SMT.

CHANDIBAI HIMATHMAL MANSUKHANI COLLEGE

DEPARTMENT OF ACCOUNTANCY

1. “Introduction to Auditing”

Q 1. Define and Explain the Meaning of Auditing? What are its advantages and disadvantages?
Ans: A) Meaning of Auditing:-
The word audit is derived from the Latin word “Audire” which means to hear.
In olden days, when the owner of the business suspects frauds, they appoint independent and impartial
person who use to hear the explanation given by the accountant. Such person was known as ‘Auditor’.
However, the importance of Auditor increased after the industrial revolution and introduction of Joint Stock
Company where there is separation of ownership and management.
As per the provision of Companies Act, 1956, every company, whether Public or Private, must get its
accounts audited by ‘Practicing Chartered Accountant’.
In Brief, the word ‘Audit’ means examination of accounts and ‘Auditor’ refers to the person examining the
books of accounts.

B) Definition and Features of Auditing:

Auditing may be defined as,

“A Careful and critical examination of books of accounts by a properly qualified person on the
basis of proper evidence so as to express an opinion (i.e. views) about the truth and fairness of
Financial Statements”.
Thus, from the above definition, following are the main features of Auditing:-
a) Auditing is an examination of books of accounts of a business.
b) Audit is done by properly qualified person. In case of Joint Stock Company, audit is to be done only by
Practicing Chartered Accountant.
c) Audit is based on proper evidence (i.e. proof). Evidence may be in the form of vouchers, bills, invoice,
chequebook, correspondence with parties like creditors, bankers, debtors etc
d) The purpose or object of audit is to report by expressing an opinion about the true ant fairness of
books of accounts and financial statement.

C) Advantages of Auditing:
Following are the main advantages of auditing:
1) Auditing helps in detection and prevention of errors and frauds.
2) Auditing helps to keep the books of accounts up-to-date. This helps the business to take corrective
and timely decision as any required information is readily available.
3) In case of loss by fire, auditing accounts are helpful in determination of claim from the insurance

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 Company.
4) Audited accounts are considered more reliable for obtaining loans and credit facilities from the Banks
and Financial institutions.
5) Audited accounts are taken as more reliable by the tax authorities for determining tax dues.
6) In case of Joint Stock Company, audited accounts create a sense of confidence in the mind of
Shareholders. An auditor acts as a trustee of the shareholder and safeguards their financial interest.
7) In case of partnership firm, admission, retirement, dissolution etc becomes easier on the basis of
Audited Accounts.
8) Business can get expert advice in relation to accounts since an auditor is an expert in this field.
Thus, Auditor can give concrete suggestions regarding improvement of business.
9) Auditing helps in systematic and proper comparison of accounts from year to year.
10) Auditing builds up reputation of the business.
11) Auditing enables the management to decide correct valuation of assets and liabilities for the purpose
of purchase and sale of business.
12) Auditing accounts can be produced as evidence in the court of law in case of disputes.

D) Disadvantages of Auditing:

1) Post-mortem Examination:
Auditing begin where accountancy ends. Thus, auditing is like post-mortem examination. It
may be useful for future but less helpful for the past.
2) Dependence on Officers:
An auditor has to depend upon the books of accounts and other information presented to
him and on the information, explanation and clarification from the officers of the company. If some
officers are involved in the manipulation of accounts then he may not get correct and complete
information.
3) Dependence on experts:
An auditor may not be expert in all the areas. He may not have the knowledge of
engineering or lawyer or valuation. In those cases, he obtains the certificate from various experts
who may not give correct information. As a result of this, the purpose of auditing may not be served.
4) No Guarantee:
The auditor does not give any guarantee as to the correctness of the books of accounts. An
auditor only expresses his opinion. He does not give any guarantee that the books of accounts are
Cent percent correct.
5) Costly:
Small concern cannot bear high cost of auditing. For them, accounting is necessity, while
auditing is luxury.
6) Staff of client becomes lazy and careless:
Staff on client may become careless and lazy, as they know that the auditor is going to
detect all the errors and irregularities.
7) Skill and Intelligent auditor:
Auditing is the work of skill and intelligence. If the auditor himself is not Skilled and
Intelligent, then the purpose of auditor will not be served.

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Q 2. Distinguish Between: Book-Keeping, Accountancy and Auditing
Ans: The following are the main points of distinguish between Book-Keeping, Accountancy and Auditing.
BOOK KEEPING ACCOUNTANCY AUDITING
1) Meaning 1) Meaning 1) Meaning
Book keeping may be define as an Accounting may be define as a Auditing may be defined as a
art of recording daily transactions process of preparation of final careful and critical examination
in a set of financial books like accounts of a concern and their of books of account by a properly
purchase daybook, sales daybook analysis. qualified person on the basis of
etc. proper evidence so as to express
It consists of:
an opinion about the truth and
It consists of:
a) Checking the work of Book fairness of financial statement.
a) Journalising the transaction Keeper.
An audit is conducted by an
b) Posting, totalling and b) Preparation of trial balance.
‘Auditor’.
balancing the ledger. c) Preparation of trading and
profit and loss account and
balance sheet and analysis of
the same.
2) Purpose 2) Purpose 2) Purpose
The purpose of book keeping is The purpose of account is to find The purpose of auditing is to find
to ensure that all business out the working results (i.e. profit the truth and fairness of the
transaction are properly or loss) of a business for a given business and financial position of
recorded in the books of period and to show the financial the business. It also serves the
accounts. position as on particular date. purpose of detection and
prevention of errors and frauds.
3) Order 3) Order 3) Order
Book keeping is the starting Accounting begins where book Auditing begins where
point of accounting and auditing. keeping ends. accounting ends.
4) Knowledge required 4) Knowledge required 4) Knowledge required
The work of book keeping is The work of accounting is of The auditor has to express his
more or less of mechanical specialised nature and hence it opinion regarding the truth and
nature and hence it does not requires sufficient knowledge of fairness of financial statement
require any specialised fundamentals principle of and hence he must have a wide
knowledge of principal of accounting. knowledge of principles and
accounting. techniques of accountancy &
Audit.
5) Qualification 5) Qualification 5) Qualification
A book keeper need not be An accountant has to prepare An auditor must be a qualified
qualified as his work is of final accounts so he must be ‘Chartered Accountant’.
mechanical nature. qualified. However he need not to

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 be a Chartered Accountant.
6) Scope of Work 6) Scope of Work 6) Scope of Work
The scope of work of book The scope of work of accountant The scope of work of auditor is
keeping is laid down by is also laid down by management. laid down by provision of
management. Companies Act, 1956.
7) Reporting: 7) Reporting 7) Reporting
Book keeper is not required to Accountant is also not required Auditor has to report about the
report after completing the report after preparing the final true and fairness of books of
work. accounts. accounts to shareholders.
8) Employees 8) Employees 8) Employees
Book keeper is an employee of An accountant is also an An auditor is not an employee of
the concern and is entitled for employee of the concern and the concern. An auditor is
the salary. entitled for the salary. independent person and entitled
for audit fees.
9) Errors and Frauds 9) Errors and Frauds 9) Errors and Frauds
A book keeper may make certain An accountant also may make An auditor is not suppose to
errors or commit fraud while certain errors or commit fraud commit errors or frauds. On the
recording the transaction while preparing final accounts. other hand, he has to detect the
errors and frauds committed by
book-keeper and accountant.
10) Appointment 10) Appointment 10) Appointment
Book keeper is appointed by An accountant is appointed by An auditor is appointed by
Management. Management. Shareholders.
11) Professional Regulations: 11) Professional Regulations 11) Professional Regulations
Book keeping is not governed by Accountancy is also not governed Auditing is governed by the code
any Professional Regulation. by any Professional Regulation. of conduct and standard as laid
down by the Institute of
Chartered Accountants of
India(ICAI).
MP-OK-PQRS-EEA
Q 3. Write short note on: Objects of audit.
Ans: Objects of audit means purposes of audit. The objects of audit are broadly classified as primary object and
secondary objects.
Primary object of audit is ‘Reporting’ whereas secondary object of audit are ‘detection and prevention of
errors’ and ‘detection and prevention of frauds’.

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These objects of audit can be illustrated in the chart as follows.

OBJECTS OF AUDIT

Primary objects Secondary objects

Reporting of True
and Fair views
Detection and Detection and
prevention of errors Prevention of Frauds

Errors of Principle Clerical Errors 1) Misappropriation of cash

2) Misappropriation of Goods
1) Error of omission 3) Fraudulent manipulation of
2) Error of Commission accounts
3) Error of Compensating
4) Error of Duplication

1) PRIMARY OBJECTS:-
The primary object of auditing is to report after going through the books of accounts, to the shareholders
of the company:-
a) Whether the profit and loss account and balance sheet are properly drawn according to the
Companies Act, 1956.
b) Whether the balance sheet exhibits (shows) a true and fair view of the state of affairs of the concern
as on that date.
c) Whether the profit and loss account exhibits (shows) a true and fair view of the profit earned or loss
suffered by the concern during the year.
II) SECONDARY / SUBSIDIARY OBJECTS:-

A) Detection and prevention of errors:-

An error may be defined as, “Unintentional mis-statement or mis-description made in the
books of accounts or records”.
An error may be:-
i. Error of Omission
ii. Error of Commission
iii. Error of Duplication
iv. Error of Principles
v. Compensating error.
An auditor should detect and prevent all types of errors.

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 B) Detection and prevention of frauds
Fraud may be defined as, “A false statement or untrue entry made in the books of accounts
“Intentionally” to cheat someone”.
A fraud may be:-
i) Fraud by misappropriation of cash.
ii) Fraud by misappropriation of goods.
iii) Fraudulent manipulation of accounts.
The auditor has to be very careful in detection of frauds.
In brief, the auditor has to audit in such a manner that all the aspects of finances are touched upon
so that errors and frauds are not left undetected. He must take reasonable skill and care while
auditing.

Q4.
A. What do you mean by errors? What are the types of errors?
B. What do you mean by frauds? What are the types of frauds?
C. What are the duties of an auditor regarding errors and frauds?
A. Meaning and types of errors:
i) Meaning:-
An error may be defined as, “ Any unintentional mis-statement or mis-description made in the
books of accounts or records.”
Errors are generally innocent and unintentional and are due to either carelessness or ignorance
on the part of employee.
ii) Types of errors:-
Following chart shows the various types of errors:-

TYPES OF ERRORS

Error of Error of Compensating Error of Error of

Omission commission error Duplication principles

Total Partial
omission omission

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1) Error of omission:-
Error of omission arises when a transaction is not recorded in the books of accounts either
totally or partially. Such error arises because of ignorance on the part of employee.
Errors of omission are of two types:-
a) Total omission:-
Total omission is said to take place when a transaction is not at all recorded in the books of accounts.
For example, credit purchases not at all recorded in the books of accounts
Such Errors do not affect trial balance from tally point of view. Hence such errors are difficult to
locate.
b) Partial omission:-
Partial omission is said to take place when a transaction is partially recorded in the books of
accounts. In other words, only one aspect of transaction is recorded.
For example, rent paid not posted in the rent account.
Such errors affect the trial balance from tally point of view. Hence such errors are easy to locate.

2) Errors of commission:-
Errors of commission arise when transactions are entered in the books of accounts with the wrong
amount.
Such error arises due to carelessness and ignorance on the part of employees.
For example, a sale of Rs.1000 is entered in the books as sale of Rs.100.

