Sybcom Sem Iv - Audit Chapter 1 & 2

FY BAF, SY BMS, SY BCOM - AUDITING 1 KARNAVAT CLASSES
1. INTRODUCTION TO AUDITING
Q.1. Define Auditing. Explain its features.

Ans. The term "Audit" is derived from the Latin term "Audire" which means to hear. In early days an auditor
used to listen to the accounts read out by the accountant in order to check them.
Every business organisation prepare final accounts every year, which are used by shareholders, lenders,
creditors, employees, government, customers etc. for different purposes. All these users need to be sure
that the financial statements prepared by the management are reliable, true and fair.
An auditor is an independent person who examines the accounts of a business concern and reports on its
reliability.
Definition :
1. According to International Auditing guidelines "Auditing is a independent examination of financial
information of any entity with a view to expressing an opinion thereon.
2. According to Auditing and Assurance Standard (AAS): Auditing is an independent examination of
financial information of any entity, whether profit oriented or not & Irrespective of its size or legal form
When such an examination is conducted with a view to expressing an opinion thereon.
3. In the words of L. R. Dicksee, "Auditing is a systematic examination of accounting records undertaken
with a view to establish whether they correctly and completely reflect the transactions to which they
relate".
Features of auditing are as follows:

1. Documentary Evidence : It is done with the help of vouchers, documents, information and explanations
received from the authorities.
2. Systematic and scientific examination : It is the systematic and scientific examination of the accounts of
a business.
3. Intelligent and critical examination : It is an intelligent and critical examination of the accounts of a
business.
4. Independent person: It is done by an independent person or body of persons qualified for the job.
5. Verification of results : It is a verification of the result shown by:
a. Profit & Loss A/c
b. Balance Sheet.
6. Review of accounting system & internal control : It is a critical review of the system of accounting and
internal control.
7. Reporting : The auditor has to satisfy himself about the authenticity of the financial statements and report
that they exhibit true and fair view of the state of affairs of the concern.
Q.2. Explain the primary and secondary objectives of audit.

Ans. According to Auditing and Assurance Standard (AAS) - 2 issued by Institute of Chartered Accountant Of
India (ICAI).
Objective of an Audit are as follows :
1. Primary Objectives : The main objective of auditing is to enable an auditor to express an opinion on the
financial statement and gives report to the shareholders ensuring true and fair view.
As per sec. 227 of Companies Act 1956 the auditor of a company is to state
a. Whether the balance sheet represents true and fair of state of affairs of the company.
b. Whether profit and loss accounts present true and fair view of profit or loss for the financial period
2. Secondary Objects :
a. Detection and prevention of errors.
b. Detection and prevention of frauds.
Laymen generally feel that the main objects of an audit is the detection of errors and frauds but this is
only incidental objects of audit. Detection of errors and frauds is no doubt important. If the accounts are
to be true and fair, they must be free from errors and frauds.
Auditor should advice the management how the accounting system and internal control should be
established to prevent such errors or frauds in the future.
Q.3. What is an Error? What are the different types of errors?

Ans. "Error" means an unintentional mistake in financial information.
Most of the errors are detected during normal course of audit. Error can take place due to fatigue, ignorance,
human tendencies, lack of knowledge etc. Auditor should carefully check the transactions, so that if there
are any accounting errors, they can be detected.
Following are different types of error which may be committed at various levels:
1. Error of Principle : In accounting certain basic principles have to be followed which when violated result
into error of principles.
Few Examples are given below :
a. Capital Expenditure wrongly treated as revenue expenditure e.g. a purchase of machinery passed
through purchase day book. This should be debited to machinery account not to purchase account.
b. Revenue Expenditure treated as capital expenditure e.g. debiting of routine repairs to the account of
assets.
c. Ignoring prepaid or outstanding expenses and incomes etc.
d. Over and undervaluation of stocks etc.
2. Clerical Errors :
a. Errors of omission :
These are of two types.
i. Partial Omission: The transaction entered in the subsidiary book but is not posted to the ledger.
This can happen in relation to any subsidiary book.
E.g. A credit purchase entered in the purchases book but not posted to the credit of suppliers
account.
ii. Complete Omission: Here the transaction is completely omitted from books. The book keeper
may fail to enter an invoice in the sales day book. Similarly, a receipt may not be entered in the
cash book. Such cases will have to be located carefully and then rectified.
b. Error of commission :
An error of commission occurs when a transaction is wrongly entered in the books of accounts.
These mistakes arise often due to ignorance and absent - mindedness of the book - keeper or
ledger clerks. i.e. something being done which should not be done. The following are the examples
of such errors.
i. Mathematical errors : i.e. entering wrong amount in subsidiary books or ledger or in trial balance
etc.
E.g. Sales bill of Rs.50,000 entered in sales as well as debtors account as Rs.5,000.
ii. Casting errors : Casting errors means error in totaling, carry forward which may take place in
day books, ledgers, trial balance etc. The error of casting affects only one account.
E.g. Error of casting in purchase book affects purchases account. Sometimes error in casting may
be the result of wrong carry forward of total from one Page of the day book to another. The total
of a page may be Rs.135 and carried forward to the next page as Rs.315. Naturally this results in
over casting of the book.
iii. Posting errors : This may occur when some other account is given effect instead of actual account
to be given effect in.
E.g. Sale to Shyam of Rs.10,000 wrongly debited to Mr. A. Actually it should be debited to
Shyam's account.
c. Compensating errors : When effect of one error is cancelled or compensated by another error, then
such another error is called as compensating error.
E.g. Purchase of Rs.5,000 is debited as Rs.500 and on the credit side one of the creditors account is taken
short by Rs.4,500.
These errors are difficult to locate as the trial balance tallies but they can be detected through vouching,
obtaining statement of account's or confirmations from parties etc.
d. Errors of Duplication : Where the same transaction is recorded twice by the clerk concerned and the
same is also posted twice in ledger it results into error of duplication. Since both debit as well as
credit effects are given twice the trial balance will tally but they can be detected through scrutiny of
ledger account's confirmation from parties.
Q.4. Explain procedures to be followed by the Auditor to detect the errors.

Ans. Following procedure may be followed by the Auditor to detect the errors, when Trial Balance does not
tally:
1. Check totals of both sides of the Trial Balance.
The difference may be due to an error while taking totals of the Amount Columns.
2. Match nature and balances of accounts.
Check that the accounts which should normally show debit balances (assets and expenses) have debit
balances and accounts which should normally show credit balances (liabilities and income) have credit
balances.
3. Check ½ the amount of difference in Trial Balance
Thus, if the Trial Balance difference is Rs.10,000, ½ the amount is Rs.5,000. Check if any account has a
balance of Rs.5,000. Check this account thoroughly for posting on wrong side i.e. debit on credit side and
vice versa.
4. Check if the difference in Trial Balance is divisible by 9
If so, it may mean that figures are transposed, e.g. 59 is written as 95. (95 - 59 = 36. The difference in Trial
Balance of 36 is divisible by 9).
5. Go back through the steps involved in preparing the Trial Balance.
a. Check closing balances of ledger accounts with Trial Balance.
b. Check totals of ledger accounts
c. Check opening balances into ledger from final Trial Balance of last year.
d. Check posting from registers into ledgers.
e. Check totals of registers i.e. books of original entry.
f. Check subsidiary ledgers (Sundry Debtors / Creditors Control Accounts)
g. Check whether debit and credit totals of such journal entry are same.
Q.5. What is a fraud? What are the different types of fraud?

