A Book Of

A U D I TI N G
T.Y.Bcom. : Semester − V
[Course Code : 354; Total Credits : 4]
(Core Course - I)

As Per New Syllabus, Effective from June 2021

CBCS Pattern

Dr. Rupali Bipin Sheth Dr. Dnyandev Laxman Nitve

Ph.D. (Accountancy) SET, B.Com., M.Com., M.Phil, B.Ed., P.h.D.
M.Com., ICWA (Inter) Assistant Professor
Assistant Professor JSPM's, Jayawantrao Sawant College
Huzurpaga Mahila Vanijya Mahavidalaya, of Commerce and Science,
691, Narayan Peth,Pune 411030 Hadaspar, Pune 411028

Price ` 190.00

N5739
 Auditing ISBN 978-93-5451-049-6
First Edition : July 2021
© : Authors
The text of this publication, or any part thereof, should not be reproduced or transmitted in any form or stored in any computer
storage system or device for distribution including photocopy, recording, taping or information retrieval system or reproduced on any
disc, tape, perforated media or other information storage device etc., without the written permission of Authors with whom the rights are
reserved. Breach of this condition is liable for legal action.
Every effort has been made to avoid errors or omissions in this publication. In spite of this, errors may have crept in. Any mistake,
error or discrepancy so noted and shall be brought to our notice shall be taken care of in the next edition. It is notified that neither the
publisher nor the authors or seller shall be responsible for any damage or loss of action to any one, of any kind, in any manner,
therefrom.
Published By : (Poly Plate) Printed By :
NIRALI PRAKASHAN YOGIRAJ PRINTERS AND BINDERS
Abhyudaya Pragati, 1312, Shivaji Nagar Survey No. 10/1A, Ghule Industrial Estate
Off J.M. Road, Pune – 411005 Nanded Gaon Road
Tel - (020) 25512336/37/39, Fax - (020) 25511379 Pune - 411041
Email : [email protected] Mobile No. 9404233041/9850046517

DISTRIBUTION CENTRES
PUNE
Nirali Prakashan : 119, Budhwar Peth, Jogeshwari Mandir Lane, Pune 411002, Maharashtra
(For orders within Pune) Tel : (020) 2445 2044, 66022708, Fax : (020) 2445 1538; Mobile : 9657703145
Email : [email protected]
Nirali Prakashan : S. No. 28/27, Dhayari, Near Asian College Pune 411041
(For orders outside Pune) Tel : (020) 24690204 Fax : (020) 24690316; Mobile : 9657703143
Email : [email protected]
MUMBAI
Nirali Prakashan : 385, S.V.P. Road, Rasdhara Co-op. Hsg. Society Ltd.,
Girgaum, Mumbai 400004, Maharashtra; Mobile : 9320129587
Tel : (022) 2385 6339 / 2386 9976, Fax : (022) 2386 9976
Email : [email protected]
DISTRIBUTION BRANCHES
JALGAON
Nirali Prakashan : 34, V. V. Golani Market, Navi Peth, Jalgaon 425001, Maharashtra,
Tel : (0257) 222 0395, Mob : 94234 91860; Email : [email protected]
KOLHAPUR
Nirali Prakashan : New Mahadvar Road, Kedar Plaza, 1st Floor Opp. IDBI Bank, Kolhapur 416 012
Maharashtra. Mob : 9850046155; Email : [email protected]
NAGPUR
Nirali Prakashan : Above Maratha Mandir, Shop No. 3, First Floor,
Rani Jhanshi Square, Sitabuldi, Nagpur 440012, Maharashtra
Tel : (0712) 254 7129; Email : [email protected]
DELHI
Nirali Prakashan : Room No.2, Ground Floor, 4575/15 Onkar Tower, Aggarwal Road, Darya Ganj,
New Delhi 110002 • Mob. +91 9555778814/+91 9818561840
• Email : [email protected]
BENGALURU
Nirali Prakashan : Maitri Ground Floor, Jaya Apartments, No. 99, 6th Cross, 6th Main,
Malleswaram, Bengaluru 560003, Karnataka; Mob : 9449043034
Email: [email protected]
Other Branches : Hyderabad, Chennai
Note : Every possible effort has been made to avoid errors or omissions in this book. In spite this, errors may have crept in. Any
type of error or mistake so noted, and shall be brought to our notice, shall be taken care of in the next edition. It is notified that neither
the publisher, nor the author or book seller shall be responsible for any damage or loss of action to any one of any kind, in any manner,
therefrom. The reader must cross check all the facts and contents with original Government notification or publications.
[email protected] | www.pragationline.com
Preface …

It is our immense pleasure to connect with T.Y.B.Com students with the subject of
Auditing through book. Financial Audit is examination of books of accounts with the
knowledge of Book Keeping and Accounting. Savitribai Phule Pune University has
revised syllabus of T.Y.B.Com from the year 2021-2022.

As per the requirement of Savitribai Phule Pune University, we have revised and
added new content in this book. This will help the student to acquaint with Meaning of
Audit, Process of Audit, and Requirement in Audit as per Company Act 2013. Students
will get knowledge about auditing in EDP environment and also get an idea about
Forensic Audit one of the emerging branch in auditing. We have tried to explain in
simple language and tried to make subject very interesting.

We are extremely thankful to Nirali Publication for giving us this opportunity and for
having entrusted us with responsibility of writing this book. We are extremely thankful
and obliged to Mr. Dineshbhai Furia and Mr. Jigneshbhai Furia, for placing us in the
panel of writers of his esteemed publishing house Nirali Publication. We are also thankful
to Mr. Amol Mahabal, Mr. Ravindra Walodare, Mrs. Yojana G. Deshpande,
Mr. Umesh Mundada and entire team of Nirali Publication,

Hope and pray the book fulfill the need of students

Best of Luck

Authors

❂❂❂
 SYLLABUS
1. INTRODUCTION TO PRINCIPLES OF AUDITING AND AUDIT PROCESS

• Definition • Nature

• Objects • Advantages of Auditing

• Types of Errors and Frauds, various Classes of Audit.

• Audit programme, • Audit Note Book,

• Working Papers, • Internal Control

• Internal Check • Internal Audit.

2. CHECKING, VOUCHING AND AUDIT REPORT

• Test checking-Vouching of Cash Book

• Verification and Valuation of Assets and Liabilities.

• Types of Audit Report

• Audit Certificate

• Difference between Audit Report and Audit Certificate

• Auditing and Assurance Standards. (AAS : 1, 2, 3, 4, 5)

3. COMPANY AUDIT AND TAX AUDIT

• Company Audit : Qualification, Disqualifications, Appointment, Removal, Rights,

Duties and Liabilities of Company Auditor

• Tax Audit : Provisions under Income Tax Act, 1961 (Section 44 AA, 44AB, 44AD,
44ADA, 44AE), Recent Amendment made as applicable as per Income Tax Act, 1961

4. AUDIT OF COMPUTERIZED SYSTEMS AND FORENSIC AUDIT

• Auditing in an EDP Environment : General EDP Control, EDP Application Control,

Computer Assisted Audit Techniques (Factors and Preparation of CAAT)

• Forensic Audit : Definition, Importance of Forensic Auditor, Services Render by

Forensic Auditor, Process of Forensic Auditing and Forensic Audit Techniques and
Forensic Audit Report.

❂❂❂
 CONTENTS

1. Introduction to Principles of Auditing and Audit Process 1.1 − 1.60

2. Checking, Vouching and Audit Report 2.1 − 2.52

3. Company Audit and Tax Audit 3.1 − 3.34

4. Audit of Computerized Systems and Forensic Audit 4.1 − 4.28

❖ APPENDIX : Multiple Choice Questions A.1 − A.12

❂❂❂
Chapter 1…
Introduction to Principles of
Auditing and Audit Process
Contents …
1.1 Auditing
1.1.1 Introduction
1.1.2 Origin of Auditing
1.1.3 Auditing in India
1.1.4 Meaning of Auditing
1.1.5 Definitions of Auditing
1.1.6 Nature of Auditing
1.1.7 Scope of Auditing
1.1.8 Objectives of Auditing
1.1.9 Principles of Auditing
1.1.10 Importance of Auditing
1.1.11 Difference between Accounting and Auditing
1.1.12 Types of Audit or Classes of Audit
1.1.13 Audit Process
1.1.14 Advantages of Auditing
1.2 Errors and Frauds
1.2.1 Introduction
1.2.2 Types of Errors
1.2.3 Detection and Prevention of Fraud
1.2.4 Types of Frauds
1.2.5 Difference between Error and Fraud
1.1
Auditing Introduction to Principles of Auditing and Audit Process

1.3 Audit Programme

1.3.1 Features/Characteristics of an Audit Programme
1.3.2 Objective of Audit Programme
1.3.3 Advantages of Audit Programme
1.3.4 Disadvantages of an Audit Programme
1.4 Audit Note Book
1.4.1 Contents of an Audit Note Book
1.4.2 Advantages of Audit Note Book
1.4.3 Disadvantages of Audit Note Book
1.5 Audit Working Papers
1.5.1 Objectives of Audit Working Papers
1.5.2 Essentials of a Good Audit Working Papers
1.6 Internal Control
1.6.1 Types of Internal Control
1.6.2 Limitations of Internal Control
1.7 Internal Check
1.7.1 Features of Internal Check
1.7.2 Advantages of Internal Check
1.7.3 Disadvantages Internal Check
1.8 Internal Audit
1.8.1 Objectives of Internal Audit
1.8.2 Features of Internal Audit
1.8.3 Difference between Internal Audit and Internal Check
1.8.4 Difference between Internal Control and Internal Check
• Points to Remember
• Questions for Discussion
Learning Objectives..
After reading this chapter, the students should able to understand:
1. To study the basic concepts of auditing
2. To acquaint the learner about types of errors and frauds in Auditing
3. To learn the various Classes/Types of Audit
4. To understand about Audit programme, Audit Note Book & Working Papers
5. To impart knowledge about meaning of Internal Control, Internal Check and
Internal Audit

1.2
Auditing Introduction to Principles of Auditing and Audit Process

1.1 Auditing
1.1.1 Introduction
• After the Industrial Revolution, the importance of auditing has increased and today
auditing has become inevitable. The area of business was limited after the
Industrial Revolution. Business owners were responsible for managing, accounting
and maintaining their own businesses. Since the business is self-owned, there is no
need to check the accounts, financial transactions from others to verify its accuracy.
Due to the limited size and nature of the business, as well as the fact that the legal
matters related to the business were not very complicated; accounting, making
various records, etc. were simplified. The owner of the business used to make sure
if the accounts were correct. As a result, appointment of another person was not
necessary.
• After the Industrial Revolution, the nature of business changed. The principles of
division of labour were implemented and the form of organizations changed.
Business associations began to take on new forms and companies were formed on
larger scales. Expert managers were appointed to look after decision making,
accounting etc. Thus ownership and management became separate from each
other. The auditors needed to check whether the employees of the companies were
managing the financial recourses properly; like their money transactions, property
transactions and keeping proper accounts.
• The audit is an intelligent and critical examination of the books of accounts of the
business. Auditing is done by one independent person or body of persons qualified
for the job with the help of statements, papers, information and comments
received from the authorities so that the examiner can confirm the authenticity of
financial accounts prepared for a fixed term and report.
• Auditing, in the general sense, is the examination of the books of accounts or a
business concern by an independent person called the auditor.
• The work of an auditor begins on completing the accounting process. Hence,
auditing is a post-mortem analysis of the books of accounts.
• Auditing is a mathematic and accuracy examination of financial statements.
Financial statement audit, energy efficiency audit, e-mail log audit, environment
audit etc. are few examples of the same.
• Although, auditing is a broad term, it is understood to be closely linked with
financial auditing, i.e. an in-depth review of the books of accounts of an entity to
ensure that the financial statements prepared on the basis of the books of accounts
are accurate and reliable. It may be so because it is more commonly used by
business organisations for the review of financial statements.
1.3
Auditing Introduction to Principles of Auditing and Audit Process

1.1.2 Origin of Auditing

• Auditing has recently developed with a remarkable pace with the development of
accounting. The origin of auditing can be traced back to 1494 when Luca Pacioli
published his book on Double Entry System of Accounting.
• The Industrial Revolution led to a great increase in the volume of trading
operations which necessitated the use of more capital. Consequently, big
enterprises in the form of partnership firms and joint stock companies were formed
which necessitated an improved accounting system and independent and impartial
audit of the books of accounts. It was only in the latter part of the nineteenth
century that auditing took its firm root in the modern sense.
• Back in the 18th century, when the practice of large scale production developed as
a result of the Industrial Revolution, auditing started gaining popularity. Systems of
checks and counter checks were implemented to maintain public accounts as early
as the days of ancient Egyptians, Greeks and Romans. The last decade of the 15th
century was a crucial period during which a great impetus was given to trade and
commerce by Renaissance in Italy, and the principles of double entry book-keeping
were evolved and published in 1494 at Venice, Italy by Luca Paciolo. This system of
accounts was quite capable of recording all types of mercantile transactions.
• The Industrial Revolution of England was another landmark in the history of trade
and commerce. The industrial revolution led to a significant expansion in the
volume of trading transactions which compelled the use of more money and the
ordinary trader was encouraged to form partnerships with other individuals.
Consequently, a big enterprise was framed in the form of partnership firms and
joint-stock companies. This growth of business enterprises before and after the
industrial revolution accompanied an improved accounting system. Besides, British
Companies made stockholders realize that an independent and impartial audit
could well protect their interest. Such developments had a direct effect on the
evolution of the practice of auditing, but the audit of business accounts could not
be standardized until the 19th century.
• A Royal Charter incorporated the Institute of Chartered Accountants in England and
Wales on May 11, 1880. The key purpose of this incorporation was to prepare
Auditors for the examination of financial matters. In January 1923, the British
Association of Accountants and Auditors got established and a person could be
fully competent to work as a professional.
1.4
Auditing Introduction to Principles of Auditing and Audit Process

1.1.3 Auditing in India

• The system of accounting and auditing is believed to have existed in our country
under the Mauryas, Chandragupta and other Hindu Kings. Kautilya, in his
Arthashastra had mentioned about the accounting and auditing of state finances.
He stated that; “all undertakings depends on finance. Hence, foremost attention
should be paid to the treasury.” He also listed various kinds of frauds and
embezzlements and prescribed punishments to deal with them. However, the
growth of the accounting profession in India is a recent development.
• The first company legislation in India, the Joint stock Companies Act of 1857,
contained regulations for the annual audit of company accounts. But adoption of
these regulations were entirely optional as there was no legal obligation on the
part of a company to have the audit of their annual accounts. It was the Companies
Act of 1913, which made it compulsory for every company incorporated under it to
have its accounts audited by professional accountants. This Act, for the first time,
prescribed the qualifications of the auditor, made special mention of his powers
and duties as well as laid down the procedure for his appointment. Under this Act,
provincial governments were authorised to conduct examinations and to issue
certificates to accountants entitling them to act as qualified auditors.
• In 1918, the Government of Bombay started a Government Diploma in
Accountancy (GDA). The Diploma was awarded to those who completed three
years of articleship traning and passed the necessary examination. These diploma
holders were allowed to practice in India. In the beginning of 1930, the control over
accountants in practice was shifted from the Provincial Governments to the Central
Government, with a view to maintain uniformity in standards throughtout the
country.
• In the year 1932, the Central Government established an Indian Accountancy board
to advice on matters relating to professional accounting. Under the regulations of
this board, the Central Government used to issue certificates of registered
accountant to those who wanted to work as qualified auditors.
1.1.4 Meaning of Auditing
• The word ‘Audit’ comes from the Latin word ‘Audire’ which means ‘to hear’. In the
middle ages, an auditor was a person, appointed by the owners whenever they
suspected fraud, to check accounts and to hear explanations given by persons
responsible for financial transactions. Auditing at that time was carried out to
locate frauds and errors. But in 1464, an Italian named Luca Pacialo, published his
treatise on the double entry system of book-keeping for the first time and also
described the duties and responsibilities of an auditor. Since then, there have been
1.5
Auditing Introduction to Principles of Auditing and Audit Process

noticeable changes in the scope of audit and in the duties and responsibilities of an
auditor. Further, when corporate enterprises started to grow, the result was
dispersed ownership and the distinct separation of management from ownership.
At the same time, institutional loans and borrowings came to play a significant role
in the running of industry and business. Also, the gradual expansion of the idea of
social responsibility of the state led to the introduction of the regulatory enactment
in the field of trade, industry and commerce. In short, diverse interests grew and
developed and as a result, the objective of audit correspondingly changed in
emphasis from time to time.
• As mentioned above, originally a large majority of audit in the early days was
related to ascertain whether the accounting party had properly accounted for all
receipts and payments on behalf of the owners. In other words, the orginal object
of making audit was to find out whether cash has been embezzled and if so, who
embezzled it and the amount of the embezzlement involved. It was merely a cash
audit. But the main object of modern audit is to see whether the balance sheet of a
firm presents an authentic view of its financial state of affairs. This would show that
funds of the shareholders and those who have given loans to the company have
been employed by the management to carry further the objectives for which the
company was formed.
• The emphasis now is clearly on the verification of accounting data with a view to
report on the reliability of the accounting statements.
• Auditing is the verification of the accuracy and correctness of the books of
accounts by independent persons qualified for the job and not in any way
connected with the preparation of such accounts. It is an intelligent and critical
examination of the books of accounts and other documents through checking,
vouching and verification of the critical examination to establish that the entries in
the books truly reflect the transactions to which they relate. The auditor would also
verify the financial position disclosed by the financial statements.
• In short, an audit implies an investigation and a report. The process of checking
and vouching continues until the study is completed and the auditor enables
himself to report under the terms of his appointment. Auditing, therefore, is an
examination of the books of accounts and vouchers of the business by an
independent person who should be qualified for the job, in order to ascertain their
accuracy.
• Thus, the meaning attached to the term has been broadening ever since its
inception. The definition given at different times by experts in the field has also
changed over the years. The following list of definitions is the most accepted ones.

