Auditing Notes - (I - V) Units

AUDITING
UNITS CHAPTER PAGE NO
UNIT-I Introduction 4-22
UNIT-2 Internal control and Vouching 23-33
UNIT-3 Verification and Valuation of assets and 34-39

liabilities
UNIT-4 Audit of Companies 40-51
UNIT-5 EDP – Auditing 52-58
Prepared by
Dr.S.MOHAMED RAFIQUE
M.Com.,M.Phil.,NET.,SET.,MBA.,PhD
Assistant Professor in Commerce
C.Abdul Hakeem College(Autonomous)
Melvisharam
Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 1

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AUDITING
Syllabus for B.Com., only for batch 2020-2021
Year: III Year Subject Code : U20MCM502 Semester : V
Major - 14 Title: Practical Auditing
Credits: 4 Max. Marks. 75
Objective:
OBJECTIVES To enable the students to understand the concepts of auditing
and new measurement procedures in auditing
COURCE OUTCOME(S)
CO1 Understanding of objectives, audit programmme and methodology of

auditing.
CO2 Apply and demonstrate the accounting knowledge and skills in

Vouching and Assesse and estimate the various assets and liabilities
to evaluate overall concern effectiveness
CO3 Develop the degree of professionalism required of the certified

public accountants and need for keeping abreast of current auditing
issues and regulations in companies
CO4 Demonstrate basic proficiency with an EDP auditing that is widely

used in practice
UNIT-I:Introduction
Meaning and Definition of Auditing – Objectives auditing- Advantages and limitations of
auditing- Distinction between auditing and Accounting- Classification of auditing-Audit
Programme-meaning- Objectives- Contents- Audit note book- Contents – audit working
papers- importance
# Share capital audit – Audit of financial statements and Audit reports
UNIT-II: Internal control and Vouching

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AUDITING
Internal control- Meaning- definition – Objectives- Importance- InternalCheck- Meaning-

Objectives-Difference between internal control, internal check and internal auditing.
Vouching: Meaning and definition- Objectives – Important points to be considered at
vouching- Vouching of cash transaction- Vouching of trade transactions
# Types Auditor’s certificate
UNIT-III: Verification and Valuation of assets and liabilities
Meaning and definition of verification- Objectives – Distinction between verification and
valuation. Mode of valuation of fixed assets, floating assets, current assets, floating assets and
wasting assets. Verification of assets – current assets and fixed assets. Verification of liabilities-
Share capital, trade creditors, bills payable, outstanding expenses and contingent liabilities.
# Audit of Non-profit Companies
UNIT-IV: Audit of Companies
Company Auditors- Qualification –Disqualification- appointments- removal of auditors-
remuneration of auditors- Powers and duties of auditors- Liabilities of an auditors- Civil
liabilities and criminal liabilities
# Professional ethics and code of conduct for auditors
UNIT-V: EDP – Auditing
EDP- Audit- Meaning- Features of computer assisted audit techniques (CAAT) –
Documentation under CFAT- Approaches to audit under EDP Environment- Internal controls
relating computerized information system- limitation of EDP Audit
# Audit Procedures in an Electronic Data Processing Audit
NOTE: # Self study topic for advance lerners
TEXT BOOK
1. B.N. Tandon, A handbook of practical auditing, Sultan Chand & Co, New Delhi.
REFERENCE BOOKS
1. B.N. Tandon, Sudharsanam, Sundharabahu Practical auditing– S Chand & Co, New Delhi.
2. Sharma, Auditing, SahityaBhavan, Publications, Agra
3. Dr.N.Premavathy, Practical Auditing, Sri Vishnu Publications, Chennai.
4. S. Vengadamani, Practical Auditing, Margham Publications, Chennai.

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AUDITING
PRACTICAL AUDITING
UNIT-I
INTRODUCTION
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 Mesopotamia,
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. The original objective of auditing was to detect
and prevent errors and frauds Auditing evolved and grew rapidly after the industrial revolution
in
the 18th 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 objective of audit shifted and audit was expected to ascertain whether the accounts were
true and fair rather than detection of errors and frauds.
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 main objective of audit
shifted to ascertaining whether the accounts were true and fair rather than true and correct.
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
The International Accounting Standards Committee and the Accounting Standard board of the
Institute of Chartered Accountants of India have developed standard accounting and auditing
practices to guide them. Accountants and auditors in the day to day work 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 computerised accounts
DEFINITION
The term auditing has been defined by different authorities.
1. 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."
2. 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.
FEATURES OF AUDITING

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AUDITING
a. Audit is a systematic and scientific examination of the books of accounts of a business;

b. Audit is undertaken by an independent person or body of persons who are duly qualified for
the job.
c Audit is a verification of the results shown by the profit and loss account and the state of
affairs as shown by the balance sheet.
d. Audit is a critical review of the system of accounting and internal control.
e. Audit is done with the help of vouchers, documents, information and explanations received
from the authorities.
f. The auditor has to satisfy himself with the authenticity of the financial statements and report
that they exhibit a true and fair view of the state of affairs of the concern.
g The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the
transactions and examine correspondence, minute books of share holders, directors,
Memorandum of Association and Articles of association etc., in order to establish correctness
of the books of accounts.
OBJECTIVES OF AUDITING
There are two main objectives of auditing. The primary objective and the secondary or
incidental objective.
a. Primary objective – as per Section 227 of the Companies Act 1956, the primary duty
(objective) of the auditor is to report to the owners whether the balance sheet gives a true and
fair view of the Company’s state of affairs and the profit and loss A/c gives a correct figure of
profit of loss for the financial year.
b. Secondary objective – it is also called the incidental objective as it is incidental to the
satisfaction of the main objective. The incidental objective of auditing is:
i. Detection and prevention of Frauds, and
ii. Detection and prevention of Errors.
Detection of material frauds and errors as an incidental objective of independent financial
auditing flows from the main objective of determining whether or not the financial statements
give a true and fair view. As the Statement on auditing Practices issued by the Institute of
Chartered Accountants of India states, an auditor should bear in mind the possibility of the
existence of frauds or errors in the accounts under audit since they may cause the financial
position to be mis-stated.
Fraud refers to intentional misrepresentation of financial information with the intention to

deceive. Frauds can take place in the form of manipulation of accounts, misappropriation of
cash and misappropriation of goods. It is of great importance for the auditor to detect any
frauds, and prevent their recurrence.
Errors refer to unintentional mistake in the financial information arising on account of
ignorance of accounting principles i.e. principle errors, or error arising out of negligence of
accounting staff i.e. Clerical errors.
(III) Specific Objective
Primary Objective or Main Objective: -
Expression of expert opinion: - The main objective of auditing is to verify the accounts and
records and to report to the owners of the business whether the profit and loss account and the
Balance sheet have been properly drawn up according to the requirements of law, and whether
they exhibit a true and fair view of the profit and the financial position of the business. To
ensure that the primary objective of audit is achieved, an auditor must:
(a) Examine the Internal Control and Internal Check.

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AUDITING
(b) Verify whether all the books of accounts as required by law are kept.
(c) Verify whether proper accounting principles and procedures are followed.
(d) Check the arithmetical accuracy of the books of accounts.
(e) Verify the authenticity and validity of the transactions.
(f) Confirm the existence and the values of the assets and liabilities by physical verification.
(g) Find out whether the financial statement is properly drawn up.
(h) Report whether the profit and loss gives a true and fair view of the profit or loss for the year
and Balance sheet gives a true and fair view of the financial position of the business at the end
of the financial year.
Subsidiary or Ancillary objectives: - Subsidiary objectives of auditing are

(1) Detection and prevention of errors.
(2) Detection and prevention of frauds.
Detection and prevention of Errors: - Errors refer to unintentional misstatements in the records
or books.
Errors are two types namely
(1) Clerical or technical errors and
(2) Errors of principle.
Clerical Errors: - Clerical errors refer to all types of errors committed on account of clerical
mistakes.
They are
(1) Errors of omission
(2) Errors of Commission
(3) Compensating errors and
(4) Errors of duplication.
Errors of Omission: - An error of omission is one which arises when a transaction has been
omitted to be recorded in the books of accounts either wholly or partially. An error of omission
may be an error of complete omission or an error of partial omission. An error of complete
omission does not affect the agreement of the trial balance, as both the aspects of the transaction
are omitted from the trial balance, they cannot be detected easily. They can be detected only
by an intensive checking of the subsidiary books, and the postings from the subsidiary books
to the ledger. On the other hand, an error of partial omission affects the agreements of the trial
balance, as only one of the aspects of the transactions is omitted from the trial balance, it can
be detected easily.
Errors of Commission: - Errors of commission refer to errors committed in the process of
posting from the subsidiary books to the ledger accounts, casting, carry forward and balancing
of ledger accounts. Some of the errors of commission will not affect the agreement of the trial
balance. They cannot be detected easily.
Only a thorough checking of the subsidiary books and posting to the ledger can help to detect
these errors.
Compensating errors: - When the effect of one error is counter balanced, set off or
compensated by another error, the errors are known as compensating errors or offsetting errors.
Compensating errors do not affect the agreement of the trial balance, as they are counter
balanced or set off.
Errors of Duplication: - Errors of duplication arise when an entry in a book of original entry
has been made twice and also been posted twice.
Errors of Principle: - An error of principle arises when the generally accepted principles of
accountancy are not observed, while recording a transaction in the books of account. In other
words, if a transaction is recorded in the books of account against the generally accepted
principles of accountancy, the error is known as an error of principle. Capital expenditure

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AUDITING
recorded as revenue expenditure or vice versa, capital receipt recorded as revenue receipt or
vice versa is examples of errors of principle. Errors of principle will not affect the agreement
of the trial balance. Only a detailed and intensive checking will reveal these errors.
Detection and prevention of frauds: - It is intentional or willful representation or deliberate
concealment of material fact with a view to deceive, cheat or mislead somebody.
Fraud may be broadly classified into three types. They are
(1) Misappropriation of cash
(2) Misappropriation of goods
(3) Manipulation of accounts
Misappropriation, Defalcation or Embezzlement of Cash: - Misappropriation of cash
means the fraudulent appropriation of cash belonging to another person by whom it has been
entrusted. Misappropriation of cash may take place in any of the following ways:
(a) Suppression or non disclosure of Cash receipts :
The following are examples of suppression of cash receipts:
(1) By misappropriating the receipt by not recording the same in the Cashbook.
(2) By entering lesser amount on the counterfoil and misappropriating
The difference between money actually-received and the amount entered on the counterfoil of
the receipt book
(3) By not recording the receipt of sale of a casual nature for example Sale of scrap, sale of old
newspapers etc.
(4) By omitting to record cash donations received by non-profit making charitable institutions
(5) By misappropriating the cash received on discounting the bills Receivable and showing
them as bills outstanding on hand.
(6) By misappropriating cash received from debtors and concealing the same by giving
artificial credit to the debtors in the form of bad debts, Discount or sales return etc.
(7) By adopting the method of "teeming and lading" or "lapping process". This is one of the
methods of misappropriation of cash.
Under this method cash received from the first customer is misappropriated by the cashier. The
money received from the second customer is credited to the account of the first customer, the
money received from the third customer is credited to the account of second customer, and the
money received from the fourth customer is credited to the account of third customer and so
on. This process is carried out throughout the year.
(8) By suppressing the cash sales by not recording them or by treating the cash sales as credit
sales.
(9) By misappropriating the sale proceeds of VPP sales or sales of Goods on approval basis by
treating the transaction as goods Received or not approved.
(10) By under casting receipt side total of the cashbook.
Inflating the payments or showing false cash payments: - The following are examples of
this type of misappropriation:
(1) Recording fictitious or false cash purchases and pocketing the amount.
(2) Inflating the cash purchases and pocketing the difference.
(3) Recording payments to fictitious creditors for purchases and pocketing the money.
(4) Recording the payment to creditors at a figure higher than the actual amount and pocketing
the difference.
(5) Recording payments to dummy workers and pocketing the money.
(6) Recording fictitious payments of expenses and pocketing the money.
(7) Recording payments of some accounts at figures higher than the actual payments and
pocketing the difference.
(8) By showing credit purchases as cash purchases and misappropriating the amount
(9) Recording personal expenses as business expenses

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AUDITING
MANIPULATION OF ACCOUNTS
Manipulation of accounts means falsification of accounts without any misappropriation

of cash or goods.
It implies presentation of accounts more favourably than what they actually are. Manipulation
of accounts may be done in any of the following ways:
(1) Non provision of depreciation on fixed assets.
(2) Provision of less depreciation on fixed assets
(3) Provision of more depreciation on fixed assets
(4) Over valuation of assets
(5) Under valuation of assets
(6) Over valuation of liabilities.
(7) Under valuation of liabilities
(8) Recording revenue expenditure as capital expenditure.
(9) Recording capital expenditure as revenue expenditure
(10) Showing expenses of the next year in the current year’s profit and loss account
(11) Showing income of the next year in the current year’s profit and loss account.
(12) Not recording the accrued expenses in the current year’s profit and loss account.
(13) Not recording the accrued incomes in the current year’s profit and loss account.
(14) Omission of prepaid expenses.
(15) Omission of incomes received in advance.
(16) Inflating the profits by showing fictitious purchases and sales returns.
(17) Deflating the profits by showing fictitious expenses.
(18) Window dressing: - It is the practice by which the balance sheet is made to show a state
of affairs that is different from the actual state of affairs. Generally,
the practice of window dressing is adopted to make the balance sheet show a state of affairs far
better than the actual state of affairs.
Window dressing may be done in any of the following ways:
(1) Non provision of depreciation on fixed assets.
(2) Provision of less depreciation on fixed assets
(3) Over valuation of assets
(4) Under valuation of liabilities
(5) Recording revenue expenditure as capital expenditure.
(6) Showing income of the next year in the current year’s profit and loss account.
(7) Recording of fictitious sales.
(8) Recording fictitious purchase returns
(9) Showing short term liabilities as long term liabilities.
(10) Recording sales of the next year in the current year’s revenue account.
Specific objectives
There will be specific objective in respect of each type of specific audits. For example, in
operational audit, the aim of audit is to evaluate the existing operations of the entity in order to
give expert advice to improve their efficiency.
The cost audit is to check the cost records of the entity in order to make a report on the proper
ascertainment of cost of production of goods or services. Depending upon the nature of specific
audit, there may be different objective in respect of each specific audit.

