AUDITING

Auditing meaning
The term audit is derived from Latin word ‘audire’ which means to hear, in ancient times
auditors used to hear accounts read out by bookkeepers.
Definition- according to ICAI, auditing is independent examination of financial information
of any entity whether profit oriented or not and irrespective of its size and legal form, when
such an examination is conducted with a view to expressing opinion thereon.
Features of auditing
- It is scientific and systematic examination of the books of accounts.
- It is undertaken by independent person or body of persons who are duly qualified for
the job.
- It is verification of results shown by profit and loss account and state of affairs shown
by balance sheet.
- It is critical review of the system of accounting and internal control.
- Audit is done with the help of vouchers, documents, information received from
authorities.
- Auditor must satisfy himself with authenticity of financial statement and then report
his true and fair view about it.

Distinguish between accounting and auditing.

Accounting Auditing

1. Meaning- accounting means 1. Meaning- it is examination of

writing books of accounts and accounts to report whether they are
prepare financial statements. true and fair.
2. Objective- to know about financial 2. Objective- to examine and report
position and financial whether financial statements are
performance of the organisation. showing true and fair view.
3. Scope- scope of accounting is 3. Scope- auditing has wider scope like
limited to books of accounts only. checking books of accounts,
4. Done by- accounting is done by authenticating transactions, physical
the employees within the verification of stocks, etc.
organisation. For e.g.- 4. Done by- auditing is done by
accountants. independent expert who should be
5. Responsibility- accountant is practising chartered accountants.
employed by and responsible to 5. Responsibility- Auditor is appointed
management. by owners/shareholders and
6. Starting and end point- accounting reported to them.
begins with journal entry and ends 6. Starting and end point- Auditing
 with preparation of final accounts. begins after the completion of final
accounts and ends when auditor
submits his audit report.

Errors and its types

Detection and prevention of errors is the principal objective of auditing. Errors means
unintentional mistakes in the financial statement by the accountant. Errors are broadly
classified into:
a. Error of principle- Error of principle occurs when transactions are not recorded as
per basic accounting principles. The debit or credit is given to wrong head of
accounts, these errors do not affect trial balance, but they affect true and fair view of
accounts. For e.g., overvaluation or undervaluation of stock, overcharging or
undercharging of depreciation, treat capital expenditure as revenue expenditure and
vice versa. Errors of principle are detected by vouching all material transactions,
verification of assets and liabilities, scrutiny of ledger, quantity reconciliation, etc.
b. Clerical errors-
 Errors of omission- An error of omission occurs when transaction is omitted from
the books of accounts wholly or partly. If transaction is partly omitted trial
balance would not tally and error can be detected and rectified. In case of
complete omission, trial balance gets tallied. Such error can be detected through:
-
i. Bank reconciliation statement
ii. Vouching cheque counters
iii. Scrutiny of creditor’s account, etc.
 Error of commission- It includes: -
i. Mathematical errors- mathematical errors of calculations may occur in
vouchers, journal, ledger, trial balance. Such errors can be detected by
checking vouchers, scrutiny of party accounts etc.
ii. Casting error- casting error means errors in totalling, carry forward in
journal and ledger. These errors will lead to difference in trial balance and
can be detected by casting of different ledger accounts.
iii. Posting errors- these errors occur while posting amounts from journal to
ledger the error of posting wrong amount or of posting on wrong side of
account will affect the trial balance. These errors can be detected through
reconciliation statement, ratio analysis, comparison with previous years’
figures etc.
 Compensating errors- compensating errors occur when effect of one error is
compensated by another error. These errors cancel each other and do not affect
trial balance. It is very difficult to trace out these errors. These errors are
detected through vouching, obtaining statements of accounts from other parties,
etc.
  Error of duplication- the error occurs when transactions is recorded twice in the
books of accounts. The posting is also done twice this error can be detected by
careful vouching, scrutiny of ledger accounts, quantity reconciliation, ratio
analysis, etc.

Fraud
The standard on auditing (SA) defines fraud.
“an intentional act by one or more individual among management, those charged with
governance or employees involving the use of deception to obtain illegal advantage.”
Types of fraud
a. Manipulation of financial records-
i. Not recording transaction- transaction may not be recorded at all in the
books of accounts. For e.g., goods sold may not be recorded in the sales
register such type of fraud occurs when error of omission is intentional.
ii. Recording dummy transactions- sometimes dummy transactions maybe
recorded. For e.g., goods sold on approval basis maybe shown as actual sales
such fraud occurs when an error of commission is intentional.
iii. Misapplication of accounting policies- accounting policies may be applied
wrongly. For e.g., income accrued maybe shown as advanced income such
fraud occurs when error of principle is intentional.
b. Misappropriation of cash-
i. From cash receipt- cash received maybe misappropriated by not recording
cash received at all or recording only part amount as received and pocketing
the balance.
Cases- sale of scraps, sale of assets, windfall gains (recovery of bad debts,
discount from creditors)
ii. From cash payments- cash maybe misappropriated at the time of cash
payment by recording dummy or excess payments. For e.g., salaries or wages
paid to dummy employees or amount paid maybe shown at higher than
actual payment.
c. Misappropriation of goods-
i. From goods received- goods received maybe misappropriated by not
recording goods received at all or recording only part quantity. This fraud
may happen in case of big control over purchases and sales and storage.
ii. From goods dispatched- here goods maybe misappropriated by recording
dummy or excess sales.
iii. From stock in hand- goods maybe actually stolen out of the stock lying at
warehouse.
Window dressing
Window dressing means skill of arranging goods attractively usually it is done in shops. In
case of accounting window dressing means skill of presenting accounts in such a way that it
creates good impression. In window dressing the accounts will show much better condition
than actual condition profits and net worth are overstated. Such a condition exists where
the assets are overvalued and the liabilities are undervalued. Due to window dressing it
shows that the financial performance and the financial position is good.