1.6
Auditing Introduction to Principles of Auditing and Audit Process

1.1.5 Definitions of Auditing

• Auditing means the scrutiny of accounts books and the relative documentary
evidence by an independent qualified person in order to ascertain the accuracy of
the figures appearing therein.
• Some of the definitions of Auditing given by well- established writers are given
below:
1. The International Auditing Practices Committee
“The independent examination of financial information of any entity, whether
profit orgiented or not and irrespective of size, or legal form, when such an
examination is conducted with a view to expressing an opinion thereon”.
2. Mautz
“Auditing is concerned with the verification of accounting data, with determining
the accuracy and reliability of accounting statements and reports”.
3. Lawrence R. Dickey
“An audit is an examination of accounting records undertaken with a view of
establishing whether they correctly and completely reflect the transactions to
which the purport to relate.”
4. Taylor and Perry
“Audit is defined as an investigation of some statements of figures involving
examination of certain evidence, so as to enable an auditor to make a report on
the statement.”
5. F.R.M De Paula
“An audit denotes the examination of balance sheet and profit and loss accounts
prepared by others together with the books of accounts and vouchers relating
thereto in such a manner that the auditor may be able to satisfy himself and
honestly report that in his opinion such balance sheet is properly drawn up so as
to exhibit a true and correct view of the state of affairs of a particular concern
according to the information and explanations given to him and as shown by the
books.”
6. J. R. Batliboi
• “Auditing is an intelligent and critical scrutiny of the books of account of a
business with the documents and vouchers from which they are written up, for
the purpose of ascertaining whether the working results for a particular period, as
shown by the profit and loss account, as also the exact financial condition of that
business as reflected in the balance sheet are truly determined and presented by
those responsible for the compilation”.
7. Prof. Montgomery
“Auditing is a systematic examination of the books of records of business or
other organization in order to ascertain or to verify and to report upon the facts
regarding its financial operations and the result thereof.”

1.7
Auditing Introduction to Principles of Auditing and Audit Process

8. Spicer and Pegler

“Audit is an examination of the books of accounts and vouchers of a business as
will enable the auditor to satisfy himself that the balance sheet is properly drawn
up so as to give a fair and true view of the state of affairs of the business and
whether the profit and loss of accounts gives a true and fair view of profit and
loss for the financial period according to the best of his information and
explanations given to him and as shown by the books and if not in what respect
he is not satisfied.”
9. J.B. Bose
“Audit may be said to be verification of the accuracy and correctness of the
books of accounts by an independent person qualified for the job and not in any
way connected with the preparation of such accounts.”
10. A.K. Chandra
“Audit is not an inquisition and its mission is not one of fault finding. Its purpose
is to bring to the notice of the administration lacunae in his rules, regulations and
lapses and to suggest possible ways and means for the execution of plans and
projects with greater expedition, efficiency and economy.”
11. Institute of Chartered Accountants of India (ICAI)
“Auditing is defined as a systematic and independent examination of data,
statements, records, operations and performance of an enterprise for a stated
purpose. In any auditing situation, the auditor perceives and recognizes the
propositions before him for examination, collect evidence, evaluates the same
and on this basis formulates his judgement which is communicated through his
audit report”.
• From the above definitions of audit, we can see that audit is a vast concept. While
auditing the accounts of any business organization, the auditor's work is not only
done to see if the accounts kept by those organizations are mathematically
accurate, but all the transactions of the organization are authorized and properly
recorded.
• The auditor is also required to provide an opinion on whether the statements
prepared from it, e.g., profit-loss statement, balance sheet reflect the true financial
position of the respective institution. It is important to make sure that there is no
fraud during the audit.
• Former Controller and Auditor General of India A. K. Chanda, however, remarked
that audit is a process which points out errors and irregularities in management,
administration and rules. The audit also involves suggesting measures on how the
next plan can be completed more efficiently, promptly and economically.
1.8
Auditing Introduction to Principles of Auditing and Audit Process

1.1.6 Nature of Auditing

• The nature of auditing is explained with the following points:

Examination Comparison Verification Confirmation Opinion

Fig. 1.1 : Nature of Auditing

1. Examnation
• An audit 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 express an opinion thereon.”
• Auditing also attempts to ensure that the books of accounts are properly
maintained by the concern as required by law.
• Auditors consider the propositions before them, obtain evidence and evaluate the
propositions in their auditing report.
2. Comparison
• The auditor can compare the accounting records with financial statements to check
that the same has been processed for preparing the final accounts of a business
concern.
• The auditor determines whether the relevant information is properly
communicated by comparing the financial statements with the underlying
accounting records and other source data to see whether they properly
summarized the transactions and events recorded therein.
3. Verification
• The auditor is required to provide opinion on financial statements whether they
reflect true and fair view of financial position or not.
• Verification refers to the inspection of assets appearing in the balance sheet part of
financial statements and ensuring that assets are recorded as per legislation.
1.9
Auditing Introduction to Principles of Auditing and Audit Process

• The auditor has to fairly ascertain and examine the correctness of assets and
liabilities appearing in the balance sheet. So, the auditor has to keep in mind
certain aspects while verifying the assets such as,
(a) Ensuring existence of assets.
(b) Legal ownership and possession of assets.
(c) Ensuring proper valuation of assets.
(d) Ensuring the assets are free from any charge.
4. Confirmation
• Confirmation is the process of obtaining and evaluating a direct communication
from a third party in response to a request for information about a particular item
affecting financial statement assertions.
• The process includes:
(a) Selecting items for which confirmations are to be requested.
(b) Designing the confirmation request.
(c) Communicating the confirmation request to the appropriate third party.
(d) Obtaining the response from the third party.
(e) Evaluating the information, or lack thereof, provided by the third party about the
audit objectives, including the reliability of that information.
5. Opinion
• The audit opinion is given on whether the financial statements give a true and fair
view of the entity’s financial statements and whether they have been properly
prepared in accordance with the applicable reporting framework.
• An auditor's opinion is a certification that accompanies financial statements. It is
based on an audit of the procedures and records used to produce the statements
and delivers an opinion as to whether material misstatements exist in the financial
statements.This opinion is reached after:
(a) Extensive testing of controls and substantive tests on transactions and balances for
validity, accuracy and completeness of recording.
(b) Extensive verification procedures have been performed to test for existence,
ownership, valuation, presentation and disclosure of items in the financial
statements.
(c) Extensive review of whether the financial statements comply with applicable
accounting standards and legal requirements.
• As such, the audit opinion gives a high level of assurance to the users of financial
statements. Whenever an audit is conducted, it must be performed in accordance
with the auditing standards.
• The auditor’s report on financial statements illustrates the high level of assurance
given by an audit.
1.10
Auditing Introduction to Principles of Auditing and Audit Process

1.1.7 Scope of Auditing

• The scope of an audit is:
1. Legal Requirements 2. Entity Aspects
3. Reliable Information 4. Proper Communication
5. Evaluation 6. Test
7. Comparison 8. Judgments
9. Errors 10. Opinion
• The scope of audit can be explained by following points:
Legal
Require-
ments
Entity
Opinion Aspects

Test Reliable
Information

Scope of
an Audit

Proper
Comparison Communi-
cation

Judgements Evaluation

Errors

Fig. 1.2 : Scope of an Audit

• Audit scope are explained in detail as below:
1. Legal Requirements
• The auditor can determine whether the scope of an audit of financial statements
are according to requirements of legislation, regulations or relevant professional
bodies. The professional can frame rules for determining the scope of audit work.
In the same way, professional bodies can make rules to conduct the audit.
1.11
Auditing Introduction to Principles of Auditing and Audit Process

2. Entity Aspects
• A business entity has many areas of working. A small entity may have few functions
while a large concern has many functions. The auditor has to go through all the
functions of the business. The audit should be organized to cover all aspects of the
entity as far as they are relevant to the financial statements being audited.
• The audit report should cover all functions so that the reader may know about all
the workings of a concern.
3. Reliable Information
• The auditor should obtain reasonable and accurate information contained in the
accounting records and other source data is reliable and should sufficient for the
preparation of the financial statements. The auditor can use various techniques to
test the validity of data.
• All auditors while doing the audit work usually apply the compliance test and
substance test. The auditor can show such information in the report.
4. Proper Communication
• Accounting is an information system so facts and figures must be so presented that
the reader can get information about the business entity.
• The auditor should decide whether the relevant information is properly
communicated in the financial statements. The auditor can mention this fact in his
report.
• The principles of accounting can be applied to decide about the disclosure of
financial information in the statements.
5. Evaluation
• The auditor assesses the reliability and sufficiency of the information contained in
the underlying accounting records and other source data by making a study
and evaluation of accounting systems and internal controls to determine the
nature, extent and timing of other auditing procedures.
6. Test
• There are compliance tests and substantive tests to examine the data. The
vouching, verification and valuation technique is also used.
• The auditing assesses the reliability and sufficiency of the information contained in
the underlying accounting records and other source data by carrying out other
tests, inquiries and other verification procedures of accounting transactions and
account balances as he considers appropriate in the particular circumstances.
1.12
Auditing Introduction to Principles of Auditing and Audit Process

7. Comparison
• The auditor can compare the accounting records with financial statements to check
that the same has been processed for preparing the final accounts of a business
concern.
• The auditor determines whether the relevant information is properly
communicated by comparing the financial statements with the underlying
accounting records and other source data to see whether they properly
summarized the transactions and events recorded therein.
8. Judgments
• The auditor assesses the selection and consistent application of accounting
policies, how the information has been classified and the adequacy of disclosure.
• The auditor determines whether the relevant information is properly
communicated by considering the judgment that management has made in
preparing the financial statements accordingly.
9. Errors
• It is the duty of the auditor to check through records of company to detect errors
and frauds and to discover errors in accounting books and other records. It is
important to confirm and clear doubts while finalize financial statements.
10. Opinion
• The important scope of audit is auditor’s opinion in audit report. Qualified opinion
or disclaimer of opinion should be expressed as a appropriate.
1.1.8 Objectives of Auditing
• The objective of audit is to lend credibility to information and thereby improve its
reliability for decision-makers. Thus, the objective of auditing is to give assurance
of the truthfulness of the information under review.
• The type of audit conducted determines the specific objective of the audit under
consideration. For Example, the object of cost audit is to verify the truth and
fairness of cost of production of goods or rendering of service by an entity.
• The object of environment audit, on the other hand, may be to evaluate how well
the organisation, management and equipment are contributing towards safe-
guarding the environment and how well the business entity is following the
standard required by the law etc.
(A) Primary Objectives
• The main purpose of the audit is to ascertain and provide the real situation of the
business. These important objectives can be explained in more detail as follows:
1. Ensuring the Accuracy of the Annual Accounts
• The auditor needs to scrutinize the business and profit and loss accounting and
balance sheet of the business to know the profit earned by the business in the
respective period from the profit and loss account and to make sure that the
balance sheet gives a clear picture of the financial position of the business. This is
the most important objective of audit.
1.13
Auditing Introduction to Principles of Auditing and Audit Process

Primary
Objectives
Secondary
Objectives

Fig. 1.3 : Objectives of Auditing

2. Make Sure that the Accounts are kept as per the Rules
• The purpose of audit is to see that the business accounts are in accordance with
the tradition of the business concerned and the rules applicable to that business
and that there are no irregularities in it.
3. Encouraging efficiency and accuracy or precision in accounting.
(B) Secondary Objectives
• In order to express a view on the truth and fairness of financial statements, the
auditor has to ensure that there are no misstatements in the financial statements.
The incidental objective of a financial audit is the detection and prevention of
errors and frauds.

Satisfying
Government
Officials

Control Effects
on Accounts
Finding Errors in
Department
Accounting
Staff

Secondary
Objectives

Curbing fraud, Detecting fraud,

embezzlement embezzlement
in accounts

Help with
future policy
making

Fig. 1.4 : Secondary Objectives

1.14
Auditing Introduction to Principles of Auditing and Audit Process

1. Finding Errors in Accounting

• While recording the transactions, some mistakes are made unknowingly by the
accountant. Sometimes theoretical errors occur due to insufficient knowledge of
accounting rules or other reasons. For example, revenue and capital expenditure
are not properly assessed when creating a profit-loss account.
2. Detecting Fraud, Embezzlement in Accounts
• Mistakes are caused by ignorance of the rules and can be avoided by working
carefully. But deception, fraud, or embezzlement is intentional, deliberate, intended
to endanger the owner. Despite having sufficient knowledge of the rules of
accounting, the employee deliberately makes incorrect entries to embezzle money
for his own self-interest. In order to commit such frauds, the employee makes
incorrect entries from time to time. The purpose of the audit is to detect such
fraudulent transactions.
Example
• Failure to record receipts or underpayments, overstatement of searches or false
recordings. This can lead to money laundering.
• The purpose of the audit is to check the fraudulent records that can be scammed in
the same way as the goods coming and going.
3. Curbing Fraud, Embezzlement
• The auditor's job does not end with the mere discovery of fraudulent transactions.
One of the objectives of the audit is to carry out audits and preventive measures to
suggest improvements in the accounting system or system so that such fraudulent
transactions do not recur in the future.
4. Control Effects on Accounts Department Staff
• The purpose of the audit is to exert such control over the accounting staff so that
the accounting staff will do their job more carefully and avoid cheating or fraud,
knowing that the accounts they have written will be scrutinized by another person.
5. Satisfying Government Officials
• Officials of various government departments like income tax, sales tax have to take
account of business as their basis while doing their tax assessment work. These
officials have to make sure that the revenue of the government is not wasted by
falsifying these accounts. These officers do their job assuming that if the accounts
are audited, they are correct. Therefore, auditing is also an objective of satisfying
government officials.
1.15
Auditing Introduction to Principles of Auditing and Audit Process

6. Help with Future Policy Making

• The future strategy of each business is based on the information gathered from its
past accounts and the conclusions drawn from it.
• The accounts are audited to make sure that the information on the basis of which
important decisions are made about the future of the industry is correct.
• Audit is thus useful for the business to make future decisions.
1.1.9 Principles of Auditing

Principle of Principle of Principle of Principle of

Objectivity Documentation Planning Audit Evidence

Principle of
Principle of Principle of Audit conclusion
Accounting System
Independence Competecy and Report
and Internal Control

Principle of Principle of
Integrity Confidentiality

Fig. 1.5 : Principles of Auditing

1. Principle of Objectivity
• Principle of objectivity attempts to ensure that any subjectivity of auditor in signing
documents, examining evidence, collecting information is minimized. There is no
room for subjectivity of the auditor while auditing.
• In order to be objective, an auditor should apply the standard audit technique and
procedures. No doubt, an auditor is expected to give his expert opinion on the
truth and fairness of financial information, but his personal prejudices and opinions
are not accepted.
• The principle of objectivity increases the credibility of the audited financial
statements for all the uses of the financial information.
2. Principle of Documentation
• The principle of documentation seeks to protect the auditor and others. As per this
principle, auditor should document matters which are important in providing
1.16
Auditing Introduction to Principles of Auditing and Audit Process

evidence that the audit was carried out in accordance with the basic principles of
auditing. Adequately documented plans and control of audit work evidences the
practices, procedures followed in audit and important findings.
• “Documentation means writing the manner and matter of audit authenticated by
the signature of appropriate parties and their safe- keeping. For instance, entries
made in the ‘audit note book’ and ‘audit programme’ should be signed by the
concerned audit staff.
3. Principle of Planning
• In any audit assignment, an audit plan is very important. A detailed plan ensures
that all the work necessary for an effective audit is performed. Well- planned and
effectively controlled audit enhances the quality of audit work.
• Bearing in mind the audit aim, the auditor must programme his work, schedule
them, depute staff, divide the work among them, coordinate their work, supervise
the progress of the work and make review of their findings before giving an
opinion certificate or advice.
4. Principle of Audit Evidence
• The report of the auditor should be based on evidence obtained in the course of
the audit. An auditor may obtain evidence for these from within the entity, or from
sources outside the entity.
• The evidence is obtained by the following methods:
(a) Inspection (b) Observation (c) Inquiry and confirmation
(d) Computation (e) Analytical review
5. Principle of Accounting System and Internal Control
• This principle requires that the auditor should evaluate the accounting system and
internal control system of the organisation.
• The audit work depends on the extent of effective accounting and internal control
system prevalent in the organisation. If the systems are effective, he can go for
sample checking. But this does not reduce his duty towards his client.
6. Audit Conclusion and Report
• An auditor should form his opinion about accounts on the basis of the audit
evidence. He should state his expert opinion as to whether he is satisfied about the
truth and fairness of the financial information submitted to him to the best of his
knowledge and as per the evidence collected by him. He should submit his report
to shareholder/ client.
1.17
Auditing Introduction to Principles of Auditing and Audit Process

7. Principle of Competency
• Audit should be conducted by competent persons only. In India, the Companies
Act, 1956 requires the auditor to be a member of the Institute of Chartered
Accountants of India (ICAI). In order to become a member, one must undergo
practical training and pass the prescribed examination. Further, the Chartered
Accountants need to update their competency by continuing with the education
programme of the institute.
8. Principle of Independence
• Besides competence, the auditor must be independent. Independence implies
acting without any fear or favour. Unless an auditor is independent, his opinion is
not reliable. The very purpose of getting the reports audited shall be defeated.
Independence is lost when the auditor has or acquires vested interest in the
organisation.
• In order to protect the independence, the following persons cannot become
‘Company Auditor’ as per the companies Act:
(a) An officer or employee of the company under audit, like director etc.
(b) A person who is a partner, or who is in the employment of the company.
(c) A person who is indebted to the company for an amount exceeding one thousand
rupees, or who has given guarantee in connection with the indebtedness of any
third person for the same amount.
(d) A company auditor cannot hold any security of the company which carries voting
rights.
(e) A statutory auditor cannot be appointed as an internal auditor.
(f) An auditor should not accept contingent fees etc.
9. Principle of Integrity
• Integrity implies moral character or honesty. An auditor must be prepared to
resign, rather than sign a document, which he knows does not exhibit a true and
fair view.
• The principle of integrity demands that even when his duty to his client is opposed
to his own interest, the auditor must carry out his duty faithfully and honestly.
10. Principle of Confidentiality
• An auditor should keep the information concerning his clients confidential. He
should not disclose these to others unless there is a legal or professional duty to
divulge information.
• Further more, the audit assistants should refrain from discussing the client’s affairs
amongst themselves and with others.
1.18
Auditing Introduction to Principles of Auditing and Audit Process

1.1.10 Importance of Auditing

Defects and
Understands the true shortcomings in the
nature of business accounting system can
be rectified

Mistakes in
accounting are Capital Raising
noticed and Assistance
mistakes are made

Compensation is
Official evidence easy to get

Availability of Increases
necessary business
information reputation

It is possible to get Valuing the assets

a loan of a business entity

Various
professional Investors
associations

Fig. 1.6 : Importance of Auditing

1. Understands the True Nature of Business
• The auditor checks the books of accounts properly and certifies that they are
accurate. Similarly, the auditor has to state his opinion in his report as to whether
the profit-loss statement shows proper profit or loss and whether the balance sheet
also shows true and correct position.
• In the Companies Act of 2013, the term 'true and appropriate situation' was used in
reference to the balance sheet. The auditor gives the certificate that the profit and
loss statement prepared on this basis is only true and accurate.
• The auditor was not responsible for how much depreciation was incurred, whether
other provisions were made correctly or not.
1.19
Auditing Introduction to Principles of Auditing and Audit Process

