AUDITING NOTES

UNIT ONE

INTRODUCTION, NATURE, PURPOSE AND OBJECTIVES OF AUDIT

Auditing is a professional task of carrying out responsibilities with care, skill and judgment. In early
periods the methods of accounting maintenance was crude, the business houses were small and were
managed by owners themselves and thus there was no need for accounts maintenance as owners were
able to check and maintain all records. Thus was it held as a waste of time and money to have an
external accountant out checking the books?

The origin of auditing may be traced back in 18th century when practice of large-scale production was
developed as a result of industrial revolution and emerging of companies where owners were separated
from management. Hence need for pure accounting and auditing was emphasized.

The ancients Egyptians, Greeks and Romans were said to the earliest operators of auditing. The audit is
derived from LATIN work AUDIRE which means TO HEAR. Customary for persons responsible for
accounts maintenance were to read the accounts records to judges to hear and express their opinions
regarding, their reliability, hence thus judges were termed as auditors. The word Audit means to hear as
Public Accounts were accepted by hearing

Definitions

Auditing has been defined by various peoples as follows;-

1. Spicer and plegler

’’An audit may be said to be such an examination of books, accounts and vouchers of business
as will enable the auditor to satisfy that the balance sheet is properly up , so as to give true and
fair view of the state of affairs of the business and whether the profit and loss accounts gives a
true and fair view of profit or loss for the financial period according to the best of his
information and explanations given to him and shown by the books and if not in what respect he
is not satisfied.’’
2. Montgomery
‘’auditing is a systematic examination of the books and records of the business or other
organization in order to ascertain or verify and report upon the facts regarding its financial
operations and the result thereof’’
3. R.B. Bose
‘’Audit may be said to be verification of the accuracy and correctness of the books of accounts
by an independent person qualified for the job and not in any way connected with preparations
of such accounts’’

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DISTINCTION BETWEEN ACCOUNTACY AND AUDITING

A line of demarcation has to be drawn between accountancy and auditing. The following can be
helpful to do so:-

1) Accountancy is mainly concerned with preparation of summary and analysis of records

prepared by the bookkeeper. Hence accountant prepares annual accounts. While
auditing is the examination of the completed records.
2) Main object of accounting is to ascertain trading results of the business during a
financial year. Auditing objective is to certify as whether financial records are prepared
by accountant are correct or not.
3) An accountant is business employee, while an auditor an external independent person.
4) Accountant draws monthly salary as employee, while auditor is paid a remuneration
agreed upon.
5) Accountant need not to have knowledge of auditing, while auditor should have through
knowledge of accountancy.
6) Accountant is a permanent employee, while auditor can be changed from year to year.
7) An accountant need not present his report on financial statements prepared by him, but
an auditor must submit a report to clients regarding the audited accounts regularly as
agreed.

SCOPE AND ROLE OF AUDIT

Audit plays an important role in the society; its role can be traced from its wide scope it
covers such as:
 Cost audit- Cost Audit represents the verification of cost accounts and check on
the adherence to cost accounting plan. Cost Audit ascertain the accuracy
of cost accounting records to ensure that they are in conformity
with Cost Accounting principles, plans, procedures and objective.
Objectives of cost audit: (a) Prospective Objective: Under which cost audit
aims to identify the undue wastage or losses and ensure that costing system
determines the correct and realistic cost of production. (b) Constructive
Objectives: Cost audit provides useful information to the management regarding
regulating production, economical method of operation, reducing cost of
operation and reformulating Cost accounting plans .
The purpose is checking whether such costs are effective, justified and controlled to
maximize organizational returns through cost reduction)
 Management audit- Management Audit is an assessment of methods and
policies of an organization's management in the administration and the use of
resources, tactical and strategic planning, and employee and organizational
improvement. A management audit is an analysis and assessment

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 of the competencies and capabilities of a company's
management in carrying out corporate objectives. The purpose of
a management audit is not to appraise individual executive
performance but to evaluate the management team in its
effectiveness to work in the interests of shareholders, maintain
good relations with employees, and uphold reputational
standards. (Checking management efficiency and evaluate their performance in
achieving the set objectives)
 Environmental audit – An environmental audit is a type of evaluation intended
to identify environmental compliance and management system implementation
gaps, along with related corrective actions. In this way they perform an
analogous (similar) function to financial audits. There are generally two different
types of environmental audits: compliance audits and management systems
audits. Compliance audits tend to be the primary type in the US or within US-
based multinationals (evaluating environmental impact of an activity called
environmental impact assessment. In Kenya it is a function of National Environment
Management Authority (NEMA). This includes noise pollution, water and air
pollution and other environment effect of activities to society
 Tax audit- A tax audit is an examination of an organization's or individual's tax
return to verify that financial information is being reported correctly.

 Operational audit:- An operational audit process is the series of steps an auditor takes to
evaluate the operational activities of a given company or other organization. The process
is very similar to the processes for other forms of audits, such as the financial audit, but
the operational audit process is a much more in-depth review of the business. It usually
does not focus on a single department or project, because each department plays a role in
the overall operational process and is interconnected. Goal:- The goal of the operational
audit process is to determine whether the internal controls of the business, such as
policies and procedures, are sufficient to produce an optimum level of efficiency and
effectiveness. This is critical for businesses, because a lack of efficiency and
effectiveness typically translates to fewer sales or increased operational costs, which
sometimes mean the inability of the business to compete and stay in business.
 Financial Audit- A financial audit is an independent, objective evaluation of an

organization's financial reports and financial reporting processes. The primary

purpose for financial audits is to give regulators, investors, directors, and

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 manager’s reasonable assurance that financial statements are accurate and
complete.
 Forensic Audit: A forensic audit is an examination and evaluation of a firm's or
individual's financial records to derive evidence that can be used in a court of law or legal
proceeding. Forensic auditing is a specialization within the field of accounting, and most
large accounting firms have a forensic auditing department. Forensic audits require the
expertise of accounting and auditing procedures as well as expert knowledge about the
legal framework of such an audit. Forensic audits cover a wide range of investigative
activities. A forensic audit may be conducted to prosecute a party for fraud,
embezzlement, or other financial crimes. In the process of a forensic audit, the auditor
may be called to serve as an expert witness during trial proceedings. Forensic audits
could also involve situations that do not involve financial fraud, such as disputes related
to bankruptcy filings, business closures, and divorces.

But the main roles of financial audit are:-

1) The detection of errors.

2) The detection of frauds
3) Prevention of recurrence of errors
4) Prevention of recurrence of frauds
5) To enable the audit give his opinion as required
6) Requirement by law i.e company act cap 486 (as revised 2015)
7) To create confidence to public and users of the information.

What is an error? Errors arise out of innocence and carelessness on part of responsible person prepare
accounts records without any intention of deceiving.

ERRORS

 Error of omission
 Error of commission
 Compensating error
 Error of principle

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 I. Errors of Omission
It is a clerk’s mistake to omit entering a transaction in the books of accounts.
II. Error of commission
It arises due to negligence in matter of recording some transaction in the books. If an
item is incorrectly recorded in journal or posted in the ledger wrongly, example an error
where the right amount is entered on the wrong account but on the right side i.e debit
S.John account with shs 10.but instead debit W.John account. Also error of commission
{is sale of ship is entered into journal as Shs 100}
III. Compensating error
They arises when the errors are counter balanced or compensated by another error or
errors so that the adverse effect of one debit or credit side is neutralized by another on
debit or credit side. Example “A”s account was to be debited for sh 200 but it was
credited for sh 200 and similarly “B”s account was to be credited for sh 200 but was
debited the same amount.
IV. Error of principle
It arises due to disregard of accounting principles. At times may be committed
intentionally. Example: incorrect allocation of expenditure between capital and revenue
in nature.