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AUDITING
PROCEDURE TO BE FOLLOWED TO DETECT ERRORS
Following procedures may be adopted by the auditor to detect the errors.

1. Check the opening balances from the balance sheet of the last year.
2. Check the posting into respective ledger accounts
3. Check the total of the subsidiary books.
4. Verify all the castings and the carry forwards.
5. Ensure that the list of debtors and creditors tally with the ledger accounts.
6. Make sure that all accounts from the ledger are taken into accounts.
7. Verify the total of the trial balance.
8. Compare the various items from the trial balance with that of the previous year.
9. Find out the amount of difference and see whether an item of half or such amount is entered
wrongly.
10. Check differences involving round figures as Rs. 1,000; Rs. 100 etc.
11. See where there is misplacement or transposition of figures that is 45 for 54; or 81 for 18
etc.
12. Ultimately careful scrutiny is the only remedy for detection of errors.
THE AUDITOR’S POSITION AND DUTY IN REGARD TO DETECTION AND
PREVENTION OF ERRORS AND FRAUDS
1. Examine all aspects of the finance.
2. Vouch all the receipts from the counterfoils or carbon copies or cash Memos, sales mart
reports etc.
3. Check thoroughly the salary and wages register.
4. Verify the methods of valuation of stocks.
5. Check up stock register, goods inwards notes, goods out wards books and delivery challans
etc
6. Calculate various ratios in order to detect fraudulent manipulation of accounts
7. Go through the details of unusual items.
8. Probe into the details of the problems when there is a suspicion.
9. Exercise reasonable skill and care while performing the duty.
10. Make surprise visit to check the accounts.
An auditor’s position and duty in relation to detection and prevention of errors and frauds had
been beautifully explained in the case of Kingston Cotton Mill Company. In this case it was
remarked, “An auditor is a watch dog and not a blood hound”.
The remark an auditor is a watch dog limits the audit examination to mere verification of
accounts but does not cover detection of errors and frauds. But an effort to detect errors and
frauds and suggest ways and means to prevent the errors and frauds in the future. Verification
of accounts also implies vigilance on the part of the auditor to detect errors and frauds. As such
while verifying the books of accounts, if an auditor smells some irregularities he must follow
them h them. Up and unearth them. He should act honestly and takes reasonable skill and care
in detecting errors and frauds.
In India, the duty of an auditor has to detect errors and frauds have also been emphasized by
the Council of Chartered Accountants. According to this council, an auditor should bear in
mind the possibility the existence of fraud or other irregularities, because the financial position
may be misstated as a result of errors and frauds.
It is true that an auditor has to detect errors and frauds. But while performing his task of
detection of errors and frauds, he need not be a blood hound. He is not required to take to task
those staff that has been found guilty of committing errors and frauds. This view was upheld
in the case of London Oil Storage Company Ltd VS Seears Hasluck and Company. In this case

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AUDITING
it was held an auditor is not bound to assume when he comes to do his duty that he is dealing
with fraudulent and dishonest people. If circumstances of suspicions arise, it is his duty to probe
them to bottom.
To sum up, an auditor is not an insurer against errors and frauds. That he does not guarantee
that the books do not contain any errors and frauds. However, he has always to be very careful
about errors and frauds. He must exercise reasonable care and skill in the detection of errors
and frauds. Once he suspects the existence of errors and frauds, he must go in to the roots and
unearth them. In short, an auditor is not just a watch dog. But, at the same time, he need not be
blood hound.
ADVANTAGES OF AUDIT: -
Audit offers several advantages. They are:
1. Advantages of Audit to the business enterprise and Management
(1) Audit ensures the accuracy or correctness of the books of accounts
(2) Audit ensures the authenticity and reliability of the financial statements.
(3) Audit helps in the detection and rectification of errors and frauds.
(4) Audit helps the enterprise and management to ascertain whether the legal requirements are
complied with.
(5) Audit point out the weakness of the existing system of internal check and internal control.
(6) Audit examination makes the employees in charge of accounts and records vigilant, regular
and up- to –date in their work.
(7) Loans and credit facilities can be easily obtained by a concern on the basis of audited
accounts.
(8) Liability of an enterprise as to income tax, wealth tax, and value added tax
etc can be easily determined on the basis of audited accounts.
(9) A business can enjoy better reputation, if its accounts are audited by an independent
professional auditor.
(10) Audited accounts are more reliable as evidence in courts of law.
(11) Facilitates calculation of purchase consideration.
(12) The insurance claim can be easily determined on the basis of audited accounts.
(13) Audited accounts serve as a basis for solving the disputes as to higher wages.
(14) Comparison of accounts from year to year becomes easier since the accounts are uniformly
prepared.
2. Advantages of audit to the owners of the business:

(1) In the case of a sole trader, auditing assures him that all business transactions have been
duly accounted for and there are no errors or frauds. It also helps him to know the true facts
about the business.
(2) In the case of partnership firm, audited accounts serve as an evidence of proper management
of the affairs of the business. Audited accounts are help in the valuation of goodwill and
settlement of accounts on the admission, retirement or death of a partner. Again audited
accounts minimize the chances of disputes among the partners.
(3) In the case of a joint stock company, audit of accounts assures the shareholders that the
affairs of their company are smoothly and their investment is safe. The shareholders of a
company can value their shares on the basis of audited accounts.
(4) In the case of a co – 0p society or a trust, audit assures the members or the beneficiaries
that the affairs of the society or trust are conducted properly and their investment are looked
after properly.
3. Advantages of Auditing to others: -
(1) Lenders can depend on audited financial statements while taking a decision to grant credit
to the business concern.

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AUDITING
(2) Tax authorities can depend on audited statements in assessing sales tax, income tax and
wealth tax of the business.
(3) Audit of accounts safeguards the interests of the workers and is helpful in the settlement of
claim for higher wages and bonus.
(5) Insurance company can rely on audited accounts to settle claims in respect of damage or
loss of any business asset by fire, theft etc.
(6) The purchaser of a business can easily calculate the amount of purchase consideration on
the basis of audited accounts.
(7) Audited accounts create confidence in the minds of investors in a joint stock company.
Limitations of Auditing: -
Generally following are the Limitations of auditing
1. Non-detection of errors or frauds: - Auditor may not be able to detect certain frauds which
are committed by the clients.
2. Dependence on explanation by others: - Auditor has to depend on the explanation and
information given by the responsible officers of the company.
Audit report is affected adversely if the explanation and information prove to be false.
3. Dependence on opinions of others:- Auditor has to rely on the views or opinions given by
different experts viz Lawyers, Solicitors, Engineers, Architects etc, he cannot be an expert in
all the fields
4. Conflict with others: - Auditor may have differences of opinion with the accountants,
management, engineers etc. In such a case personal judgement plays an important role. It
differs from person to person.
5. Effect of inflation : - Financial statements may not disclose true picture even after audit due
to inflationary trends.
6. Corrupt practices to influence the auditors: - The management may use corrupt practices
to influence the auditors and get a favourable report about the state of affairs of the
organisation.
7. No assurance: - Auditor cannot give any assurance about future profitability and prospects
of the company.
8. Inherent limitations of the financial statements: - Financial statements do not reflect
current values of the assets and liabilities. Many items are based on personal judgement of the
owners. Certain non-monetary facts cannot be measured. Audited statements due to these
limitations cannot exhibit true position.
9. Detailed checking not possible: - Auditor cannot check each and every transaction. He may
be required to do test checking.
10. Auditing is a post mortem examination of accounts.
DISTINCTION BETWEEN ACCOUNTING AND AUDITING
Points of difference Accounting Auditing

1. Meaning It is recording of all the day to day It is the critical examination of the
transactions in the books of accounts transactions recorded in the books of
leading to preparation of financial accounts.
statements.
It is concerned with establishment of
2. Nature It is concerned with finalization of reliability
accounts. of financial statements.
3. Objects The object is to ascertain the trading The object is to certify the
results. Correctness of financial statements.

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4. Commencement Accounting Commences when book Auditing begins when Accounting

keeping ends. ends.
5. Scope It involves various financial It depends upon the agreement or upon

statements. It involves maintenance the provisions of law.
of books of accounts. It goes beyond books of accounts.
6. Report An accountant is not required to An auditor is required to submit a report

submit any report to the proprietor of to the proprietor of the business.
the business.
Auditing work is generally,
7. period Accountancy work is conducted conducted at the end of the
continuously throughout the year year or periodically.
8. Qualification
An accountant, who is in charge of An auditor, who is in
accounting work, need not be a charge of auditing work,
qualified person. must be a qualified person.
9.Position An accountant is an insider ie an An auditor is an outsider, not an

employee of the undertaking. employee of the undertaking.
10. Remuneration An accountant being an employee of An auditor is paid fixed fee for his
the concern is paid regular salary for work.
his work
CLASSIFICATION OF AUDIT OR TYPES OF AUDIT

Audit can be classified on different types:
( 1) Classification of Audit on the basis of Organization structure.
( 2)Classification of audit on the basis of Degree of independence of the auditor
( 3) Classification of Audit on the basis of method or approach to audit work or on the basis of
extent of work to be performed or on the basis of conduct of audit.
(4) Classification of audit on the basis specific objectives
Classification on the basis of organization or organization structure : - On
the basis of organization structure, audit may be classified into three types.
They are:
( 1)Statutory audit
( 2) Government audit
( 3) Private Audit
Statutory Audit: - Statutory audit refers to the audit of accounts of a business enterprises
carried out compulsorily under the provisions of a statute or law. It is is the audit carried out
compulsorily under any statute any law.
Features of statutory audit are:
1. Statutory audit is compulsory under law.
2. Statutory audit is required to be conducted by a qualified auditor.

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3. In the case of Statutory audit, the rights, duties and liabilities of the auditor are governed by
the statute or law applicable to the undertaking.
4. Statutory audit is an independent audit.
5. Statutory audit is an external audit.
6. Statutory audit must be a complete or full audit. It cannot be partial.
Statutory audit is carried out in a number of Organizations, such as
1. Joint stock Companies governed by the Companies Act of 1956.
2. Banking companies governed by the Banking Regulation Act of 1949.
3. Insurance companies governed by the Insurance Act of 1938.
4. Electricity supply companies governed by the electricity supply Act of 1948.
5. Co – operative societies registered under the Co –operative Societies Act.
6. Public and charitable trusts registered under Religious and Endowment Acts
2. Government audit: - Government audit refers to the audit of accounts of Government
departments and offices, Government companies and statutory or public corporations.
The features of government audit are
1. Government audit is prescribed for by law.
2. It is conducted either by the comptroller and Auditor General of India and his staff or
professional chartered accountant approved by the Comptroller and Auditor General of India.
3. It is internal audit.
4. A government audit is a continuous audit.
Objectives of Government audit
1. To ensure that all payment has been sanctioned by the competent authority.
2. To ensure that every payments is made as per the rules and regulations.
3. To see that the payments have been made to the right persons.
4. To ensure that the expenditure is not excessive.
5. To see that payments are properly classified as capital and revenue.
6. To verify the existence of stocks and stores.
7. To ensure that a proper system of stock taking has been adopted.
Government audit may be classified into three types. They are:
1. Audit of government departments and offices.
2. Audit of Government Companies.
3. Audit of Statutory Corporations registered as statutory corporations.
3.Private audit or Voluntary audit : - Where an audit is not compulsory under any statute,
but is undertaken by the owners voluntarily to get the benefit of audit, the audit is called private
audit. In other words , private audit refers to the audit of accounts of private enterprises such
as a sole trading concerns, partnership firms and other individuals and institutions.
Advantages of private audit
1. Audit assures to the owners that the accounts of the business are properly maintained and
there are no irregularities.
2. It provides a moral check on the employees.
3. It helps the owners of the business to know the real profitability and the state of affairs of
their business.
4. Audited accounts serve as a basis for assessment of tax liability.
5. Audited accounts facilitate the process of raising loans from banks and other financial
institutions.
6. Audited accounts help in the settlement of dispute and claims between the partners of a firm.
Classification of audit on the basis of Degree of Independence:-
1. Internal audit
2. External audit

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AUDITING
Internal audit: -Internal audit is a continuous and systematic review of the accounting, financial
and other operations of a concern by the staff specially appointed for the purpose. In other
words, it is the audit of accounts by the staff
specially appointed for the purpose.
Objectives of Internal audit: -
1. To ascertain whether internal check and accounting systems are adequate and effective.
2. To ascertain whether predetermined policies, plans and procedures have been complied with.
3. To ascertain the reliability of the accounting and other data.
4. To evaluate the performance of the personnel.
5. To ascertain whether the properties of the concern are safeguarded.
6. To suggest to the management the improvements desired in the internal check systems,
accounting system etc.
Features of Internal audit: -
1. It is generally undertaken by large concerns.
2. It is not compulsory.
3. The scope of internal audit may vary, depending upon the nature and size of the concern.
4. It may be in addition to external audit.
5. It is conducted by the staff of the concern.
6. The techniques and methods of auditing employed in internal audit are the same as those in
external audit.
7. It is an integral part of internal control.
8. The staff engaged in internal audit is appointed by the management. They are responsible to
the management.
Importance and advantages of internal audit
1. It is helpful to the management to ascertain whether the internal check and accounting
systems are adequate and effective to prevent errors and frauds.
2. It helps the management to ascertain whether the predetermined policies, plans and
procedures have been complied with.
3. It is helpful to ascertain the reliability of the accounting and other data complied within the
organization.
4. It is helpful to evaluate the performance of the personnel.
5. It helps to ascertain whether the properties of the concern are safeguarded.
6. It covers the review of accounting and non accounting matters.
Disadvantages
It is conducted by staff who may not be a qualified one.
1) It is optional.
2) Quality depends upon the decisions of management.
2. External Audit.
Audit conducted by independent qualified person and examines the books of accounts and
report to the management.
Difference between Government Audit and Commercial Audit
Government Audit Commercial Audit
1. It is adopted in government departments, government offices and Government Company.
2. It is compulsory.
3. It is conducted by CAGI and his staff and qualified staff.
4. Continuous audit.
5. Disbursing officer is responsible for the work of audit.
6. Treasury officer undertake preliminary audit.
1. It is conducted in private enterprise.
2. It is optional.