Reasons for window dressing

a. Mislead investors and lenders- a company wants to mislead investors into buying its
shares by showing better picture of its net worth banks or financial institutions may
give larger loans on higher net worth even in some cases the business is taken by
another business for high price.
b. Hide losses- sometimes the concern may suffer extraordinary losses the business
organisation may not like to show huge losses in the books of accounts the company
also shows fictitious profits to be able to pay dividends to their shareholders.
c. Higher commission- sometimes window dressing is done by directors itself so as to
earn more commission on higher profits shown in the books of accounts.

How window dressing is done

Window dressing is possible by
a. Overstatement of assets- e.g., recording new fixed assets purchased in the books at
higher cost, revaluation of fixed assets, recording fictitious purchase of fixed assets,
providing less depreciation by changing methods.
b. Understatement of liabilities- e.g. recording liabilities in the books in the lower value,
liabilities are omitted to record, treating a liability as an item of income(advance rent
received is treated as receipt of rent).

Objection against window dressing

1. No true and fair view- when window dressing is done by concerned the balance
sheet does not disclose actual net worth of the concerned, the profit and loss
account fails to disclose actual working result of the business.
2. Shareholders suffer- shareholders do not know the true picture of the value of their
investments. They may get dividend but that is out of their capital.
3. Hide inefficiency of management- window dressing helps the management to hide
its inefficiency better picture show in the books of accounts is used to hide losses.
4. Against companies act 2013- window dressing is against the provisions of companies
act 2013. It includes following provisions: -
 a. Disclosure of additions or withdrawals from the reserve.
b. Disclosure of proper amount of depreciation.
c. Disclosure of true and far view of profits.

Secret reserve
Reserve is a part of profit kept aside for future use. Secret reserves are those reserves which
are not shown in the balance sheet. Whenever secret reserve is created financial position of
the company seems to be worse than actual hence it is exact opposite window dressing.

Why secret reserve is created.

1. Mislead the competitors- organisation may like to mislead the competitors by hiding
its real earning. They also mislead the tax department just to avoid payment of tax.
2. Hide abnormal profits- any extraordinary profits earned by the organisation may
transfer to secret reserves to set off losses and also to maintain rate of dividend in
future.
3. Fraud- secret reserves are created for personal benefits. Sometimes directors may
withdraw money from excess funds generated in the organisation.
4. Legally allowed to banks- banks can create secret reserves, banks are allowed not to
disclose their provision for bad and doubtful debts to maintain public confidence.

How secret reserves are created.

1. Understatement of assets- e.g., Omitting to record new assets in the books, show
lower quantity of closing stock, purchase of assets should be shown at lesser value.
2. Overstatement of liabilities- e.g., record liabilities with higher amounts, record
fictitious liabilities in the book, treat contingent liabilities as actual liabilities, etc.

Objections against secret reserves.

1. No true and fair view- when window dressing is done by concerned the balance
sheet does not disclose actual net worth of the concerned, the profit and loss
account fails to disclose actual working result of the business.
2. Shareholders suffer- shareholders do not know the true picture of the value of their
investments. They may get dividend but that is out of their capital.
3. Hide inefficiency of management- window dressing helps the management to hide
its inefficiency better picture show in the books of accounts is used to hide losses.
4. Against companies act 2013- window dressing is against the provisions of companies
act 2013. It includes following provisions: -
d. Disclosure of additions or withdrawals from the reserve.
e. Disclosure of proper amount of depreciation.
 f. Disclosure of true and far view of profits.

Duties of auditor
1. Disclose in audit report- the auditor of a company has to report whether accounts
give true and fair view:
a. In case of balance sheet, the state of company’s affair is fair at the end of
financial year.
b. In case of profit and loss true value of profit or loss. Also, he should give report
regarding window dressing or secret reserves of the company.
2. Check articles of association- he should study articles of association of the company
to verify the provisions regarding depreciation, reserves etc.
3. Verify income- he should verify that all the direct and indirect incomes has been
properly brought in recorded and reported in the books of accounts. He should
check supplementary vouchers also. For e.g., invoice.
4. Verify assets and liabilities- he should verify all the assets and check valuation of
each asset. He can cross confirm liabilities through ledger account. He should see
that no contingent liability is shown as actual liability.
5. Verify closing stock- he should verify value of closing stock. He should see that there
is no change in the basis of valuation of closing stock, if there is any change it affects
the profit, therefore it should be properly disclosed.
6. Disclose change in the method of accounting- He should see whether there is any
change in the method of accounting for example depreciation method, accounting
for foreign exchange transactions etc. if there is any such change, that information
and its effect on profit should be disclosed.