2. Mistakes in Accounting are Noticed and Mistakes are Made

• Accumulation-Expenditure, if there are any mistakes in writing the accounts, they
are quickly noticed while auditing the accounts. Auditing creates a kind of
reluctance on the part of accounting staff to curb accounting errors, fraud, or
deception.
3. Availability of Necessary Information
• Importance of audit is in terms of availability of necessary information when
needed. Due to audit, the staff is responsible for prompt, alert, and diligent
accounting system. Therefore, the books of accounts are updated and properly
written and as a result, when the management or the auditor needs it, the
necessary information about the accounts can be obtained without delay.
4. It is Possible to get a Loan
• Industry- Business needs credit for many things. Such loans are provided by banks
or non-bank financial institutions. While lending, banks and other lending
institutions rely heavily on the audited accounts of the business entity, profit-loss
statement, balance sheet and from that they can decide whether to grant the loan
or not. This means that it is easier for businesses to get loans on the basis of
audited statements of accounts.
5. Defects and Shortcomings in the Accounting System can be Rectified
• As the audit books are properly scrutinized by the auditor, the accountant tries to
write all the accounts properly, carefully, but if there are any defects in it, the
auditor points out the shortcomings and defects. It also provides guidance on how
to adopt the right approach. This increases the standard of work of the accounting
department.
6. Capital Raising Assistance
• Often established enterprises need capital to create new projects, to expand. Such
capital is raised by selling shares or bonds. For this, they publish a few years of
audited financial statements for potential investors. Such details are audited and
also the certificate of auditor is published. Investors can also decide whether to
invest by considering auditors remark.
7. Compensation is Easy to Get
• Just as banks and other institutions can rely on audited accounts to decide whether
or not to lend to a business, similarly, insurance companies also decide on
indemnity by relying on the audited return. Auditing is also very important in this
regard.
1.20
Auditing Introduction to Principles of Auditing and Audit Process

8. Increases Business Reputation

• Auditing is also very important in terms of enhancing the reputation of the
business, because they are right after checking the accounts of the business-
industry.
• The auditor also certifies the profit and loss statement of the organization, showing
the balance sheet, 'correct and realistic picture', thus creating a kind of trust in the
people associated with the organization and enhances the reputation of the
organization.
9. Valuing the Assets of a Business Entity
• If an organization is to be converted into another type of organization or a
business organization is to be sold, it is necessary to determine the value of the
organization's assets, notoriety. Profit-loss statements, balance sheets, etc. of
audited accounts are very useful as a proper basis for this.
10. Various Professional Associations
• Importance of audit from the point of view of various professional associations.
• The audit is also very important from the point of view of various business
associations like entrepreneurs, sole traders associations, partnership, companies
etc. If a person is doing all the business, then it is not possible for such a person to
pay attention to all the things in his business. At the very least, he can get an idea
of whether the written accounts are correct or not, whether there are any
shortcomings, errors or misappropriations, so that he can take appropriate
measures accordingly.
11. Investors
• Auditing is important from the point of view of investors. The audit can reveal the
reality of the business dealings of the business association. People who want to
invest capital in various enterprises can invest by considering the expected profit-
loss statement, balance sheet. Similarly, for those who have already invested, the
idea of whether their capital is safe or not which is reflected through the audited
financial statements.
12. Official Evidence
• Audit is important for providing official evidence.
• Business associations are required to pay GST, income tax, property tax, etc.
according to the nature of the business. In order to properly levy such taxes,
audited accounts reflects clear picture.
1.21
Auditing Introduction to Principles of Auditing and Audit Process

1.1.11 Difference between Accounting and Auditing

• Accounting is the process of recording, classifying and summarizing the
transactions that affect an entity and interpreting the results. Accounting helps to
prepare the Income statement and other position statement. Income statement i.e.
profit and loss account determines the operating results and balance sheet reveals
the financial position of a business enterprise.
• Auditing helps verify the financial information prepared by those who are not
owners of the company and inform the owners about the truthfulness and fairness
of the accounting information.
Points Accounting Auditing
1. Meaning and It is the recording, It is the detailed examination
Objective classifying and of financial information
summarizing of the provided by accounting, so
business transaction to as to enable the auditor to
determine the operating express his opinion about
results of the the truthfulness and fairness
organisation for a of financial statements.
period and its financial
position as on a
particular date.
2. Standardisation There are standard There is no single method
accounting principles for examination of
that are to be followed, accounting information. It
while accounting, like may differ from organisation
Double Entry System of to organisation to depending
Book-keeping, GAAP upon the number of
etc. transactions, nature of
business, nature of operating
cycle, extent of internal
control and internal check
system etc.
3. Qualification An accountant need not An auditor should be a
necessarily be a chartered accountant.
chartered accountant.
4. Nature of Work An accountant prepares An auditor’s work adds
the final statements. credibility to it.
5. Relationship with An accountant is an An auditor is appointed by
management and employee of the the owner’s shareholders to
shareholders organisation. safeguard their interest. He is
not an employee of the
organisation.
1.22
Auditing Introduction to Principles of Auditing and Audit Process

1.1.12 Types of Audit or Classes of Audit

• Audit is a broad term. It is not restricted to financial audit. It is reflected in the
following definition of audit. “It is a systematic process of independent examination
or review of a condition or situation, by an expert, to ascertain the degree of
correspondence between the assertions and the set criteria, and communication of
expert opinion to the interested parties”.
Types of Audit

Basis of Audit

Ownership Periodicity Objectives Scope of Employer of Manner of

Audit Auditor Checking

1. Private 1. Contin- 1. Financial 1. Complete 1. Internal 1. Standard

Audit ouous Audit Audit Audit Audit
2. Govt. 2. Annual 2. Operatio- 2. Partlit 2. External 2. Balance
Audit nal Audit Audit Audit Sheet
Audit
3. Statu- 3. Interim 3. Cash 3. Post and
tory Audit Voucher
Audit Audit
4. Occasion- 4. Mana-
al gement
Audit
5. Con- 5. Tax Audit
current
Audit
6. Social
Audit
7. Environ-
mental
Audit
8. Prope-
tory
Audit
9. Perfor-
mance
Audit
10. Secre-
tarist
Audit
Fig. 1.7 : Types of Audit
1.23
Auditing Introduction to Principles of Auditing and Audit Process

(A) Pattern of Ownership

• On the basis of ownership, i.e. whether private individuals are owner or the
government is owner of the organisation, there can be three types of audit, viz;

Government
Audit

Private Statutory
Audit Audit

Fig. 1.8 : Types of Audit as per Pattern of Ownership

1. Private Audit
• It is the audit of accounts or any other situation by private organisations like sole
proprietorship, partnership firms and non-trading organisations. There is no
statutory compulsion to get the accounts audited for such organisations.
• The objective and scope of a private audit is determined by the persons who
appoint the auditor.
2. Government Audit
• Government audit is the audit of accounts of union of Indian states, Government
Departments, Government undertakings and local bodies.
• The auditors appointed for government audits are called government auditors and
their appointment is in accordance with the provisions contained in the
Constitution of India.
3. Statutory Audit
• When an audit is conducted as per statutory requirements, it is called a statutory
audit. Banks, insurance companies, joint stock companies, co-operatives and trusts
are required by the respective statutes to compulsorily get their accounts audited.
• The auditors who conduct the statutory audit are called ‘statutory auditors’.
1.24
Auditing Introduction to Principles of Auditing and Audit Process

(B) Periodicity of Audit

• On the basis of the frequency with which an audit is conducted, it can be classified
as:

Interim Annual Continuous Concurrent Occasional

Audit Audit Audit Audit Audit

Fig. 1.9 : Types of Audit as per Periodicity of Audit

1. Continuous Audit
• It involves the examination of books of accounts at regular intervals such as one
month or three months. The auditor visits the clients business at regular intervals or
irregular intervals during the financial year and checks each and every transaction.
At the end of the year, the auditors checks the profit and loss account and the
balance sheet.
• This type of audit is sometimes called ‘Detailed Audit’. It is suitable in case of large
organisations.
2. Annual Audit
• Audit that is conducted at the close of the financial period, after the final accounts
are prepared is called the annual audit, final audit or complete audit. It is
conducted at the end of the financial year. Since, audit work is completed in one
continuous session it is also called a complete audit.
• The auditor visits his client only once a year and checks the accounts pertaining to
the whole period under review.
3. Interim Audit
• Many companies declare their half-yearly and quarterly results, on the basis of
audited accounts till the close of the period concerned. The audit which is
conducted in between two annual audits with a view to finding out the interim
profits is called an interim audit.
• An interim audit enables a company to declare interim dividend.
1.25
Auditing Introduction to Principles of Auditing and Audit Process

4. Occasional Audit
• Organisations like sole trading concerns, partnership firms etc. are not required by
law to get their accounts audited. But, due to the various benefits that accrue to a
business due to auditing, these organisations opt for auditing.
• Some of these entities get their accounts audited whenever they suspect error or
fraud, or whenever the need arises like for claiming insurance amount, admission,
death or retirement of partner in case of partnership firms, or in case of sale of
business etc.
5. Concurrent Audit
• It is a system of audit prevalent in large banks and large branches of banks. It is an
examination which takes place on the occurrence of transactions or an examination
which is carried out at the earliest.
• The object of such an audit is to ensure adherence to prescribed systems and
procedures and timely detection of irregularities.
(C) Objectives of Audit
• On the basis of the specific objectives, there can be many classes of audit as stated
below.
Cost Audit

Financial Audit

Secretarial Audit

Performance Audit

Propriety Audit
Objectives of
Audit
Environment Audit

Operational Audit

Social Audit

Tax Audit

Management
Audit
Fig. 1.10 : Types of Audit as per Objectives of Audit

1.26
Auditing Introduction to Principles of Auditing and Audit Process

1. Financial Audit
• Independent financial audit is conducted for the purpose of ascertaining whether
the balance sheet and profit and loss account of a business shows a true and fair
view of operating results and financial position of the business.
• It is conducted by professionally qualified auditors. It is compulsory for joint stock
companies, trusts, Government undertakings and departments etc. and is optional
in case of sole proprietorship, partnership firms etc.
2. Cost Audit
• Cost audit is audit of cost records of the company. It is the checking of cost
accounts and costing techniques, methods, systems followed by the entity. The
cost auditor seeks to verify the truth and fairness of cost of production of goods or
rendering of service by an entity.
• As per the amendments to the Companies Act, 1956, a cost audit is compulsory in
case of specified companies.
3. Operational Audit
• It is a review of operations of an entity. It is generally carried out by internal
auditors. It involves intelligent examination of various operations of functional
areas of the business, i.e. production, marketing, stores etc.
• It is used to observe weaknesses, lapses, inefficiency in the operations and
suggesting ways to strengthen the system, for averting lapses and for improving
efficiency and profitability of operators.
4. Management Audit
• It is an audit to review, examine and appraise the various policies and practices of
the management on the basis of certain standards.
Example
• Clarity in downward communication, organizational hierarchy, departmentation,
the quality control system etc.
5. Tax Audit
• The income tax audit has been made compulsory for specified persons under the
provisions of Income Tax Act, 1961.
• Tax audit is an examination of financial records to assess the correctness of
calculation of taxable profit to ensure compliance with provisions of the Income
Tax Act, 1961 and also to ensure fulfilment of conditions for claiming deductions
under the Act.
1.27
Auditing Introduction to Principles of Auditing and Audit Process

6. Social Audit
• It is an audit to review the non-financial impact of an organisation on the society.
Awareness of social responsibility of business has increased in recent years, so the
scope of this audit is also enlarged.
7. Environment Audit
• Environment audit is also called a green audit. An audit of the impact of the
activities of an organisation on the environment is called ‘Environment Audit’.
• The areas covered by ‘Green Audit’ include energy usage, wastage recycling
procedures, conservation of raw materials and adoption of cleaner technology.
8. Propriety Audit
• Propriety audit goes beyond financial impact of the actions and decisions of the
management to verify if the actions are in public interest and are in accordance
with the accepted standard of ‘Proper Conduct’.
9. Performance Audit
• It is concerned with the evaluation of performances compared with the set
standards.
• The auditor examines maximum output is achieved for a given input or minimum
input is used for a given output.
10. Secretarial Audit
• A company secretary ensures that the working of the company is in accordance
with the provisions of the Companies Act, 2013 and other applicable laws.
(D) Scope of Audit
• On the basis of coverage of audit, there can be complete audit and partial audit.
Statutory audits are complete audits. The clients of the auditor cannot limit the
coverage of an audit. Partial audits are audits of stated books of accounts only.
These kinds of audit are found in case of private audits.
(E) Employer of Auditors
1. External Audit
• An audit is said to be an external audit if the auditors is appointed by persons other
than those whose performance is to be evaluated. For example, an auditor for a
financial audit may be appointed by shareholders to ensure that their funds have
been properly utilized by the board of directors.
1.28
Auditing Introduction to Principles of Auditing and Audit Process

2. Internal Audit
• Internal audit is conducted by an auditor who is appointed by persons who are
responsible for the performance of the entity.
• An internal auditor is usually appointed by the management.
(F) Manner of Checking
• On the basis of manner of checking, the audit may be classified into standard audit,
balance sheet audit and post and vouch audit.
1. Standard Audit 2. Balance Sheet Audit 3. Post and Voucher Audit
1.1.13 Audit Process
• “The audit process is a well-defined methodology for organizing an audit and is
adopted to accomplish audit objectives”.
• Every successful audit is based on sound planning and in an atmosphere of
constructive involvement and communication between the client and the auditor.
• Every audit assignment is unique, but there are standardized steps which are
undertaken to conduct an audit.
Audit Process

Planning Conduct Audit Report

of Audit

Scope Knowledge Audit Manpower Determine Communication

of about Programme the through Audit
Audit client truthfulness Report
and fairness

Audit Evidence Examination Audit Control Coordinating Communication

Audit Assistance Work Performed by others

Fig. 1.11 : Audit Process

1.29
Auditing Introduction to Principles of Auditing and Audit Process

(I) Audit Planning

(A) Scope of Audit
• In any audit assignment, an auditor must be clear about what he is required to
perform. He must understand the scope of audit. Any abiguity with regards to
coverage of audit may result in unnecessary work and neglect of essential audit
work.
• An auditor may be required by the client in different capacities, as an accountant,
as an expert consultant, or as a person giving his expert opinion on the situation
under review.
• In the audit work, the auditor may be expected to cover what is generally expected
of in such engagement or he may be expected to cover certain special matters in
addition to it. Any misunderstanding of the position by the auditor may lead to
unnecessary litigation.
• An auditor determines the scope of his audit, i.e. audit expectation from
1. The terms specified in the letter of appointment by the client.
2. The enactments governing the audit.
3. The general expectation in such engagement.
Example
• The Companies Act, 1956, clearly mentions the scope of audit work of a financial
auditor of a joint stock company. In the case of non-statutory audit, the
engagement letter is the only basis of the scope of audit work.
(B) Knowledge of Clients Business
• In order to discharge the audit duty efficiently, the auditor needs to know his client.
• The following information about the clients business helps him in his audit work.
1. Nature of business.
2. Accounting system.
3. Internal control systems operating in the business.
• The auditor should know the organisational structure, line of business, technical
details as to the process employed, market trends in the industry, the impact of
various government policies and regulations on the industry and business of the
client etc. These details will help the auditor know the business environment in
which it is functioning. This understanding, in turn, will make him feel comfortable
and will help him conduct the audit with utmost quality.
1.30
Auditing Introduction to Principles of Auditing and Audit Process

(C) Audit Programme

• Before setting-up an audit programme for the conduction of audit, the auditor
should consider the following:
1. Identification of Significant Audit Areas
• Certain audit areas are important for all business because of the high degree of
fraud risk. For example, remuneration of management, stock valuation, creation of
reserves, depreciation on fixed assets etc.
2. Setting-up of Materiality Level
• An auditor must link a possibility of fraud to the aim of his audit and determine if
the error or fraud in a particular area of the business is material or immaterial to his
audit aim. This will help him in deciding the extent of audit work to be conducted.
(D) Manpower Planning
• While setting out the audit programme, the auditor identifies the tasks to be done
to perform the audit work. Manpower planning is done on the basis of the amount
and complexity of the tasks to be done.
• An auditor determines the number of audit assistants he needs to perform the
audit task and also their categories like senior clerks, junior clerks, managers etc. he
does the stocktaking of the actual manpower assigned to him and accordingly
finds out how many more assistants he would need to complete the job. Further he
may decide to take more clerks or may go for permanent staff depending on the
nature of audit work.
(II) Conduct of Audit
• At this stage of the audit process, the auditor conducts the audit work through his
assistants and controls and coordinates their work through supervision.
• The process of conducting audit includes the following steps:
(A) Audit Evidence
• In the course of audit, the auditors must gather audit evidence and test them so
that his opinion about the financial statements of the concern can be based on
those evidences.
• While gathering evidence, the auditors need to determine:
1. The relevance of the evidence to examine the assertions of the management.
2. How much evidence is to be obtained.
1.31
Auditing Introduction to Principles of Auditing and Audit Process

(B) Examination
1. Auditing in Depth: Taylor and Perry
• “It implies the examination of the system applied within a business, entailing the
tracing of certain transactions from their origin to their conclusion, investigating at
each stage the records created and their appropriate authorization.”
2. Test Check : Prof. Meig
• “Testing and test checking means to select and examine a representative sample
from a large number of similar items”.
(C) Audit Control
• A good audit plan has to be complemented by a good audit control. An auditor
exercises control over his assistants and over the work performed by others.
• The control over audit assistants is exercised with the following aims:
1. Audit work performed by the assistants should be as per the audit programme.
2. To provide needed training and guidance to the assistants in carrying out the work.
3. To update the audit programme in light of the practicality of the audit programme.
(D) Co-ordinating the Work of other Auditors
• In case of a joint audit, branch audit and internal audit, the auditor has to rely on
the work performed by other auditors. In case of a joint audit, the auditors have to
plan division of work amongst themselves.
• In case of a branch audit, the statutory auditor has to rely on the expertise of the
branch auditor. He cannot rely on the internal audit report without being
responsible for the said task.
(E) Documentation
• Documentation involves reducing in writing the audit matters, manner and their
proper upkeep. It includes maintenance of audit notes, working papers and
keeping classified files.
• The audit document is an evidence of the audit practices and procedures followed
by the auditors and form the basis for the formation of audit opinion.
(III) Audit Report
• An audit report is a written opinion of an auditor concerning an entities financial
statements. The report is prepared in a standard format, as mandated by Generally
Accepted Auditing Standards (GAAS). GAAS requires certain variations in the
report, depending on the situations of the audit work that the auditors is engaged
in.
1.32
Auditing Introduction to Principles of Auditing and Audit Process