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3. It is conducted by professionally qualified persons.

4. Periodical audit.
5. Disbursing officer is not responsible.
6. There is no preliminary audit.
3. On the basis of Conduct of audit or methods or approach to audit work
1. Continuous Audit.
Continuous audit is one where the auditor’s staff is occupied continuously on the accounts
whole the year round and performs interim audit. It is an audit under which detailed
examination of the books of accounts is conducted continuously throughout the year. It is
continuous review of the accounts of the organization. It is generally applicable to banking
company and insurance company.
Advantages.
1) Easy and quick discover of errors and frauds.
2) Technical knowledge.
3) Quick presentation of accounts.
4) Keep the client staff regular.
5) Moral check on the client’s staff.
6) Efficient audit.
7) Preparation of interim accounts is very easy.
8) Audit staff can be kept busy.
Limitations.
1) Alteration of figures.
2) Dislocation of the work of the client staff.
3) Expensive.
4) Queries may remain outstanding
5) Extensive note taking may be necessary.
6) Chance for collusion between client staff and audit staff.
7) Mechanical and monotonous.
Precautions or steps to be taken to overcome the drawbacks:
1) Well dream up audit program should be followed by the auditor.
2) No alterations to be allowed after the accounts are audited.
3) If any alterations are made, it should be made in the rectification entries in the journal.
4) A note should be made in respect of queries asked.
5) If any alterations are made in figures before auditing, a special tick mark must be made.
6) Recommend surprise visit.
7) Rotate the audit work among auditors.
2. Final Audit or Annual or periodical audit
It is an audit carried out after the preparation of financial statement. It is an audit where the
auditor takes up his work of checking the books of accounts only at the end of the accounting
year. In this case, the audit work is commenced and completed in a single uninterrupted session.
Advantages:
1) Cost of audit is less than that of continuous audit.
2) Audit work is completed in one continuous sitting.
3) Not causing any dislocation of client work.
4) No possibility of alteration of figures.
5) It is not mechanical and monotonous.
6) Less chance for collusion between client staff and audit staff.
7) There is no lose the thread of the work.
Limitations
1) Errors and frauds remains in the accounts for long period of time.

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2) Post-mortem examination of accounts.

3) Little time for checking.
4) Rely upon test checking.
5) Not suitable for imposing moral check on the client staff.
6) Not helpful for preparing interim accounts.
7) Not suitable for large size organizations.
3.Interim Audit.
It is an audit conducted between two annual audits. In other words, it is the audit conducted in
the middle of the financial year. It is carried out for some specific purpose for declaring interim
dividend, ascertaining interim profit.
Advantages.
1) Quick discovery of errors and frauds.
2) Imposes moral check on client staff.
3) Helpful for speedup the final audit.
4) Useful for publication of interim figures.
5) Audit becomes easy and can be completed without lapse of time.
4. Balance sheet audit : - Balance sheet audit is a type audit which concentrates mainly on the
verification of the items in the balance sheet such as capital, reserves, profit and loss account
balance, liabilities and provisions and all the assets of the business.
5. Occasional Audit:- An occasional audit is an audit which is conducted once a while,
whenever the need arises. In other words , it is a kind of audit which is not conducted on
regular basis, but is conducted for a special event, time or purpose.
6. Complete Audit : - Complete audit is a kind of audit under which all the records and books
of accounts are audited by an auditor.
7. Partial Audit: - It is a kind of audit the scope of which is limited one. It is carried out in
respect of only a part of the books of accounts of a business, for a part of whole of the period.
4. Classification of audit on the basis of specific objectives: -
1. Cash Audit: - It is a type of partial audit which is undertaken for only cash receipts and cash
payment.
2. Special Audit:- It is a kind of audit with some special object in view. It is a fact finding
enquiry.
3. Operational Audit: - It is an efficient examination of the various operations of the different
functional area of business.
4. Proprietary Audit: - It is an audit in which various actions and decisions are examined to
find out whether in public interest and whether they meet the standard of conduct.
5. Efficient Audit: - It is an evaluation of overall efficiency and performance of an
organization.
6. Tax Audit: - It means audit for tax purpose. Audit required to be carried out of income tax
act of 1961. It is conducted by certified Chartered Accountant.
There are certain circumstances in which tax audit is necessary.
1. Compulsory tax audit under section 44 AB of the Income tax Act 1961
2. Tax audit for claiming deductions and Reliefs under the Income Tax Act.
3. Tax audit for Tax Consultancy and Representation.
7. Cost Audit.
It is a thorough examination of the cost accounting records of a company by a cost auditor to
ensure that they are accurate and they also follow to the cost accounting principles, procedures
and plans.
Objectives.
1) Verifying the accounting entries related in the cost books.
2) To find out whether the cost records have been properly maintained.

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3) To verify whether the cost accounting principles are complied with.

4) To find out whether the cost statements are properly dream up.
5) To verify the items of cost expenditure are correctly incurred.
6) To find out the efficiency and inefficiency of handling of material, labour and other
expenses.
7) To check up the overall working of the cost accountant.
8) To reduce the volume of work of the external auditor.
9) To detect errors and frauds.
8. Management Audit.
It is the critical examination, scrutiny and appraisal of plans, policies, procedures, objectives,
means and operational area of the organization.
It is the audit of managerial actions and decisions. It is the audit of activities of various level
of the managers.
Objectives of Management audit: -
1. To identify the overall objectives of an organization.
2. To pinpoint the deficiencies and defects in functional areas and suggest remedies for
improvement.
3. To assist the various level of management in discharge their duties.
4. To help the management in achieving co- ordination among the various departments.
5. To ensure that management objectives are achieved.
Advantages of Management Accounting: -
1. It identifies the overall objectives of the organization.
2. It reviews plans, policies, procedures and controls.
3. It assesses the performance in each functional area
4. It also ascertains the motivational system in operation in the business.
5. Suggesting ways and means for the attainment of management goals.
Criticism against management audit: -
1. It is argued by some managers and accountant that management audit is a vague concept and
so, it serves no material purpose.
2. Management audit may discourage the managers from undertaking tasks which are useful to
the organization.
3. It is argued that it will adversely affect to the efficiency and production.
9. Social Audit: - Social audit is a systematic study and evaluation of a business enterprise’s
social performance as distinguished from its economic performance. Social audit is intended
to evaluate the social performance or social contribution of a business organization. TISCO
firstly adopted social audit.
AUDIT NOTE BOOK

What is an Audit Note Book?
During the course of audit the audit clerk experiences several difficulties. He cannot remember
everything at all time. So he maintains a book with him in which he makes note of important
points and queries, which he has to refer to the client’s staff or clarify with the chief auditor.
Such a book is called Audit Note Book.
Audit note book is also called as a remembrance book. It contains all matters that come to the
notice of the auditor in the course of audit. It also plays an important part in defending the
auditors if any legal action is brought against them. Audit note book can be used as authentic
evidence in support of the work done by them.

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Audit note book may be in the form of a bound book or of a permanent file of the audit office.
It may also be in the form of loose sheets where the auditor files these sheets subsequently
according to the sequence of dates for the future reference.
Definition of Audit Note Book

E.L. Kohler formulated a detailed definition for the term. According to him,
“Audit note book is a record, used chiefly in recurring audits, containing data of work done
and comments outside the regular subject matter of working papers. 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 staff
administration, personnel assignment, time requirements and notations for use in succeeding
examination”.
Contents of Audit Note Book
An audit notebook generally consists of the following information:
1. The nature of the business and summary of important documents relating to the constitution
of the business such as Memorandum of Association, Articles of Association or Partnership
Deed, etc.
2. A list of the books of accounts maintained.
3. Particulars as to the system of accounts followed and the system of internal check in force.
4. Names of principal officers, their duties and responsibilities.
5. Progress of audit work together with the dates on which the work was undertaken and
completed.
6. Extracts from correspondence with different authorities.
7. Audit programme.
8. Allocation of work among different audit staff.
9. All queries which have not been clarified so far.
10. Lists of missing receipts, vouchers, bills, etc.
11. Any special point arising during the course of audit to which the attention of the auditor
must be drawn.
12. Particulars of cash balances, investments, fixed deposits, and the reconciliation statements
of principal bank accounts.
13. Extracts of the minutes and contracts affecting the accounts.
14. Record of audit work done with dates of commencement and of completion.
15. Particulars regarding the financial policies followed by the business.
16. All mistakes and errors discovered.
17. Points to be incorporated in the audit report.
18. Points, which need further explanations and clarifications.
19. All important matters for future reference at subsequent audits.
20. Information of permanent nature relating to the business and notes of all important technical
transactions.
These matters are very useful in preparing the audit programmes for subsequent audits.
Importance of Audit Note Book
1. Audit note book shall be taken as reliable evidence even by the Court of law in case of
dispute or if the auditor is charged with negligence.
2. It is useful for drawing the audit programmes.
Advantages of Audit Note Book
Some the advantages of audit note book are given below:
1. Audit note book enables the auditor to record important points, which arise during the course
of his audit; otherwise he might forget these points.

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AUDITING
2. An auditor can produce this book as a documentary evidence in a suit filed against him for
negligence or misfeasance.
3. It facilitates the preparation of the audit report.
4. If the assistant in charge is changed before the completion of a particular work, it acts as a
guide and makes the completion of balance work easier.
5. A credit note book makes the work of audit convenient because all the important details
about audit can be recorded in this book and, as such, any change in the staff of the auditor
does not disturb or dislocate the work of audit.
6. It can help in making an assessment of the work of audit clerks.
7. It provides a key to evaluate the efficiency of the audit staff.
Disadvantages of Audit Note Book
There are, however, certain disadvantages of audit note book. They are as follows:
1. Very often, it creates misunderstanding between the client staff and the audit staff.
2. If it is not properly and carefully prepared it cannot be used as evidence against the auditor
for negligence.
3. It develops a fault finding attitude in the minds of the staff of the audit.
4. Audit staff has to depend too much upon the client’s staff for its preparation.
Audit Programme
The written plans prepared by an auditor showing the nature, duration and extent of the audit
procedures to be adopted to conduct the audit more efficiently and effectively is called audit
programme.
While developing the audit programme, the auditor considers;
▪ Organizational structure of the firm, nature of business, its size and complexity.
▪ The experience he already had in the organization.
▪ Present environment under which the organization is functioning.
The auditor before designing the audit programme, holds discussion with the management. He
analyzes the previous year’s working papers, minutes, annual report and internal audit reports.
The auditor distributes the works to the audit staff through audit programmes, thereby
facilitating effective supervision and control of audit.
Meaning and Definition

Audit programme represents an outline of procedure to be followed to support an opinion on
financial statements. It is the auditor’s plan of action. It provides a plan of work of examination
and a set of audit procedures.
According to Megis, An audit programme is 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.
According to holmes, Audit programme is a flexible planned procedure of examination. Thus
audit programme is a planning of audit by auditor so that he may be able to complete his work
in a diligent manner and complete the work without loss of time.
PURPOSE OF AUDIT PROGRAMME
1. NO OMISSION: The purpose of audit programme is to complete whole audit work. There
should be no omission on the part of audit staff. The auditor can prepare a plan of action in
such a way that all books Of accounts and relevant record are checked.
2. ISSUE INSTRUCTIONS: The purpose of audit programme is to issue instructions to audit

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AUDITING
staff. Principal auditor issues instructions. The audit clerks can follow the instructions in order
to complete their work.
3. CONTROL AUDIT WORK: The purpose of audit programme is to control the work of
audit. It relates to supervision and direction. The auditor can watch activities of audit clerks
while work is going on. The pace of audit must be according to the time fixed for audit.
4. RESPONSIBILITY OF AUDIT STAFF. The purpose of audit programme is to fix
responsibility of audit staff for carelessness. When given work is completed according to
established standards there is no responsibility. There may be negligence of duty during audit
work.
5. EVIDENCE FOR AUDIT WORK: The purpose of audit programme is to develop an
evidence for work done by audit staff. It is a written record of audit work. The number of books
and other record examined is stated in it. The auditing clerk puts his signatures as evidence.
6. GUIDE TO AUDIT STAFF: The purpose of audit programme is to guide audit staff in
completing their work. The date, time and quantity of work are stated. The audit staffs are
engaged according to the amount of work.
7. TIMETABLE: The purpose of audit programme is to prepare a timetable for whole audit
work. The auditor is successful if he completes audit work within the stated time period. The
efficiency is noted with performance. The time fixed for work is most important.
8. CONTROLS COST OF AUDIT: The purpose of audit programme is to control cost-of
audit work. The fee is settled with the client. The auditor is able to control the cost of audit
work to be done within fixed time. The cost of an audit should not exceed fee of an auditor.
9. HELPS AUDIT: The purpose of audit programme is to facilitate audit work. The timetable
is a guideline for every person to complete his part of audit work. The questions can be asked
about doubtful entries. In this way flow of work is maintained.
10. BASIS FOR REPORT: The purpose of audit programme is to conduct an audit. This proof
becomes the basis audit report. The auditor is able to write a report on the business matters.
11. AUDIT DECISION: The purpose of audit programme is to make audit decision. The audit
programme collects basic information relating to any business. It is a systematic approach to
compile data for business.
12. FUTURE REFERENCE: The purpose of audit programme is to prepare a record for
future reference. The data may be needed for planning and checking.
CONTENTS OF AUDIT PROGRAMME
1. NAME: The audit programme contains the name of a client. The auditor can write the name
of a business. There is need of complete address of concern client.
2. OBJECTS: The audit programme contains objects of business enterprise. There are various
objects of any business unit. A small business has few objects while large companies have
many objects.
3. DATE: The audit programme contains the date of start of an audit. The auditor can consult
the client before fixing audit date. It must be convenient to management. The audit programme
can show the details
Of audit work date wise.
Advantages of the Audit Programme

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AUDITING
1. An audit program helps in ensuring that all-important areas are considered while
conducting the audit.
2. An audit program helps an auditor in the allocation of work among its team members
according to their skills and competency.
3. It enhances the accountability of audit team members towards work performed by them
4. An audit program also reduces the scope for misunderstanding among team members
regarding the performance of audit work.
5. It helps the auditor in checking the status of audit work, its progress, how much it is left for
performance while conducting the audit.
6. Auditor prepares audit working papers which contains a record of various audit procedure
applied which serves as evidence against the charge of negligence.
7. Audit program enables the auditor to keep a record of useful information specifically for
future audit and references.
Disadvantages of Audit Programme
1. Rigidity: There is no set standard audit program that can be applied in the case of every
entity. However, programs differ for different types of entities. Every entity has its own
problems. Therefore, we cannot apply for a single audit program in the case of
all business entities.
2. Reduces the Initiative of Efficient Staff: – A program reduces the initiatives of efficient
and competent staff. Thus, staff members cannot make changes in the audit plan and cannot
make suggestions to it.
3. Audit Work becomes Mechanical: The program becomes mechanical when it ignores
other aspects like internal control.
4. Overlooking New Areas: A program may overlook the new areas. With the change in time
and technology, new problems may arise which an audit program may not consider.
AUDIT WORKING PAPERS

The term audit working papers designate the files of analysis, summaries, comments and
correspondence built by an auditor during the course of the field work of an audit engagement.
These papers contain essential facts about the accounts which are under audit.
According to Arnold W. Johnson, ‘’ Audit working papers are the written private materials,
which an auditor prepares for each audit. They describe the accounting information which he
receives from his client, the methods of examination used, the conclusions (and reasons
thereof) and the financial statements.”
According to Jack C. Robertson, “Working papers are auditor’s own evidence of compliance
with generally accepted auditing standards and of the decisions respecting all procedures
necessary in the circumstances unique to the audit engagement.”