Responsibilities of Auditor.

Module 1 ends
Module 2 Introduction to Auditing

Advantages of auditing

 Assurance of true and fair accounts: -

 Audit provides an assurance to various users of financial statement like owners,
management, creditors, bankers, and government that accounts are true and fair
balance sheet shows correct amount of assets and liabilities so that there will not
be any window dressing or secret reserve.

 Tally with books

The audited final accounts can be tallied with books of accounts income tax
officer can start with the figure of the audited reports. Any outside party need
not go through entire books of accounts.

 Audit is as per law.

The audited final accounts can be assumed to follow rules and requirements laid
down by law (schedule 6 of companies act 2013)

 Disclose risk on material facts.

Audited final accounts discloses all material facts regarding assets its
depreciation, cash in hand, cash at bank, debtors and creditors position so that
user can rely upon audited accounts for making any investment or lending
decision.

Audit planning
a) Reason- the auditor should plan his work to enable him to conduct effective
audit in efficient and timely manner.
b) Basis- audit planning should be primarily based on knowledge of clients’
business.
c) Coverage- audit plan should be made to cover:
i. Acquiring knowledge of client’s accounting system, policies and internal
control procedure.
ii. Determine nature, timing and extent of audit.
iii. Coordination of the work to be performed.
d) Benefits- adequate audit planning helps to:
i. Ensure appropriate attention to important areas of audit.
ii. Ensure that potential problems are promptly identified.
iii. Coordinate the work done by other auditors and experts.
e) Responsibility- the auditor may discuss his overall plan with client, audit plan and
audit programme remain auditor’s responsibility only.
f) Knowledge of client’s business- the auditor should gather knowledge of client’s
business from the following sources of information:
i. Client’s annual report to shareholders.
ii. Minutes of meetings of shareholder, board of directors, and important
committees.
iii. Previous years’ audit working papers.
 iv. Discussion with client.
v. Client’s policy and procedure manuals.
vi. Auditor has to visit client’s premises, office and factory both.
vii. Previous years’ matters- the auditor should pay particular attention to
previous year’s matter recorded in the audit file that require special
consideration for their effect on working of current year.
viii. Discussion with clients- discussion with the client help the auditor to
judge complexity of the audit and the environment in which the entity
operates.
1. Complexity of audit can be judged by changes in management,
organisation structure and activities of the client.
2. Environment in which the entity operates cover following matter:
a) Current government legislations, rules, current business
developments, change in technology or type of product or service.

Precommencement consideration
Before commencing an audit auditor must take following steps and procedures:
1. Type of audit
The first step is to identify which type of audit assignment is there:
a) Statutory audit
b) Voluntary audit
c) Continuous or final audit
The auditor should identify whether the audit is statutory or voluntary. If the audit is
statutory for e.g., financial audit under companies act 2013, the audit must be
conducted in accordance with provisions of companies act.
If the audit is voluntary the auditor must know why the audit is being conducted for
e.g., Valuation of business at the time of admission or retirement.
The auditor should make sure that whether the audit is continuous of final this
enables the auditor to decide the extent of checking and type of audit procedure to
be followed.
2. Documents to be obtained from the client.
The auditor should obtain the following documents from the client before
commencing the audit work:
a) Letter of appointment
b) Memorandum and articles of association of company.
c) Partnership deed in case of partnership firm
d) Organisational chart showing different departments.
e) List of directors, officers entitled to sanction payments, sign cheques and offer
explanation to auditor.
f) List of places of business, books of accounts.
 g) Past annual accounts and annual reports.

3. Instruction to the client to prepare documents.

Before commencement of audit auditor should issue detailed instruction to the
client that he should be ready with following:
a) Books of accounts
b) Bills and invoices
c) All ledgers should be properly posted and tallied.
d) Details of investment by company
e) Details of cash in hand and cheques in transit
f) Details of prepaid and outstanding expenses.

4. Audit programme

Meaning- audit programme is the detailed plan of the audit work to be performed,
procedures to followed in verification of each item in the financial statement and for
estimated time period.
Audit programme is outline of how the audit is to be conducted by the audit staff
who will be responsible for any work and within what time.

