PRINCIPLES OF AUDITING

UNIT-1
Auditing– Origin – Definition – Objectives – Types – Advantages and Limitations –
Qualities of an Auditor – Audit Programmes.
UNIT- 2
Internal Control – Internal Check and Internal Audit –Audit Note Book – Working
Papers. Vouching –Voucher – Vouching of Cash Book – Vouching of Trading
Transactions – Vouching of Impersonal Ledger
UNIT-3
Verification and Valuation of Assets and Liabilities – Auditor’s position regarding the
valuation and verifications of Assets and Liabilities – Depreciation – Reserves and
Provisions – Secret Reserves.
UNIT-4
Audit of Joint Stock Companies – Qualification – Dis-qualifications – Various modes
of Appointment of Company Auditor – Rights and Duties – Liabilities of a Company
Auditor – Share Capital and Share Transfer Audit – Audit Report – Contents and
Types.
UNIT-5
Investigation – Objectives of Investigation – Audit of Computerized Accounts –
Electronic Auditing- investigation under the provisions of companies act.

1
 UNIT-1
INTRODUCTION OF AUDITING

AUDITING:

DEFINITION:

Auditing, in the context of principles of auditing, refers to the systematic examination

and verification of financial information, records, transactions, and operations of an
organization.

OBJECTIVES OF AUDITING:

1. Reliability and Accuracy: Ensure that financial statements and information are
free from material misstatements and accurately represent the entity's
financial position.
2. Compliance: Verify compliance with legal and regulatory requirements.
3. Safeguarding Assets: Ensure that assets are safeguarded against theft or
misuse.
4. Operational Efficiency: Assess the efficiency and effectiveness of operations
and suggest improvements.
5. Reliability of Systems: Evaluate the reliability of internal control systems.
.

TYPES OF AUDITING:

1. Financial Auditing: Focuses on financial statements to ensure accuracy and

compliance with accounting standards.
2. Operational Auditing: Evaluates the efficiency and effectiveness of internal
processes and procedures.
3. Compliance Auditing: Ensures adherence to legal and regulatory
requirements.
4. Information Systems Auditing (IS Audit): Examines the controls of
information systems to ensure data integrity and security.

ADVANTAGES OF AUDITING:

1. Reliability: Provides assurance on the reliability of financial information.

2. Transparency: Enhances transparency in financial reporting.
3. Fraud Detection: Helps in detecting and preventing fraud and
mismanagement.
4. Improved Efficiency: Identifies areas for improvement in operational

2
 efficiency and effectiveness.
5. Investor Confidence: Builds confidence among investors, creditors, and other
stakeholders.

LIMITATIONS OF AUDITING:

1. Sampling Risk: Auditors rely on sampling, which may not capture all errors or
irregularities.
2. Inherent Limitations: Certain aspects of an organization may not be audited
due to inherent limitations.
3. Fraud Concealment: Cleverly orchestrated fraud may go undetected.
4. Relying on Historical Data: Auditing is based on historical financial
information and may not predict future events.
5. Dependence on Internal Controls: The effectiveness of auditing depends on
the strength of internal controls.

QUALITIES OF AN AUDITOR:

1. Integrity: The auditor must be honest and impartial.

2. Independence: An auditor should be free from bias and external influences.
3. Professional Competence: Possesses the required knowledge, skills, and
experience.
4. Due Professional Care: Conducts the audit with diligence and thoroughness.
5. Confidentiality: Maintains the confidentiality of information obtained during
the audit.

AUDIT PROGRAMS:

Audit programs are detailed plans outlining the procedures to be followed during an
audit. They typically include:

1. Audit Objectives: Clearly defined objectives of the audit.

2. Audit Procedures: Detailed steps to be followed during the audit, including
sample selection and testing.
3. Timing: Schedule for conducting the audit.
4. Staffing: Assignment of responsibilities to audit team members.
5. Reporting: Outline of how findings will be communicated.

PURPOSE OF AUDIT PROGRAMS:

1. Systematic Approach:
 Audit programs provide a systematic and organized approach to

3
 conducting an audit. They help ensure that all relevant areas are
covered during the audit engagement.
2. Efficiency and Effectiveness:
 By outlining specific procedures and steps, audit programs contribute
to the efficiency and effectiveness of the audit process. They guide
auditors in performing their work in a logical and comprehensive
manner.
3. Risk Assessment:
 Audit programs are designed to address the specific risks associated
with the audit engagement. They help auditors identify areas of higher
risk and allocate resources accordingly.
4. Compliance with Standards:
 Audit programs are developed in compliance with auditing standards,
whether they are generally accepted auditing standards (GAAS) or
international auditing standards. They provide a framework for auditors
to meet professional requirements.
5. Documentation:
 Audit programs serve as a form of documentation. They provide a
written record of the procedures to be performed, making it easier for
other auditors or reviewers to understand the audit process and
reproduce the work.