3) Compensating errors:-
Compensating errors are those errors in which the effect of one error is countered balanced or
compensated by any other error so that the effect of one error is neutralized by other.
For example cash received from Mr.’ A’ of Rs.100 is posted as Rs.1000 and cash received from Mr.
‘B’ of Rs.1000 is posted as Rs.100.
Compensating error will not affect the trial balance and hence they are not easily located. To find out
such types of errors, a complete and exhaustive preparation on the part of auditor is required.

4) Errors of Duplication:-
Errors of duplication arise when the same transaction is recorded twice in the books of original
entry and hence posted twice in the ledger accounts.
For example, credit sales made to Mr. A recorded twice in the books of accounts.
Such errors are also difficult to detect, as the trial balance will not be affected at all from tally point
of view. Careful watching and examination is the only answer to locate such type of errors.

5) Errors of principles:-
Errors of principle arise when fundamentals and accepted principles of accounting are not

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observed while recording the transaction in the books of accounts.
Following are the examples of errors of principles:-
a) Revenue expenditure is shown as capital expenditure and vice versa.
b) Outstanding assets and liabilities are ignored.
c) Improper valuation of closing stock.
d) Making inadequate provision for bad and doubtful debts.
e) Inadequate provision for depreciation.
f) Recording deferred revenue expenditure as revenue expenditure.
Errors of principles do not affect the trial balance from tally point of view. The auditor should
exercise utmost care in discovering such errors.
An auditor has to exercise reasonable care and skill in the performance of his duty. Therefore
he must be careful in detection of all types of errors.

C) Meaning and Types of Frauds:

i) Meaning:-
Fraud may be defined as ,”The false statement or false representation or untrue
entry made in the books of accounts “intentionally” with an intention to cheat
someone.”
A fraud is an act of cheating to another person to get some gain or benefit. It
is willful misrepresentation or a false statement or deliberate concealment of truth.
Here the act of committing fraud is intentional or willful.
ii) Types of frauds:-
The following chart shows the various types of frauds:-

TYPES OF FRAUDS

Misappropriation Misappropriation Fraudulent manipulation

of cash of goods of accounts

a) To show more profit than the b) To show less profit than the
actual profit (i.e. Window Dressing) actual profit (i.e. Secret Reserves)

From the above charts there are three types of frauds:-

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 I. Misappropriation of cash
II. Misappropriation of goods
III. Fraudulent manipulation of accounts

I. Misappropriation of cash :-
Misappropriation of cash means fraudulent application of cash. When the owner of the
business has no direct control over the receipts and payment of cash, the chances of
misappropriation of cash are more. In such cases, a cashier or such other person can misappropriate
the cash.
Misappropriation of cash may be committed in any of the following ways:-
a) Non-recording of cash sales
b) Recording of less sales than the actual sales.
c) Recording the less amount of cash than the actual amount of cash received.
d) Teeming and lading i.e. concealing money received from one customer and entering in his
account when cash received from another customer.
e) Recording false purchases.
f) Showing fictitious payment or expenses.
g) Entering dummy workers in the wage sheet.

To detect fraud by way of misappropriation of cash the auditor should carefully compare the entries
in the cash books with those in the rough cash book, counterfoil in the money receipt book and
original evidence in the form of vouchers, invoice, salary register, wage sheet etc.

II. Misappropriation of goods:-

Misappropriation of goods means “unauthorized” and “unaccountable” removal of goods from the
factory by a person for his personal gain.

Misappropriation of goods may be committed in any of the following ways:-

a) Actual theft of stock.
b) Entering less quantity in the books than the actual quantity purchased.
c) Showing more “damaged goods” or “obsolete goods”.
d) Entering sales of larger quantity than actually supplied.
Fraud of this type can be detected or located by:-
a) Maintenance of proper records for purchase and sales.

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 b) Regular stock taking
c) Proper control of incoming and outgoing goods.
d) Comparison of gross profit ratio (G.P ratio) for the year under the audit with the previous
year or years.
III). Fraudulent manipulation of accounts:-
Generally fraud by manipulation of accounts is committed by persons holding responsible
position in the business like managing director, manager etc.
There are normally two objects behind this type of fraud:-

a) To show more profit than the actual profit (i.e. window dressing) and
b) To show less profit than the actual profit (i.e. secret reserves)

a) To show more profit than the actual profit (i.e. window dressing):-
Profit is shown more than the actual profit because of the following reasons:-
i. To get more commission on profit, if commission is paid as a percentage of profit.
ii. To retain the confidence of shareholders intact.
iii. To attract the prospective shareholders and investors.
iv. To retain the market price of the shares.
v. To obtain more credit facilities from banks and financial institutes.

b) To show less profit than the actual profit:-

Profit is shown less than the actua profit because of the following reasons:-
i. To reduce income tax burden by showing less profit.
ii. To hide the information about the progress of the company from the trade competitors.
iii. To equalize rate of dividend thereby maintaining financial stability of the company.
iv. To meet the extra ordinary loss in future.
Following are some of the ways to manipulate the accounts:-
i. Revenue expenditure is shown as is shown as capital expenditure and vice versa.
ii. Under valuation and over valuation of assets.
iii. Under valuation and over valuation of liabilities.
iv. Showing fictitious purchases and expenses.
v. Showing fictitious receipts and sales.
vi. Make inadequate or excess provision for depreciation.

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 vii. Make inadequate or excess provision for bad and doubtful debts.
viii. Ignoring goods in transit.
The auditor should be very careful in detecting such types of frauds because such
types of frauds are committed by the person holding responsible position in the
concern like managing director, manager etc. he should search tactfully and
intelligently whenever he is having any doubt.

D) Duties of auditor regarding Errors and Frauds:-

Subsidiary object of auditing is to detect and prevent errors and frauds. Therefore the auditor has to
audit in such a way that all the objects of the finances are touched upon so that errors and frauds
are not left undetected. He must take reasonable care and skill while auditing.
Auditor should verify the following:-
i. He should vouch all the receipts from the counterfoils or carbon copies.
ii. Cash sales will be vouched with reference to carbon copies of cash memos, sales receipt etc.
iii. Salary and wages register should be thoroughly checked.
iv. Auditor should verify the method of accounting of stocks.
v. He should examine the stock register, quantitative records, goods inward register and goods
outward register.
vi. He should tally the stock with stock register.
vii. He should see that valuation of stock is as per Generally Accepted Accounting Principles (GAAP).
viii.Auditor should try to locate carefully the fraudulent manipulation of accounts.
ix. He should tactfully apply techniques like comparing various ratio, analysis of the same etc.
x. He should carefully check unusual items.
Auditor should not approach any problem with doubt or suspicion. But once suspicion is aroused; he
should probe and make all the necessary inquiries. He is a watchdog, but act firmly once the doubt
have arisen. He should exercise reasonable care and skill while performing his duties.

Q 5.

What is investigation? Distinguish between auditing and investigation?

Ans.: According to Taylor and Perry,
“Investigation involves enquiry into facts behind the books and Accounts in the technical,
financial and economic position of the transactions.”
Investigation means an examination of the books of accounts and records of the business for special
purpose. Investigation may be described as special audit.
Investigation is carried out with a pre- determined purpose like:-

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 i. To detect a suspected fraud.
ii. To ascertain the cause of losses.
iii. To ascertain the causes of low productivity.
iv. To find causes of high labour turnover etc.
Investigation may be carried out on behalf of the owner or the proprietor or on behalf of third party
like prospective shareholder, creditor, government etc.
Distinguish between auditing and investigation.
AUDITING INVESTIGATION

1) Meaning Meaning
Auditing may be defined as a careful and critical Investigation involves enquiry into facts behind
examination of books of accounts by a properly the books and accounts in the technical, financial
qualified person on the basis of proper evidence and economic position of transaction.
so as to express an opinion about the truth and Investigation is examination of books of accounts
fairness of the books of accounts and records. for special purpose. It is special audit.
2) Object: Object:
The object of audit is to find out the true and The object of investigation may be:-
fairness of financial statement and earning of
1) To detect a suspected fraud.
the concern and to detect and prevent errors
and frauds. 2) To ascertain the cause of losses.
3) To ascertain the cause of low productivity.
4) To find out the cause of high labour turnover
etc.
3) On whose behalf: On whose behalf:
An audit is carried on behalf of the proprietors An investigation may be carried out on behalf of
of the business only. the proprietors or third parties like prospective
shareholder, creditor, government etc.
4) Compulsory or optional: Compulsory or optional:
Audit is compulsory for every limited company Investigation is not compulsory. It is voluntary
under provisions of the Companies Act, 1956. depending upon the necessity.
5) Checking: Checking:
An auditor can rely on test checking, if he is An investigator has to do a thorough and detail
satisfied with the internal control system within checking.
the concern.
6) Period: Period:
Audit generally covers one financial year. Investigation may cover less than a year or it may
extend to 3 or more years depending upon the
purpose for which the investigation is carried out.

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 7) Qualification: Qualification:
An audit can be conducted by a practicing Investigation can be conducted by a person who
chartered accountant. may not be chartered accountant.
8) Report format: Report format:
An auditor’s report generally follows a standard An investigation does not require any standard
format. format or pattern of report.
9) Scope of audit: Scope of audit:
The scope of audit is restricted to the books of The scope of investigation may go beyond the
accounts of the concern. books of accounts into technical, financial and
economic position of the concern.
10 Opinion: Opinion:
)
An auditor’s report must contain his opinion. An investor’s report need not contain his opinion.
It contains the facts finding his investigation.
11 Order: Order:
)
Audited accounts are further investigated for Investigated accounts are not audited in the
some special purpose in view. ordinary sense.
12 Report to whom: Report to whom:
)
An auditor has to report to the owner. An investigator is required to report to the person
on whose behalf he has undertaken the
investigation.
13 Appointment: Appointment:
)
Auditor is appointed according to the provision The investigator is appointed by virtue of an
of Companies Act, 1956. agreement or contract.
Q 6.

Write short notes on :-

1. Window dressing.
2. Secret Reserve.
3. Concept of True and Fair View.
4. Principles of auditing.
5. Teeming and lading.
6. Test checking.
7. Contingent liabilities.
8. Necessity of auditing.
1) WINDOW DRESSING:-
A) Meaning: Window dressing means showing a better picture than the one, which is actually existing.
In other words, in window dressing:-

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a) Profit and loss account shows a higher profit than the profit actually earned by the concern.
b) Balance sheet shows a better financial position than the actual state of affairs as on that date.
Window dressing is more of misrepresentation. It is different from fraud, which
would involve recording of fictitious transactions or avoiding certain transactions.
In brief, in window dressing financial statements are prepared in such a manner as to
show rosier or better picture than what actually is.
B) Purpose or object of window dressing:-
Following are the objects of window dressing:-
i. To get more commission on profit, if commission is paid as a percentage of profit.
ii. To retain the confidence of shareholders intact.
iii. To attract the prospective shareholders and investors.
iv. To retain the market price of the shares.
v. To obtain more credit facilities from banks and financial institutes.
vi. To arrive a larger value of goodwill while admitting a new partner.