Ans. Fraud means intentional misrepresentation of financial Information by management, employees or third
parties.
It is an intentional malafide act which is done with an intention to cheat someone.
Frauds can be of following types :
1. Manipulation or Falsification or Alteration of books / records.
2. Misappropriation of Cash or goods.
1. Manipulation of books / records - it can be done by :
a. Non recording transactions: it can take place when any transaction is intentional hidden or
suppressed or omitted.
E.g. Purchase of goods may not be recorded in purchase register.

b. Recording dummy transactions : This can be done by excess Incomes through not actual ones.
E.g. Goods sent on consignment or on approval may be taken as actual sales.
c. Misapplication of accounting policies : It takes place when error of principle is done intentionally i.e.
basic accounting policies like proper valuation of stocks, distinction between capital and revenue etc.
are not followed.
Such manipulation leads to "Window Dressing" which means to show a better position of the business
than that what actually it is or "secret reserve" which means to show a picture worse than its actual
position.
2. Misappropriation of cash or goods :
a. Misappropriation of cash : It can be stolen out of ;
i. Cash received : Cash received may be misappropriated by ;
Not recording cash received either wholly or partly on account of cash sales, scrap sales,
recovery of bad debts, discount from creditors etc.
ii. Teeming and landing : i.e. amount received from one party is pocketed and when amount
from 2nd party is received it is accounted for in previous party's account, when amount is
received from 3rd party it is given effect in 2nd party's account and so on.
iii. Cash payments : This can be done by recording excess or dummy payments and pocketing
the difference.
iv. Cash balance : Cash may be stolen out of the cash lying in the cash box.
b. Misappropriation of goods : goods may be misappropriated out of ;
i. Goods Received : It can be done by either partially or wholly omitting the goods received
from the purchase register.
ii. Goods Despatched : It can be done by recording dummy or excess sales.
iii. Stock - in - hand : Goods can be stolen from the godown where they are lying ready for dispatch.
Q.6. What is ‘Fraud’? What are the different methods of perpetrating a fraud? To what extent the auditor is
liable for not detecting the fraud?
Ans: FRAUD may be defined as “the false representation or untrue entry made in the books of account intentionally
or without belief in its truth with a view to defraud the proprietors or somebody else”, the act of committing
fraud is willful. All intentional errors are frauds as there is intention to deceive or to mislead or to conceal the
truth.
Fraud also includes willful misrepresentation or deliberate concealment of material facts to induce a person
to enter into a transaction and suffer a loss. Therefore, fraud is nothing but cheating.
Fraud is classified into three groups:
1. Frauds involving the misappropriation or embezzlement of cash.
2. Frauds involving the misappropriation of goods or property.
3. Frauds involving manipulation of accounts.
(1) MISAPPROPRIATION OF CASH:
In every type of business organisation cash plays a vital role. Therefore, the chances of committing frauds by
misutilisating the cash or improper handling of cash are many. In small concern comparatively there are less
chances of such fraud than in large concerns. A person may defraud his owners or proprietors in cash
transaction by following methods:
(A) AT THE TIME OF RECEIPT OF CASH:

1. Not entering the cash received e.g. suppression of cash receipts from debtors etc.
2. Recording lesser amount of cash than what has been actually received.
3. Not recording the cash received on sale of scrap etc.
4. Writing off debts as bad though cash is received from such debtors, and then not recording such cash
received.
5. Not entering Cash receipt of a Casual Nature.
6. Teeming and lading.
(B) AT THE TIME OF MAKING PAYMENTS:
7. Showing fictitious payments or expenses.
8. Inflating the payments or expenses.
9. Manipulating the totals of wage rolls or salary sheets or showing wages paid to Dummy workers.
10. Not recording discounts and allowances received while making payments.
( 2 ) MISAPPROPRIATION OF GOODS:
1. Goods may be removed out of factory premises or godowns without a proper entry for the same, and
are sold privately. Then it is named as misappropriation of goods.
2. Likewise, goods might be shown in the books as purchased, for more quantity but actually less quantity
is entered thereby selling the balance outside privately and not accounting for such sales.
3. Showing the goods as damaged or obsolete etc. and taking out the same and realising the same without
recording the same.
4. While delivering the goods on a sale invoice or delivery challan more goods may be moved out than
that is specified in challan etc. This method is called as issuing a quantity of goods more than invoiced.
( 3 ) FRAUDULENT MANIPULATION OF ACCOUNTS.
Under this type of fraud accounts are presented in such a manner that profit or losses are overstated or
understated, i.e. ‘True and Fair’ view of the financial statements is distorted. Usually this type of fraud is
committed by persons holding a responsible position like manager: directors etc. some of the benefits connected
with this type of frauds are as under:
(A) BENEFITS FROM SHOWING MORE PROFITS:
1. The manager or other officers may get more commission on profits when commission is payable
as a percentage of profits.
2. The shares may be sold at a higher price by fraudulently raising price of shares which has
resulted from the declaration of higher rate of dividends, by showing more profits.
3. They may be able to fetch more finance or credit by showing more strengthened position of
the business ( i.e. window dressing) than what actually it is.
4. To retain the confidence of investors.
5. To get their services confirmed by showing to the shareholders that because of their efficiency
the firm has earned more profits etc.
(B) BENEFITS FROM SHOWING LESS PROFIT:
6. Showing lesser profits than what actually they are with an intention to cause a fall in the
market value of shares, when they are intending to purchase the shares.
7. Showing lesser profits when they do not want to declare any dividend so as to strengthen the
working capital position.
8. Showing lesser profits for avoiding the payment of income-tax.
9. Showing a wrong position to mislead the competitor in the business field etc.
ACCOUNTS MAY BE MANIPULATED IN MANY WAYS. SOME OF THEM ARE AS UNDER:

1. Not providing any depreciation, or providing less depreciation or more depreciation.
2. Undervaluation or overvaluation of assets, including stock in trade.
3. Undervaluation or overvaluation of liabilities.
4. Showing a revenue expenditure as a capital expenditure or vice versa.
5. Recording fictitious purchases or omission of purchases.
6. Recording fictitious sales or omission of sales or goods in transit shown as sales.
7. Utilising secret reserves when the concern has not made the profits without disclosing the facts.
8. By crediting the profit and loss account with the income receivable in next year, or income received in
advance for next year.
DETECTION OF FRAUDS
(A) DETECTION OF MISAPPROPRIATION OF CASH:
Misappropriation of cash can be detected by an auditor if he carries out vouching of the cash book
very carefully, with all the relevant documents like a salesman’s reports, counterfoils of the receipt
books, salary books, invoices etc. He can also verify the internal check system and find out the loopholes
in the same through which such frauds take place.
(B) DETECTION OF MISAPPROPRIATION OF GOODS:
Misappropriation of goods is very difficult to detect especially when the goods are less bulky and are
of higher value. Verification of method of accounting, internal check in vogue or a reconciliation of
stock on the basis of gross profit etc. are some of the ways of detecting such type of frauds.
(C) DETECTION OF FRAUDULENT MANIPULATION OF ACCOUNT:
The frauds in the method of manipulation of accounts are very difficult to detect. Because usually
these are committed by the people who are presumed to be honest and trustworthy. As they are very
cleverly made. Auditor should be very careful in detecting such frauds. He should carry out vouching
and verification very carefully and should ask tactful and intelligent inquiries. He should apply
technique of Ratio Analysis.
Detection of fraud was formerly the main aim of audit, but now it is one of the important duties of the
auditor. Auditor is not responsible for failure to detect deeply laid out frauds, if he had carried out his
audit carefully and has made reasonable inquiries. But if at any time there arises a suspicion, he is
required to make an enquiry in detail so as to reach the depth (bottom) of the transaction. The criteria
on the basis of which auditor’s liability is judged is ‘whether he has exercised a reasonable care and
skill in the performance of the audit.’
If there remains a deeply laid fraud in the accounts, which in the normal course of examination of
accounts may not come to light, it will not be construed as failure of auditor provided he was not
negligent or deficient in the carrying out of his normal task.
Suppose there is a loop-hole in the accounting system due to which frauds take place and auditor has
informed the management about the same with its possible consequences, he will be no more liable
for frauds committed due to the failure of the management to plug such loop-holes.
Auditor is to act as a watchdog and not as a blood-hound. All that an auditor can do is to advise his
client the ways and means to prevent the future occurrence of frauds.
Q.7. Write Short Notes on:

(1) Concept of True & Fair view.
(2) Window Dressing.
(3) Secret Reserve
(4) Auditor - A Watch-dog and not a Blood Hound.

Ans.:
(1) CONCEPT OF TRUE & FAIR VIEW:
After completion of the audit of accounts an auditor has to prepare his report on the accounts audited by him.
In this report he has to state whether the accounts show a true and fair view of the state of affairs of the
concern. Therefore it is necessary to understand the meaning and significance of the true and fair view concept.
Before the enactment of the Companies Act, 1956, the phrase used in the auditor’s report was “True and
Correct”. The words “True and Correct” mean arithmetical accuracy in the accounts is not sufficient. The
accounts must also show a fair picture from the point of view of a number of persons. With this view point,
Sec. 227(2) of the Companies Act 1956, requires the auditor to state in this report whether:
(a) the Balance sheet gives a true and fair view of the Company’s affairs as at the end of its financial year,
(b) the Profit and Loss Account gives a true and fair view of the Company’s Profit or Loss for its financial
year.
The concept of the true and fair has not been defined under the companies Act, 1956. However, it can be said
that a true and fair presentation of accounts statements would require the following:
Requirement of True & Fair presentation of Accounts
i) the financial statements shall be prepared as per the provisions of Schedule VI of the Companies Act
1956 and that they should be in Agreement with the books of accounts
ii) there is no under valuation or over Valuation of the assets and liabilities of the concern.
iii) that the stocks are neither under valued nor ever valued and that the same method of valuation is
consistently followed.
iv) Proper depreciation is provided on the fixed assets.
v) Proper provision has been made for bad and doubtful debts, outstanding liabilities, expected losses
etc.
vi) that there are no secret reserves.
vii) that a proper distinction is made between capital and revenue expenditure.
viii) that there is a proper disclosure of contingent liabilities events occurring after the Balance Sheet date
etc.
ix) that the Profit and Loss Account shows clearly and correctly the result of the working of the year.
x) that the Balance Sheet exhibits a clear position of the assets and liabilities on the Balance Sheet date.
On the basis of the above it can be said that the expression “true and fair” would mean that the accounts must
be presented in such a manner that they are fair from the point of view of the interests of the shareholders,
investors, creditors, etc. The words “true ad fair” place a greater responsibility on the auditor to satisfy himself
that the accounts audited by him are not only arithmetically correct but they are also a fair representation of
the state of affairs of a concern. In short it means two things:
1. Absence of window pressing and
2. Absence of secret Reserve.
(2) WINDOW DRESSING:
Window dressing offers to the art of showing the position of a concern at a better level than the existing one.
It means that the real state of affairs of the company is not disclosed i.e. true value of the assets and liabilities
is not shown in the Balance sheet. A sound financial position is painted on the face of Balance Sheet by
concealing the actual state of affairs of the concern. Hence, window dressing is a position where the true and
fair view is distorted.
A rosy picture of assets and liabilities of the business is presented. It is a reverse picture to the creation of
secret reverse. Following are the methods by which window dressing may takes place.
Methods or Ways of Window Dressing (How Window Dressing is done)
1. Inadequate depreciation is provided on fixed assets.
2. No Provision for doubtful debts is created on debtors.
3. Revenue expenditure treated as capital expenditure.
4. Overvaluation of stock.
5. Slow moving item of stock or damaged stock etc. are shown at full cost.
6. Fictitious assets are not written off but shown as real assets.
7. Actual liability shown as contingent liability.
8. Showing fictitious credit sales.
9. Treating a capital receipt as an item of income e.g. treating an advance from a customer as actual sale.
10. Treating a Liability as an item of income e.g. treating advance rent received as a receipt of rent.
The purpose of window dressing is as under:
1. To attract more applications for shares or debentures in case of public issue.
2. To get more remuneration to the managerial personnel on a percentage of profit basis.
3. To get finance facilities like overdraft or loan from banks etc.
4. To get better credit terms on purchases.
5. To attract more purchase consideration in case of amalgamation etc.
6. To demand more goodwill in case of admission of partner.
Window dressing is manipulation of account in which certain adjustment is made in such a way by the
management that the financial statement shows the position of the company much better and sound then the
actual position. It does not necessarily involves misappropriation of cash. It does not mean that there is fraud
done by cashier in maintaining cash book, it is just fraudulent manipulation of account generally done by
management and therefore it does not necessarily contains or results into misappropriation of cash and goods.
Auditor’s Duty regarding window Dressing
If window dressing is done, the financial statement does not give true and fair view. So auditor should not
allow existence of window dressing. It is against the principles of accountancy. If he find window dressing
then first he should ask the directors to put the matter right but if directors do not agree then he should report
this fact to shareholders.
1. Disclose in Audit Report
The auditor of a company has to report under s. 227(2) of the Companies Act. Whether the accounts give a
true and fair view (a) in the case of the Balance Sheet, of the state of the company’s affairs as at the end of the
financial year, and (b) in the case of the profit and loss account, of the profit or loss for the financial year. So,
it is his duty to prevent or report any window dressing.
2. Verify Income
He should verify whether the income has been properly recorded in the books and reported in the final accounts.
3. Verify Assets and Liabilities
He should verify all the assets and check the valuation of each asset. Similarly, he should verify all the liabilities
and examine the correctness of their value. He should see that no actual liability is shown as a contingent
liability. To check the valuation of Fixed Assets he should see that adequate depreciation is charged.
4. Verify the value of closing stock
He should verify the value of the closing stock. He should see that there is no change in the basis of valuation
of the closing stock. If there is any change, its effect on the profit for the year should be disclosed separately.
5. Disclose change in Method Accounting
He should see whether there is any change in any method of accounting e.g. in the method of charging
depreciation or in valuation of closing stock or in accounting for foreign exchange transactions and so on. If
there is any change, the information of such a change ad its effect on the profit for the year should be disclosed
separately.
6. Prevent Omission of Liabilities
Similarly, he should see that none of the liabilities is omitted from the books. All outstanding expenses are
recorded with correct amount.
(3) SECRET RESERVES:

A Secret Reserve is any reserve which is not seen on the face of the balance sheet. Other terms for secret
reserve are Inner Reserve, Internal Reserve or Hidden Reserve. This is enacted by understanding the assets or
overstating the liabilities. There is no account called secret reserve. It is indirectly created by recording the
usual accounting transactions in an unusual manner. In secret Reserve Assets are undervalued, liabilities are
overvalued and profit is understated.
Only Banking and Insurance Companies have a provision to create secret reserves. Other companies do no
usually create such reserves.
Why Secrete Reserves are created Or Objects of Secret Reserve:
1. Mislead Competitors :
A concern may like to mislead its competitors by hiding its real earnings.
2. Hide Abnormal Profits:
Sometimes, the concern may earn extra-ordinary or abnormal profits. The concern may not earn such
profits in future. Such profits may be transferred to Secret reserve to set off losses or for maintaining
dividends in the year of loss in future.
3. Mislead workers:
Workers may be mislead by showing low profit in order to avoid increase in wages and bonus.
4. Speculation in shares:
Management circle may buy shares at low price and sell later on at higher price by showing more
profit.
5. Legally allowed to Banks
In banking companies, a secret reserve is legally allowed to be created. Banks are allowed not to disclose
their provision for bad and doubtful debts in order to maintain public confidence.
Method of Creating Secret Reserves:
1. By charging excess depreciation.
2. Posting capital expenses as revenue expenses.
3. Showing contingent liabilities as real.
4. Excessive provision for doubtful debts.
5. Overvaluing liabilities. Like outstanding expenses.
6. Undervaluing closing stock
7. Suppressing sales.
8. Ignoring income receivable and pre-paid expenses.
9. Showing fictitious credit purchases
However, there are many charges and objections to maintaining secret reserves. Some of them are:
Objections to Secret Reserve
a. Financial statements do not show a true and fair view.

b. The dividend declared will be less than possible.

c. Fall in dividend could cause fall in share market value.
d. Insurance claims for damages will be less in case of under-valuation of assets.

e. Misuse of funds drawn to pay fictitious liabilities by directors.
f. Use of funds by directors to cover losses caused due to their negligence.

g. Directors could speculate in shares of the company by varying dividend.
Secret Reserves could be used by directors to misuse the power they hold. Creation of secret reserves is now
prohibited by Parts I and II of Schedule VI of the ICA. The Central Government can exempt any class
of company to maintain secret reserve in public interest. Now Banks and Insurance companies are
allowed to maintain secret reserves.
Auditors Duties with regard to Secret Reserves:
1. Audit Report:
The auditor of a company has to report whether the accounts give a true and fair view.
(a) in case of the Balance Sheet of the state of the company’s affairs as at the end of its financial
year, and
(b) in the case of the profit and Loss for its financial year. So, it is his duty to report any secret
reserve.
2. Articles:
He should study the Articles of Association of the company to verify the provision regarding reserves
contained there in. For other companies registered under Indian Co.’s Act 1956 it is not allowed but in
case of banking company it is allowed if it is in the interest of general public.
(4) AUDITOR - “A WATCH-DOG AND NOT A BLOOD HOUND”
The above statement is a famous remark of Justice Lopes in the Kingston Cotton Mills case in 1986.
The facts of the case were as follows. The accounts of the company had been falsified by its manager by over-
valuation of stock in trade for a number of years. Thus profits were inflated and consequently dividend was
paid out of capital. The auditor had relied on the stock sheets prepared by the officers of the company and
signed by the manager. So, the auditor was sued for negligence for having relied upon stock sheets so prepared.
The auditor contended that as there was nothing to arouse his suspicion, he relied upon the stock sheets signed
by a responsible official of the company.
In the course of judgement, Justice Lopes remarked on the following lines: The auditor has to use
reasonable caution, care and skill. What is reasonable care depends on the circumstances of each case. The
auditor need not behave like a detective. He need not approach his work with a foregone conclusion that the
transactions are fraudulent. “He is a watchdog and not a blookhound”. He is justified in believing the tried
servants of the company. But if there is anything suspicious, he has to probe deeper. Otherwise reasonable
care would do. Auditors are not to be made liable for not tracing out ingenious and carefully laid schemes of
fraud by the directors which have gone undetected for years.
The analogy is between the auditor and the watchdog. The auditor is the watchdog that protects the
property of the shareholders. The watchdog will bark if there is a trespass. The auditor will see that proper
accounts are maintained and the Profit and Loss Account and the Balance Sheet show a true and fair view of
the finances of the company. To that purpose, he would use reasonable skill and care in auditing the company’s
accounts. He will report if he finds anything improper.
The Kingston Cotton Mills judgment, however, has come under sever criticism, and particularly after
the Mckesson and Robins case in the U.S.A., the standard of work expected of an auditor has undergone a
great change. In U.S.A., auditors now attend stock taking. Even in England, it is now considered essential that
the auditor should be physically present at the stock taking at least for sometime and see if the stock verification
procedure is properly followed, and he would test check a few items. It will not now do if he merely accepts a
signed certificate of the value of the stock.
Though essentially the auditor is not a bloodhound, he has to be a very alert watchdog and not the one
that will bark only if a thief trips on it ! If reasonable care would detect a fraud and the auditors have not
detected it, he will be held liable. In the Irish Woolen Co. Ltd. V. Tyson case, for example, the auditor was held
liable for damages sustained by a company by reason of falsification which might have been discovered by the
exercise of reasonable care and skill in the performance of the audit.
Q.9. Write Short Notes on Teeming & Lading :

Ans. Teeming & Lading is method of committing a fraud. Such a fraud is committed in connection with the receipt of
cash from debtors.
In such a case, when cash is received from one debtor, It is misappropriated by the cashier. After while when
the second debtor makes his payment that amount is recorded as receipt from the first debtor. The second
debtor is given credit only when the third debtor pays off his dues. This is done on continuous basis. This process
is adopted with every subsequent collection so that no customer account is outstanding for a long period.
For e.g. suppose the cashier has received cash from Ram at that time the cashier does not pass any entry for the
receipt. He has thus misappropriated this money. After some days the cashier receives cash from Shyam. At
this moment the cashier gives credit to Ram and not to Shyam and he carries on this process, so that he can use
the money for himself. When the cashier finally gets his own money, he puts it in the cash book of the company
giving credit to the last person from whom he had received cash but had not credited his account earlier. This
method of committing a fraud is also known as "Delayed accounting of money received" or "Carry-over frauds"
or "Lapping" or "Short Banking"
Such frauds, if exists have to be detected by the auditor in the following manner :
1. Check debtors account : He should check the debtor account from time to time, specially the debtor who have
made part payment.
2. Confirmation of debtors balance : The auditor can directly confirm the balances with the debtors themselves.
3. Internal control system: Set up a good internal control system for recording cash transactions. E.g. cashier
should not have access to ledger.
4. Surprise cash counting : The Responsible officer should do surprise cash counting
5. Compare amount deposited with pay-in-slip : Amount deposited in the Bank should be compared with the
pay-in-slip counterfoil to check whether any misappropriations have taken place.
6. Compare dates : The auditor should compare the date on which the money has been received, the date on
which cheque has been deposited into the Bank and the date of entry of that transaction in the Cash Book.
Q.10. What are the basic principles governing audit?