Fraud
This false representation or entry, which is made intentionally with some mischievous
objectives. The person making such mistakes knows them with an intention of
deceiving. Fraud includes.
 Manipulation of cash
 Theft of cash
 Theft of cheques
 Manipulation of goods
 Issue factious credit notes to customers
 Actual stock theft
 Manipulation of accounts
 False entry of cash/goods

UNIT TWO
CLASSIFICATION OF AUDITING

Auditing can be classified in various ways. It can be simplified according to its nature as follows:-
i) When: - when it is done or carried out.
ii) Who: - who does it.
iii) Why: - why do it.
iv) How: - how it done.
A) WHEN

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i. Final audit
a. This audit commences after the end of the year whose accounts are examined.
Accountant completes all records and prepares final accounts then hands over
to the auditor.

Advantages

 As all record are available auditor can carry out detailed examination in depth ,
hence his report is more reliable.
 As the period of recording is over the accounting staff can start writing accounts
of the next period.
 The auditor do not interfere the accounting staff’s day to day work.
 No possibility of alteration of figures after auditor has checked them.
 Speed of work of the auditor is faster as he is in possession of all records needed

Disadvantages

 As audit starts after the end of the financial year some errors or fraud may be
discovered too late to be rectified or action to be taken or prevent them.
 Audit report may be delayed as audit can commence only after account period
is over.
 If a company wishes to prepare quarterly or half yearly accounts these will not
be certified by the auditor until the end of the financial year.
ii. Continuous audit
In this audit, the auditor pays regular visits to his client’s offices checking the work done.
The audit work is spread throughout the whole year by the time final accounts are
prepared also routine checking work is already over, hence auditor needs to check only
the final draft of accounts.

Advantages
 As audit work is spread throughout the year more detailed checking can be
carried out.
 Errors and fraud are discovered in time and actions are taken to rectify them
quickly.
 Frequently a visit by auditor discourages any temptation of staff’s dishonest.
 Accounting staff is likely to keep his work up to date.
 Auditor work is available quickly after the final year ends.
 Publications of audited accounts quarterly and half yearly are possible.
 As work is spread throughout the year the year the auditor gets less staffing
problems.

Disadvantages

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  Figures may be altered after being checked by the auditors. The auditor checks
the books and returns them to client’s staff that may do alterations.
 The method is expensive to client. Frequent visits and annual occupation is
payable.
 Frequent visits by the auditor may be inconvenient the accounting staff whose
work may be divided between routine duties and attending the auditor.
 Also auditor may hold up some books to go through while staffs are waiting for
them.
iii. Interim audit
This audit is carried out sometime during the course of the financial year and it covers
part of the whole year. Its objective is to enable the client publish interim accounts to
pay interim dividends.

Advantages
 It enables the client to pay interim dividends.
 It offsets the disadvantages of final auditing i.e delay of the final report.
 It reduces the workload of the auditor at the end of financial year.

Disadvantages

 It only covers part of the financial year hence no detail analysis of the whole
year.
 Figures may be altered after being checked by the auditor.
B) WHO
i. Internal audit
Internal audit is carried out in large companies, which need to maintain good system of
internal control. An internal auditor is independent from accounts department and he
submits his report to management for internal management use. Internal audit is
carried continuously throughout the year.

Advantages
 Helpful to make internal control system of accounts more effective.
 Helpful source of information to management decisions.

Disadvantages

 He is not always reliable for external use.

 He may be influenced by directors in his report since he is not independent.
 Duty to familiarize themselves by itself to do audit. The scope of such private
audit is defined by the clients who hire the auditor.
ii. External audit

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 it is carried out by independent outsider and qualified person usually appointed by
shareholders. He the report on how accounts have been prepared such reports are
submitted to shareholders.

Advantages
 His report is always reliable for external use and he is independent.
 He is a qualified professionals hence his report might be more effective.

Disadvantages

 Its cost is high.

C) WHY
i. Statutory audit
Such audit is carried out under the provisions of the law of the country, i.e under
company’s act which says joint stock companies ought to be audited, banking and
insurance institutions. It is compulsory audit by law. The scope of audit work and
reporting standards is governed by the act providing for audit.
ii. Voluntary audit
An organization or business may not be required to obtain an audit report of its account
but it may consider it necessary to do audit of its books for self-interest. Business such
as partnership, sole proprietors may decide to do audit for their personal needs. The
scope of such audit should be defined by the client who hires the auditor.
D) HOW
i. Balance sheet audit
This an approach of auditing an auditor starts his examinations from the balance sheet
and works backward trying to verify each item shown thereof , thus restricting the
auditor report on the balance sheet facts only. This is an American system of audit.
ii. Vouching audit
In this approach the auditor starts from source documents to primary records like daily
journals and works upwards to the trial balance and profits andloss accounts and then
the balance sheet. This the British system of audit and its adopted in east Africa

UNIT THREE

APPOINTMENT OF AN AUDITOR DUTIES AND RIGHTS

The auditor’s appointment can be classified into the following groups:-

 Auditor in the sole proprietorship.

 Auditor in a partnership firm.
 Auditor in a limited company.

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I) Sole proprietorship
There is no law guiding his appointment or conduct of his duties. Auditing is not a
compulsory but voluntary. Hence auditor’s appointment, duties, rights and removal,
remuneration, qualification and independence all are mainly depends on the owner of
the business in agreement with the auditors. But there are general rights and duties.

General Rights
 Rights to check books of accounts.
 Rights to examine according to the duties assigned.
 Right to call for any explanations and information from the company officials
this is necessary for the audit purpose.
 Right to mention in his report any information not furnished to him.
 Right to receive his due (remuneration).

General duties

 Duty to scrutinize the accounts with reasonable care, skill and caution.
 Duty to make final audit.
 It is requested to give advice regarding the working of the business he should do
so.
 Duty to familiarize himself with the scope of his duties before commencing it.
II) Partnership firm
Appointment, remuneration, duties and rights may be arrived at mutual agreement or
may be affected by the provisions of the partnership deed. But the following are his
general rights and duties.

General Rights
 Right to examine partnership deed.
 Right to have access to books of accounts’
 Right to remuneration as agreed or stated in the deed.
 Right to obtain information and explanations from the firm for purpose of his
work.

General duties

 It is his duty to obtain clear instructions regarding his duties before commencing
his work by studying partnership deed.
 He should work sincerely and honestly.
 He should make the report after his work is over.
 He should give suggestions to improve working of business if asked to do so.
III) Auditor of a limited company

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 Appointment
In joint stock companies, Cooperative societies, government institutions and any
organization receiving tax payer’s funds, the auditor is appointed by shareholders at
their annual general meeting and hold office until the next annual general meeting
usually after one year.

Appointments also can be done by the directors in the following ways:-

a. If they have been authorized to appoint the auditor by the shareholders, then
they can do so.
b. A newly formed company which has not held its first annual general meeting to
appoint the auditor.
c. If at any time of the year the office becomes vacant due to death or resignation
of the auditor the director can appoint someone.
But all the above appointment by directors must be ratified at the next annual
general meeting by shareholders

The retiring auditors are legible for reappointment through a member proposal or
directors, then a resolution is passed. The appointed person must hold a certificate
of C.P.A issued by the Kenya Accounts and Secretaries National Examination Board
(KASNEB) or any other body recognized by Institute of certified Public Accountant of
Kenya (ICPAK) and KASNEB.

