Unit 1 Introduction To Auditing

PRINCIPLES AND PRACTICES OF AUDITING
III B.COM V SEM (NEP)
MODULE NO-1 INTRODUCTION TO AUDITING

Introduction
The term Audit is derived from the Latin term ‘Audire,’ which means to
hear. In early days an auditor used to listen to the accounts read over by an
accountant in order to check them. Auditing is as old as accounting. It was in use
in all ancient countries such as Mesopotamia, Greece, Egypt, Rome, U.K. and
India. The original objective of auditing was to detect and prevent errors and
frauds.
Meaning of Auditing
“Auditing is concerned with verification of accounting & financial records

with view to determine their accuracy & reliability”.
Auditing means “Detailed examination of books of accounts of an

organization for a given period by an independent & qualified person, who with
the help of vouchers, documents & information given, whether the profit & loss a/c
position & balance sheet exhibits a true & fair state of affairs of the business or
not”.
Auditing refers to “an intelligent and critical examination of books of

accounts of a business for the purpose of verifying the true and fair view of the
profit or loss and financial position of the business”.
Definition of Auditing
According to R.B. Bose “ Auditing may be said to be the verification of the

accuracy & correctness of the books of accounts by an independent person
qualified for the job & not in any way connected with the preparation of such
accounts”.
According to R.K. Mautz “Auditing is concerned with the verification of

accounting data, with determine the accuracy & reliability of accounting statement
& reports”.
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ASST.PROFESSOR, SSCASC, TUMKUR. 1
According to Montgomery “Auditing is a systematic examination of the

books & records of a business or other organization in order to ascertain or verify
& to report upon the facts regarding the financial operation & the results thereof”.
According A.W Hanson” An Audit is an examination of such records to

establish their reliability & the reliability of statements drawn from them”.
Characteristics of Auditing
1. Audit is a crucial review of the system of accounting & internal control.

2. It is an organized & scientific examination of the books of accounts of a
business.
3. Audit is undertaken by an independent person or body of persons who are
duly qualified for the job.
4. Audit is a verification of the results shown by the profit & loss account &
the state of affairs as shown by the balance sheet.
5. Audit is done with the help of vouchers, documents, information &
explanation received from the authorities.
6. The auditor has to satisfy himself with the authenticity of the financial
statements and report that they exhibit a true and fair view of the state of
affairs of the concern.
Objectives of Auditing
Objectives of Auditing
1. Primary or Main objective 2. Subsidiary or Ancillary objective
I. Detection and Prevention of Errors

Verification of Accounts and
Financial Statements II. Detection and Prevention of Frauds
III. Prevention of Errors and Frauds
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1. Primary or Main objective:-
The main objective of audit is to report to the owners of the business

whether the balance sheet exhibits a true & fair view of the state of affairs of the
company as at the end of the financial period & the Profit and Loss Account
exhibits a true & fair view of the Profit & loss for the financial period.
2. Subsidiary or Ancillary objective:-
i .Detection & Prevention of Errors
ii. Detection & Prevention of Frauds
iii. Prevention of Errors and Frauds
I. Detection & Prevention or Errors
Meaning of Errors
Errors refer to unintentional mis-statements or mis-descriptions made in the

books of accounts by the account assistants.
An error is a mis-statement or mis-representation of a transaction in the
books of accounts.
Errors are reportedly committed innocently, an auditor should be very

careful about it, because sometimes, errors which might appear as innocent are the
results of fraudulent manipulation.
Types of Errors
a) Technical Errors or Clerical Errors

b) Errors of Principle
a) Technical Errors or clerical Errors: - Errors which occur due to

carelessness of the staff.
Errors which committed in the course:

 In the course of recording transaction in the books of original entry such as
the cash book, purchase book, sales book etc.
 In casting, carry forward & balancing the subsidiary books.
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 In posting the entries from the books of original entry to the concerned
accounts in the ledger.
 In the totaling or balancing ledger accounts.
a) Technical or clerical errors may be sub divided into three types
i. Errors of Omission
ii. Errors of Commission
iii. Compensating Errors
i. Errors of Omission
Errors which arise on account of transaction not being recorded in the books of
accounts either wholly or partially are called errors of omission.
If a transaction is completely omitted to be recorded in a subsidiary book, it is an

error complete omission. An error of complete omission does not affect the agreement
of trial balance as both the aspects of the transaction are omitted from the trial balance.
Therefore such errors cannot be detected easily, an intensive checking of the
subsidiary books & the posting from subsidiary books to the ledger is required.
In certain cases, if transactions are partially recorded, these errors may

affect trial balance.
Ex: omission of cash receipts or payments to be posted to ledger accounts

from cash book.
ii. Errors of Commission
When incorrect entries are made in the books of accounts either wholly or
partially, the errors are known as errors of commission.
Ex: The amount 535 might be entered as 355 in the books of original entry such
errors can be located while vouching the purchases with original invoices.
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iii. Compensating Errors
A Compensating error is one which is counter balanced by another error or

errors.
When the effect of one error is counter-balanced, set off or compensated by
another error are known as compensating errors or offsetting errors.
Ex: If salaried account is under cast by Rs. 100 & wages account is over cast by
Rs 100 the errors in salaries account is set off by the error in wages account. Such
errors detected only by through checking of different subsidiary books & ledger
accounts.
b) Errors of Principle
If a transaction is recorded in the books of accounts against the generally

