FEDERAL COLLEGE OF EDUCATION ZARIA

BEA 326 AUDITING LECTURE NOTE

PREPARED BY
NATHAN HENRIATTA JUMMAI
AND
DR. NURADREEN USMAN MIKO

COURSE OUTLINE
(1) Nature or meaning, purpose and objectives of Auditing
(2) Types of Audit
(3) The Auditor: Qualification, Professional Ethics, Independence, Right and
Responsibilities
(4) The Process of Audit: Evidence Decisions
(5) Types of Audit Approaches used in conducting Audits
(6) Auditing of Final Accounts including Balance Sheet
(7) Verification and Valuation of Assets and Liabilities
(8) Internal Control
(9) Investigation and detection of Fraud &Errors
(10) Procedure for writing Audit Report

1.0 NATURE OR MEANING OF AUDITING

1.1 Introduction of auditing
The practice of Auditing existed even in the Vedic period. Historical records show that
Egyptians, Greeks and Roman used to get this public account scrutinized by and
independent official. Kautaly in his book “arthshastra” has stated that “all undertakings
depend on finance; hence foremost attention should be paid to the treasury”. Auditing as it
exists today can be associated with the emerging a joint stock company during the
industrial revolution. The company’s act of 1956 gives regulations regarding the audit
work. Audit was originally confined to ascertaining whether the accounting party had
properly accounted for all receipts and payments on behalf of his principal, and was in fact

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merely a cash audit. Modern audit not only examine cash transactions, but also verify the
purport to which the cash transactions relate.

1.2Meaning of Audit: The word audit is derived from the Latin word “AUDIRE” which
means to hear. Initially auditor was a person appointed by the owners to check account
whenever the suspected fraud, he was to hear explanation given by the person responsible
for financial transactions. Emergence of joint stock companies changed the approach of
auditing as ownership was pestered from management. The emphasis now is clearly on the
verification of accounting date with a view on the reliability of accounting statement.
Audit is an examination of accounting records undertaken with a view to establishing
whether they correctly and completely reflect the transactions to which they purport to
relate.

1.3 Meaning of Auditing: define auditing can be explain as an examination of the books,
accounts and vouchers of a business’s which enable the auditor to satisfy himself whether
or not the balance sheet is properly drawn up so as to exhibit a true and correct view of the
state of affairs of the business according to his best of the information given to him and as
shown by the book.

1.4Purpose and objectives of auditing

Auditors are basically concerned with verifying whether the account exhibit true and fair
view of the business. The objectives of auditing depend upon the purpose of his
appointment. We have primary and secondary audits

1.4.1. Primary Objective: The primary objective of an auditor is in respect to the owners
of his business expressing his opinion whether account exhibits true and fair view of the
state of affairs of the business. It should be remembered that in case of a company, he
reports to the shareholders who are the owners of the company and not to the director. The
auditor is also concerned with verifying how far the accounting system is successful in
correctly recording transactions. He had to see whether accounts are prepared in

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accordance with recognized accounting policies and practices and as per statutory
requirements.

1.4.2 Secondary Objective: The following objectives are incidental to the main objective
of auditing.
1.4.2.1It is mainly aim atdetection and prevention of errors: errors are mistakes committed
unintentionally because of ignorance, carelessness. Errors are of many types:
i. Errors of Omission: If a transaction has been totally omitted it will not affect
trial balance and hence it is more difficult to detect. On the other hand if a
transaction is partially recorded, the trial balance will not agree and hence it can
be easily detected.
ii. Errors of Commission: When incorrect entries are made in the books of accounts
either wholly, partially such errors are known as errors of commission. E.g.:
wrong entries, wrong Calculations, postings, carry forwards etc. such errors can
be located while verifying.
iii. Compensating Errors: when two/more mistakes are committed which counter
balances each other. Such an error is knownan Compensating Error. Eg: if the
amount is wrongly debited by Rs 100 less and Wrongly Credited by Rs 100 such a
mistake is known as compensating error.
iv. Error of Principle: These are the errors committed by not properly following the
accounting principles. These arise mainly due to the lack of knowledge of
accounting. Eg: Revenue expenditure may be treated as Capital Expenditure.
v. Clerical Errors; A clerical error is one which arises on account of ignorance,
carelessness, negligence etc.
1.4.2.2 Deduction and Prevention of Fraud: A fraud is an Error committed intentionally
to deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 type.
1.4.2.2.1Misappropriation of Cash:This is one of the majored frauds in any organization
it normally occurs in the cash department. This kind of fraud is either by showing more
payments/ less receipt. The cashier may show more expenses than what is actually
incurred and misuse the extra cash

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1.4.2.2.2Misappropriation of Goods: here records may be made for the goods not
purchase not issued to production department, goods may be used for personal purpose.
Such a fraud can be deducted by checking stock records and physical verification of
goods.
1.4.2.2.3Manipulation of Accounts: this is finalizing accounts with the intention of
misleading others. This is also known as “WINDOWS DRESSING”. It is very difficult to
locate because its usually committed by higher level management such as directors.

