Course Objectives

• The course will have the following objectives:

1. To make students understand the nature and objectives of audit;
2. To make them understand the basic principles and procedures of auditing;
3. To develop their skills to understand auditing techniques such as vouching &
verification.
4. To make students understand the role of management in the field of auditing;
5. To make them understand the powers and liabilities of auditors;
6. To develop their skills to understand the internal control system; and
7. To equip the students with modern auditing tools and use of information
technology.
 Course Books
• Text Books
– Principles of Auditing by Dr. Khwaja Amjad Saeed.

• Reference Books
– Principles of Auditing: An Introduction to International
Standards of Auditing by Rick Hayes et al.
Introduction to Auditing
 Origin of Audit
• “Audit” is derived from the Latin word

“Audire" which means to hear.

• In the good old days whenever the proprietors of a concern

suspected a fraud, certain people were appointed to hear verbal

evidence of transactions of barter etc., and to judge the facts.

• They 'heard' the points of view of those who maintained the

accounts.
 Origin of Audit (cont.)
• The roots of 'modern audit' lie deep

in the birth of Industrial Revolution

which brought large-scale production in its wake.

• The rapid growth of banking, transport and insurance development,

use of mechanical appliances and computers in business concerns

and massive growth of joint stock companies have resulted in the

growing importance of audit.

 Origin of Audit (Cont..)
• The need of audit became imminent when the management and

ownership of business was divided among different groups of

people.

• Now, it has become necessary that those who are owners of a

business should know how their money is being utilized by those

who manage the business.

• For this purpose, independent auditor has become a necessity.

 Definition of Audit
• The word 'audit' has been defined by many distinguished

authors and every one of them has attempted to highlight one

aspect or the other.

• Definitions of the word 'audit' given by authorities on the

subject are as follows:

 Definition of Audit (cont.)
"Audit is an examination of the books, accounts and vouchers of
a business that enable the auditor to satisfy himself whether the
balance sheet is properly drawn up, so as to give a true and fair
view of the state of affairs of the business, and that the profit and
loss account gives a true and fair view of the profit or loss for the
financial period, according to the best of his information and the
explanations given to him as shown by the books; and if not, in
what respects he is not satisfied."
 Definition of Audit (cont.)
• "An audit is an examination of accounting records undertaken
with a view to establishing whether they correctly and
completely reflect the transactions to which they purport to
relate.'‘
• An examination intended, to serve as a basis for an expression
of opinion regarding the fairness, consistency and conformity
with accepted accounting principles, of statements prepared by
a corporation or other entity for publication — in this case
more generally called 'examination'.
 Definition of Audit (cont.)

• Perhaps the best way to define audit is to tell why it is done, as

the action is presumably such as to fulfill its purpose.
• In this context the definition of audit would differ depending
upon whether it is in the case of concerns which voluntarily
get their accounts audited or whether it is mandatory.
 Definition of Audit (cont.)

• ISA1 entitled Objective and Basic Principles Governing an

Audit has defined audit as under:
• "An audit is the independent examination of financial
statements or related information of an entity, whether profit
oriented or not, and irrespective of its size, or legal form, when
such an examination is conducted with a view to expressing an
opinion thereon."
 Definition of Audit (cont.)
• ISA 1 lays down that the auditor is responsible for forming
and expressing his opinion on the financial statements.
• The term "Financial Statements" includes balance sheets,
income statements or profit and loss accounts, statements of
changes in financial position, notes and other statements and
explanatory material identified as part of financial statements.
 Definition of Audit (cont.)
(Rickey Hayes et al.)-the Reference Book Author

An audit is a systematic process of objectively obtaining and

evaluating evidence regarding assertions about economic actions
and events to ascertain the degree of correspondence between
these assertions and established criteria, and communicating the
results to interested users.
 What is an “Audit”?