COMPONENTS OF AUDIT PROGRAMS:

1. Objectives:
 Each audit program begins with clearly defined objectives. These
objectives align with the overall goal of the audit engagement and
guide the auditor in planning specific procedures.
2. Audit Procedures:
 Detailed steps and procedures are outlined in audit programs. These
include the specific tests and inquiries the auditor will perform to
gather evidence on the financial statements.
3. Timing and Extent:
 Audit programs specify the timing of audit procedures (e.g., at year-end)
and the extent of testing (e.g., sample size for substantive testing).
This helps in resource allocation.
4. Staff Responsibilities:
 For larger audit engagements, audit programs may assign
responsibilities to different members of the audit team. This ensures
that tasks are appropriately distributed.
5. Risk Assessment:
 Audit programs often incorporate risk assessment procedures. They
identify areas of higher risk and detail additional procedures or scrutiny
required in those areas.

4
 6. Documentation Standards:
 Audit programs adhere to documentation standards, requiring auditors
to maintain complete and accurate workpapers. This documentation
supports the auditor's findings and conclusions.

TYPES OF AUDIT PROGRAMS:

1. Preliminary Audit Program:

 Developed during the planning phase of the audit, this program outlines
the initial procedures to be performed, including risk assessment and
understanding the client's business.
2. Substantive Audit Program:
 Focuses on substantive procedures, such as testing transactions and
account balances. Designed to gather evidence on the completeness,
accuracy, and validity of financial information.
3. Test of Controls Program:
 For audits that rely on the effectiveness of internal controls, this
program outlines procedures to test the design and operating
effectiveness of those controls.
4. Completion or Finalization Program:
 Developed towards the end of the audit, this program outlines
procedures to be performed to ensure that all necessary audit work
has been completed, and the financial statements are ready for
issuance.

DEVELOPMENT AND CUSTOMIZATION:

1. Client-Specific Considerations:
 Audit programs need to be customized based on the specific
characteristics, risks, and complexities of the client's business. They
are not one-size-fits-all and should be tailored to the individual
circumstances of each audit engagement.
2. Updates and Revisions:
 Audit programs should be regularly reviewed, updated, and revised to
reflect changes in the business environment, accounting standards,
and regulatory requirements.

APPLICATION AND EXECUTION:

1. Audit Execution:
 The audit team uses the audit program as a guide during the execution
phase of the audit. The program serves as a roadmap for auditors to
follow to achieve the audit objectives.
2. Flexibility:

5
  While audit programs provide a structured approach, auditors need to
exercise professional judgment and flexibility. They may need to
modify procedures based on unexpected findings or changes in
circumstances.

In conclusion, auditing plays a crucial role in providing assurance to stakeholders

regarding the accuracy and reliability of financial and non-financial information. The
process involves systematic examination, and auditors must possess key qualities
to perform their duties effectively. While there are advantages to auditing, it also has
inherent limitations that should be acknowledged. The use of audit programs helps
ensure a structured and comprehensive approach to the audit process.

6
 UNIT-2
INTERNAL CONTROL

INTERNAL CONTROL:
Meaning:
Internal control is the system of policies, procedures, and processes
established by an organization to ensure the reliability of financial reporting,
safeguard assets, and promote operational efficiency. It involves the
organization's internal checks and balances.
Definition:
Internal control is a process designed to provide reasonable assurance
regarding the achievement of objectives in the effectiveness and efficiency of
operations, reliability of financial reporting, and compliance with applicable laws
and regulations.

INTERNAL CHECK:
Meaning:
Internal check is a component of internal control that involves dividing
responsibilities and duties among employees to minimize the risk of errors and
fraud. It includes cross-verification of work within the organization.
Definition:
Internal check is a system in which the work of one employee is
complementary to the work of another so that errors or fraud are likely to be
discovered by the cross-verification of the work.
 Objectives:
 Detect and prevent errors and fraud.
 Enhance accountability and responsibility.
 Ensure accuracy and reliability of financial information.
 Features:
 Division of tasks and responsibilities.
 Rotation of duties.
 Cross-verification and reconciliation of records.
INTERNAL AUDIT:
Meaning:
Internal audit is an independent and objective assurance activity designed
to add value and improve an organization's operations. It helps in evaluating and
improving the effectiveness of risk management, control, and governance
processes.

ADVANTAGES OF INTERNAL AUDIT:

7
 1. Enhanced Control and Governance:
 Internal audit contributes to the establishment and maintenance of
effective internal controls and governance structures within an
organization. It helps ensure that policies and procedures are followed.
2. Risk Identification and Mitigation:
 Internal audit assists in identifying and assessing risks across various
business processes. By doing so, it helps management in
implementing measures to mitigate these risks, contributing to better
risk management.
3. Operational Efficiency:
 Through the evaluation of operational processes and controls, internal
audit can identify areas for improvement. This, in turn, can lead to
increased operational efficiency and effectiveness.
4. Compliance Assurance:
 Internal auditors verify whether the organization complies with relevant
laws, regulations, and internal policies. This helps in ensuring legal and
regulatory compliance and reduces the risk of penalties or legal issues.
5. Fraud Detection and Prevention:
 Internal audit plays a crucial role in detecting and preventing fraud by
assessing internal controls, investigating irregularities, and
recommending improvements to prevent fraudulent activities.