WHO CANNOT BE APPOINTED AS AN AUDITOR (DISQUALIFICATIONS)

The following persons are disqualified to be external auditor even if they hold professional
qualification:-

i. An officer or servant of the company.

ii. A person who is a partner of or in employment of, an officer or servant of the company.
iii. A body corporate with limited liability.
iv. A person who for any of these reasons is disqualified from appointment as auditor of
company that is subsidiary or holding company.
v. Debtor of a company.

UNIT FOUR

AUDIT PLANNING PRACTICE, PRINCIPLES AND CONTROLS

INTIAL INQUIRIES BY AUDITOR BEFORE ACCEPTING THE POST

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The auditor should make the following inquiries before accepting his appointment:-

i. Study the relevant statitute and laws i.e company act, banking act if the company is a bank and
establish the scope of his duties.
ii. Inspect the company’s article and memorandum of association and other legal documents.
iii. Ascertain the legal nature of the business and obtain clear ideas of technicalities.
iv. Get list of all books i.e financial statistical and statutory, major officials of the company
authorized to execute various duties.
v. Obtain preliminary information about the company’s internal control systems.
vi. If the company previously had different external auditor, the new auditor should consult him
and seek his views on the company auditor. If the company refuses the consultation he can
decline the appointment.
vii. He should obtain published copy of accounts and supporting schedules and the working of the
company for the careful study to get general ideas about the company’s position reporting
standards

After going through initial inquiry the auditor can write an engagement letter or acceptance letter for
the post.

REMOVAL OF AN AUDITOR

Auditor removal is done by shareholders in the following ways:-

i. When the first auditor of the company is appointed by the directors prior to first annual general
meeting ,such auditors may be removed by members at their annual general meeting and
nominate another.
ii. Any other case auditors may be removed by shareholders after the approval by the concerned
government authorities at their meeting. The case of removal should also be reported to
Institute of Certified Public Accounts of Kenya (ICPAK) to evaluate and deregister him/her as
professional. If the case is approved by ICPAK as valid and deregistered then automatically
he/she shall be removed by the company as non-professional.

REMUNERATION OF AN AUDITOR

If he is appointed by board of directors his remuneration should be fixed by them. But in other cases the
remuneration should be fixed by the company’s general meeting or such a manner as the company’s
general meeting may decide.

RIGHTS OF AN AUDITOR

1. Right to access books of account.

2. Right to obtain information and explanations.(i.e from directors, employers and other officers of
the company that he thinks necessary for performance of his duties).
3. Right to correct any wrong statement. He has the power to make any report to members of
accounts examined for any wrongdoing. He also can advise directors to amend their systems of

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 on accountsmaintenance if it is in fault, if his suggestions are taken into account has to refer to
the members.
4. Right to visit branches.
5. Right to sign his audit report.
6. Right to receive notice and other communications relating to general meeting and attend them.
7. Right to speak in the general meeting if he feels so for purpose of his duty.
8. Right to be indemnified. As a company officer he has right to indemnity against liabilities arising
out of his duties.
9. Right to have legal and technical advice.
10. Right to receive his remuneration.

DUTIES OF AN AUDITOR

Auditor’s duties can be discussed in three main points. These are:-

A) ACCORDING TO COMPANIES ACT

1) Duty to inquire whether loans are advances made by the company have been properly secured
and whether terms of securing are not prejudicial to the company interest.
2) Duty to inquire whether transactions of the company represented in the books entry are not
prejudicial to the company interest.
3) Duty to ensure whether loans and advances made by the company have been shown as
deposits.
4) Duty to see whether personal expenses have been charged to revenue account.
5) Duty to check and see if all shares issued have been properly done so and recorded in the books
accordingly.
B) REPORTING DUTIES
1) Duty to give his opinion whether balance sheet and profit and loss account are properly drawn
exhibit true and fair view of the state of affairs of the business.
2) Duty to report whether he has obtained all information and explanation necessary for the
purpose of his audit.
3) Duty to report whether in his opinion proper books of accounts as required by the law have
been kept by the company as per his examinations.
4) Duty to report whether reports of branch offices audited by external auditor have been
forwarded to him as required.
5) Duty to report whether company’s balance sheet and profit and loss account dealt with by the
report are in agreement with the books of accounts and returns.
6) Duty to sign his audit report.
C) OTHER DUTIES
1) Duty to give a report in his prospectus before it is issued regarding issues like profits and losses
of the company. Assets and liabilities of the company , rates of dividends for preceding years i.e
5 years
2) Duty to certify the statutory report regarding issue of shares , their allotment and cash received
3) Duty to make report in case a company is declared insolvent (U/S488/1).

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 4) Duty to give assistance required to any officer authorized by the government/court to inquire
some issues of the company.
5) Duty to correspond to previous auditor before accepting appointment as new auditor.
6) Duty to inform the shareholders the issue regarding the violation of any provisions of the
company’s act.
7) Duty to handle his work with Care, skill and caution.
8) Duty to satisfy himself that securities of the company do exist and are intact and in safe custody.

PREPARATION BEFORE AND PROCEDURES OF AUDIT

PRINCIPLES OF AUDIT:

There should be some basic principles adopted in every scientific field. The principles are necessary and
vital to understand the objectives of work to be done , also in auditing if the auditor don’t understand
the principles of auditing cannot do his work effectively. Therefore he must be trained and understand
them as preparation for professional duty.

Principles are the basic rules and involve all those procedures which are completed during the course of
examination. For example purchase of raw material is a revenue expenditure item as a matter of
principles of accounting.

Fundamental principles
A professional accountant shall comply with the following fundamental principles:

1. Integrity - to be straightforward and honest in all professional and business relationships.

2. Objectivity - to not allow bias, conflict of interest or undue influence of others to override
professional or business judgments.

3. Professional competence and due care - to maintain professional knowledge and skill at the
level required to ensure that a client or employer receives competent professional
services based on current developments in practice, legislation and techniques and act diligently
and in accordance with applicable technical and professional standards.

4. Confidentiality - to respect the confidentiality of information acquired as a result of professional

and business relationships and, therefore, not disclose any such information to third parties
without proper and specific authority, unless there is a legal or professional right or duty to
disclose, nor use the information for the personal advantage of the professional accountant or
third parties.

5. Professional behaviour - to comply with relevant laws and regulations and avoid any action that
discredits the profession.

TECHNIQUES OF AUDIT

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Techniques are the devices which are adopted in applying the principles of audit. They are used by the
auditor to acquire necessary audit evidence and establish the reliability of a given fact. They include:-

1) Physical Inspection
It involves counting or examining the physical matter represented by items in the accounts.
Example is physical stock taking , cash counting to determine their existence.
2) Confirmation
it consist obtaining verification of a fact ,balance or condition from third party. The auditor
contacts responsible officials through interview and open communication to obtain validity and
accuracy.
3) Re-computation
Such entries or balances, which are based on certain computation, can be verified by re-
computation of the number involved. Example bad debts provision is 15% of current debts of Sh
100000. Computed =5000/=
4) Retracing procedures
This is taking an entry in a ledger and retraces it to its original entry. i.e in the vouchers. This will
provide information to the auditor to issues regarding internal control and its reliability.
5) Vouching
Involves examination of documents supporting a transaction or an entry in order to determine
its authenticity. For example, if it is properly drawn and authorized and are in agreement with
other documents.
6) Reconciling
The differences in figures are reconciled and causes for their existence are brought to light i.e
balances as per cash book and bank statement or total of debtors per schedule and balance of
sales ledger control account.
7) Performance indicators
These are various accounting ratios calculated to monitor the performance of business. For
example the current year ratios can help the auditor to assess general performance level.
8) Testing
This is the technique applied to examine the large number of transactions by choosing few items
randomly to represent the test.
9) Scouring
This technique is applied to critical study or appraisal of the characteristics of data.
10) Footing
To test the accuracy of totals, the column of different accounting figures should be added.