C) Ways or methods of window dressing:

Following are some ways by which window dressing can be done:-
i. Showing revenue expenditure as capital expenditure.
ii. Over valuation of closing stock.
iii. Making less provision for depreciation.
iv. Making less provision for bad and doubtful debts.
v. Recording of income which is neither due nor received.
vi. Showing actual liabilities as contingent liabilities.
vii. Non-recording of liabilities like income received in advance.
viii. Revaluation of assets.

D) Auditor’s duty regarding window dressing:-

As per the provisions of the Companies Act, 1956, balance sheet and profit and loss account must
exhibit (show) true and fair view of the financial position and profit earned or loss suffered during the
year. Therefore, the auditor should be very careful and go into details to ensure that there is no
window dressing.
To ensure that there is no window dressing, the auditor has to verify the following:-
i. Auditor should see that the proper distinction is made between capital expenditure
and revenue expenditure.
ii. He should see that fundamental accounting principles has been observed while

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 recording the transaction into books of accounts.
iii. He should ensure that closing stock is properly valued.
iv. He should see that adequate provision is made for depreciation.
v. He should see that adequate provision is made for bad and doubtful debts.
vi. He should ensure that actual liabilities are not taken contingent liabilities.
vii. He should ensure that all liabilities are recorded in the books of accounts.
viii. In case of revaluation of assets, auditor must ensure that revaluation is done as per the
accepted principles of accounting.
If the above safeguards are taken by the auditor, then there are less chances of
making window dressing, if not impossible.

2) SECRET RESERVE:-
A) Meaning:
A secret reserve may be defined as “a reserve, which in reality exists in the business but it
is not appearing on the face of the balance sheet”
A secret reserve is also called as, “unpublished reserves”, “undisclosed reserves”, “hidden
reserve”, or “internal reserve”.
Secret reserve denotes concealment of profit by means of either under statement of assets
or over statement of liabilities. The existence (availability) of secret reserve denoted that the
actual financial position of the concern is much more better than what it is shown by the
balance sheet.
Normally all the reserves are shown or disclosed in the balance sheet. Even addition and
deduction from the reserves are also to be disclosed. These reserves are nothing but the part
of earned profit set aside as reserves for future. However, secret reserves are kept secret and
they are not disclosed on the face of balance sheet.
Here, net worth of the company is deliberately understated.

B) Purpose or object of creating secret reserves:-

Following are the ways by which secret reserves may be created:-
i. To reduce the income tax burden by showing less profit.
ii. To hide the information about the progress of the company from the trade competitors.
iii. To equalize rate of dividend thereby maintaining financial stability of the company.
iv. To meet extra ordinary loss in future, without disclosing the facts to the shareholders
and outsiders.
v. If in a particular year, the company has made abnormal profit, a secret reserve may be
created out of it to be used in unprofitable years.

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 C) Ways or methods of creating secret reserves:-
Following are the ways by which secret reserves may be created:-
i. Showing capital expenditure as revenue expenditure.
ii. Under valuation of closing stock.
iii. Making excess provision for depreciation.
iv. Making excess provision for bad and doubtful debts.
v. Non recording of income, which is due but not received.
vi. Showing contingent liability as actual liability.
vii. Non recording of assets like prepaid expenses.
viii. Over valuation of liabilities.

D) Auditor’s duty regarding secret reserve:-

According to the provisions of Companies Act, 1956, creation of secret reserve is prohibited
except in case of Banking, Insurance, Finance and Electric Supply companies. Also, Central
Government has power to grant exemption to certain categories of companies, for the creation of
secret reserve, if it is in the public interest.
Therefore in case of Banking, Insurance, Finance and Electric Supply companies, the auditor
should carefully enquire into the necessity of creating secret reserve. If he finds that, the intention of
director is honest and if is in the best interest of the company and the amount is reasonable, he may
allow such secret reserve and need not qualify his report.
However, in the case of other companies (i.e., except Banking, Insurance, Finance and
Electric Supply companies) auditor has to disclose the fact that secret reserve has been created. If he
fails to do so, the balance sheet will not show “true and fair” view of the state of affairs of the
company. Thus he will not discharge his statutory duties.

3) CONCEPT OF TRUE AND FAIR VIEWS:

According to sec. 227 (2) of the Companies Act, 1956, the auditor of a limited company has
to report to shareholders whether the accounts give true & fair views.
A) In the case of the balance sheet of the state of Company’s affairs at the end of financial year and
B) In case of profit and loss account of the profit earned or loss suffered for the financial year.

However , the Companies Act, 1956 does not define anywhere the term, “True & Fair”.
According to sec.211 (3) of the companies Act, 1956, the balance sheet & profit & loss a/c of a
company shall be deemed not showing a true & fair view, if they do not disclose any matters required to be
disclosed under schedule VI of the company’s Act 1956.
In other words, when the financial statements are prepared (drawn up) in conformity with

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(according to) provision of schedule VI , then they would to be deemed to be disclosing true & fair view of
the state of affairs of the company.
Generally, the concept of true & fair implies that the financial statements should be true. They
should not contain any false information. At the same time, the statement should be fair. They should
disclose all that is required as per the provision of the law.
In brief, the concept of “True & Fair” implies that:
1) There is an absence of window dressing. (i.e. an attempt to show the position of the concern better
than it is)
2) There is absence of secret reserve
3) Balance sheet & Profit & Loss a/c are drawn up according to generally accepted principles of
accountancy (GAAP).
4) A proper distinction is made between capital expenditure & revenue expenditure
5) Assets are neither under-valued nor over-valued.
6) Liabilities are neither under-valued nor over-valued.
7) Adequate provision is made for depreciation.
8) Adequate provision is made for bad & doubtful debts.
9) All Incomes& Expenses relating to the year are taken into consideration.
10) All contingent liabilities are disclosed as a “Foot Note” to the balance sheet.
11) Proper distinction is made between provision & reserves & excess provision is shown as reserve.
12) Events occurring after the balance sheet dare are properly disclosed.
13) Last but not the least, financial statements and accounts disclosed all material facts to be disclosed as
per Schedule VI of Companies Act, 1956.

Under the old Companies Act, 1913, the annual account were required to disclose a “true &
correct” view of the state of affairs of the company, where as the present companies act 1956
requires that the annual accounts should disclose a “True & Fair” views of the state of the
companies.
In brief, concept of true and fair views requires that the auditor should not see only the
arithmetically accuracy of the transaction, but he should go behind the transaction to ascertain
whether the true facts of transaction are reflected in the final accounts or not as required by law.

4) Principles of Auditing:
The word ‘principle is defined as a fundamental truth or basic law or a settled rule of action.
Principles of auditing mean the fundamental truth necessary for accomplishment of the auditing
objectives.
The Institute of Chartered Accountants of India (ICAI) has laid down following principles of
auditing as per Standard Auditing Practices (S.A.P.-1)

PRINCIPLES OF AUDITING
1. Integrity, objectivity and independence
2. Confidentiality
3. Skill and competence
4. Work performed by others
5. Documentation

17
 6. Planning
7. Audit evidence
8. Evaluation of accounting system and internal control
9. Audit conclusions and reporting.

1) Integrity, objectivity and Independence:

The auditor should be honest, straight forward and sincere in his professional work. He must be fair
and objective. He should maintain an impartial attitude in his audit work. He should be independent
to achieve the objects of auditing.

2) Confidentiality:
The auditor should keep the information acquired in the course of his work, confidential and should
not disclose such information to a third party without specific authority or unless there is legal of
professional duty to disclose.

3) Skill and Competence:

The auditor specialized skill and competence. He should have adequate qualification and practical
experience. He should be aware of recent development in the field of auditing changes in company
law and recent judgement given by courts of which have bearing on the audit work.

4) Work performed by others:

The auditor direct, supervise and review the work done by his assistance. He should carefully
delegate work to his assistance and see that work done by them is upto his satisfaction.

5) Documentation:
The auditor should maintain working papers and audit notebook as evidence that the audit was
carried out in accordance with the basic principles. Auditor should preserve the confirmation letters
received by the firm from debtors, creditors and bankers’ etc., list of queries raised and explanations
received, detailed audit programmed etc. To prove that audit was conducted with due care.

6) Planning:
The auditor should plan his audit work. He should prepare a detailed audit programme to complete
audit efficiency and in time. Plan should be further developed and revised as necessary during the
course of audit.

7) Audit evidence:
The auditor should obtain sufficient and appropriate audit evidence. Evidence may be obtained
through vouching, verification, ratio analysis, enquiry of unusual items, etc. As the audit report is
based on audit evidence, the quality of audit depends on the quality of audit evidence.

8) Evaluation of Accounting System & Internal Control:

The auditor should evaluate the accounting system and internal control existing in the concern. This
will help the auditor to know the adequacy or otherwise of accounting system so as to decide about
rely on the same.

9) Audit Conclusions & Reporting:

18
 The audit report should contain a clear written opinion on the financial statements. The auditor
should arrive at his opinion on the accounts on the basis of audit evidence. He should submit his
report, which may be unqualified or qualified. When a qualified opinion is given, the audit report
should state the reason thereof.

5) TEEMING & LADING:

Teeming and Lading is one type of fraud that is committed in connection with receipt of Cash. It is
also known as “Lapping”.

Teeming and Lading can be explained with the help of the following example:
Suppose the cashier has received cash from Mr. “A”. At that time, he does not pass any entry for this
receipt and misappropriate this money for personal use. After sometime, the cashier received cash
from Mr. “B”. At this movement, the cashier gives credit to Mr. “A” and not to Mr. “B”. For the time
being, he is wrongly using the money for himself. Later on, when he received cash from Mr. “C” , he
gives credit to Mr. “B” and not to Mr. “C” and so on.

Later on, when the cashier get his own money he put it into cashbox of the company giving credit to
person whose account has not yet been credited so far.

Following chart explains the concept of Teeming and Lading:

Time of Receipt Received from Time of entry for cash receipt
First Receipt Cash received from Mr. “A” No entry passed for this receipt
Second Receipt Cash received from Mr. “B” Now, entry passed for receipt from Mr.
“A” and not for receipt from Mr. “B”
Third Receipt Cash received from Mr. “C” Now, entry passed for receipt from Mr.
“B” and not for receipt from Mr. “C”
Fourth Receipt Cash received from Mr. “D” Now, entry passed for receipt from Mr.
“C” and not for receipt from Mr. “D”
Thus, in case of teeming and lading, there is misappropriation of cash for certain time and at last
when the accounts are to be closed, the cashier put the cash from his pocket into the cash box and
give the credit to the person to whom he has not given credit.
Thus, strictly speaking in teeming and lading, there is no misappropriation of money; even the cashier
has use the money of the company for his personal gain without authority.
However, even though the cashier has returned the money at the close of the year but this type of
fraud should be prevented as this may encourage the cashier to commit the bigger fraud and actual
misappropriation of cash.

6) TEST CHECKING:

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A) Meaning:
The term “Test Checking” refers to an “AUDIT technique” where instead of complete examination of
all the transaction recorded in the books of accounts, only some of the transactions are selected and
verified. The underline intension is to (check) some of the transaction to form an opinion of the
whole.
According to Prof. Meighs
“Testing and Test Checking means to select and examine a representative sample from a large
number of similar items”.
“Test Checking” is a substitute for detailed checking. It involves only partial checking of the
transaction. In Test Checking the auditor does not check all the records but certain items are
randomly selected or through a process of sampling, certain items are selected and verified. If
selected items of transactions were correct, the auditor assumes that remaining items or
transactions would also be correct likewise.