DISADVANTAGES OF INTERNAL AUDIT:

1. Costly:
 Maintaining an internal audit function can be expensive, especially for
smaller organizations. Costs include salaries, training, and technology
to support the audit process.
2. Independence Challenges:
 There may be challenges to the independence of internal auditors,
especially if they report to management. This could potentially affect
the objectivity of their assessments.
3. Limited Expertise:
 Internal audit teams may have limitations in terms of specialized
expertise, particularly in complex or highly technical areas. External
experts may be needed for certain audits.
4. Resistance from Management:
 Management may resist internal audit findings or recommendations,
particularly if they perceive them as critical or challenging. This
resistance can hinder the effectiveness of the internal audit function.
5. Resource Constraints:
 Smaller organizations may face resource constraints in maintaining a
dedicated internal audit function. This can result in a reduced
frequency of audits or a focus on only high-priority areas.

8
 6. Limited Scope:
 Internal audit may not cover all aspects of an organization's operations.
There could be areas that are overlooked or receive limited attention,
leading to potential gaps in risk management.
7. Potential for Conflict:
 There may be conflicts of interest if internal auditors are tasked with
investigating areas that involve their colleagues or superiors. This can
compromise the independence of the audit process.
8. Subject to Management Pressure:
 Internal auditors, especially if they report to management, may face
pressure to downplay or omit certain findings to avoid conflict or
negative consequences. This compromises the integrity of the audit
process.
9. Limited Accountability:
 Internal auditors may lack the authority to enforce corrective actions.
While they can recommend improvements, the responsibility for
implementing changes rests with management, and there may be
limited accountability for non-compliance.

AUDIT NOTE BOOK:

Meaning:
An audit note book is a document used by auditors to record their
observations, procedures performed, and findings during the audit process.
Definition:
An audit note book is a record maintained by auditors containing details of
audit procedures, working papers, and other relevant information. It serves as a
reference for the audit team and provides evidence of the work performed.
 Objectives:
 Document audit procedures and evidence.
 Facilitate communication within the audit team.
 Support the preparation of the audit report.
 Features:
 Contains details of audit objectives and scope.
 Records audit procedures and findings.
 Organized for future reference and review.

FUNCTIONS OF AUDIT NOTE BOOK:

1. Record of Audit Procedures:
 The audit note book documents the procedures performed by auditors
during the audit. It details the steps taken to obtain evidence and verify
financial transactions.
2. Documentation of Audit Planning:
 It contains information related to the planning phase of the audit,

9
 including the audit plan, scope, objectives, and the overall audit
strategy.
3. Evidence of Audit Work:
 The note book provides a detailed record of the evidence gathered
during the audit. This includes supporting documents, calculations, and
analyses that substantiate the auditor's findings.
4. Reference for Audit Team:
 The note book serves as a reference for the audit team, ensuring that
all team members have access to consistent and organized
information about the audit procedures and findings.
5. Facilitation of Supervision and Review:
 Audit managers and supervisors use the note book to review and
supervise the work of auditors. It allows for quality control and ensures
that audit procedures are conducted in accordance with professional
standards.
FUTURES OF AUDIT NOTEBOOK:

1. Documentation:
 The primary function of an audit notebook is to serve as a
comprehensive and organized repository for documenting the audit
process. It includes details on audit planning, procedures performed,
evidence obtained, and conclusions reached.
2. Audit Trail:
 An audit notebook creates a clear audit trail by recording the sequence
of audit procedures. This facilitates the review and verification of audit
work by other team members, external auditors, or regulatory
authorities.
3. Organization:
 The notebook is organized in a systematic manner, often following the
audit program or engagement plan. Each section corresponds to a
specific area or aspect of the audit, making it easy to locate
information.
4. Cross-Referencing:
 To enhance clarity and transparency, the audit notebook often includes
cross-references. For example, it may refer to specific workpapers,
supporting documents, or sections within the financial statements.
5. Timeliness:
 Entries in the audit notebook are made contemporaneously with the
performance of audit procedures. Timely documentation ensures
accuracy and reduces the risk of information gaps.
6. Neatness and Legibility:
 The notebook is maintained in a neat and legible format. Clear and
organized documentation helps in the efficient review of audit work by
supervisors, managers, or external parties.

10
 WORKING PAPERS:
Meaning:
Working papers are documents prepared by auditors during the audit
process, containing supporting evidence, calculations, and other documentation.
Definition:
Working papers are the documents prepared by auditors and retained as
evidence of the audit work performed, including procedures applied, tests
performed, information obtained, and conclusions reached.
 Objectives:
 Provide evidence of audit procedures.
 Support the audit trail and conclusions.
 Facilitate communication among audit team members.
 Features:
 Contains calculations, analyses, and references.
 Supports the documentation of audit trail.
 Aids in the preparation of the audit report.