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AUDITING
They consist of draft copies of trial balances, adjusting entries, accounts analysis, schedules of
debtors and creditors summaries of reconciliation statements, certificates of official comments,
copies of correspondence between auditors and debtors, creditors and bank, detailed schedule
of items like depreciation, inventories previous audit reports, important quarries with
explanation audit programme and other important materials.
Objectives of Audit working papers
The working paper serves following purposes:
1. They represent the volume of work performed by the auditor and his staff, which helps in
preparing the report.
2. They show the extent of adherence to accounting principles and auditing standards.
3. They are useful as evidence against the charge of negligence.
4. They act as guide for subsequent examinations.
5. They enable the auditor to know the weakness of the internal check system in operation as
also the accounting system.
6. They assist the auditor in coordinating and organizing the work of audit clerks.
7. They assist in planning and performance of audit work.
IMPORTANT QUESTIONS
2. MARKS QUESTIONS
1. Define auditing
2. What is meant by error of omission?
3. What is accounting
4. What do you mean by audit note book?
5. Write note on audit working papers.
6. Define audit programme.
7. What are the objectives of audit?
5 MARK QUESTION
1. Difference between auditing and accounting.

2. What are the contents in audit note book?
3. What are the objectives/purpose of audit programme?
4. Explain the importance/advantages of audit working papers.
5. State the various types of errors.
10 MARKS QUESTIONS.
1. What are the advantages/merits/benefits and disadvantages/demerits/limitations?
Of auditing
2. Explain the objectives of auditing.
3. Explain the classifications of auditing
4. State the advantages and disadvantages of audit programme

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AUDITING
UNIT-2
INTERNAL CONTROL AND VOUCHING MEANING AND DEFINITION
Internal control is a broad term with a wide coverage. It covers the control of whole
management system. Internal control involves a number of checks and controls exercised in a
business to ensure its efficient and economic working.
According to The American Institute of Certified Public Accountants, “Internal control
comprises of the plan of organization and all the coordinate methods and measures adopted
within a business to safeguard its assets, check the accuracy and reliability of its accounting
data to promote operational efficiency and to encourage adherence to prescribed managerial
policies.”
The system of internal control can be defined as, “the plan of organization and all the methods
and procedures adopted by the management of an entity to assist in achieving the
management’s objectives of ensuring, as far as practicable, the orderly and efficient conduct of
its business.”
In brief it can be stated that internal control includes not only internal check and internal audit
but the whole system of controls, financial and otherwise, established by the management in
order to carry on the business of the company in an orderly manner, to safeguard its assets and
to secure as far as possible the accuracy and reliability of records.
Objectives/Need of the Internal Control:
1. Providing reliable data: Business decisions require accurate information to run the business
efficiently. Examples of significant areas where management requires reliable information are
fixation of selling prices production directives depending upon requirements etc. with the
efficient internal control in place the accurate, required and reliable information can be
provided for taking the important decisions and efficient performance of the activities.
2. To promote operational Efficiency: the controls within an organization are meant to prevent
unnecessary duplication of efforts, protect against waste in all aspects of business and
discourage other types of inefficient use of resources so as to promote the operational
efficiency.

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AUDITING
3. To encourage adherence to the prescribed policies: the system of internal control is meant to
provide reasonable assurance that procedures and rules of various institutes are followed by
company personnel.
4. Safeguarding assets and records: the physical assets of the company can be stolen, misused
or accidently destroyed if not properly protected by adequate controls. The internal control
helps to safeguard the physical assets and to secure the accuracy and reliabilities of the records
of the company.
INTERNAL CHECK
Meaning and Definition:
Internal check is the valuable part of the internal control. It is an arrangement of the duties of
members of staff in such a manner that the work performed one person is automatically and
independently checked by the other.
According to F.R. M.e paula, “internal check means practically a continuous internal audit
Carried on by the staff itself, by means of which the work of each individual is independently
checked by other members of the staff.”
According to D.R. Davar, “ Internal check is a system or method introduced with defined
instructions given to staff as to their sphere of work with a view to control and the verification
of their work and also the maintenance of accurate records as the ultimate aim.
According To Joseph Lancaster, “The internal check is a method of organizing the entire
operations, office, warehouse, factory and the duties to the respective staff so that frauds and
irregularities are impossible without collusion.”
All the definitions of internal check give a common idea about system organized within the
concern itself, wherein the work of one employee is automatically checked up by the other and
the possibility of error or fraud is reduced to the minimum.
Objectives of internal check:
1. To exercise moral pressure over the staff.
2. To ensure that the accounting system produces reliable and adequate information.
3. To provide protection to the resources of the business against fraud, carelessness and in
efficiency.
4. To distribute work in such a manner that no business is left unrecorded.
5. To allocate duties and responsibilities of each clerk in such a way that he may held
responsible for particular fraud or error.

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AUDITING
6. To increase the efficiency of clerks because the allocation of duties is based on the principle
of division of labour.
7. To detect errors and frauds easily if it is committed, because in an efficient internal check
system, there is a provision for independent checking.
Advantages of Internal Check:

1. Proper division of work: internal check entails a proper and rational distribution of work
among the members of staff of the enterprise keeping in view their individual qualifications,
experience and area of specialization.
2. Detection of errors and frauds: since no individual worker is allowed to handle a job
completely from the beginning to the end, and the work of each clerk is automatically checked
by the other, this helps in the early detection and discovery of errors and frauds.
3. Increased efficiency coupled with economy: A good system of internal check increases
the efficiency of work among the staff and leads to overall economy.
4. Convenience to auditor: where an organization is operating the system of internal check,
the statutory auditor may conveniently avoid detailed checking of the transactions. He may
apply a few tests here and there and can relieve himself from detailed checking.
5. Accuracy of the accounts can be relied upon: If there is a good system of internal check
the owner of the concern may rely upon the genuineness and accuracy of the accounts.
6. Increase in Profits: overall efficiency and economy in operations result in more profits-
thus ensuring larger dividends for the owners or shareholders.

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AUDITING
Internal Check, Internal Control and Internal Audit | Auditing
The upcoming discussion will update you about the differences among internal check,
internal control and internal audit.
Internal Check: Internal Control: Internal Audit:

1. Purpose: Safeguarding or minimising Formulation and Detecting and reporting errors
errors and frauds in actions circulation of and frauds and irregularities re-
transactions and records, and management garding assets committed, if any
profiting assets. So as to ensure principles and detection and prevention activity
the efficient running of busi- policies and effective
ness. and speedy

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AUDITING
execution thereof
with the help of
internal checking
and internal audit
activities.
2. Scope: Rather restricted to formulation Wider in scope than Limited to a continuous internal
and working of proper internal check and system of checking financial and
accounting and other internal audit as non-financial operations and
operational systems and specified above. reporting to internal top manage-
reporting or offering ment.
suggestions to appropriate
internal authorities.
3. Proceeds simultaneously with Spreads through the Commences after transactions are
Periodicity: initiation of transactions and process of internal completed and recorded.
ends with recording thereof checks upto taking
action on internal
audit reports
4. Internal staff with no spe- Top management Specially qualified and skilled
Personnel: cialised knowledge or skill but personnel audit staff as a part of internal
with clearly defined division of accountable to personnel responsible to senior or
each work so that no one owners/stakeholders. top management
employee can be in complete
control over completion and
recording of any transaction—
responsible to
departmental/branch/unit-
heads.

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AUDITING
VOUCHING
Vouching is concerned with examining documentary evidence to ascertain the authenticity of

entries in the books of accounts. In other words it is an inspection by the auditor of evidence
supporting the transactions made in the books. Vouching is a technique used by an auditor to
judge the truth of entries appearing in the books of accounts. Some important definitions of
vouching are:
“Vouching means testing the truth of items appearing in the books of original entry.” –
J.R. Batliboi
“Vouching is an act of comparing entries in the books of accounts with documentary
evidence in support thereof.” - Dicksee
From the above definitions we can conclude that vouching is a technique in which an auditor
verifies authenticity and authority of transactions recorded in the books and on the basis of
which he submits a report, indicating that accounts are correct, free from errors or fraud and
complete.
Objectives of Vouching:
1. All the transactions which are connected with the business have been recorded in the books
of accounts properly.
2. To verify that all transactions recorded in the books of accounts are supported by
documentary evidence.
3. The vouchers which support the entries are legally valid from the view point that they are
authentic, addressed to the business and properly dated.
4. To verify that no fraud or error has been committed while recording the transaction in books
of accounts.
5. The vouchers have been processed carefully through various stages of internal check system.
6. While recording the transaction whether distinction has been made between capital and
revenue items.
7. Whether accuracy has been observed while totaling, carrying forward and recording an
amount in the account.
VOUCHING OF CASH TRANSACTIONS:
How to vouch various cash receipts (Receipt side)

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AUDITING
1. Cash sales: In vouching cash sales, cash register should be fully checked with carbon copies
of cash memos. Then, the auditor should verify the daily deposits of cash received in the bank
dates of the cash and the date on which the receipts are recorded in cash book must be same.
Where the cash memos are cancelled, all copies including the original copy duly cancelled
should be kept in the book. Where a company has a discount policy, if more discount is allowed
in a transaction it must be approved by a responsible officer.
2. Cash received from the debtors: The auditor should verify amount received from debtors
from the counterfoils or carbon copies of the receipt issued to the customers. All these receipts
should be serially numbered. Amount should be entered in the cash book on the day when
received. Discount allowed to customers should be authorized by a responsible officer.
Sometimes correspondence made with customer can also be verified.
3. Loans: While vouching the loans received, the terms and the conditions contained in the
agreement should be verified. If the loan is secured what security has been offered, whether
the fact has been disclosed in the balance sheet.
4. Bills receivable: Bills receivable book maybe verified because the various details regarding
the bills matured and discounted are available in it. Auditor should check the amount received
with the bank statement. Some bills might have become due but no amount has been received.
Whether the entry for the dishonor of such bill has been made.
A verification of the bills discounted should be made. Whether, entry for discount has been
made. Such bills should appear as contingent liability in the balance sheet; if the date of
maturity is after the date of balance sheet.
5. Sale of Investment: If the sales have been affected through a bank, the auditor should
examine the bank advice to know the various details. Sometimes the investment is sold through
the broker. Broker’s sold note or commission should be examined to verify the sale proceeds
and commission charged by the broker.
If the investments are sold at cum-dividend price, auditor should see that proper apportionment
has been made between capital receipts and revenue receipts.
Sometimes the investments are made against specified funds. Profit or loss on sale of such
investments must be transferred to such funds account.
6. Sale of Fixed Assets: Sale of fixed assets may be vouched with minute book of board of
directors, correspondence, agents’ sale account and sale contract. It should be seen that proper
account has been credited. Any profit arising on the sale of asset shall be credited to revenue

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AUDITING
account which is not available for distribution of dividends. If any expense on the sale of assets
is paid, the sale proceeds of the asset should be reduced by such amount and the balance should
be credited to asset account. It must be seen that sale of fixed assets has been sanctioned by the
authorized person or committee.
VOUCHING OF CASH PAYMENTS (PAYMENT SIDE):
1. Cash Purchases: good purchased are actually received by store keeper. Cash memos can be
compared with goods inward book to verify the goods received. Only the net amount (after
trade discount) should be entered in the books.
2. Payment to creditors: Should be examined with the receipts issued by the creditors. The
receipts should indicate the purpose for which the payment has been made. If the payment is
made in full and final settlement of account, the balance should be accounted for as discount
received. Where the payment is made in excess of the bill, either the excess payment is in
advance or the payment is made by mistake, which should be recovered back from the creditor.
3. Bills payable: Bills payable honored on the date of maturity and is returned by the payee
after receiving the payment. These bills should be cancelled after being paid. Bills payable paid
can be vouched with bills book. If the payment is made by the bank, bank statement or pass
book can be examined to verify the payment of bill
4. Wages: wages paid and calculated for various months should be compared. If the wages of
particular month differ from the preceding month, the auditor should look into the reasons for
difference. Random checking of wages calculations should be made. The auditor should see
the proper record is maintained for unpaid wages, deductions for any advance taken by the
worker should also be verified, and deductions made from the wages should also be entered in
the proper account. Special attention should be given to the payments made to casual workers.
5. Payment Of Salaries: in vouching the payment of salaries following points are important
a. Auditor should check salary register with the entries made in the cash book
b. He should examine carefully alterations in the amount of deductions on account of fines,
funds, loans, insurance etc.
6. Purchase of Investment: the auditor should compare the investment purchased with
Broker’s Bought Note. If the possible, physical verification of investments should be made.
Investments must be in the name of the company. Where the investments are purchased at cum-
interested price, interest included in the purchase price should be debited in the interest account
and the balance in investment account. Later on when the interest is received on the investment,
it should be credited in the interest account.