accepted principles of accountancy, the errors are known as errors of principle. As such
errors not disclosed by the disagreement of trial balance, they cannot be detected by
mere routine checking.
Ex: Capital expenditure is recorded as a revenue expenditure, incorrect provision

for doubtful debts, incorrect provision for discount on debtors etc.
II Detection & Prevention of Frauds
Meaning of Frauds
Fraud refers to intentional misstatements or mis-descriptions made in the

books of accounts by the account assistants, with a view to cheat or deceive some
body.
Types of Frauds
a. Misappropriation
b. Fraudulent manipulation of accounts
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a. Misappropriation
It refers to dishonest use of another’s funds or property for one’s own use.
Misappropriation may be sub divided into two types
i) Misappropriation or embezzlement of cash

ii) Misappropriation of goods
i) Misappropriation of embezzlement of cash
Misappropriation or embezzlement of cash refers to the fraudulent

appropriations of cash belonging to another person by one to whom it has been
entrusted or by one who handles it.
Different ways to misappropriating the cash:
(a)Non-disclosure of cash receipts: - Recording the cash sales proceeds at a figure

lower than the actual cash sales proceeds, omitting to record the credit sales.
(b)Showing false cash Payments: - Recording false cash purchase & pocketing the
amount, inflating the cash purchase i.e. at a figure higher than the actual &
pocketing the difference etc,
ii) Misappropriation of Goods
It means the wrongful conversion or fraudulent application of goods by

those who handle them.
Different ways of misappropriation of goods:
(a) Recording sales of larger quantities than actually supplied & misappropriating
the balance quantity.
(b) Recording purchase of large quantities, getting delivery of lesser quantities &
receiving the balance quantity privately.
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b. Fraudulent manipulation of accounts
It is said to be committed when a person makes a false entry in the business

records or alters, erases, removes or destroys a true entry in the business records.
Different ways of manipulations of accounts:
1. Non-payment of depreciation on fixed assets

2. Provision of less depreciation on fixed assets
3. Provision of more depreciation on fixed assets
4. Over-valuation of assets
5. Under- valuation of assets
6. Creation of secret reserves.
III. Prevention of Errors and Frauds
Lastly the duty of an auditor is not only to detect errors and frauds but also
to prevent them by advising the management. This is possible through proper
internal check system.
As regards the prevention of frauds an auditor does not do anything directly.

He can only indirectly help in the prevention of frauds by advising the
management. Auditor has to carry out the routine checking and vouching most
carefully and makes searching tactful and intelligent enquiries. Auditor should act
as a “watch dog and not a blood hound”. All that an auditor can do is to advice
his client the ways and means to prevent their future occurrence.
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Difference between Accounting and Auditing

BASIS BOOK KEEPING AND AUDITING
ACCOUNTANCY OR
ACCOUNTING
1.Period The book keeping & accounting Auditing work is generally

work is done Continuously undertaken at the end of the
throughout the year. financial year.
2.Nature of work The book keeping & Auditing is concerned

accounting work is constructive with examination of past
in approach. transactions. Auditing
work is analytical and
critical in approach.
3.Recording of The book keeping & Auditing is concerned

business accountancy is concerned with examination of past
transactions with current recording of transactions.
business transactions.
4.Detection of The book keepers & Auditors are required to

frauds accountants are not expected detect frauds.
to detect frauds.
5.Status The book keepers & Auditors are the outsiders.
accountants are the The qualified Chartered
employees of the concern. accountants.
6.Remuneration The book keepers & Auditors are given fee for
accountants are paid the specific work done.
regular salaries.
7.Qualification The book keepers & Auditors should be
accountants need not be Chartered accountants.
chartered accountants.
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8.knowledge The book keepers & Auditors must have the

accountants may or may not Knowledge audit techniques
have the knowledge of & procedures.
audit techniques &
procedures.
9.Accountancy & The book keepers or Auditors can take up both
audit work accountants cannot take up accountancy & audit
both accountancy & audit work.
work.
10.Code of conduct The book keeping & Auditing work is
accounting work is not governed by code of
governed by any code of conduct prescribed by the
conduct prescribed by Institute of Chartered
any professiona l body. Accountants.
Classification or Types of Audit
I. ON THE BASIS OF THE CONDUCT OF AUDIT
a) Continuous Audit or Detailed Audit or Running Audit

b) Interim Audit
c) Balance Sheet audit
d) Final audit or Annual Audit or Periodical Audit or Completed Audit
e) Partial Audit
f) Occasional audit
II. ON THE BASIS OF SPECIFIC OBJECTIVES OF AUDIT

a) Cash audit
b) Cost audit
c) Management audit
d) Special audit
e) Operational audit
f) Performance audit
g) Propriety audit
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III. ON THE BASIS OF DEGREE OF INDEPENDENCE
a) External Audit or Independent Audit

b) Internal Audit
IV. ON THE BASIS OF ORGANISATIONAL STRUCTURE
a) Statutory audit or Compulsory audit

b) Private Audit or Voluntary Audit
c) Government Audit
I. ON THE BASIS OF THE CONDUCT OF AUDIT
a) CONTINUOUS AUDIT OR DETAILED AUDIT OR RUNNING AUDIT
It is an audit, where the books of accounts are verified throughout the year or
at regular or irregular intervals say weekly, monthly & quarterly and the profit and
loss account and the balance sheet (financial statements) of the business are
examined at the end of the year.
Definition of Continuous Audit
According to R.C Williams, “A continuous audit is one where the auditor or

his staff is constantly engaged in checking the accounts during the whole period or
where the auditor or hiss staff attends at regular or irregular intervals during the
period.”
Continuous audit becomes imperative in the following types of business

(Suitability):
1. When internal check system is not satisfactory.