1.1.14 Advantages of Auditing

• We have learned that auditing is not only necessary to detect or correct errors, but
that auditing can lead to increased efficiency and accuracy in the work of
accounting.
• The benefits of such an audit can be summarized as follows:
Directors Potential
regularly receive Investor
audited Confidence Stakeholder
statements Interests

Mistakes and Harmony among

scams are curbed partners

Understands the
Convenient for actual financial
tax assessment condition of the
business

Help in raising Advantages The books of

capital or getting of Auditing accounts remain
loan up to date

Fig. 1.12 : Advantages of Auditing

1. The Books of Accounts Remain up to Date
• Since the audit is done on a regular basis, the deposits and expenditures must be
written in full. Therefore, business books are kept up to date.
2. Understands the Actual Financial Condition of the Business
• The audit of the annual accounts of the business reveals the true financial position
of the business to the directors, shareholders and the general public.
3. Help Determine Business Returns at the Time of Business Sale
• When buying a business or converting a business into a joint venture company,
both the buyer and the seller are prepared to calculate the purchase returns of the
business on the basis of audited accounts. This makes it easier to assess assets and
liabilities.
4. Harmony among Partners
• Mutual trust between partners is maintained if the partnership accounts are
audited. They have no doubt about the accuracy of the calculations.
1.33
Auditing Introduction to Principles of Auditing and Audit Process

5. Stakeholder Interests
• The management of the company is overseen by the directors elected by the
shareholders. The company's audited accounts assure the shareholders that they
have not committed any fraud or deception in the financial affairs of the company
and have not done any harm to the shareholders for their own self interest.
• The auditor is considered as a representative of the stakeholders. Therefore, it is
assumed that he will take necessary care in the interest of the stakeholders while
conducting the audit. The auditor mentions the mistakes made by the directors in
his report and thus controls the misconduct of the directors.
6. Potential Investor Confidence
• Potential investors gain confidence to invest in a company by relying on the
company's audited accounts. As they are regularly audited, they are informed
about the financial condition of the company from time to time and from this
information they make their investment decisions.
7. Directors Regularly Receive Audited Statements
• Directors receive regular audited accounts of their businesses. Hence they get
reliable information about the exact reasons for the increase in expenses or
decrease in income and can think about the necessary measures in time. Since the
accounts were examined by an independent expert, it is safe to assume that the
audited statements were correct.
8. Mistakes and Scams are Curbed
• Employees are careful while writing the accounts because the mistakes made by
them knowingly or unknowingly are exposed during audit.
9. Convenient for Tax Assessment
• Since the audited accounts are reliable, it is convenient to collect income tax or GST
on their basis.
10. Help in Raising Capital or Getting Loan
• The general public or lending institutions have more confidence in the audited
accounts of the business, making it easier for the company to sell new capital or
obtain loans from banks, etc.
1.34
Auditing Introduction to Principles of Auditing and Audit Process

1.2 Errors and Frauds

1.2.1 Introduction
• Though errors are reportedly committed innocently, an auditor should be very
careful about it, because sometimes, errors which might appear as innocent are the
results of fraudulent manipulation.
• For example, a debtor sends ` 500 by bank draft and the accountant forgets to
make an entry in the books; it is an error. On the other hand, if the accountant
intentionally keeps the money with him and spends it for his own use and does not
make an entry in the books it becomes a fraud. Thus, an auditor must pay
particular attention to it.
• In short, miss-statements in the financial statements can be due to ‘errors’ or
‘fraud’. The term error refers to an unintentional misstatement in the financial
statements including omissions. In general, errors are unintentional but sometimes
errors that may appear to be unintentional are ultimately found to be due to
fraudulent manipulation.
1.2.2 Types of Errors
• Different types of transactions are declining in trade and all of them are being
recorded by different individuals in big trades. At the end of the year, final accounts
are created based on these transactions. This is likely to be a mistake somewhere
when reporting transactions throughout the year. Such errors do not come to light
unless the books of credit are audited.
• Mistakes can be easily corrected if they go unnoticed, but deliberate mistakes can
be difficult to detect and correct. Because there is an intention to commit fraud
behind the mistakes made on purpose. If the mistakes go unnoticed, they affect the
balance sheet and profit and loss statement. Therefore, the main objective of the
audit is to find out and rectify as many mistakes as possible. For this, the auditor
needs to be experienced in his field.
Types of Errors
(A) Clerical Errors
• A clerical error is one which arises on account of wrong posting. For example,
posting item to a wrong account. If the trial balance is agreed upon, the clerical
error would be discovered, unless counter is balanced by other errors. But some
clerical errors are of such a kind, that even if undetected, do not affect the trial
balance. For example, an amount received from A is credited to B. The trial balance
will still get tallied.
1.35
Auditing Introduction to Principles of Auditing and Audit Process

Errors of
Omission

Errors of
Commission

Clerical errors

Partial
Omission
Errors of
Principle
Complete
Types of Errors Omission

Compensating
Errors

Errors of
Duplication

Fig. 1.13 : Types of Errors

• These errors include a complete or partial misrepresentation of a transaction. These
types of mistakes include:
1. Errors of Omissions
• When a transaction is not recorded in the original book or is underpaid, the error is
called a 'leak error'. In other words, errors which arise on account of transactions
not being recorded in the books of accounts, either wholly or partially, are called
errors of omission.
• These types of mistakes happen unknowingly, which means that a transaction is left
unnoticed. For example, non-recording of loan, sales or under-payment, non-
recording of lending costs, non-recording of goods purchased at the end of the
year, etc. No account is affected if the entries are omitted altogether. If a small
amount is recorded, a lower figure is presented in both the accounts. Therefore,
this mistake does not have any effect while preparing the balance sheet, making it
difficult to detect it by the accountant.
• In case where a transaction has been totally omitted, it will not affect the trial
balance and hence it is more difficult to detect.
1.36
Auditing Introduction to Principles of Auditing and Audit Process

Example
• Omission to enter purchases in purchase books. It means that both the debit and
credit aspects of the transaction are equally omitted and the numerical accuracy of
the trial balance is not affected.
• On the other hand, partial omission can be easily discovered as the trial balance
will not tally. For instance, if the entry for purchase is made in the purchase books
but is omitted from the accounts of the concerned customer. Similarly, the rent
account must show twelve entries for the rent paid in a year whereas if only nine
entries are shown, it means the rent for three months has not been paid. In these
cases, the trial balance will not tally and the auditor can locate these errors by
conducting a thorough check of the records.
2. Errors of Commission
• When incorrect entries are made in the books of accounts either wholly or partially,
the errors are known as errors of commission. Examples of such errors are wrong
entries in the books of original entry, wrong calculations, postings, additions,
castings and carry forwards. For instance, the amount in the books of original entry
is wrongly recorded. The amount of ` 232 might be entered as ` 322 in the books
of original entry. Such errors can be located while vouching the purchases with the
original invoices and are then rectified.
• Some of these errors will be detected by the non-agreement of the trial balance
while some errors of commission do not affect the trial balance.
3. Compensating Errors
• When there are two or more errors which exactly counter- balance each other, they
are referred to as compensating errors. They are also known as offsetting errors,
because the effects are offset. They are difficult to detect as the trial balance will
still agree.
• For example, X account was credited by ` 20 instead of ` 80. There was a short
credit of ` 60, while Z account is debited by ` 20 instead of ` 80. Thus, there is a
short debit or ` 60. It means that there is only a short credit and a short debit of `
60 each. Both the sides of the trial balance are equally affected. At the same time, it
may or may not affect the profit and loss account.
4. Errors of Duplication
• These errors occur when the same transaction has been recorded twice in the
books of original entry and also posted twice in the ledger. For example, purchase
worth ` 5,000 may be recorded twice in the accounts. As these errors will not affect
the agreement of the trial balance, it is not so easy to trace them. Such errors can
be located while vouching records.
1.37
Auditing Introduction to Principles of Auditing and Audit Process

(B) Errors of Principles

• As the name indicates, errors of principle are those where some fundamental
principle of sound accountancy is not properly observed while recording a
transaction. In other words, such errors may arise quite unintentionally due to the
lack of correct knowledge of the principles governing the preparation of the
accounts of a business.
• Examples of such errors are incorrect allocation of expenditure between capital and
revenue, ignoring outstanding assets and liabilities, wrong valuation of assets and
provision for liabilities and bad debts, etc.
• This is the most important class of error because an error of this kind does not
affect the agreement of the trail balance; but the profit and loss account may be
very much affected. For example, if the revenue expenditure is shown as capital
expenditure or when closing stock is overvalued, the profit gets inflated. The profit
is shown more than what it actually should be.
• Such errors will never be discovered by mere routine checking. Therefore, an
auditor should exercise utmost care in discovering such errors, make an intelligent
enquiry and investigation of every transaction.
• Sometimes, such errors are committed intentionally to manipulate the accounts in
order to show more profits or less profits or less profits than they actually are for
the year. Therefore, an independent checking and detailed enquiry should made by
an auditor to locate such errors, otherwise he will not be able to give the correct
financial position of the organization for the year. For instance, if more depreciation
is provided, the profit is reduced.
(C) Compensating Errors or Off-setting Errors
• When the commission of the error offsets another error, the errors are called
compensating errors. For example, total of purchase book is under cost by ` 100
and the total of sales return book is over cost by the same amount. The reduction
in the purchase account is compensated by an increase in the sales return account.
Thus, one error is offset by another error of the same magnitude.
• Since, these errors are not disclosed by the disagreement of trial balance, these
cannot be detected easily. Such errors may affect the amount of profit or loss.
When one of the errors is in a revenue account and the other error is in a capital
item, the profit or loss computed will be erroneous.
1.38
Auditing Introduction to Principles of Auditing and Audit Process

1.2.3 Detection and Prevention of Fraud

• Fraud is intentional and is knowingly committed to defraud the proprietors of the
concern. This is done deliberately which means that there is an intent to deceive, to
mislead or to conceal the truth or the material facts. Frauds are more serious than
unintentional errors because of the implication of dishonesty which accompanies
them. They are more difficult to detect than innocent errors. Thus detection and
prevention of frauds is of great importance and constitutes an important duty of an
auditor.
• In short Fraud is a misstatement made without belief in its truth or intentionally
made to defraud somebody.
Definition of Fraud
According to ICAI, “The term fraud refers to an intentional act by one or more
individuals, among management, those charged with governance, empoyees or
third parties involving the use of deception to obtain an unjust or illegal
advantate”.
• Thus, Fraud
1. Is a misstatement in the financial statements.
2. The misstatement is made intentionally, i.e. without belief in its truth.
3. Such false statements may be made by one or more than one employee, or
member of management or third parties of the organisation.
4. The purpose is to obtain an illegal advantage.
1.2.4 Types of Frauds
(A) Employee Fraud
1. Embezzlement of Misappropriation of Cash
• In small types of business enterprises, the possibilities of misappropriation of
money are very little because the individual owner is in touch with all the affairs of
the business. But in big business houses, where there is a separation between
ownership and the management and the individual owner has no direct control
over the receipts and payments of cash, the opportunities of committing frauds are
frequent.
• Broadly frauds resulting in misappropriation of cash are perpetrated by:
(a) Inflating of Payments
• It is done by inflating purchase invoices or inflated amounts being paid by
manipulating totals of wage sheets either by including therein names of dummy
workers, or in any other manner or amounts paid against fictitious vouchers.
1.39
Auditing Introduction to Principles of Auditing and Audit Process

Embezzlement of
Misappropriation of
Cash
Employees Fraud
Misappropriation of
Goods

Types of Fraud Omission of Events

Manipulation of
Accounts
Management
Fraud
Misapplication of
accounting policies

Internal Control
system overridden

Fig. 1.14 : Types of Fraud

(b) Suppression of Receipts
• In order to detect all these types of frauds, the auditor should make a detailed
checking of all the important books and documents i.e. cash books, vouchers,
invoices, wage sheets and confirmations of balances from the customers etc.
2. Misappropriation of Goods
• Fraud may be in respect of goods. This type of fraud is difficult to detect; unless a
proper stock record is kept i.e., proper records of goods inwards and outwards
must be maintained. An efficient system of internal check must be introduced in
the business. There should be adequate external security arrangement to see that
no goods are taken out of the business premises without proper authority. The
goods may be removed by junior staff or by senior officials of the concern.
• The auditor can detect this by undertaking a thorough and strenuous record
checking and the physical verification of the goods.
(B) Management Fraud
1. Manipulation of Accounts
• This type of fraud is always intentional, predetermined and is more difficult to
detect as it is usually committed by the higher management cadre persons
connected with the business such as directors and managers.
1.40
Auditing Introduction to Principles of Auditing and Audit Process

• The accounts are so prepared that they present a picture of the state of affairs of
the business different from what it actually is. As a result of the manipulation of
accounts, profits are increased or reduced. The true position is concealed.
• The object of manipulation and falsification may be to avoid payment of taxes i.e.,
GST and income tax, window dressing; to mislead a prospective buyer of the
business by presenting a better state of affairs than the actual position of the
concern, giving higher amount of commission, securing more capital and giving a
wrong information of its financial position to internding competitors, borrow
money to maintain a reasonable rate of dividends and to attract new shareholders
for the company, to withhold the declaration of dividends despite sufficient profit
and for receiving higher remuneration where managerial remuneration is payable
by reference to profits.
• The object can be achieved in a number of ways, some of which are given below:
(a) Recording fictitious sales or purchases so that profit may be increased or reduced.
(b) Recording fictitious purchases or omission of purchases.
(c) Omission of expenses or income and by not adjusting outstanding liabilities or pre-
paid expenses.
(d) By undervaluation or over-valuation of assets.
(e) Showing fictitious payments or receipts.
2. Omission of Events
3. Misapplication of accounting policies
4. Internal Control system overridden
1.2.5 Difference between Error and Fraud
• Misstatement in financial statements can be error or fraud. The common feature of
the two is that both show an incorrect picture of the operating results and financial
position of the entity.
Points Error Fraud
1. Meaning Error is a unintentional Fraud refers to intentional
mistake in the mistake in financial statement.
measurement or
presentation of financial
information.
2. Detection The detection of error is Fraud is more difficult to detect
easier when compared to as the defrauding party makes
fraud. deliberate attempts to conceal
it.
3. Consequence Auditor should get the Auditor should consider its
on Audit Work financial statement effect on financial statements
adjusted incorporating the and determine the reliability of
correction. management.
1.41
Auditing Introduction to Principles of Auditing and Audit Process

1.3 Audit Programme

Introduction
• Audit Programme is a plan prepared by the Auditor showing how various stages of
the audit work are to be completed by the cost audit staff, the procedure to be
followed by them for doing cost audit work assigned to them, the extent to which
the examination and verification of the cost data should be carried out by them
and in how much time the cost audit work should be completed by them.
• It is thus a plan which shows the distribution of the cost audit work among the cost
audit staff, how the work of checking and verification of the cost data is expected
to be done by the cost audit staff and time schedule in which each part of the cost
audit should be completed by them.
• With the help of the cost audit programme the work of the cost audit is done
properly and systematically.
Meaning
• An audit programme is a detailed, written statement designed by the auditor
indicating the work to be performed by the audit assistants, specifying the time
limit for completion of work, instructions and guidance to the audit staff. In short, it
is a tool for planning, directing and controlling the audit work.
• An audit programme is a detailed plan of the auditing work to be performed. It
specifies the procedures to be followed in the conduct of audit more efficiently.
• The auditor outlines the whole procedure of audit from beginning till the
finalization of audit report.
• Audit programme is generally contained in the audit notebook.
Definitions of Audit Programme
1. Prof. Meigs
“An audit programme is a detailed plan of the auditing work to be performed,
specifying the procedures to be followed in verification of each item and the
financial statements and giving the estimated time required.”
2. Prof. Steller
“An audit programme is an outline of all procedures to be followed in order to
arrive at an opinion concerning the client’s financial statements”.
3. “An audit programme consists of the procedure undertaken or for the particular
work done by an accountant in carrying out an audit. It is a description,
memorandum or an outline of the work to be done, prepared by an auditor, for
the guidance and control the assignments. It provides a guide in arranging and
distributing the work and in checking against the possibility of omissions”.
1.42
Auditing Introduction to Principles of Auditing and Audit Process

1.3.1 Features/Characteristics of an Audit Programme

1. It is a set of procedures to be adopted to conduct the audit more efficiently.
2. It is a written scheme designed by the auditor.
3. It is a blue print of the audit work.
4. It facilitates delegation of work, based on the capabilities of audit staff.
5. It acts as an evidence in future for the audit work being performed.
6. It specifies the work to be done by the audit staff, the manner and time limit for
completion of the work.
1.3.2 Objective of Audit Programme
1. To provide clear instructions to the audit assistants specifying the nature of work to
be performed and fixing the time span for completion of each work.
2. To facilitate coordination among various parts of audit work.
3. To ensure uniformity in the performance of audit work and to avoid duplication
and repetition of work.
4. To attain a fair allocation of work among audit team.
5. To fix responsibility and accountability of each audit assistant.
6. To serve as a guide for planning the audit work in future.
7. To serve as an evidence in future showing the date of completion of audit work,
methods or procedures undertaken, persons involved in completion of audit work
etc.
1.3.3 Advantages of Audit Programme
1. Helps in Estimation and Division of Work
• Audit Programme helps in estimating the quantum of audit work in advance and
also helps in dividing the work among the audit assistants based on their
capabilities.
2. Helps in Fixation of Responsibility
• It enables to fix responsibility on the audit assistants by clearly defining the scope
of audit work.
3. Helps in Future Planning
• Audit programme serves as a basis for planning the audit work for subsequent
year.
4. Serves as a Guide
• It serves as a valuable guide for the audit staff in execution of the audit work for
succeeding years.
1.43
Auditing Introduction to Principles of Auditing and Audit Process

Coordination

Uniformity Continuity

Helps in
Advantages of
Valuable Estimation
Audit
Evidence and Division
Program
of Work

Helps in
Fixation of Serves as a
Responsibility Guide
Helps in
Future
Planning

Fig. 1.15 : Advantages of Audit Program

5. Valuable Evidence
• It serves as an evidence for the work done as initials of those who have done the
particular work are appended to it.
• The auditor can produce the audit programme as a proof when a charge of
negligence being brought upon him.
6. Uniformity
• It provides for uniformity in audit work as the same work will be done every year.
7. Continuity
• When an audit staff goes on leave others can continue the work by referring to the
audit programme, hence audit programme provides for continuity of work.
8. Coordination
• If facilitates coordination and helps in supervising the work of the audit staff.
1.3.4 Disadvantages of an Audit Programme
1. Mechanical
• When audit work is conducted mechanically every year based on the audit
programme, it causes monotony and boredom to the auditor and audit staff.
2. No Quality in Work
• The audit staff will be more interested to complete the work in time rather than to
maintain any standard in the work.
1.44
Auditing Introduction to Principles of Auditing and Audit Process

Unsuitable

Shelter for Inefficient Staff

Rigidity

Loss of Initiative

No Quality in Work

Mechanical

Fig. 1.16 : Disadvantages of an Audit Programme

3. Loss of Initiative

• Audit staff cannot take their own decisions and they are compelled to comply with

the audit programme. Hence, an efficient audit clerk loses his initiative and interest

as he cannot make any suggestions.