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AUDITING
7. Rent paid: the auditor should verify the payment of rent from the agreement. The ret voucher
should be supported by rent receipt from the landlord. It should be seen that payment of rent is
sanctioned by responsible officer.
8. Loans: Auditor should be that the loan voucher should be supported by the receipt given by
the party. Further details regarding terms and condition of the loan can be verified from the
loan agreement. It should be seen that installment of loan along with interest are received in
time. Mortgage Deeds and other documents should also be examined.
9. Interest on Loan: Auditor should verify that rate of interest on loan does not differ from the
terms and conditions of loan agreement. Debenture interest can be verified from debenture
interest book. All the payments of interest must be supported by vouchers and receipts.
VOUCHING OF TRADING TRANSACTIONS
Vouching of purchase book:
The main aim vouching of purchases book is to see that all purchase invoices are entered in
purchases book and the goods entered in the purchases book are entered are actually received
by the business.
While vouching credit purchases the auditor should examine and see the following points.
i. There should be proper record for all purchase orders. A duplicate copy of the order is kept
in office for record.
ii. A copy of purchase order shall be send to the Accounts Department.
iii. All goods received should be recorded on goods received note; a copy of it should be sent
to Accounts Department.
1. The auditor should see that only credit purchases of the goods are recorded in purchase book.
2. The purchases book can be verified from purchase invoices, copies of orders placed, goods
received note, goods inward book, copies of challans from suppliers.
3. The quantity mentioned in the invoice must be same as is shown in the purchase order.
4. The price charged by the supplier must be as per quotation/pricelist of the supplier.
5. The supplier bill must be in the name of business and for the period under audit.
6. While vouching the purchase vouchers, each voucher should be stamped or initialed after
examination, so that it could not be produced again.
7. Any purchase, made not for the purpose of business of the client, must not be debited to
purchase account.

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AUDITING
8. Duplicate invoices must not be entered in the purchase book if original invoices have already
been recorded.
9. The auditor should be more careful while vouching the purchase made in th first and last
month of the accounting period, because sometimes the purchase of last year may be included
in the purchases of first month of current year or purchases of the last month of current year
may be recorded in the next.
Vouching of Purchase Returns
While vouching the purchase returns the following points should be taken into consideration
by the auditor.
1. He should see that a Debit note has been sent to the supplier or Credit note has been received
from the supplier.
2. The quantity returned as per the return note must correspond with storekeeper’s record,
return outward register and gatekeeper’s outward register.
3. The amount showed in the credit note should be verified.
4. He should be careful about the recordings of purchases return in the current year. Sometimes
the profits of current year may be manipulated by recording current year’s purchases return in
the subsequent year.
5. The purchases return of the first month and last month of the Accounting year should be
vouched carefully, to detect any manipulation of amounts.
Vouching of Credit Sales
1. The sales register should be examined with copies of sales invoices. The sale of capital items
should not be recorded in the sales book, otherwise the profits will be inflated.
2. Test check should be applied on the calculations made in sale invoices.
3. The totaling and the castings of sales book should be verified.
4. Sales Tax, duties collected thorough sales invoices must be recorded under separate
accounts.
5. It should be verified that all sales invoices are prepared on the basis of challans and then
sales invoices are entered in sales book and from there, posted to their respected accounts.
6. Sales made in the current year must be recorded under that year and shall not be treated as
sales of subsequent year.
7. All cancelled sales invoices must be kept together for verification by auditor, Who should
see that cancelled invoices are properly treated in the books.

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AUDITING
8. The statement of accounts should be verified by getting confirmations from the customers.
Vouching of Sales Return
The Auditor should pay special attention to the following while vouching the sales return
1. Date on which the goods are actually retuned.
2. Credit note or Debit note of sales return.
3. Gatekeeper’s receipt book.
4. Return inward register.
5. Stores records.
6. Corresponding entry for the return of goods in customer’s account.
7. Goods returned should form the part of closing stock at cost price or market price whichever
is less.
Vouching of Goods sent on consignment basis
The goods sent on consignment basis by principal to his agent should not be considered as sale.
Only when the goods are sold by the consignee, the entry for sale should be made in the books.
The goods sent on consignment still lying with the consignee should be taken into closing
stock. A separate book should be maintained to show the record of goods sent on consignment
basis. At the end of the year an account sale is received by the consignee, indicating the goods
sold by him and balance of closing stock of goods sent on consignment basis. The auditor
should verify the goods sent on the consignment basis from proforma invoices, goods outward
register, correspondence with consignee and account sales.
2 Marks question
1. Define internal check

2. What is internal control?
3. What do you mean by internal audit?
4. What is Vouching?
5. Define Voucher
5 and 10 Mark questions
1. Explain the objectives of internal check

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AUDITING
2. Distinguish between internal check and internal audit and internal control
3. What are the advantages of internal control?
4. List out the objectives of Vouching
5. How do you Vouch the various cash transactions? Explain
6. How do you vouch the various trade transactions? Explain
Unit -3
VERIFICATION AND VALUATION OF ASSETS AND LIABILITIES

Verification means the procedures normally carried out at the year end, to confirm the
ownership, valuation and existence of items at the balance sheet date. In simple words
verification means, proving the truth or conformation.‘
―The verification of assets implies an enquiry into the value, ownership and title, existence
and possession, and the presence of any charge on the assets.‖ - Spicer and Pegler
VALUATION
Valuation means to set the exact value of an asset on the basis of its utility. Valuation forms an
important part of the everyday audit. It is because the accuracy of balance sheet depends much

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AUDITING
upon how correctly the estimation of the value of various assets and liabilities has been made.
Both over valuation and under- valuation of assets and liabilities would exhibit wrong picture
of the financial affairs of a concern. The auditor has to see that the assets and liabilities
appearing in balance sheet have been exhibiting their proper value i.e. neither they have been
over-valued nor under- valued.
METHODS OF VALUATION:
Cost price: The price which is paid for the acquisition of an asset is known as cost price,
of course the expenses incurred in the purchase of an asset and its installation in its cost price.
Market value: A value which an asset can fetch in the market when sold is known or
termed as Market value.
Replacement Value: It is a price at which a particular asset can be replaced. The assets
such as commission, freight etc. is included in such a value.
Book Value: A value at which an asset appears in the books of accounts is known as its
book value. It is usually the cost less depreciation written off so far.
Going Concern value or Conventional value or token value or Historical value: It Is
equivalent to the cost less reasonable amount of depreciation written off. No notice is taken of
any fluctuation in the price of the assets. Reason for this is that these assets are acquired for
use in the business and not for sale.
Residual Value: A value which will be realized in the market and received from the sale
of an asset it is known as its realizable Value.
Scrap Value: A value which is obtained from the asset if it is sold as scrap.
Verification and Valuation of Different assets

For the purpose of convenience we may divide the assets in the following categories
1. Intangible Assets. Viz., goodwill, patents, trademarks, copyrights etc.
2. Fixed Assets viz., land and building, plant and machinery, furniture and fixtures etc.
3. Floating assets viz., cash in hand and at bank, BR, stock in trade, sundry letters etc.
Intangible assets:
1. Goodwill:
Verification: Where goodwill has been purchased along with a running business, the same
should be verified from the agreement with the vendor showing the price paid
for it. But when the amount is not specially fixed, the goodwill is the amount for the purchase
of the business over the net assets taken over.
It should be verified that the goodwill has been recorded in the books of accounts only when
some consideration in money or its equal has been paid for.
In case of partnership the auditor should verify the changes made in the goodwill account from
time to time on the basis of provisions made I the partnership deed.
Manonmaniam Sundaranar University, Directorate of Distance & Continuing Education,
Tirunelveli
Valuation: Goodwill should be valued at a cost less amounts written off.

2. Patents:
Verification: The Auditor should examine the patents with the help of certificate which have
granted such patent rights. The auditor should also ensure that the patents are registered in the
name of client
Valuation: patents must be valued at cost less depreciation. The patents should be written off
in a period of sixteen years after which the right automatically lapses unless the term is
extended.
1. Copyrights:

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AUDITING
Verification: In verifying the copyrights, auditor should inspect the agreement between the
auditor and the publisher.
Valuation: Generally the value of the copyright is not stable because copy rights lose their
value by passage of time. In the balance sheet copyright must be shown a cost less amounts
written off from time to time.
Trademarks:
Verification: Trademarks can be verified by examining the assignment deed duly endorsed by
the office of the registrar of trademarks. In case they have been purchased from others, the
auditor should vouch the expenditures incurred in connection with their acquisition e.g.
registration fees, payments made to designers etc.
Valuation: The valuation method is the most suitable method valuation of trademarks. it
should be seen that trademarks are properly valued and shown in balance sheet.
Manonmaniam Sundaranar University, Directorate of Distance & Continuing Education,
Tirunelveli
Fixed Asset:
1. Freehold land and building:
Verification: The auditor should examine the title deeds to ensure that they are in the name of
the client. Any addition or sale during the year should be carefully examined.
Valuation: Freehold land being a no depreciable asset is generally shown at cost which
includes the purchase price, broker‘s commission, registration fees, legal charges etc. Any
payments made to Municipality Corporation or improvement trust as developmental charges
should be included in the cost. If market realizable value is taken as basis for valuation of
freehold land the same should be disclosed clearly in the balance sheet Valuation of buildings:
Buildings should always be valued at cost less depreciation at a reasonable rate. Actually, the
market or realized value of the buildings
keeps on fluctuating. Therefore, it should be taken into account while valuing the buildings.
2. Leasehold property:
Verification: The auditor should inspect the lease agreement to find out the value and duration.
The auditor should see that lease agreement is registered with the registrar and certificate
testing to the validity of the same.
Valuation: Leasehold land and buildings are to be valued at cost less depreciation which
should be sufficient writes it off completely during the period of lease
3. Plant and machinery:
Verification: Auditor should commence the process of verification by obtaining a schedule of

plant and machinery certified by responsible officer of the concern.
Valuation: For valuing the plant and machinery, the auditor should prepare a list of each
machine from the plant register and should get the list certified by the woks manager. The
auditor should see the plant and machinery account is shown in the balance sheet at cost less
depreciation after making proper adjustments regarding new purchases of machinery and sale
of older machinery during the year.
Floating Assets:
1. Cash in hand:
Verification: The auditor should verify the cash in hand by actually counting it on the date of
balance sheet.
2. Cash at Bank:

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AUDITING
Verification: The auditor should verify cash at bank by comparing the balance shown in cash
book and pass book. In verifying the bank balance the auditor should also prepare bank
reconciliation statement to ascertain the correct position.
3. Stock in trade:
Verification: It is practically impossible for auditor to physically verify each item of the stock
in hand because of various reasons i.e. limited time and the lack of technical knowledge.
Therefore the auditor has to rely upon test checks to ascertain the accuracy of stock in trade
Valuation: The stock in trade being a floating asset should be valued at cost price or market
price whichever is less.
The cost price can be calculated from any of the following methods
a. Unit cost method
b. Average cost method
c. First in first out method (FIFO)
d. Last in first out method (LIFO)
e. Highest In first out (HIFO)
f. Base stock method
g. Adjusted selling price method
h. Standard cost method.
4. Investments:
VERIFICATION: The auditor should verify the details of the schedule of investment by
applying tests e.g. financial journals and newspapers should be consulted for checking the
market rates. The securities themselves may be consulted or the broker‘s notes may be
examined for checking the cost etc.
The auditor should verify the amount of interest or dividends ass have already have been
declared before the date of the balance sheet, should be taken into account as outstanding ones.
Valuation:
If investments are to be held as a fixed asset for the purpose of earning interest/dividend; these
are to be valued at cost which includes brokerage and stamp duty paid in regard there to.But if
the investments are held as current assets, these assets should be valued at cost or market price
whichever is less. The auditor may come across the situations where the market Value is much
below the cost of acquisition of investments. Ordinarily he should ignore a temporarily fall in
the market value, but where the fall in value seems to be of a permanent nature, he should see
that adequate depreciation is provided by passing the required entries
Verification of Liabilities:
Capital:
In case of firm, the auditor should verify the liability on account of the capital with the help
of partnership deed; pass book and the cash book. In case of a company auditor should examine
the memorandum of association to verify the information as to the maximum capital
the company is authorized to raise. He should also ascertain the amount of called up in respect
of each class of shares and also ascertain how many shares of each class are allotted as fully
paid. Auditor should also specify the sources from which the bonus shares are issued i.e.
capitalization of profits are reserves for share premium accounts. He should also ensure that
capital profit, if any on issue of forfeited shares, has been transported to capital reserve.
Debenture:
The auditor should note the following points while verifying the depreciation:
a. Debenture trust deed‘ should be inspected and with its help, the debenture account in the
ledger should be examined.
b. If necessary, the auditor can obtain a certificate from the debenture holders.
c. Since the debentures are supposed to be redeemed, the auditor should see the arrangements

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AUDITING
for their redemption.

