall understanding of the audit. The extent of documentation is a matter of professional
judgement since it is neither necessary nor practical for the auditor to document in his working
papers every observation, consideration or conclusion made.
3. All significant matters, which require the exercise of judgement, with the auditor's conclusion
thereon, should be included in the working papers.
4. The form and content of working papers are affected by matters such as:
(a) The nature of the engagement.
(b) The form of the auditor's report.
(c) The nature and complexity of the client's business.
(d) The nature and condition of the client's records and degree of reliance on internal controls.
(e) The need, in particular circumstances for direction, supervision and review of work
performed by assistants.
5. Working papers should be designed and properly organized to meet the circumstances and the
auditor's need for each individual audit. The use of standardized working papers (e.g., checklists,
specimen letters) may improve the efficiency with which they were prepared and reviewed. They
facilitate the delegation of work while providing a means to control its quality.
6. To improve audit efficiency, the auditor normally plans with the client to utilize schedules,
analyses other working papers prepared by the client. In such circumstances, the auditor should
satisfy himself that those working papers have been properly prepared.

Classification of Working Papers

In the case of recurring audits, some working paper files may be classified as permanent audit
files as distinct from current audit files relating to the audit of a single period.
Thus, working papers may normally be divided between the following two files: Current file and
Permanent file.

Contents of current file

A current file contains information primarily relating to the set of accounts subject to audit
during the current year. Following are some of the examples of audit working papers to be
placed in a current file.
(a) Correspondence relating to acceptance of annual appointment
(b) Evidence of the planning process of the audit and audit programme
(c) A record of the study and evaluation of the accounting system and related internal control.
This might be in the form of narrative descriptions, questionnaire or flow charts, or combination
thereof.
(d) Analysis of transactions and balances
(e) A record of the nature, timing and extent of auditing procedures performed, and the results of
such procedures.
(f) Evidence that the work performed by assistants was supervised and reviewed
(g) An indication as to who performed the audit procedures and when they were performed
(h) Copies of communication with other auditors, experts and third parties
(i) Copies of letters or notes concerning audit matters communicated to or discussed with the
client including the terms of the engagement and material weaknesses in internal control.
(j) Letters of representation or confirmation received from the client
(k) The working trial balance, bank reconciliation statement
(1) Conclusion reached by the auditor concerning related aspects of the audit, including how
exceptional and unusual matters (if any) disclosed by the auditor's procedures, were resolved or
treated
(m) Copies of the financial information being reported on and the related audit reports.
(n) Schedules of debtors, creditors; statement of depreciation, schedules of inventories.

Contents of permanent file

(a) Information concerning the legal and organizational structure of the entity such as
memorandum and articles of association in case of a joint stock company and other appropriate
regulations
(b) Extracts or copies of important legal documents, agreements and minutes
(c) Analysis of significant ratios and trends
(d) Notes regarding significant accounting policies
(e) A short description of the type of business carried on and the places of business.
Thus, a permanent file contains papers and information, which are of considerable use and
important for the succeeding audits.

Ownership and Custody of Working Papers

The auditor has always been considered as the rightful custodian of working papers. But there
has been some difference of opinion over the question of ownership of working papers in the
past. One view has been that the client should be the owner of working papers as it contains
information about the entity, which is derived or obtained from client's books of account and is,
therefore, of confidential nature. According to a different opinion, auditor should be the owner of
the working papers as it contains information collected and evaluated by the auditor for proper
discharge of his duties. In case the auditor is charged with negligence, the working papers would
be of immense evidentiary value to him. However, the controversy has now been settled in the
light of courts' decisions and professional pronouncements. The claim of auditors over the
working papers has been established beyond doubt.
In Sockockinsy v. Bright Graham and Co., it was held that all types of working papers belonged
to the auditor as he is an independent contractor and not agent of the client. In Chantrey Martin
and Co. v. Martin, the court distinguished between working papers prepared by the auditor as an
independent professional and those working papers which are brought into existence while the
professional accountant is acting as an agent for his client, for example, correspondence between
an accountant and tax authorities. The court opined that the ownership of working papers
prepared for the purpose of producing a balance sheet, for example, schedules prepared by client
or his staff for purpose of audit and draft accounts of the company, belonged to the auditor and
not to the client. However, client is the owner of those working papers, which are prepared by
the auditor as an agent. Thus, the decisions in the above two cases make it clear that audit
working papers are the property of auditor and not of the client.
The view similar to that expressed by the courts in the above cases, is echoed in professional
pronouncements of self-regulatory bodies of accountants and auditors all over the world. In
India, too, Institute of Chartered Accountants of India (ICAI) has issued SA 230, which
addresses this issue.
Following points can be made on the basis of the Standard:
Ownershi a. The ownership of working papers belongs to the auditor. However, he may
p make copies available to the client.
b. The auditor's property rights are subject to limitations of clause 1, Part I of
Second Schedule to the Chartered Accountants Act, 1949, which prohibits
disclosure of confidential client information without the management's
consent except when required by the law.
Retention a. There are no explicit rules relating to the retention of working papers. They
should be retained as long as the auditor opines them to be useful in
servicing the client or to comply with legal or professional requirements.
b. Standard on Quality Control (SQC) - 1, however, requires it to be at least
seven years from the date of auditor's report.