FUNCTIONS OF WORKING PAPERS:

1. Evidential Support:
 Working papers provide the evidential support for the auditor's findings
and conclusions. They include detailed information on audit
procedures performed, supporting documents examined, and the
evidence obtained.
2. Documentation of Audit Procedures:
 Working papers document the entire audit process. They outline the
planned audit procedures, actual steps taken, and any deviations or
modifications made during the course of the audit.
3. Audit Planning:
 During the planning phase, working papers outline the overall audit
strategy, materiality thresholds, risk assessment, and key audit
objectives. This helps in aligning the audit approach with the client's
business and industry.
4. Risk Assessment:
 Working papers include the assessment of risks identified during the
audit. They document the auditor's evaluation of inherent and control
risks, as well as the planned response to those risks.
5. Support for Financial Statements:
 Working papers provide the necessary support for the figures and
disclosures presented in the financial statements. They include
schedules, reconciliations, and analyses that validate the accuracy and
completeness of financial information.
6. Basis for Audit Opinion:
 The working papers serve as the basis for the auditor's opinion on the

11
 fairness of the financial statements. They document the auditor's
professional judgment and support the conclusions reached.
7. Cross-Referencing:
 Working papers often cross-reference each other and refer to specific
sections within the financial statements. This ensures that auditors
and reviewers can trace the audit trail and understand the relationships
between different pieces of information.

VOUCHING:
Meaning:
Vouching is the process of verifying the authenticity of transactions by
examining supporting documents.
Definition:
Vouching is the examination of documentary evidence supporting a
transaction to ensure the accuracy and authenticity of recorded transactions.
 Objectives:
 Verify the accuracy of transactions.
 Detect and prevent errors or fraudulent activities.
 Confirm compliance with accounting principles and policies.
 Features:
 Involves tracing entries back to source documents.
 Ensures validity and authenticity of transactions.
 Critical for accuracy in financial reporting.

VOUCHER:
Meaning:
A voucher is a document that provides evidence of a financial transaction.
Definition:
A voucher is a written or electronic document that serves as evidence of an
economic transaction. It contains details such as the nature of the transaction,
amount, date, and authorization.
 Objectives:
 Serve as evidence for financial transactions.
 Support entries in the books of accounts.
 Facilitate the audit trail.
 Features:
 Includes transaction details and authorization.
 Supports entries in the books of accounts.
 May take various forms, such as invoices, receipts, or purchase
orders.
VOUCHING OF CASH BOOK:
Meaning:
Vouching of the Cash Book involves verifying entries in the Cash Book

12
 against supporting documents.
Definition:
Vouching of Cash Book is the process of examining supporting documents
such as bank statements, cash receipts, and disbursement vouchers to ensure
the accuracy and completeness of cash transactions recorded in the Cash Book.

DUTIES OF VOUCHING CASH BOOK:

1. Verification of Cash Receipts:
 Auditors verify cash receipts recorded in the cash book by examining
supporting documents such as cash register tapes, bank statements,
deposit slips, and acknowledgment receipts. This ensures that all cash
inflows are valid and accurately recorded.
2. Confirmation of Cash Payments:
 Auditors confirm the authenticity of cash payments by vouching them
against source documents, such as invoices, receipts, and other
payment vouchers. This helps in ensuring that all disbursements are
legitimate and supported by appropriate documentation.
3. Examination of Bank Statements:
 Vouching the cash book involves comparing the entries in the cash
book with bank statements to confirm the accuracy of recorded
transactions. Bank statements serve as external evidence supporting
cash transactions and help in detecting any discrepancies.
4. Verification of Bank Reconciliation:
 Auditors reconcile the cash book with bank statements and verify the
accuracy of the bank reconciliation statement. This ensures that the
ending cash balance in the cash book agrees with the bank statement
and that any reconciling items are appropriately accounted for.
5. Review of Internal Controls:
 Auditors assess the internal controls related to cash handling and
recording. This involves evaluating procedures for authorizing,
recording, and reconciling cash transactions to ensure that they are in
accordance with organizational policies and procedures.

VOUCHING OF TRADING TRANSACTIONS

Meaning:
Vouching of Trading Transactions involves verifying transactions related
to the purchase and sale of goods.
Definition:
Vouching of Trading Transactions is the process of examining
documents such as purchase invoices, sales invoices, delivery notes, and other
relevant records to ensure the accuracy of entries in the trading accounts.

VOUCHING OF IMPERSONAL LEDGER:

Meaning:

13
 Vouching of Impersonal Ledger involves scrutinizing entries in the general
ledger related to non-personal accounts.
Definition:
Vouching of Impersonal Ledger is the process of verifying entries in the
general ledger that pertain to non-personal accounts such as rent, depreciation,
and other expenses. It includes confirming the validity of supporting documents.
 Objectives:
 Confirm accuracy and validity of ledger entries for non-individual
transactions.
 Ensure compliance with accounting principles
ROLE:
1. Verification of Transactions:
 Vouching of impersonal ledger involves the verification of entries in the
general ledger related to non-personal accounts, such as rent,
depreciation, utilities, and other expenses. This verification ensures
that these transactions are valid and supported by appropriate
documentation.
2. Authenticity of Expenses:
 Auditors vouching impersonal ledger accounts scrutinize supporting
documents, such as invoices, contracts, bills, and receipts, to confirm
the authenticity of recorded expenses. This process helps in detecting
any unauthorized or fraudulent transactions.
3. Accuracy of Accounting Entries:
 By vouching impersonal ledger entries, auditors confirm that the
amounts recorded in the ledger are accurate and correctly reflect the
financial transactions of the organization. This is essential for
maintaining the integrity of financial reporting.
4. Compliance with Accounting Policies:
 Vouching ensures that transactions recorded in the impersonal ledger
comply with accounting policies and principles. This includes verifying
whether expenses are recognized in the correct accounting periods
and in accordance with applicable accounting standards.
5. Support for Financial Statements:
 Vouching of impersonal ledger accounts provides support for the
amounts reported in the financial statements. Auditors rely on these
vouching procedures to ensure that the information presented in the
financial statements is based on accurate and valid data.
6. Identification of Irregularities:
 Through vouching, auditors can identify irregularities or discrepancies
in the recording of expenses in the impersonal ledger. This includes
instances where expenses may have been recorded twice, omitted, or
misclassified.
7. Confirmation of Obligations:
 In the case of accounts like accrued expenses or outstanding liabilities,