Contents of audit programme

There will not be any standard audit programme for all audits. Audit programme has
to be prepared specifically for each client and every year. It includes the following
details:
a. Client and accounting year- the heading of audit programme should be the name
of the client and the respective accounting year.
b. Audit procedure- the main part of audit programme includes detailed
instructions regarding how audit should be conducted from first step that is
evaluation of internal control till last step that is submission of audit report.
Audit procedures include:
i. Evaluation of internal control system
ii. Check arithmetical accuracy of books of accounts by checking posting,
casting, carry forwards etc.
iii. Vouching the books of accounts like journal, ledger and subsidiary books
iv. Verification of assets and liabilities
v. Scrutiny of ledgers
vi. Checking grouping disclosure and presentation of all items in final
accounts
vii. Preparation of audit report
c. Distribution of audit work
It specifies allocation and distribution of audit work among senior auditor, junior
auditors and assistants so that each one knows what work is to be done. In case
 of joint audit, audit programme specifies the areas for which every auditor is
responsible.

d. Timetable
Audit programme gives schedule of audit work, it shows the time expected to be
taken and actual time taken for carrying out each step of audit procedure.

Types of audit programme

a. Fixed audit programme

This type of audit programme is fixed at the beginning of the audit work and
it should be followed strictly throughout the audit.

b. Flexible audit programme

This type of programme is modified time to time in the light of the actual
audit work done

Advantages of audit programme

i. Guidance to the assistants
Audit programme provides detailed guidance to assistants regarding what work
is to be done, how the work should be done, who will be responsible and when
the work is expected to be done.

ii. No omission or repetition of work

Audit programme ensures that no important area should be left out. It also
avoids the same job being done twice.

iii. Checklist of procedures

Audit programme lays down the exact procedure to be followed. It should check
that authentic evidence are collected. It should follow all the steps from
evaluation of internal control till preparation of audit report.

iv. Delegation and supervision of work

Audit programme enables the senior auditor to delegate audit work to juniors
depending upon their level of education and experience. It also helps the senior
auditor to supervise and control delegated work.

v. Evidence in court
 Audit programme is a good evidence for the auditor in case of any suit filed
against him for negligence in audit. With the help of audit programme auditor
can prove what work is done by him is already know to the client.

vi. Timely completion of audit

As audit programme contains timetable for each task audit can be completed
within time. A constant review at each stage reveals whether the work
proceeding as per the schedule or not. In case of delay at any stage, more
assistance can be sent to ensure completion of work within time.

Disadvantages of audit programme

i. Since audit programme involves detailed instructions for the work, the audit
work becomes mechanical and routine.
ii. The audit staff resort to work as per rule only that is each one does the work
allotted to him in specific way only therefore audit staff may lose their initiative
the aspect of quality and creativity is neglected.
iii. Inefficient audit assistants may take shelter behind audit programme to defend
their negligence. They can say that they are forced to follow the audit
programme strictly and any deficiency in their work is due to absence of specific
instruction.
iv. Audit programme contains a strict timetable for each work, so audit becomes
merely a race to complete each work in time. Audit staff has to follow deadlines,
it may affect quality of work.

Audit evidence
Distinguish between internal evidence and external evidence
Nature- internal evidence is one which has been created within client’s organisation. For rg
invoice or bill.
External evidence is collected from outside the client’s organisation. For eg note received
from debtor
Examples- internal: sales and purchase invoices, employees time report, inventory reports,
wage sheets, minute books, etc.
External: lease agreements, bank statements, cancelled cheques, insurance policies,
mortgage deeds, etc.
Source- internal evidence are create and retained within the organisation only.
External evidence is obtained from outside parties.
Reliability- internal evidence is less reliable as it can be managed anytime.
External evidence is more reliable as it cannot be changed easily.

Audit notebook
Audit notebook is part of current audit file it contains notes made by the audit team for
recording special points which have been observed during Audit.
Audit notebook is usually in the form of bound book however, loose sheets are used for
entering queries and subsequently it will punch.
Contents of audit notebook
Audit notebook contains audit programme, detailed analysis of transaction evidence that
the work performs by assistance, copies of letter concerning audit matters communicated to
the client and conclusions reached by the auditor on significant aspects of audit.
Identification
While making any entry in the audit notebook the audit team should clearly identify:
1) For example, a query is about purchased invoice the audit notebook should contain
purchase invoice number, date of the transaction, etc. if sample testing is done then
the details about sample selection should be mentioned in audit notebook.

Limitations of auditor
 Much of the evidence involve to the auditor can enable him to draw reasonable
conclusion but there is possibility of wrong judgement.

Types of audit
1. Continuous audit
According to RC Williams, continuous audit is one where the auditor constantly or at
regular time intervals engaged in checking accounts during the period. Generally
audit work begins after the accounting year is over but in case of continuous audit,
audit work begins in the accounting year itself, which means, we can say that
accounting and auditing both is done almost side by side. The auditor may make
periodic visits and at each visit the work would be taken up from where it was left in
earlier visit.

 Necessity of continuous audit- continuous is necessary in following cases-

a. When volume of transaction is too high.
 b. When it is desired to have audited accounts ready immediately after the end
of the accounting year.
c. Where the system of internal control or internal check is weak.
d. Where management requires reliable and authentic accounting records at
the end of every quarter.