PREPARATION OF AUDIT WORK

As any work needs planning an auditor should also plan his work on how much time should be devoted,
Circumstances of particular case of audit etc. Good preparation of an auditor depends on experience,
training and knowledge of the auditor. The auditor should prepare before audit by:-
I. Defining the scope of work

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 He should examine the volume of work, which he has to perform. The scope of work will depend
on the terms of agreement entered with his client, conditions laid by the appointment or
provisions of the company’s act. Before determining his scope of operation he should discuss
the nature and purpose of audit.
II. Knowledge about business
He should try to have full knowledge about the business and its affairs. In this case he should
scrutinize important document. I.e memorandum and articles of association, partnership deed
etc.
He should study the methods of books maintenance.
He should ask the list of officers in charge of various records and their authority.
He should examine the systems of internal check in operation and see its reliability.
He should inquire any technical operation system.
He should through the previous audited reports, balances and profits and loss account to see
any objections and recommendations by early auditor.
III. Instruction to client
He should issue instructions to client on particular things that should be done and given to him,
example the books of account should be totaled up and trial balance and final accounts should
be ready, vouchers should be serially arranged, names and addresses and signatures of directors
be made ready.
IV. Auditor’s internal preparation
The auditor must prepare himself and his team. The most important preparation include:-
 Distribution of work He should distribute work and assign duties among his subordinates
according to their qualification, experience and training.
 Audit program
This is auditor’s plan of work. It presents an outline of procedures to be followed on carrying out
his audit
The preparation of audit is usually based on the systems of internal control or check. If internal
control is ineffective the audit program will be detailed in length. Unlike effective internal
control.
What is an audit program? Defined as “a detailed plan of audit work to be performed,
specifying the procedures to be followed in verification of each item in the financial statements
and giving the estimated time required”.
The preparation of such work involves three main things to be disclosed. They are:-
a. How much work is to be done.
b. Who is going to do a particular portion of work?
c. What duration of time the work will be completed.
Preparation of audit program is done by auditor and senior clerks.

ADVANTAGES OF AUDIT PROGRAMME

1) It locates exactly the responsibility of every clerk in the auditor’s staff according to his capability.
2) The auditor can know easily the progress of the work done by each staff.

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 3) Since it contains details of the work to be followed no work will remain unchecked.
4) It increases efficiency of staff since it minimizes possibility of errors and negligence.
5) Incase a clerk leaves it is easy to locate where work was left and assign it to another.
6) It acts as auditor evidence incase of charges of negligence are revealed against him.
7) The audit program shows the work done by him.
8) It acts as guidanceensures all work has been distributed and none is left or omitted.
9) Work is done smoothly with conformity without delay or going astray.
10) It acts as a summary of auditor’s report to go through to ensure all work has been done.
11) Act as a clue to prepare a plan of action for the year to come.
12) Helpful to complete work in time, methodically and efficiently.
13) It is the guiding base for auditor’s staff regarding their duties.

DISADVANTAGES
1) It discourages clerks from necessary changes they desire to do which are not recommended in
the program.
2) The clerk do not get sufficient opportunity to show their intelligence and initiative as they have
to proceed accordance with the program is already set for them. Example they are not in a
position to make suggestions even if they think it necessary.
3) Even exhaustive and detailed audit program cannot be able to take into account every minute of
work involved in the course of audit.
4) At times careless and inefficient auditors try to conceal their weakness and defects on the basis
of audit program.
5) For small business need not to have an audit program.

AUDIT NOTE BOOK

This a notebook maintained by each clerk to record down important points and inquiries he had made
so as to refer them later on or discuss with his senior officers or auditor himself. All replies received,
inquiries made, correspondence is noted down in this book.

Contents of audit note book

1) Technical details about the business.

2) Queries for which explanations and information’s have been demanded.
3) Missing vouchers, invoices whose duplicates have to be obtained.
4) Fraud and errors found in books.
5) Facts to be included in the audit report.
6) Audit program.
7) Notes regarding the system of accounts maintenance.
8) Names of officials to certify bad debts deprecation etc.
9) Information to be needed in future.
10) Progress of audit work.
11) Records and suggestions made by audit staff.

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 Advantages

1) It enables the auditor to record important points otherwise he may forget them.
2) He can produce it as documentary evidence in charges against him.
3) Audit work is made convenient as important details are noted down even changes of staff
cannot disturb much.
4) Such books can be used to assess the knowledge, capability and efficiency of staff.
5) It makes the work of subsequent audit easier.

Disadvantages
1) It develops fault findings attitudes in the minds of the audit staff.
2) It places too much reliance on the staff for its preparations.
3) If preparednegligently, the auditor can use it in court as evidence against charges.
4) Very often creates misunderstanding between clients staff and auditors staff.

Audit working papers

These are papers and documents which contains details about accounts, which are under audit. The
auditor note down important facts about the accounts in these paper. The main objects of these papers
are not to control the current year audit and provide base for the following year. It also provides
detailed information about the accounts conditions. These papers are helpful to auditors for making
references when he is going through the books and when compiling his final report.

Contents of audit working papers

i) Schedules of debtors and creditors.

ii) Certificates issued by banks regarding bank balances, safe custody or document etc.
iii) Correspondences between the auditor to debtors and any other persons.
iv) Rough trial balance.
v) Important transactions extracted from the minutes of books.
vi) Draft of final accounts.
vii) Particular of investments.

Purposes of audit working papers

Working papers are actually the compilation of all evidences, which have been gathered by the
auditor in the course of audit. These papers serve the following purposes:-

a) They represent the volume of work which has been performed by the auditor and his staff. With
these papers it becomes easy to draft and prepare detailed audit reports.
b) The various details and facts of audit report can be well substantiated on the basis of finding
summarized in these papers.

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c) It serves as auditors evidence incase of any negligence charges against him.
d) The auditor co-ordinates and organize the work of audit clerks with the help of working papers.
e) Auditors detailed advice to clients in regard to the improvement of internal system and efficiency.
f) It acts as a guide to the auditor in subsequent examinations.

Characteristics of good working papers

1. They should be complete in all respects. They should contain full information with essential
data.
2. They should be properly organized and arranged. Thus to overcome inconveniences in
pinpointing particular facts.
3. They should contain accurate information for reliability and actionable.
4. There must be clarity in thought and expression so that the information given therein
mayauditors be comprehensive and understandable to everyone.
5. The relevant details should always be kept in the working papers.

Talk of ownership

a. Auditor is an agent of client hence no needsto hold then to himself he should surrender
client.
b. The auditor had prepared them purposely for audit report and he uses them as evidence
of any charge in later date hence need to own them.