B) Need for “Test Checking”:

In small concern where the transactions are simple and limited, the auditor can examine each and
every transaction. However, in case of large concern where there are large numbers of transaction, it
is neither possible nor perhaps necessary to examine each and every transaction as the auditor has
limited time at his disposal, in such a case the auditor can apply “Test Checking”.

C) Circumstances under which “Test Checking” can be adopted:

1. In case of big concern where the number of transactions are quite large
2. Where an auditor has a little time at his disposal.
3. Where the transaction are of “identical nature”.
4. Where there is existence of satisfactory internal control system.

D) Precautions to be taken in applying “Test checking” / Principles of “Test Checking”

The “Test Checking” is now one of the accepted techniques of auditing. However, it should be noted
that an auditor would still be held liable if he has adopted test checking and some errors and frauds
have remained undetected. Therefore, following precautions should be taken before applying the
technique of test checking. In other words, following are the principles of test checking so as to
ensure the success of “Test Checking”:

1. As far as possible, sample transaction should be selected from every book or ledger covering
the whole of the period under audit.
2. Selection of transaction should be distributed in such a way that work of almost all clerks of
the client is checked.
3. Selection of transaction should be made at random.
4. The entries relating to the first and last month of the year should be thoroughly checked as
fraudulent manipulations of accounts are generally made during the months.
5. Cashbook and passbook should be through checked.
6. No consultation should be made with the shift of the client. When a selection of transaction
for “Test Checking” is made by the auditor.
7. In the selection of entries and accounts for apply test checking, care should be taken to check
the different portions of the work at each audit. For example, if accounts pertaining to May

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 and November were selected for test checking n the year 2019, accounts pertaining to July
and December may be selected in 2020 for that purpose.
8. Selection of the items of period should not be known to the clients in advance.
9. Items of exceptional and non-recurring nature should be checked fully.
10. A large number of transactions should be checked from the area where the system of
internal control is weak and a few number of transaction should be checked from the area.
Where the system of internal control is strong.
If the above safeguards are exercised with the care and caution by the auditor,
the results are bound to be encouraging and satisfactory.

E) Auditor and Test Checking:

Though test checking saves auditor time of checking, it does not reduce the liability of the
auditor and hence auditor should take maximum care in deciding the extent of checking and
in selecting the sample for checking.

7) CONTINGENT LIABILITY:
A) Meaning: A contingent liability may be defined as ,
“A liability which may or may not arise on the happening of a certain unforeseen events.”
A Contingent liability is not actual liability on the date of balance sheet. Also it may or may
not involve the payment of money.
In case of contingent liability, uncertainly play an important role and therefore differentiate
contingent liability from the actual liability.
B) Example of “Contingent Liability”
Following are the example of contingent liability:
1. “Bill Received” discounted with bank but not matured on the date of balance
sheet. Thus, if on the due date the acceptor of the bill honour the bill then
there is no liability but if the bill is dishonoured, then the company will have to
make the payment. Thus, it is a contingent liability depending upon honouring
or dishonouring of the bill.
2. Guarantee given by the company on behalf of third parties.
3. Cases pending in the court of law.
4. Arrears of cumulative preference share dividend.
5. Uncalled liability on partly paid up shares.
C) Disclosure of contingent liability as per the companies act, 1956:
According to part I of the schedule VI of the Companies Act, 1956, “ Contingent Liability”
should be shown as a “foot-note” to the balance sheet under the following heads:
1. Claims against the company not acknowledge as debts.
2. Uncalled liability on shares partly paid up.
3. Arrears of fixed cumulative dividend on preference shares.
4. The estimated amount on contracts remaining to be executed on capital
account and not provided for.
5. Other amount for which the company is contingent liable.
D) Auditor’s duties regarding “ contingent liability”:
The auditor should pay special attention to the verification of contingent liability. If
contingent liability is mixed with actual liability, then the books of accounts will not show

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 “True and Fair” view.
Auditor should take the following steps for verification of contingent liability:
1. Auditor should check thoroughly bills receivables books and discounted bills
with banks.
2. He should verify guarantee deeds, contracts deeds, etc.
3. He should verify legal documents and ensure that whether any case is pending
against the company or not.
4. He should ensure that “contingent Liability” is not mix-up with actual liability.
5. Last but not the least, he should ensure that all “contingent liability” have been
shown as a “foot note” to the balance sheet as required by part I of the
companies act, 1956.

8) NECESSITY OF AUDITING:
Auditing is necessary for the following reason:
1. To review the system of accounting and internal controls.
2. To review the system and procedure of business.
3. To examine documentary evidence to determine authenticity, validity and
recording of business transactions.
4. To ensure arithmetical accuracy of the transactions recorded in the books of
accounts.
5. To verify title, existence and valuation of assets.
6. To ensure distinction between capital and revenue expenditure.
7. To report to the appropriate persons on the truth and fairness of the accounts
and
8. To ensure that accounts prepaid are in conformity with the statutory
requirements.

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 2. “Planning of Audit”

Q. 1 What steps should be taken by an auditor before commencement of Audit?

Ans: The auditor should take the following steps before commencement of audit:
a) Appointment:
The auditor should see that his appointment is valid. In case of limited company his appointment
should be subject to the provisions of Companies Act, 1956. In case of the Auditor is appointed in place
of another auditor, he should communicate with the retiring auditor in writing.

b) Getting information about the client:

The auditor should start gathering important information about the client. He should obtain the
important documents like past 2 to 3 years final accounts along with auditor’s report, partnership
deed, Memorandum and Article of Association copies of important agreements, etc. At this point, he
has to create Master file of the client in which documents will be filed for permanent reference.

c) Review of Internal Control & Check:

The auditor should review the internal control & checks existing in the client’s office. The auditor
should prepare internal Control questionnaires. With the help of Internal Control questionnaires the
auditor will be able to form an opinion about & then rely upon the degree of internal control and check
in the Client’s office.

d) Deciding the quantum of work:

Based on the review of Internal check & control system the auditor should be able to decide the extent
of checking to be carried out. The areas where internal control is weak, the extent of checking will be
more.

e) Determination of the audit teaming:

The auditor will to select the audit team from his staff who will conduct the audit, there should be

23
 proper mix of senior members and junior members. The senior assistant members are given complex
assignment and junior members are given responsible for resting work. This will help auditor to
distribute the work efficiently.

f) Designing the audit programme:

The scope of work, the procedure to be followed in accomplishing the audit work, the person
responsible for accomplishment of the work, duration of time within which the audit work is to be
completed is decided and will be put in writing. This is called as “Audit Programme.” Before the audit
commences, the audit programme is discussed and explained to the audit team to ensure its successful
implementation.

g) Communicating with the client:

The client should be communicated about the starting date of audit, the number of staff members who
will be visiting the client’s office and the expected duration of the audit. The client should also be asked
to complete all the books of accounts, file vouchers in order, prepare various schedules, etc.
The audit can start the audit work once the clients informs that he has kept the things ready as per the
requirement sent by the auditor.

Q. 2 What is Audit Programme? What are its Advantages? What are its disadvantages?
Ans: Before the commencement of an audit, the auditor chalks out a plan of action indicating the work to the
accomplished, the procedure to be followed in accomplishing it, the person responsible for accomplishment
of work and duration of time within which they have to finish the work. Such planned and predetermined
procedure for the conduct of an audit is known as “Audit Programme.”
Thus, an audit programme is a detailed statement giving full instructions, hints & guidance to audit staff, as
to how they should proceed with the audit work and make it dependable. It is written scheme prepared by
the auditor to distribute work to be followed during audit. The preparation of such programme involves
mainly these things:
 How much work is to be done?
 Who is going to do a particular portion of work?
 What is the duration of time by which the work is to be finished?
Advantages:
1) Completion of work:
It ensures that all necessary work has been done and nothing has been omitted.?
2) Efficient distribution of work:
It leads to efficient distribution of work. An audit programme is prepared keeping in mind the
educational qualification the level of competency and experience of such individual member of the
audit staff. While senior audit assistance are given complex assignment, the junior are made
responsible for routine work. Thus, the work is executed in a smooth and efficient manner.
3) Progress of Audit:
The auditor is in a position to know about the progress of the work done by his assistants.
4) Responsibilities:
An audit programme lies in clear terms, what work is to be done by whom and within what duration

24
 of time. This way responsibility of any default can be easily paced on the person concerned.
5) Guide to Audit Assistants:
An audit programme scenes as a guidance to the audit staff as to what position of work is completed
and what is remaining to be completed. When an audit assistant goes on leave, or has left the audit
before the work assigned to him, another audit assistant can be given balance of work without much
difficulty.
6) Guide for subsequent years:
It serves as guide for audits to be carried out in the subsequent years.
7) Evidence:
A properly drawn audit programme serves as an evidence in case of any charges of negligence
against the auditor. An auditor programme can serve as a proof that the Auditor has done his work
with reasonable care and skill.

8) Better supervision and control:

The work can be better supervised and controlled became the work is planned.
9) Relief to Auditor:
The auditor is saved from issuing instruction to his senior and junior staff again and again as the audit
programme covers all the planned work and who should do what work.
10) Completion of audit in time:
It assumes that audit work is completed in time and in the most systematic manner.
Disadvantages:
1) Mechanical Work:
The audit assistants have to work strictly as per the instructions given. As a result the audit assistants
may carry out the audit without understanding the object. Thus, audit usually becomes too
mechanical.
2) No initiative:
The audit assistant may lose initiative because he has to follow a pre-determined programme he has
no opportunity to show their judgement and intelligence.
3) Rigid and Inflexible:
In audit programme, it is difficult to include new items as a result of change within the organisation
or became of change in economic conditions, commercial laws, etc. As a result, audit programme
may become rigid & inflexible.
4) Shelter to inefficient assistants:
Audit programme may give shelter to the inefficient assistants they can defend themselves on
grained that the audit programme did not contention prepare instructions for the matters in which
they have committed mistakes.
5) Suitable for large concerns:
An audit programme is suitable for large concern. It is not prepared for small concern. As a result,
small concern loses the benefits of planned audit.
6) Too much speed:
In an audit programme, audit is to be completed within a fixed time schedule. As a result, audit may
be conducted with too much speed and proper examination may not be done.

Q.3 What is an audit notebook? What are its contents?

OR

25
 Write a short note on Audit Note Book.
Ans: During the course of an audit, an audit assistants experiences several difficulties and hence he maintains a
book with him in which he notes own the important points and enquiries which he has to refer to the officials
of his clients or to discuss with the auditor. Such a book is known as “Audit Note Book.”
Thus, Audit Note Book refers to a book, which is generally used for recording different types of queries and
special points raised by the audit assistants in the course of audit. It is also called as “Audit Memoranda.”
The audit notebook may be in the form of bound register of loose sheet filed together. It serves as a valuable
aid/ asset to remember a large number of information, queries and explanation rendered in the course of
audit.
Contents:
An audit notebook generally contains the following particulars:
1. The name of clients and audit year.
2. Date of commencement and completion of audit.
3. List of important officers, their duties and responsibilities.
4. List of books of accounts maintained by the business.
5. The technical terms used in the business.
6. System of accounts and internal check in operation.
7. Routine queries like missing vouchers receipts, etc.
8. Matters requiring explanation or clarifications.
9. Errors and frauds discovered.
10. Points to be included in the audit report.
11. Bank reconciliation statement.
12. Any failure or irregularity.
13. Prevision of memorandum of Association and Articles of Association having effect on the audit.
14. Points on which information is required.
15. Other matters arising during the course of audit.