4. Rigidity

• A rigid and inflexible audit programme cannot be laid for all types of business.

• During the course of audit, new areas to be verified may come to the notice of the

audit staff. Unless the audit programme is revised, such areas may escape from

auditing.

5. Shelter for Inefficient Staff

• Inefficient audit staff conceal their mistakes or weakness on the basis of audit

programme. Hence, it provides shelter for inefficient audit staff.

6. Unsuitable

• Pre-determined audit programme is not suitable for small business organizations.

1.45
Auditing Introduction to Principles of Auditing and Audit Process

Fig. 1.17 : Specimen of Audit Programme

1.46
Auditing Introduction to Principles of Auditing and Audit Process

1.4 Audit Note Book

Introduction
• An audit note book is of great value in conducting an audit. It is maintained by the
audit assistant to note down all those uncleared queries which he may come across
in the course of an audit and on which he required further clarification and
explanation. It contains definite information regarding the day-to-day work
performed by the audit staff.
• Notes about all types of errors, difficulties and uncleared queries or points to be
discussed with the auditor/ client and the points to be included in the audit report
are recorded in the audit note book.
Meaning
• Audit Note Book is a register maintained by the audit staff to record important
points observed, errors, doubtful queries, explanations and clarifications to be
received from the clients. It also contains definite information regarding the day-
to-day work performed by the audit clerks.
• In short, audit note book is usually a bound note book in which a large variety of
matters observed during the course of audit are recorded. The note book should
be maintained clearly, completely and systematically. It serves as authentic
evidence in support of work done to protect the auditor against any legal charge
initiated against him for negligence. It is of immense help to the auditor in
preparing audit report. It also acts as a valuable guide for conducting audit for
future years.
• Audit not book should be two parts:
1. For keeping a record of general information as regards the audit as a whole.
2. For recording special points which the audit staff may have come across during the
course of audit of the accounts of different years.
Definition of Audit Note Book

1. Eric L. Kohler
“A record, used chiefly in recording audits, containing data on work done
comments outside of the regular subject matter of working papers. It generally
contains such items as audit programme, notations showing how sections of the
audit are carried out during successive examinations, information needed for the
auditor’s office and for staff administration, personnel assignments, time
requirement and notations for use in suceessding examination. It may be a part
of permanent file”.
1.47
Auditing Introduction to Principles of Auditing and Audit Process

• Besides that, an audit note book plays an important part in defending the auditor if
legal action is initiated against him. The auditor can use it, as an authentic evidence
in the court of law, to defend his case.
Example
• In the proceedings against the auditor in the case of the city equitable insurance
company, the defendant auditor was greatly assisted by the well maintained audit
not book.
1.4.1 Contents of an Audit Note Book
1. The name of the client and the audit year.
2. A list of books of accounts in use of the business.
3. Names of principal officers, their duties and responsibilities.
4. Particulars of the accounting and the financial system followed and the internal
check in operation in the business.
5. Details regarding accounting and financial policies followed in the business.
6. A copy of the audit programme.
Queries Recorded in the Audit Note Book
Voucher Account Debited ` Querry How disposed
No.
6 Commission 1,000 Receipt required Receipt obtained
10 M/s. Dnyandev 1,200 Receipt required for Party reminded
Nitve pending assets: Board
of Directors
81 Furniture 8,000 Sanction required Sanction obtained
82 Machinery 4,000 Wrongly debited Accountant
building account to be advised
debited
1.4.2 Advantages of Audit Note Book
1. Facilitates Audit Work
• It facilitates the work of an auditor as all important details about the audit are
recorded in the note book which the audit clerk cannot remember at all the time.
• It helps in remembering and recalling the important matters relating to the audit
work.
2. Preparation of Audit Report
• Audit note book helps in providing required data for preparing the audit report. An
auditor examines the audit note book before preparing and finalizing the audit
report.
1.48
Auditing Introduction to Principles of Auditing and Audit Process

3. Serves as Documentary Evidence

• Audit note book serves as a documentary evidence in the court of law when a suit
is filed against the auditor for his negligence.
4. Serves as a Guide
• When an audit assistant is changed before the completion of audit work, audit note
book serves as a guide in completion of balance work. It also acts as a guide for
carrying on subsequent audits.
5. Evaluating Work of Audit Staff
• It helps to assess the work performed by the audit staff and helps in evaluating
their level of efficiency.
6. Fixation of Responsibility
• Audit note book helps in fixing responsibility on concerned clerk who is responsible
for any undetected errors and frauds in the course of audit.
7. No Dislocation of Audit Work
• An audit note book contains all important details about audit hence any change in
the audit staff will not disturb or dislocate the audit work.
1.4.3 Disadvantages of Audit Note Book

Adverse Effects on
Fault-finding Misunderstanding Improper
Subsequent
Attitude Preparation
Audits

Fig. 1.18 : Disadvantages of Audit Note Book

1. Fault-finding Attitude
• It leads to development of a fault-finding attitude in the minds of the staff.
2. Misunderstanding
• Very often maintenance of audit note book creates misunderstanding between the
client’s staff and the audit staff.
3. Improper Preparation
• Since it serves as an evidence in the court of law, it needs to be prepared with great
caution. When the audit note book is prepared without due care, it cannot be used
as evidence against the auditor for negligence.
4. Adverse Effects on Subsequent Audits
• Since audit note book is used in performing subsequent audits, any mistakes in the
note book may have adverse impact on the next audit.
1.49
Auditing Introduction to Principles of Auditing and Audit Process

1.5 Audit Working Papers

• Audit working papers are those papers which contain essential facts about account:
which are under audit. This term designates the file of analyses, summaries,
comments and correspondence built up by the auditor during the course of the
field work of an audit engagement.
• Audit working paper contains essential facts about accounts so that the auditor
may not have to go over the accounts of his client again in case he wants to refer
to them later.
Examples of Audit Working Papers
1. Audit programme.
2. Working trial balance.
3. Schedule of debtors and creditors, details of investment, fixed assets etc.
4. Correspondences between auditor and bank, debtor, creditors etc.
5. Certificate recording stock valuation.
6. Letters of confirmation.
7. Photo copies of documents.
8. Abstracts from the minute book etc.
1.5.1 Objectives of Audit Working Papers
1. To support the preparation of audit report.
2. To provide evidence in case of any suit aginst the auditor for negligence.
3. To aid the auditor in conducting and supervising the audit.
4. To enable the auditor to point out to the client the weaknesses of the internal
control system, the inefficiency of the accountancy system etc.
5. The audit working papers help the auditor to plan the audit for the succeeding
year.
1.5.2 Essentials of a Good Audit Working Papers
• In order to enjoy the advantage of audit working paper, the following qualities are
essential:
1. In order to have full utility, the working paper should be complete, i.e. It should
contain all the essential information.
2. It should be arranged in a systematic way so as to help locate easily a particular
fact out of the paper.
3. The facts laid down in the working papers should be clear.
4. The working papers should be of uniform size, so that handling of the papers is
easy.
5. Each paper should contain some blank space so that an auditor can note down any
point related to the contents of the paper.
6. The papers used should be of good quality, so that it does not tear off easily.
1.50
Auditing Introduction to Principles of Auditing and Audit Process

1.6 Internal Control

Introduction
• Today, communication and integrity of financial information is of utmost
importance to the companies. To know the integrity function performed by the
auditing profession, the auditors need to obtain an understanding of Internal
Control and an evaluation of the extent to which control may be relied on to assure
the accuracy and reliability of accounting records.
• Internal Control means the whole System of Control, Financial or otherwise
established by the management in order to carry on the business of the company
in an orderly manner, safeguard its assets and secure as far as possible the
accuracy and reliability of its record.
• The plan of organization and all the coordinated methods and procedures
adopted within a business to safeguard its assets, check the accuracy and
encourage adherence to the prescribed managerial policy.
Definitions of Internal Control
1. “A process designed, implemented and maintained by those charged with
governance, management, other personnel to provide reasonable assurance
about achievement of entity’s objectives with regard to reliability of compliance
with effectiveness and safeguarding of financial laws and efficiency of assets
reporting regulations operations”.
2. Spicer and Pegler
“Internal control is best regarded as the whole system of controls, financial and
otherwise, established by the management in the conduct of a business including
internal check, internal audit and other forms of control”.
3. Oxford Dictionary
• “The measures an organisation employs to ensure that opportunities for fraud or
misfeasance are minimized”.
1.6.1 Types of Internal Control
1. Accounting Control
• Internal control system is applied to accounting system with the object to attain the
following:
(a) Efficient and orderly conduct of accounting transactions.
(b) Safeguarding the assets.
(c) Prevention and detection of errors and frauds.
(d) Ensuring accuracy, completeness, reliability and timely preparation of accounting
data.
1.51
Auditing Introduction to Principles of Auditing and Audit Process

Accounting
Control

Internal
Control
Administ
rative
Control

Fig. 1.19 : Types of Internal Control

2. Administrative Control
• Administrative control seeks to achieve adherence to management policy in various
areas of business operations.
(a) Efficient and orderly system may be established to ensure that ‘ABC’ control over
material is followed.
(b) Timely supply of reliable management information.
(c) Maintenance programme for machines.
1.6.2 Limitations of Internal Control
• No system of internal control can be good enough to ensure the accomplishment
of all the objectives of internal control system. The following inherent limitations
can be found in any internal control system:
Manipulations
Human Possibility of Management
by
Error collusion discretion
Management

Fig. 1.20 : Limitations of Internal Control

1. Human Error
• Human errors are caused due to employee’s carelessness, misunderstanding of
instruction and errors in judgement that adversely affect the internal control
system.
2. Possibility of Collusion
• Fraud can still be committed if two or more employees collude in a plan of
defrauding the organisation.
3. Manipulations by Management
• The management, which designs and maintains the internal control system may
override the system and manipulate the accounts.
4. Management Discretion
• The management, while implementing an internal control system, may adopt a
system which is inefficient to a transition.
1.52
Auditing Introduction to Principles of Auditing and Audit Process

1.7 Internal Check

• Internal check means the check imposed on day-to-day transactions whereby the
work of one person is checked independently by another person, the object being
prevention and early detection of errors and frauds and to ensure accuracy.
• Thus, internal check includes matters such as the allocation of authorities, division
of work and the proper methods of recording transaction, etc.
• It is a part of the overall internal control system and operates as a built-in-device so
far as staff, organization and job allocation aspects of control system are
concerned.
• It minimizes the possibilities of errors and increases the chances of detection of
frauds.
• Internal check is one of the methods of internal control system applied to the
accounting system of a concern.
Definitions
1. L. R. Dicksere
“Internal Check system is such an arrangement of book-keeping routine that
errors and frauds are likely to be prevented or discovered by the very operation
of the book-keeping itself”.
2. F. R. M. De Paula
“Internal Check means practically a continuous internal audit carried on by the
staff itself, by means of which the work of each individual is independently
checked by other members of the staff”.
3. Prof. Arnold W. Johnson
“Internal Check system is none wherein the accounting work of the employee is
completed and verified by the work of another employee- both employees
working independently and without duplications of each other work”.
4. Michael J. Pratt
“Internal Check is provided by segregating duties in such a way that no person
can intiate, authorize, conduct and record a transaction from start to finish
without his work coming under the surveillance of at least one other person”.
• Thus, internal check system is such an arrangement of the work of different clerks
that the work of one person is automatically checked by another in the very course
of processing and recording of the transaction. Thus, the possibility of error is
minimized.
• The chances of fraud are also minimized because each clerk does only a small part
of the work related.
1.53
Auditing Introduction to Principles of Auditing and Audit Process

1.7.1 Features of Internal Check

• A good internal check system must provide in-built checking and balancing while
the operations are being performed. To achieve this end, the system should have
the following control mechanisms:

Accounting
Controls

Division of Authority
Work Level
Features
of Internal
Check

Separation Job
of Custody Rotation
and Recording

Fig. 1.21 : Features of Internal Check

1. Division of Work
• The work is divided into small tasks and no one is allowed to do the whole work
from beginning to the end. Specialized tasks increase the speed of work and
increase the efficiency of the employees. This automatically introduces internal
check in the system.
• What is more important is every one, who is a part of one work does his/ her task
on the basis of a separate copy of the original voucher.
2. Separation of Custody and Recording
• A person who handles any asset like cash, goods, etc. is not allowed to record the
transactions. For example, in a bank, the cashier makes payments and enters in the
rough cash chits. The officer authorizing the payment is different, who maintains a
scroll of authorised payments.
3. Job Rotation
• A clerk is not allowed to occupy a particular job for a long period. A policy of job
rotation is adopted, since familiarity with a particular position offers grater chances
to manipulate the system.
1.54
Auditing Introduction to Principles of Auditing and Audit Process

4. Authority Level
• There are clear-cut authority levels for giving sanctions to various transactions. The
existence of authority levels helps review the operations of subordinates.
5. Accounting Controls
• Various cross- checks are introduced in internal check with regard to recording of
accounting records. The use of ‘control accounts’ self-balancing system,
preparation of reconciliation statements are some of the methods of cross-
checking.
1.7.2 Advantages of Internal Check
1. It increases the efficiency of work as division of work leads to specialization.
2. Internal check system involves proper segregation of duties among the staff of an
organisation. As duties are well- defined, it becomes easier to fix responsibility in
case of errors and frauds.
3. Since no single person is allowed to do a job from the beginning till the end,
manipulation of accounting records is difficult. Further, the custody of assets and
recording for the assets rests with different individuals and thus frauds are
minimized.
4. The information generated through internal check system is more reliable as the
system has an in-built system of cross-check of a clerk's work by another person.
5. When the internal check system is sound, an auditor can rely on the information by
making test checks.
6. Job rotation enables the employees to learn all tasks. Thus, their employability also
increases.
1.7.3 Disadvantages Internal Check
1. Internal Check system is costly to establish and maintain as this requires more
number of staff due to increase in the work and also due to division of work.
2. Employees know their work is cross- checked, so they are likely to become careless.
3. It reduces the work load of the auditor but does not in any way reduce his
responsibility. In this sense, if he relies on the information generated by the system
due to efficient internal checks and later, if errors and frauds are discovered, he will
be held liable for the same.
1.55
Auditing Introduction to Principles of Auditing and Audit Process

1.8 Internal Audit

Introduction
• The term internal audit has been defined as “the independent appraisal of activity
within an organisation for the review of accounting, financial and other business
practices as a protective and constructive arm of management. It is a type of
control which functions by measuring and evaluating the effectiveness of other
types of controls. It deals primarily with accounting and financial matters, but it
may also properly deal with matters of an operating nature.”
• From the definition, it is clear that internal audit not only includes the verification of
accounting matters, but also includes financial and other matters.
• The common understanding of the term internal auditing is that its purpose is to
ensure that the accounting and allied records are properly maintained; that the
assets of the enterprise have been properly safeguarded and the policies and
procedures laid down by the management are complied with.
• However, the modern view suggests that internal auditing need not be confined to
financial transactions and that its scope may be extended to the task of reviewing
whether the resource utilization of the enterprise is efficient and economical. This
would therefore mean the review of all operations of the organization as well as to
ascertain the effectiveness of the management.
Definition of Internal Audit

“Internal Audit is an independent management function which involves a

continuos and critical appraisal of the function of the entity. The objective of
internal audit is to suggest improvements to the function of the entity in order to
add value to it and strengthen the overall governance mechanism of the entity
including its strategic risk management and internal control system”.
1.8.1 Objectives of Internal Audit
1. To verify the correctness, accuracy and authenticity of the financial accounting and
statistical records presented to the management and to the external agencies.
2. To confirm that liabilities have been incurred by the organization in respect to its
valid and legitimate activities.
3. To comment on the effectiveness of the internal control system and procedure and
the internal check system in force and to suggest ways and means to improve
these systems.
1.56
Auditing Introduction to Principles of Auditing and Audit Process

4. To examine the protection afforded to the company assets and the uses to which
they are put.
5. To identify the authorities responsible for purchasing assets and other items as well
as the disposal of assets.
6. To ensure that the standard accounting practices which have to be followed by the
organization are strictly adhered to.
7. To undertake special review of the managerial function of the organization.
8. To verify Compliance by various segments with the policies, plans and procedures
of the organization as well as with the relevant rules, laws and regulations.
1.8.2 Features of Internal Audit
1. Internal audit is a part of internal control system designed by the management.
2. It is an appraisal activity within an organisation for the review of accounting,
financial and other business practices.
3. It is designed to protect the management.
4. It is a continuous review of operating activity by a full-time employee of an
organisation who has expert knowledge of accounting.
5. Internal audit report is submitted to the management of the client.
6. It is a continuous audit and one which is not compulsory.
1.8.3 Difference between Internal Audit and Internal Check
Sr. Internal Audit Internal Check
no.
1 Internal audit is an independent function Internal check is such an
of management involving a continuous arrangement of the work of different
and critical appraisal of the function of clerks that the work of one person is
the entity. automatically checked by another in
the very process of recording and
processing of the transactions.
2 The objective of internal audit is to A clerk is not allowed to occupy a
suggest improvement to the function of particular job for a long period. A
the entity and add value to and policy of job rotation is adopted,
strengthen the overall governance since familiarity with a particular
mechanism of the entity including its position offers greater chances to
strategic risk management and internal manipulate the system.
control system.
1.57
Auditing Introduction to Principles of Auditing and Audit Process

