Auditing

Concept of Auditing
Auditing is the process of examining the financial statement and information of the entity. In
this process, we examine that is the company making profit or not. It is a systematic process in
which we analyze the economic condition and actions.

Meaning and Definitions of Audit

Once we complete preparing the final statements and accounts for the year the accounting
process is over. However, we still cannot be completely certain of the accuracy of these
accounts. This is when the concept of auditing comes in. Let us see the audit meaning and
features of an audit.

Audit Meaning
The word “audit” is a very generic word; it essentially means to examine something
thoroughly. But we will be learning about auditing as it relates to accounting and the finance
world. So audit meaning is the thorough inspection of the books of accounts of
the organization.

This involves the examination of vouchers and the verification of various assets of the
organization. And the person who carries out such an audit is known as the auditor.

The International Federation of Accountants has given the following definition of an audit,
“audit is an independent inspection of the financial information of any organization, whether
profit-oriented or not profit-oriented, irrespective of its legal form, status or size when such
examination is conducted with a view to express an opinion thereof”.

The one important thing to remember is that an audit is a close inspection of the books of
accounts, but it does not absolutely guarantee error-free books. The auditor only expresses his
opinion on the accuracy of the books, he does not give his opinion on the financial status of
the company or predict its future.

If he is satisfied with the examination then he will state that the financial accounts are true and
fair, which means they are absent of any material misstatement. But this is not an opinion
about the financial status of the company.

Features of an Audit
1. Auditing is a systematic process. It is a logical and scientific procedure to examine the
accounts of an organization for their accuracy. There are rules and procedures to follow.
2. The audit is always done by an independent authority or a body of persons with the
necessary qualifications. They have to be independent so their views and opinions can be
totally unbiased.
3. Once again, an audit is the examination of all the books of accounts and financial
information of the company. So it is essentially a verification of the final accounts of the
organization, i.e. the profit and loss statement and the balance sheet at the end of the
financial year.
4. Auditing is not only the review of the books of accounts but also the internal systems and
internal control of the organization.
5. To conduct the audit we need the help of various sources of information. This includes
vouchers, documents, certificates, questionnaires, explanations etc. He may scrutinize
any other documents he sees fit like Memorandum of Association, Articles of
Associations, vouchers, minute books, shareholders register etc.
6. The auditor must completely satisfy himself with the accuracy and authenticity of the
financial statements. Only then can he give the opinion that they are true and fair
statements.

Techniques of Auditing
Following are the common techniques of auditing −

1. Checking of posting and casting.

2. Physical verification of assets.
3. Verification and examination of transactions with available evidences.
4. Scrutiny of the books of accounts,
5. Checking of various calculations.
6. Checking of carried forward balances in next year.
7. Checking of Bank reconciliation statements.
8. Auditor can get information from inside and outside sources of organization.
Investigation
An investigation may be done with a specific purpose. It is usually conducted to know the
financial position of a business, extent of fraud and misappropriation and the earning
capacity of any business unit, etc. The time duration for investigation may also extend
beyond one year. Investigation may not be necessarily done by a qualified Chartered
Accountant.

Qualities of an Auditor
An Auditor must have the following qualifications and qualities −
1. He should be a qualified Chartered Accountant or he should be a qualified member
of The Institute of Cost & Works Accountants of India to do cost audit.
2. He must have adequate skills and qualities to conduct his work efficiently.
3. An Auditor must be honest, impartial and unbiased. He should also be hard-working,
have adequate common sense, capacity to hear arguments of others, systematic and
methodical.
4. An Auditor should ask for clarification on matter on which he is unable to
understand the information provided to him.
5. His audit report should be correct and clear.
6. In case where any suspicious situation arises, he should assume that he is dealing
with dishonest and fraudulent peoples.
7. He must have thorough knowledge of accounting principles and practices.
8. He must have the know how of all the domestic and international court case
decisions.
9. He must have thorough knowledge of financial management, industrial management
and business organizations.
10. He must have up-to-date knowledge of the Mercantile law and the Companies
Act.

Scope of Auditing
In comparison with earlier days, where the main objective of auditing was to detect fraud,
we now have enhanced ways to determine a true and fair view of financial statements. In
recent times, almost every country of the world has introduced various legislations and
framed rules and regulation of auditing. In India also legislations related to Tax Audit,
Cost Audit, Management Audit and operation Audit, etc. are coming up.
The main purpose of auditing is to certify the correctness of financial statements and to
detect errors and frauds.