14
 vouching ensures that these obligations are properly recorded in the
impersonal ledger. This confirmation is essential for presenting a
comprehensive picture of the organization's financial position.
8. Disclosure of Contingencies:
 Vouching helps auditors identify and assess any contingencies or
potential liabilities that may not be immediately apparent. This is
crucial for providing a clear and accurate representation of the
organization's financial status in the financial statements.
9. Internal Control Evaluation:
 Vouching of impersonal ledger transactions contributes to the
evaluation of internal controls. Auditors assess whether there are
adequate controls in place to ensure the accuracy and validity of
entries in non-personal accounts.
10. Audit Trail Documentation:
 The vouching process creates an audit trail by documenting the
evidence and supporting documents for each transaction in the
impersonal ledger. This documentation is essential for future reviews,
external audits, and regulatory compliance.

15
 UNIT-3
VALUVATIONS OF ASSETS AND LIABILITIES

VERIFICATION AND VALUATION OF ASSETS AND LIABILITIES:

Meaning:

Verification of assets and liabilities involves the process of checking and

confirming the existence, ownership, and accuracy of items in the financial
statements. Valuation refers to the determination of the monetary value assigned to
assets and liabilities, often based on historical cost, market value, or other applicable
methods.

Definition:

VERIFICATION: It is the process of establishing the authenticity and existence of

assets and liabilities by physical examination, inspection, or third-party confirmations.

VALUATION: It is the assignment of a monetary value to assets and liabilities based

on applicable accounting principles and methods.

Functions:

 Confirming the existence of assets and liabilities.

 Ensuring proper ownership and rights to assets.
 Verifying the accuracy of amounts recorded in the financial statements.
 Assessing the appropriateness of valuation methods.

Features:

 Physical inspection for tangible assets.

 Confirmation letters for receivables and payables.
 Use of valuation techniques such as market comparisons.

Role:

 Ensures the reliability and accuracy of financial statements.

 Supports the fair presentation of an entity's financial position.
 Assists in detecting and preventing misstatements or fraud.

Advantages:

16
  Enhances the credibility of financial statements.
 Provides assurance to stakeholders.
 Detects errors or discrepancies in asset and liability records.

Disadvantages:

 May be time-consuming and resource-intensive.

 Relies on available evidence, which may not be exhaustive.
 Market valuations can be subjective and vary over time.

AUDITOR’S POSITION REGARDING THE VALUATION AND VERIFICATION OF

ASSETS AND LIABILITIES:

Meaning: The auditor's position refers to the stance taken by auditors in assessing
the accuracy and reliability of asset and liability valuations and verifications.

Definition: The auditor is responsible for expressing an opinion on whether the

financial statements are presented fairly and in accordance with applicable
accounting standards, which includes assessing the valuation and verification of
assets and liabilities.

Functions:

 Reviewing management's valuation methods and assumptions.

 Conducting independent verification procedures.
 Forming an opinion on the fairness of asset and liability presentation.

Features:

 Independence and objectivity are critical.

 Detailed examination of valuation policies and procedures.
 Careful consideration of evidence supporting asset and liability values.

AUDITOR'S ROLE AND RESPONSIBILITIES:

1. Independence:
 Auditors must maintain independence from the entity being audited to
ensure objectivity and impartiality. This independence is essential for
providing an unbiased assessment of asset and liability values.
2. Assessment of Management's Policies:
 Auditors review and evaluate management's policies for the valuation
of assets and liabilities. This includes understanding the methods,
assumptions, and estimates used by management in the financial
reporting process.
3. Verification Procedures:
17
  Auditors design and perform verification procedures to confirm the
existence, ownership, and accuracy of assets and liabilities. This may
involve physical inspection, third-party confirmations, and other
auditing techniques.
4. Analytical Procedures:
 Analytical procedures are employed to assess the reasonableness of
asset and liability values. Auditors compare current and historical data,
industry benchmarks, and other relevant information to identify any
unusual fluctuations or discrepancies.
5. Review of Internal Controls:
 The auditor evaluates the effectiveness of internal controls related to
the valuation and verification of assets and liabilities. Strong internal
controls contribute to the reliability of financial information.
6. Consideration of Risks:
 Auditors assess the risks associated with asset and liability valuations.
This involves identifying potential misstatements, fraud risks, and
uncertainties that may impact the accuracy of financial reporting.
7. Professional Judgment:
 Professional judgment is a key element in the auditor's position.
Auditors use their expertise and experience to form opinions on the
reasonableness of asset and liability values, considering the unique
circumstances of the entity.
8. Communication with Management:
 Auditors communicate with management to obtain additional
information, clarification, and explanations related to asset and liability
values. This dialogue is essential for a comprehensive understanding
of the financial reporting process.
9. Documentation:
 Auditors maintain detailed documentation of their audit procedures,
findings, and conclusions. This documentation serves as evidence of
the work performed and supports the auditor's opinion expressed in
the audit report.
10. Consideration of Legal and Regulatory Requirements:
 Auditors ensure that asset and liability valuations comply with relevant
legal and regulatory requirements. Non-compliance can have
implications for the accuracy and legality of financial statements.

KEY CONSIDERATIONS FOR AUDITORS:

1. Consistency:
 Auditors assess whether management has applied consistent
valuation methods across periods. Inconsistencies may require
additional scrutiny and explanation.
2. Fair Presentation:

18
  Auditors ensure that financial statements present a true and fair view
of the entity's financial position. This includes verifying that asset and
liability values are not overstated or understated.
3. Materiality:
 Auditors consider materiality thresholds when evaluating the impact of
potential misstatements. Material misstatements in asset and liability
values could affect the overall fairness of financial statements.
4. Disclosure:
 Auditors assess whether the entity has disclosed relevant information
about the methods used for valuation and any significant assumptions
or uncertainties. Adequate disclosure enhances transparency.
5. Use of Experts:
 In certain cases, auditors may engage experts to assist in the valuation
of complex assets. The auditor remains responsible for evaluating the
appropriateness of the expert's work.
6. Subsequent Events:
 Auditors consider events occurring after the balance sheet date that
may impact the valuation of assets and liabilities. Adjustments may be
necessary if events materially affect the financial statement

Advantages:

 Enhances confidence in financial reporting.

 Contributes to the reliability and credibility of financial statements.
 Encourages transparency and accountability.

Disadvantages:

 Limited by the information provided by management.

 May not detect sophisticated fraud schemes.
 Relies on historical information that may become outdated.

DEPRECIATION:

Meaning: Depreciation is the systematic allocation of the cost of a tangible asset

over its useful life.

Definition: Depreciation is an accounting method that reflects the reduction in the

value of an asset due to wear and tear, obsolescence, or the passage of time.

19
RESERVES AND PROVISIONS:

Meaning: Reserves and provisions are appropriations of profits for specific purposes
or recognition of liabilities, respectively.

Definition: Reserves are set aside from profits for future use, while provisions are
recognized liabilities based on uncertainties or future obligations.

RESERVES:

1. Nature of Reserves:
 Reserves are appropriations of retained earnings set aside by a
company for specific purposes. They represent a portion of profits that
is not distributed as dividends but retained within the business.
2. Types of Reserves:
 General Reserves: These are created to strengthen the financial
position of the company and are not earmarked for specific purposes.
 Specific Reserves: Created for a particular purpose, such as the
provision for doubtful debts or a specific contingency.
3. Audit Procedures for Reserves:
 Auditors review the resolutions of the board of directors authorizing
the creation of reserves.
 They ensure compliance with legal requirements and accounting
standards.
 Auditors assess the necessity and reasonableness of the reserves
created.
4. Disclosure and Presentation:
 Auditors verify that the reserves are appropriately disclosed in the
financial statements, indicating their purpose and the basis for their
creation.
5. Use of Reserves:
 Auditors assess whether the reserves are being used for their intended
purposes and ensure that any changes in their utilization are
adequately disclosed.

PROVISIONS:

1. Nature of Provisions:
 Provisions are liabilities recognized in the financial statements to
reflect uncertainties or potential obligations that may result in the
outflow of resources.
2. Types of Provisions:
 Provision for Bad and Doubtful Debts: Recognized to cover potential
losses from doubtful receivables.

20
  Provision for Warranty: Recognized for potential warranty claims on
products sold.
 Provision for Legal Claims: Recognized for potential legal liabilities.
3. Audit Procedures for Provisions:
 Auditors assess the adequacy of provisions by reviewing the basis and
assumptions used in their calculation.
 They examine supporting documents, such as legal opinions or expert
reports, to validate the necessity of provisions.
4. Disclosure and Presentation:
 Auditors ensure that provisions are appropriately disclosed in the
financial statements, including details on their nature, amount, and
timing of expected outflows.
5. Review of Changes:
 Auditors review changes in provisions from the prior period to assess
the reasonableness of adjustments made and to identify any potential
management bias.
6. Use of Provisions:
 Auditors evaluate whether provisions are used for their intended
purposes and assess the appropriateness of any reversals or
adjustments made during the period.
7. Contingent Liabilities:
 Auditors consider contingent liabilities that may require provisions if
they become probable. They assess the adequacy of disclosures
related to contingent liabilities.