Audit Notebook
An audit notebook refers to a record of some important and meaningful information gathered or
experienced prior to or during the course of audit. While conducting an audit, the auditor comes
across certain points which require further clarification, explanation and investigation and he
records the same in a diary maintained for the purpose known as the audit notebook. It contains
significant audit observations. Objections, queries raised and replies received thereto,
correspondence with the client, etc.
It generally contains such items as the audit programme, notations showing how sections of the
audit are carried out during successive examinations, information needed for the auditor's office
and for administration, personnel assignments, time requirements and notations for un-
succeeding examinations. It serves as a valuable aid to remember a plethora of information,
queries and explanations sought and rendered in the course of an audit.
The audit note book has also great evidentiary value in case any charge of negligence or
impropriety is brought against the auditor by the client.

Purpose of Audit Note Book

1. To know about the nature of business i.e regarding provision of Memorandum, Articles of
Association etc.
2. Not to leave any errors and frauds undetected, which helps to make audit more effective and
efficient.
3. To make the future audit work easier. Auditor can get information regarding nature of
business from previous audit note book.
4. To check the list of debtors and creditors so that false list can be detected.
5. To know about the facts where clarification and explanation are essential.
6. To present as proof by the auditor to get clearance over the cases if auditor has been accused
for misfeasance and negligence.
7. To assure the audit of major function or items of the business where there are chances of
frauds and errors.

Contents
General information
1. Name of the business.
2. Organisation structure of the enterprise.
3. Provisions of the Memorandum and Articles of Association having a bearing on the audit.
4. List of books of account maintained by the enterprise.
5. Accounting methods followed in the enterprise, and their defects.
6. Names of key officials and their powers, duties and responsibilities.
7. Dates of commencement and completion of audit.

Specific information
1. Instructions from the management having relevance to the audit.
2. Any irregularities in the observance of laws and notifications applicable
3. Audit queries not cleared immediately. During the conduct of the audit, all those
vouchers, which remain insufficiently vouched, are to be noted in the query list of the
audit notebook. A complete record as to how they were cleared and those, which
remained unclear and reported to management, is also maintained.
4. Matters requiring explanation or clarification.
5. Weaknesses of the internal control system.
6. Totals and/or balances in important accounts particularly in respect of cash and bank
account should be noted so that after the work has been done alterations if any, in the
closing balances may not be carried out.
7. Bank reconciliation statement.
8. Errors and fraud as discovered.
9. Books and records not made available for audit.
10. Points to be noted for subsequent audits.
11. Points to be included in the audit report.
It should be noted that an audit note book is meant to record only important and strategic items.
Matters which are, or can be, sorted out on the spot, or those of a trivial nature, need not be
entered therein. Further, if the notes have been properly taken in the audit notebook, they might
prove of great value to the auditor subsequently, in case a suit is filed against him for negligence
or misfeasance.

Advantages of Audit Notebook

1. Evidence Value: In case notes have been properly made in the Audit note book, it might
prove of great value to the auditor later on. It has an evidence value in case a suit is filed
against him for negligence or misfeasance. Such a notebook will be a documentary
evidence in favour of the auditor even after several years by which time the auditor might
have forgotten everything about the particular audit.
2. Subsequent Audit Value: The Audit note book should be clear, concise and complete so
that it may be quite intelligible to the clerk who audits the accounts of the same company
next year. Such a note book can be a useful guide to such a clerk.
 3. Planning value: The Audit note book is an useful document in planning the next audit of
the entity. It is also useful in preparing the next audit programme as the weaknesses
shown in the Audit note book on various aspects and segments of accounting would
require close follow-up.
4. Report finalisation Value: The Audit note book is also very useful at the time of
finalising the Audit Report. In the case of follow-up observations made by the Auditor, it
may get settled with explanation and evidence given by the management at a subsequent
stage. After that, the Auditor has to consider only the unsettled observations from various
relevant angles for preparing the Audit Report. Thus, Audit note book is the primary
basic document in preparing the Audit Report on the true and fair view of the financial
statements.