Advantages:
1. It helps to remember important points, which arises during the course of audit.
2. It serves as evidence in the court of law in case of suit filed against him for negligence.
3. It keeps the auditor in assessment of efficiency of audit staff. Such a notebook keeps the auditor to
assess the knowledge, efficiency and work of audit clerks.
4. It facilitates easy preparation of audit report.
5. It acts as a guide to assistants for conducting the audit.

Q 4.
Write a short note on “Audit Working Papers”:
Ans:
According to the Institute of Chartered Accountants of India (ICAI), Audit working papers means a
record of :
1. The audit plan.
2. The audit procedure performed and
3. The conclusion drawn from the evidence obtained.

26
 Thus, Audit working papers are those working papers, which contain important details about the
accounts, which are under audit. Audit working papers are written records kept by the auditor as
evidence collected during the course of audit.

Contents:
Audit working papers have the following contents:
a) Audit programme
b) Working Trial Balance.
c) A schedule of debtors, creditors, fixed assets, Investments, etc.
d) Correspondence with debtors, creditors bankers, etc and confirmation obtained from them.
e) Certificates as regards quantity and value of stock-in-trade.
f) Certificates from management that all outstanding assets & liabilities have been included in
accounts.
g) Particulars of Investments.
h) Particulars of depreciation.
i) Draft of audit report.
j) Draft of final accounts.
k) Copies of important contracts, agreements, etc.
l) Copies of minutes book of the meeting of the Board.
m) Details of contingent liabilities.

Advantages:
1. Extent of work:
The auditor with the help of audit working papers can find out how and to what extent his assistant
have followed his instructions.
2. Help in finalizing the report:
Audit working papers helps the auditor in finalizing his report without fail.
3. To access the efficiency:
Audit working papers helps in forming an opinion about the efficiency or otherwise of audit staff.
4. Used as evidence:
Audit working papers can be used as evidence by the auditor to defend himself from the changes of
negligence.
5. Guiding:
The audit working papers are the sources of training to audit staff.
6. Planning:
They help the auditor in planning for next year.

Q. 5. Explain filing of working papers.

OR
Write short notes on Current File and Permanent File.
Ans: Working papers are valuable documents for the clients as well as for the auditor. Hence, they should be filed
systematically. They must be preserved in a proper manner. For the sake of convenience, working papers

27
may be divided between current and permanent files.

FILING OF WORKING PAPERS

CURRENT FILE PERMANENT FILE

A) CURRENT FILE:
It is a file which contains working papers of the year under audit. The current file should include the following
documents:
1. A copy of the accounts.
2. Audit programme.
3. Details of audit tests performed.
4. Extract of minutes of meeting of the directors and shareholders.
5. Queries raised during the course of audit.
6. Official comments on the queries raised.
7. Confirmation letters confirming accounts.
8. Certificate for valuation of stock.
9. A statement of missing vouchers.
10. Bank Reconciliation statement.
11. Statement of computation of tax, bonus, gratuity, etc.

B) PERMANENT FILE:
It is a file which contains papers of continuing importance affecting the company and the audit. The
purpose of this file is to provide background information about the company. The file should include
the following papers:

1. A certified copy of the Memorandum of Association.

2. A certified copy of the Articles of Association.
3. A copy of partnership deed and trust deed.
4. A copy of legal regulations.
5. A note on the nature of business carried on.
6. A note on location of various offices and factories.
7. Client’s letter containing specific instruction regarding the audit work.
8. A list of books of accounts.
9. A list of directors with their details regarding their association with companies as directors.
10. A copy of the organisation chart.
11. A list of officers with the nature of work done by them.
12. Details of holding company/subsidiary company.
13. A brief note on the system of internal control.
14. A statement of basis of stock valuation, work in progress and depreciation.
ADVANTAGES OF PERMANENT FILE:

28
 Permanent file has the following advantages:
1. Important data are available in one file.
2. It is convenient for handling.
3. Previous year’s file enables the auditor to prepare the audit programme.
4. It acts as a handy reference to the new comers.
5. It is useful for finalising the accounts.
6. It helps the auditor to review the complete working of the client.

3. Internal Check and Internal Control

Q1. What is internal check? What points should be considered while framing a system of
internal check?

A. Meaning:-
Ans Internal check is an integral part of internal control system.

Internal check is an arrangement of the duties of the member of staff in such a manner that
the work performed by one person is automatically and independent checked by another
person without any duplication of work.

Thus, under the internal check system:-

1) The whole work relating to a particular transaction is not done by one person
alone.
2) It is divided into the hands of a number of persons so that the work of every
person is, in ordinary course, automatically checked by another person without
duplication of work.

For example, in a departmental store,

Sales memo are made by the salesman,

The cashier receives the cash,

The delivery clerk delivers the goods.

Finally, the gatekeeper at the gate checks the goods.

Thus, there is a division of work, which automatically & independent check the work of one
employee by another employee and also without any duplication of work in the ordinary course
of work which makes it difficult for the employees to commit fraud or make error.

29
 B. Points to be considered while framing a system of Internal Check:-

While framing a system of internal check, following points should be considered so as

to ensure an effective and sound system of internal check.

1. Authorities, duties and responsibilities of each member of staff should be clearly

defined.
2. All the members should be given clear-cut instructions, preferably in writing, so as
to enable them to perform their work in an orderly and efficient manner.
3. There should be division of work as far as possible.
4. There should not be any duplication of work.
5. Duties of members should be arranged in such a manner that work performed by
one person is automatically, in ordinary work, checked by another person.
6. The work should be divided in such a manner that one individual is not allowed to
perform any work single handed from beginning to end.
7. An employee having physical custody of assets should not have access to the
books of accounts.
8. There should be regular stock-taking.
9. All accounting procedures should be verified periodically.
10. Self balancing system should be introduced.
11. There should be effective control over purchase, receipt and issue of goods.
12. Duties of the member of the staff are changed from time to time without prior
notice so that the same person does not perform the same function for so long time.

Q2. A) What are the advantages /objects of internal check?

B) What are the disadvantages/ limitations of internal check?

A) Advantages/ Objects of internal check:

1. Proper division of work among the various employees.

2. Early detection of errors and frauds: Since no individual employee is allowed to

handle a job completely.

3. Prevention of errors and frauds: As an employee knows that his work will be
checked.

4. Fixation of responsibility.

5. Accuracy and reliability of books of accounts.

30
 6. Early preparation of final accounts.

7. Reduce the work of auditor.

B) Limitations of Internal Check:

1. Suitable only for large concerns.

2. Expensive and time consuming.

3. Over confident.

4. Possibilities of error and frauds (If employee joint fraud).

Q3. What are the duties of auditor regarding internal check?

A) Auditor’s duties regarding internal check:

Standard Auditing Practices-6 (SAP-6) issued by the Institute of Chartered
Accountants of India (ICAI) makes the following recommendations in this
regard:
1. RESPONSIBILITY OF MANAGEMENT: - Basically the management is responsible
for establishing and operating the internal check.
2. AUDITOR’S DUTY: - The auditor’s duty is to study the checks, verify whether the
checks were actually in operation and evaluate the checks to ascertain how much he
can rely upon them.
3. NEED FOR EVALUATION: - An auditor needs to evaluate the internal checks to
ensure that they can prevent and detect errors and frauds. Study of internal checks
help the auditor to decide what to check, when to check, how to check and how much
to check. If the internal checks are reliable, he can use test check and concentrate on
only the important areas of audit.
4. STEPS IN EVALUATION:- In order to evaluate the system of internal checks the
auditor should take the following steps:
i. Understand the system: He can trace a few transactions through the
system to know the procedures.
ii. Test application: He should verify whether such checks were actually
applied in practice.
iii. Evaluate the system: He should judge, on the basis of above test etc.,
whether he can rely on the check and if so to what extent.
5. REPORTING :- The auditor has to report:
a) Whether, a service company has reasonable system of recording receipts,
issues and consumption of materials and stores and allocation of
materials consumed to the relative jobs.
b) Whether a service company has a reasonable system of allocating man
hours utilized to the relative jobs.
c) Whether there is a reasonable system of authorization at proper levels on
issue of stores and allocation of stores and labour to jobs.

Q 4. Suggest a suitable system of Internal Check in respect of following:

31
 1) Cash Receipts 2) Cash Payments 3) Cash Sales 4) Purchases 5) Sales 6)
Stores(Stock) 7) Petty Cash 8) Wages
Checking of all cash transaction should be given utmost importance because it is
here that employees prone to commit a fraud, find the temptation most difficult to
Ans: resist. For example, receipt may not be entered in the cashbook; record of cash
received may be understated by preparing duplicate receipts for amount less than
the original.

1) Internal check as regards to cash receipt.

The following point should be kept in mind in respect of internal check as
regards cash receipts:-
1) All cheque and postal order should be cancelled on receipt by means of a stamp with
a crossing of “Not Negotiable- Account payee only”.
2) All cash and cheque must be banked immediately after receipt, preferably daily.
Where this is not possible for some reason, the limitation as to the unbanked amount
and the maximum period for which it may be so retained must be clearly satisfied.
3) Counterfoils of the pay-in-slip should be regularly checked against the document
recording receipts of cash and cheque.
4) Receipts to be issued against cash and cheque should be duly accounted for.
5) Cash for disbursement purpose should not be withdrawn from cash receipt.
6) Immediately upon receipt of cash or cheque, a rough record of the account should be
made and the document accompanying cash or cheque should be indelibly marked
with the amount of receipt.
2) Internal check regarding cash payment
1) All payment should, as far as possible, be by cheque excluding of course petty
cash payment, which should be in charge of a separate person.
2) As soon as a cheque has been prepared the relevant bill of invoice should be
stamped “PAID” so that it is not, by mistake or otherwise, again passed for
payment.
3) In case any payment is of a special nature of involves a big sum, there should be
authorization for it from a high official and more than one official should preferably
sign the cheque for it.
4) Bank reconciliation statement should be prepared at regular intervals, preferably
by an independent person.
5) There should be specific instruction not to sign cheque in advance or in favour of
the person signing.
6) Each cheque should be accounted for and cancelled cheque is carefully
preserved.

3) Internal check as regard to cash sales:

A) Sales at the counter:
1) The salesman authorized to sell goods at the counter should be specifically
named.
2) The customer is then required to carry all the three copies to the cashier who
after collecting the amount and recording it in his cash register should return
two copies to the customer duly stamp marked “CASH PAID”
3) At the end of the day duplicate of the pre-numbered cash memos should be
checked to the summaries of cash sales prepared by the counter sales,
cashier and delivery counter clerk.
4) Where cash recording machine are used the total cash received as given out
by the machine, show be checked with amount actually banked.
5) Daily cash receipts should be deposited in the bank on the same day.

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 B) Sales by travelling salesmen:
1) Travelling salesmen should be issued with pre-numbers rough receipt books.
2) Special attention should be paid to customer account, which have become
overdue.
3) There should be surprise transfers of travelling salesmen from one area to
another.

C) Postal sales:
1) There should be a separate register to record sales by post of V.P.P
2) Separate bank pay-in-slip should be prepared to deposit cash received
against postal sales.
3) At frequent intervals a responsible officer should check the V.P.P register for
goods, which have been returned as also those against which payment has
not been received.