2. In big concerns where the volume of transactions are numerous.
3. In concerns, where monthly accounts are required to be presented to the
management.
4. Where it is desired that the audited final accounts should be ready immediately
after the close of the accounting period.
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Advantages of Continuous Audit
1. Detection of errors & frauds: - Auditor gets sufficient time to check all the
books of accounts in detail, in case of continuous audit. This facilitates
auditor to detect errors & frauds easily & quickly.
2. Moral Check: - Frequent visits of the auditor to the client’s business impose
a moral check on the accounting staff to keep the books of accounts up-to-
date & accurate.
3. Early presentation of accounts: - As accounts are checked throughout

year. It becomes possible for the accountant to present the audited financial
statements to the owners of the business immediately after the close of the
accounting year.
4. Valuable suggestions:- In case of continuous audit, auditor gets an

opportunity to familiarize himself with all the aspects of the clients business
this will help the auditor to give valuable suggestions for the improvement
of operational efficiency of the business.
5. Preparation of interim accounts: - If the directors of a company decide to

declare an interim dividend, continuous audit will help them in preparing
interim accounts without much delay.
6. Work efficiency:-As auditor has constant touch with the client’s business &
business & sufficient time, he can plan his work proper1y& carry out his
work more efficiently.
Disadvantages of Continuous audit
1. Very expensive: -It is very expensive, as more audit fees is required to be

paid to the auditor for his continuous visits.
2. Time consuming: - It involves much time. The time spent on audit will be a
sheer waste, if the size of the business is small.
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3. Alteration of figures: - In case of continuous audit, figures may be altered

by the dishonest accountant, after the auditor has checked the books of
accounts for a particular period.
4. Losing link in the audit work: - If proper notes of the work done on
previous visits are not correctly made, the auditor may lose link the work &
will fail to clear up the outstanding queries.
5. Monotony: - As audit is carried out throughout the year in case of

continuous audit, there is the danger of the audit work becoming mechanical.
6. Inconvenience: - Frequent & unexpected visits of the auditor to the client’s

business may cause inconvenience to the client’s staff & dislocation of
clients work.
b)INTERIM AUDIT
It is kind of audit, which is done between the two annual audits. In other
words, it is an audit conducted in the middle of the financial year. It is suitable for
those companies, which wants to declare interim dividend.
Advantages of Interim audit
1. The final audit can be completed very soon, if there has been an interim
audit.
2. Errors & frauds can be detected easily & quickly,
3. It imposes a moral check on the staff of the client.
4. This audit will be useful to have authenticated interim figures for
publication.
Disadvantages of Interim audit

1. Figures may be altered in the accounts, which have already been audited.
2. Even in case of interim audit, auditor is required to take extensive notes of
the figures audited. This would increase the work of the auditor.
3. It is comparatively expensive, as it involves additional financial burden to
the organization.
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Difference between Interim Audit & Continuous Audit
Basis Interim Audit Continuous Audit

1.period Accounting records of only a Accounting records of one
part accounting year are audited.
of the accounting year are
audited.
2.verification Verification of assets & Verification of assets &
liabilities liabilities is undertaken
is undertaken at the at the close of the
time of interim audit. financial year.
3.Auditors Auditors report is submitted Auditors report is submitted
report at the at
time of interim audit. the end of the financial
year.
4.Detailed The detailed checking is not The detailed checking is
checking done. done.
c) BALANCE SHEET AUDIT
It is type of audit, which concentrates mainly on the verification of the items

in the balance sheet, such as capital, reserve & provisions, profit & loss account
balances, assets & liabilities of the business. It may be noted that in case of balance
sheet audit, audit work commences from the balance sheet, working back to the
books of original entry & documentary evidences.
Suitability:
It is suitable for small & medium sized business units. It is also quite
effective in those big concerns, which have a good internal control system &
qualified accountants.
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Difference between continuous audit & Balance sheet Audit

Basis Continuous Audit Balance sheet Audit
1.suitability It is suitable for big It is quite suitable for small
business &
units, where the medium sized business
volume of business units.
transactions is
numerous.
2.Detection of It facilitates auditor to It does not facilitate
error & frauds detect auditor to
errors & frauds easily & detect errors & frauds
quickly. easily & quickly.
3.Moral check Frequent visits of the The auditor visits the
auditor to clients
the client’s business business only at the end
impose a moral check of the accounting year.
on the accounting staff . Therefore it is difficult
for the auditor to impose
a moral check on the
accounting staff.
4.Preparaition of It will helps in the It will not help in the
interim accounts preparation of preparation of interim
interim accounts accounts without much
without much delay. delay.
5.Work Auditor can carry out his It may be difficult for the
efficiency work auditor to carry out his
more efficiently. work more efficiently.
6.Expensive It is very expensive. It is less expensive.
7.Time It involves more time. It involves less time.
consuming
8.Alteration of Figures may be altered by There is no scope for
figures the alteration of figures.
dishonest accountant.
9.Monotony There is the danger of the There is no danger of the
audit audit
wok becoming work becoming
mechanical. mechanical.
10.Inconvenience It may cause It may not caused
inconvenience to inconvenience to the
the client’s staff clients staff.
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d) FINAL AUDIT OR ANNUAL AUDIT OR PERIODICAL AUDIT OR

COMPLETED AUDIT
It is an audit, where the auditor takes up his work of checking the books of
accounts at the end of the accounting period, when the transactions for the whole
year are completely recorded & financial statements have been prepared.
In simple words final audit is an audit which is done after the financial
period is over and the accounts are ready. It is continued in a session until the
complete audit work is over. It is also known as Annual or periodical audit.
Definition of Final Audit

According to Spicer and Pegler, “a final or completed audit is commonly
understood to be an audit which is not commenced until after the end of the
financial period, and is then carried on until completed.”
Suitability:
Final audit is adopted by almost all concerns. This type of audit is more
suitable for small concerns.
Advantages of Final Audit
1. Final audit is less expensive. Therefore, it is suitable for small concerns.