“Audit is an independent examination of financial

statements of an entity that enables an auditor to express
an opinion whether the financial statements are prepared
(in all material respects) in accordance with an identified and
acceptable financial reporting framework (e.g. international or
local accounting standards and national legislations)”.
 Why is there a need for an audit?
• Audit is required because the management reports
may not be credible to owners as they may:

a. Contain errors
b. Not disclose fraud
c. Be inadvertently misleading
d. Be deliberately misleading
e. Fail to disclose relevant information
f. Fail to conform to regulations
 Difference b/w Auditing and Accounting
• Both are closely connected but are separate activities.
• Accounting is the process of recording, classifying,
summarizing and reporting financial information in a
logical/systematic manner for the purpose of decision making.
• In auditing the financial statements, the concern is with
determining whether the presented financial statements
properly (true and fair) reflect the financial information that
occurred during the accounting period.
 Accounting VS Auditing
• It means maintaining the books of accounts • It means examining the accounts and reporting on
their accuracy.

• The work done by the accountants enable the • The auditor’s work begins, where the accountant’s
auditor to give a finishing touch. work ends.

• The accountant prepares the financial statements. • Audit entails preparation and submission of report
on the checking and examination of the accounts etc.

• No prescribed qualifications are legally required to • It is mandatory that an auditor of a public limited
be possessed before appointment of an accountant company must be a charted accountant.
is made.

• The job of an accountant is generally entrusted to • The auditor of a public limited company is
him by management and he is expected to perform appointed by shareholders
the same.
 Qualities Required in an Auditor

• The qualities required in an auditor are:

1. Professional Competence

2. Integrity

3. Confidentiality

4. Skills and Competence

 1. Professional Competence
• He must be well versed in the fundamental principles and theory of
all branches of accounting viz., general accounting and cost and
management accounting etc.
• He should possess a sound knowledge of the techniques of audit and
be conversant with the decided legal cases in the field of theory and
practice of auditing.
• This store of knowledge must be constantly replenished and kept up
to date.
 1. Professional Competence (cont.)
• He must possess a sound working knowledge of taxation laws
(income-tax, wealth-tax, gift-tax, sales-tax etc.) of his country.
• He should be quite familiar with the company and mercantile
laws.
• He should have a thorough training in business organization,
management and finance.
• He should have an understanding of the general principles of
economics and business statistics.
 2. Integrity
• The word 'integrity' implies “complete honesty”
together with “strength of mind”.
• Integrity and keeping its flag flying up should be kept
by an auditor as a guiding inflexible rule.
• He must be tactful and scrupulously honest.
 2. Integrity (cont.)
• He must possess qualities of withstanding and resisting the

influence (direct or indirect) exerted by others in the course of

the discharge of his duties.

• He should not disclose the secrets of his clients.

• He should never compromise his principles without being

rigid in his attitude.

 3. General Skills
• He should be able to grasp quickly the technical details of the nature of his
clients' business.
• He must have the tact of putting intelligent questions to extract full
information.
• He must be prepared to hear arguments and decide on logical grounds.

• He should have the ability to write his report in a concise, clear and correct
manner.
• He will often be in need of patience, both with people and with his
professional problems.
 4. Integrity, Objectivity, and Independence

• The auditor should be straightforward, honest and sincere in

his approach to his professional work.
• He must be fair and must not allow prejudice or bias to
override his objectivity.
• He should maintain an impartial attitude and both be and
appear to be free of any interest which might be regarded,
whatever its actual effect, as being incompatible with integrity
and objectivity.
 5. Confidentiality

• The auditor should respect the confidentiality of information

acquired in the course of his work and should not disclose any

such information to a third party without specific authority or

unless there is a legal or professional duty to disclose.

 6. Skills and Competence
• The audit should be performed and the report prepared with
due professional care by persons who have adequate training,
experience and competence in auditing.
• The auditor requires specialized skills and competence which
are acquired through a combination of general education,
technical knowledge obtained through study and formal
courses concluded by a qualifying examination, and practical
experience under proper supervision.
 6. Skills and Competence (cont.)
• In addition, the auditor requires a continuing awareness of

developments including relevant international and national

pronouncements on accounting and auditing matters, and

relevant regulations and statutory requirements.

 Objectives of an Audit

1. The detection and prevention of errors or mistakes

2. The prevention and detection of loss to the client

3. Expression of independent opinion on accounts

4. Moral check
1. The Detection and Prevention of
Errors or Mistakes
 a) Clerical Errors
• Errors of Omission: These occur where the transaction has
been either omitted wholly or partially.
– Such errors do not affect the accuracy of the trial balance.