d. The debenture may be issued at par or at premium.
e. The auditor should see the details as given in the Register of Mortgages and charges.
Trade creditors:
a. The First task the auditor is to ask for schedule of creditors.
b. The purchase ledger should be checked with the books of original entry, invoices and credit
notes etc.
c. Discount on creditors should be checked with reference to creditor‘s account.
d. If any debt Is found unpaid for a longer period of time any enquiry should be made since it
is possible that instead of paying to the creditor the amount might have been misappropriate
Loans:
The auditor should examine the loan agreement in order to ascertain the terms of loan, amount
of loan and period and the nature of the loan. In case the loans are overdrafts have been taken
from a bank an agreement with the bank and a certificate to that effect should be
obtained and examined.
Outstanding liabilities for expenses:
The auditor should obtain a certificate from responsible officer of the company stating that
All outstanding liabilities for expenses incurred have been brought into account. The auditor
can verify those items of expenses which usually constitute outstanding liabilities.
E.g. salaries payable, legal expenses, rent, wages, audit fees etc.
Reserves and Funds:
The auditor should examine and verify that whether the decision to create reserve or fund is
dictated by needs and circumstances of business and relevant legal provisions and check the
relevant entries in books of accounts and check the entries passed for the purpose in the profit
and loss appropriation account.
Income Received in Advance
The auditor should examine the schedules of income received in advance and ensure that these
are fully disclosed in the balance sheet The auditor duty is to examine whether interest,
rent, installments etc, received in advance should be classified as liability and shown as such
in the balance sheet.
DIFFERENCE BETWEEN VOUCHING AND VERIFICATION
It has been stated earlier that both vouching and verification are very important aspects to
auditing. However, verification is a much wider term than vouching. The points of difference
between the two may be stated as follows:
(1)Vouching means substantiating an entry in the books of account with the supporting
vouchers like receipts, invoices, correspondence, contracts etc.
Verification means examining with regard to the assets shown in the balance sheet that they
exist, are in the name of the company, are properly valued and are free from any charge.
(2)The object of vouching is to check that the entries made in the books of accounts are correct.
Whereas the object of verification is to check the existence, valuation, ownership and
possession of the assets.
(3)Vouching is carried out with the help of vouchers. Verification includes in addition to
vouching, the checking of physical existence, valuation and ownership of the assets.
(4)Vouching is done at any time during the year. Verification is done only after accounts are
completed and balances are drawn.
.(5)Vouching of assets is undertaken once during the life time of the asset.
Verification of assets shown in the balance sheet is done every year.
(6)Vouching does not include valuation of assets and liabilities. Verification includes valuation
of assets and liabilities.
(7)Vouching is the first step taken before verification. It involves examining the transactions

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AUDITING
when they take place. Verification is the next step after vouching is completed. It includes
checking many aspects of assets and liabilities.
DIFFERENCE BETWEEN VALUATION AND VERIFICATION
1. Meaning Verification means checking Valuation means

whether the assets shown in determining the proper
the balance sheet are in the values of assets and
name of business, whether liabilities shown in the
they exist or not, whether balance
there is any charge on it etc. sheet
2. Purpose The purpose of verification is The purpose of valuation is

to check existence, to determine the proper
ownership and possession of values of assets as per
assets. generally accepted
principles.
3. Basis The basis of verification is The basis of valuation of

the type of assets, and assets is the types of assets
liabilities. There is not fixed are valued on different basis
method of
Verification.
4. Certificate The auditor is not able to get The auditor is entitled to get
certificate of verification of certificate of valuation of
assets and liabilities. assets from responsible
officer of the
business unit.
5. Vouching Verification includes Valuation does not include

vouching. vouching
6. Scope The scope of verification is The scope of valuation is

wide. It includes checking of limited. Here only values of
many things like existence, assets and liabilities are
ownership, possession etc. determined
and checked.
2 mark question
1. Define Valuation
2. What is Verification
3. What are current assets?
4. List out current liabilities.
5. Write any for fixed assets

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AUDITING
5marks and 10 marks questions
1. Differentiate between valuation and verification

2. Distinguish between verification and vouching
3. Explain various methods of valuation
4. State the procedure for Verification and valuation of fixed assets and current assets
5. State the procedure for Verification and valuation of Current assets.
Unit-4
AUDIT OF COMPANIES
Qualities of an Auditor:
The Auditor must possess the following qualifications and qualities:
1. Only the qualified chartered accountant can be appointed as auditor of a limited company.
2. The auditor must have thorough knowledge of principles and practice of all aspects
of accountancy. He must be familiar with all systems of accountancy in use.
3. He should have adequate knowledge of financial management, industrial administration
and
business organization.
4. He must have thorough knowledge of audit case laws as per the various cases decide by
the
courts in and outside India.

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AUDITING
5. He should be able to understand the technical details of business whose accounts

he is going to audit.
6. An auditor must be honest i.e. He must certify that he does not believe to be true and
he must take reasonable care and skill before he believes what he certifies is true.
7. He must act impartially and not influenced by others, directly or indirectly while
discharging
his duties.
8. He should be hard working, systematic and methodical.
9. He must have capacity to hear arguments of others.
10. He should have adequate skills and courage to write audit report correctly clearly
and concisely.
11. He should not disclose the secrets of his client
Appointment of an Auditor
Appointment of Auditor in case of Sole proprietor: The appointment of Auditor in case
of sole trader is done by the owner of the business. In case of sole traders the auditor
generally acts as an accountant who also prepares accounts besides checking their
accuracy. As He is appointed by an individual he must get clear instructions from his client
in writing as to what he is expected to do. His work and its scope will depend upon the
agreement with his client since the appointment of an auditoris not under any statute,
therefore the rights and the duties will depend upon the agreement.
Appointment of Auditor in case of partnership:
The Auditor of a partnership firm is made by the mutual consent of all the partners
APPOINTMENT OF COMPANIES AUDITORS: The provisions regarding

appointment of the auditor
are contained in section 139 of Companies Act 2013
1. Appointment of auditor by members [sec 139(1)]:
a. A company shall appoint an individual or a firm as an Auditor at the first annual general
meeting and each subsequent sixth annual general meeting.
b. Such auditors shall hold office till conclusion of sixth annual general meeting.
c. Such appointment shall be placed before the members at each annual
general meeting for ratification.
2. Period for which the appointment is made [sec 139(2)]:
a. An individual can be appointed for a term no more than five years.
b. An audit firm can be appointed for a consecutive term not more than two terms of five
years.
c. An individual or a firm which has completed its term shall not be eligible for
reappointment as auditor in the same company for five years from the completion of term.
3.Appointment of auditor of Government companies (sec 139 (5)):
The comptroller andAuditor general shall in respect of financial year appoint an auditor duly
qualified within 180 days from the commencement of financial year who shall hold office
till conclusion of annualgeneral meeting.
4.Appointment of First Auditor by Board of Directors [sec139 (6)]:
The first auditor of acompany other than government company shall be appointed by the
board of directors within 30 days of registration of company. If the board fails to appoint
first auditor it shall inform the members of company who shall appoint auditor within 90

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AUDITING
days at extra ordinary general meeting who shall hold the office till conclusion of first
annual general meeting.
5.Appointment of First Auditor of Government Company [sec 139 (7)]:
The first Auditor of a Government Company shall be appointed by Comptroller and
Auditor general within 60 days of registration of company. In case of its failure to appoint
first auditor, then board of directors shall appoint auditor within next 30 days. The company
shall inform the members if the board fails to appoint first auditor who shall appoint the
auditor within 60 days at extra ordinary general meeting who shall the office till conclusion
of the first general meeting.
6.Casual vacancy of an Auditor [sec 139 (8)]:
a. The casual vacancy of auditor, except in case of Government Company, shall be filled
by the board of directors within 30 days but if it arises as a result of resignation of the
auditor it shall be approved by company at general meeting convened within 3 months o
recommendation of board. Such auditor shall hold office till conclusion of next annual
general meeting.
b. Casual vacancy in case of Government Company shall be filled by
Comptroller and Auditor General within 30 days if he fails to fill the vacancy,
the board shall fill the vacancy within next 30 days.
Reappointment of a retiring auditor [sec 139 (9)]:
Such an auditor can be reappointed at annual general meeting if.
a. He is not disqualified for reappointment.
b. He has not given notice to company of his unwillingness.
c. A special resolution has not been passed at annual general meeting
appointing some other person or providing expressly that he shall not be
reappointed.
All the above is subject to the provisions of sec 139 (1)
QUALIFICATIONS OF AN AUDITOR:
1. A person shall be eligible for the appointment of an auditor of a company only if he is a

chartered accountant.
2. Where a firm including a limited liability partnership is appointed as an auditor of a
company, only the partners who are chartered accountants shall be authorized to act and
sign on behalf of firm.
Disqualifications of an Auditor:
The following persons shall not be eligible for the appointment as an auditor of a company:
1. An officer or employee of the company.
2. A person who is a partner, or who is in employment or an officer or employee of the
company.
3. A person or a firm who, whether directly or indirectly has business relationship with the
company, or subsidiary of such holding company or associate company of such nature as
may be prescribed.
4. A person whose relative is director or is in the employment of the company as director
or key managerial personnel.
5. A person who is in full time employment elsewhere or a person or a partner of a firm
holding appointment as its auditor, if such persons or partner is at the date of such
appointment or reappointment holding appointment as auditor of more than 20 companies.

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AUDITING
6. A person who has been convicted by a court of an offence involving fraud and a period
of 10 years has not elapsed from the date of such conviction.
REMUNERATION OF AN AUDITOR (SEC 142)
1. The remuneration of the Auditor of a company shall be fixed in its general meeting or
in such manner as may be determined therein.
2. The Remuneration under sub section (1) shall, in addition to the fee payable to an
auditor, include the expenses, if any, incurred by the auditor in connection with the audit
of the facility extended to him but does not include any remuneration paid to him by any
other services rendered by him at the request of the company.
REMOVAL, RESIGNATION OF AN AUDITOR
1. The Auditor appointed under section 139 may be removed from his office before expiry
of is term only by a special resolution of the company after obtaining the previous approval
of the central Government.
2. The Auditor who resigns from the company shall file within a period of thirty from the
date of resignation, a statement in a prescribed form with the company a registrar, the
auditor shall also file such statement with the comptroller and auditor –general indicating
the reasons and other facts as may be relevant with regard to his resignation.
Rights & Powers of Auditor
1. Right of access to Books of account & Vouchers [Sec. 143(1)]

2. Right to obtain information & explanation [Sec. 143(1)]
3. Right to visit branch offices & access to branch account
4. Right to receive notice & attend general meeting
5. Right to make representation
6. Right to report to members
7. Right to sign audit report
8. Right of seeking opinion of an expert
9. Right to receive remuneration
Right of access to Books of account & Vouchers
The auditor has a right to access, at all times the books of accounts & vouchers of the company,
whether kept at head office or elsewhere. It is an absolute right & is not subject to any
restriction, exception or qualification.
The term book includes all types of books such as financial statutory or statistical books. The
right of access at all times implies that an auditor can inspect the books, accounts & vouchers
of the company during the normal business hours of the audit.
Right to obtain information & explanation

An auditor of the company is entitled to required from the officers, of the company such
information & explanation as he may think necessary for the performance of his duties as an
auditor. The auditor is bound to state in his report whether he has obtained all the information
& explanations which to the best of his knowledge & belief were necessary for the purpose of
the audit.

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AUDITING
Right to visit branch offices & access to branch account

Where the accounts of any branch office are audited by a person other than the company’s
auditor, the company’s auditor is entitled to visit the branches, if he deemed it necessary to do
so for the performance of his duties as an auditor.
However, the auditor does not have right to visit foreign branches of a banking company & it
will be adequate if he is allowed access to such copies of extracts from the books or accounts
of the branch as have been sent to the principal office in India.
Right to receive notice & attend general meeting

The auditor has the right of receiving all the notices & other communications relating to any
general meeting of a company which any member of the company is entitled to have. He is
entitled to attend any general meeting & to be heard at any general meeting which he attend on
any part of the business which concerns him as an auditor.
However, the auditor has no obligation to attend such meetings. Also, this right does not extend
to board meeting.
Right to make representation

The retiring auditor is entitled to receive a copy of the special notice intending to remove him
or proposing to appoint any other person as auditor. The retiring auditor has a right to make his
representation in writing & request that the same is circulated among the members. In case the
same could not be circulated, the auditor may require that the representation shall be read out
at the general meeting.
Right to report to members

The auditor has right as well as duty to make a report to the members on the accounts examined
by him & to state whether in his opinion & to the best of his information & explanation given
to him. Auditor has to state whether the financial statements give a true & fair view of the state
of affairs of the business of the company.
Right to sign audit report
The auditor has right as well as duty to sign the audit report & the balance sheet & the profit &
loss account including all the documents attached or annexed therewith.
Right of seeking opinion of an expert

In respect of any special technical matters, the auditor is entitled to consult & take the opinion
of an expert. He is also entitled to take legal advice so as to discharge his duties efficiently.
Right to receive remuneration

The auditor has an inherent right to receive remunerations for auditing the accounts of the
company, though such rights accrue only after he has completed the work.
Duties of Auditor
1. Report to members [Sec.143(2)]

2. Examination of accounts

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AUDITING
3. Reporting on true & fair view

4. Duty as to Enquiry [Sec.143(1)]
5. Report as to additional matters
6. Duty to sign report
7. Duty as to statutory report
8. Duty as to prospectus [Sec.56]
9. Duty to assist investigation
Report to members [Sec.143(2)]

The auditor is required to make a report to the members of the company.
• On the accounts examined by him.

• On the balance sheet & profit & loss account.
• On every other document declared by the act.
His report must state whether in his opinion & to the best of his information & according to the
explanations given to him the said accounts give a true & fair view in case of balance sheet, of
the state of company’s affairs as at end of the financial year, & in the case of the profit & loss
account for its financial year.
Examination of accounts
The auditor has to state in his report
• Whether he is obtained all the information & explanations which to the best of his
knowledge & belief were necessary for the purpose of audit.
• Whether in his opinion proper book of accounts as required by law has been kept by the
company & proper returns adequate for the purpose of audit have been received from the
branches not visited by him.
• Whether any branch audit report under section 228 forwarded to him & how he has dealt
with the same in preparing auditors report.
• Whether the company’s balance sheet & profit & loss account dealt with the report are in
agreement with the book of account & returns.
• Whether in his opinion the balance sheet & Profit & loss account comply with the
accounting standards.
• If any adverse effect on the functioning of the company is observed it needs to be comment
in bold & italic font.
• Whether any director is disqualified from being appointed as director under sec. 274 (i) (g)
Whether cess payable under sec. 441A has been paid & if not the details of the amount of
cess.
Reporting on true & fair view
The primary duty of the auditor is to express his opinion whether the balance sheet shows true
& fair view of the state of company’s affair as at the end of the financial year.
Scheduled VI refers only to the minimum disclosure requirement, if certain information has a
material bearing on the representation made in the financial statements, it must be disclosed
even if there is no legal requirement for its disclosure under schedule VI.

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AUDITING
Before expressing his opinion on the truth & fairness of the financial statement, the auditor
must ensure
• They are drawn up according to exact legal requirements.