2. It involves less time. The audit work can be finished quickly within a reasonable
time.
3. There is less scope for alteration of figures. As audit work is done only in a one
continuous session chance for alteration figures.
4. There is no scope for the auditor may to lose the link of the work. As audit work
is done & completed in a continuous session, link in work can be properly
maintained.
5. There is less danger for the audit work becoming mechanical.
6. It does not cause inconvenience to the client’s staff, as the auditor visits the
client’s office only once a year the office work is not unnecessarily disturbed.
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Disadvantages of Final audit
1. Auditor does not get sufficient time to check all the books of accounts in
detail. Hence there is every chance that some of the errors & frauds may be left
undetected.
2. Auditor does not impose a moral check on the accounting staff to keep the
books of accounts, up to date and accurate.
3. It is not possible for the accountant to present the audited financial
statements to the owners of the business immediately after the close of the
accounting year.
4. Auditors do not get an opportunity to familiarize himself with all the
aspects of the clients business.
5. It does not help him them in preparing interim accounts in time.
6. For large scale concerns, periodical audit is rarely practicable & it is not
much popular for them.
e) PARTIAL AUDIT
When the auditor is asked to check some of the records and books for a part
of whole of the period, it is called as partial audit.
It is kind of audit, where the work of the auditor is curtailed (limited). For
instance, auditor may be asked to check only the cash book to detect
misappropriation of cash. It may be noted that partial audit is not permitted in case
of companies.
f)OCCASIONAL AUDIT
It is a kind of audit, which is not conducted on a regular basis.
An occasional is audit is an audit which is conducted once a while,

whenever the need arises. It is kind of audit, which is not conducted on a regular
Basis, but is conducted for a special event, time or purpose. For instance, if an
audit is ordered to discover error or fraud or when an incoming partner or a
creditors desires etc. It is called occasional audit. It is not suitable for joint stock
companies.
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II. ON THE BASIS OF SPECIFIC OBJECTIVES OF AUDIT
a) Cash Audit:
It is a type of audit which only the cash receipts & payments are audited in
detail by the auditor.
b) Cost Audit
It is an independent & critical examination of the various records maintained

by the company by the cost auditor to ascertain whether cost of the product
manufactured by the company have been correctly in accordance with the
correct costing principles.
Cost Audit is the verification of the correctness of cost accounts and

adherence to the cost accounting plans. Cost Audit is the detailed checking of
costing system, techniques and accounts to verifying correctness and to ensure
adherence to the objectives of cost accounting.
c) Management Audit
The auditor examines the policies & the actions of the management to
ensure that there is proper & maximum utilization of available resources.
Management audit is a systematic examination of decisions and actions of

the management to analyse the performance. Management audit involves the
review of managerial aspects like organizational objective, policies, procedures,
structure, control and system in order to check the efficiency or performance of
the management over the activities of the company.
d) Special Audit
When the affairs of the company are not being managed, according to the
sound business principles, the central government is empowered to appoint a
special auditor to audit the company’s working & its state of affairs. Such audit
is known as special audit.
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e) Operational Audit
It involves intelligent examination of the various operation of the different

functional area of a business, & observing the weakness, lapses, inefficiencies
in operation & suggesting ways for strengthening the system.
Operational audit is the type of audit service that the review is mainly
focused on the key processes, procedures, system, as well as internal control
which the main objective is to improve productivity, as well as efficiency and
effectiveness of the operation.
f) Performance Audit
It is a procedure for analyzing the profits & losses of different economic

activities carried on by a business unit, examining the relationship between
production & sales & discovering the avenues for maximizing profits.
g) Propriety Audit
It is carried out with the objective of ascertaining that contracts entered into
with third parties are in the best interest of the concern & there is a system,
which ensures the safety of the assets of the concern.
In other words, Propriety Audit is that audit through which the auditor
ensures that the decisions taken by the management are for the benefit of the
organization, the expenses incurred are absolutely necessary to carry on the
businesses, the amounts expended are reasonable and there is no leakage of
revenue or misappropriation of funds.
III. ON THE BASIS OF DEGREE OF INDEPENDENCE
1. Independent Audit or External Audit
It is conducted by the independent qualified auditor. The purpose of

independent audit is to see whether financial statements give true and fair view of
financial position and profits. Mainly it is for safeguarding the interest of owners,
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shareholders and other parties who do not have knowledge of day-to-day

operations of organization.
External auditors are independent firms that inspect the accounts of entity &
render an opinion on whether its statements conform to GAAP & present fairly the
financial position of the company & the results of operations.
The external auditor’s primary obligation is to users of financial statements

outside the organization. External auditors are required to register with ISO 9000.
2. Internal Audit
Internal Audit is a continuous & systematic review of accounting, financial &

other operations of a concern by the staff specially appointed for the purpose.
Internal auditing considers the examination, monitoring & analysis of