2.0 TYPES OF AUDIT

There are many types of audits: some of which are,
(1) Statutory Audit: audit carried on as base on the requirement of law is called
statutory audit. e.g.: all companies have to get their accounts audited as per the
provision of the company’s Act of 1956.
(2) Periodical/ Annual Audit: it is a kind of audit where the auditor verifies the
account at the end of the financial year. This is a common audit and is mostly used
by small organizations.
(3) Interim audit:it’s an audit conducted in the middle of the accounting year before
the accounts are closed. The objective is to get periodical results, to declare interim
dividend.
(4) Partial Audit: when an auditor is asked to audit only a part of the account system
it’s called partial audit. E.g.: he may be asked to audit only the payment side of
cash book.
(5) Balance sheet audit: it’s a kind of partial audit and is concerned with the
verification of only those items appearing in the Balance Sheet. It is more popular
in the USA. Infact while verifying BS items the auditor verifies/ checks all related
items/accounts.
(6) Management audit: Management audit may be defined as a comprehensive
examination of an organizational structure of a company, institution/government
and its plans and objectives it means of operations and use of human and physical
facilities.

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 (7) Continuous audit: a continuous audit is one in which the auditor visits his client’s
office at regular intervals throughout the year to verify the account. The objective
of Continuous Audit may be-
a. To get final account audited immediately after the closure of accounting year.
b. When the business is very large.
c. When interval control system is into effective.
d. When regular final accounts are required.

3.0 THE AUDITOR: QUALIFICATION, PROFESSIONAL ETHICS,

INDEPENDENCE,RIGHT AND RESPONSIBILITIES
3.1 Qualification of Auditor
According to Section 226(1) and 226(2) of the Companies Act, the prescribed
qualifications of an auditor are as follows:
1. A person who is a chartered accountant within the meaning of the Chartered
Accountant’s Act 1949.(Section 26(1)
2. A person who holds a certificate under the Restriction Auditors Certificate Rules 1956
is also qualified to act as an auditor of a company. Such persons are also known as
certified auditors and are always subject to rules made in this behalf by the central
government [section 226(2)]
The central government in empowered to frame rules relating to granting renewals,
suspension or cancellation of such certificates.

3.2 Disqualification of a Company Auditor

According to section 226(3) of the Companies Act, the following persons shall not be
appointed as auditors of a company.
I. A body corporate.
II. An officer or an employee of the company.
III. A person who is a partner in the business.

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IV. A person who is indebted to the company for an amount exceeding organizational
limit or who has given any guarantee or provided any security in connection with the
indebtedness of any third person to the company for an amount exceeding limit.
If an auditor, after his appointment becomes a subject of any of the above mentioned
disqualifications, he shall be deemed to have vacated his office forthwith.

3.3 Removal of an Auditor

1. The first auditors appointed by the directors prior to the first annual general meeting of
the company may be removed by the members in the annual general meeting even if
there tenure of office has not expired.
The general meeting may in their place, appoint any other person, notice for whose
nomination has been given by any member not less than 14days before the date of the
meeting.
2. In any other case, the auditor may be removed from office before the expiry of his term
by the company in the annual general meeting after obtaining the previous approval of
the central government in this behalf. This provision is as per section 224(7) of the
Companies Act.
3. But section 225 of the Companies Act makes special provisions in this respect, in order
to safeguard the interests of an independent auditor against unfair and unjust removal
at the hands of an unscrupulous management.