Advantages and Limitations of Auditing

Auditing is the process of inspecting the books of accounts to authenticate their accuracy and
reliability. It is an important process to the company itself, the government, the investors,
creditors, shareholder etc. They all rely on audited accounts to make important decisions. Let
us now take a look at the advantages of auditing and the disadvantages of auditing in some
detail.
Advantages of Auditing
1] Assurance to the Owners/Investors
One of the biggest advantages of auditing is that it offers assurances to the owners, investors,
shareholders etc. The owners of the business will be assured about the accuracy of their books
of accounts.

They will be satisfied with the workings of their various departments and the overall
efficiency and profitability of their business operations. It is the same case with investors, who
will find assurance in the books of accounts after auditing.

2] Errors and Frauds

An error is something that is done without the intention to fraud the company, it is an innocent
mistake. Fraud, on the other hand, is deliberate. During the process of auditing, both errors
and frauds are discovered. Auditing also helps prevent such errors and frauds. It creates a fear
of being detected.

So auditing helps us minimize the risks of errors and frauds in our books of accounts but does
not eliminate the risk entirely. There is always the chance that the error may go unnoticed, and
the fraud is very cleverly hidden so may go undetected.

3] Independent Viewpoint
If the auditor is an external auditor, the business can get a second opinion on their financial
statements and their financial standing as well.

An external auditor will closely inspect the books and be completely true and fair in his
opinion as he has no hidden agenda. If he says the accounts are true and fair, it has a lot of
weightage with the company and the investors.

4] Moral Check
One of the other advantages of auditing is that the staff and the workers of the company do not
try to steal or defraud the company. They are under constant scrutiny since they know that the
accounts will be audited. Any irregularities can be identified during such an audit, and they
will be caught eventually. This helps the staff in being honest and responsible at all times.

5] Stakeholders Confidence
After auditing stakeholders like creditors, investors, banks, debenture holders etc. can rely on
the books of accounts with more confidence. And so after auditing by an independent
authority, the financial statements have more credibility.

Limitations of Auditing
1] Cost Factor
A very thorough and detailed audit would be a costly affair. It is not cost effective. So the
auditor has to limit the scope of his audit and use techniques like sampling and test checking.

2] Time Factor
Auditors generally work on a very specific timeline. Sometimes this is due to statutory
requirements. This means he has to audit a whole year’s accounts in a few weeks. Hence
insufficient time is one of the main limitations of auditing.

3] Inconclusive Evidence
Generally, the audit evidence the auditor collects is persuasive in nature, not conclusive in
nature. So there is never cent percent conclusive evidence in most cases while auditing.

This is one of the major limitations of auditing. There also a lot of use of estimates in
accounting. The auditor cannot measure or comment on the exact accuracy of these estimates.
He has to rely on his knowledge.

Principle Aspects Covered by Auditing

1] Review of all Systems
The primary objective of any audit is the review of all systems and procedures that relate to
the accounting and financial processes. The auditor must first understand the system and its
functionality before he started with the audit of the final statements of accounts. It will be the
base of the entire auditing exercise.

2] Review of the Internal Controls

The effectiveness of the organizations internal control system will dictate the scope of the
audit. If the internal controls of the company are in place and very effective, then the auditor
can rely on the system. Then he need no go through the accounts very minutely.

However, if on the other hand the internal controls are not effective, the auditor has to go
through the accounts with a fine tooth comb. And as per CARO 2003, it is compulsory for the
auditor to review the internal control system.

3] Arithmetical Accuracy
The auditor must also routinely check the accuracy of the books of accounts. This includes
checking the arithmetical accuracy of the books, by ensuring the posting of the entries is
perfect.
4] Accounting Principles
The auditor must ensure that proper distinction is made between the capital and revenue
transactions. All financial transactions must be properly categorized as either revenue or
capital transactions. The auditor must also check the items of both income and expenditure for
their accuracy.

5] Verification of Assets
The auditor must physically verify all the assets of the company. So he must check all the
legal documents, certificates, official statements etc. to analyse the ownership of all assets.
The auditor will also have to ensure no assets have been left out of the balance sheet either.

6] Verification of Liabilities
The auditor must also verify all the liabilities of the organization. Again he will inspect all
documents, letters, certificates etc. If necessary he can ask third parties for confirmation as
well.

7] Vouching
Ever financial transacting leaves a paper trail. The auditor has to examine these supporting
documents to check the existence and accuracy of these transactions. This is known as
vouching. For example the organization has shown an electricity expense of 12,000/-. Then
the auditor must inspect the electricity bill to cross check this transaction.

8] Statutory Compliance
It is the duty of the auditor to check that the financial records of the company are in
compliance with all the laws, rules and regulations in effect at any given time. So he must
make sure that the accounts are in compliance with the Companies Act 2003, Income Tax Act
1961 etc.