Advantages of continuous audit

a. Quick preparation of final account is possible as routine audit is done continuously so
journal, ledger, and trial balance these steps are error free.
b. Shareholders will get dividend soon after the ending of financial year so they could
be happy.
c. Up to date final accounts are useful to banks and investors for taking decisions
regarding loans and investments.
d. Constant checking of accounts throughout the year helps to detect and even prevent
fraud and errors. Employees work regularly and sincerely to keep the accounts ready
and up to date.
e. Since auditors spend more time at client’s place, he becomes familiar with all aspects
of the client’s business. This helps a lot to him in the audit work.
f. Audit staff can be kept busy throughout the year. Audit work can be evenly
distributed to avoid overwork at the year end.

Disadvantages of continuous audit

a. Since the auditor has to spend more and more time to audit work, the audit fees are
more, and thus continuous audit becomes expensive.
b. Frequent visit by auditor may disturb working nature of account staff. Day to day
accounting work may also suffer if accountants have to attend audit work frequently.
c. In continuous audit client and accountant may become unduly dependant on the
auditor even for small matters may be referred to the auditor so sometimes
becomes bulky for the auditor.
d. If the employees changes some figures in the books of accounts already audited by
the auditor during his previous visit, it would be difficult to detect such errors and
frauds.
Balance sheet Audit
balance sheet audits are not conducted in all cases it is conducted in case of very large
organisations it is conducted in case of following circumstances:
1. When internal control system is very strong the controls have been developed and
tested over the years then only balance sheet audit is conducted.
2. When the volume of transactions is so large that detailed checking is impossible.
3. If the organisation has its own internal audit department.
 4. If the accounts staff is highly qualified, there is computerized accounting system and
if management is professional.
Special items: The Auditor should pay special attention to the following items of final a/c.
1. Verify fixed assets and investments physically.
2. Check addition in fixed asset or deduction from fixed asset or investment.
3. Check whether proper depreciation is charged.
4. Check the accounts of major debtors and creditors and obtain confirmation and
statement of accounts from them.
5. Verify cash and stock physically.
6. Ascertain number of bad debts

VOUCHING Module no. 5 20-25% paper

Meaning
Vouching is important audit technique for collecting important audit evidence. Normally the
entries in the books of accounts are made on the basis of documentary evidence like bills,
receipts, pay-in-slips, etc such documentary evidence is called as voucher and vouching is
critical examination of vouchers.
Objectives and importance of vouching
Vouching enables the auditor to ascertain whether entries in the books of accounts are true
and fair, vouching provides evidence in the respect of following matters:
1) occurrence
Vouching helps the auditor to ascertain whether the transaction is occurred or not.
2) Amount
Vouching helps the Auditor to check whether the transaction is recorded with right amount.
3) Relevant entries
Vouching helps the auditor to ascertain, the entries recorded in the books of accounts are
relevant i.e., they are related to concern and current accounting year only.
4) As per accounting standard or policy
Vouching enables the auditor to verify whether an item is accounted as per recognised
accounting standard or policy he will also ensure that the transaction complies with the
provision of the law.
5) Disclosure
Vouching enables the auditor to ensure that items are properly disclosed in the final
accounts as required by schedule 3 of companies act, 2013.

How will you vouch the following:

1) Rent
A) Supporting documents
The rent paid should be supported by
1. rent agreement.
2. payment voucher.
3. bank statements.
4. Rent receipt.
B) Name of the concerned in the rent receipt agreement and on the payment,
voucher should be same, and it should be clients name only.
C) Date: date appears on rent receipt in bank statement and in the payment,
voucher should be tally and it pertains to current year only.
D) Amount: amount appears on rent payment voucher, rent receipt and amount
mentioned in the rent agreement must be tallied similarly, amount given in
words and numbers on all supporting documents should be same.
E) Time period: the period of occupation mentioned in the rent receipt or rent
payment voucher should tally with the period mentioned in the rent
agreement.
F) Signature: rent agreement should be signed by authorised official of the
client to indicate approval.
Rent receipt should be signed by authorised official of the landlord which will
indicate that it is genuine.
The payment voucher should be signed by the person preparing document
and by the person making entry in the books of accounts.
G) Errors: auditor should ensure that there are no errors of omission or
commission. Specifically, he should pay attention to the transactions close to
year end if any prepaid or outstanding amount pertaining to current year it
should be properly adjusted.
H) Disclosure: rent paid should be shown under other expenses in the statement
of p & l and rent received should be shown under other income in the
statement of p & l.

2) Travelling expenses
A) Supporting documents
1. Bus ticket
2. Rail ticket
3. Plane ticket
4. Bills for lodging and boarding in the hotels.
5. In case, of foreign trips sanction of RBI for expenses in foreign currency.
B) The document should pertain to client and not to any other person.
 C) The travelling should occur in current accounting year only.
D) The contents of ticket and hotel bills and other statements should be checked by
auditor to understand purpose of travelling and whether it is recorded under
proper trades.
E) The auditor should carefully check that amount as per tickets, bills tallies with the
amount mentioned in the voucher.
F) Travelling expense should be mentioned in the profit and loss account in the
proper manner.