Routine Checking
Auditing is basically a process of verification of accuracy and propriety of financial statements.
This invariably needs checking the correctness or otherwise, of the books of account and
transactions. There are certain records and books, which are common to all types of business
undertakings irrespective of size, constitution and nature of activities and transactions of a
business. The checking of such common records and books is known as routine checking.
Routine checking is carried on by the auditor and includes checking of:
1. castings, sub-castings, carry forwards and other calculations in the books of original entry.
2. postings into the ledger accounts.
3. castings and balances of various ledger accounts; and
4. transfer of balances from the ledger to the trial balance.
Routine checking, therefore, is a sort of simple checking. Therefore, it can only help to discover
simple clerical errors and ordinary frauds, and may not unearth complex errors such as errors of
principle, or compensating errors, or ingeniously perpetrated fraud. However, it is invaluable
insofar as it ensures arithmetical accuracy of the books of account and keeps a check on
alteration or erasure of figures after these have been audited.

Purpose of Routine Checking

1. Making totals and sub-totals of primary books of accounts, carrying them forward to the
next page, and calculating the balances and their checking.
2. Checking of the ledger postings derived from the primary books and journal, and to see
whether they are properly done or not.
3. To see the totals of debits and-credits of different accounts and their balances.
4. To check whether balances of various accounts are properly taken to the Trial Balance, or
not.

Advantages of Routine Checking

1. In routine checking, the books of original entry can be checked thoroughly and errors and
frauds can be spotted easily.
2. It constitutes an important base of the entire audit as it involves a thorough examination
of all transactions without exception from the books of original entry up to the ledgers.
3. Routine checking does not reveal only the errors and frauds of a simple nature but if
carried on with due care and precaution, it helps in the verification of the arithmetical
accuracy of the entries.
 4. Routine checking is a simple job, which can be performed easily by a person having
ordinary knowledge of accountancy. It involves the work of an elementary nature.

Disadvantages of Routine Checking

1. Routine checking is a mechanical process and often leads to monotony of accounting
procedures for those who are entrusted with this task.
2. It can discover simple clerical errors and ordinary frauds and incompetent to uncover
complex errors such as errors of principle or compensating errors or cleverly committed
frauds.
3. Routine checking is not economical as it takes more time and is costly.
4. It also tends to be quite boring because of its mechanical and monotonous nature.
5. Routine checking is considered redundant in certain cases, e.g., a business where in self-
balancing accounting system exists, routine checking is almost of no use.

Audit Sampling
Audit sampling is the process of selecting and examining a portion of a group of related items for
the purpose of obtaining information, or evaluating some characteristic about the group as a
whole. The group as a whole is called the population. In audit sampling, the population may be
represented by an account balance or a class of transactions.
Audit sampling is based on the theory of probability which says that a sample selected from a
mass of items will by and large have the same characteristics as are present in the mass. The
characteristics chosen for approximation may, for example, be-
(a) presence or absence of the initials of authorising official on the documents supporting a class
of transactions;
(b) correct valuation of stock-in-trade;
(c) number of cheques to be presented or collected;
(d) number of unpaid accounts; and so on.
The need for audit sampling has been recognised by many professional bodies of accountants,
The "Statement on Auditing Practices" issued by the Institute of Chartered Accountants of India
states that "it is now generally accepted that in the case of businesses where an adequate system
of internal control is in force, the auditor is entitled to apply appropriate test checks.

Types of sampling
1) Test checking or Judgmental sampling: Under test checking, the auditor checks a
selected number of transactions on the basis of his own judgment without using any
statistical procedures. The evaluation based on the examination of a selected portion of
the population is called inference. Thus, the auditor may select and check 25% of the
postings from the Cash Book to the General Ledger for all the months, or all the postings
from the Cash Book to the General Ledger for any two or three months. Likewise, he
may use sampling in the case of confirmation of the debtors (by seeking confirmation
from a select number of them), or physical verification of stock (by physically checking a
select percentage of the stock items).
Thus, test checking implies selecting a few transactions on the basis of auditor’s
judgment and examining them. The opinion formed by the auditor after such checking is
extended to the whole set of transactions, which is referred to as population/universe and
 portion of universe selected and examined is called sample. The universe is composed of
all items of similar nature.
The number of transactions to be taken up for checking should be decided by the auditor
only, and the client's staff should not be given any inkling even as to the pattern of
selection of transactions. For, if the staff knows or can guess about the areas to be taken
up for sample checking, it might destroy or remove all evidence of any error or fraud
committed by then and this would defeat the very purpose of sampling.
Though test checking is a traditional auditing technique and used more commonly than
statistical sampling, it suffers from certain major drawbacks:
Firstly, it does not provide for scientific determination of the size of the sample to be
checked. As a result, it is difficult to know what size of the sample would reasonably
represent the entire mass of data. Whether the sample consists of transactions of a few
specified months, or a percentage of transactions over the entire audit period, questions
can always be raised about the representative character of the sample.
Secondly, the audit assistants may pick up for sample checking only transactions which
are simple and straight.
Lastly, it is not possible to measure the risk element in checking.