Auditing - Detection and Prevention of Fraud

The main objective of auditing is to ensure the financial reliability of any organization;
detection of fraud is just an incidental object.
Independent opinion and judgement form the objectives of auditing. The job of an Auditor
is to ensure that the books of accounts are kept according to the rules stipulated in the
Companies Act; an Auditor also needs to ensure whether the books of accounts show a true
and fair view of the state of affairs of the company or not.
The following are the three distinct types of fraud −

1. Misappropriation of Cash
2. Misappropriation of Goods
 3. Manipulation of Accounts
Misappropriation of Cash

Misappropriation of cash is the easiest way of fraud especially in large business houses
where there is limited or no communication between the owner of an organization and the
cashier. Following are some of the ways through which embezzlement or misappropriation
can be done −
 Theft of cash receipts and petty cash and showing fictitious payment to workers,
creditors, purchases, etc.
 Showing false payments or excess payments in cash book.
 By using the Teeming and Lading method, the money received from any customer
can be pocketed and the money received from another customer can be shown as
money received from the former.
 Cash sale can be shown as credit sale.
Strict internal control system should be followed in receipts and payments of cash so that
the work done by one person should be automatically checked by another person.

Misappropriation of Goods

Misappropriation of goods can be done in the following ways −

 Goods may be stolen by employees or with the help of employees.

 By issuing false credit notes to customer on account of goods return.
Detection of misappropriation of goods is more difficult rather than detecting
misappropriation of money, especially where management is not much vigilant and sound
system of book-keeping, internal control and adequate system of securities are not
available. To keep control on the physical verification of goods, reconciliation of physical
stock with books and careful checking of sale and purchase is must.

Manipulation of Accounts

Two types of manipulation of accounts are mainly done by top management to mislead
some parties for some specific purpose.
 Showing higher profits − Following are the reasons behind showing higher profit
than actual −
o To obtain credit or to enhance existing credit from financial institutions and
also to show credit worthies to suppliers of the company.
o To maintain confidence of shareholders.
o To hike the market price of shares of the company and enable the sale of those
at higher price, it may be done by declaring higher dividends on shares.
o To get more commission where commission is calculated on the basis of profit
earned.
o To declare dividend at higher rate.
  Showing low profits − Following are the reasons behind showing lower profit than
actual −
o To avoid or to reduce Direct Taxes of the company (Income Tax, Wealth
Tax).
o To purchase shares at lower price.
o To give wrong impression to the other competitors of the business.

Manner of Manipulation of Accounts

Manipulation of accounts may be done in the following ways −
 Window dressing is a manipulation or miss-representation of financial data in such
a way that it seems better than what it actually is. Some of the method of window
dressing is given as hereunder.
o Over valuation of closing stock
o Under valuation of Liabilities or Over-valuation of assets
o Purchases and expenses of current year may be deferred to next financial year
o Charging revenue expenses as capital expenditure
o Sale and other incomes of preceding year may be shown as income or sale of
the current year.
 Secret reserves of previous years may be used in the current financial year to inflate
the profit or secret reserves may be created to suppress the profit of the current
financial year.
 Stock may be under or overvalued. Income and sales may be suppressed or inflated.
Expenses and purchases may be suppressed or inflated.

Auditing - Detection and Prevention of Errors

Auditors should be very careful about the detection of errors because manipulation in
accounting may also appear as error or it may be a result of carelessness on part of a
bookkeeper.
Errors may be broadly classified as follows −

 Error of Principle
 Errors of Omission
 Errors of Duplication
 Errors of Commission
 Compensating Errors

Error of Principle

Where the recording of the items of transactions are not done according to the Principle of
Accounting, it is known to be an error of principle. These errors are not traceable from trail
balance; these errors may be committed unintentionally or for the purpose of manipulation
of accounts to inflate or deflate profit.
Following are the examples of such type of errors −
 Providing excessive or inadequate depreciation
 Where the provision for outstanding expenses or prepaid expenses is wrong
 Where revenue expenses may be treated as capital expenditure or vice versa
 Where valuation of Plant & Machinery, Stock, investment and other assets are not
done according to the Principle of Accounting.
 Where income received is credited to personal account of the person who is making
the payment; for example, commission received from Mr. A credited to Mr. A’s
account instead of the commission account, it will increase creditors in the
BalanceSheet and reduce profit in the Profit & Loss account.
 Where the payment of expenses is posted to the personal account of a person who
receives payment; for example, the rent paid to Mr. A wrongly debited to Mr. A’s
account, it will increase profit and also increase debtors in the Balance-sheet.

Errors of Omission

There may be two types of omission of entry while recording the transactions in the books
of accounts;
 Where transaction is totally omitted from the books of accounts, it will not affect
the trial balance and the detection of such error is difficult. Following are the
examples of such errors;
o Omission of purchase or sale from the purchase day book or the sale day book
respectively.
o Omission of outstanding or unpaid expenses.
 Examples of the transactions which are partially omitted from the books of
accounts are −
o Where total of purchase day book or sale day book omitted to be posted in
purchase or sale account respectively.
o Where payment or receipt transaction omitted to be recorded in ledger account
from cash book.