3) Salaries and wages (IMPORTANT)

Auditor can voucher salaries and wages as follows:

A) Supporting documents
I. Payroll or wage sheet.
II. Attendance or personnel record
III. Statutory returns filed with provident fund, income tax, etc.
IV. Bank statements.
B) The payroll or wage sheet should pertain to client only and not to any other person.
C) The salaries and wages pertain to current year only and not to the earlier or next
year.
D) The auditor should carefully check amount paid to employee is asper payroll and it
also tally with payment voucher.
E) Computation of amount:
a. The amount of gross salary or wages should tally with attendance record or
personnel record.
b. The attendance record shows no. of days employee were present or absent.
Personnel record shows basic salary allowances, etc. Auditor can check
computation on sample basis.
F) The employee should have signed in the payroll against his name.
G) In case of senior management officials, the auditor should pay particular attention to
determine whether salaries payable are as per terms in the contract.
H) In case of casual or contractual labours the auditor should specifically examine
sanction of competent authority for employment of such labours. He also ascertains
whether such employees retained as per time rate or piece rate basis.
I) Ex-employees
a. The auditor should obtain list of the employees who have retired or
otherwise left the service during the period under audit, auditor should
examine that they have not been included in the payroll.
J) Accounting principles and policies:
a. Auditor should check whether the entry is correct as per accounting principle
for example: gross amount of salaries and wages should be debited to salary
or wages account and the amount of deduction like income tax, provident
fund should be credited to respective account.
K) Disclosure under schedule 3:
 Salaries and wages should be disclosed under separate head called as employee
benefits expenses in profit and loss statement.

4) Advertisement expense
A) Supporting documents
I. Bill for advertising agency
II. Receipt of advertising agency
III. Proof of advertisement in newspaper, social media, etc.
B) Name of the client
The document should pertain to client.
C) Amount- The auditor should carefully check amount as per bill tallies with the
amount as per voucher.
D) Date of the documents- the advertisement should appear in current accounting
year only; it should not pertain to previous year or next year.
E) Quantity- If payment is pertaining to any gift voucher or sales promotional
material the auditor should check quantity mentioned in the bill tallies with
quantity in the delivery chalan gate pass, etc. In case of banner advertising auditor
should cross verify number of banners.
F) Signature- Delivery chalan invoice should be properly signed and stamped on
behalf of party, the goods receipt note should be signed by storekeeper,
inspection note should be signed by inspector.
G) Disclosure in the books of accounts.
If the advertisement expense is material that it exceeds 1% of its operating
revenue, then it should disclose properly as per schedule 3 of companies act, 2013.

Techniques of verification
Verification means examination of assets and liabilities by auditor for this purpose he may
use following techniques:
1) Physical inspection
Auditor must physically inspect all the assets for example: Counting the cash in the
cash box, taking inventory of closing stock, physical verification of fixed assets like
building, machinery, laptop, etc.
In case, of liability for example loan taken, auditor can verify loan agreement.
2) Observation
Observation means observing or witnessing inspection of assets done by others.
Thus, auditor may not himself take the inventory but only observe that the inventory
is been taken by the audit staff in the right manner.
3) Confirmation
Confirmation means obtaining written evidence from outside parties regarding
existence of asset or liability for example, he can obtain statements from debtors or
creditors of business organization.
Distinguish between vouching and verification (most important)
Vouching Verification
1. Meaning- Vouching is comparing 1. Meaning- Verification is checking
entries in the books of accounts existence, possession and
with documentary evidence. ownership of asset and liability.

2. Time period- vouching is done for all 2. Time period- verification is done for
the entries during accounting year. assets and liabilities on balance date
only.
3. Vouching covers income, 3. Verification covers only assets and
expenditure, assets purchased or liabilities as on last day of
sold, liabilities repaid during the accounting year.
year.
4. Importance: 4. Importance:
a) Whether the transaction is a) Whether assets or liabilities are
actually incurred. existed.
b) Whether the amount is b) All assets and liabilities are
recorded in the books of correctly valued correctly.
accounts correctly. c) Whether assets are owned, and
c) To check all entries are related liability is owed at the year-end
to current year only. is correct.
d) Proper disclosure of all the items d) Whether assets and liabilities
as per schedule 3 of companies are legally valid.
act, 2013.

5. Audit Technique- Vouching involves 5. Verification involves physical

checking of vouchers, checking of verification, inspection by auditor
supporting documents and entries and confirmation from third party.
in the books of accounts.