Common Considerations:

1. Materiality:
 Auditors consider the materiality of reserves and provisions in the
context of the financial statements. Material items require more
extensive audit procedures.
2. Judgment and Estimates:
 Reserves and provisions often involve management judgment and
estimates. Auditors assess the reasonableness of these estimates and
consider the impact of changes in assumptions.
3. Consistency:
 Auditors review the consistency in the application of accounting
policies for reserves and provisions and assess whether changes in
policies are adequately disclosed.
4. Legal and Regulatory Compliance:
 Auditors ensure that the creation and utilization of reserves and
provisions comply with relevant legal and regulatory requirements.
5. Management Representations:
 Auditors obtain management representations regarding the

21
 completeness and accuracy of information related to reserves and
provisions.

SECRET RESERVES:

Meaning: Secret reserves are undisclosed or hidden reserves that are not revealed in
the financial statements.

Definition: Secret reserves refer to surplus amounts intentionally withheld from the
financial statements to provide a cushion against future uncertainties or to manage
perceptions.

Functions:

 Act as a financial safety net for unforeseen losses.

 Smooth out reported earnings and maintain financial stability.

Features:

 Not disclosed in financial statements.

 Known only to management and possibly the auditor.

Role:

 Provides a buffer against unexpected losses.

 May be used to manipulate perceptions of financial health.

Advantages:

 Offers financial flexibility and stability.

 Can be used strategically for business reasons.

Disadvantages:

 Lacks transparency and violates the principle of full disclosure.

 Can mislead stakeholders about the true financial position.

In summary, verification and valuation of assets and liabilities, the auditor's position,
depreciation, reserves and provisions, and secret reserves are integral components
of the auditing and financial reporting process.

22
 UNIT-4
AUDIT OF JOINT STOCK COMPANIES

AUDIT OF JOINT STOCK COMPANIES:

The audit of joint-stock companies refers to the examination and verification

of the financial statements and financial activities of a company that is organized as
a joint-stock company.

QUALIFICATION OF AUDITORS:

1. Professional Qualifications:
 Auditors should possess professional qualifications recognized by
regulatory bodies. Common qualifications include being a Chartered
Accountant (CA) or Certified Public Accountant (CPA).
2. Experience:
 Auditors are expected to have relevant audit experience, ensuring they
are familiar with auditing standards and practices.

DISQUALIFICATIONS OF AUDITORS:

1. Conflict of Interest:
 Auditors may be disqualified if there is a conflict of interest, such as
holding a significant financial interest in the company being audited.
2. Lack of Independence:
 Auditors must maintain independence to ensure an unbiased
examination. Any financial or personal relationships that compromise
independence can lead to disqualification.
3. Legal Restrictions:
 Legal regulations may specify conditions under which an auditor is
disqualified, such as being an undischarged bankrupt or having a
criminal record.

MODES OF APPOINTMENT OF COMPANY AUDITOR:

1. Appointment by Shareholders:
 Shareholders, in the annual general meeting, often appoint auditors
based on the recommendation of the Board of Directors.
2. Appointment by Board of Directors:
 In some cases, the Board of Directors may recommend the
appointment of auditors, subject to shareholder approval.

23
RIGHTS AND DUTIES OF A COMPANY AUDITOR:

RIGHTS:
 Access to Information: Auditors have the right to access all relevant
financial records and information.
 Attendance at General Meetings: Auditors can attend general
meetings to answer questions related to the audit.
DUTIES:
 Compliance with Standards: Auditors must perform the audit in
accordance with applicable auditing standards.
 Independence: Auditors must maintain independence in fact and
appearance throughout the audit.
 Fraud Detection: Auditors have a duty to detect and report fraud or
irregularities.

LIABILITIES OF A COMPANY AUDITOR:

1. Civil Liability:
 Auditors may be held civilly liable for negligence or breach of duty,
leading to financial damages.
2. Criminal Liability:
 Criminal liability may arise if auditors are involved in fraudulent
activities or will be full misconduct.
3. Professional Liability:
 Auditors may face professional consequences, including the loss of
professional certification, for violations of ethical standards.

SHARE CAPITAL AND SHARE TRANSFER AUDIT:

1. Share Capital Audit:

 Auditors verify the issuance and redemption of shares, ensuring
compliance with the Companies Act and accuracy in recording.
2. Share Transfer Audit:
 Auditors examine the procedures for the transfer of shares, ensuring
compliance with legal requirements and accurate recording.

24
AUDIT REPORT – CONTENTS AND TYPES:

In the principles of auditing, an audit report is a formal document that expresses

the independent auditor's opinion on the fairness and reliability of an entity's
financial statements.

CONTENTS OF AUDIT REPORT:

 Title: Clearly stating that it is an audit report.