• They show the financial position & profit & loss without any distortion.
• They do not contain any misstatement as to income or expenses.
• They have generally accepted principles of accounting have consistently been followed in
drawing up financial statements.
• All necessary information is made available to shareholders as to the true financial position
of the company.
Duty as to Enquiry
It is the duty of the auditor to enquire
• Whether loans & advances made by the company on the basis of security have been properly
secured & whether the terms on which they have been made are not prejudicial to the interest
of the company.
• Whether the transactions are represented merely by book entries are not prejudicial to the
interest of the company.
• Whether the company is not an investment company or a banking company, whether so
many of the assets of the company have been sold at a price less than at which they were
purchased by the company.
• Whether loans & advances made by the company have been shown as deposits.
• Whether personal expenses have been charged to revenue account.
• Whether the position is stated in books of accounts & balance sheet is correct, regular &
misleading.
The auditor is not required to report on the matters specified under this section unless he has
any special comments to make on any of the items referred to therein. If he is satisfied as a
result of the enquiries, he is not required to report that he is so satisfied.
Report as to additional matters

In exercise of this power, the Central Government has issued Companies ( Auditor’s Report )
Order CARO,2003. The auditor has to make a statement on each of the matters specified in the
order.
Duty to sign report

It is the duty of the auditor to sign the auditor’s report or sign or authenticate any other
document of the company required by law to be signed or authenticated by the auditor. In case
of a firm, only a partner of the firm practicing in India can sign the report.
Duty as to statutory report

It is the duty of the auditor to certify as correct that part of the statutory report that relates to
• The shares allotted by the company.

• Cash received in respect of such share
• Receipt & payments of the company.

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AUDITING
Duty as to prospectus
Section 56 deals with matters to be stated & the reports that is to be set out in the prospectus.
It is the duty of the auditor to certify this report for the purposes of the prospectus.
Duty to assist investigation

Where any investigation has conducted, it is the duty of auditor.
• To preserve & to produce all books & papers relating to the company to inspector.
• Give to the inspector all assistance in the connection with investigation.
It may be noted that no limitation can be placed upon the duties of the auditor under section
227, either by the articles of the company or by any resolution of the members.
Scope of Duties of Auditor
The scope of duties of an auditor depends upon the nature of the business carried on by the
concern. The duties & the responsibilities can be briefly summarized as follows:
• To verify that the statements of account are drawn up on the basis of the books of the
business. However, the auditor is not liable for facts which are concealed & kept out of
books which he cannot verify in the ordinary course of the exercise of reasonable care &
diligence.
• To verify that the statements of the account exhibit a true & fair state of affairs of the
business.
• To confirm that the management has not exceeded the financial administrative power vested
in it by the articles or by any specific resolution of shareholders passed at a general meeting.
• To investigate matters in regard to which his suspicion is aroused as to the result of a certain
action on the part of the servants of the company.
• To perform his duties by exercising reasonable skill & care. He should not rely on the
certificate of the management for those items which he can verify directly.
LIABILITIES OF AN AUDITOR:
The liabilities of an auditor can be summed under following heads:
1. Civil liabilities
2. Criminal Liabilities
1. Civil Liabilities:
(I) Liability for Negligence: The liability of an auditor arises where it is proved that his
client has suffered a loss due to his professional negligence. The auditor may be held
personally liable, if it is proved, that had he exercised reasonable care and skill, he must
have discovered the discrepancy. In a case it was held that if an auditor fails to show as
much skill and diligence as is expected of a man of ordinary prudence, he must suffer the
consequences.
(ii) Liability for misfeasance: According to section (340), the court may assess damages
against delinquent director and other officers of the company, including an auditor for
misfeasance or breach of trust. In case of an auditor who also comes within the definition

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AUDITING
of officer in section 2 (59) for purpose of the section, if he is guilty of neglect of duty or
misfeasance, so as to cause loss of company in any way, proceedings may be taken under
this section against him either independently or other officers or jointly with them. This
section provides a simple way to the company to recover damages where an auditor or any
other officer of the company is guilty of misfeasance. The time limit for bringing an action
is 5 years.
2. Criminal Liabilities:
i) Mis-statement in prospectus section 34:

Where an auditor makes false statement with material particulars in returns, reports,
prospectus or other statements knowingly it to be false or omits any material facts knowing
them to be false, he shall be punishable with imprisonment for a minimum term of 6 months
extendable to 10 years.
ii) Non compliance by auditor with section 143 and 145: If the auditor does not comply
with section 143 and 145 regarding making his report or signing or authentication of any
document and makes willful neglect on his part he shall be punishable with imprisonment
up to 1 year and with fine not less than twenty thousand extendable to five lakhs. In case
an auditor knowingly or willfully with the intension to deceive the company or
Shareholders or creditors or tax authorities, he shall be punishable with imprisonment up
to 1 year and fine not less than 1 lakh extendable up to twenty five lakhs.
iii) Failure to assist in the investigation section 217 (6):
Where the central Government appoints an inspector to investigate the affairs of the
company, it is the duty of the auditor to preserve and produce to the inspector all books and
papers relating to the company. If an auditor fails to assist the inspector in investigation,
he shall be punishable with imprisonment up to 1 year and with fine not less than twenty
five thousand extendable to 1 lakh
iv) Penalty for falsification of books section 336:
Any officer including auditor of a company which is being wound up, with an intention to
defraud or deceive any person, destroys, mutilates, alters, falsifies any books, papers or
securities. He shall be punishable with imprisonment for a term not less than 3 years
extendable to 5 years and with fine not less than 1 lakh extendable to three lakhs.
V) Penalty for deliberate act of commission or omission section 448:
If any
officer including auditor of the company deliberately make a statement in any return,
report, certificate, balance sheet, prospectus etc. which false or which contains omission of
material facts he shall be punishable with imprisonment for a term not less than 6 months
extendable to 10 years and fine not less than amount involved in fraud extendable to 3
times of such amount
AUDITOR’S REPORT
In the end, the management auditor prepares a report. On the basis of findings and definite
information, the auditor prepares a report making suggestions for improvement in the
working of the management. His report should give a correct assessment of the working of
organization. He should not hesitate in criticizing the management. His recommendations
should be constructive and not merely condemning in nature. His report may include the
following matters:

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

2. Whether the return to shareholders is adequate.
3. Whether the methods of production are out-dated.
4. Comparison of operating efficiency of the organization with other concerns.
5. Rate of the return on investment.
Contents of Audit Report
Under section 227 (2) every auditor is required to make report to the shareholders on the
accountants examined by him and every balance sheet and profit and loss A/c and every
document declared by law to be part of or annexed to the balance sheet and profit or loss
A/C which are placed before the shareholders of the company at the general meeting during
tenure of his office. The report has to state whether, in his opinion and to the best of his
information and according to the explanations given to him, the said accountants give the
information required by the Companies Act in manner so required and give a true and fair
view.
i. In the case of the balance sheet, of the state of the company‘s affairs as at the end of its
financial year; and
ii. In the case of profit and loss account, of the profit or loss account for its financial
year. Sub-section (iii) of the section 227 required that the auditor‘s report shall also
state.
a. Whether he has obtained all the information and explanations which to the best of his
knowledge and belief were necessary for the purpose of his audit;
b. Whether in his opinion, proper books of account as required by law have been kept by
the company so far as appears from hiss examination of these books, and proper returns
adequate for the purposes of his audits have been received from the branches not visited by
him .
c. Whether the report on the accounts of any branch office audited under section 228 by a
person other than the company‘s auditor has been forwarded to him and how he has dealt
with the same in preparing the auditor‘s report.
d. Whether the company‘s balance sheet and profit and loss A/C dealt with by the report
are in agreement with the books of accounts and returns.
If any of the matters as referred to in section 227 (2) and (3) is answered in the negative or
with the qualification the auditor has to state in his report the reasons for such answer.
Qualified opinion /report
Qualified report is given by the auditor in either of these two cases:
When the financial statements are materially misstated due to misstatement in

one particular account balance, class of transaction or disclosure that does not
have pervasive effect on the financial statements.
When the auditor is unable to obtain audit evidence regarding particular account balance, class
of transaction or disclosure that does not have pervasive effect on the financial statements.
The report is mostly like a Clear Opinion Report and only includes a paragraph viz. Basis
for Qualification after Scope paragraph and before Opinion paragraph. Opinion paragraph
in addition to its standard wording includes ―except for the matter described in Basis
for Qualification paragraph the financial statements give true and fair view.‖

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AUDITING
Detailed below:
A Qualified Opinion report is issued when the auditor encountered one of the two types
of situations which do not comply with generally accepted accounting principles, however
the rest of the financial statements are fairly presented. This type of opinion is very similar
to an unqualified or "clean opinion", but the report states that the financial statements are
fairly presented with a certain exception which is otherwise misstated. The two types of
situations which would cause an auditor to issue this opinion over the unqualified opinion
are:
Single deviation from GAAP – this type of qualification occurs when one or more
areas of the financial statements do not conform with GAAP (e.g. are misstated),
but do not affect the rest of the financial statements from being fairly presented
when taken as a whole. Examples of this include a company dedicated to a retail
business that did not correctly calculate the depreciation expense of its building.
Even if this expense is considered material, since the rest of the financial statements
do conform with gaap, then the auditor qualifies the opinion by describing the
depreciation misstatement in the report and continues to issue a clean opinion on
the rest of the financial statements.
Limitation of scope – this type of qualification occurs when the auditor could not
audit one or more areas of the financial statements, and although they could not be
verified, the rest of the financial statements were audited and they conform to
GAAP. Examples of this include an auditor not being able to observe and test a
company's inventory of goods. If the auditor audited the rest of the financial
statements and is reasonably sure that they conform with GAAP, then the auditor
simply states that the financial statements are fairly presented, with the exception
of the inventory which could not be audited.
The wording of the qualified report is very similar to the unqualified opinion, but an
explanatory paragraph is added to explain the reasons for the qualification after the scope
paragraph but before the opinion paragraph. The introductory paragraph is left exactly the
same as in the unqualified opinion, while the scope and the opinion paragraphs receive a
slight modification in line with the qualification in the explanatory paragraph.
The scope paragraph is edited to include the following phrase in the first sentence, so that
the user may be immediately aware of the qualification. This placement also informs the
user that, except for the qualification, the rest of the audit was performed without
qualifications:
"Except as discussed in the following paragraph, we conducted our audit..."
The opinion paragraph is also edited to include an additional phrase in the first sentence,
so that the user is reminded that the auditor's opinion explicitly excludes the qualification
expressed. Depending on the type of qualification, the phrase is edited to either state the
qualification and the adjustments needed to correct it, or state the scope limitation and that
adjustments could have but not necessarily been required in order to correct it.
For a qualification arising from a deviation from GAAP, the following phrase is added to
the opinion paragraph, using the depreciation example mentioned above:
"In our opinion, except for the effects of the Company's incorrect determination of

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AUDITING
depreciation expense, the financial statement referred to in the first paragraph presents
fairly, in all material respects, the financial position of…"
For a qualification arising from a scope of limitation, the following phrase is added to the
opinion paragraph, using the inventory example mentioned above:
"In our opinion, except for the effects of such adjustments, if any, as might have
been determined to be necessary had we been able to perform proper tests and
procedures on the Company's inventory, the financial statement referred to in the
first paragraph presents fairly, in all material respects, the financial position of…
Unqualified Opinion
An opinion is said to be unqualified, or unmodified, when the Auditor concludes that the
Financial Statements give a true and fair view in accordance with the financial reporting
framework used for the preparation and presentation of the Financial Statements. An
Auditor gives a Clean opinion or Unqualified Opinion when he or she does not have any
significant reservation in respect of matters contained in the Financial Statements. The
most frequent type of report is referred to as the "Unqualified Opinion", and is regarded by
many as the equivalent of a "clean bill of health" to a patient, which has led many to call it
the "Clean Opinion", but in reality it is not a clean bill of health, because the Auditor can
only provide reasonable assurance regarding the Financial Statements, not the health of the
company itself, or the integrity of company records not part of the foundation of the
Financial Statements.[2] This type of report is issued by an auditor when the financial
statements are free of material misstatements and are presented fairly in accordance
with the Generally
Accepted Accounting Principles (GAAP), which in other words means that the company's
financial condition, position, and operations are fairly presented in the financial statements.
It is the best type of report an auditee may receive from an external auditor.
An Unqualified Opinion indicates the following –
The Financial Statements have been prepared using the Generally Accepted
Accounting Principles which have been consistently applied;
The Financial Statements comply with relevant statutory requirements and
regulations;
There is adequate disclosure of all material matters relevant to the proper
presentation of the financial information subject to statutory requirements, where
applicable;
Any changes in the accounting principles or in the method of their application and
the effects thereof have been properly determined and disclosed in the Financial
Statements.
2 mark question
1. State the qualification of auditors

2. What do you mean by audit report?

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AUDITING
3. What is qualified audit report?

4. Write note on unqualified report.
5. What are the civil liabilities of auditor?
6. Mention about Liability for misfeasance.
7. What do you mean by liability of negligence?
5 mark and 10 mark question
1. State when auditor becomes disqualification.