3.4 Professional ethics in auditing

The general public demand professional accountants to maintain a high ethical standard in
order to maintain public confidence in the accountancy profession. Professional
accountants are required to comply with the Code of Ethic. Any member that fails to
comply is liable to be investigated, resulting in possible disciplinary action such as an
order to remove the name of the member from the Institute’s membership register.
3.4.1. Fundamental Principles
Professional accountants are required to abide by the following five fundamental
professional principles:
3.4.1.1. Integrity

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A professional accountant should be Straightforward, honest and sincere in the approach
to professional work.
3.4.1.2. Objectivity
A professional accountant should not allow bias, conflict of interest or undue influence of
others to override professional or business judgments. When reporting on financial
statements which come under auditors review, they must maintain an impartial attitude.
3.4.1.3. Professional Competence and Due Care
A professional accountant has a continuing duty to maintain professional knowledge and
Skill at the level required to ensure that a client or employer receives competent
professional service based on current developments in practice, legislation and techniques.
3.4.1.4. Confidentiality
A professional accountant should respect the confidentiality of information acquired as a
result of professional and business relationships and should not disclose any such
information to third parties without proper and specific authority unless there is a legal or
professional right or duty to disclose.
3.4.1.5. Professional Behaviors
A professional accountant should comply with relevant laws and regulations and should
avoid any action that discredits the profession. Must conduct in a manner consistent with
the goal reputation of their profession and refrain from any conduct which might bring
discredit to their profession.
3.4.1.6. Independence
Must be and should be seen to be free of any interest which might be regarded, whatever
its actual effect, as being incompatible with integrity and objectivity. Auditors’ may
compromise their professional independence because of outside pressures.

3.5. AUDITOR’S INDEPENDENCE

Audit independence is an absence of interests that create an unacceptable risk of material
bias with respect to the reliability of financial statements. The objective of audit
independence is to makes the audit more effective by providing assurance that the auditor
will plan and execute the audit objectively and also improve the reliability of information
used for investment and credit decisions.

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3.6.Rights and Responsibility of Auditors
3.6.1. Rights of Company Auditors.
According to Section 227(7) of the Companies Act, a company auditor has the following
rights.
3.6.1.1.Right of Access of Books of Accounts:
As per Section 227(1) of the Companies Act every auditor of the company has the
right to access at all times to the books of accounts and vouchers of the company,
whether kept at the head office of the company or elsewhere.

3.6.1.2.Right to Obtain Information and Explanations:

An auditor can call for any information or explanation from different officers of the
company which he may think necessary for the performance of his duties.
Under section 221, apart from the auditor’s right to obtain information and explanation
it is the duty of every officer of the company to furnish without delay the information

3.6.1.3.Right to Receive Notices and Other Communication Relating to General

Meetings and to attend them.
According to section 231, of the companies act an auditor of a company has the right
to receive notices and other communications relating to the general meetings in the
same way as that of the members of the company.

3.6.1.4.Right to Visit Branches.

According to section 228 of the companies act the auditor of the company has the right
to visit the branch office or offices of the company.He can also audit such accounts of
eh offices of the company provided that there is not qualified auditor to audit the
accounts of the branch office or offices of the company, in such cases, the auditor has
the right to access at all times to the books of accounts and vouchers that the company
maintains at branch office or offices.

3.6.1.5.Right to Correct Any Wrong Statement.

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 The company auditor is required to make a report to the members of the company on
the accounts examined by him of the final accounts and the related documents which
are laid down before the company in the general meeting.

3.6.1.6.Right to sing the Audit Report

As per section 229 of the companies act only the person appointed as auditor of the
company or where a firm is so appointed, only a partner in the firm practicing, may
sign the audit report or authenticate any other document of the company required by
law to be signed.

3.6.1.6.Right to Being Indemnified.

Under Section 633 of the Companies Act, an auditor is considered to be an officer of
the company and he has the right to be indemnified out of the assets of the company
against any liability incurred by him in defending himself against any civil and
criminal proceedings by the company if it is proved that the auditor has acted honestly
or the judgment is delivered in his favor.

3.6.1.7.Right to seek Legal and Technical Advice.

The company auditor has the full right to seek the opinion of the experts and to take
their legal and technical advice so as to discharge his duties efficiently.

3.6.1.8.Right to Receive Remuneration.

As per Section 224(8) of the Companies Act, the company auditor has the right to
receive remuneration provided he has completed the work which he has undertaken to
do so.

3.6.2. Responsibilities or Duties of Company Auditor.

The various duties of the company auditor are as follows:

3.6.2.1.To make special enquiries and investigation: in connection with the following
matters under section 227(1-A) of the Companies Amendment Act 1965.