4) Internal check as regards purchases:

1) It should be supervised and controlled by a separate department to be called a

buying or purchase department.
2) The purchasing cycle should begin with the placing of a requisition by a
responsible person with the purchase department.
3) Upon receipt of a requisition, the purchase department should send letters of
inquiry to the listed suppliers asking them to quote their terms as to rates, quality
of goods and delivery period.
4) Receipt of goods should be recorded in the goods received register. The person in
charge of receiving the goods should prepared a Goods Received Note and send
a copy thereof to the Account Department and to the department upon whose
requisition the goods had been ordered.
5) The account department should make any payment to the supplier unless the
invoice has been passed for payment by an authorized person should be marked
on the invoice.
6) Goods received should also be entered in respective stores ledgers. From there,
the relevant entries should be passed in the stock cards.
7) All incoming credit notes should be numbered and stamped the same way as
invoices. These should also be checked with the advice note covering the return
have rejected goods to the suppliers.

5) Internal check as regards sales:

1) Person authorized to accept orders and to pass these on for production or supply
should be clearly specified.
2) There should be control accounts to operate a debtor’s ledger.
3) A strict check should operate on credit notes for prices adjustment, errors in
invoices or special allowances. These should be prepared on serially numbered
printed form and properly authorized.
4) Authority to deal with customer’s enquiries overdue accounts and writing off of
bad debts, should rest with a responsible person.
5) Goods returned by customer should be entered in a separate register e.g., Goods
inward books, and reason therefore should be inquired in to and recorded therein.
6) Duties as regards checking of quantities, prices, discounts and totals in the
invoices should be clearly earmarked.

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 7) Authority to grant credit terms should vest in a responsible official.

6) Internal check as regards stores:

1) Person engaged in maintenance of stock records should have nothing to do with
actual/ physical stores.
2) Bin cards should be used for maintenance of stores. These should contain
particulars as to receipt, issues and balance of stores.
3) Permits to ensure that persons going outside do not remove any goods without
proper authority should regulate entry into stores.
4) Stores cards of different colors of sizes should be used for easy identification.
5) The system of requisitioning stores should be very carefully done into to ensure
against wastages or losses.
6) There should be a separate places for each category of stores.
7) Responsibility as to safeguarding and maintenance of stores should be clearly
determined.
8) There should be a regular checking on stores ledger with the bin cards, Goods
received Note, Goods returned note and requisition slips.

7) Internal check as regards petty cash

1) Petty cash transaction should be under the charge of petty cashier and not, the
head cashier.
2) ALL “PAID” voucher number should be shown in the petty cash booking the
appropriate column.
3) As a rule the employees should not be allowed to borrow or to take advance from
petty cashier.
4) At regular intervals the cashier or any other responsible officer should check the
petty cash book with vouchers in detail.
5) Petty cash book should be maintained on the Impress System.
6) Amount of impress should not be increased without proper authorization.
7) There should be surprise verification of petty cash balance.
8) At regular intervals responsible officer should check the petty cash book with
vouchers in detail.

8) internal check as regards wages:

Meaning: the system of internal check as regards payment of wages should be

carefully designed because there are greater possibilities of fraud in payment of wages
especially in large concern employing a number of workers. The following points
should be noted in regard to internal check for wages.

I) Maintenance of wages records:

1) Workers are normally paid wages on the basis of time. Hence, the time spent by
each worker should be recorded in Time Record Book.
2) There should be incoming & outgoing master or automatic punch card machine,
which will record the correct time.
3) If the workers are paid on the basis of piece wage system, each worker should be
provided with job card for recording the actual work done by him.
4) Proper records should be kept for the workers who are leaving the factory before
the scheduled time.
5) Proper record should be kept for overtime.

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 II) Preparation of wage sheets:
1) The account department must carefully check the totals, gross wages and net
wages.
2) The work relating to preparation of wages sheets should be subdivided among
different employees wages sheet should be prepared by one person, another
should check all the details like number of days present, wage rate, overtime etc.
3) Care should be taken to deduct installment of loan and advance regularly from
each month’s wage.
4) The account department should ensure that deduction on account of provident
fund, income tax, Employment State Insurance Scheme (ESIS) is properly made.

III) Payment of wages:

1) Proper arrangement should be made for withdrawal of cash from bank for payment
of net wages.
2) Payment of wages should be under the supervision of a responsible official.
3) Pay packets should be filled by those who are not connected with the preparation
of wages sheet.
4) Senior official should do surprise checking of wages sheet and payment of wages.

Q5. What is Internal Control? What are its objects? What are characteristics of an effective
Internal control system? How is the auditor is concern with the same?

OR

Write short note on “Internal Control”.

According to Institute of Chartered Accountant, in England “ By Internal Control is

Ans: meant not Internal Check and Internal Audit but the whole system of controls, financial
or otherwise, establishment by the management in order to carry on the business of the
company in an orderly manner, safeguards its assets and secure as far as possible the
accuracy and reliability of its records”.

Thus, internal control refers to various methods and procedures adopted by an organization to
achieve the following objectives:

1) To conduct business in an orderly and efficient manner.

2) To protect the assets of the business against waste, inefficiency and carelessness.
3) To ensure that policies laid down by the management are properly followed.
4) To detect and prevent error and frauds.
5) To ensure that accounting records are accurate and reliable.
6) To ensure that financial statement are prepared in time.
Thus, internal control does not mean control over finance only. Its scope is wider. It
includes all types of management controls, financial as well as non-financial. It includes
Internal check and internal audit.

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 Characteristics of an effective internal control system:

An effective system of internal control system has the following

characteristics:

1) A plan of organization, which provides appropriate division of financial

responsibilities.
2) A system of authorization and records procedures to ensure that:
a. Every item of expenditure is properly authorized.
b. Every item of receipts is properly recorded.
c. There is a proper custody of all assets.
d. Sound practices in the performance of duties and functions of each
department.
e. Proper personnel.
f. Review.
Auditor and internal control:

The installation of an effective system of internal control is the responsibilities of the

management.

However, the auditor must study the internal control system existing in the
organization. The aim behind the study of internal control system by the auditor is to
establish a basis for reliance upon the system so as to determine the extent to which
he should apply tests during the course of the audit. If there is an effective system of
internal control the work of the auditor become quite easy.

Thus, an auditor is mainly concerned with the evaluation of the internal control
system in force that he may be able to know:

1) Whether the system of control ensure the accuracy of financial statement.

2) Whether the system of control prevents and / or detects mistakes.
3) Whether the systems of control prevent or disclose the losses that may
occur due to carelessness, inefficiencies or inadequacies.
4) Whether the system of control ensures that the policies and the
procedures are properly followed.

Q4. What is Internal Audit? What are its features?

It is a review of the operations, records and systems continuously undertaken within a

business, by specially assigned staff or the independent professional.

While the Internal check consists of a detailed procedure for effecting a particular transaction
forming part of the entire accounting system, the internal audit is a thorough examination of
the accounting records and system to ensure that they are properly maintained and followed.

Prof. Meigs defined ‘Internal Audit’ as a continuous, critical review of financial and other
operating activities by a staff of auditors, functioning as full time salaried employees.

SAP7 issued by ICAI defines Internal Audit as a separate component of Internal Control
established to determine whether other Internal Controls are well designed and properly
operated.

Guidance Note issued by ICAI says that Internal Audit is an independent appraisal activity

36
 within an enterprise for the review of accounting financial and other operations and controls as
a basis for service to management. It involves a specialized application of the techniques of
auditing.

Features:

1. It is normally done by the employee of an organization.

2. It is a part of the system of Internal Control.
3. It is a critical review of other internal controls.
4. Usual audit techniques are followed for internal audit.
5. It is a kind of continuous audit.

4. “AUDITING TECHNIQUES & SAMPLING”

Q 1. What are the important techniques of auditing?

Ans Audit techniques are the techniques by which an auditor obtains evidence about the transaction recorded
: in the books of accounts. There are various techniques of audit. Selection of proper technique depends
on the type of proposition to be reviewed. It also depends on the nature of evidence available in support
of the proposition. Important techniques of auditing as given by SAP 5 are given as follows:
1. INSPECTION:
It consists of examination of records, documents and tangible assets. Examination of documents
is one of the most important techniques of auditing. As most of the transactions are supported by
documents, it becomes necessary for the auditor to examine large numbers of documents in the
course of audit.
Documents are examined by the auditor with reference to authenticity, appropriateness,
authorization and proper recording. Authenticity implies genuineness of the transaction.

37
 Appropriateness implies that the transaction is legitimate. Authorization refers to that there is a
proper approval for the transaction.
Documentary evidence is clarified into four categories, from the point of view of reliability:
1. Evidence originating from and held by third parties.
2. Evidence originating from third party and held by the entity.
3. Evidence originating from the entity and held by the third parties.
4. Evidence originating from and held by the entity.
Physical examination of tangible assets provides reliable evidence as regards their existence. It
does not provide evidence as regards ownership of the asset or its valuation.
2. OBSERVATION:
It implies witnessing a process or procedure which is performed by others. For example, the
auditor may observe stock taking done by the staff.
3. ENQUIRY AND CONFIRMATION:
It amounts to seeking appropriate information from a right person i.e. a person who has got
knowledge of the transactions. The auditor may make enquiry by asking oral questions to the
concerned persons. Alternatively, he may prepare a questionnaire and send it to the right
persons with a request to complete the same and send back to the auditor.
Confirmation consists of response to an enquiry. For example, the organization may get
confirmation from debtors and creditors.
4. COMPUTATION:
It refers to checking the arithmetical accuracy of the transactions recorded in the books of
accounts. The auditor may follow the same procedures as is followed by the accountant for
verifying arithmetical accuracy.
5. ANALYTICAL REVIEW:
It implies studying important ratios and trends and investigating into the unusual fluctuations.
While auditing the financial statements the auditor can correlate various figures in order to
establish financial soundness of the company. During the course of audit the auditor can scan
various unusual transactions and examine them thoroughly. Proper scanning of the transactions
requires greater degree of skill on the part of the auditor.

Q 2. What is Audit Sampling? Explain revised standard on Auditing. Which factors are considered
while determining the sample size?
Audit sampling means the application of audit procedures to less than 100% of the items within a class of
Ans transactions or an account balance to enable the auditor to form certain conclusions about that class or
: balance as a whole.
Sampling is considered as an important audit technique. It enables the auditor to select some
transactions out of a large mass of repetitive data in a manner that he can draw valid conclusions about
the entire data after a thorough examination of the transactions.
Revised Standard on Auditing (SA 530)
Revised (SA) 530 deals with audit sampling. Revised standard on Auditing (SA 530), Audit sampling,
also recognizes that sampling methods, both statistical and non-statistical, can provide sufficient
appropriate audit evidence when applied appropriately.
Purpose of Sampling
The purpose of sampling can be stated as under:
1. To enable the auditor to design and select an audit sample by using statistical/non-statistical methods.
2. To evaluate sample results and
3. To provide appropriate audit evidence.
Factors in determining Sample Size:

38
 In determining sample size the following factors are considered:
1. Sampling Risk:
A risk is undoubtedly involved in selecting and checking only some items to reach a conclusion
about all of them. Sampling risk arises from the possibility that the Auditor’s conclusion based on
a sample may be different from the conclusion he would reach if the same audit procedures were
applied to the entire population. It arises in carrying out both compliance procedures and
substantive procedures.
2. Tolerable Error:
Tolerable error is the maximum errors in the population that the auditor would be willing to accept
and still conclude that the result from the sample has achieved the audit objective. Tolerable
error is considered in the planning stage.
3. Expected Error:
If the auditor expects error to be present in the population a larger sample that when no error is
expected ordinarily needs to be examined to conclude that the actual error in the population is
not greater than the planned tolerable error.
In addition to the above factors the Auditor has to consider the following related factors:
4. Efficiency of internal control 5. Level of assurance required
6. Results of previous audit work 7. Stratification

Q 3. What are the methods of selecting sample items?