Ans. The Institute of Chartered Accountants of India (ICAI) has laid down the basic principles governing an audit
[Auditing and Assurance Standard 1 (AAS -1)]. These basic principles of audit guide an auditor as to how to
conduct an audit and give an audit report.
1. Integrity, Objectivity and Independence:
Integrity: Auditor should be straight forward, honest & sincere in his approach to his professional work.
Objectivity: Auditor should do auditing objectively and not subjectively. He should be free from bias and emotions
while doing auditing.
Independence : The audit should be carried out by person not having any interest or influence in the organization.
Auditor should maintain an impartial attitude and he should be free from all obligations of the management.
The objectives of auditing cannot be achieved unless the principle of independence is respected.
2. Confidentiality :
While auditing the books of accounts, auditor may come across confidential information of clients business. He
should not disclose such information to third parties except when there is a legal or professional duty to disclose.
In other words, the auditor should keep his eyes and ears open but his mouth shut up.
3. Skill and Competence :

Audit should be performed and the report should be prepared with due professional care by persons who have
adequate training, experience and competence in auditing. Auditor should have a professional qualification.
4. Work Performed by Others:
The auditor should carefully direct, supervise and review the work performed by his assistants. He should
obtain reasonable assurance that work performed by other auditors or experts or assistants is adequate for his
purpose.
5. Documentation / Working Papers:
The auditor should document matters which are important in providing evidence that the audit was carried
out in accordance with the basic principles.
6. Planning:
The auditor should plan his work to enable him to conduct an effective audit in a efficient & timely manner.
Plans should be based on knowledge of clients business and revised during the course of audit, if required.
7. Audit Evidence:
Auditor should obtain sufficient appropriate audit evidence so as to enable him to draw reasonable conclusions
and give his opinion on the financial statements. The evidence may be obtained through Vouching of transactions,
Verification of assets and liabilities, Ratio analysis, etc.
8. Evaluation of Accounting System and Internal Control:
The auditor should ensure that the accounting system is adequate. He should see to it that all the transactions
have been properly recorded in the books of accounts. He should study and evaluate the internal control.
9. Audit conclusion & Reporting:
On the basis of audit evidence obtained, auditor should form his opinion about the financial statements. He
should submit his opinion report to the shareholders.
Q.11. What are the Essential qualities of an Auditor?

Ans. Essential Qualities of an Auditor :
1. Integrity : Auditor should be honest, sincere & straightforward while performing his professional duties.
2. Objectivity : He must be unbiased, he has to adopt impersonal approach.
3. Independence : He should not subordinate his judgement to the will of others.
He should be independent while doing his work.
4. Confidentiality : He should not disclose confidential information acquired during the conduct of his professional
duties to any third party except when
a. Permitted by client or
b. Required by law
5. Communication Skill : During conduct of audit, he has to interact with various officers & staff of organisation
& third parties, thus he requires good oral & written communication abilities.
6. Technical skills : He must have good hand on accounting & auditing etc. Moreover, he should be aware of
latest development in auditing standards so that he can perform audit in effective manner.
7. Logical Skills : He must be able to analyse & interpret problems so that he can accordingly deal with the same.
8. Chartered Accountant : A company auditor must be chartered accountant. This is a qualification rather than
quality.
9. Knowledge : He should have general knowledge of clients business and economic trends etc. He should be
aware of Company Laws, Business Laws, Income Tax Laws & Contract Act etc.
He should be aware of all latest amendments in laws as well as technique of accounting.
10. Judgement : He should be capable to taking firm judgement in controversial matters.
11. Tact / Smart : He must be smart enough to raise queries on relevant matters. He must be able to deal with
different person in different situation. He has to direct & supervise his own staff as well, thus he should be
tactful.
Q. 12 Disinguish between :
Ans. 1. Accounting & Auditing :
Accounting Auditing
1. Meaning
Accounting is writing of books of accounts & Auditing is examination of books of accounts &
preparation of final Accounts. reporting whether they are true & fair or not.
2. Objective / Purpose
Object is to prepare balance sheet to show financial Object is to examine and report:
position as at the year end and Profit & Loss A/c - Whether Balance sheet shows true & fair financial
to show profit or loss for the year only position.
- Whether Profit & loss A/c shows true & fair amount
of Profit or Loss.
3. Scope
Accounting is limited to books of accounts only. Auditing is not limited to only books of accounts.
4. Qualification
No qualification is prescribed for an accountant. In case of auditors, he should always be a Chartered
However, if the accountant is a qualified person, Accountant within the meaning of Chartered
it is always desirable. Accountants Act, 1949.
5. Responsibility / Appointed By
Accountant is employed by and is responsible to Auditor is appointed by owners / Shareholders and
management. reports to them.
6. Reporting
An accountant prepares the financial statement and The auditor has to submit report to the shareholders
explains them to management but has not to report in prescribe form.
thereon.
7. Beginning and End
Accounting begins with vouchers and books of Auditing begins where accounting ends. Audit is
original entry & ends with preparation of final complete when auditor submits his audit report.
accounts.
8. Errors & Frauds
Accountant may commit errors & frauds. Auditor can not afford to commit errors & frauds.
Auditor will detect& prevent errors & frauds.
2) Auditing Investigation
1. Meaning
Auditing is examination of books of accounts & Investigation means an inquiry to be made for
reporting whether they are true & fair or not. specific purpose.
2. Objective / Purpose
Purpose of auditing is to find out whether the Specific purpose of investigation may be to:
Balance Sheet and Profit and Loss A/c show true - Detect a fraud,
and fair view of state of affairs of business. - Find out profitability,
- Find out financial position, etc.
3. Scope
Scope of the Audit is restricted to Balance Sheet & Investigation is not restricted to the financial
Profit & Loss Account, related vouchers & statement and the books of account only.
documents.
4. Qualifications
Auditor of a company must be a practicing No qualification are prescribed by law for an
chartered accountant. investigator i.e. employee of the company or outside
agency can be appointed as an investigator.
5. Responsibility / Appointed By
Auditor is appointed by owners or shareholder. Investigator may be appointed by outsider e.g.
Income - tax Dept., Registrar of companies, investors,
Lenders, purchaser of business / Shares.
6. Reporting
Auditor's Report is presented to the shareholders The investigation report is presented to the clients.
of the company in a prescribed form in case of There is no prescribed form.
limited companies.
7. Nature of Assignment
Audit is an annual recurring assignment. Investigation is a specific non - recurring assignment.
8. Compulsory
Audit is compulsory for companies. Investigation is not compulsory.