Errors of Duplication

The detection of error of duplication is very difficult. It might be detected with proper and
minute observation of accounts; for example, purchase may be recorded twice with
original and duplicate copy of purchase invoice, etc. It is also possible to post the total of
any ledger account twice in the trial balance.

Errors of Commission

Error of commission occurs the entry made in the books of the original entry or the ledger
account is wrong. Let us see the following examples −
  Purchase of goods for Rs. 25,000 wrongly entered as Rs. 2,500 in purchase book.
 Credit purchase from AB Company wrongly credited to BA Company’s account.
 Wrong totaling − total of purchase day book is totaled as Rs. 1,12,500 instead of
1,21,500.
 Purchase from AB Company wrongly debited to AB company account instead of
crediting AB company account and debiting purchase account.

Compensating Errors

When the effect of an error compensates with another error; it is known to be a

compensating error. Such errors do not affect the trial balance; for example, total of a debit
account as well as credit account totaled short by Rs. 7,500. This type of error will
compensate both.

Prevention of Errors and Fraud

After the completion of audit, the Auditor can suggest his client to make changes in the
accounting systems and also to improve his internal control system as an Auditor cannot
do anything directly to prevent errors and frauds.
Auditors are expected to conduct audit as per professional standards expected from him.
He cannot guarantee that no fraud exists. An Auditor should ensure and follow these
standards −
 Internal control system
 While recording the business transaction whether accounting principle are being
followed or not
 Policies of management are being followed or not
 Whether provisions laid in the Companies Act are being followed while preparing
books of accounts
 Whether Balance-sheet and Profit & Loss account show true and fair view of state of
affairs of concern
Following factors decide whether an Auditor is responsible for non-detection of
errors and frauds −
 An Auditor should audit as per the principles laid out for auditing.
 He should fulfil his duty as per the prevailing standards of his profession.
 Error should be rectified during his audit and fraud is to be reflected in his audit
report.
 Even a simple hint that reflects that there is something wrong should not be
overlooked.
 He should believe on substantial accuracy in statement of accounts.
Customize your c Auditing - Classifications
In this chapter, we will learn the various types/classes of Audit and their basis. The
following table lists out the different types of audit.
Basis Types

 Specific Audit − Cash audit, Cost audit, Standard

audit, Tax audit, Interim audit, Audit in depth,
Management audit, Operational audit, Secretarial
Scope audit, Partial audit, Post & vouch audit, etc. are
common types of specific audit.
 General Audit − It can be an internal or an
independent Audit.

Activities  Commercial
 Non-Commercial

Organization  Government
 Private

 Statutory − Insurance Company, Electricity

Legal Company, Banking Companies, Trust, Company,
Corporations, Co-operative societies.
 Non-statutory − Individual, Firm, Sole trader, etc.

Examination  Periodicals
methods  Continuous

Who conducts  Internal Audit

 Independent Audit

Let us now understand the important classifications of audit.

Audit of Individuals

Sources of income of any individual may be from his investments, property, shares,
commission as agent, interest income, etc.
Following are the purposes and benefits if anyone opts for an audit −

 To know the correct income from all of his sources.

 Assurance of accuracy.
 Prevention and detection of any fraud or misappropriation
 Helpful and useful in Income Tax Assessment.
 To keep moral check on accountant and agent.
Audit of Sole-Trader’s Books of Accounts

The scope of audit will depend on the instructions and agreement between Auditor and
sole proprietor, the latter being an individual owner of the business; the sole proprietor
decides himself the scope of audit.
The purpose and benefit of audit in a sole trader’s business are almost the same as for an
individual. Following are some additional benefits −
 Assurance about proper vouchers of his expenditure and preparation of his accounts
with accuracy and correctness.
 Assurance about true and fair picture of his business income and expenditure.
 His accounts can be compared with the previous years’.