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 A company auditor shall enquire:
a. Whether loans and advances made by the company on the basis of security have
been properly secured and whether the terms of which they have been made are
not prejudicial to the interests of the company or its members.
b. Whether the transactions which are not supported by any fact or evidence, though
recorded in the books are not prejudicial to the interests of the company.
c. Whether personal expenses have been charged to the revenue account.
d. Whether it has stated in the books of accounts of the company that any shares
have been allotted for cash and whether cash has actually been received in respect
of such allotment, and if no cash has actually been received, whether the position
as stated in the account books and the Balance Sheet is correct and regular.
e.
3.6.2.2.Duty to make a Report to the Shareholders.
Under Section 227(2,3,4&5) of the Companies Act, the auditor shall report to the
shareholders about the accounts examined by him. The report so mentioned shall
contain the following.
a. Whether in his opinion, the Profit and Loss Account referred to in his report
exhibits a true and fair view of the profit or loss.
b. Whether in his opinion, the Balance Sheet referred to in his report is properly
drawn up, so as to exhibit a true and fair view of the state of affairs of the business
according to the best of his information and explanations given to him and as
shown by the books of accounts.
c. Whether he has obtained all the information and explanation which to the best of
his knowledge and belief were necessary for the purpose of his audit.
d. Whether in his opinion, proper books of accounts as required by law have been
kept by the company and proper returns adequate for the purpose of his audit have
been received from branches he visited or not.
e. Whether report on branch accounts audited under section 28 by a person other
than the company’s auditor has been forwarded to him as required by clause (c)
sub section (3) of that section and how he had dealt with the same in preparing the
auditor’s report.

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 f. Whether the company’s Balance Sheet and Profit and Loss Accounts dealt with by
the report are in agreement with the books of accounts and returns.
If the answer to any of the above mentioned questions is in the negative, the
auditor should submit his report accordingly.
3.6.2.3.Duty to comply with the Directives of the Central Government.
It is the duty of the auditor to comply with the various directives issued to the auditor
of the joint stock companies from time to time to give specific reports on the financial
accounts of the companies.
For example in 1975 it was made compulsory for some of the specified companies
which are engaged in any of the below mentioned activities to conduct cost audit, that
is, those companies engaged in
a. Manufacturing, mining or processing.
b. Supplying and rendering services
c. Trading
d. Business of financial investments, chit funds, nidhi or mutual benefit societies.

3.6.2.4.Duty to sign the Audit Report.

As per section 229 of the company’s act 1956, it is the statutory duty of the company
auditor to sign the report prepared by him. Only a partner practicing in a firm in India
can sign the audit report for and on behalf of a partnership firm practicing as chartered
accountants.

3.6.2.5.Duty to give a Statement in the Prospectus.

As per section 56(1) of the companies act, the prospectus issued by an existing
company shall contain a report from the auditor of the company regarding
a. Profits and losses during the previous year.
b. Assets and liabilities of the company and its subsidiaries and
c. The rate of dividend paid by the company in respect of each class of shares in the
company for each of the five financial years preceding the issue of prospectus.
So it is the statutory duty of the company auditor to submit his report containing
the above mentioned points.

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3.6.2.6.Duty to Certify the Statutory Report.
According to section 165(4) the auditor of the company has to certify the statutory
report regarding the shares allotted by the company, the cash received in respect of
shares, and the receipts and payments of the company. The statutory report should also
be certified as correct by two directors, one of whom shall be managing director.
Every company shall within a period of not less than one month and not more than
6months from the date which the company is entitled to commence business has to
conduct a general meeting of the members of the company which is known as the
statutory meeting.

3.6.2.7.Duty to make a declaration of Solvency, if the company Goes into Voluntary

Winding up
When a company goes into voluntary winding up, then a declaration of solvency is to
be made by the directors of the company. Under section 488(1) of the Companies Act,
this declaration is to be accompanied by the report of the auditor of the company under
the section 488(2) of the companies act. So it is the duty of the auditor to make such
reports.

3.6.2.8 Duty to produce information and to assist the investigation, if any

investigation is conducted regarding the working of the company.
Under section 240(6) (b), it is the duty of an auditor to preserve and produce to the
inspector or any other person authorized by him in this behalf with the previous
approval of the central government, all books and papers of or relating to the company
or as the case may be, of relating to the other body corporate which are in their custody
or power and other wise to give to the inspector all the assistance in connection with
the investigation which they are reasonably able to give.

3.6.2.9.Duty to perform the contract

It is the duty of the auditor to discharge the duties according to the terms of contract
between the auditor and the party who has appointed him. It is to be remembered that

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 the scope of statutory duties of a company auditor cannot in any way be curtailed. But
on the other hand, the scope of duties of the auditor can be enlarged by passing a
resolution at the annual general meeting making a provision in the Articles of
Association of the company. If so, it is the duty of the auditor to perform the additional
work.