2. AUDIT PLANNING, PROCEDURES AND DOCUMENTATIONS
Q.1. What are the preliminary steps to be taken by an auditor before commencement of an audit?
Ans. A person, who is qualified under Section 226, will be appointed as auditor to company under Section 224,
Before Commencing the Audit work. The following preliminary steps are to be executed.
1. Verification of Appointment: First of all auditor has to conform whether his appointment is properly
made or not. If appointment is not proper, he can claim remuneration, if he is appointed by share
holders, he has to see whether the procedure specified under Section 224, is properly followed or
not. If he is appointed by directors he has to go through the resolution made by the court.
2. Verification of Memorandum: Memorandum is started of the company. It deals with external affairs
of the company. Out of its clauses, the information written under objects clause, liability clause and
capital clause is useful to auditor. Therefore he should refer to memorandum and such information
should be taken to audit note book.
3. Verification of Articles: Articles read about internal affair of the Company. It includes calls on share,
transfer of shares, transmission of shares, reserves, payment of dividend etc. All these things are
useful to Company auditor and hence abstracts from articles should be taken to audit note book.
4. Verification of Prospectus: Before commencing the audit work, auditor should refer to prospectus
also to obtain information relating to minimum subscription, preliminary expenses, underwriters
commission, terms of issue etc.
5. Verification of Contract Deeds: On account of legal entity company can enter into contracts. Auditor
should refer to those contract deeds to know about names of parties to the Contract, Contract prices,
other terms etc.
6. Verification of Certificate of incorporation and certificate of Commencement of business: If it is
first audit of the company, auditor should refer to Certificate of Incorporation and Certificate of
Commencement of Business issued by registrar of Companies to conform that the company has got
formed properly in accordance with requirements of companies act.
7. Verification of Internal Check System: Internal check means arrangement of staff in such a way
where work done by one clerk automatically gets checked by the other. Well planned internal check
system minimizes scope for frauds and errors. In presence of well designed internal check system,
auditor can follow shortcut methods like test checking etc. Good internal check system reduces the
work load of auditor.
8. List of Books: Auditor should obtain list of books maintained by the company. Company maintains
several statutory books or compulsory books, Statistical or Optional books, Cost records, financial
records etc. All those books are to be listed.
9. List of Offices: Auditor should refer to organization chart of the company and key positions are to
be found. Here auditor has to gather names, rights, duties, specimen signatures etc. of staff members
employed at such key positions.
10. Verification of Financial Statement: Auditor should get copies of previous 3 or 4 years financial
statements along with audit reports. By going through them an idea with regard to profitability,
financial position and previous auditor’s opinion can be obtained.
11. Central Government Permission: On certain occasions company has to obtain permission to central
government. For example; to issue share warrants, to grant to directors etc. Here auditor has to
observe whether permission from Central Government is obtained or not.
12. Audit Program: Planning of audit work is called Audit Programme. It shows division of audit work
among audit staff. After preparation of audit program audit work can be commenced. Audit program
has several advantages like completion of audit work within desired period, proper entrustment of
work, etc. At the same time audit programme has certain disadvantages also like making work
mechanical etc.
Q.2. What is "Audit Planning"? Factors to be considered in Audit Planning?

Ans. As per Auditing and Assurance Standard 1, "Basic Principles Governing an Audit", Audit Planning is one
of the basic principles. Accordingly, it states
"The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner.
Plans should be based on knowledge of the client's business.
Plans should be made for :
(a) Acquiring knowledge of the client's accounting systems, policies and internal control procedures;
(b) Establishing the expected degree of reliance to be placed on internal control;
(c) Determining and programming the nature, timing, and extent of the audit procedures to be performed;
and
(d) Coordinating the work to be performed.
Adequate audit planning helps to:
• Ensure that appropriate attention is devoted to important areas of the audit.
• Ensure that potential problems are promptly identified;
• Ensure that the work is completed expeditiously;
• Utilize the assistants properly; and
• Co-ordinate the work done by other auditors and experts
FACTORS TO BE CONSIDERED FOR PLANNING AUDIT:
Planning his audit, the Auditor will consider the following factors -
1. Complexity of the Audit: The scope of work and reporting responsibilities is analyses in order to determine
the complexity of audit. Environment in which the entity operates: This enables the Auditor to understand
various operational aspects of audit, e.g. extent of computerization, nature of internal controls, general
attitude of personnel, etc.
2. Previous experience with the client: By analysing the previous year's audit working papers and other
relevant files, the Auditor should pay particular attention to matters that required special consideration
and decide whether they might affect the work to be done in the current year.
3. Knowledge of the client's business: This is required to establish the overall audit plan. The Auditor will
be able to -
(a) identify areas of special audit consideration,
(b) evaluate the reasonableness both of accounting estimates and management representations, and
(c) make judgments regarding the appropriateness of accounting policies and disclosures.
4. Discussion with Client: The Auditor can discuss his overall plan and certain audit procedures with the
client to improve the efficiency of the audit and to coordinate audit procedures with work of the client's
personnel. The overall audit plan and the audit Programme, however, remain the Auditor's responsibility.
Q.3. What is an Audit Programme? What are the advantages of audit programme?
Ans. An Audit Programme is a detailed plan of work, prepared by the Auditor for carrying out an audit. It constitute
the plan of the work and provides a basis for the supervision and control of the audit work. It consists of a set of
techniques and procedures, which the Auditor plans to apply in the given audit for forming an opinion about
the Financial Statements.
The advantages of Audit Programme are :
1) Instructions :
The audit programme specifies the extent and manner of checking and verification to be carried out
in respect of different aspects of the accounting record. These instructions help the assistants and
staff in knowing how much is to be checked and in what manner.
2) Checklist :
It servers as a ready checklist of procedures and techniques to be applied and minimises the possibility of
overlooking any of the important audit steps.
3) Phasing work :
The work can be planned and phased properly. The possibility of ignoring or overlooking certain
aspects of verification based on a mental plan, is avoided.
4) Selection of Team Members :
The audit programme helps in selection of assistants for jobs on the basis of their capability. It is
possible to match audit staff capabilities with work requirement.
5) Supervision :
The work can be supervised and controlled better by periodic reference to the programme.
6) Work Review :
The progress of the work at any point of time can be readily known by reference to the entries on the
audit programme.
7) Future Planning :
It serves as a guide for carrying out the current audit and as a basis for drawing the future audit
programme.
8) Responsibility :
The programme specifies instructions to various members of the audit team. Responsibility for an
audit examination is fixed on the team member who has signed after completing a particular procedure
under the programme.
9) Basis for opinion :
It serves as evidence of the work performed and provides a sound basis for the expression of Auditor's
opinion.
10) Record of Work :
Audit programme is a record of work done particularly in defending a suit brought against the
Auditor for negligent performance of work. It is sufficient proof that the work was carried out with
reasonable skill and care that is expected of a professional.
Q.3 What are the disadvantages of audit programme? By what measures can the disadvantages of Audit
Programme be overcome?
Ans. The disadvantages of Audit Programme are :
1) Mechanical work :
The audit may be performed mechanically without reference to the special circumstances of the client
or to the development of any new or unusual features in the client's business.
2) Rigidity :
Special circumstances may sometimes require additional procedures or techniques. The staff members,
however, may limit themselves to the pre-determined programme.
3) False sense of security :
Members of the audit team may feel that everything is taken care of by the audit programme. They
may fail to apply their mind in circumstances that arise during the course of work.
4) Lack of Initiative :
Independent judgment and initiative of the staff may be restricted. It may frustrate talented and
efficient audit staff.
5) Lack of Suitability :
Wrong procedures may be undertaken which may be inappropriate to the circumstances of the client's
business. The limitations of audit programme maybe avoided by taking the following precautions -
1) Suitability :
While laying down the audit programme, the Auditor should consider whether the same is
commensurate with factors like -
a) nature-of the entity's business,
b) scale of operations,
c) volume of transactions and
d) the efficacy of internal controls.
2) Review of Internal Controls :
Internal Controls should be reviewed and evaluated to obtain knowledge of changes in the controls
and systems and procedures. The Auditor can spot weaker aspects of the control and use his knowledge
in revising the audit programme.
3) Changed business operations :
The Auditor should obtain information about new lines of business or new systems to carry on the
old business. The audit programme should be recast or modified to suit the changed business operations
and practices.
4) Participative approach :
The Auditor should encourage his audit assistants to keep an open mind and make suggestions for
amending the programmes. The persons doing the actual field work would be in a better position to
know the actual changes and requirements of the situation.
5) Flexibility :
The audit programme should not become stereotyped. There should be revision from time to time
according to circumstances even though no material change has taken place in the client's business
operations and the business practice.
6) Minimum Requirement :
It should be impressed upon the audit assistants that the programme provides for the minimum tests
that should be carried out and they should undertake tests and surprise checks, considered
appropriate, even though not provided in the programme.
Q.4 What is Audit Evidence ? What are the methods (techniques) of obtaining evidence?
Ans. Meaning of Audit Evidence Any document, piece of information, voucher written or oral statement of any
procedure which assists an auditor in forming his opinion in regard to the accuracy of data under audit. The
role of the auditor is that of an independent professional critic who investigates, analyses and evaluates
the information underlying the statement as a means of reaching a conclusion as to their fairness. Before
and auditor can express an opinion on financial statements, he must have sufficient evidence that
• The items in the financial statements are supported by the balances in the ledger accounts.
• The balances in the ledger account summarize correctly the numerous debit and credit entries.
• These debit and credit entries in the accounts represent proper accounting interpretation of all the
transaction entered into be the business.
Techniques (Methods) to obtain Audit evidence :
Audit Techniques means the methods used to obtain audit evidence. As per [AAS-5] audit techniques are
of following types :
1. Inspection : It consists of examination of records, documents and tangible assets. Examination of
documents is one of the most important techniques of auditing. As most of the transaction are supported
by documents, it becomes necessary for the auditor to examine large number of documents in the course of
audit.
2. Observation : Observation consists of observing a procedure being performed by others. Thus, auditor
may observe the procedure of physical inventory being taken by the client's staff.
3. Inquiry : Inquiry consists of seeking information from others. Thus, auditor may seek information or
explanation from employees of the client. He may also seek information from outsiders e.g. bankers,
lawyers, customers or suppliers of the client.
4. Confirmations : Confirmation is a formal inquiry from outsiders. Thus, auditor may seek confirmations
from banks, suppliers, debtors etc. regarding their balances with the concern.
5. Computation: It refers to checking the arithmetical accuracy of the transactions recorded in the
books of accounts, vouchers, documents. The auditor may follow the same procedures as is followed
by the accountant for verifying arithmetical accuracy.
6. Analytical Review : Analytical Review consists of study of various accounting ratios (e.g. Gross
Profit to Sales, Input - Output Ratio, Debtors' Turnover Ratio). It also consists of comparison of
figures of current year with those of past to ascertain unusual differences. Ledger scrutiny uses this
technique to analyse accounts.
Q.5 Write a note on Audit Working Papers.