activities related to a company’s operation, including its business structure,
employee behaviour & information system.
IV. ON THE BAISI OF ORGANISATIONAL STRUCTURE
1. Statutory Audit or Compulsory Audit
It refers to the audit of accounts of a business unit compulsorily under the

provisions of a statue or law. It is carried out in number organizations such as a
Joint stock companies, Banking Companies, Insurance companies etc.
2. Private Audit or Voluntary Audit
Where the audit is not compulsory under any statue, but is undertaken by the
owners voluntarily to get the benefits of audit, such audit is known as private or
voluntary audit. This suits to sole trading concerns, partnership firms & other
individuals.
3. Government Audit
It refers to the audit of accounts of Government Departments & offices
Government Companies & statutory or public corporations.
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Merits and Demerits of Auditing
Merits of Auditing
1. Ensures account correctness: Auditing conducts a detailed examination of

all accounting books of an organization. It finds out the accuracy of
financial records and ensures whether they fulfill all statutory requirements
or not.
2. Detects and prevent errors: It plays an efficient role in finding out errors
and prevention of fraud. Auditing evaluates each financial transaction of
business for checking if there is any mistake or not. This way it reduces the
chances of errors and overall risk occurring due to such errors or frauds.
3. Helps in maintaining accounts regularly: Maintenance of all accounts on
a regular basis is another major advantage provided by the auditing process.
It keeps a check on the regularity of account and raises questions if they are
not maintained in an adequate manner.
4. Easy procurement of loans: Auditing reports serves as a tool for easily
acquiring the required funds from various financial institutions. These
reports depict the true financial position of organizations to investors which
helps them in deciding the credibility of concerned business organizations.
5. Keeps morale check: Auditing monitors the overall financial dealing of
organizations. This prevents the working staff from committing any error
and fraud. All employees work efficiently towards their role with a fear that
all irregularities will be identified by auditing.
6. Assists in decision making: It provides valuable information to managers
for efficient decision making. Auditing is done by various experts of account
and finance who have detailed knowledge of subjects, so they provide
advice and resolves all problems.
7. Stakeholder’s confidence: Auditing statements enables in gaining the
confidence of stakeholders. All stakeholders such as creditors, shareholders,
banks, investors, etc. have more confidence in audited financial accounts of
the company.
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Demerits of Auditing
1. Costly: Auditing process puts a financial burden on organizations as it

requires the huge cost to conduct an examination of all financial accounts.
Business needs to pay large fees to auditing experts for their services.
2. Rely on experts: Auditor is dependent on experts of various fields for
conducting auditing process. For acquiring true information regarding the
valuation of fixed assets and contingent liabilities, he needs to approach
valuers, engineers and lawyers.
3. Impossibility of checking all transactions: Another major drawback of
auditing is that it is not always possible to check each financial transaction
of organizations. Some organizations are too big and have a large number of
transaction, where evaluating all of them become quite an impossible task.
4. Unsuitable for small concern: Auditing may not be fruitful for small
organizations where there are limited transactions. Their accounts can be
evaluated without an audit program.
5. Chances of fraud: Audit may lead to errors and frauds in a business. Audit
staff may perform their task carelessly and present an inaccurate audit
report. Also, there may be chances where staff auditing accounts may be har
assed within the organization and may be forced to manipulate the figures.
Relationship of Audit with other disciplines
1. Accounting: It is a known fact that auditing and accounting are closely

related. Auditors rely on accounting records and financial statements to
assess accuracy of financial information. It naturally calls on the part of the
auditor to have a thorough and sound knowledge of generally accepted
principles of accounting before he can review the financial statements.
2. Law and Legal Studies: Auditors need a strong understanding of laws and
regulations that pertain to financial reporting and business operations. Such
knowledge helps to ensure compliance of auditing with relevant laws.
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3. Economics: It is a fact that economic trends and indicators can impact on

entity’s financial performance and risk profile. So, auditor must consider
economic factors when assessing an organization’s financial health.
4. Statistics and Data Analysis: Auditing involves analyzing large volume of

financial data. Statistical techniques helps auditor to determine the reliability
of financial information, identify unusual patterns and select sampling for
testing.
5. Mathematics: Auditors use Mathematical calculations to pertain analytical

procedures, evaluate financial ratios and assess the reasonableness of
financial figures.
6. Finance and Investment: It helps auditors to evaluate an organization

financial performance and assess its investment attractiveness. So, auditing
plays a significant role in providing assurance to investors and stakeholders.
7. Management and Business Administration: knowledge of management

principles helps auditors to assess organization operations, internal control,
risk management processes and operational processes .
In addition to the above auditing has a relationship with Information

Technology (IT), Ethics and Philosophy, Environment Studies, Psychology
and communication and Risk Management.
Preparation before commencement of new Audit
1. Obtaining the letter of appointment

He must have a proper letter of appointment from the appropriate authority
& ensure that his appointment is an order. Further if he has been appointed in place
of another auditor, he should enquire from the retiring auditor, the reasons for the
changes.
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2. Knowing the nature & scope of his duties