Safeguards/ Precautions for the application of test checking

Test checking should be carried out intelligently and carefully, otherwise it may lead to
dangerous consequences. Certain safeguards should be taken to ensure reliability of results of
test checking. These are mentioned below:

1) Representativeness of the sample - The sample selected should be representative in

character i.e, work of almost all clerks of the client and transactions from all of the books
should be included in it. Moreover, universe from where sample is being selected should
be homogeneous in nature.
2) Random selection - The selection of sample must be done on a random basis. The
auditor may use random tables and various computer programmes for this purpose.
3) Complete examination - Some transactions like opening and closing entries,
depreciation entries and non-recurring or exceptional transactions e.g. related party
transactions or overseas sales should not be subject to test check. Cash book and pass
book should also be thoroughly checked.
4) Ensure complete coverage of transactions - Test checking is normally conducted in
such a way that the audit programmes for three to five years cover all types of
transactions for the whole year. For example, in the year 2000-2001, transactions relating
to January, June and December are checked; in the year 2001-2002, transactions covering
the months of February, May and July are checked and in the year 2002-2003,
transactions were selected from the months of March, August and November and so on.
5) Study the processing of a transaction in detail - Procedures for processing a
transaction right from the beginning to the end must be studied in a sequential order for
transactions selected for test checking. Not only the procedures should be studied, but
also the objective of each check at any point in the transaction cycle should be clearly
understood by the audit staff. For example, every purchase of goods should be properly
requisitioned and ordered, goods received should be in a good condition and the amount
paid for them should match the amount on vendor invoice.
Advantages
1. Test check helps an auditor to complete work in less time because a test of a few
transactions can be made. It is one of the technique which reduces time, cost and energy
of both the auditor and the client.
2. The work of an auditor is reduced considerably as he checks only a few transactions,
extra time available can be utilized for concentrating on areas of considerable
importance. An auditor can complete the work of audit of various organizations within a
stipulated time.
3. Test check saves labor, time and cost of an auditor. So, an auditor can check in detail the
specific items rather than checking similar items. It enables the auditor to complete the
work quickly as the auditor checks only a few or limited transactions.
4. Test check gives assurance of the accuracy and reliability of transactions to some extent.
It can be effective if the auditor selects the transaction to be checked carefully.
5. Accounting staffs remain alert and careful because auditor checks the transactions of
various times on a random basis. It serves as a guide for the auditor to arrive at
conclusion regarding the true and fair view of the state of affairs of the business.

Disadvantages
1) All errors or frauds may not be detected: Test checking is based on the selection of
representative sample of transaction. The possibility of detection of all errors or frauds is,
therefore, reduced.
2) Difficulty in determining the sample size - It does not provide for any scientific
technique for determining the size of the sample to be selected. Hence, the sample
selected may not be representative.
3) Does not measure the risk element in checking - There should always be a measure of
risk (called confidence level) associated with results drawn on the basis of a sample and
extended to universe. But in test checking, the risk element in checking cannot be
measured.
4) Unsuitable for small businesses - Test checking is unsuitable for small businesses
because the sample selected may not be representative.

2) Statistical sampling: Though statistical sampling has the same objective as that of test
checking, it is more scientific and provides a specific estimate. It uses probability theory
to measure the risk of sampling error. Consequently, it can control the risk of sampling
error and also calculate an optimal sample size which might in some cases be smaller
than the one which is considered appropriate under test checking. Statistical sampling is
thus valuable in cases where the size of the population is large. It can be done in the
following ways:
a) Random selection method
This method of selecting sample ensures that all items in the population have an equal chance of
selection. For example, random number tables are used. As the results of only a representative,
unbiased sample can be interpreted, an auditor should select his sample very carefully. The
sample should be selected at random. It means that each transaction has a known and equal
chance of being included in the sample. Today, many computer programs for generating random
numbers are available, for example, Microsoft spreadsheet software Excel has a function that can
generate random numbers. These computer programs save time, reduce the possibility of errors
and provide an automatic documentation of the selected numbers.
b) Systematic Selection Methods
This method of selection involves selecting items using a constant interval between selections,
the first internal having a random start. The interval might be based on a certain number of items
(for example every 20th voucher number) or on monetary total (for example, 1,000 increase in
the cumulative value of the population).
When the auditor employs systematic selection, he would need to determine that the population
is not structured in such a manner that the sampling interval corresponds with a particular pattern
in the population. For, example, if in a population of branch sales a particular branch’s sales
occur only as every 100th items and the sampling interval selected is 50, the result would be that
the auditor would have selected all or none of the sales of that particular branch.