3.6.2.10. Duty to care and caution.

The auditor is appointed in the capacity of an expert, therefore, he must act honestly
and exercises cure care and caution in the performance of his duties. The auditor can
never give ignorance as an excuse for defense. So the auditor must prove that in the
course of his audit work, he has employed skills that would reasonably be applied by
any other auditor.

4.0. THE PROCESS OF AUDIT: EVIDENCE DECISIONS

4.1 Evidence:
Any information used by the auditor to determine whether the information being audited
is stated in accordance with the established criteria. Evidence is used by scientists,
lawyers, and historians all use evidence to help them draw conclusion about what
evidence to gather and how much of it to accumulate.

4.2 Audit Evidence Decisions

4.2.1 Which audit procedures to use: detailed instruction that explains the audit evidence
to be obtained during the audit?

4.2.2. What sample size to select for a given procedure vary the sample size from one to
all the items in the population being tested
4.2.3. Which items to select from the population Methods can be used to select the
specific items to be examined

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4.2.2 When to perform the procedures (timing) vary from early in the accounting period
to long after it has ended. In part, the timing decision is affected by when the client
needs the audit to be completed

4.3 Six Characteristics of Reliable Evidence

4.3.1 Independence of provider refers to the degree to which evidence can be believable
or worthy of trust Evidence obtained from a source outside the entity is more
reliable than that obtained from within.
4.3.2. Effectiveness of client’s internal controls When a client’ s internal controls are
effective, evidence obtained is more reliable than when they are weak
4.3.3. Auditor’s direct knowledge Evidence obtained directly by the auditor through
physical examination, observation, recalculation, and inspection is more reliable
than information obtained indirectly
4.3.4. Qualification of individuals providing the information the individual providing
evidence must be qualified
4.3.5. Degree of objectivity Objective evidence is more reliable than evidence that
requires considerable judgment to determine whether it is correct. the
qualifications of the person providing the evidence in subjective evidence.
4.3.6. Timeliness Evidence is usually more reliable for balance sheet accounts when it is
obtained as close to the balance sheet date as possible for income statement
accounts, evidence is more reliable if there is a sample from the entire period under
audit, such as a random sample of sales transactions for the entire year
4.4 Types of Audit Evidence
1. Physical examination
2. Confirmation
3. Documentation
4. Analytical procedures
5. Inquiries of the client
6. Recalculation
7. Performance
8. Observation

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5.0. TYPES OF AUDIT APPROACHES USED IN CONDUCTING AUDITS
There is no specific approach mentioned in the audit standard both local and
internationally. Both the Nigerian standard on Audit (NSA) and International Standard on
Audit (ISA) did not specifically give directives as to the approach to be adopted in
carrying out audit assignment.
It only gives guideline on the approaches to be used in carrying out audit assignment, this
has been highlighted above although, audit may be carried out based on two different
approaches, which are:
i. Traditional audit approach; and
ii. Balance sheet audit

5.1. Traditional audit approach

This involve the traditional mean of auditing the account of an entity starting from the
source documents through the book of original entries or day books, trial balance
preparation, trading, profit and loss account and balance sheet.

This approach is based on the conventional means of auditing the account of a concerned
entity; the system encompasses all the process and procedure of carrying out audit which
includes obtaining preliminary understanding of the principal features of the Client’s
accounting system, internal control procedures, testing the accounting system whether it is
in operative throughout the year, carrying out compliance and substantive test and writing
of report.

5.2. Balance sheet audit

These are audit which involves the verification of assets and liabilities of an entity at a
particular point in time such as the balance sheet date. They are carried out commencing
form balance sheet back to the book of original entry and source document (documentary

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evidence). This approach requires that there is a reliable system of internal check and
internal control system in operation.
All other procedure and planning must be strictly adhere with but the only difference is
that, this audit is done from balance sheet back to the book of original entry and source
document as again the conventional audit approach. This audit is mostly found in advance
countries like America, Great Britain, China etc.

6.0. AUDITING OF FINAL ACCOUNTS INCLUDING BALANCE SHEET

Auditing as earlier explain, is the process carried out by a suitably qualified Auditors
during which the accounting records and the financial statement of an entity are subjected
to examination by independent auditors with the main purpose of expressing an opinion in
accordance with his terms of appointment.
Auditing comprises of all systematic strategy and professional approach adopted auditor in
gathering enough audit evidence and audit working papers which must be adequate to
enable an auditors make opinion on the concerned financial statement.

In auditing the final account of an entity, some factors need to be considered in

determining the audit approach to be adopted by an auditor. These factors are:
i. Whether the audit is a new audit (new client); or
ii. Subsequent audit (old client).
It is important to note that auditing of a new client requires more attention and more time
than auditing an existing or old client.