Methods of Selecting Sample Items
Ans The auditor should select sample items in such a way that the sample can be expected to be
: representative of the population. This requires that all items in the population or universe have an
opportunity of being selected. There are several methods of selection. However, the statistical methods
commonly used are, random selection, systematic selection and haphazard selection.
1) Random Selection:
This methods of selecting sample ensure that all items in the population have an equal chance of
selection, for example, by use of random number tables. Random Sampling may be
(i) Simple Random Sampling; or (ii) Stratified Sampling
2) Systematic selection:
This method of selection involves selecting items using a constant interval between selections,
the first internal having a random start. The interval might be based on a certain number of items
(for example every 20th voucher number) or on monetary total (for example, Rs. 1,000 increase in
the cumulative value of the population). When the auditor employs systematic selection, he
would need to determine that the population is not structure in such a manner that the sampling
interval corresponds with a particular pattern in the population. For, example, if in a population of
branch sales a particular branches sales occur only as every 100 th items and the sampling
interval selected is 50, the result would be that the auditor have selected all or none of the sales
of that particular branch.
3) Haphazard Selection Methods:
This may be an acceptable alternative to random selection, provided the auditor attempts to draw
a representative sample from the entire population with no intention to either include or exclude
specific units. When the Auditor employs this method, care has to be taken to guard against
making a selection that is biased, for example, towards items which are easily located, as they
may not be representative.

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 5. Vouching and Verification
Q 1. What is voucher? What is Vouching? What is the importance of vouching? What are its objects?
Ans A) Voucher:
Voucher is documentary evidence supporting the entries in the records. For example Bill, Invoice,
Receipt, Certificate, confirmation from parties, Minutes of the meeting etc.
Thus, Any document which supports the entries in the books of accounts and establishes the
arithmetical accuracy is called as voucher.
B) Vouching:
Vouching means the critical examination of documentary evidence (i.e. Voucher) in support of
entries to establish the authenticity of the transaction recorded. Vouching is an important procedure
for obtaining audit evidence. Normally, entries in the books of accounts are made on the basis of
documentary evidence such as bills, receipts, cheque counter-foils, pay-in-slips, pay roll and so on.
When the auditor checks the entries with these documents, it is called Vouching.
Prof. Dicksee has defined vouching as comparing the entries in books of accounts with documentary
evidence in support thereof.
Vouching is known as essence of auditing. The quality of Audit Report depends upon the quality of
vouchers available.

40
 C) Importance of Vouching:
1) Ensures genuineness of transactions.
2) Enables the auditor to know the nature of transactions.
3) Helps the auditor to ascertain that transactions are pertaining to the accounting period.
4) Facilitates proper allocation of Capital and Revenue Expenditure.
5) Detects frauds and errors.
6) Decides authenticity of transactions.
7) Ensures proper accounting.
8) Compliance with law
9) Ensures proper disclosure
D) Objectives of vouching:
The basic objectives of vouching are as follows:
1. To ensure that all the transactions are recorded properly in the books of accounts.
2. To see that all the entries of the transactions are supported by proper evidence.
3. To make it sure that fraudulent transactions are not recorded in the books of accounts.
4. To see that all transactions relating to business are recorded in the books of accounts.
5. To see that all transactions are properly authenticated by a responsible person.

Q 2. How would you vouch the following incomes:

Ans: 1) Cash Sales:
The auditor should take the following steps to vouch cash sales:
1. Internal check
Examine the system of internal check.
2. Daily cash summary:
Test check the salesman’s daily cash summary with the carbon copies of cash memos and see
that they are properly entered.
3. Proper entry:
See that the total of daily cash sales as per salesman’s abstract is properly entered on the receipt
side of cash book. If they are deposited into bank, check the same with counterfoil of pay-in-slip
books and banks pass books.
4. Cancelled cash memo:
See that the original is also attached to the carbon copy; if any cash memo is cancelled.
5. Authority for discount:
See that discount and allowances are properly allowed by a proper authority.
6. Difference in cash memo and cash book:
Dates of cash memos and the dates on which receipts are recorded in the cash book should be
the same. Any difference should be enquired into.
7. Reconciliation:
Test check the reconciliation between sales and stocks.
8. Posting:
Test check the postings from cash book into ledger.
9. Sale of fixed assets
Ensure that sale of fixed asset is not included in sales.
10. Sales of scrap:
See that sale of scrap is recorded separately.
11. Automatic cash register:
It automatic cash register is employed, the daily totals entered in the cash book should be checked
with the till rolls.
12. Disclosure under revised schedule VI
As per provisions of revised schedule VI, sales shall be disclosed under the heading “revenue
from operations”. Revenue from operations shall separately disclose in the notes as revenue from:
a) Sale of products
b) Sale of services
c) Other operating revenue
d) Excise duty

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 The company disclose by way of notes additional information regarding earnings in foreign
exchange through export of goods on F.O.B basis.

2) Royalty received:
The auditor should take the following steps:
1. Agreement:
See the royalty agreement and get acquainted with the provisions regarding calculation of royalty.
2. Correspondence:
Go through the correspondence with the other parties.
3. Test check:
Test check calculation of royalty, rate, mode of calculation, tax deduction etc.
4. Receipts:
Examine counterfoil or carbon copies of the receipts issued to the parties.
5. Statement of royalty:
Examine the royalty statement received and ensure that royalty has been calculated as per the
terms of the contract.
6. Cash book:
Examine cash book with reference to the covering letter from the publishing.
7. Bank statement:
Trace the receipt of royalty in the bank statement.
8. T.D.S certificate:
Verify that tax has been deducted at source and the certificate is issued.

3) Sales On Approval:
1) See that a separate register is maintained if the number of such transactions is large.
2) Check the entries in the register with the help of the proforma invoices.
3) In case an approval has been received from the customer, compare the entries in the goods sent
on approval register with sales register and see that the entry in the former register is cancelled by
mentioning reference of the invoice number and the date of approval.
4) See that the goods returned from the customers are recorded in goods sent on approval register
and the store register.
5) See that the incidental expenses are properly accounted in the books of accounts.
4) Consignment sales:
1. See that consignment transactions are recorded in a separate journal maintained for the purpose.
2. Check the transactions with the proforma invoice for consignment.
3. Check the entries in the cash book with the help of vouchers for submitted by the consignee.
4. Compare the entries in the consignment register with the account sale submitted by the
consignee.
5. Verify the valuation of goods lying with the consignee. See that it is valued at cost plus
proportionate non-recurring expenses incurred.
6. See that proper adjustments are made with the accounts for finding profit or loss correctly if the
goods are sent at a higher price.
5) Sales Returns:
Internal Check, Entries In The Books, Sales Returns Of First And Last Month, Credit Note, Casting
And Posting, Condition Of Returned Goods, Genuineness.
6) Bad Debts Recovered:
Proof Of Collection, Proper Entry, Order Of Official Receiver, Disclosure, Correspondence, Amount
Written Off, Competent Authority, Entry In The Cash Book, Bank Statement, Disclosure Under Revised
Schedule VI.
7) Rental Receipts:
Internal Check, Lease Agreement, Rent Register, Agent’s Statement, Adjustment For Rent
Receivable, Arrears, Authority For Bad Debts, Entry In Cash Book, Provision For Outstanding Rent,
Certified List, Rent Against Deposits, Examination Of Counterfoils, Disclosure, Income Tax Act,
Reconciliation, Adjustment, Disclosure Under Revised Schedule VI.
8) Interest And Dividend Received:

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 Ensure The Receipt, Verify Correctness, Bank Advice/ Bank Pass Book, Arrears, Verify Interest
Warrants/ Dividend Warrants, Allocation Between Capital And Revenue, Deduction Of Tax At Source,
Bank Statement, Loan Agreement, Interest Received On Earmarked Investment, Pay Special Attention
To Interest Outstanding, Proper Recording, Disclosure Under Revised Schedule VI.
Q 3. How would you vouch the following expenses:
Ans: 1. Salaries and Wages:
1. Supporting documents:
Salaries and Wages payments should be supported by 1) Pay Roll or Wage sheets 2)
Attendance and Personnel Records 3) Statutory Returns filed with Provident Fund, Income-tax
etc. 4) Cheque Counter-foils.
2. Pertains to Client:
The pay rolls etc. should pertain to the client and not to any other concern.
3. Pertain to Current year:
The salaries and wages should pertain to the current accounting year and not to the earlier or
next year.
4. Details of Payment:
The contents of the Pay Roll, Wage Sheets, Statutory Returns etc. should be checked in the
following respects-
a. Amount: The auditor should carefully check that the amount as per the Pay Roll etc. tallies
with the amount mentioned in the voucher.
b. Computation: The amount of gross salaries or wages should tally with the attendance
record or the personnel record. The attendance records show the number of days an
employee was present or on leave. The personnel records show the Basic Salary,
Allowances etc. due to each employee. Auditor can check the computation on a sample
basis. He should also check the calculations in respect of the deductions from salaries
such as Provident Fund, Income Tax, etc. He should cross check that these deduction in
the Pay Roll tally with the returns filed with the Provident Fund, He should also check the
cross totals carry-forwards and castings.
c. Signature of Receiver: The employees should have signed in the Pay Roll against their
names on a revenue stamp to acknowledge receipt.
5. Accounting Principles and Practice:
The auditor should check whether the entry is correct according to the basic principles of
accounting e.g. Gross Amount of Salaries and Wages should be debited to Salaries and
Wages Account. The amounts of deduction should be credited to the respective accounts such
as Provident Fund, Income tax and the net payments should be credited to Cash or Bank
Account.
6. Disclosure Vide Revised Schedule VI:
Salaries and Wages should be disclosed under separate head- “Employee Benefits Expenses’
in the Statement of Profit and Loss and classified as prescribed under Schedule VI.