Sr. Internal Audit Internal Check

no.
3 Internal audit calls for the appointment of It is applied to the accounting system
professional. of a concern.
4 Internal audit systems aim at discovering It is a part of the internal control
the irregularities before it is found out by system.
the external auditor.
5 Internal auditor reports to the The objective of internal check is to
management about the books of minimise the chances of errors and
accounts and other related matters. frauds.
1.8.4 Difference between Internal Control and Internal Check
Sr. Internal Control Internal Check
No.
1 Internal control system consists of Internal check is such an arrangement
various control procedures adopted of the work of different clerks that the
by an organisation in financial and work of one person is automatically
non- financial areas. checked by another in the very process
of recording and processing of the
transactions.
2 It covers accounting and non- It is applied to the accounting system of
accounting spheres. a concern.
3 Internal control includes internal It is a part of the internal control
check and internal audit systems. system.
4 The objective of internal control is to The objective of internal check is to
bring about efficiency and orderliness minimise the chances of errors and
in operations. frauds.
Points to Remember
1. Audire
• Latin word meaning ‘to hear’.
2. Financial Statements
• The annual statements summarizing a company’s organisations activities over the
last year, consisting of profit and loss account, balance sheet, cash-flow statement,
fund-flow statement, etc.
1.58
Auditing Introduction to Principles of Auditing and Audit Process

3. Errors
• Unintentional misstatements or omissions.
4. Frauds
• Intentional misstatements or omissions.
5. Embezzlement
• A form of theft in which an employee dishonestly appropriates money or property
given to him/ her on the behalf on an employer.
6. Interim Audit
• It is an audit for less than a 12- month period before the annual audit.
7. Concurrent Audit
• It is the examination of transactions as soon as they are entered in the books of
account. The recording and auditing take place almost simultaneously.
8. Documentation
• It is the collection and preparation of audit evidence, authenticated by appropriate
authorities and their safe- keeping.
9. Audit Evidence
• The evidence required by an auditor on which the audit opinion is based.
10. Compliance Test
• This is the test conducted by an auditor to determine the effectiveness of an
organisations control procedure.
11. Substantive Test
• These are the tests conducted by an auditor to examine the accuracy and
completeness of accounting records and financial statements.
12. Test check
• This involves checking the sample transactions in detail.
13. Audit Notebook
• It is a written record of queries made, replies received there to, correspondence
entered into etc. during the course of an audit.
14. Audit Programme
• It is a detailed plan of audit work specifying the tasks to be performed.
15. Audit Working Papers
• These papers contain essential facts about the accounts of clients collected by the
auditor for reference. An auditor need not go over the accounts of his client every
time if he wants any information.
1.59
Auditing Introduction to Principles of Auditing and Audit Process

16. Internal Control System

• A system of controls, financial and non-financial, established by the management
of a company, to carry out the business of the company in an orderly and efficient
manner.
17. Internal Check System
• It is such a system of work assignments, among the employees of an organisation,
that the work of one person is automatically checked by another person.
18. Internal Audit
• An audit conducted by employees of an organisation to examine the functioning of
the organisation.
19. Investigation
• It is a search in enquiry into any matter relating to an organisation.
Questions For Discussion
1. Define Auditing. State its Nature.
2. Explain the Scope of Auditing.
3. What are the Principles of Auditing ?
4. Describe the various Types of Audit.
5. Explain in detail about the Audit Process.
6. Explain the various Types of Errors.
7. State the different Types of Frauds.
8. Define Audit Programme. State its Advantages and Disadvantages.
9. What is Audit Note Book ? State its Contents.
10. Define Internal Control. State its Types
11. What is Internal Check ? State its Advantages and Disadvantages.
12. What is Internal Audit ? State its Features.
13. Write Short Notes
(A) Advantages of Auditing
(B) Origin of Auditing
(C) Error v/s. Fraud
(D) Advantages of Audit Note Book
(E) Audit Working Papers
(F) Internal Check v/s. Internal Audit
(G) Features of Audit Programme
(H) Detection and Prevention of Fraud
❂❂❂

1.60
Chapter 2…
Checking, Vouching
and Audit Report
Contents …
2.1 Test Checking

2.1.1 Meaning and Definition of Test Checking

2.1.2 Safeguards for Application of Test Checking

2.1.3 Advantages and Disadvantages of Test Checking

2.1.4 Difference between Routine Checking and Test Checking

2.2 Voucher

2.2.1 Meaning and Definition of Voucher

2.2.2 Components of Voucher

2.3 Vouching

2.3.1 Objects of Vouching

2.3.2 Precaution to be taken while Examining the Vouchers by the Auditor

2.4 Internal Check

2.4.1 Meaning and Definition

2.5 Vouching of Cash Book

2.6 Verification and Valuation of Assets and Liabilities

2.6.1 Introduction

2.6.2 Verification

2.6.3 Verification of Assets and Liability

2.1
Auditing Checking, Vouching and Audit Report

2.6.4 Valuation

2.6.5 Mode of Valuation of Different Types of Assets

2.6.6 Auditors Position regarding Valuation of Assets

2.6.7 Verification of Different Items of Liabilities

2.6.8 Difference between Valuation and Verification

2.7 Audit Report

2.7.1 Form of Audit Report

2.7.2 Types of Audit Report

2.8 Audit Certificate

2.8.1 Distinction between Audit Report and Audit Certificate

2.9 Auditing and Assurance Standards (AAS : 1, 2, 3, 4, 5)

2.9.1 Auditing and Assurance Standards in India

2.9.2 Objectives and Functions of the Auditing and Assurance Standards Board
(AASB)

• Points to Remember

• Questions for Discussion

Learning Objectives..
After reading this chapter, the students should able to understand:

1. To get knowledge about concept of Checking, Vouching, Verification and Valuation

regarding items of financial statement

2. To learn the verification and valuation of assets and liabilities

3. To understand the various types of audit reports

4. To study the meaning of audit certification

5. To know difference between audit report and audit certificate

6. To elaborate the auditing and assurance standards

2.2
Auditing Checking, Vouching and Audit Report

Introduction
• Many transactions in the business are recorded in the ledger. The most important
part of the audit work is to check the authenticity of the records. The auditor has to
rely on a number of documents to verify the authenticity of the transaction record.
For example, invoices, receipts, purchase and sale documents etc. These documents
are also called audit tools. Documents that are recorded in the books of accounts
are examined in a number of ways, for which the auditors have to adopt various
methods.
• The exact method of audit can be used according to the nature and scope of the
business organization and the audit situation. In short, the basic methods of
collecting and evaluating evidence are called 'audit techniques'.
2.1 Test Checking
2.1.1 Meaning and Definition of Test Checking
• It is not possible for an auditor to inspect all transactions in large businesses due to
lack of time. A detailed examination of all transactions is neither practical nor
necessary. This is because at present, management is aware about the need of
keeping accurate accounts and use of internal control system. Therefore, the
accountant selects some samples of same transactions and examines them to
understand the authenticity of other transactions. Such an investigation is called a
'test investigation'. It depends on internal check system. Under it, only a few
transaction records are checked. This investigation is based on probability theory.
• Although some errors or omissions are found in this investigation, other
transactions are deemed to have such errors or omissions and then the other
transactions are investigated. The opinion of the auditor is based on sample
transactions which represent the whole population.
Definition of Test Checking

1. Prof. Meigs
“Test checking means to select and examine a representative sample from a large
number of similar items”.
2.1.2 Safeguards for Application of Test Checking
• The adoption of test inspection greatly reduces the work of the auditor, but it does
not reduce the responsibility of the auditor. If the audit reveals mistakes, lies and
fraud in the accounts, then the auditor will be responsible.

2.3
Auditing Checking, Vouching and Audit Report

• The auditor will not be able to defend that the errors in the accounts could not be
detected due to the adoption of the test inspection. Although some of the
transactions are examined by the sample in the test inspection, he is responsible
for the inspection of all the transactions.
• In this context, L. R. Dicksee's following statement is relevant:
“The theoretical responsibility of the auditor extends ultimately to every entry in
the books of accounts, but it does not follow that it is either necessary or
possible to examine every in details”.

Representative
Complete Extent of Test
Examination Checking

Safeguards
for Random
Random size
Application of
of Test Sample
Checking

Study the Complete

processing Coverage
Materiality
level

Fig. 2.1 : Safeguards for Application of Test Checking

1. Random
• Selection of sample should be random, it will represent whole sample to give
correct opinion.
2. Complete Examination
• Some transactions like opening and closing entries, depreciation entries and non-
recurring or exceptional transactions should be checked in depth. Here, test checks
may not give correct results.
3. Representative
• Transactions from all the books and of all the clerks should be included in the
sample.
2.4
Auditing Checking, Vouching and Audit Report

4. Extent of Test Checking

• The use and extent of test checking is dependent on the system of internal check in
operation for the business. More efficient the internal check system, lesser the
extent of test checking.
5. Size of Sample
• Sample size can be determined with the help of statistical tools after determining
the confidence level, precision level and tolerable error required by the auditor.
6. Complete Coverage
• The selection of transaction should be made in such a way that over a span of 4 to
5 years all the transactions come under the review of the auditor.
7. Study the Processing
• The selected transactions should be studied in detail from the beginning till the
end.
8. Materiality Level:
• The auditor should set a materiality level to discover error.
2.1.3 Advantages and Disadvantages of Test Checking
(I) Advantages of Test Checking
1. Saves time and labour of the auditor.
2. Understands the accuracy of transaction records.
3. Audit of many business organizations can be done in a certain period of time.
4. Testing allows the auditor to complete his audit in less time.
5. Creates frustration on the part of business employees. Because any transactions
can be taken for investigation.
(II) Disadvantages of Test Checking
1. Although the audit reduces the work of the auditor, it does not reduce his
responsibility.
2. Testing does not reveal errors or deceptions in the balance sheet. This is because if
there are no errors in the selected sample transactions, errors in other transactions
will not be detected.
3. The adoption of test inspection will not allow the auditor to understand the true
state of the financial affairs of the organization.
2.5
Auditing Checking, Vouching and Audit Report

2.1.4 Difference between Routine Checking and Test Checking

Points Routine Checking Test Checking

1. Meaning “Occasional inspection is to “Test checking means to select
check the mathematical and examine a representative
accuracy or precision of sample from a large number
transaction records is called as of similar items”.
Routine Checking”.
2. Concept Routine checking involves the Test checking involves the
checking of books and records. examination of few
transactions selected by
auditor.
3. Relationship Routine checks may be Test checking may be the base
perfomed on the basis of test for routine checking.
checking.
4. Objective The main object is to ensure The main object is to ensure
airthmetmetical accuracy of the arithmetical accuracy of the
entries in the original books entries in the original books
and ledgers and posting to and ledgers and posting to
correct ledgers account. correct ledgers account.
5. Nature Occasional checks are tasks that Testing is done to check
are directly related to certain transactions due to
accounting activities such as lack of time.
credit, account balance,
subtraction, balance or not.
6. Assumed Occasional audit work depends The inspection is based on the
Element to a large extent on accounting assumption that certain
and internal control systems. transactions representing
multiple transactions or entries
should be selected as a
sample and checked, and if
they are correct, then other
transactions must be correct.
2.6
Auditing Checking, Vouching and Audit Report

Points Routine Checking Test Checking

7. Completion In any case, the task of The test inspection reduces
of Work occasional investigation is the work of the auditor.
tedious, but it must be done Auditors use this method to
thoroughly. save their labour and time.
This method does not cover all
transactions in detail.
8. Utility Occasional checks are useful for The test method is useful as a
small businesses. method of auditing in large
scale businesses where the
number of transactions are
huge.
9. Relation to The accounts of the original Testing has nothing to do with
Accounting accounts or the various accounting.
accounts in them are
ascertained.
2.2 Voucher
• It is important to understand the concept of voucher before learning the concept
of Vouching.
2.2.1 Meaning and Definition of Voucher
• A voucher is a written paper or document in support of an entry in the books of
accounts. It is the documentary evidence to support the various entries.
• Certain vouchers may be of primary nature while other of a collateral or secondary
nature.
• A voucher is documentary evidence in support of any transaction in books of
accounts. Voucher can originate within the organization or outside the
organization i.e. they can be internal or external. It indicate accuracy of transaction.
• Examples of vouchers are cheque book, receipt, invoice, bill, pay-in slip, etc.
Definition of Voucher

“A voucher is any documentary evidence in support of transaction in the books of

accounts”.
2.7
Auditing Checking, Vouching and Audit Report

Examples of Voucher
• The following are the Examples Vouchers for Certain Transactions:
Name of Transactions Vouchers Available
1. Cash receipts Counterfoils of receipts issues, carbon copies of receipts,
contracts, correspondence and letters from the debtors
confirming the balances of the accounts.
2. Cash paid Original receipts from payee, invoices, bills demand
notes, salary books, wage sheets, contracts, confirmation
by creditors etc.
3. Purchases Invoices, copies of orders and correspondence etc.
4. Sales Orders record and goods outward books etc.
5. Opening Journal Purchase and sales returns, bills payable and receivables
Entries and last years balance sheet entries etc.
2.2.2 Components of Voucher
1. Supplier identification number
2. The amount payable
3. The date on which payment will be made
4. The accounts payable to record the liability
5. Any valid early payment discount terms
6. The approval signature or stamp
2.3 Vouching
• The act of examining documentary evidence in order to ascertain the accuracy and
authenticity of entries in the accounts books is called ‘vouching’.
• It is a technical term which refers to the inspection by the auditor of documentary
evidence means a careful examination of original evidence i.e., invoices, statements,
receipts, correspondence minutes and contracts etc. with a view to ascertain the
accuracy of the entries in the books of accounts and also to find out as far as
possible that no entries have been omitted in the books of accounts.
• In simple word vouching is examination of documentary evidence to ascertain the
authenticity in the books of accounts. It is a technique used by an auditor to judge
the truthfulness of the entries recorded in the books of accounts.
2.8
Auditing Checking, Vouching and Audit Report

Definitions of Vouching

1. Dicksee
“Vouching consists of comparing entries in books of accounts with documentary
evidency in support thereof”.
2. Joseph Labcaster
“If is often thought that vouching consists of the mere examination of the
vouchers or documentary evidence with the book entries. This, however, is quiet
wrong, for vouching comprises such an examination of the ledger entries as will
satisfy the auditor, not only that the entry is supported by documentary evidence
but that it has been properly made upon the books of accounts”.
3. Ronal A. Irish
“Vouching is a technical term which refers to the inspection by the auditor of
documentary evidence supporting and substantiating a transaction.”
4. Spicer and Pegler
“The examination by the auditor of all documentary evidence, which is available
to support the authenticity of the transactions entered in the clients records.”
5. D. Paula
“Vouching does not mean merely the inspection of receipts with the cash book,
but includes the examinations of the transaction of a business, together with
documentary and other evidence of sufficient validity to satisfy an auditor that
such transactions are in order, have been properly authorised and are correctly
recorded in the books.”
6. R. B. Bose
“By vouching it is meant the verification of the authority and authencity of
transactions as recorded in the books of accounts.”
7. J.R. Batliboi
“Vouching means testing the truth of items appearing in the books of original
entry.”
• In short vouching is technique used by an auditor to verify correctness of
transactions recorded in the books of accounts. On that basis he submit his report.
• From all these definitions, it is clear that vouching means testing the truth of
entries appearing in the primary books of accounts.
2.9
Auditing Checking, Vouching and Audit Report

2.3.1 Objects of Vouching

Accounting Entries

Verification

Ensuring the transaction is

related to the trade

Ensuring that the transaction is

properly recorded

Authentication of transactions

Fig. 2.2 : Objects of Vouching

1. Authentication of Transactions
• Verifying the genuineness of the transactions recorded is the basic object of
vouching. The purpose is to certification and ensure that all transactions in the
ledger are done by the person authorized to do so. Explanations about
authorization related to the rights, responsibilities and liabilities of various persons
in the business are given in the Constitutional Rules.
2. Ensuring that the Transaction is Properly Recorded
• Every transaction recorded in the book of accounts should be accurate, true and
factual. The purpose of certification is also to ensure that the amount of the
transaction is recorded correctly, the classification of the accounts is done properly
and the transaction is recorded in the correct ledger at all times.
3. Ensuring that the Transaction is related to the Trade
• All transactions recorded in the accounts are related to the respective trades. The
purpose of the certification is to ensure that personal transactions are recorded and
that no business-related transactions are left unregistered in the books of accounts.
4. Verification
• Ensuring that all records are authentic and that proper documentary evidence is
available.
5. Accounting Entries
• Ensuring that every documented record in the accounts is available and related to
the financial transaction for which audit is to be done.
2.10
Auditing Checking, Vouching and Audit Report

2.3.2 Precaution to be taken while Examining the Vouchers by the

Auditor
• The part of core auditing is Certification. The success of the auditor depends on
how effectively and efficiently certification is done by an auditor. The standard that
is created as soon as the transaction takes place in the business is called the
'original standard' (E.g. cash voucher). The events that take place to record the
transaction and the examples of such events are purchase order, agreement
between the seller and the buyer, letter of delivery, acknowledgment of receipt of
goods, etc. Basic standards and secondary standards in business are submitted to
the auditor for certification.
• The auditor needs to consider the following while examining both of these criteria:
1. Person Names should not be Authenticated
• The name of the person whose account is being audited should not be
authenticated, but the name of the employees in the office and organization
should be mentioned
Example
• Mr. Joshi owns ABC Company. He is working as a manager of a ABC Company. The
standard should be created in the name of the company. If the certificate is in the
personal name of 'Mr. Joshi', it should not be considered official. This is because
the standard can also be a private transaction and the amount of this private
transaction is likely to be paid from the business. Therefore, such certification
should be considered as an invalid.
2. The Auditors should Check the Standards themselves and with the Help of
their Collegue
• The auditor should never enlist the help of the organization's staff to check the
standards. This work should be done by the auditor himself or assigned to one of
his responsible colleagues.
3. The Standard should Preferably be in Print
• The certificate submitted should be in the name of the concerned office and
preferably in printed form. This certificate should be signed by the responsible
officer concerned. If the certificate is not printed, the office should have a rubber
stamp. It should also be stamped with authorized signature. Otherwise it will be
considered as cancelled.
2.11
Auditing Checking, Vouching and Audit Report