Audit of Partnership Firm

An Auditor for a partnership firm may be appointed by the partners with mutual consent.
Mutual agreement between partners and Auditor is based on the latter’s rights, liabilities &
the scope of his audit. Reference to the partnership deed is must for an Auditor and he
should refer to the Partnership Act, 1932 in case where partnership deed is silent.
Certificate of an Auditor will contain points related to the following −
 Reliability of accounts depending upon the nature of business.
 If any restrictions and limitations imposed by the partners on his audit scope.
 Whether the auditor got all the required information and explanations or not.
Important provision of Partnership Act
An Auditor should refer to following provisions of the Partnership Act, 1932, where
partnership deed is silent.
 A minor can be admitted to a firm as a partner only for profits, he will not be liable
for any loss.
 Property of the firm can be exclusively used by the partners for business purpose.
 Partners will share profit & loss equally.
 There is no entitlement of any remuneration or salary to any of the partner.
 6% interest on capital will be paid to partner in case of any addition to capital made
by any partner in excess of agreed amount.
 Interest on capital will be payable out of profits only.
 Goodwill of the firm will be treated as assets of the firm at the time of dissolution of
the firm.
 At the time of dissolution of the firm, the settlement of account will be done in the
following order −
o Out of profit
o Out of capital
o By the partners individually in their profit sharing ratio

Government Audit
Government of India maintains a separate department known as the Account and Audit
Department and this department is headed by the Comptroller and Auditor General of
India, which works only for government offices.
Important Features of the Government Audit
 In almost every government department, prior sanction is must before any payment
of expenditure.
 Before making any payment, a preliminary examination of bills is done by the
Treasury officer.
 Nature of Government audit is always continuous due to large number of
transactions and huge amount of expenditure.
 Major portion of the accounts is prepared by the Accounts and Audit department
which work independently.
Objectives
The following are the main objectives of Government audit −
 To check and ensure that prescribed rules and regulations have been followed while
making payments.
 To ensure that expenditure should not be excessive.
 To check and verify physical stock, stores and spares along with their proper
valuation. Stock-taking should be done at regular intervals and the recording of
stock in the stock register should be done correctly and up-to-date.
 To check whether every payment is sanctioned by proper authority or not.
 To ensure that expenditure should be done in public interest only by the right person
and should be paid to the right person.
 To ensure that no expenditure should be incurred for any personal benefit of any
authority.
 To give suggestion for any kind of improvement in efficiency and economy.
 To verify that the amount due from others are properly recorded in the books and
also to verify that such amount is regularly recovered.

Statutory Audit

Where the appointment of a qualified Auditor is compulsory as per the law is called as a
statutory audit. The following are the essential characteristics of statutory audit −
 An Auditor must be a qualified accountant.
 Norms of the appointment of Auditor are provided by the law. Rights, duties and
liabilities of an Auditor are as defined by the statute; management cannot make any
changes in it.
 Organization cannot restrict the scope of statutory audit.
 Statutory audit provides true and fair view of financial position to shareholders and
members of an organization. It helps the shareholders to keep themselves protected
from any fraud and misrepresentation.
 Statutory audit is a compulsory audit. Auditor is an independent person and
management doesn’t have any control over his work.
Following stakeholders are covered under the statutory or compulsory audit.
Audit of Companies
First time in India, the Indian Companies Act, 1913 made it compulsory for joint stock
companies to get their accounts audited by a qualified person (chartered accountant).
Appointments, duties, qualifications, powers and liabilities are amended through the
Companies Act, 1956 and 2013.
Audit of Trust
The Public Trust Act provides compulsory audit of accounts by a qualified Auditor.
Conditions and terms as laid down in Trust deed are the basis on which accounts of trusts
are maintained. Any Beneficiary of trust does not have control or access over accounts of
trust, therefore, there are more chances of fraud and misappropriations.
Audit of Co-operative Societies
The Companies Act is not applicable to societies; co-operative societies are established
under the Co-operative Societies Act, 1912. It is a must for a qualified accountant to have
the required expertise and he should be updated with various amendment of the Act. An
Auditor should also have knowledge of the by-laws of this act.
Audit of other Institutions
Banks, Insurance companies and Electricity companies are audited as per the provisions of
special Act of the Parliament.

Cost Audit

“Cost audit would apparently mean an examination of Cost books, Cost Accounts, Cost
Statements and Subsidiary and prime documents with a view to satisfy the Auditor that
these represent a fair and true view of the cost of production. This will naturally mean an
examination of appropriateness of the cost accounting system adopted by business and
effectiveness of its implementation.”

- J.G. Tickhe
Services of qualified cost accountants are necessary to have full control on the records of
costs and cost variations. Big business houses and manufacturing units do understand the
importance of cost accounting. Cost Auditors check the work done by Cost Accountants to
ensure correctness of the accounting.
Objectives of Cost Audit

 To verify arithmetical accuracy of cost accounting.

 To help management to take decision about production and cost variations.
 To detect error and frauds.
 To have control over cost accounting department.
  To give suggestions about efficiency of material, labour and machine.