– A searching eye and a critical scrutiny of the accounts only can

uncover such errors.
– For example, scrutiny of salaries account in the general ledger may
indicate that salaries for only 11 months have been accounted for and
the outstanding amount for the 12th month has not been provided for.
 a) Clerical Errors(cont.)
• Errors of Commission: These consist of incorrect
additions, wrong postings and entries. Examples may be:
– Errors in additions, carry-forwards in the books of original entries or
ledgers.
– Errors or incorrect postings – debit amount posted to credit, wrong
amount posted to an account, an amount posted twice, omission to post
an amount from a book of original entry to ledger
 a) Clerical Errors(cont.)

Errors of Commission (cont.)

– Errors in taking out balances of the ledger accounts.

– The above errors will affect the agreement of the trial balance

– Checking the arithmetical accuracy of books of original entries and

ledger and postings from the books of original entries to the ledger

would reveal the above errors.

 a) Clerical Errors (cont.)
• Compensatory Errors: It is an error which is counter-
balanced by another error of same amount in the opposite direction.
– For example, an over-casting of an account by Rs. 500 may be counter-
balanced by under-casting of another account to the same extent.
– Such type of errors will not affect the agreement of trial balance.

– Checking of the arithmetical accuracy of books of accounts and posting would

detect such errors.
 a) Clerical Errors (cont.)

• Trial Balance Errors:

– These may consist of casting error in the trial balance, omission of a
balance while extracting balance from the books of accounts or
entering an amount incorrectly or on the wrong side.
– These errors would be spotlighted during the routine check.
 b) Errors of Principle
• Incorrect Allocation: this will occur when correct
distinction between revenue and capital is not strictly maintained,
e.g. capital expenditure charged to revenue expenditure and vice-
versa.
• Omission of Outstanding Assets and Liabilities: E.g. payments are
ignored and the amount charged off to the profit and loss account,
outstanding expenses in respect of rent, salaries, commission etc.,
are ignored and not accounted for etc.
 b) Errors of Principle (cont.)
Incorrect Distinction (cont.)

• Incorrect Valuation of Assets:

– Current assets are not valued at cost or market price whichever is lower.

– Fixed assets are not valued at cost less depreciation etc., as required by the

Act.

• The above errors can only be detected by an intelligent vouching

and complete verification (including checking of valuations) of the

assets and liabilities.

 c) Location of Errors
• Trial Balance Checking
– Check casts of the trial balance, lists of debtors and creditors

– Establish the amount of difference

– Check balances from personal and impersonal ledger into the trial
balance
– While checking the balances, care must be taken to ensure that the
closing balances are correctly entered in the right column
 c) Location of Errors (cont.)
• Short-Cut Method
– Look for an item of half that amount which might have been
entered on the wrong side.
– If the difference is divisible by nine, it may mean an error of
transposition of figures (69 written as 96 or 86 written as 68
etc.)
– If the difference is a round sum, it is probable that the mistake
has been made in totals of trial balance or carry-forward of its
figures.
 c) Location of Errors (cont.)
• Short-Cut Method (cont.)
– If the difference is of a large amount, it is advisable to compare
the trial balance with that of the previous year, in order to
ascertain whether the figures under the different heads of account
are very near the same as those of the previous year, and whether
the balances fall on the same side of the trial balance.
– If the difference happens to be of an amount which constantly
recurs in the books, all posting of this amount is to be rechecked.
 c) Location of Errors (cont.)
• Extensive Checking (where the short cuts
don’t work)
– Ascertain that all opening balances have been correctly
brought forward in the current year's books.
– Check casts, cross casts and carry-forwards of the various
books of original entries and ledgers.
 c) Location of Errors (cont.)
• Extensive Checking (where the short cuts don’t work)
– If the ledgers are self-balancing, the work would be restricted to
checking the balances, postings and casts of only that ledger the trial
balance of which does not agree.

– The Journal and subsidiary books should be scrutinized to see that the
total debits and credits of each entry tally and there were no un-ticked
items.

– The postings from the various subsidiary books should then be

checked into the impersonal ledger.