5) Vouching for interest income

-> bank statement
->
How you will verify plant and machinery
a) Review of internal control- auditor should study and review system of
internal control relating to acquisition and use of plant and machinery. It
includes effective control over capital expenditure the concern should
maintain proper record of details of machinery, etc.
b) Scrutiny of ledger accounts-
i. Auditor should scrutinise ledger accounts of plant and machinery to ascertain major
transactions of purchase, sales etc.
ii. Auditor should check that no asset purchased in the purchase book and assets sold
should not be recorded under sales book.
iii. Legal ownership- the auditor should check whether the machinery is legally owned
by the concern or not, in case of machinery purchased from outsiders the auditor
should verify supplier’s invoices and other documents. If the machinery is fabricated
by the organisation auditor should obtain certificate from expert valuer regarding
cost of fabrication and ownership of machine.
How you will verify outstanding expenses
i. Accrual accounting- Accrual is fundamental basis of accounting. A limited
company must maintain its accounts on accrual basis. Under this system
expenses which have accrued are booked even if they are not actually paid. If
any expenses are paid in advance they are treated as prepaid expenses.
ii. Scrutiny of expense account- Auditor should scrutinise all expenses accounts for
e.g., interest, rent, salary to ascertain the exact amount of outstanding expenses.
iii. Service charges- Service charges accrued when service is performed or
completed. For e.g., if job is completed within accounting year but yet not billed
auditor should ensure that service charges should be shown under outstanding
expenses, on the other hand if any amount is paid and job is not completed it
should be shown under prepaid expenses.
iv. Rent- Rent is also accrued on the agreed rent. For e.g., rent agreement states
that rent of Rs 1,000 is payable for month then rent for the year is rs 12,000, if
lesser amount is paid then it is called as outstanding and if more than 12,000
amount is paid then it is called as prepaid. Other examples include salaries and
wages and interest due.
How will you verify investment?
Auditor should verify investment in shares and debentures as follows:
1.Transaction
The auditor should ascertain whether the investment made by entity are within its
authority, purchase and sale of investment should be supported by proper documentation.
Auditor also needs to check the prices paid or received with reference to stock exchange
quotations.
2. Inspection
The auditor should carry out physical inspection of share certificate, debenture certificate,
dividend warrants issued by company. This will prove that shares or debentures are
purchased by the concern.
3. Held by others.
Where the investments are held by others, for example by banks on the behalf of entity, the
auditor needs to examine certificates received from others.
4. Held in different names.
If the investments are held otherwise then the name of entity, for example in the name of
nominee or trustee the auditor should examine reason for the same and examine relevant
documentary evidence.
5. Foreign exchange
In case foreign exchange is involved in purchase or sale in investment auditor should see
that amounts are converted in rupees in proper manner.
6. Correct computation
Auditor should verify that arithmetical computation while finding out value of purchase or
sale of investment is correct.
7. Accounting
Auditor should see that investments are accounted in the books of accounts according to
basic principles of accounting. The accounting must confirm to as per guidelines issued by
ICAI (Institutes of charted accountants of INDIA) as per provision investment shown as per
AS 13 which is named as accounting in investment.
8. Auditor should see that Investments are purchased or sale in accordance with
provisions of companies act.
9. Auditor should ascertain whether any event after the date of balance sheet has
affected value of investment as at the year end.

Module 4 INTERNAL CHECK SYSTEM

 1. Test check
Introduction:
It is duty of Auditor to judge quality of final accounts for this purpose he has to
obtain audit evidence, he should vouch various transactions and verify assets and
liabilities. However, 100% checking of all this is not possible therefore he has to
select few items from books of the accounts it is called as test checking.

Definition:
According to Prof. Meigs test checking means to select and examine a representative
sample from large number of similar items.
For example: checking 25% of purchase vouchers, taking 25% of ledgers etc.

Unsuitable:
Test checking is unsuitable for following items:
a. Opening and closing entries
b. Bank reconciliation statements
c. Transactions on which auditor must report under companies act.
d. Nonrecurring or exceptional transactions which cannot be tested on yearly basis.
Importance:
a. Full checking is impossible-
When the number of transactions is very large then auditor cannot check 100%
transactions.
For example: in case od audit of a bank it is physically impossible to check all the
payments made by bank. Therefore, auditor should go for test check.
b. Full checking is unnecessary-
In most cases 100% checking is unnecessary detailed checking become routine
and mechanical. Test checking allows the auditor to concentrate on important
areas.
Advantages of test checking
1)Test checking helps to reduce cost of Audit.
2) it helps to speed up the audit work.
3) it helps to decide whether financial records are reliable or not.
4) it is labour saving technique.
5) it helps the auditor to arrive at a conclusion regarding true and fair view of books of
accounts

Drawbacks of test checking

 1) Arbitrary selection
The items to be checked and the extent of checking are selected or arbitrary basis.
The selections depend on personal judgement of auditor.

2) Ignore statistical techniques.

Test checking ignores statistical techniques like sampling, random selection, risk
assessment, etc. thus auditor may not sure that samples selected are 100% correct.

3) Ignores quality.
An audit instruction regarding 25% of checking of purchase entries does not indicate
how those 25% entries should be selected. It means that test checking emphasis on
quantity rather than quality of checking. Audit assistants may check simple entries
only which is wrong.

4) Risk
Risk means the possibility that conclusions based on test checking maybe different
from those based on 100% checking. Risk is involved when auditor 100% rely on
internal control.