He should obtain definite instructions from his client about the nature &
scope of his work i.e. whether he is to do continuous audit or final audit, whether
he is to do the accountancy work or audit work or both. This question will not arise
in the case of companies, as his duties, powers & liabilities are laid down by the
companies act itself.
3. Knowledge of the system of accounting employed
He should examine the system of accounting employed by his client. If he
finds any weak point, he must study it thoroughly & make recommendation to his
client to remove these weak spots.
4. Obtaining of the list of principal officers of the client’s organization
He should obtain a list of principal officers of the client’s organization
together with their authorities and responsibilities. This will help them to obtain the
required information from them.
5. Knowledge of internal control in force in the client’s business
He should obtain a written statement of internal control system in force in
the client’s organization. It will help him in determining the extent of his audit
work.
6. Obtaining of the list of books
He should obtain a list of all the books maintained in the office, together
with the names of in charge persons & their specimen signatures. A list should be
duly signed by a responsible official of the company.
7. Study of the previous year’s financial statements
He should study the previous year’s financial statements as well as the
auditor’s report. This will help him to know the state of affairs of the concern.
8. Study of the important documents
He should study all the documents like Memorandum of Association, Article
of Association etc., which have a bearing on the accounts.
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9. Giving instructions to the client

He should give clear instruction to his client in regard to the following:
a) The books should be closed before audit.
b) The vouchers should be arranged date wise.
If this has not been done, he should never begin his work until the
documents are arranged as per the instructions given by him.
10. Ascertain the nature of business

He should ascertain the nature of the business of his client i.e. whether it is
manufacturing or trading or service. The knowledge helps the auditor in planning
of the audit procedure.
11. Knowledge of the organization structure
He should get organization structure present in the client’s business. This
will help the auditor in planning his work procedure wisely.
After all the above steps are taken auditor should prepare his audit
programme that is a complete programme of his audit work.
Audit working papers

Audit working papers are the written private materials which an auditor
prepares for each audit. They describe the accounting information which he has
received from his client, the methods of examination used, his conclusions &
financial statements.
Advantages of Audit working papers
1. It provides evidence of work done to support the audit opinion.

2. It assists in planning future audit.
3. It helps to organize the work done.
4. Audit working papers increase value for the audit by improving the efficiency,
effectiveness and economy of an audit carried out.
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5. Audit working papers contains all evidence obtained and conclusions drawn for
future reference
6. It provides evidence of work done in case of litigation.
Disadvantages of Audit working papers
1. Maintaining comprehensive audit working papers can be time consuming and

resource intensive.
2. The creation of management of audit working papers can add to the overall
cost of conducting an audit. .
3. Lack of standardization in audit working papers, which can lead to
inconsistencies in documentation across different auditors and audit firms.
4. Maintaining confidential and sensitive information about the client’s financial
and operational processes is crucial.
Essentials of Audit Working papers
1. It should be in a standard form, the subject matter should arranged under

various headings and sub-headings.
2. Paper used for the preparation of working papers should be of better quality
and uniform size.
3. The relevant details should always be kept in the working papers. All
irrelevant information should be kept out of the space in order to enhance
their utility for the purpose for which they are kept.
4. The audit working paper files should be properly preserved and filed. These
files should be serially numbered and indexed so that they may be made
available whenever they are needed.
5. They must contain accurate information so that they will be relied upon.
6. They should contain the facts, which are of self-explanatory.
7. The facts given in working papers should be readily apparent to the reader.
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Auditors Note Book or Audit Memoranda
Meaning of Audit Note Book
Audit note book is a diary or register maintained by audit staff to note errors,
doubtful quarries and difficulties during the course of action.
An Audit Note book is a book, register or diary maintained by the audit staff
during the course of audit for recording his observations during the course of audit,
the points to be discussed with the senior audit clerk or auditor, the points which
require further clarifications, explanations & investigation & also the enquiries
made & the replies received there too.
Contents of Audit Note Book

1. A list of books of accounts maintained.
2. The names, duties and responsibilities of principal officers.
3. The particular of missing receipt and voucher the duplication of which have to
obtain.
4. Mistakes and errors detected or discovered.
5. Queries made and replies received.
6. The important points which need clarifications and explanations.
7. Various totals and balances.
8. The Points to be a part of audit report or points to be included in the audit
report.
Advantages of Audit Note Book
1. It helps the auditor to have a record of important points which arise during
the course of audit.
2. It is helpful in the preparation of audit report.
3. It is helpful in assessing the efficiency, ability & sincerity of the audit staff.
4. It can serve as evidence in the court of law, if a suit is filed against the
auditor for negligence of duty.
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Disadvantages of Audit Note Book
1. If it is not prepared carefully & properly, it can be used in a court of law as

an evidence of negligence on the part of the auditor.
2. It promotes a fault-finding attitude in the minds of the audit staff.
3. It may create misunderstanding between the staff of the client & audit staff.
Audit Program
Meaning of Audit Program
An audit program is the auditor’s plan of action, specifying the work to be

done, the procedures to be followed for doing the work, the persons responsible for
the completion of the work & the duration of time within which the work has to be
completed.
Advantages of Audit Program
1. Helps in Estimation and Division of Work: Audit Programme helps

in estimating the quantum of audit work in advance and also helps in dividing the
work among the audit assistants based on their capabilities.
2. Helps in Fixation of Responsibility: It enables to fix responsibility on the

audit assistants by clearly defining the scope of work.
3. Helps in Future Planning: Audit programme serves as a basis for planning the
audit work for subsequent year.
4. Serves as a Guide: It serves as a valuable guide for the audit staff in execution
of the audit work for succeeding years.
5. Valuable Evidence: It serves as an evidence for the work done as initials of

those who have done the particular work are appended to it. The auditor can
produce the audit programme as a proof when a charge of negligence is being
brought upon him.
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6. Uniformity: It provides for uniformity in audit work as the same work will be
done every year.
7. Continuity: When an audit staff goes on leave others can continue the work by
referring to the audit programme, hence, audit programme provides for continuity
of work.
8. Coordination: If facilitates coordination and helps in supervising the work of