 Introductory Paragraph: Identifying the financial statements audited.
 Responsibility Paragraph: Describing management's responsibility for
financial statements.
 Auditor's Responsibility Paragraph: Outlining the auditor's
responsibilities.
 Basis for Opinion: Indicating the basis for the auditor's opinion.
 Opinion Paragraph: Expressing the auditor's opinion on the financial
statements.
 Other Reporting Responsibilities: Including additional information, if
any.
 Signature and Date: Signed by the auditor with the date of the report

TYPES OF AUDIT REPORTS:

 Unqualified Opinion: Conveying a clean opinion that the financial
statements are fairly presented.
 Qualified Opinion: Issued when the auditor has reservations about
specific aspects but overall believes the financial statements are
acceptable.
 Adverse Opinion: Issued when the auditor concludes that the financial
statements are not presented fairly.
 Disclaimer of Opinion: Issued when the auditor is unable to form an
opinion due to limitations in the scope of the audit.

25
In summary, the audit of joint-stock companies involves adherence to professional
qualifications, independence, and compliance with legal and regulatory requirements.
Auditors have specific rights and duties, and they can be held liable for negligence or
misconduct. The audit report is a critical communication tool, and its contents and
types provide stakeholders with insights into the reliability of financial statements.

26
 UNIT-5
INVESTIGATION

INVESTIGATION:

Definition: Investigation refers to a detailed examination or inquiry into specific

financial or operational aspects of an entity. It goes beyond the scope of a routine
audit and may be conducted in response to specific concerns or needs.

FEATURES:

1. Challenges:
 Complexity: Computerized accounting systems can be complex,
requiring auditors to understand the software and data structures.
 Automation Risks: Automated processes may increase the risk of
errors or fraudulent activities if not properly controlled.
 Data Security: Ensuring the security and integrity of electronic data is
crucial.
2. Audit Procedures:
 Understanding IT Environment: Auditors need to understand the
entity's IT environment, including controls over data entry, processing,
and reporting.
 Testing Automated Controls: Assessing the effectiveness of
automated controls in place.
 Data Analytics: Using data analytics tools to analyze large volumes of
electronic data.
 IT General Controls: Evaluating general IT controls such as access
controls and change management.

ELECTRONIC AUDITING:

Definition: Electronic auditing, or e-auditing, involves the use of technology in the

audit process. It includes both the audit of electronic financial data and the use of
electronic tools in conducting the audit.

Technological Tools:
 Data Extraction Software: Tools to extract and analyze data from
electronic sources.
 Audit Management Software: Platforms to manage audit workflows
and documentation.
 Blockchain Technology: Ensuring the integrity and traceability of
transactions.

27
INVESTIGATION UNDER THE PROVISIONS OF COMPANIES ACT:

1. Mandatory Investigations:
 The Companies Act in many jurisdictions empowers regulatory bodies
to initiate investigations into the affairs of companies under certain
circumstances.
2. Fraudulent Activities:
 Investigations under the Companies Act may be initiated to examine
fraudulent activities, mismanagement, or irregularities within a
company.
3. Appointment of Inspectors:
 The regulatory authorities may appoint inspectors to conduct
investigations, examine records, and report on their findings.
4. Powers of Investigators:
 Investigators under the Companies Act have wide-ranging powers,
including the authority to examine witnesses, call for documents, and
access company premises.
5. Reports and Legal Actions:
 Upon completion of the investigation, inspectors submit a report to the
regulatory body. The findings may lead to legal actions, penalties, or
recommendations for corrective measures.

Meaning of Investigation under the Companies Act:

1. Legal Mandate:
 The Companies Act provides a legal framework for the regulation and
governance of companies. Under certain circumstances, the Act
empowers regulatory authorities, shareholders, or creditors to initiate
an investigation into the affairs of a company.
2. Scope of Investigation:
 Investigations under the Companies Act can cover a wide range of
areas, including financial statements, business operations, compliance
with legal requirements, adherence to accounting standards, and
overall corporate governance.
3. Objective:
 The primary objective of the investigation is to determine whether the
company is operating in compliance with the law and established
corporate governance principles. It aims to identify any irregularities or
violations that may impact the interests of stakeholders.

28
Principles of Auditing in Investigation:

1. Independence:
 Investigators must maintain independence and objectivity during the
inquiry. This ensures that the findings are unbiased and free from
undue influence.
2. Professional Competence:
 Investigating teams should possess the necessary professional
competence, skills, and knowledge to conduct a thorough examination
of financial records and business operations.
3. Confidentiality:
 Investigators must treat information obtained during the investigation
with confidentiality. This is particularly important to protect the
reputation and interests of the company under investigation.
4. Communication of Findings:
 The investigators are expected to communicate their findings to the
relevant authorities or stakeholders in a clear and comprehensive
manner. This may include the identification of any irregularities,
recommendations for corrective actions, or legal actions if required.
5. Compliance with Legal Requirements:
 Investigators need to ensure that the investigation is conducted in
strict compliance with the legal requirements outlined in the
Companies Act. This includes following prescribed procedures and
timelines.

29
Conclusion:

In the principles of auditing, investigation plays a crucial role when there are
specific concerns or requirements that go beyond the scope of a routine audit. The
audit of computerized accounts and electronic auditing highlight the challenges and
opportunities associated with technological advancements. Additionally, the
Companies Act provides a legal framework for investigations into the affairs of
companies, aiming to ensure compliance, transparency, and the protection of
stakeholders' interests.

30