Ans. MEANING: The audit working papers constitute the link between the auditor's report and the client's
records. Documentation is one of the basic principles listed in AAS 1. according to AAS 3, documentation
refers to working papers prepared or obtained by the auditor and retained by him in connections with
performance of his audit. The objects of an auditor's working papers are to record and demonstrate the
audit work from one year to another. Therefore, working papers should provide for:
a) Means of controlling current audit work;
b) Evidence of audit work performed;
c) Schedules supporting or additional item in the accounts;
d) Information about the business being audited, including the recent history.
IMPORTANCE OF AUDIT WORKING PAPERS:
1. It provides guidance to the audit staff regard to the manner of checking the schedules.
2. The auditor is able to fix responsibility on the staff member who signs each schedule checked by him.
3. It acts as an evidence in the court in the court of law when a charge of negligence is brought against
the auditor.
4. It acts as the process of planning for the auditor so that he can estimate the time that may be required
for checking the schedules.
FEATURES :
1. As audit working papers are quite useful they should be prepared properly. They should have the
following essentials:
a) Standard form - they should be prepared in a standard form. The subject matter should be arranged
under various heading and sub-headings.
b) Proper layout - there should be proper design and layout of the working papers. This will bring
uniformity into the maintenance of working papers.
c) Space for margins - there should be enough space for margin after each note for noting down the
auditor's remarks and decisions.
d) proper organisation and arrangement - the working papers should be properly organized and
arranged. In other words the working papers should be so organized and arranged that the
auditor will be able to locate any particular matter easily.
e) Completeness - the audit working papers should be complete in all respects. They should contain
detailed information on all essential facts or points.
f) Clarity and Accuracy - the working papers should be quite clear and self explanatory. The
information contained in the working papers should be accurate.
g) Good quality paper - paper of good quality should be used for working papers as they are
subject to frequent handling further the paper used should be of uniform and convenient size so
that they can be easily filed.
Q. 6 Disinguish between permanent audit file and current audit file.