6.1 AUDITING OF A NEW CLIENT

In auditing the account of a new client, all the aforementioned audit process of the write-
up must be strictly observed. They include; the nature of the enterprise, the nature of the
industry in which the business is operating, the position of the enterprise in the industrial
sector, familiarization with the internal control system, understanding the method of
operation, studying the copies of previous audit among other factors.

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After the necessary preliminary understanding of the company basic information and
system of accounting in operation, the steps required by Auditors in auditing the final
account (trading, profit & loss account and balance sheet) of an entity are:
i. Obtain a copy of the final account prepare and duly signed by at least two
directors of the enterprise;
ii. Compare the figures in each items e.g. sales, purchases etc with previous year
items and demand explanation for variation where the arises this is called
analytical review;
iii. Auditor should examine the gross profit ratio of two years and the ones to
watch are:
(a) Ratio of debtors to sales
(b) Credit to purchases, etc and note any material variation
iv. The sales figure should be critically reviewed for accuracy and correctness.
The necessary source documents should be checked to avoid double recordings
and other errors;
v. The returns both inwards and outwards should equally be checked

7.0 VERIFICATION AND VALUATION OF ASSETS AND LIABILITIES

Verification implies an inquiry into the value, ownership and title, existence and
possession and the presence of any charge on the assets. Verification ‘signifies the
physical examination of certain class of assets and confirmation regarding certain
transactions. Sometimes verification is confused withvouching but they differ from each
other on the nature and depth of the examinationinvolved. 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 ofthe assets and liabilities appearing in the
Balance Sheet. Verification includes verifying:-
1. The existence of the assets
2. Legal ownership and possession of the assets
3. Ascertaining that the asset is free from any charge, and
4. Correct valuation

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Of course it is not possible for the auditor to verify each and every asset,hence, he is
requireto verifies all the assets and liabilities appearing in the balance sheet. In the case of
failure, the auditor can be held liable for damages. According to the `statement of auditing
practices‘ issued by ICAI, ―the auditor‘s object 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 the persons authorized by him.
4. They are not subject to undisclosed encumbrances or lien.
5. They are stated in the balance sheet at proper amounts in accordance with sound
accounting principles
6. They are recorded in the accounts.

Benefits of verification of assets

1. It avoids manipulation of accounts
2. It guards against improper use of assets
3. It ensures proper recording and valuation of assets
4. It exhibits true and fair view of the state of affairs of the company.

Techniques
1. Inspection:
It means physical inspection of the assets i.e. company cash in the cash box, physical
inventory, inspection of shares certificates, documents etc.

2. Observation:
The auditor may observe or witness the inspection of assets done by others.

3. Confirmation:
It means obtaining written evidence from outside parties regarding existence of assets.

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8.0.INTERNAL CONTROLSYSTEM
Internal control is a broad term which is normally used to control financial and non-
financial activities. It involves a number of checks and controls exercised in a business to
ensure efficient and economic working. Internal Control is defined as “the whole system
of controls, financial and otherwise established by the management in the conduct of a
business including internal check internal audit and other forms of control. Internal
control is an important tool of management. It assists the management in the performance
of its various functions. It means the built in cross-checks in the system supplemented
with proper supervision and internal audit carried out by the staff appointed by the
organization. These days business has been become more complex both in nature and size
and the management finds it difficult to get correct information about the various aspects
of the business. Internal control assures the management that the information supplied to it
is reliable and accurate. The Internal controls are exercised to ensure the accuracy and the
reliability of accounting data and other records, to identify weaker areas of operation and
to improve them to increase operational efficiency of the business, to safeguard its assets
and to ensure orderly conduct of business.

8.1. Objective/ advantages of Internal Control:

1. From the clients point of view.
a. Internal control system provides authentic and reliable data useful to take business
decisions.
b. It safeguards the physical and non-physical assets in the form of records,
documentation etc.
c. It promotes operational efficiency, by preventing waste, duplication of work and
inefficient use of resources.
d. A good system of internal control provides that the company follows the
procedures and rules as required by the law.

2. From auditors point of view.

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 An auditor evaluates a system of control before commencing an audit work his work
becomes easier if the control system is efficient. He can also decide whether detail
verification is necessary or not.

8.2 Disadvantages of Internal Control

1. It involves expenditure which may not be affordable by the small organizations.
2. Internal control is concerned with routine transactions many times unusual
transactions may be over looked.
3. The system of internal control may be weakened due to inefficiency in handling of the
system.
4. There are chances of diverse objectives among employees in the departments and staff
in charge of internal control.
5. Management may manipulate the operation of internal control system.