2. Postage and courier:

1. Examine the postage register if it is maintained.
2. Compare the postage book with the Cash Book or the Petty Cash Book and verify the entries
relating to courier charges.
3. Verify the closing balance of stamp in hand.
4. Where the franking machine is used by the client’s office, the receipt issued by the post office
for its payment should be verified.
5. See that the monthly expenses are debited to postage account.
6. Verify Dispatch Register and cross check postage/ courier expenses with the Register. Check
up outward mail Register to see whether any mail has been sent on that day.
7. Agreement with Courier Company, if any, should be verified.
3. Purchases (Credit and Cash):
Supporting Documents, name, date, Serial no, amount, quantity, signature on Vouchers and
Goods Received Note, signature and stamp of party, errors and frauds, reconciliation, payment to
related concern, disclosure vide revised schedule, audit report under CARO 2003, income tax Act.
4. Purchases returns:

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 Supporting Documents, name, date, Serial no, amount, quantity, signatures, signature and stamp
of party, errors and frauds, reconciliation, disclosure.
5. Rent:
Supporting Documents, name, date, amount, period, signatures, errors, disclosure vide revised
schedule VI.
6. Insurance Premium:
Supporting Documents, name, date, amount, period, signatures, errors, disclosure vide revised
schedule VI.
7. Telephone Expenses
Supporting Documents, name, date, amount, period, signatures and errors.
8. Petty Cash Expenses:
1. See that the vouchers for payment are duly authorized by the responsible officer of the
organization.
2. See that all the vouchers are recorded properly.
3. Ensure that expenses are debited to respective accounts.
4. See that the petty cash is recorded by the petty cashier on the same day on which it is
received from the chief cashier.
5. Examine supporting vouchers and evidence in payment of expenses.
6. Confirm that the vouchers are signed by the persons who have received payment.
7. Check up that the amount is written in words and figures.
9. Travelling Commission:
Agreement, documentary evidence, correctness of amount, provision for outstanding commission,
T.A. Bills and Vouchers, Adjustment of Advance, Test Check Accounting.
10. Advertisement:
Supporting documents, pertains to client, date of document, details of transaction, amount,
quantity, signature and stamp of party, accounting principles and practice, Payment to related
concern, disclosure vide schedule VI, income tax act, other related matters.
11. Interest Expense:
Schedule of interest, payment vouchers, bank reconciliation, statement of account, TDS returns,
general ledger, financial statement, disclosure under revised schedule VI

Q 4. What is verification? What are the objects of verification? What points to be considered by Auditor
while conducting verification?
Ans: A) Meaning:
Verification is defined by Spicer and Pegler as:”an inquiry into the value, ownership and title,
existence and possession and the presence of any charge on the assets”. Verification is a
process by which an auditor satisfies himself about the accuracy of the assets and liabilities appearing
in the balance sheet by inspection of the documentary evidence available.
Verification means proving the truth, or confirmation of the assets and liabilities appearing in the
balance sheet.
B) Objects of verification:
According to the ‘Statement of Auditing Practices’ issued by ICAI, “the auditor’s objects in regard to
assets generally is to satisfy that:
1. They exist;
2. They belong to the client;
3. They are in the possession of the client or persons authorized by him;
4. They are not subjected to undisclosed encumbrances or lien.
5. They are stated in the balance sheet at proper amounts in accordance with sound accounting
principles and
6. They are recorded in the account.
C) Points to be considered:
1. Existence: the auditor should confirm that all the assets of the company are physically existing on
the date of Balance Sheet.
2. Possession: The auditor has to verify that the assets are in the possession of the company on the
date of Balance Sheet.

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 3. Ownership: The auditor should confirm that the asset is legally owned by the company.
4. Charge or lien: The auditor should verify whether the asset is subject to any charge or lien.
5. Record: The auditor should confirm that the assets and liabilities are recorded in the books and
there is no omission of any asset or liability.
6. Audit Report: Under CARO 2003, the auditor has to report whether the management has
conducted physical verification of fixed assets and stock and the differences, if any, between the
physical inventory and inventory as per the books.
7. Events after Balance Sheet date: The auditor should find out whether any event after the date of
Balance Sheet has affected any items of assets and liabilities.

Q 5. Distinguish between vouching and verification.

Ans:
VERIFICATION VOUCHING
1. NATURE
Establishes truth about the assets and liabilities. Examines the entries in the book of accounts with
the help of documentary evidence.
2. TIME
It is done at the end of the year. It is done during the whole year.
3. BASIS
It is based on personal and documentary It is based on documentary evidence only.
evidence.
4. VALUATION
It includes valuation also. It is not concerned with valuation.
5. UTILITY
Certifies correctness of assets and liabilities Certifies correction of records.
6. PERSONNEL
It is done by the auditor himself. It is done by the junior staff of the auditor.
7. AUDIT TECHNIQUES
It involves scrutiny of ledger physical It involves examination of vouchers, supporting
verification, inspection of documents and documents and entries in the books.
confirmation from the third parties.

Q 6. How would you verify the following assets?

Ans: A) Quoted Investments:
The auditor should take the following steps:
1. Broker’s Note: Ascertain and note the following from the Broker’s Note:
a. Date of purchase
b. Rate of purchase
c. Details of securities purchased
d. Quotations Ex or cum interest or dividend.
2. Stock exchange Quotations: Obtain stock exchange quotation and compare it with the rate
of purchase. In case of significant variations, suitable explanation should be sought.
3. Payment voucher: Verify the amount paid towards purchase of investment. Trace the amount
in Bank Statement.
4. Nature: Verify capital, revenue distinction, brokerage, transfer, fees, stamp duty, and
quotation.
5. Schedule of investment: Obtain a certified schedule of investment from the management and
physically examine the same.
6. Certificates: Examine the investment certificates and see whether they are with the Bank and
obtain confirmation certificate, if no certificates are received, check up the allotment letters for
shares. Investments held in the name of nominees, trustees should examine with documentary
evidence.
7. Legal Provisions: Ensure that the provisions of law complied with.
8. Financial statements: Examine that the investments are reflected in the financial statements

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 properly.

B) Unquoted Investments:
The auditor should take the following steps:
1. Investment Register: The auditor should examine the Investment Register and see the details
of investments.
2. Valuation: See that the shares are valued at cost.
3. Provision of Loss: Ascertain whether any provision for loss has been created.
4. Disclosure: See that proper disclosure of the investment is made in the Balance Sheet.
Unquoted shares are disclosed under “investment”.
5. Compliance: Ensure that the provisions of law and AS 13 are complied with for disclosure.

C) Copy Rights/ Trademarks:

1. Agreement: The auditor has to examine the written agreement of assignment alongwith the
price paid to the author for such copy rights.
2. Registration: He has also to see that such assignment is properly registered.
3. Schedule of Copy Right: Ask the client to prepare a schedule of copy rights and get the
detailed information to confirm that all of them are shown in the balance sheet.
4. Valuation: See that the value is determined on revaluation basis and the period of copy rights.
5. Written off: Ensure that id any copy right does not command sale of any books, the same
should be written off in such year.
6. Alive: See that the legal life of the copy right has not been expired.

D) Book Debts/ Debtor:

Confirmation of balances. Scrutiny of ledger, verification of the position of debtors. Compliance of
legal requirements. Disclosure of Hire Purchase debtors, Disclosure of customers who have
purchased goods on approval basis, disclosure of Credit balances on debtors account, confirm
ownership, verification of encumbrances, cut off transactions, provision for bad and doubtful debts,
events after year end.

E) Stock- Auditors General Duties:

i) Verification: Verify Existence, possession, Cut-off Transactions, Subject to Charge or
Lien, Audit Report under Companies Act, Duty Prescribed by ICAI.

ii) Procedure for Stock-taking: Written instructions, Note Quantity on Tags, no stock
Movement, Test Check, check all tags , Stock Sheets, Upto date Stock Books,
Reconciliation, Stock of outsiders.

iii) Valuation: Method of Valuation, no change in method, correct computation, Foreign

Exchange, accounting, companies Act, Disclosure vide Revised Schedule VI, Duty
Prescribed by ICAI.

iv) Importance: To show proper value of assets, to show proper profits

v) Special type of stocks: Stock of Goods on Consignment, stock of Goods sold on hire
Purchase, stock of goods sent on sale or return.

F) Loose Tools:
Cost of loose tools, certification of the value, physical verification, proper valuation, disclosure.

G) Spare parts:
Inventory, cost of purchase, valuation, not usable, disclosure.

H) Patterns & Dies:

Inventory, method of valuation, cost, documents, valuation of a) purchased items, b) manufactured

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 items c) obsolete items d) defective / damaged.

I) Empties or containers:
Terms, records, provision for liability.

J) Patents rights
Ownership, register of patents, agreement, registration, legality, capitalization of expenses,
confirmation, valuation, cost written off, validity of title, income tax.

K) Plant and machinery:

Plant register, adequate depreciation, consistency in depreciation, installation / Acquisition
expenses, separate reserve, machinery on hire, physical verification, sale of plant and machinery,
entry for depreciation, opening balance, proper authority, valuation and disclosure, plant and
machinery abroad.

L) Leasehold Property:
Compliance, lease agreement, registration, validity of sub lease, provision for dilapidation,
disclosure, acquisition expenses written off.

M) Freehold property:
Title deed, correspondence, builder’s bill, certificate from the mortgager, certificate from the
bankers, validity of title deed, registration, insurance, basis of revaluation, separate account for
land.

N) Furniture & Fixtures:

Internal controls, serial no, schedule of furniture, physical examinations, verify cost, depreciation,
verify existence, verify ownership, verify disclosure.

O) Land and Building

Records, ownership charge or lien, valuation, costing, revaluation of land and building, constructed
building.

Q 7. How would you verify the following liabilities?

Ans: A) Outstanding expenses:
1. List of outstanding expenses: Obtain the list of outstanding expenses classified by nature of
expenses.
2. Material variances: Compare current year’s outstanding expenses with that of the previous
year and enquire into the material variance if any.
3. Estimates of outstanding expenses: Verify carefully the estimates of outstanding expenses.
4. Documentary evidence: Examine the documentary evidence supporting the outstanding
expenses.
5. Payment of outstanding expenses: See that the usual outstanding expenses are paid off by
the time of audit.
6. Adequate provision: Make sure that provision has been made for all the usual outstanding,
e.g. last month’s salary, wages, rent, etc.
7. Correspondence: Examine the correspondence, minute books etc.
8. Service contract: Verify the service contracts made by the company and see that all
outstanding expenses have been provided for.
9. Disclosure: See that outstanding expenses have been disclosed in the balance sheet under
liabilities.

B) Secured and unsecured loans:

1. Power to borrow money: Examine the partnership deed or Memorandum and Articles of

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 Association to find out the powers of client to borrow money.
2. Validity: Examine the loan agreement and correspondence relating to loans.
3. Entries: Check the cash received along with the receipt issued and check up the same in the
cash book.
4. Scrutiny of agreement: Scrutinize the agreement made with the bank in case of overdraft.
5. Security: Enquire into the details of the security given against loan in case the loan is secured.
Ensure that such a fact has been disclosed in the balance sheet.
6. In the interest of the company: Find out the reason of borrowing and see that it is in the
interest of the client.
7. Registration of mortgage: See that the mortgage is registered with the Registrar of
companies under section 125 of the companies Act 1956. Ensure that entry is made in the
register of mortgages.
8. Payments made: Verify the payment of interest and installments with the receipt issued by the
lender and confirm that they are paid in accordance with the time schedule mentioned in loan
agreement.
9. Compliance with companies act: Ensure that the provisions of companies act regarding the
maximum amount of loan that the company can raise, have been complied with.
10. Utilization: Ascertain the purpose for which loan is taken and see that it is utilized for the right
purpose.
11. Confirmation: Obtain confirmation letter from the parties.
12. Reconciliation: The auditor should verify the reconciliation and see that the book balance
agrees with the statement sent by the lenders.

C) Bills Payable:
Statement Of Bills Payable, Compare, Verification, Test Check Posting, Confirmation, Disclosure
Of Charge, Dishonor.

D) Contingent Liabilities:
Meaning, Examples, Discovery, Certificate, Report Under Caro 2003, On Guarantees For Loans,
Disclosure.

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