Principles and Practice of Auditing

Introduction to Auditing
Meaning:-
The term “audit” has been derived from the Latin word “audire,” which means
“to hear.” Hence, an auditor is a person who hears or listens.
Auditing is a systematic examination of the books and records of a business or other
organisation to ascertain or verify and report upon the facts regarding its financial operations
and the results thereof.
Auditing is concerned with verifying accounting data by determining the accuracy and
reliability of accounting statements and reports.

Definition:-
The Report of the Committee on Basic Auditing Concepts of the American Accounting
Association (AAA) defines, Auditing is a systematic process of objectively obtaining and
evaluating evidence regarding assertions about economic actions and events to ascertain the
degree of correspondence between those assertions and established criteria and communicate
the results to interested users.
According to the audit definition given by the International Federation of
Accountants (IFAC), “An audit is the independent examination of financial information of any
entity, whether profit-oriented or not and irrespective of its size, or legal form when such an
examination is conducted to express an opinion thereon.”
According to R.R. Comber, “Audit is an independent examination of the financial books
and records of some person or persons responsible or accountable to the third party with a view
of verifying the accountancy of statements prepared by or for the accounting party.”

Auditor:-
An auditor is a professional that accumulates and evaluates evidence to report on the degree to
a company’s assertions that they comply with an established set of procedures or standards
(criteria).

Essential Features of an Audit

The six essential features of auditing can be described as follows:
1. Systematic process,
2. Three-party relationship,
3. Subject matter,
4. Evidence,
5. Established criteria,
6. Opinion.
The essential features of auditing are explained below;
1. Systematic Process
Auditing is a systematic and scientific process that follows a sequence of activities, which are
logical, structured, and organised.
2. Three-party Relationship
The audit process involves three parties: shareholders, managers, and auditors.

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3. Subject Matter
Auditors give assurance on a specific subject matter. However, the subject matter may differ
considerably, such as – data, systems or processes, and behaviour.

4. Evidence
The auditing process requires collecting the evidence, that is, financial and non-financial data,
and examining thereof.

5. Established Criteria
The evidence must be evaluated regarding established criteria, which include International
Accounting Standards, International Financial Reporting Standards, Generally Accepted
Accounting Principles, industry practices, etc.

6. Opinion
The auditor has to express an honest and professional opinion as to the reasonable assurance
of the entity’s financial statements.

Objectives of an Audit
The objective of an audit is to express an opinion on financial statements. The objectives of the
audit can be categorised into;
1. Primary objectives of the audit,
2. Subsidiary objectives of the audit.
Primary Objectives of Audit
The main objectives of the audit are known as the primary objectives of the audit.
They are as follows:
1. Examining the system of internal checks.
2. Checking arithmetical accuracy of books of accounts, verifying posting, casting,
balancing, etc.
3. Verifying the authenticity and validity of transactions.
4. Checking the proper distinction between capital and revenue nature of transactions.
5. Confirming the existence and value of assets and liabilities.
Subsidiary Objectives of Audit
These are such objectives that are set up to help in attaining primary objectives.
They are as follows:
1. Detection and prevention of errors.
Errors are mistakes committed due to carelessness, negligence, lack of knowledge, or
without a vested interest. Errors may be committed without or with any vested interest. So,
they are to be checked carefully. Errors are of various types. Some of them are:
a. Errors of Omission:
These are the errors which arise on account of a transaction being not recorded in the
books of accounts either wholly or partially. If a transaction has been totally omitted it will not
affect trial balance and hence it is more difficult to detect. On the other hand if a transaction is
partially recorded, the trial balance will not agree and hence it can be easily detected.
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b. Errors of Commission:
When incorrect entries are made in the books of accounts either wholly, partially such
errors are known as errors of commission. Eg: wrong entries, wrong Calculations, postings,
carry forwards etc such errors can be located while verifying.
c. Compensating Errors:
When two/more mistakes are committed which counter balances each other. Such an
error is known as a Compensating Error. Eg: if the amount is wrongly debited by Rs 100 less
and Wrongly Credited by Rs 100 such a mistake is known as compensating error.
d. Error of Principle:
These are the errors committed by not properly following the accounting principles.
These arise mainly due to the lack of knowledge of accounting. Eg: Revenue expenditure may
be treated as Capital Expenditure.
e. Clerical Errors:
A clerical error is one which arises on account of ignorance, carelessness, negligence
etc.
2. Detection and prevention of fraud
Frauds are those mistakes that are committed knowingly with some vested interest in
the direction of top-level management.
Management commits frauds to deceive taxes, to show the effectiveness of
management, to get more commission, to sell a share in the market, or to maintain the market
price of the share, etc.
Detection of fraud is the main job of an auditor. Such frauds are as follows:
● Misappropriation of cash.
● Misappropriation of goods.
● Manipulation of accounts or falsification of accounts without any misappropriation.
3. Under-or over-valuation of stock
Normally such frauds are committed by the top-level executives of the business. So, the
explanation given to the auditor also remains false. So, an auditor should detect such frauds
using skill, knowledge, and facts.