4. Verification of Authenticity
• The auditor should make sure that the certification submitted is approved by the
appropriate authority. In order to ensure that the expenditure incurred is
authorized, the person who has the authority must sign the standard. To check it,
the auditor should verify the rules of the company, partnership agreement or
company history book
5. Check the Term and Date of the Standard
• The date of certification should be in the year for which audit is conducted. The
date on the standard and the date of entry in the original book should be the
same. If an old transaction from a previous date was reported later, there is a
possibility of a scam.
6. Receipt Stamped should be
• If the amount is more than ` 20, a receipt stamp of ` 20 should be affixed on the
receipt. Only then will that receipt or standard be considered as acceptable.
7. Check that Expenses are Properly Classified
• There are many types of expenses which re-incurred in the business so proper
classification /categorization of the expenses are needed.
• Some of the expenses in the business are capital in nature, while some of the
expenses are in the form of revenue. If revenue expenditure is classified as 'capital
expenditure' during classification, it can result in more or less profit.
• If capital expenditures are recorded as revenue expenditures, it can have an effect
on the profit and loss of the business. So make sure that the cost is properly
classified.
8. Certification Doubts Resolved
• If any of the standards that are presented as documentary evidence during the
audit are doubtful, the doubts should be completely resolved. The standards
should be verified to be authentic and correct.
9. Certification by the Cashier Himself
• At times in the business, the cashier has to create his own standard. Such standards
should be carefully checked. For example, the cashier of the kuli so will prepare the
certificate himself after paying the kuli’s wages. Kuli is illeterate, so the cashier must
take the thumb impression paid to the kuli. The thumb will be appropriate for the
kuli and the actual amount paid to the kuli. As kuli is uneducated, he will not be
able to understand the actual amount of money he took. Such certification must be
signed by the cashier as well as the officer in charge of the department. The auditor
should certify all this matters in depth.
2.12
Auditing Checking, Vouching and Audit Report

10. Uncertified Entries

• Sometimes some standards are not presented to the auditor. Ask for reasons why
there are no standards and ask them to submit. If missing, find out the cause. An
official copy of the certification should be requested as well as certified by the
responsible officer.
11. All Standards Presented Simultaneously
• Only when the standard examination begins, the auditor call for all the standards at
once and keep them with him till the end of his work. For example, when the
auditor start checking the sales book, he should asked to bring all the receipts at
once.
12. Use of Tokens
• The auditor should take care that not a single receipt will be re-submitted while
certifying. For this, when the inspection of the standard is completed, a special
symbolic mark should be made on it. Only the auditor should understand the
meaning of that mark.
13. The Standard should not be Removed from the Standard Book
• There may be an error in writing the certificate from the accountant or the
concerned employee or the certificate may become unusable for other reasons. In
such a case, the useless standard should not be removed from the book. That
standard should be in the same place as in the same book. The cancellation should
be written and signed by the concerned officer.
14. Examination of Standard Information, Handwriting, Numbers etc.
• The text written in the standard should match the disclosure in the accrual book.
Example
• If the amount withdrawn from the salary in advance check that amount is not
accidentally credited to the salary account.
• When recording the serial number and transactions written on the standard, make
sure that the serial number written in the ledger is the same.
15. Order Matching of Certificates
• Prior to the audit, the auditor should sort out all the credentials and expenses
separately and systematically according to by date, in the order of registration and
give them serial numbers. So it is not a waste of time to find standards.
16. Uncertified Certificates
• If a certifier is found any certificate which is without a record, it should be noted
and inquired and the certifier should be recorded if it is correct.
17. Certification and Internal Inspection Methods
• If the business has a system of internal control and the auditor has to check system
of implementation. He can save time if he certifies the test by the test method.
However, in accepting this approach, the auditor should not forget his
responsibility.
2.13
Auditing Checking, Vouching and Audit Report

2.4 Internal Check

2.4.1 Meaning and Definition
• Internal check is the important and integral part of the internal control system.
• It is an arrangement of the duties of members of staff in such a manner that the
work performed by one person is automatically and independently checked by the
other.
Definitions of Internal Check
1. F. R. Mepaula
“Internal check means practically a continuous internal audit carried on by the
staff itself, by means of which the work of each individual is independently
checked by other members of the staff.”
2. D.R. Davar
• “Internal check is a system or method introduced with defined instructions given
to staff as to their sphere of work with a view to control and the verification of
their work and also the maintenance of accurate records as the ultimate aim.
3. Joseph Lancaster
“The internal check is a method of organizing the entire operations, office,
warehouse, factory and the duties to the respective staff so that frauds and
irregularities are impossible without collusion.”
2.5 Vouching of Cash Book
• A Cash book is the primary book of record. It is a journal. It records all cash receipts
and cash payments. It shows closing and opening cash balance on any particular
day.
• Cash book is recorded in Double Column Cash book having Bank and Cash column.
Some organization keep triple column cash book having additional discount
column in it. Discount allowed is recorded to the debit side and discount received
is recorded to the credit side.
• The auditor should examine the internal check system in operation because the
chances of misappropriation of cash are very high in any organisation. Auditor is
responsible for checking effectiveness of internal check system
• An effective internal check system for cash receipts and payments should include
the following:
1. Cash should be received by the cashier; however, he should not have any access to
the ledger accounts.
2. Cash received should be entered in a rough cash book or diary.
3. Cash received should be acknowledged by the issue of a printed receipt and the
organisation should have a counterfoil or carbon copy of such receipt.
4. Remittances received should be opened by the cashier in the presence of a
responsible officer who should not be connected to the cashier’s office.
2.14
Auditing Checking, Vouching and Audit Report

5. All receipts of the day should be deposited in the bank at the end of the day or in
the next morning.
6. Bank reconciliation statement should be prepared regularly.
7. All payments, as far as possible should be made by way of crossed cheques.
8. While issuing a cheque, it should be presented to a responsible officer for his
signature. The details of the account of the party to whom the payment is made
should be presented to the officer.
Process of Vouching of Cash Book

Debit side
for the
cash book
(Receipt)

Process of
vouching
of cash
book

Credit side
for the
cash book
(Payment)

Fig. 2.3 : Process of Vouching of Cash Book

Process of Vouching of Cash Book
Debit Side of the Cash Book Credit Side of the Cash Book
• Opening balance • Payment of capital expenses
• Cash sales • Wages
• Cash received from debtors (credit • Time records
sales) • Piece work records
• Rent received • Travelling allowance
• Bills receivable • Bill payable
• Sale of investment • Insurance premium
• Commission • Freight and carriage
• Income from hire purchase • Salary
agreement • Custom duites
• Income from investment • Rent payable
• Interest on deposits and loans • Payment to creditors
• Insurance claim • Petty cash payment
• Subscriptions • Director's Fees
• Proceeds from the sale of fixed • Postage
assets
• Miscellaneous receipts
2.15
Auditing Checking, Vouching and Audit Report

(A) Debit Side of the Cash Book/ Vouching of Receipt Side

• Auditor after satisfying about the efficiency of the internal check system regarding
the receipts and payments of cash, should start the work of vouching the debit side
of the cash book because it is more difficult. It has been accepted by accountants
and auditors that the vouching of the debit side of the cash book is more difficult
than that of the credit side, since only indirect evidences are available i.e.
counterfoils of receipts issues, carbon copies of receipts, contracts and letters from
the debtors confirming the balances of their accounts etc.
• It is difficult to vouch the cash book as some receipts might have been omitted
altogether. The auditor must compare the receipt side with that of the rough cash
book. If on comparison, he finds that there is a time lag between the receipt of
cash and entry in cash book, he must examine it in depth as is posted against the
accounts with delay.
Important Items on the Debit Side of the Cash Book
1. Opening Balance
• The opening cash balance which is recorded in cash book is the closing cash
balance of the previous year. This item can be vouched by reference to the duly
audited balance sheet of the previous year. This is done to verify that the actual
balance has been brought forward.
2. Cash Sales
• Opportunities for fraud under this head are many because the salesman may sell
the articles and not enter in the cash book. i.e; misappropriation of money.
Therefore, the auditor should examine the effectiveness of the internal check
system in operation in regard to cash sales.
• Generally it is seen that in big concerns, the salesman is neither allowed to receive
cash from copies of the cash memo. When the goods are sold to a customer, to
whom two carbon copies of the cash memo are handed over. The salesman then
sends the goods attaching one carbon copy of the cash memo to the delivery clerk.
• While vouching cash sales, cash register should be fully checked with carbon copies
of cash memos. The auditor must verify that the daily deposits of cash received in
the bank dates of the cash and the date on which the receipts are recorded in cash
book must be the same. If the cash memos are cancelled, all copies including the
original copy duly cancelled should be kept in the book. If a company has a
discount policy and more discount is allowed in a transaction then it must be
approved by a responsible officer.
2.16
Auditing Checking, Vouching and Audit Report

Procedure for Vouching of the Cash Sales

Vouchers
(a) Copies of cash memos, total cash received if automatic cash recording machine are
used and till record if computerized tills are used.
(b) Counterfoils of pay-in-slips.
(c) Cash sales summary by cashier, salesman’s summary and goods delivered
summary.
Procedure
(i) The auditor should examine the cash sales amount entered on the debit side of
cash book with daily
(a) Cash sales summary, and
(b) Copies of cash memos.
• If the company is using cash recording machines, the auditor should compare the
entry in the cash book with that of the total of cash received as shown by the
machine. In case, computerized tills are used, the entries in the cash book should
be compared with the till records.
(ii) The auditor should select a sample of cash memo and examine whether the price
charged, discounts allowed and rates of sales tax charged are correct and properly
authorized. He must verify the cash discount policy of the concern and ensure that
the discount allowed is within the rules. He should give particular attention to the
dates mentioned in the cash book with that of the dates stated in all the
summaries.
(iii) On depositing the daily cash, the depositors get the counterfoils of the pay-in-slip
as proof for having made the deposit. The auditor should examine the counterfoils
with the cash sales summary to ensure that the deposit is made on the same day. If
the deposit is made at a later date, he must find out the reasons for the same.
There is a possibility of ‘lapping’ in such case.
(iv) Besides the above, he should check the arithmetical accuracy of cash memos, cash
sales summary and gate keepers goods delivered summary. He should ensure that
the cash received, the discounts allowed and sales made are entered in the correct
accounts with correct amounts.
3. Cash received from Debtors (Credit Sales)
• The cash received from customers to whom goods have been sold on credit in the
past can be vouched with the help of counterfoils of the receipts issued to them.
2.17
Auditing Checking, Vouching and Audit Report

• When the money is received from such debtors, the receiving party credits the
debtors account and issues the receipt to this effect. But it is often noticed that less
amount is inserted in the counterfoils than that was actually received from the
debtors. In some cases, less amount is recorded on the debit side of the cash book
instead of the actual amount received. Sometimes, the cashier misappropriates or
misuses cash received from debtor through the process of ‘Teeming and Leding
Method’ i.e. not entering cash received in the cash book immediately and entering
it only when a similar amount is received from another debtor.
• Amount should be entered in the cash book on the day when it is received. The
auditor should verify amount received from debtors from the counterfoils of the
receipt issued to the customers. All these receipts should be serially numbered
• Discount allowed to customers should be authorized by a responsible officer. If
necessary, correspondence made with customer can also be verified.
Receipt from Debtors
(a) Counterfoils of receipt issued to debtors.
(b) Debtor accounts to analyses the way payments are normally made.
(c) Counterfoils of pay-in-slips.
(d) Statements of account of debtors to be prepared and sent to debtors.
(e) Discount policies.
(f) Bad-debts written-off.
4. Rent Received
• The auditor should examine the lease deed and agreement to ascertain the exact
amount receivable and the due date. He should also verify provisions regarding
repairs and the rent received as per the cash book and should be compared with
‘rent rolls’ on the list of properties if maintained. In case the rent is collected by an
agent, then it should be vouched with the accounts submitted by him. If receipts
are issued to the tenants for the rent received, the counterfoils of the receipts
should also be checked.
• Rents-outstanding should be carefully examined and if the arrears are heavy, the
auditor, with the consent of the client, should write to the tenants in order to
confirm the amount of the arrears. It is often seen that rent has been recovered but
has been shown as an outstanding and the amount has been misappropriated. He
should see that a reasonable provision should be made for the doubtful
outstanding rents.
• Sometimes, a property or part of it is not ‘let-out’. In that case, the rent will not be
received until it is let out. The auditor should get a certified list from a responsible
officer in respect of such vacant properties.
2.18
Auditing Checking, Vouching and Audit Report

5. Bills Receivable
• Sometimes, the debtors accept the bill of exchange payable. It means that after the
expiry of this period, the amount becomes receivable on account of this bill of
exchange. The amount so received on maturity after this expiry of the period,
should be checked by comparing the bills receivable book with the cash book and
the bank pass book. In respect of those bills which have been discounted before
maturity, the bills discounted book should be checked. It is also possible that such
bills might have been paid and the amount received might have been
misappropriated by the cashier.
• The auditor should examine the bills receivable book in order to ascertain the
correct position. The contingent liability, in respect of bills receivable discounted
with the banker but which have not matured on the date of the balance sheet
should also be determined and shown on the balance sheet.
• Bills receivable book may be verified because the various details regarding the bills
matured and discounted are available in it. The amount received can be checked
with the bank statement. Some bills might have become due but no amount has
been received in such a case, whether the entry for the dishonour of such bill has
been made or not should be checked by auditor.
6. Sale of Investment
• The sale proceeds on account of the sale of investment should be vouched with the
‘Broker sold note’ or ‘contract note’. This note is the most important supporting
evidence and will contain all the details about the actual amount received and the
commission paid to the broker.
• If the sale has been effected through the bank, the banker’s advice should be
examined to know the details.
• If the investment has been sold ‘cum dividend’, the auditor should see that
dividend is subsequently received and that sale proceeds thereof is properly
apportioned between capital and revenue.
• If the investment has been sold ‘ex-dividend’, the auditor should see that the
dividend is received and recorded subsequently.
• In case investments pertain to some earmarked funds, the profit or loss on the sale
of investments should also be transfer to that earmarked fund account.
2.19
Auditing Checking, Vouching and Audit Report

7. Commission
• The auditor should obtain the list of parties from whom commission is receivable.
The amount of commission received can be vouched with the counterfoils or the
carbon copies of the receipts issued to the parties from whom the commission has
been received. The copy of the agreement should be examined to ascertain the
rate of commission. Counterfoils of the receipt should be compared with the
amount entered in the cash book. In order to find out the correct amount of the
commission, the auditor should make the calculations himself.
• Where such a commission is received from abroad, the auditor should verify the
banks advice and see that provisions of the foreign exchange regulations are
compiled with.
8. Income from Hire Purchase Agreement
• Sometimes, assets are sold on a hire purchase agreement basis. In such a situation,
the instalments are received as per the hire purchase agreement. The auditor
should inspect this agreement in order to ascertain the amount of instalment, total
number of instalments, the rate of interest and other terms and conditions. He
should vouch the amount of instalment received with the help of a counterfoil or
the carbon copy of the receipt issued. He should also see that the whole amount of
the instalment received should not be credited to the sales amount but proper
allocation should be made between ‘sales and interest’.
9. Income from Investment
• Interest and dividends received from investment in government securities and in
the shares of limited companies, can be vouched with the counterparts of interest
and dividend warrants or the letter covering the cheque.
• Interest received on securities can be vouched from the securities themselves or
the tax deduction certificates. The months when the interest would be received and
the rate of interest are mentioned in the security itself. The auditor must check that
dividend or interest in respect of investments that have been received on the due
date and accounted for.
• In case the dividend is collected directly by the bankers, the banks pass book
should be examined.
• Where the shares are sold ‘ex-dividend’ or purchased ‘cum-dividend’, the auditor
should check the brokers sold note and purchase note. He should see that the
dividend has been received subsequently and credited to the dividend account.
• A proper record in respect of the total investments must be maintained as it will
enable both the client and the auditor to verify whether interests and dividends are
received on all the investments regularly.
2.20
Auditing Checking, Vouching and Audit Report

10. Interest on Deposits and Loans

• Interest on bank deposits will be vouched with the entry in the bank statement
(bank pass book) and advice from the bank. The rate of interest should be
inspected and calculations should be checked. The auditor should also check the
interest received on the fixed deposits. The interest on fixed deposits is received as
per the terms and conditions in each case.
• Interest is received from loans granted to borrowers. Loan may be given to parties
in the form of debentures or simple loans. The terms and conditions of the loan
should be examined to find out the rate of interest and the due dates of payment.
For all cash receipts in this connections, counterfoils of the receipts may be
checked. Where instalments in respect of repayment of loan are also received with
interest, the auditor should see that only interest is credited to the Interest
Account.
11. Insurance Claim
• Generally, business houses get their fixed and current assets insured against
various kinds of risks. Insurance money received as compensation should be
checked or vouched by means of correspondence and with the accounts rendered
by the insurance companies or the authorized insurance agents. The auditor should
also inspect the copy of the insurance claims lodged with the insurance company
and the counterfoil of the receipts issued to the insurance.
12. Subscriptions
• The membership subscripting received by a club or society should be vouched by
means of counterfoil of receipts issued to the members and with the register of
subscribers.
13. Proceeds from the Sale of Fixed Assets
• Generally fixed assets are sold through a broker or auctioneer. The auditor should
vouch this item by examining the correspondence with the part, sale contracts with
the party or auctioneer’s account. In case there is any profit or loss it, should be
adjusted in the relevant accounts. He should see that the appropriate fixed asset
account is credited with the cash received. He should also check properly the
adjustments made about the prepaid expenses in respect of assets. The auditor
should also see that the sale of the assets has been duly sanctioned by appropriate
authorities.
14. Miscellaneous Receipts
• Any other receipts i.e. bad debts recovery, share capital, income from hire-
purchase agreements and royalty etc. can be vouched with correspondence along
with contracts with the parties or other relevant documents or evidence available.
2.21
Auditing Checking, Vouching and Audit Report