Routine checking
Meaning:
Routine checking means checking of Arithmetical accuracy of books of original entry and
ledgers with a view to detect clerical errors and simple frauds.
Features of Routine checking
1) Detailed checking
Routine checking involves detailed checking of every accounting step i.e., entries in
the journal, posting into ledger, preparation of trial balance and final account. In
routine checking efforts are made to check maximum no. of transactions so that
result could be accurate.
2) Traditional system
It is traditional system of audit which is also known as vouch and post system.
3) Audit work is usually done by junior members of the audit staff as this is routine and
mechanical work.
4) Ticks- distinctive ticks are used in routine checking for different purposes for eg. For
totals, for postings, etc. hence routine checking is also known as tick work.
5) Routine checking is of mechanical work, but it should be done thoroughly and
intelligently as it will help to discover many errors in posting, totalling etc. the main
objectives of routine checking are:
i. Verification of the arithmetic accuracy of the entries.
ii. Verification of the accuracy of the posting in the ledger.
iii. Verification of correct balancing of the ledger.
iv. Ensuring that no figures can be altered after checking.
Advantages of routine checking
1. It is simplest form of audit work.
2. Errors and frauds of simple nature can be easily detected.
3. Books of accounts are thoroughly checked.
4. It helps in checking posting and casting.
5. Arithmetical accuracy of all transactions can be confirmed by this method.
6. It offers an opportunity to train junior auditors.
Disadvantages of routine checking
1. It is mechanical and boring work.
2. It can detect only simple arithmetical errors and frauds.
3. It is time consuming and expensive.
4. It is unnecessary in case of large business organisation where computerised
accounting is used.

Internal control
According to WW Biggs internal control is whole system of a control, financial or other wise
established by management, in the conduct of the business including internal check,
internal audit and other forms of a control.

Objectives of internal control:

a) Accounting control
Accounting control aims to ensure that:
1. All transactions are duly authorised.
2. All transactions are properly recorded.
3. All transactions should be recorded promptly as soon as they occur.
4. All accounting policies adopted by management in the respect of stock valuation,
depreciation is correctly implemented.
5. The assets of the concerned are safeguarded, the assets are not used or sold
without proper authorisation and assets are verified regularly.
6. Errors and frauds are detected are prevented.
7. Books of accounts are complete and accurate.
8. The final accounts are reliable and ready in time.
b) Operational or administrative control
Operational control aims to ensure that management policies in the respect of
operations and administrations are properly implemented. This ensures that
business is conducted in an orderly and efficient manner.
Examples of operation controls are Quality control, budgetary control, quantitative
control, internal audit, etc.

Features of internal control system

A) Control environment
Control environment means overall attitude awareness and actions of directors and
management regarding internal control system.
Elements in control environment includes:
1. Organizational structure and methods of assigning authority and responsibility.
2. Functions performed by directors.
3. Management’s philosophy and operating cycle, etc.
B) Control procedure
Control procedure includes policies and procedures established to achieve specific
objectives.
1. Bank reconciliation statement.
2. Check arithmetical accuracy of the record.
3. Controlling computer information system.
4. Approving and controlling documents.
5. Comparing internal data with external sources of information.

Adequate accounting system

Management is responsible for maintaining adequate accounting system to identify

assemble calculate, classify and record of each and every business transaction.
Supervision and modification
The system of internal control must be under the supervision of management to
determine it is functioning as per prescribed manner. Management should adopt
necessary changes in the policies if situation so demand.

Budgetary control and internal audit

There should be strong awareness and actions by directors and management
regarding internal control system. There should be strong control environment for
example if budget is decided by management, then no one can cross that limit or will
be responsible or answerable any excess expenditure or lower income.

Corrective actions on weaknesses

Management should take corrective actions on weaknesses of internal control
system which are pointed by auditors.

Distinguish between:
Internal control and internal check
 Internal control Internal check

1. It is one of the internal controls

1. It is entire system of control Which divides the work to help to carry
cross checking. on business efficiently.
2. It includes internal check 2. It is small part of internal control.
plus internal audit. 3. It is done by actual administrative staff
3. It is established by hire during day-to-day operations.
management at planning 4. It aims to prevent errors only during the
stage. work.
4. It aims to prevent errors and
frauds and to detect them
afterwards.

MODULE 6

Section 226 of companies act deals with provisions regarding appointment of the auditor.
a. First auditor of the company
According to section 226(5) of companies act, the first auditor of the
company shall be appointed by the board of directors within one month from
the date of registration of the company. Such auditors can hold office till
conclusion of first annual general meeting. If the first auditors are not
appointed by board of directors, they may be appointed by the company in
the first annual meeting.
b. Tenure of appointment
Section 224(1) provides that auditor is appointed for particular time period
that is from the conclusion of one annual general meeting to conclusion
second annual general meeting. But if annual general meeting is not held
within prescribed time period then auditor can continue his work till next
annual general meeting held and concluded.

c. Appointment by shareholders
Except in case of first auditor or an auditor to fill the casual vacancy, every
company should appoint auditor in its annual general meeting such auditor is
appointed by shareholders.

d. Appointment by central government

When an auditor is not appointed in the annual general meeting the
company should notify this fact to the central government within 7 days
thereafter and central government will appoint auditor for the company. If
company fails to intimidate this fact within 7 days to central government
then every officer of the company in default shall be punishable with fine
which may extend to Rs 500.

e. Rights and powers of the auditor