Other objectives
● To provide information to the income-tax authority.
● To satisfy the provisions of the Companies Act.
● To have a moral effect.
Types of audit:-
I) Based on ownership:
On the basis of ownership audit can be:-
1. Audit of Proprietorship:
In case of proprietary concerns, the owner himself takes the decision to get the accounts
audited. Sole trader will decide about the scope of audit and appointment of auditor. The

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auditing work will depend upon the agreement of audit and the specific instructions given by
the proprietor.
2. Audit of Partnership:
To avoid any misunderstanding and doubt, partnership firms audits their accounts.
Partnership deed on mutual agreement between the partners may provide for audit of financial
statements. Auditor is appointed by the mutual consent of all the partners. Rights, duties and
liabilities of the auditor are defined in the mutual agreement and can be modified by the
partners.

3. Audit of Companies:
Under Companies Act, audit of accounts of companies in India is compulsory.
Chartered accountant who is professionally qualified is required for the audit of accounts of
companies. Companies Act 1913 for the first time made it compulsory for joint stock
companies to get their accounts audited from a qualified accountant. A number of amendments
have been made in Companies Act, 1956 and 2013 regarding appointment, duties,
qualification, power and liabilities of a qualified auditor.

4. Audit of Trusts:
The beneficiaries of the trusts may not have access and knowledge of accounts of the
trust. The trustees are appointed to manage and look after the property and business of the trust.
Accounts of the trust are maintained as per the conditions and terms of the trust deed. The
income of the trust is distributed to the beneficiaries. There are more chances of frauds and
mis-appropriation of incomes. In the trust deed as well as in the Public Trust Act which provide
for compulsory audit of the accounts of the trust by a qualified auditor. The audited accounts
of the trust ensure true and fair view of accounts of the trust.

5. Audit of Accounts of Co-operative Societies:

Co-Operative societies are established under the Co-Operative Societies Act, 1912. It
contains various provisions for the regulations and the working of these societies. Some of the
states have adopted it without any change, while others have brought certain changes to it. The
auditor of the Co-operative Society should have an expert knowledge of the particular act under
which the Co-operative society under audit is functioning. He should also study by-laws of the
society and make sure that the amendments made from time to time in the by-laws have been
duly registered in the Registrar’s Office. Companies Act is not applicable to the co-operative
Societies. The Registrar of co-operative societies shall audit or cause to be audited by some
person authorised by him, the accounts of the society once in every financial year.

6. Government Audit:
Audits of government offices and departments are covered under this heading. A
separate department is maintained by the government of India known as Accounts and Audit
Department. This department is headed by the Comptroller and Auditor General of India. This
department works only for the government offices and departments. This department cannot
undertake audits of non-government concerns. Its working is strictly according to government
rules and regulations.

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II) Based on Time:

On the basis of time the audit can be of following types:
1. Interim Audit:
When an audit is conducted between two annual audits, such audit is known as Interim
audit. It may involve complete checking of accounts for a part of the year. Sometimes it is
conducted to enable the board of directors to declare an Interim dividend. It may also be for
the purpose of dealing with interim figures of sales.