PROCEDURES OF AUDIT
How to proceed with audit is an important issue needed to be considered by the auditor. There
is no hard and fast method of audit that can be laid down but the best procedure depends with
prudence, experience, knowledge and tactics of auditors himself. The success of his mission will
absolutely depend upon his skills.
The following are the general procedures adopted in audit.

Adoption of distinctive ticks:

The auditor should use distinctive tick of various colour while auditing the book of accountsbut its
successful use involves a lot of care to be taken. The following are the precaution given before adopting
distinctivetick, which are used for different purpose in the book of accounts.For purpose of identifying
errors, fraud, missing document or where there is an audit query.
a. He should use different type of tick for different purposes e.g for vouching, posting, addition,
carry forward etc. Example such signs can be used = 0 $ o
b. Instruction to be issued to staff that such tick should be private not be known to client staff.
c. They should be small and clear .
d. Kind of tick use should not be the same as that used by client’s staff.
e. While using tick he should have pencil and ink of different colour in his control.
f. It is strategically advisable to use different ticks colors and inks in every year.

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 g. He should use special tick for figures, which had already been erased so as to ensure that no
change would be made afterwards.
h. Vouching should be entrusted to two clerks as shown below:
 The senior auditor should change the voucher and carry out the amount given in it and:
 The junior clerk should compare the amount and place a tick against the item in the cashbook.

Routine checking

There are certain books, which are common to all type of business or organization despite of the size,
nature of activities and transaction of the business. The checking of such common record and books,
which are carried on by the auditor as a matter of routine is known as the routine checking in auditing.

Routine checking involves normally four types of function:-

a. Checking of casts, sub-casts, carrying forward and other calculation of the book of original entry.
b. Checking of posting into the ledgers.
c. Checking of casts and balance of various accounts into the ledger.
d. Checking of transfer of balances from the ledgers onto the trial balance.

This simple checking is done in a routine way and can reveal clerical errors and fraud ordinary
nature. Thus routine can verify arithmetical accuracy of entries made in books.

Advantages of routine checking

1. Books of original entry can be thoroughly checked and errors as well as fraud can be easily
detected.
2. Posting can be checked .
3. It ultimately helps in checking final accounts, whose results depends on routine checking.
4. It reveals errors and fraud of simple nature and helps in verifications of arithmetical accuracy.
5. It is the simplest device for audit work.
6. It is a simple job to be done by anybody with ordinary knowledge of accounting.

Disadvantages

1. It is a routine work that can cause monotony to those entrusted the task.
2. Complex fraud may not be detected by routine checking.
3. It is difficult to trace compensating errors and errors of principle.

Conclusively the work of routine checking is very important and must therefore be carried out
intelligently and carefully. So auditing of books needs a compulsory routine checking.

Test checking (selective verification)

Test checking is the substitute of detailed checking. The auditor normally does not check completely all
the records made and the books for account. He normally selects few books for checking through

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process for sampling and if they are found correct he presumes that the remaining entry books will also
be correct likewise. Thus test checking is based on simple thing that if a representative number of
transaction; so selected at random by the auditor for the test checking is found correct, then the
remaining ones will also be correct.

Precaution of test checking

The following guidelines must be followed for selecting a sample from the universe:

i. Selected representative sample should cover each and every book of ledgers covering the whole
period under audit.
ii. Selection samples should cover the work of almost all clerks of the clients.
iii. Entries pertaining first and last month of the financial year should be thoroughly checked as
fraud are usually committed at this time.
iv. Cash books and pass books should be fully and well checked.
v. No consultation should be made to client’s staff regarding selection of tests.

Importance of test checking

1. It saves time and energy by reducing the volume of work.

2. Auditor can undertake different audit simultaneously.
3. It helps to reduce the cost of audit.

Criticism of test checking

1. Since based on selection of representative transaction it is possible that all errors and fraud may
not be detected.
2. Client’s staff may become careless as they know not all of their work will be checked.
3. Test checking has no use if internal control system is not effective.
4. It is of no use for small business houses.

Audit in debt (detailed checking)

This is the opposite of test checking. It is a detailed examination of each transaction and their entry from
the origin to conclusion. This method is adapted in the internal control system is not effective or test
system had shown much errors or fraud in the samples selected.

UNIT FIVE

INTERNAL CONTROL
What is not internal control?

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Internal control is not only internal check and internal audit but is the whole system of control
established by management in order to carry all the business of the company in an orderly manner to
safeguard the assets and accuracy of records.

Also we can say that internal control system established by management to conduct the affairs of the
business efficiently, this includes internal check, internal audit and other forms of control.

Internal control system includes all those measures adopted by business enterprise to fulfill the
following objectives:-

1. To avoid waste, inefficiency and fraud to keep resources intact.

2. To attain highest accuracy and reliability of account and operating data.
3. To evaluate the efficiency and performance of business.
4. To provide aid in management planning.
5. Effect coordination and hospitable environment of work.

Characteristics of good internal control

The following are characteristics of good internal control.

1. There should be a well developed plan of organization with delegation of proper responsibility at all
levels of operation.
2. There should be a scientifically developed system of record procedures.
3. Personnel engaged in the business should be of high quality, character, well trained and
understanding of their responsibilities.
4. The operational system should be well defined and simple to understand.
5. It should be supported by all employees at all levels.
6. Physical handling of assets should be separated from accounting work should be done on separate
hand.
7. The work should be divided between people, that work done by one is checked by another.

Divisions of internal control

Every business is expected to have well organized internal control system, and that depends on the
nature and the environment where the business is established. The main divisions in all overall can
cover the following areas:

Diagram be put at this point

1) General Financial Control

This includes proper efficient system of accounting, adequate supervision, recording efficient
staffing and maintenance of staff relationships.
2) Cash Control
Control of cash receipts, payments and balance held including internal audit staff and exercising
of regular checks.

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 3) Employees Remuneration
System control to cover all sections of employees remuneration methods of payments, recod
maintenance should be brought under tight control.
4) Transactions
This is control on purchases, sales etc. tight procedures should be laid down on handling,
recording techniques and acquisition of goods.
5) Stock Maintenance
Control on raw materials, work in progress and finished goods should be properly maintained.
6) Fixed Assets
This is control on capital expenditures on fixed assets.
7) Investments
This is control on investments records maintenance and safeguarding documents titles.

INTERNAL CHECK

Business work connected with preparation and maintaince of books, is distributed among members of
staff in accordance to their qualification i.e one person enters transactions into books while others
perform duties relating to posting, handling cash and entering cash and entering cash transactions into
cashbooks ; this is what we term as internal check. Thus we can define internal check as follows:-

Definition:

“An internal check means practically it continuous internal audit carried on by the staff itself, by means
of which the work of each individual is independently checked by other members of the staff”.

Example:

A large business with large numbers of labourers has six clerks needed to prepare wage sheets and
makes payment:- two clerks will maintain wages records: two prepare wage sheets and two payment of
wages .

OBJECTS OF INTERNAL CHECK

1) To allocate duties and responsibilities to every clerk in such a way each person is held
responsible for particular error and fraud.
2) To minimize the possibilities of errors and fraud.
3) To detect errors and fraud easily if committed through efficient system of independent internal
check.
4) To enhance efficiency of clerks in their work.
5) To distribute work in such a way on work is left unrecorded.
6) To prepare final accounts with ease and efficiency as internal control can make accounts more
regular and reliable.
7) To exercise moral pressure over staff.