8.3 Elements, features characteristics principles of a good Internal Control System:

An effective internal control system should have the following factors:

1. Competent and trust worthy staff: people in charge of internal control system must
be reliable and highly competent about the work. Lack of knowledge and dishonesty
will spoil the efficiency of the system.

2. Records of financial and other organizational plans: A good internal control system
must have good documentation system. Filing, recording, classifying, etc will help in
this regard.

3. Segregation of duties: normally, there should be a separate department for internal

control this reduces frauds, bias etc. normally; a clerk in charge of accounting function
should not be in charge of assets also.

4. Supervision: proper reviewing of the operations of the company regularly makes the
control system effective.

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5. Authorization: all transactions must be properly authorized. In other words, the
authority of each person should be well defined.
6. Sound practices: the company should have well established procedures, policies,
delegations organizational manuals etc.
7. Internal Audit: it’s a part of internal control and it should be independent of internal
check.
8. Accounting Controls: proper accounting information systems should be established
so that the information relating to accounts is properly collected, recorded and
accounts prepared.

8.4 .Scope of Internal Control or Areas of Internal Control

(1) General financial Control: It’s concerned with control over all finance functions
i.e., planning, acquiring and investing funds and management of profits. It deals
with accounting supervision recording e.t.c. of the finance department. It ensures
correct and reliable records of transactions in conformity with normally accepted
accounting principles. Such controls comprise primarily the plan of organization
and the procedures and records that are concerned with and directly related to the
safeguarding of assets and liabilities of financial records
(2) Cash Control: it’s concerned with proper control over receipts payments and
balance of cash. The control system must ensure that misappropriation of cash is
prevented.
(3) Control over wages: this includes maintenance of time records, wage records, and
payment to workers. The main area of concern in this regard is the check payment
to wages for the work not done and misappropriations of cash.
(4) Control over purchases: the system of internal control regarding purchases
should be developed in such a manner that purchasing accounting, handling and
issuing of goods are properly controlled.
(5) Administrative control:The scope of this control is very wide. They also include
accounting controls. Suchcontrols comprise of the plan of organisation that are
concerned mainly with operationalefficiencies. In short they may include anything
from plan of organisation to procedures,record keeping, distribution of authority

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 and the process of decision making. Theyinclude controls viz. Time and motion
studies, quality control through inspection,statistical analysis and performance
evaluation etc.

9.0 INVESTIGATION AND DETECTION OF FRAUD & ERRORS

The term fraud means the willful misrepresentation made with an intention of deceiving
others. It is a deliberate mistake committed in the accounts with a view to get personal
gain. In accounting, fraud means two things.
(1) Defalcation involving misappropriation of either cash or goods
(2) Fraudulent manipulation of accounts not involving defalcation.
9.1 Fraud covers the following
 Fraud through Defalcation
Following are the methods of defalcation involving misappropriation of cash or goods
 By misappropriating the receipt by not recording the same in the cashbook
 By destroying the carbon copy or counter foil of the receipt and misappropriating
the cash received
 By entering lesser amount on the counterfoil and misappropriating the difference
between money actually-received and the amount entered on the counterfoil of the
receipt book.
 By not recording the receipt of sale of a casual nature for example sale of scrap,
sale of old newspapers etc.
 By omitting to record cash donations received by non-profit making charitable
institutions
 By misappropriating the cash received on discounting the bills receivable and
showing them as bills outstanding on hand.
 By misappropriating cash received from debtors and concealing the same by
giving artificial credit to the debtors in the form of bad debts, discount or sales
return etc.
 By adopting the method of "teeming and lading" or "lapping process". Under this
method cash received from one debtor is misappropriated and deficiency in that
debtors account is made good when another payment is received from second

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 debtor by crediting the second debtors account less by that amount. This process is
carried out round the year.
 By suppressing the cash sales by not recording them or by treating the cash sales
as credit sales.
 By misappropriating the sale proceeds of VPP sales or sales of goods on approval
basis by treating the transaction as goods received or not approved.
 By under casting receipt side total of the cashbook
 By recording fictitious or bogus payments
 By recording more payments than actual amounts paid by altering the figures on
the vouchers.
 By showing the same payment twice.
 By showing credit purchases as cash purchases and misappropriating the amount
Recording personal expenses as business expenses
 By not recording discounts and allowances given by the creditors and
misappropriating the amounts
 By overcasting the payment side total of the cashbook Recording fictitious and
inflated purchases and misappropriating that amount.
 By suppressing the credit notes for returns and showing the full payment to
creditors
 By including the names of dummy workers or the workers who have? The job in
the wage sheets and misappropriating the amount
 By over casting the total of wages sheets and drawing that amount for
misappropriation
 By misappropriating the undisbursed wages.
 Fraud through manipulation of Accounts implies presentation of accounts more
favorably than what they actually are. Windowdressing means showing a wrong
picture. The fraud through manipulation of accounts isalso known as window
dressing because accounts are manipulated to show a wrongpicture of the profit or
loss of the business and its financial state of affairs. Commonlythis type of fraud is
committed by the people at the top management level. This does notinvolve any
misappropriation of cash or goods but it is either over statement of profit