2. Continuous Audit:
The Continuous Audit is conducted throughout the year or at the regular short intervals
of time.
“A continuous audit involves a detailed examination of all the transactions by the
auditor attending at regular intervals, say weekly, fortnightly or monthly, during the whole
period of trading.” - T.R. Batliboi
“A continuous audit is one where the auditor or his staff is constantly engaged in
checking the accounts during the whole period or where the auditor or his staff attends at
regular or irregular intervals during the period.” -R.C Williams

III) Based on Objectives:

On the basis of objectives the audit can be of following types:
1. Statutory Audit
Statutory audit is often called financial Audit. Independent financial audit is generally
conducted to ascertain whether the Balance Sheet and Profit & Loss Account presents a true
and fair view of the financial position and working result of the organisation under audit. The
need for financial audit arises as the control of the company is vested in the hands of the
management of the company and the financial statements are also prepared by the management.
The owners (shareholders), therefore, need assurance that the financial independent expert –
assures the owners about the reliability of the financial statements. Similarly, investors wish to
invest their money in the shares of companies on the basis of their profitability and financial
position. They will also place greater reliance on financial statements if they have been audited.
Other users of financial statements, e.g., trade creditors, banks, financial institutions, tax
authorities, other government authorities, labour unions, etc., also place greater reliance on
audited accounts.
The main provisions regarding statutory audit are:
● Auditor will have access to books of accounts and vouchers etc. at all times and he can
seek information from officers of the company as he may deem necessary.
● In his report he must state, besides other things, whether the financial statements
represent a true and fair view of the state of the company's affairs as at the end of the
financial year.
● In case of any qualifications in the audit report, the reason for the same must be stated
in the report.
● Auditors are required to comply with Auditing Standards.
● In case an auditor suspects any fraud, he must immediately report the same to the
Central.
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2. Internal Audit
Section 138 of the Companies Act, 2013 contains provisions regarding internal audit.
As per Companies Act, 2013, certain class or classes of company as may be prescribed shall
appoint an internal auditor who will conduct an audit of the functions and activities of the
company and make a report thereon to the Board of Directors. Any chartered Accountant
(except statutory auditor of the company) or Cost Account or other professional as may be
decided by the Board, can be appointed to conduct the internal audit.
According to Rule 13 of The Companies (Accounts) Rules, 2014 following class or
classes of companies shall be required to appoint an internal auditor or firm of internal auditors,
namely:
(a) Every listed company;
(b) Every unlisted public company having-
(i) Paid up share capital of 50 crore rupees or more during the preceding financial year;
or
(ii) Turnover of 200 crore rupees or more during the preceding financial year; or
(iii) Outstanding loans or borrowings from banks or public financial institutions
exceeding 100 crore rupees or more at any point of time during the preceding financial year;
or
(iv) Outstanding deposits of 25 crore rupees or more at any point of time during the
preceding financial year; and
(c) Every private company having-
(i) Turnover of 200 crore rupees or more during the preceding financial year; or
(ii) Outstanding loans or borrowings from banks or public financial institutions
exceeding 100 crore rupees or more at any point of time during the preceding financial year:
3. Cost Audit:
Cost Audit is the verification of the correctness of cost accounts and adherence to the
cost accounting plans. Cost Audit is the detailed checking of the costing system, techniques
and accounts to verify correctness and to ensure adherence to the objectives of cost accounting.
4. Secretarial Audit:
Secretarial Audit is concerned with verification compliance by the company of various
provisions of Companies Act and other relevant laws. Secretarial audit report includes
a. Whether the books are maintained as per companies act, 2013.
b. Whether necessary approvals as required from central Government, Company law
board or other authorities were obtained.
5. Independent Audit:
Is conducted by the independent qualified auditor. The purpose of independent audit is
to see whether financial statements give a true and fair view of financial position and profits.
Mainly it is for safeguarding the interest of owners, shareholders and other parties who do not
have knowledge of day-to-day operations of the organisation.

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6. Tax Audit:
Now-a-days tax audit has become very important to ascertain the accuracy of tax related
documents. Tax audit mostly covers income returns, invoices, debit and credit notes and
various current and fixed assets. Tax audit is an innovation of the 21st century. It has added
one more chapter to the practice of auditing. Tax audit ensures the validity and credibility of
tax related documents.

Differences between Accounting and Auditing:-

Accounting Auditing

1. It’s a continuous process carried out 1.It’s a one time activity after the closure of
throughout the year. the accounting year.

2. No prescribed qualification is required 2. He must be the member of Institute of

to be an accountant. Chartered Accountants of India to become an
auditor

3. An accountant is a employee of the 3. An auditor is an independent professional.

company

4. An accountant gets a regular salary for his 4. He gets remuneration for his professional
work. work. Audit fees.

5. Accounting is concerned with recording of 5. It's concerned with verification of accounts

business transactions systematically. prepared by the accountant.