ADVANTAGES OF INTERNAL CHECK

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 a) For Business
 It enables a proper and well distribution of work to all members of staff.
 It helps detection of errors and fraud.
 Commission of errors and fraud can be minimized.
 Good system of internal control increases efficiency of work as clerks do their work with care
and caution.
 It enables the staff to prepare final accounts easily and quick.
 Moral check is exercised by clerks since internal check system is based on specialization.
 It reduces cost.
b) For auditor
 It helps him to complete his work quickly without doing the detailed checking of accounts.
 His work and report will be quite efficient and more factual to accuracy.
c) for owners
 if there is a good internal check system, the owner may rely upon the genuineness and accuracy
of accounts.
 Good internal check leads to efficiency , high profit yielding and cost reduction.

DISADVANTAGES

 Possibility of responsible high officials may be careless as they have over confidence that the
work is automatically going efficiently.
 The system is quite expensive especially to small business.
 If the system is not properly organized it may create chaos and disorder in the working of
the business.
 The work of the auditor may not be free from irregularities if the system is defective.

FUNDAMENTAL PRINCIPLES OF INTERNAL CHECK

The following are some important rules of making system of internal check efficient and
successful:-

1) The work should be allocated among clerks such their duties, rights and responsibilities may be
clearly defined to avoid and cover room for interference.
2) Distribution of work should be done so that no single person does job solely from beginning to
the end.
3) One person should be entrusted with similar nature of work to necessitate efficiency and
specialization.
4) No clerk should engage in particular job for long time change of duties is necessary
5) There must be an automatic checking of work of an assistant by another.
6) The division of work should not be expensive.
7) The clerk should not be relied too much.

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 8) The use of labour saving devices, such as cash registers, calculating machine, time recording
check etc should be availed.
9) There should be proper system of filling vouchers correspondence etc.
10) The system should be simple, clearly comprehensive.
11) Cash should be sent daily to the bank.
12) Person dealing with the cash, securities, chequesetc should be compelled to take annual
holidays in an unbroken period.

INTERNAL AUDIT

Internal audit is an effective system of internal control. It is usually available to large scale companies
who can afford the expense of setting internal audit department. This department is separate from
accounts department and often reports directly to the management. There work is to check day to day
transactions.

Duties of an internal auditor

i. Regular examination of all accounting records, checking them against source documents.
ii. Verifying that all documents are properly authorized before being acted upon, there-by ensuring
all controls are in place.
iii. Reviewing all continuous basis of internal control procedures and ensure that it is regularly
revised and improved to changing circumstances.
iv. Keeping management aware of internal control efficiency or weaknesses as to assist on its
improvement.

CASE STUDY: Internal CheckOn Wages

i. Possibilities of misappropriation of cash under wage payment are high and it will be difficult for
auditors to discover such cases unless the system of control is efficient.
ii. The auditor to study this system he must satisfy himself with arrangement and preparation of
wage sheets.

INTERNAL CHECK AS REGARDS WAGES

1) MAINTENANCE OF WAGE RECORDS

a) Time record: wages may be paid according to the time worked. Hence there is need to keep
time records regarding time devoted in the factory.
 Time recording clock: this is a slot of clock in the gates the workers enters his card in it to record
the time he entered and the time he leaves. Thus the clock provide the messages of the time
spent by the worker.
 Use of tokens: each worker is given a token which he hangs on the board when entering and
time keeper records it down.

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 Attendance cards:attendance cards is maintained by each employee, he/she drops it in the box
made for entry in the factory and attendant records it in the attendance register. The time if
going out is also recorded of entry and leaving. The record of gate keeper and foreman should
be compared for similarities.

b) Piece Work
This is a system of wage payments on piece of work one has done. To keep the records a
card known as job card or piecework card is given to each worker. This card is signed by the
worker, foreman and storekeeper where produced goods are kept. A separate register is
also kept for comparison with the job card.
c) Overtime record
No worker should work overtime unless authorized by responsible officer. An overtime slip
should be provided to each worker. They should be separately maintained from other work.
d) Pass-out records
This is when worker goes out for personal work during working hours. He should not go
without authority. Double slip of pass-out slip must be mentioned, one by gate keeper and
other by foreman. Second one should be sent to wages department for record.

2) PREPERATIONS OF WAGE SHEETS

Wage sheets are prepared from original records kept by records maintenance department.
Wage sheet preparation normally is divided into four portions to be done by clerks as follows:
i. Two clerks: to examine time or piece wage records, overtime, foreman statements and
irregularities.
ii. Third clerk fills names, address, rates of wage and gross amount of wages etc
iii. Forth clerk: to check work done and calculate net amount of wages and make
necessary deductions.
iv. Fifth clerk: to check the whole work thoroughly. All these clerks should perform their
work and sign it and certify as correct by authorized officer of higher rank.

3) PAYMENT OF WAGES
Wages sheet should be passed to cashier who must not be associated with their preparations.
The cashier withdraws necessary amount. The following procedures should be followed for
payment:-
 Clerks who were associated to wages sheets preparations should not participate in
payment.
 Use of envelops indicating names and the amount therein should be used.
 All workers to be paid should be present physically.
 Foreman of each department should be present to identify his people and victorious
workers.

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  Precautions should be taken seriously when paying workers who became absent that
time. (Authority letter must be availed from absent worker).

UNIT V: VOUCHING
MEANING

It is an important part of auditor’s duty to certify as corrected the transactions entered in the books of
accounts that they are free from errors and fraud. The accountant does not enter any transactions
without proper documentary evidence I.e voucher. Thus when the auditor checks and examines the
authority and authenticity of transactions as recorded in the books of accounts with the support of
proper documentary evidence he is doing the work of vouching. We can say vouching is to examine the
correctness and authenticity of the transactions recorded in the books of prime entry.

DEFINATION: vouching does not mean merely the inspection of receipts with the cash books, but
include the examination of receipts with the transaction of a business, together with documentary and
other evidence of sufficient validity to satisfy an auditor and such transactions are in order, have been
properly authorized and correctly recorded in the books.

OBJECTS OF VOUCHING

a) To satisfy that all transactions connected with the business have been recorded in the books
nothing has been left unrecorded.
b) To ensure that no transaction has been recorded in the books is not connected to the business.
c) To ensure that all transactions recorded are authorized, genuine and are supported by
documentary evidences.
d) To satisfy that real values have been recorded as shown by documentary evidence.
e) To have full confidence of recommending the genuinety of the books of accounts and final
accounts.

VOUCHING OF CASH TRANSACTIONS

In most cases errors and fraud arises in cash book during the receipt or payment of cash. At least
vouching should be carried out to detect such mistakes.

a) Vouching of cash receipts

The following are ways to vouch cash receipts:-
 Check can be certified with internal check system of operation.
 Compare rough cash book with cash book.
 Check the control over use of receipts books. Auditor should check whether receipt
books are kept well so that people may not misuse them.

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  Check if all the receipts and receipt books are in printed form and serially numbered
accordingly.
 Compare the dates, amount, name etc in the receipts with those in the cash book.
 Check that receipts have been signed by authorized person.
 Check the methods available for depositing cash to the bank and check on pay in slip for
confirmation of deposits.
 Cash sales: check and compare saleman abstracts, cash books, cash sale summary f
books.etc
 Receipts from debtors: check counter foil of the receipt issued and any correspondence
made also make person contact to the debtor.
 For income from investments and dividends: check interest pass books, agreement,
schedule, counter foil , dividend warrants and passbooks etc
 Sales of investments: check broker’s sold note , bank advice, agreement signed and
passbook on the amount received.
 Receipts of higher purchase; check higher purchase agreement, counterfoils if receipts.
 Rent received: check on lease deeds, agreement entered, accounts received from
agents, counterfoils and correspondence.
b) Vouching of cash payments
The voucher relating to cash payment should be properly authorized, serially numbered and
filed in order. The aim of vouching cash payment is to ensure payments has been made for:

 Business interest.
 It relate to period under audit.
 It has been paid to right person.
 It is properly sanctioned .
 Properly recorded.
 Is supported by proper voucher.
 Particulars in the voucher tally with cash book.