Tax Audit

Under the provision of section 44AB of the Income Tax Act, 1961, every person carrying a
business/Profession is required to get his accounts audited, if the total turnover or gross
receipts during the previous year exceed Rs. 100 lacs in case of business and Rs. 25 lacs in
case of profession.
Profit and Loss account of a business or profession is adjusted according to the provision
of the Income Tax Act, therefore accounting profit and tax profit differ. The reason behind
the difference in profit or loss may be because of the following −
 Amount of depreciation
 Under the Income Tax Act, certain expenses are allowed only on the basis of actual
payment and those should be within the prescribed time as provided by law, like the
payment of Provident Fund, ESI, Interest to financial institutions, VAT/Central
Sales Tax, Employees related payments, etc.

Balance Sheet Audit

Balance sheet audit is very popular in the United States of America. Balance sheet audit is
an annual audit and it covers each and every item of nominal accounts as appeared in profit
and loss account, assets, liabilities, reserves, provisions, stocks and surplus. Balance sheet
audit is also done by highly-skilled accountants.

Continuous Audit

Under continuous audit each and every transaction of the business is checked by the
Auditor regularly. Continuous audit is required in large organizations where number of
transactions is very high, internal control system is not effective, periodicals statements are
required and final accounts are prepared immediately after the close of financial years like
banks.
Advantages − Complete checking of records, up-to-date accounts, moral-check on staff
and early finalization of financial statements are the main advantages of continuous audit.
Disadvantages − High cost of continuous audit, mechanical work of Auditor, chances of
unhealthy relations with staff due to frequent visits, etc., are main disadvantages of
continuous audit.

Annual Audit

In an organization where the number of transactions is not large, an Auditor usually comes
after the close of financial year and completes his audit work in continuous session. In case
of small business houses, annual audit gives satisfactory results.
Advantages − The work that is done by an Auditor in Annual Auditing does not affect the
everyday routine of the organization and its people; the Auditor has full control over
financial statements and records. Among other advantages, Annual Audit is cost-effective.
Disadvantages − There might come instances where the unavailability of Auditor may
cause unnecessary delay in audit work; due to complete audit in one sitting, chances of
undetected errors and frauds are high. This is not recommended for big business houses
and the delay in annual general meeting is sometimes due to delay in audit which turns out
to be a major disadvantage of annual audit.

Partial Audit

Partial audit is done only for a specific purpose; for example, to check the receipt side or
the payment side of the cash book, to check cash sale, to check purchases or expenses only.
The reason for calling out for a Partial Audit largely depends on the Management of the
organization.

Internal Audit

Internal audit may be done by an independent person or by the employees of the company;
internal Auditor may or may not be qualified person for audit. Internal audit is continuous
in nature. As per section 144 of the Companies Act, an internal Auditor cannot render his
services as Statutory Auditor for the same company.
As per the new section 138 of the Companies Act, internal audit has been made
compulsory for certain categories of companies;
 Certain class of companies or may be prescribed shall be required to appoint an
internal Auditor, who shall either be a chartered accountant or cost accountant or
such other professional as may be decided by the Board to conduct internal audit of
the functions and activities of the company.
 The central Government, may, by rules, prescribed the manner and intervals in
which the internal audit shall be conducted and reported to the Board.
The following classes of companies are required to appoint an internal Auditor −
 Listed companies.
 Unlisted companies and Private companies meeting any of the following criteria.

Criteria Private Company Unlisted Company

Rs. 200 crore or more Rs. 200 crore or more

Turnover during the preceding during the preceding
financial year financial year

No such criteria is Rs. 50 crore or more

Paid up share capital applicable to private during the preceding
company financial year
 No such criteria is Rs. 25 crore or more at
applicable to private any point of time
Outstanding deposits
company during the preceding
financial year

Exceeding Rs. 100 Exceeding Rs. 100

Outstanding Loans or
crore at any point of crore at any point of
borrowings from banks
time during the time during the
or public financial
preceding financial preceding financial
institutions
year year.

Management Audit

Efforts are done to bring out an overall improvement in management efficiency through
review of all the objectives, policies, procedures and functions of management. Only a
person having good knowledge and experience of management techniques may be
appointed as Management Auditor.
Objectives of Management Audit
Following are the main objectives of management audit −

 To help management in setting sound objectives.

 To ensure the fulfilment of objectives.
 To give recommendation about change in policies and procedure for better results.
 To help management in elaborating duties, rights and liabilities of the employees.
 To help management in establishing good and sound relation with outsiders.

Post & Vouch Audit

Under this audit system, we have checking of every single original entry and their posting
in ledger along with, balancing and totaling. This audit system is only advisable in small
business units; in big business houses internal Auditor do this job and Auditor just check
the effectiveness of internal control system of that organization.

Audit in Depth

Audit in depth means detailed stepwise verification of some specific transactions; this
helps an Auditor to understand the complete procedure of transaction as adopted by the
organization to carry out any transaction. For example, to check the purchase transaction,
an Auditor will check the quotations, purchase orders (P.O.), material receipt note
(M.R.N), goods/material inspection note, bin card and stock ledger.