the audit staff.
Disadvantages of Audit Program
1. Mechanical: When audit work is conducted mechanically every year based on

the audit programme, it causes monotony and boredom to the auditor and audit
staffs.
2. No Quality in Work: The audit staff will be more interested to complete the
work in time rather than to maintain any standard in the work.
3. Loss of Initiative: Audit staff cannot take their own decisions and they are
compelled to comply with the audit programme. Hence, an efficient audit clerk
loses his initiative and interest as he cannot make any suggestions.
4. Rigidity: A rigid and inflexible audit programme cannot be laid for all types of
business. During the course of audit, new areas to be verified may come to the
notice of the audit staff. Unless the audit programme is revised, such areas may
escape from auditing.
5. Shelter for Inefficient Staff: Inefficient audit staffs conceal their mistakes or
weakness on the basis of audit programme. Hence, it provides shelter for
inefficient audit staff.
6. Unsuitable: Pre-determined audit programme is not suitable for small business

organizations.
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Qualities of an Auditor
Statutory Qualification
1. Only Chartered Accountant is qualified to act as an auditor of the company.

2. A firm can be appointed as the auditor of the company, if all partners are
practicing Chartered Accountant in India.
3. A person, who holds certificate under restricted Auditors Certificate Rules,
1956 is also qualified to act as an auditor of the company.
Professional Qualities
1. He should have knowledge of principles and practice of General accounting,

cost accounting and Management Accounting.
2. He should have knowledge of provisions relating to Income Tax, Sales tax
and Wealth tax etc.
3. He should have knowledge of Economics, Business law, Mathematics,
Statistics, Business management and financial management etc.
4. He should have the ability to draft the report clearly, correctly concisely,
5. He should be vigilant and alert in his work.
6. He should be methodical and systematic.
7. He must not disclose the confidential information about the business of his
clients to others.
8. He should convey information but not means of information.
Audit Planning
"Audit planning" means developing a general strategy and a detailed

approach for the expected nature, timing and extent of the audit. The auditor
plans to perform the audit in an efficient and timely manner.
In simple words, developing an overall strategy for the effective conduct and
scope of the examination.
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Importance of Audit Planning
1. It helps the auditor to obtain sufficient appropriate evidence.

2. It helps to keep audit costs at a reasonable level.
3. It helps avoid misunderstandings with the client by clear communication and
collaboration.
4. Audit planning includes establishing the overall strategy for the audit
engagement, with a particular focus on planned risk assessment procedures and
responses to the identified risks of material misstatement.
5. Proper planning helps to work efficiently and ensures auditing is conducted in
accordance with auditing standards.
Audit Strategy
It refers to the comprehensive plan and approach developed by an audit team
to conduct an effective and efficient audit. It outlines the scope, objectives and
methods that will be employed during the audit process to achieve the desired
outcomes.
The audit strategy sets out in general terms how the audit is to be conducted
and sets the scope, timing and direction of the audit. The audit strategy then guides
the development of the audit plan, which contains the detailed responses to the
auditor's risk assessment.
Audit Engagement
An audit engagement is a formal agreement between an auditor and a client
in which the auditor agrees to provide an objective opinion on the client's financial
statements, processes systems or controls. The engagement is governed by a
mutually agreed upon contract or engagement letter that outlines the terms, scope,
objectives, responsibilities and other relevant details of the audit.
Types of Audit Engagement
1. Financial statement audit: This is the most common type of audit

engagement, in which the auditor is engaged to express an opinion on the
fairness of the financial statements of an organization. The financial
statements may include the balance sheet, income statement, statement of
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cash flows, and statement of changes in equity.
2. Internal audit: This type of audit is performed by an organization's internal

auditing department or an external auditor. It is designed to assess the
effectiveness of the organization's internal controls and risk management
systems.
3. Operational audit: This type of audit is focused on evaluating the

efficiency and effectiveness of an organization's operations and processes. It
may include a review of the organization's processes, systems, and controls,
as well as its use of resources.
4. Compliance audit: This type of audit is designed to assess whether an

organization is complying with relevant laws, regulations, contractual
agreements and standards. It may involve a review of the organization's
policies, procedures, and controls to ensure compliance.
5. Information technology (IT) audit: This type of audit focuses on the

organization's use of information technology and may include a review of
the organization's IT systems, controls, and processes over data integrity and
security.
6. Forensic audit: This type of audit is designed to investigate potential fraud

or mismanagement or misconduct or irregularities within an organization. It
may involve the use of specialized techniques and tools, such as data
analytics, to uncover evidence of wrongdoing.
Audit Documentation
Audit documentation refers to the records, documents, and evidence

obtained and maintained by the auditors during an audit engagement. These
documents provide a comprehensive and organized record of the audit
process, procedures performed, evidence obtained and conclusions reached
and any other relevant information related to the audit.
Audit documentation is the principal record of auditing procedures

applied, evidence obtained, and conclusions reached by the auditor in the
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engagement. The quantity, type, and content of audit documentation are

matters of the auditor’s professional judgment.
Audit Evidence
It is the information and supporting documentation gathered by the auditor

during an audit engagement.
Audit evidence is all the information, whether obtained from audit

procedures or other sources that is used by the auditor in arriving at the
conclusions on which the auditor's opinion is based.
Types of Audit Evidence
1. Physical examination: This involves inspecting tangible assets, such as inventory,