6. Accounting precedes, auditing. 6. Auditing succeeds accounting

Preparation before commencement of the audit:

An auditor after receiving the appointment letter should communicate his acceptance/otherwise
in writing to the company. The following steps are necessary to commence the audit work:
1. If it is not a statutory audit, he should find out the exact nature and scope of his duties
i.e., whether he has to audit the account/prepare accounts also.
2. He should inform his clients to close all the books of account and keep them ready for
verification.
3. He should acquaint himself with the nature of his client business.
4. He should examine the efficiency of the internal control system.
5. He should obtain the names of directors, their power duties etc.
6. He should obtain a complete list of all books and documents maintained by the clients.
7. He should obtain a copy of the previous year’s audit report.
8. He should go through various documents like MOA, AOA, prospectus etc.

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Audit Programme:
Before commencing the audit he should plan his work so that it is over without delay.
For this purpose the auditor chalks out a detailed programme explaining the procedure to be
followed for audit. It explains the work to be done by the audit staff. An audit programme is
defined as “a detailed plan of the auditing work to be performed, specifying the procedure to
be followed in verification of each item in the financial statements, and giving the estimated
time required’.
Hence an audit programme is a statement giving instructions and guidance to the audit
staff as to the audit procedure. It arranges and distributes the work among the audit staff.

Advantages of Audit Programme:-

1. It provides the audit staff clear instructions about their duties.
2. It promotes division of work in a well organised manner.
3. It helps the auditor to monitor the progress of the work.
4. It will be easier to fix responsibilities for omissions and commissions.
5. It serves as valuable evidence for the work done.
6. It serves as a guide for future audit.
7. It ensures the audit process in a systematic manner.
8. It eliminates inefficiency and saves time.
9. In case if any audit assistant goes on leave, his work can be easily continued by others.
10. It avoids duplication of work.

Disadvantages of Audit Programme.

1. The audit work becomes mechanical.
2. It kills the creativity of the audit staff.
3. Chances of work not done properly/ high as the scope is to be completed within a scheduled
time.
4. A rigid programme may not be suitable for all kinds of business.

Audit Note Book:

An audit note book is one of the most important documents maintained by the auditor.
It is defined as a record used mainly in recording audit, containing data on work done and
comments made. The Audit Note book contains information regarding the day to day work
performed by the audit staff, notes about errors, explanations required etc. the auditor can use
it as authentic evidence in the court if there is any case against him.

Contents of Audit Note Book:

1. Nature of business and important documents such as MOA, AOA, Partnership deed etc.
2. List of books of accounts.
3. List of officials, their duties and responsibilities.
4. Copy of the audit programme.
5. Information on missing receipts, vouchers etc.
6. Details of errors discovered.
7. Explanations sought from the officials.
8. Points to be included in the audit report.
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An audit note book should be preserved by the auditor as it contains valuable

information in respect of the work done by its staff.

Audit Working Papers:

Audit working papers are those papers which contain essential facts about accounts,
which are being audited. It is defined as the file of analysis, summaries, comments and
correspondence build up by the auditor during the course of audit. The auditor maintains papers
as supporting evidence to the audit work. The institute of chartered accountants of India states
that “an auditor is expected to maintain evidence of work done by him and his staff”.
Usually, audit working papers contain a copy of the trial balances, schedule of debtors
and creditors, reconciliation statements, important correspondence etc.
Purpose of maintaining working paper:
1. They show the extent to which accounting principles and auditing standards have adhered
to.
2. They provide the required support for the auditors report.
3. They also reveal the efficiency with which the audit work was done.
4. They can be used as evidence in the court to defend himself against negligence in his duty.
5. They help the auditor in finalising his report quickly.
6. They help the auditor to understand the efficiency of the accounting system, internal check
system etc.
Working papers should be clear, complete, and contain the necessary information so
that they may be of maximum utility. They should be properly organised, documented and
signed. In this regard it is said that “an auditor is often judged by the quality of the working
paper prepared by him under his guidance”.
Working papers are confidential documents hence he should not disclose the facts to
others. Doing so results in professional misconduct. Working papers should be preserved
properly because they are important documents.

Auditors Lien:

It refers to the right of the auditor to withhold certain documents & papers unless
certain documents due to him are cleared. Auditor has no lien on the books of accounts
audited by him but if he has worked as an accountant also for which he is not paid he
can exercise his right of lien.

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