Ans.
Permanent File Current audit File
Meaning :
Permanent file contains papers which give Temporary file contains papers which are relevant
information about the constitution of organisation, for the audit of current year only.
policies adopted by management, systems &
procedures, etc.
Contents :
1. Certified copies are memorandum of 1. Copy of letter of appointment.
association, Articles of association, Partnership
Deed etc.
2. A brief note on the nature of business carried 2. Copy of the financial statements.
on.
3. List of directors & details of other directorship 3. Audit Plan and Audit Programme.
and details of companies or firms in which
they are interested.
4. Copy of organisation chart giving details of 4. Queries raised during the course of audit and
list of officer's along with the nature of work details of response received.
done by them.
5. Details of Holding and subsidiary companies. 5. Extract of minutes book of meeting of the
directors and shareholders.
6. Copy of accounting policies adopted and 6. Confirmation obtained from debtors, creditors,
details of internal control system. banks etc.
7. List of offices and factories giving details of 7. Certificate for valuation of stock, verification of
fixed assets, valuation of current asset & so on.
address and contact details.
8. Communication with the previous year auditor 8. Copies of correspondence with the joint or
and his reply. branch auditors.
9. Audit Report along with details of how each
conclusion was reached.
Q.7. Whose property are the audit files? How should its custody be kept? Discuss the concept of 'Lien on
Working Papers'. Explain the term 'Auditor's Lien'
Ans: 1) Ownership :
The working Papers are the property of the Auditor. The Auditor may, at his will , make portions of
or extracts from his working papers available to his clients.
2) Custody :
The Auditor should take proper measures for custody and confidentiality of his working papers.
3) Retention period :
The Working Papers should be retained for a period of time sufficient to meet the needs of his
practice and satisfy any pertinent legal or professional requirements of record retention. The ICAI
has recommended that an Auditor should maintain his records relating to audit and other work
done, including routine correspondence and other papers, for a minimum period of 10 years.
Case (Chantrey Martin and Co. V. Martin )
The following documents were the property of the Auditor -
1) Working Papers and Schedules relating to the audit,
2) Draft accounts of the Company,
3) Draft tax computation prepared by an employee of the Auditor.
4) Correspondence between the accountant and the taxationauthorities with regard to the client's accounts
and tax computations.
5) Documents confirming the Bank Balance.
6) Documents confirming the custody of securities.
7) Documents confirming the balance of Debtors or Creditors.
8) Correspondence with third parties as the Auditor of the Company or any other documents.
4) Lien on Working Papers :
Lien arises only in case of other persons' property. Hence, the question of lien on the working papers
does not arise since they belong to the Auditor.
Q.8. The Auditor's lien on client's books and records is unconditional. Explain.
Write short notes on Auditor's Lien.
Ans: 1) Meaning :
Lien refers to the right of a person for lawful possession of somebody else's property on which he
has worked. He has a right to retain such properties for non-payment of his dues for the work done.
2) Question as to Auditor's Lien :
A question arises as to whether the Auditor can exercise his lien on client's books and documents
which are in his possession for non-payment of fees by the client, for the work done on the books
and documents.
3) ICAEW Pronouncement :
The Institute of Chartered Accountants of England and Wales has expressed a similar view subject to
the following conditions -
a) Documents retained must belong to the client who owes money.
b) Such documents must have come into the Auditor's possession on the client's authority and not
received through irregular or illegal means. In case of a Company, the books must have been received
by the Auditor on the authority of the Board of Directors.
c) Some work must have been done in relation to such documents.
d) The fees for which the lien is exercised must be outstanding in respect of such work.
4) Supreme Court View :

In R.D. Saxena vs Balram Prasad Sharma [2000] 7SCC 264, the Supreme Court has held that 'no
professional can be given the right to withhold the returnable records relating to the work done by
him with his clients matter, on the strength of any claim for unpaid remuneration. The alternative is
that the professional concerned can resort to other legal remedies for such unpaid remuneration.'
5) Conclusion :
In view of the above, it can be concluded that, generally, the Auditor cannot exercise lien on his
client's books and records for unpaid remuneration.
Q.9 What is the importance of an Audit Note Book? Describe its contents and give a specimen page of on
Audit Note Book with five imaginary entries therein.
Ans: 1) Meaning :
An Audit Notebook is a bound book in which a variety of matters observed during the course of
audit are recorded. It is a notebook containing points or queries that require clarificaiton,explanation
and investigation and the manner in which they are finally settled.
2) Structure :
The Audit Notebook is generally divided into two parts -
a) for keeping a record of general information as regards the audit as a whole; and
b) for recording special points which have been observed during the course of audit of the accounts of
particular years.
3) Contents :
General Information containing -
a) Nature of the business carried on.
b) Improtant provisions affecting its functioning like Memorandum and Articles of Association,
Partnership Deed, etc.
c) Structure of the f inancial and administrative organisation.
d) A list of the books of account.
e) Name of principal officers, their duties and responsibilities.
f) Particulars of the system of accounts and internal controls which are in operation.
g) Particulars of the accounting and financial policies followed.
h) Important contracts to which the client is a party e.g. Col laboration Contracts, Royalty Contracts,
etc.
Current Information containing -
a) Audit queries not cleared immediately, e.g missing receipts, vouchers, etc.
b) Mistakes or irregularities observed during he course of audit, e.g. failure to comply with requirements
of the Companies Act, or the provisions of the Memorandum or Articles; a change in the basis of
valuation of Finished Stock and WIP or in computation of depreciation; failure to provide adequate
depreciation, etc.
c) Unsatisfactory book-keeping arrangements, costing method, internal or financial administration or
organisation.
d) Important information about the Company which is not apparent from the accounts.
e) Special points requiring consideration at the time of verification of final accounts.
f) Important matters for future reference.
4) Importance :
a) Evidence Value :
Specific observations, which require follow up are maintained systematically covering the entire
range of audit work done by the Auditor. Audit Notebook constitutes important evidence of work
done and points considered in the course of an audit.
b) Report Finalisation Value :
In the course of follow-up, the observations may get settled with explanation and evidence produced
by the management at a subsequent stage. Thereafter, the Auditor is left with only the unsettled
observations and considers them from various relevant angles for preparing the audit report. The
Audit Notebook is the primary basic document in preparing the audit report on the true and fair
view of the Financial Statements.
c) Audit Process Value :
The Audit Notebook provides new way and direction to the manner, extent and timing of audit
checkings.
d) Control Value :
The Audit Notebook will show the extent and coverage of work done when the assistants are shifted
or when there is a temporary stoppage of work.
e) Protection Value :
The Audit Notebook, being a comprehensive record of work done and audit observations, is extremely
valuable to the Auditors as a document of defence when a charge is brought against the Auditor for
negligence and other shortcomings in the audit work. (In Re City Equitable Fire Insurance Company).
f) Planning Value :
The Audit Notebook is also a very useful document to plan for the next audit of the entity as also in
preparing the next audit programme as the weaknesses shown in the audit note book on various
aspects and segments of accounting would require close follow-up.


Sybcom Sem Iv - Audit Chapter 1 & 2

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Sybcom Sem Iv - Audit Chapter 1 & 2

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FY BAF, SY BMS, SY BCOM - AUDITING 1 KARNAVAT CLASSES

Q.1. Define Auditing. Explain its features.

Features of auditing are as follows:

Q.2. Explain the primary and secondary objectives of audit.

Q.3. What is an Error? What are the different types of errors?

Q.4. Explain procedures to be followed by the Auditor to detect the errors.

Q.5. What is a fraud? What are the different types of fraud?

E.g. Purchase of goods may not be recorded in purchase register.

(A) AT THE TIME OF RECEIPT OF CASH:

ACCOUNTS MAY BE MANIPULATED IN MANY WAYS. SOME OF THEM ARE AS UNDER:

Q.7. Write Short Notes on:

(4) Auditor - A Watch-dog and not a Blood Hound.

(3) SECRET RESERVES:

a. Financial statements do not show a true and fair view.

b. The dividend declared will be less than possible.

d. Insurance claims for damages will be less in case of under-valuation of assets.

f. Use of funds by directors to cover losses caused due to their negligence.

(4) AUDITOR - “A WATCH-DOG AND NOT A BLOOD HOUND”

Q.9. Write Short Notes on Teeming & Lading :

Q.10. What are the basic principles governing audit?

3. Skill and Competence :

Q.11. What are the Essential qualities of an Auditor?

2. AUDIT PLANNING, PROCEDURES AND DOCUMENTATIONS

Q.2. What is "Audit Planning"? Factors to be considered in Audit Planning?

Q.5 Write a note on Audit Working Papers.

Q. 6 Disinguish between permanent audit file and current audit file.

4) Supreme Court View :

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