The following are ways to vouch:-

1) Internal check system should be analyzed.
2) Cash purchases: cash memos(receipts), goods inwards books and supply contract should be
checked.
3) Wages payments: check wages records, job cards, work sheets, employee’s register and
appointment letters.
4) Rent payments: check the renting agreement, receipts of payments, any correspondence made.
5) Salary: check salary books, appointments letters, agreements, minutes, counterfoils of cheques.
6) Purchase of land and buildings: check title deed lease, auctioneers note, broker’s note, contract
,archtichet’s certificates.
7) Interest on loan; loan agreement, debentures interest books , pass books, loan books.
8) Dividends payable: dividends warrants, pass book and minute book.

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 9) Directors fees: minute book, attendance register, article of association and shareholders
resolutions .
10) Insurance fees: check insurance policy, receipts and correspondences made and pass book.

UNIT VI: VERIFICATION OF ASSETS AND LIABILITIES.

Verifications of assets implies an inquiry into value, ownership, existence, possession and presence of
any charge on the assets. The auditor has a duty to report whether the balance sheet exhibits true and
fair view of the state of affairs, to do that he has to ascertain the correctness of money value of assets
and liabilities appearing in the balance sheet through verification. Thus verification to prove correctness
and authenticity of assets and liabilities in terms of value , existence , ownership and possession.

DUTIES OF AUDITOR ON VERIFICATION

The auditor has to perform the following type of functions in verifying the assets;-

1. To see that assets are clearly stated in the balance sheet.

2. To ensure that they are in existence on the day of auditing.
3. To verify that they are the property of the business or the client.
4. To if they are free from any charge i.e mortgage or pledge.
5. To satisfy himself that they are properly valued.
6. To ensure that they are properly acquired.

POSITION OF AN AUDITOR

The position is clearly stated that it is the duty of an auditor to verify the existence of assets as stated in
the balance sheet. Hence he has an option of seeking experts opinion like valuers if need arise for such
confirmation. He will be held liable for any damage and negligence of his duties. He should note two
important points for valuation of assets in order to be free from liability:-

 How far the principles of accounting have been adopted in the valuation of assets.
 Whatever steps taken in valuation of assets are based on established practices already in
operation in the business.

A. VEFIFICATION OF DIFFERENTS TYPES OF ASSETS

As stated above for verification an auditor has to check six facts value, existence, no charge and etc. the
following are some of the assets to be verified by an auditor:-

1. Goodwill(GW)

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 It is intangible asset and has a value to be determined and verified. Its value is determined by
earning capacity of the enterprise.
i. On purchase time of company assets i.e GW =purchase price –net assets.
ii. When the company revalues its assets and writes off some values, a good will a/c is opened.
iii. Incase of partnership- firm goodwill is calculated when admitting or retirement of a partner.
iv. Goodwill written off but brought back to write off losses. For verification the auditor should
check the accounts on any of the above cases and calculate the values and compare it with
balance sheet.
v. Incase of purchase of the business the auditor should verify it with the help of contract made
with vendors or any other agreements.
vi. Incase of revaluation of assets which has raised GW, account the auditor should make
references on basis of which revaluation of assets have been made or valued.
vii. Incase of GW brought back to write off losses the auditor should investigate the period over
which GW was acquired by the company and written off. Also should check the directors
minutes book for any resolution of the board approved by the shareholders for utilization of GW
for this purpose.
viii. Make reference to partnership deed, articles of association whichever is applicable on what is
stated over the GW.
ix. Check the GW is entered on costless the written off value.

2) Freehold land:
 The auditor should ensure no other assets, leasehold or freehold asset is shown along with it. He
should compare the relevant ledgers wit balance sheet to ensure that is separately shown.
 He should examine the title deeds relating to free hold land and ensure it is in the name of the client
and he should ensure that it is free of possession and title deed is genuine one.
 He should verify the sale if part of it sold out in the course of the year under audit. He should
examine correspondence, brokers note or auctioneers account.
 Verify by personal inspection to ensure it existence.
3) Freehold building:
 The auditor should examine the genuiness of the records made in the accounts to ensure that
freehold buildings are shown separately from land.
 He should examine the title deeds to ensure it is owned by the client.
 If it is purchased, he should check the correspondence and broker’s note or auctioneers
account if purchased by auction and legal documents made.
 If the building is build by the client he should check the certificate of the builder, contractor,
architect and other necessary documents.
 If the building is mortgaged and title deed is with mortgages the auditor should obtain mortgage
certificate for verification.
 On verification of value the auditor should ensure the building is valued on cost less
depreciation on market value.
 Verify by personal inspection to ensure its existence.

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4) Plants and machinery:
 To know whether the value is clearly stated in the balance sheet the auditor should verify by
checking ledger a/c ,purchase contract of the items and compare the value with the given one
in the balance sheet.
 Also correspondence, original invoices should be referred to know the real value.
 The auditor should examine the plant register in which particulars regarding the costs, sales
records, provisions for depreciation etc are stated.
 The auditor should also ask for schedules for various plants where details about costs ,
depreciation are clearly stated and compare them with the plant register and b/s value.
 If any plant has been sold then proper entry should be checked in books, verify sale contract
made, directors authority in minute , books etc.
 He should verify the existence of assets by personal inspection.
 To verify any mortgage or change the auditor should look on details given in plant register and
see the mortgage certificate .
 Verifying the value the auditor should ensure their value is shown as a going concern value at
cost price less depreciation.
 If revaluation is done the auditor can verify from revaluation sheets and any recommendations
made by the authority.

B. VERIFICATION OF LIABILITIES

If verification of liabilities is not done well then the B/S will not reveal a true and fare view of the state of
affairs of the business. Liabilities should be truly authorized, valued and correctly entered in books.
Some liabilities to be verified include the following:-

1. Trade creditors
 The auditor should check and verify from purchases book and purchases return book (return
outwards) with the help of invoices, credit notes, correspondences etc and checking posting into
ledgers.
 He should obtain and check a schedule of creditors from client and refer them to statement of
accounts received from creditors.
 He should inspect the purchase inwards books to ensure that purchased goods have been
received from the creditors.
 He should check the outstanding bills payments in the bill payable book at the dates of balance
sheet.
 He should check purchases invoices pertaining to a few weeks to the close of the financial year.
 Correspondences to concerned creditors should be carried out and confirmation ascertained
the credit value.
2. Capital
 He should examine memorandum and articles of association.