Interim Audit
Interim audit is done between two annual audits of an organization for a part of year. It
enables the Board of Directors to declare interim dividend and also to determine interim
figures of sales.

Vouching - Meaning, Objectives, Importance and

Techniques
Meaning:

Voucher is known as the evident for the support of a transaction in the books of account. It
may be bill, receipts, requisition form, agreement, decision, bank paying slip etc.

The act of examining documentary evidence in order to ascertain the accuracy of entries in
the account books is called "Vouching". Vouching is a technical term which refers to the
inspection by the auditor of documentary evidence supporting and substantiating a
transaction. Simply stated, vouching means a careful examination of all original evidence
i.e invoices, statements, receipts, correspondence, minutes and contracts etc. with a view to
ascertain the accuracy of the entries in the books of accounts and also to find out, as far as
possible, that no entries have been omitted in the books of accounts. Therefore, vouching is
the act of testing the truth of entries appearing in the primary books of accounts. It is initial
for auditing.

Voucher:

A voucher is a documentary evidence in support of a transaction in the books of account.

Objectives:

Main objective of vouching is to find out the regularity or irregularity of transactions,

frauds and errors. Regularity means maintaining record and performing the work
compliance with the rules, regulation and law. But irregularity means doing the work
crossing to the line of rules, regulation and laws. Some of the major objectives of vouching
are given below:

1. To Detect Errors And Frauds

All transactions are to be supported by evidence. Each document should be proved

by authorized authority. With the help of vouching we can detect errors and frauds by
verifying each transaction. Planned fraud can be detected through vouching.

2. To Know The Truth Of Account

Each and every transaction is checked and ratified on the basis of support document. So, we
can easily know the truth of account.

3. To Find The Unrecorded Transactions

Each and every transaction is checked and ratified on the basis of document. Vouching
helps to find out the unrecorded or missing transactions. If any voucher is found
unrecorded, auditor can suggest to record such transactions.

4. To Know That All The Transactions Are Authorized

If the transactions are made on the consent of concerned authority, such transactions are
known as authorized transactions. If transactions are not authorized, such transactions can
be fictitious transactions. So, such fictitious transactions ca be found with the help of
vouching.

5. To Know That Only The Business Transactions Are Recorded

Sometimes, transactions are performed for individual purpose but payment is made out of
business. Such transactions should not be recorded in account of business. If such
transactions are recorded, we can find it with the help of vouching. To know the real profit
or loss of business, such transactions are to be separated.

Importance:
Vouching is the act of checking evidential documents to find out errors and frauds and to
know the authenticity, accuracy and reliability of books of accounts. Thus, it is important
for an auditor due to the following reasons:

1. Vouching Is The Backbone Of Auditing

Main aim of auditing is to detect errors and frauds for proving the true and fairness of
results presented by income statement and balance sheet. Vouching is only the way of
detecting all sorts of errors and planned frauds. So, it is the backbone of auditing.

2. Vouching Is The Essence Of Auditing

Auditing not only checks the accuracy of books of accounts but also checks whether the
transactions are related to business or not. All the transactions are performed after the prior
approval of concerned authority or not, transactions are real or not because an accountant
may include fictitious transactions to commit frauds. All these facts can be found with the
help of vouching. So, vouching is essential for auditing.

3. Vouching Is Important To See Whether Evidences Are Correct Or Not

An auditor checks the books of accounts to detect errors and frauds. Frauds may be
committed presenting duplicate vouchers. All the small and big amounts of frauds can be
detected with the help of vouching. So, all the evidential documents and records are to be
checked carefully and in detail by an auditor which is the scope of vouching.

Therefore, it can be said that vouching is the heart of auditing because without the
work of vouching, the work of auditing cannot be performed.

Principles or Techniques of Vouching:

At the time of vouching auditor should keep in view the following important principles in
his mind :

1. Arranged Vouchers:
First of all auditor should check all the vouchers provided by the client are properly
arranged. These are in the same order as the entries are made in the books.

2. Checking Of Date:
The auditor should compare the date of the voucher with the date recorded in the cash book.

3. Compare the Words and Figures:

The auditor should satisfy himself amount written numbered consecutively. All the
vouchers should be properly filed. On the vouchers, its figures and words are same or not.

4. Checking Of Authority:
The auditor should examine that all the vouchers are passed by the authorized officer. If the
voucher is passed by unauthorized person it will not be correct.

5. Cutting Or Change:
If there is any cutting or change on the receipts and vouchers figures it should be signed by
the authorized officer. The auditor should satisfy himself by inquiring about it.

6. Transaction Must Relate To Business:

The auditor should carefully examine that the entries must relate to the business.