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 orunderstatement of the same. Such fraud is committed with certain objective and
isrelatively difficult to detect.

10.0 PROCEDURE FOR WRITING AUDIT REPORT

The final outcome of any audit is the issuance of the report of the auditors. The report may
be qualified or unqualified. The auditors’ responsibility is to give an opinion on the
financial statements, based on the result of the audit. The phrase “we have audited”
implies that the auditor is providing the highest level of assurance that can be given. It is
important that the reader of the document in which the financial statements appear know
precisely what is covered by the auditors’ report and, by inference, what is not It is the
auditors’ responsibility to obtain knowledge about subsequent events up to the effective
date of signing the auditors’ report on the financial statements. After the financial
statements and audit report have been issued, however, an auditor may become aware of
new information regarding the client

10.1 AUDIT REPORT: STATUTORY AUDIT

The auditor’s report that appears in illustration 8-1 overleaf indicates the wording of the
standard report as prescribed by SAS No. 58, “Report on Audited Financial Statements.”
Organization and Wording The following paragraphs explain the language used in the
standard report on audited financial statements of an entity:
(a) Title
The title should include the phrase “Auditor’s Report.” This is intended to remind the
reader of the credibility an audit adds to the financial statements because of the auditor’s
independence.
(b) Introductory paragraph
The opening paragraph of the report identifies the financial statements that are audited and
states that management is responsible for them. The auditor’s responsibility is to give an
opinion on those statements based on the result of the audit. The phrase “we have audited”
implies that the auditor is providing the highest level of assurance that can be given. The
introductory paragraph also specifies the dates and periods covered by the financial
statements that are audited. It is important that the reader of the document in which the

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financial statements appear knows precisely what is covered by the auditor’s report and,
by inference, what is not. Since an annual report or prospectus contains muchmore than
financial statements, the reader should be told specifically what has been audited (the
financial statements and the related notes that are, as stated on each page of the financial
statements and what, by implication, has not been audited, such as the Chairman’s
Statements and Report of Directors, financial ratios, and information about stock prices.
An example of a report of the auditors is set out below:

STANDARD AUDIT REPORT: REPORT OF THE AUDITORS

To Members of XYZ Limited

We have audited the financial statements of XYZ LIMITED as at December 31, 2008,
which have been prepared on the basis of the accounting policies on page x.

Respective Responsibilities of Directors and Auditorsthe Company’s directors are

responsible for the preparation of the financialstatements. It is our responsibility to form
an independent opinion, based onour audit, on those statements and report our opinion to
you.
Basis of Opinion
We conducted our audit in accordance with the Nigerian Standards on Auditing. An audit
includes examination, on a test basis, of evidence relevant to the amounts and disclosures
in the financial statements. It also includes an assessment of the significant estimates and
judgments made by the directors in the preparation of the financial statements; and of
whether the accounting policies are appropriate to the company’s circumstances,
consistently applied and adequately disclosed.

We planned and performed our audit so as obtain all the information and explanations
which we considered necessary in order to provide us with sufficient evidence to give
reasonable assurance that the financial statements are free from material misstatement,
whether caused by fraud or other irregularity or error. In forming our opinion, we also
evaluated the overall adequacy of the presentation of information in the financial

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statements. The financial statements are in agreement with the books of accounts which
have been properly kept, and we obtained the information and explanation we required.

Opinion
In our opinion, the financial statements give a true and fair view of the state of affairs of
the company as at December 31, 2008 and of the profit and cash flow for the year then
ended and have been properly prepared in accordance with the Companies and Allied
Matters Act, CAP C20, LFN 2004, and relevant statements of accounting standards issued
by the Nigerian Accounting Standards Board.

..................................................... DATE...........................
ABR & CO.
CHARTERED ACCOUNTANTS
LAGOS, NIGERIA.
AUDIT REPORTING
.
Reference

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