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  Check the cash book, pass book and the director’s minutes book to find out the number of
shares, classes, amount received thereon and the amount due from shareholders.
 If shares have been allotted to vender he should examine the contract made between the
company and the vender.
 Verify from previous years edited balance sheet if there was any alteration like amalgamation or
reconstruction. If there is alteration he should refer to section 94-95 of the company act.
 If there is reduction of shares capital he should see the provision of the company’s act.
 Check in the share allotment book to know share values and total capital.
3. Bank overdraft
 The auditor should inspect the passbook and call for statement of mortgaged assets.
 Inspect the memorandum and article of association or partnership deed as the case may be to
confirm if the facilities of overdraft have been used as authorized by these documents.
 He should see the authorityfor contracting overdraft have been ascertained from board
resolution of partners or authorized persons.
 The agreement of overdraft with the bank should be checked and ensure if it is contrary to the
welfare of the company.
 To ascertain assets given for charge inspect the register of charges and check where such
charges have been registered in the registrar of companies.
 He should verify the interest and other terms of interest payment from the agreement made.
 Amount of overdraft should be verified from the book of accounts and compared with the pass
book.
 Bank certificates should also be obtained for charges of assets like stock.
 He should see the overdraft is properly drawn under “secured loans” and the nature of the
security has been properly disclosed in the balance sheet.
 He can also inquire any correspondence to the bank for any such overdrafts.

UNIT VII: AUDIT REPORT

A report is a statement of collected and considered facts, so drawn up as to give clear and concise
information to the persons who are not in possession of the full facts of the subject matter of the report.

The auditor is appointed to audit the company’s or organization’s accounts and make a report to
shareholders, the report he gives is called auditor’s report.

Contents of Audit Report

According to the companies Act the report shall be standardized and must state the following:-

 Whether in auditor’s opinion and the best of his knowledge the information and explanations
given to him were satisfactory and necessary for purpose of his audit.

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  The audited accounts gives the information required by the act in the manner so required and
give true and fair view.
 The report should contain auditor’s opinion whether books of accounts as required by the law
have been kept by the company.
 The auditor must state whether he has received returns from braches not visited by him.
 The auditor should state whether the balance sheet and profit and loss account dealt with by
the report are in agreement with the books of accounts and returns.
 Lastly, the audit report must have the signature of the auditor.

Kinds of reports

The reports are of three kinds:-

1. Clean report: this report is given by the auditor when is finally satisfied with the examination of
books that they are properly prepared. It is also called unqualified report.
2. Qualified report: it is given by the auditor when is not fully satisfied with books. That is when
books are not properly prepared.
3. Disclaimer: auditor is not the position to give his position because some parts are not clear.

Schedule of Drafts

1. CLEAN REPORT(DRAFT)

NYANG’ARA AND CO. CHATTERED ACCOUNTANTS

P.o box 12750 NAIROBI tell: 0151521814
To:
The members of
X Y Z company limited

We have audited the financial statements on page 18 to 29 of the annual report and accounts in
accordance with auditing standards. We here report that:-
I. We have obtained all the information and explanations to the best of our knowledge
and believe were necessary for the purpose of our audit.
II. In our opinion proper books of accounts as required by the law have been kept by the
company so far as it appears in our examination of books.
III. The balance sheet and the profit and loss account dealt with by this report are in
agreement with the books of accounts.
IV. In our opinion and the best of our information and according to the explanations given
to us the said accounts given the information required by the act, in the manner so
required and give true and fair view :-
 Incase of balance sheet the state of affairs of the company as at 31st December
2009
 Incase of profit and loss account the profit for the year ended on the date.

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Nairobi For: nyang’ara and company

January 31st 2009 chattered accountants

2. QUALIFIED REPORT(DRAFT)
Note:everything to be repeated up to point number 3 above of clean report.
Subject to the reservation noted below in our opinion and to the the best of our information
and according to the explanation given to us, the accounts gives the information required by
the act in the manner so required and given a true and fair view:
 Incase of balance sheet the state of affairs of the company as at 31st December 2009.
 Incase of profit and loss account the profit for the year ended on that date.

Reservations:

1. The company has not fully disclosed the value of material amounting to sh 20000 consumed.
2. A sum of sh 10,000 has been advanced to managing director in contravention to relevant
provisions of the company act.
3. Provision of depreciation of fixed assets is inadequate.
4. The closing stock of the company have been valued at market price which is in excess of actual
cost price.

Nairobi For: nyang’ara and company

January 31st 2009 chattered accountants

UNIT VIII: LIABILITIES OF AN AUDITOR

The liabilities of an auditor may be studied I two practical point of view:

1. Liabilities in private concern

His liabilities depends on terms and conditions stated in the agreement entered into between
the auditor and client, i.e scope of his duties and terms to be fulfilled. There no laws defining
the terms of work. If he performs the work as agreed he will be free from any liability. The
auditor is liable for any charge of negligence if proved in court and the business suffers a loss
subsequently.
2. Liability in a company(joint stock company)
He is appointed under the company act and all rights, duties, remuneration and liabilities are
laid down by this act. His liabilities may be classified as follows:-
Liabilities of An Auditor
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 a) Civil liability
i. Liability of negligence
ii. Liability of misfeasance
b) Criminal liability
c) Liability of 3rd party

A. CIVIL LIABILITY
The civil liability to an auditor can be:
i. Liability of negligence
Negligence means performing his duties without taking reasonable care, skill and
prudence in all circumstances. An auditor is appointed as an agent who safeguards
interest of the shareholders. Therefore if he fails his duties the owners will suffer losses,
hence he/she as an auditor must be held liable to pay for damages of his negligence .
 Under negligence the rule is given by a case of Liverpool and Wigam Supply
Association Limited 1907 that:

An auditor is not liable for:

a. Loss without negligence.

b. Negligence without loss.
 Another case of Leeds Estate Building and Investment Society V/S Shepherd
1884:
 An auditor was held for negligence due to what he did not see and that
dividends has been paid out of capital and that he has never checked
the articles of association whether the rules of issuing dividends out of
capital have been complied with.
ii. Liability of misfeasance
Misfeasance means breach of trust or duty. It implies a wrong doing. If an auditor does
something wrongful in performance on his duty resulting to financial losses he will be
guilty of misfeasance.
Example:
An auditor as an expert has to give consent of issuing of a prospectus by ensuring that it
contains true statements, but he had just given the consent of it without checking it well
by just trusting management statements, any loss that may arise the auditor will be held
liable of misfeasance.
B. Criminal liability
An auditor as an officer of the company in that capacity he is he is liable of his act of omission or
commission of his duty as per the act of law. Under criminal liability the auditor shall be
imprisoned, fined or both i.e

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  He is required to assist the investigator or inspector authorized by the government or
court or competent authority to investigate the company, if he refuses to assist them he
will be criminally held to fine , imprisonment or both.
 Any prospection of the company he is required to assist the prosecution group, if he
refuses he is criminally held for court contempt and it is a punishable offence.
 Incase of winding up subject to the court the auditor is required to submit the returns
to court if not he should be arrested and criminally held liable.
 If he gives wrong information i.e to official liquidators criminal proceedings will be
brought against him.
 In destruction, mutilation, alteration, falsification or secreting of any document required
by the law, that is very serious crime if both imprisonment and fine.
 If he makes statement in any returns, report, certificate, balance sheet etc which is
false in any material facts knowing it to be false or defective he shall be punishable with
imprisonment , fine or both.
rd
C. 3 party liability
Arises put of contract of two parties namely first party/auditor and second party/owner. These
people become into agreement and signed contract for auditing. This contract is private and
confidential between the two parties. There the auditor has no liability to the 3rdparty but the
auditor can have liability to the 3rd party if the 3rd party proves the following:
 The auditor acted maliciously so that the 3rd party can act upon it.
 The 3rd party suffered loss due to the action of the auditor.
 Auditor acted knowingly that his report is default.

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