7. Case Of Personal Vouchers:

The auditor should not accept the voucher in personal name. There is a chance that an
officer of the company has purchased any item in his personal capacity.

8. Checking Of Account Head:

Auditor must be satisfied about the head of account on which cash is deposited and drawn.
He should examine the documentary evidence in this regard.

9. Revenue Stamp:
The auditor should also check that voucher bears a required revenue stamp or not?

10. Case Of Cancelled Voucher:

The auditor should not accept the cancelled voucher. Because it has already served the
purpose of payment. There will be a danger of double payment if it is accepted.

11. Important Notes:

The auditor should take some important notes about those items which need further
evidence or explanation.

12. Payment:
The auditor should check that whether payment is described partially or for complete
transaction of sale.

13. Agreements:
These provide the basic information to the auditor. He should check the agreements,
correspondence and other relevant papers.

14. Printer Vouchers:

Printer vouchers are considered true and these are legally acceptable. If these are not printed
then these are useless.

15. List Of Missing Vouchers:

Auditor should prepare the list of missing vouchers. This list will be helpful in detecting the
fraud and errors.

Audit Evidence

Meaning: “Audit Evidence” is a mixture of observations made by audit inquiry and data
compiled via analysis of other data which, when combined, enables the auditor to from and
substantiate an opinion on financial statement.

Audit separates all the confirmations that the auditor has obtained and that

a) Is relevant to what the auditor is trying to determine.

b) Influences the auditor in formulating an opinion as to fairness of the financial statements.

Assertion by Management

Financial statements assertions are the representations of the directors that are embodied in
the financial statements. The directors by approving the financial statements are making
representations about the information thereon. So every item in the financial statements
constitutes one or more assertions from the management.

Examples

1. If there is an item in the current assets section of the balance sheet which states as: Cash
Rs. 1, 00,000.

In this case the management’s assertions are:

Company has cash in hand of Rs. 1, 00, 000.

Asset cash is free and available for expenditure as the management directs.

2. Like wise an item is states as:

Accounts Receivables Rs. 3, 00,000 asserts that:

company has accounts receivable from its customers of Rs. 3, 00, 000.
such accounts are considered collectible within the operating cycle

they are expected to receive Rs. 3, 00, 000 in cash or an amount very close to it from the
debtors who purchased goods on credit.

Management produces financial statements and in doing so it asserts that the individual
items are correctly described and show figures which are mathematically correct or fairly
estimated. Further, the accounts are a whole show, a trace and fair view of financial state of
affairs of the concerned enterprises.

The assertion of representations that are usually made are in this connection are:

1. Existence: An asset or a liability exists on the date of balance sheet.

This is an obvious assertion in respect of items like land, building, merchandise and others.

2. Rights and obligations: An asset or liability pertains to the entity on the date of balance
sheet.

The enterprise has ownership of an asset i.e. it has all sorts of rights and obligations relating
to a given asset or liability.

3. Occurrence: A financial transaction or event took place which pertains to the entity
during the relevant accounting period. Even when false transaction have been recorded, the
assertion is that all record transactions actually took place.

4. Completeness: There are no unrecorded assets, liabilities, transactions or events or

undisclosed financial items.

This is essential for all items of balance sheet but is particularly important in respect of
liabilities.

5. Valuation: An asset or liability is recorded at an appropriate carrying value. Appropriate

means it is in accordance with the generally accepted accounting principles, Companies
Ordinance and Accounting Standards.

6. Measurement: A transaction or event is recorded as the proper amount and revenue or

expense allocated to the proper period.

7. Presentation and disclosure: An item is disclosed, classified and described in

accordance with applicable reporting framework.
Example: An overdraft of Rs. 80,000 appears in a balance sheet. So the directors are made
the following assertions:

i. There exists a liability to companies’ bankers.

ii. In balance sheet data the liability of Rs. 80,000 is exhibited.

iii. The said amount is agreed by bank.

iv. Overdraft was payable on demand.

v. Overdraft was unsecured.

vi. Memorandum and Articles of Association authorise borrowings.

vii. Bank reconciliation statement has been prepared.

viii. Bank is willing to allow the overdraft to continue.

Notice that if no overdraft appears in the balance sheet, there is an assertion that on the date
of balance sheet no overdraft liability existed.
Solved Question for You

Q: Auditing helps in securing loans from banks. True or False?

Ans: This statement is in fact, true. Audited statements are a necessity when availing loan or
credit facilities from banks. The banks are more assured about the financial position of the
company and can sanction loans accordingly.

Q: What are the main types of functional audits?

Ans: The main types of functional audits are,

 Propriety Auditing
 Efficiency Auditing
 Operational Auditing
 Voucher Auditing
 Statutory Auditing
 Social Auditing
 Cost Auditing