machinery, property or assets or documents, to verify their existence, condition, or
ownership. Physical examination provides direct evidence and is often documented
in audit work papers.
2. Confirmations: This refers to relying on third parties such as banks or customers
to confirm balances or transactions of various aspects of the financial statements
(for example, the closing bank balance or accounts payable records).
3. Documentary evidence: Auditors will gather documentation such as written or
electronic records, invoices, bank statements, internal process documents, emails,
provide documentary support for transactions and balances and to help with
different portions of the overall audit. For example, the auditors may use the
documentation for vouching or tracing a process flow as a part of the audit
procedures.
4. Analytical procedures: Comparing financial information with expectations or
industry benchmarks helps to identify unusual or unexpected fluctuations that may
require further investigation. This includes any analysis performed by the auditors
using their calculations to substantiate the financial information and any
accounting records provided by the client to find discrepancies.
5. Oral evidence: Auditors may hold question-and-answer sessions with their client’s
senior leadership team, employees, management or other parties to inquire about
the business operations when audit planning and designing the audit procedures.
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6. Re-performance and Reconciliation: The auditor assesses the control risk by re-
performing key internal control processes to check for deficiencies and also auditor
perform calculations or reconcile accounts to verify accuracy.
7. Observatory evidence: Auditors may observe control activities or physical
processes or operations to assess their effectiveness. This allows them to assess the
effectiveness of internal controls, compliance with regulatory requirements, or
adherence to specific procedures.
Written representation
Written representations refers to formal written statements by management

to the auditor to confirm certain matters related to financial statements, internal
controls, and other information being audited.
Written representations are written statements by management to the auditor

that confirm and/or support other audit evidence. Written representations are part
of audit evidence and are obtained from management during the fieldwork phase of
the audit. Written representations complement other audit evidence. They are not
considered to be sufficient audit evidence for any assertion made in the financial
statements, and getting written representations from management does not
influence the nature and extent of other audit procedures.
Written representations should be requested from management with overall

responsibility and knowledge of the matters they contain. Written representations
are usually signed by the chief executive officer and the chief financial officer of
the company.
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Unit 1 Introduction To Auditing

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Unit 1 Introduction To Auditing

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PRINCIPLES AND PRACTICES OF AUDITING

III B.COM V SEM (NEP)

MODULE NO-1 INTRODUCTION TO AUDITING

“Auditing is concerned with verification of accounting & financial records

Auditing means “Detailed examination of books of accounts of an

Auditing refers to “an intelligent and critical examination of books of

According to R.B. Bose “ Auditing may be said to be the verification of the

According to R.K. Mautz “Auditing is concerned with the verification of

According to Montgomery “Auditing is a systematic examination of the

According A.W Hanson” An Audit is an examination of such records to

1. Audit is a crucial review of the system of accounting & internal control.

1. Primary or Main objective 2. Subsidiary or Ancillary objective

I. Detection and Prevention of Errors

III. Prevention of Errors and Frauds

1. Primary or Main objective:-

The main objective of audit is to report to the owners of the business

I. Detection & Prevention or Errors

Errors refer to unintentional mis-statements or mis-descriptions made in the

Errors are reportedly committed innocently, an auditor should be very

a) Technical Errors or Clerical Errors

a) Technical Errors or clerical Errors: - Errors which occur due to

Errors which committed in the course:

a) Technical or clerical errors may be sub divided into three types

If a transaction is completely omitted to be recorded in a subsidiary book, it is an

In certain cases, if transactions are partially recorded, these errors may

Ex: omission of cash receipts or payments to be posted to ledger accounts

ii. Errors of Commission

iii. Compensating Errors

A Compensating error is one which is counter balanced by another error or

If a transaction is recorded in the books of accounts against the generally

Ex: Capital expenditure is recorded as a revenue expenditure, incorrect provision

II Detection & Prevention of Frauds

Fraud refers to intentional misstatements or mis-descriptions made in the

Misappropriation may be sub divided into two types

i) Misappropriation or embezzlement of cash

i) Misappropriation of embezzlement of cash

Misappropriation or embezzlement of cash refers to the fraudulent

Different ways to misappropriating the cash:

(a)Non-disclosure of cash receipts: - Recording the cash sales proceeds at a figure

ii) Misappropriation of Goods

It means the wrongful conversion or fraudulent application of goods by

Different ways of misappropriation of goods:

b. Fraudulent manipulation of accounts

It is said to be committed when a person makes a false entry in the business

Different ways of manipulations of accounts:

1. Non-payment of depreciation on fixed assets

III. Prevention of Errors and Frauds

As regards the prevention of frauds an auditor does not do anything directly.

Difference between Accounting and Auditing

1.Period The book keeping & accounting Auditing work is generally

2.Nature of work The book keeping & Auditing is concerned

3.Recording of The book keeping & Auditing is concerned

4.Detection of The book keepers & Auditors are required to

8.knowledge The book keepers & Auditors must have the

Classification or Types of Audit

I. ON THE BASIS OF THE CONDUCT OF AUDIT

a) Continuous Audit or Detailed Audit or Running Audit

II. ON THE BASIS OF SPECIFIC OBJECTIVES OF AUDIT

III. ON THE BASIS OF DEGREE OF INDEPENDENCE

a) External Audit or Independent Audit

IV. ON THE BASIS OF ORGANISATIONAL STRUCTURE

a) Statutory audit or Compulsory audit

I. ON THE BASIS OF THE CONDUCT OF AUDIT