2. List out the contents of audit report.
3. Explain the rights of auditor
4. Describe the duties of auditor
5. Explain the civil and criminal liabilities of auditor.
6. State the appointment provison regarding auditors under company Act
Unit-5
EDP (Electronic Data Processing) AUDIT
Meaning
Electronic data processing, also known as EDP, is a frequently used term for
automatic information processing. It uses the computers to manipulate, record,
classification and to summarize data. If someone asks what is electronic data
processing, then EPD meaning can be described as the processing of data using

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AUDITING
electronic means such as computers, calculators, servers and other similar electronic
equipment. A computer is the best example of an electronic data
processing machine. Electronic data processing is an accurate and rapid method of
data processing.
Objectives and scope of an audit change in EDP environment

The principle objectives of an audit of financial statements, prepared within a
framework of recognized accounting policies and practices and relevant statutory
requirements. If any, is to ensure that the financial statement reflect a true and fair view.
The scope of an audit of financial statements is determined by the auditor having regard
to the terms of the engagement, the requirements of relevant legislation and the
pronouncements of the institute. This would involve assessment of reliability and
sufficiency of the information contained in the accounting records and other source data
by study and evaluation of accounting system and internal controls in operation. audit
The overall objectives and scope of an does not change in an EDP environment but the
use of a computer changes the processing and storage of financial information and may
affect the organization and procedures employed by the entity to achieve adequate
internal control. Accordingly; the procedures followed by the auditor in his study and
evaluation of the accounting system and related internal controls and nature, timing and
extent of his other audit procedures may be affected by an EDP environment. The
computerization of accounts would also have an impact on the increase in fraud and
errors.
Thus when auditing in an EDP environment; the auditor should have sufficient
understanding of computer hardware, software and processing systems to plan. The
engagement and to understand how EDP affects the study and evaluation of internal
control and application of auditing procedures including computer assisted audit
techniques. The auditor should also have sufficient Knowledge of EDP to implement
the auditing procedures, depending on the particular audit approach adopted.
Thus, it is clear from the above that overall objective and scope of audit does not change
irrespective of fact that whether the accounting information is generated manually or
through EDP.
NEED FOR USING CAATs

As entities increase the use of information systems to record, transact and process data,
the need for the auditors to utilize tools to adequately assess risk becomes an integral
part of audit coverage. The use of computer-assisted audit techniques (CAATs) serves
as an important tool for the auditor to evaluate the control environment in an effi cient
and effective manner. The use of CAATs can lead to increased audit coverage, more
thorough and consistent analysis of data, and reduction in risk.
CAATs include many types of tools and techniques, such as generalized audit software,
customized queries or scripts, utility software, software tracing and mapping, and audit
expert systems.
CAATs may be used in performing various audit procedures including:
Tests of details of transactions and balances
Analytical review procedures
Compliance tests of general controls

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AUDITING
Compliance tests of application controls

CAATs may produce a large proportion of the audit evidence developed on audits and,
as a result, the auditor should carefully plan for and exhibit due professional care in the
use of CAATs.
Some of the key reasons/ Features for using CAATs are:
1. Absence of input documents or lack of a visible paper trail may require the use of
CAATs in the application of compliance and substantive procedures.
2. Need for obtaining suffi cient, relevant and useful evidence from the IT applications
or database as per audit objectives.
3. Ensuring audit findings and conclusions are supported by appropriate analysis and
interpretation of the evidence
4. Need to access information from systems having different hardware and software
environments, different data structure, record formats, processing functions in a
commonly usable format.
5. Need to increased audit quality and comply with auditing standards.
6. Need to identify materiality, risk and signifi cance in an IT environment.
7. Improving the effi ciency and effectiveness of the audit process.
8. Ensuring better audit planning and management of audit resources
CAATs DOCUMENTATION
Work papers
The step-by-step CAATs process should be suffi ciently documented to provide
adequate audit evidence. Specifi cally, the audit work papers should contain suffi cient
documentation to describe the CAATs application, including the details set out in the
following sections.
Planning
Documentation should include:
CAATs objectives
CAATs to be used
 Controls to be exercised
 Staffing and timing
Execution
CAATs preparation and testing procedures and controls
Details of the tests performed by the CAATs
Details of inputs (e.g., data used, fi le layouts), testing periods, processing (e.g., CAATs
highlevel fl owcharts, logic) and outputs (e.g., log fi les, reports)
Listing of relevant parameters or source code Audit
Evidence
Output produced
Description of the audit analysis work performed on the output
Audit findings
Audit conclusions
Audit recommendations
In audits where CAAT is used, it is advisable that the audit report includes a clear
description of the CAATs used in the objectives, scope and methodology section. The

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AUDITING
description of CAATs used should also be included in the body of the report, where the
specifi c fi nding relating to the use of CAATs is discussed. This description should not
be overly detailed, but it should provide a good overview for the reader.
In an EDP environment, the control procedures take basically two stages:

1. Manual Procedure—i.e. the clerical work done up to the translation of data into machine-
sensible form. This stage, being manual, is subjected to usual internal control conditions and
the Cost Auditor will have little difficulty in appraising them by means of ‘compliance test’
and ‘substantive’ test’.
2. Computer Procedures—i.e. the computer processing work. Auditing in this area is

actually a complex activity, for which the Cost Auditor as a prudent person should develop
himself for adequate EDP knowledge. Before he actually starts to conduct his audit in EDP
environment, he should envisage to maintain an ‘Audit Control File’, as his valuable kit.
The Computer Audit Control File may be built up containing full details of the system
including:
(i) Copies of all source documents and the details of the checks that have been done to ensure
their accuracy.
(ii) Details of physical control over source documents and any control totals on numbers,
quantities, values, including the names of the personnel keeping these controls.
(iii) Full description of how the source documents are to be converted into input media, and
the check-cum-control device.
(iv) A detailed account of the manual internal controls contained in the system, e.g. separation
of programmers from operators, control of assets from record keeping, etc.
(v) The arrangements for retaining source documents and input media for the required periods
necessitating reconstruction of stored files in the event of error, mishap, loss, etc.
(vi) A detailed Flow Diagram of what takes place during the process run.
(vii) Details of all tapes or discs produced, including their layout, labelling, storage and
retention, and
(viii) Copies of all documents of output and details of subsequent sorting and checking.
Audit Approach in EDP/ CIS Environment

There have been drastic changes in audit approaches and methodologies as a result of
emergence of CIS (Computer Information System) environment. The selection of one of
the approaches depends upon the knowledge base expertise of Auditors. There are mainly
two approaches for auditing in CIS environment that are explained as follows:
A. Black-box Approach (Auditing around the computer):
In this approach, the auditor is mainly concerned about the Inputs fed-in by the

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AUDITING
client and the output generated by the system. The auditor completely ignores the internal
processing of the Information System. For example, while testing payroll of a company,
under black-box approach, the auditor may first find out the total monthly hours worked
by selected employees from their respective time cards and then he may check the
salary/wage rate from the rate card to find out the salary/wage payable to each employee.
On the basis of above, the auditor ascertains his own output by comparing hours, rates,
extensions, over-time and leaves. Finally, the auditor compares his own results with the
system generated results. The biggest advantage of auditing around the computer is the
ease and simplicity, since the auditor does not require in-depth knowledge of system
application program in order to perform his duties. On the contrary, a major disadvantage
is that, under this approach, the auditor is completely ignorant about the internal processes
of the system. Moreover, in order to generate certain complex reports, print-outs cannot
be arranged to apply the audit procedures.
B. White-Box Approach (Auditing through the computer):

Under this approach, the auditor is not only concerned with the subject matter of the audit
(i.e. inputs and outputs), but also with the internal processing of the computer system. The
auditor focuses upon all phases of CIS activities i.e. input, processing and output. The
auditor reviews and tests general and application controls and determines their
effectiveness. This approach requires that the auditor should have sufficient knowledge
of computers, its programmes, process and controls. An auditor does auditing with the
help of Audit software and Computer Aided Audit Techniques (CAATs). Some of such
techniques are test data approach, integrated test data approach, generalised audit software
(GAS). Under test data approach the test data prepared by the auditor is processed by the
client’s processing system under the control of auditor. Then the results of the processing
are compared with the predetermined output of the auditor. In integrated test data
approach, fictitious entities are created by the auditor within the client’s actual data. The
hypothetical data for fictitious transactions are integrated with actual client data and
processed. In case of generalised audit software, audit programmes are designed by
computer manufacturers, software professionals and large firms of auditors.
INTERNAL CONTROLS IN AN EDP ENVIRONMENT

The internal controls over computer processing, which help to achieve the overall
objectives of internal control, include both manual procedures and procedure designed
into computer porgrammes. Such manual and computer controls affect the EDP
environment (General EDP Control) and the specific controls over the accounting
applications (EDP Application Controls).
EDP means (Electronic Data Processing) for the audit or a computer based systems. For
audit process of enterprise.
General EDP Controls – The purpose of general EDP controls is to establish a

framework of overall control over the EDP activities and to provide a reasonable level
of assurance that the overall objectives of internal control are achieved. These controls
may include.
a. Organization and management control are designed to establish an
organizational framework over EDP activities, including –
i. Policies and procedures relating to control functional.
ii. Appropriate segregation of incompatible functions.

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AUDITING
b. Application systems development and maintenance controls are

designed to establish control over –
i. Testing, conversion, implementation and documentation of new
or revised system.
ii. Changes to application systems.
iii. Access to system documentation
iv. Acquisition of application systems from third parties
c. Computer operation controls are designed to control the operation of the
systems and to provide reasonable assurance that –
i. The systems are used for authorized purposes only
ii. Access to computer operations is restricted to authorized personnel.
iii. Only authorized programs are used.
iv. Processing errors are detected and corrected.
d. Systems Software Controls include –
i. Authorization, approval, testing, implementation and
documentation of new systems software and systems software
modifications.
ii. Restrictions of access to systems software and documentation to
authorized personal.
e. Data entry and program controls are designed to provide reasonable assurance
that –
i. An authorization structure is established over transactions being
entered into the system.
ii. Access to data and programmes is restricted to authorized personal.
iii. Offsite back-up of data and computer programmes.
iv. Recovery procedures for use in the event of theft, loss or
international or accidental destruction.
v. Provision for offsite forecasting in the event of disaster.
DIFFERENT DESIGN AND PROCEDURAL ASPECTS OF EDP SYSTEMS –

The different design and procedural aspects of EDP systems are –
1) Consistency of performance – EDP systems perform functions exactly as
programmed and are potentially more reliable than manual systems.
2) Programmed control procedures – The nature of computer processing allow the
design of internal control. Procedures in computer programmes. These procedures
can be designed to provide controls with limited visibility (protection of data against
unauthorized access may be
provided by passwords), use with manual intervention, review of reports printed for
exception and error reporting, and reasonableness and limit checks of data.
3) Single transaction update of multiple or data base computer file – A single input
to the accounting system may automatically update all records associated with the
transaction.
4) System generated transactions – certain transactions may be initiated by the EDP
system itself without the need. For an input document the authorization of such
transaction may neither be supported by visible input documentation nor
documented in the same way as transactions which are initiated outside the EDP
system.
5) Vulnerability of data and programme storage media – Large volumes of data

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AUDITING
and the computer programmes used to process such data may be stored on portable
or fixed storage media, such as magnetic discs and tapes. These media are
vulnerable to theft or international or accidental destructions.
ASSISTED COMPUTER AUDIT TECHNIQUES (CAATs) REQUIRED IN EDP

AUDIT –
The use of computer may result in the design of systems that provide less visible
evidence than those using manual procedures. CAATs are such techniques applied
through the computer which are used in the verifying the data being processed by it.
System characteristics resulting from the nature of EDP processing that demand the use
of computer assisted audit techniques are –
1) Absence of input documents
2) Lack of visible transaction trail
3) Lack of visible output
4) Absence of appropriate control
5) Unauthorized access to data and computer programmes.
Advantages of EDP:
1. Fast: EDP access database context very speedily. Its speed depends on the
network or device.
2. Accuracy: EDP gathers accurate information accuracy depends on the EDP tool.
3. Less expensive: EDP tools are very easily available and also takes low
maintenance.
4. Storage capacity: It provides various storage media like secondary and primary
memory.
5. Automation: EDP system avoid human work during the process.
Disadvantages of EDP:
1. Training: EDP tools need extra cost for employee training.EDP tools sometimes
specify a different procedure for each tool.
2. Electricity consumption: It completely depends on electricity because EDP
equipment runs with the help of electricity directly.
3. Equipment cost/Maintenance cost: EDP system each time face lots of problem
after up-gradation of the system.
2 Marks Questions
1. Give meaning of Electronic data processing

2. What do you mean by CAAT?

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AUDITING
5 mark questions/ 10 mark question
1.State the Some of the key reasons/ Features for using caats
2.Describe CAAT documentation procedure
3.Explain Audit Approach in EDP/ CIS Environment
4.How do you make effective internal control in an EDP environment
5.What are the advantages and dis advantages of EDP audit?

.

Auditing Notes - (I - V) Units

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AUDITING

UNITS CHAPTER PAGE NO

UNIT-I Introduction 4-22

UNIT-2 Internal control and Vouching 23-33

UNIT-3 Verification and Valuation of assets and 34-39

UNIT-4 Audit of Companies 40-51

UNIT-5 EDP – Auditing 52-58

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 1

Syllabus for B.Com., only for batch 2020-2021

Year: III Year Subject Code : U20MCM502 Semester : V

Major - 14 Title: Practical Auditing

Credits: 4 Max. Marks. 75

CO1 Understanding of objectives, audit programmme and methodology of

CO2 Apply and demonstrate the accounting knowledge and skills in

CO3 Develop the degree of professionalism required of the certified

CO4 Demonstrate basic proficiency with an EDP auditing that is widely

UNIT-II: Internal control and Vouching

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 2

Internal control- Meaning- definition – Objectives- Importance- InternalCheck- Meaning-

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 3

2. Prof. L.R.Dicksee. "auditing is an examination of accounting records undertaken with a

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 4

a. Audit is a systematic and scientific examination of the books of accounts of a business;

Fraud refers to intentional misrepresentation of financial information with the intention to

Primary Objective or Main Objective: -

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 5

Subsidiary or Ancillary objectives: - Subsidiary objectives of auditing are

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 6

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 7

Manipulation of accounts means falsification of accounts without any misappropriation

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 8

PROCEDURE TO BE FOLLOWED TO DETECT ERRORS

Following procedures may be adopted by the auditor to detect the errors.

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 9

2. Advantages of audit to the owners of the business:

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 10

DISTINCTION BETWEEN ACCOUNTING AND AUDITING

Points of difference Accounting Auditing

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 11

4. Commencement Accounting Commences when book Auditing begins when Accounting

5. Scope It involves various financial It depends upon the agreement or upon

6. Report An accountant is not required to An auditor is required to submit a report

9.Position An accountant is an insider ie an An auditor is an outsider, not an

CLASSIFICATION OF AUDIT OR TYPES OF AUDIT

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 12

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 13

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 14

3. It is conducted by professionally qualified persons.

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 15

2) Post-mortem examination of accounts.

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 16

3) To verify whether the cost accounting principles are complied with.

AUDIT NOTE BOOK

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 17

Definition of Audit Note Book

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 18

While developing the audit programme, the auditor considers;

Meaning and Definition

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 19

CONTENTS OF AUDIT PROGRAMME

Advantages of the Audit Programme

Dr.S.MOHAMED RAFIQUE,M.Com,M.Phil.,MBA.,NET,SET,PhD,Assistant Professor,CAHC 20

Disadvantages of Audit Programme