(B) Credit Side of the Cash Book/Payment Side

• The auditor should strategically examine the vouchers presented to him and see
that all vouchers are numbered serially and filed in order. The following are some
of the important and main items on the credit side of the cash book:
(I) Payment of Capital Expenses
• Payment made for acquiring fixed assets are in essence capital expenditure. The
auditor should see that payments in this connection are in order, have been
properly authorized and are properly capitalized.
1. Freehold and Leasehold Property and Building
• The auditor should vouch this item with the help of the agreement for the
purchase of property, the lease deed or conveyance and the title deeds. All
these documents will provide correct information in respect of the property and
buildings purchased.
• If the property has been purchased through a broker, the broker’s statement of
accounts should be examined to know the money paid.
• If the property has been purchased through auction, the auctioneers account
should be vouched and he should see that the property has been registered in
the name of the client according to the Transfer of Property Act. He should
inspect the transfer deed and must obtain a certificate from the solicitors to this
effect.
• Expenses incurred in purchasing the fixed assets i.e. legal charges, stamp duty,
registration fee, architects fees, brokerage and auctioneers commission should
be capitalized and vouched by their respective accounts.
2. Plant and Machinery
• The auditor should examine invoices, receipts in respect of payments made and
other similar evidences giving full particulars of the transaction. He should
make sure that the purchase of the item has been properly authorized.
• The auditor should see that where a machine is imported, the customs duty,
clearing agent charges and other related incidental expenses are also
capitalized.
• The cost of carriage and the cost of erection can be added to the invoice price,
and should be debited to the plant and machinery account. He should see that
all these expenses are also capitalized.
2.22
Auditing Checking, Vouching and Audit Report

3. Patents
• In case patents have been purchased, the auditor should examine the
agreement for the purchase of patents and verify the receipts acknowledging
the payment.
• If patents have been purchased through an agent, his commission should be
capitalized. The agent’s commission can be vouched with the help of the
agent’s accounts. Any expenses incurred in acquiring it should be capitalized.
4. Investments
• The auditor should vouch the payment made for the purchase of investments
with the ‘broker’s bought note’. He should examine the investments physically.
• If they have been purchased cum-dividend, the auditor should see that the
dividend accrued is received subsequently and the expenditure is properly
allocated between capital expenditure and revenue expenditure.
• In case of the new issue, the letter of allotment and the banker receipt for the
instalments paid should be examined.
5. Loans
• The auditor should examine documents concerning a loan agreement and the
receipt given by the borrower. This will enable him to know the terms and
conditions of loan, the rate of interest and the date of repayment of loans.
• In case loan has been advanced against certain securities, he should inspect
such securities and also see that the loan is within the value of the security
amount.
• If the loan has been advanced against mortgage, he should examine the receipt
from the borrower, the mortgage deed, title deeds and other documents.
(II) Payments of Wages
• The vouching of payment of wages is of great importance in case of a large
manufacturing concern. The amount of payment involved is also very large.
Therefore, the vouching of this item requires special attention on the part of
the auditor.
• There are many chances of fraudulent payment under this head. Before
vouching the amount of wages paid, the auditor should carefully examine the
system of internal check in force in the business. He should also examine the
system regarding the preparation of wage sheets and the system in respect of
payment of wages.
2.23
Auditing Checking, Vouching and Audit Report

• If there is no satisfactory system in force or the system is bad and faulty, he

should point out its shortcomings to his client and should disown his
responsibility for this item. However, in order to avoid misappropriation in case
of errors in the wage sheets, the work should be done on the following line:
1. Time Records
• In case wages are to be paid according to the time spent by the worker, the
correct and exact time spent by him on the job must be recorded. This can be
done by means of ‘time recording clocks’. It is also important that a responsible
official should see that the workers come in time and also leave the factory in
time. This will reduce the chances of fraud.
• In large and big undertakings, each worker is given a card. The ‘time recording
clocks’ are installed at the gate. When the worker enters the factory gate, he
puts that card in the slot of the clock and the time and date of entry is recoded
on the card. He will repeat the same procedure when he leaves the factory.
• In case there is no clock, the gate-keeper should record time of each worker in
the time record register and the arrival and departure time of each worker
should also be recorded by the foreman of the concerned department. These
two records must be compared to find out the total time spent by each worker
in the factory. Both these methods will supply the exact time spent by the
worker in the factory.
• The preparation of wage sheets must be entrusted to those persons who are in
no way connected with the time-keeping office. The total time spent by each
worker, as shown by the cards, should be entered in the wage books.
• The rate of wage per day or month should be inserted by another clear and the
gross amount payable should then be calculated by a third clerk.
2. Piece Work Records
• In case wages are to be paid according to the piece wage system, each worker
should be given a card and the details regarding the amount of work done
should be entered in the piece-work card or sheet by each worker. This card
should be signed by the worker and the foreman in charge. These cards should
be passed on to the wage office, for the preparation of the wage sheets.
• If any fine is to be imposed on the worker on account of defective goods, it
must be recorded on the card. This whole work should be independently
checked as in the case of time workers.
2.24
Auditing Checking, Vouching and Audit Report

Procedure of Wages
• There are great chances of fraud in case of wage payment. Hence, it is
important that the client has an effective internal check system for wages. If the
auditor finds that there inefficient internal check system, he must state that fact
in the report.
• There are many ways to commit fraud. A few are stated below:
(a) Inclusion of names of fictitious workers in the wage book.
(b) Names of employees who have resigned and of those who are removed may
continue to appear in the list.
(c) Fraud in stating the time worked and pieces produced by workers.
(d) Over-stating the rates of wages.
(e) Understating the amount of deductions for provident fund etc.
(III) Travelling Allowance
• The auditor should examine the rules and regulations framed by the firm or the
company regarding the payment of travelling allowance to the senior and
junior staff. He should see that travelling allowance bills have been duly
cheeked and signed by a responsible officer in the light of the approved rules
and regulations. He should also see that the voucher is supported by full details
of the travelling expenses and is supported by the necessary evidences.
(IV) Bill Payable
• The auditor should check the cancelled bills returned, bank pass book and bills
payable book can also be checked to ascertain the date of payments.
(V) Insurance Premium
• The auditor should examine the premium notice, the insurance company’s
receipts towards the payment of premium and the insurance policies. Details
about the amount of premium payable, mode of payment and the date of
maturity of the policy can be verified from the insurance policy.
• Where the number of policies is more, the auditor should obtain a list with full
details of the insurance policies.
• Where the policy is not renewed, the auditor should know the reasons.
(VI) Freight and Carriage
• The payment made on account of this item should be vouched with the
statements rendered by the shipping agent or carrier together with the
supported vouchers, agents’ bill and the receipt.
• The auditor should see that allowances in respect of rebates have been
properly accounted for and all bills are in the name of the client.
2.25
Auditing Checking, Vouching and Audit Report

(VII) Salary
• The auditor should examine the ‘salary register’ which contains details
regarding the monthly salary and compulsory deductions in respect of each
employee. He should compare the cheque drawn for payment of salaries with
this register and variation if any should be looked into. He should see that the
cheque is drawn for the net amount. He should also check the due date on
which the increment of an employee falls with the copy of the appointment
letter to avoid any fictitious entry. He shall verify the totals, costing and receipts
and make sure that the salaries to the employees have been paid after
deductions in respect of provident fund, income tax, contribution to health
scheme, deductions on account of insurance premium to Life Insurance
Corporation and the advance or loan, if any.
• Every employee receiving salary must sign the register after affixing a 20 paise
revenue stamp.
• The salary register should be signed by the chief of the accounts section or any
other senior official of the concern.
(VIII) Custom Duties
• The system of payment of custom duty should be investigated. Normally,
custom duty is paid by the clearing agent on behalf of his client. If the clearing
agent has paid these duties, the amount of the custom duty paid will be
included in the bills of the clearing agents which are submitted by him monthly
or fortnightly. The bill of entry duty stamped by the customs department
should also be checked.
• The auditor should examine these bills to ascertain the date of payment and
the amount of custom duty paid. The payments should be vouched with the
goods inward book and invoices.
(IX) Rent Payable
• The agreement with the landlords and receipts from them should be examined.
The auditor should see that the voucher is properly authorized.
(X) Payment to Creditors
• Money paid to the creditors can be vouched with the receipts issued by the
creditors acknowledging the receipt of money. He should also check the
amount due to them with the accounts of the creditors and the invoices
received from the suppliers of goods. He should also see that the invoices
received from the suppliers of goods. He should also see that the vouchers
have references of bills against which payment is made.
2.26
Auditing Checking, Vouching and Audit Report

• The auditor should also check the periodical statements submitted by the
creditor with the creditors account. Where the amount of invoice from the party
differs from the amount of payment, the difference should be enquired into.
• In case of cash purchases, the auditor should compare the ‘Payee’s Receipt’,
‘Goods Inward Book’ and ‘Stock Ledgers’ with entries in the cash book.
• He should pay special attention to the trade discounts because this amount
should be deducted from purchase so that the net amount payable is recorded
in the books.
(XI) Petty Cash Payment
• The auditor should examine the system of internal check in respect of petty
cash. He should see that petty cash book is kept upon the imprest system. Cash
can be misappropriated easily as there are no vouchers for a number of petty
payments. He should verify the validity and accuracy of the transactions. He
should vouch the cheques drawn for petty cash by reference to the cash book.
• Vouchers should be insisted upon for all payments above ` 10 or so. In those
cases where it is impossible to obtain receipts, petty cash vouchers should be
made, giving details of expenditure and such vouchers should be signed by the
person actually spending the money and countersigned by the authorized
officer of the organization.
• The auditor must apply the test check in examining the petty cash vouchers at
random since there may be a large number of small transactions. He should see
that the petty cash book is checked frequently by a responsible person to
ensure that such cash payments are bonafide.
• The auditor should count the petty cash balance on the last day of the closing
year or on the day of the balance sheet. This is imperative because if there is
any discrepancy in the balances as per the petty cash book and actual cash in
hand, the auditor will be held liable to pay damages to the client.
(XII) Bank Account
• These days, settlement of payment between the parties is done through banks.
Therefore the vouching of this item is very important otherwise there can be
manipulation in accounts. In a business, cash or cheques are sent to the bank
for deposits or collections as well as money is withdrawn from the bank to
meet day to day expenses.
• The auditor should check the withdrawals and deposits in the following ways:
1. He should compare the cash book with the bank pass book.
2. Payment into the bank should be vouched with the counterfoils of the paying-
in-book.
3. Direct payment in the bank should be vouched from the banks advice notes.
4. Bank interest on the deposits should vouched from the banks advice notes.
2.27
Auditing Checking, Vouching and Audit Report

(XIII) Director's Fees

• Directors of a company are not entitled to get any monthly salary. However, the
director of a company can claim any fees or remuneration for attending the
board meetings. In that case, the auditor should examine the Articles of
Association to know whether directors can be paid fees for attending such
meetings or not.
• He should also find out from the Articles of Association about the amount of
fees payable to the directors for attending the board meeting.
• He should also examine the minute books and directors attendance register to
know the number of fees payable to directors. He should examine the voucher
duly supported by a receipt in this behalf.
(XIV) Postage
• The auditor should verify the postage register. He should compare the postage
register with the cash book in order to ascertain the purchase of stamps.
Closing balance of stamps in hand should be counted and verified.
• Where the franking machine is used by the client’s office, the receipts issued by
the post office for its payment should be examined.
2.6 Verification and Valuation of Assets and Liabilities
2.6.1 Introduction
• After a thorough examination of the books of accounts pertaining to their
correctness and authenticity of the transactions recorded in them, the auditors
should start verification of the assets and liabilities appearing in the balance sheet.
In order to do this, he should first satisfy himself about the actual existence of
assets and liabilities because the record of the assets and liabilities as appearing in
the balance sheet may not be correct.
• In case the balance sheet shows an asset which infact does not exist or which is
stated at a value different from what is considered reasonable, both the balance
sheet and the connected profit and loss account would be incorrect.
• It is often seen that assets are purchased and properly recorded in the books of
accounts, but subsequently they might have been disposed of, destroyed, pledged
or misappropriated and no entry had been made to record this fact in the books of
account before the closing of these books.It means that the actual position of
assets is different from what has been shown in the balance sheet. The auditor’s
duty is, therefore, to ensure that the assets and liabilities actually exist or were
existing at the date of the balance sheet.
2.28
Auditing Checking, Vouching and Audit Report

2.6.2 Verification
Meaning
• Verification means to confirm the truth or accuracy and to substantiate.
• It is a process by which the auditor satisfies himself not only about the actual
existence, possession, ownership and the basis of valuation but also ensures that
the assets are free from any charge or lien.
• Verification means the procedures normally carried out at the year end, to confirm
the ownership, valuation and existence of items at the balance sheet date.
• In simple words verification means, ‘proving the truth or conformation.’
• The verification of assets include the following:
1. Verifying the existence of the asset on the date of balance sheet.
2. Ensuring that they are free from charges, if not then a mention of the charge
created must be made in the balance sheet.
3. Verifying their value.
4. Assets are acquired for the business.
Definitions of Verification

1. Spicer and Pegler

“The verification of assets implies an enquiry into the value, ownership and title,
existence and possession and the presence of any charge on the assets.”
2. Joseph Lancaster
“A process by which the auditor substantiates the accuracy of the right hand side
of the balance sheet and must be considered as having three distinct objects
• The verification of the existence of the assets
• The valuation of the assets
• The authority of their acquisitions.”
3. Tendon
"Verification or measurement of property is to prove the authenticity of
property".
2.6.3 Verification of Assets and Liability
1. Existence
• It is not possible for the auditor to verify the physical existence of the tangible
assets. It is the responsibility of the management. After verifying the efficiency of
internal control system, the auditor can rely on the work of internal auditor. He
needs to examine the records with reference to the documentary evidence.
2.29
Auditing Checking, Vouching and Audit Report

Existence Ownership

Valuation Possession

Disclosure
of charges

Fig. 2.4 : Verification of Assets and Liability

2. Ownership
• The auditor needs to examine the title deeds to ensure that the clients is the owner
of the said assets. In case of such assets as debtors, cash etc., auditors should
design audit procedures.
3. Possession
• Auditor should find out whether the client is in possession of the assets. If it is
found that the assets are possessed by someone else, the auditor should find out if
it was authorized.
4. Disclosure of Charges
• If any charge is created on fixed assets, the auditor should ensure that sufficient
disclosure has been made in the books for the same.
5. Valuation
• Auditor should ensure that assets have been valued as per the Generally Accepted
Accounting Principles (GAAP).
Objectives of Verification
(A) Objectives of Property Verification
1. Ensuring that all assets in the balance sheet actually exist.
2. Satisfaction for showing assets at fair value in the balance sheet.
3. Ensuring that there are no charges on the property.
4. Ensuring that all assets shown on the balance sheet belong to the business.
5. Ensuring that the property is used for business purposes only.
6. Detecting a lie about property.
2.30
Auditing Checking, Vouching and Audit Report

(B) Objectives for Verification of Liabilities

1. To ensure that all the debts of the trader / party are mentioned in the balance
sheet.
2. To ensure that all debts shown on the balance sheet are genuine.
3. To ensure that all debts shown on the balance sheet are shown at fair value.
4. To detect a lie about liability.
Difference between Vouching and Verification
Points Vouching Verification
1. Meaning Vouching is a process of Verification is a process which
comparing the entries in the proves the existence, ownership
books of accounts with the and title to the assets.
bonafied vouchers.
2. Subject Vouching is made of the Verification on the other hand, is
Matter entries recorded in the made of assets and liabilities
books of original entry and appearing in the balance sheet at
their posting in the ledger. the end of the year.
3. By Whom Vouching is done by the Verification is done by the auditor
senior auditor and audit himself or his associates.
clerks.
4. When Vouching is done after the Verification is done at the end of
entry of transactions in the the financial year when the final
account books. accounts are to be prepared.
5. Evidence In vouching, bonafide Verification is made on the basis of
vouchers are sufficient evidence such as the title deeds,
evidence for vouching. receipts and payments etc.
2.6.4 Valuation
• The fact has been established that the verification of assets also includes their
proper valuation. The correct valuation of assets and liabilities is very important
because the accuracy of the balance sheet of any concern also depends on it. At
the same time, the correct profit or loss cannot be calculated unless assets are
properly valued.
• Setting of the exact value of an asset on the basis of its utility is known as
valuation.
• Valuation is important part in auditing, as it helps in reflecting the correct value of
an asset. The over-valuation and under-valuation of assets and liabilities would
exhibit wrong picture of the financial affairs of a concern.
• The auditor has to see that the assets and liabilities appearing in balance sheet
have been exhibiting their proper value i.e. neither they have been over-valued nor
under- valued to reflect the true and fair view of financial statements.
2.31
Auditing Checking, Vouching and Audit Report

Definition of Valuation

Battliboy
“Assessment or valuation is a meticulous examination and verification of assets in
accordance with the general accounting principles of the business.”
• The auditor should consider the following points while valuing the assets:
1. Original cost of the assets.
2. Expected working life of the assets.
3. Wear and tear of the assets.
4. Break-up value of the assets.
5. The chances of the assets becoming obsolete.
Methods of Valuation
1. Cost Price
• The price which is paid for the acquisition of an asset is known as cost price. The
expenses incurred in the purchase of an asset and its installation are added in the
cost price.
2. Market Value
• A value which an asset can fetch in the market when sold is known as Market value.
3. Replacement Value
• It is a price at which a particular asset can be replaced.
4. Book Value
• A value at which an asset appears in the books of accounts is known as its book
value. It is usually the cost less depreciation written off.
5. Historical Value
• It is equivalent to the cost less reasonable amount of depreciation written off.
6. Residual Value
• A value which will be realised in the market and received from the sale of an asset
is known as its realisable or residual Value.
7. Scrap Value
• A value which is obtained from the asset if it is sold as scrap.
2.6.5 Mode of Valuation of Different Types of Assets
• The mode of valuation of different types of assets differs depending upon the
nature of the business and the purpose for which the assets are held. There are
certain accepted principles for the valuation of the assets for the purpose of the
balance sheet.
2.32
Auditing Checking, Vouching and Audit Report

Intangible
Assets

Wasting Ficitious
Assets Assets

Current or
Fixed Assets
Floating Assets

Fig. 2.5 : Different Types of Assets

1. Fixed Assets
• These assets are of a permanent nature with which the business is carried on and
which are held for the purpose of earning income and not for re-sale in the
ordinary course of the business. They are constantly used for the production of
goods and services and are not consumed in the very process of manufacture.
• In a statement of auditing practices issued by the Institute of Chartered
Accountants of India, it has stated, “A convenient working rule is to regard fixed
assets as those acquired for the purpose of use in the business with the object of
earning revenue and which are not intended for resale at a profit and conversion
into cash in the ordinary course of business”.
2. Current or Floating Assets
• Floating assets are those which are acquired or created in the normal course of the
business. They are held temporarily for the purpose of re-sale or subsequent
conversion into cash. For example, stock-in-trade, book debts, raw material,
finished goods, work-in-progress, cash and bank balances and bills receivable etc.
3. Wasting Assets
• These assets are of fixed nature and are depleted gradually or lose a part of their
value in the process of working. For example, mines, quarries and oil wells etc.
4. Intangible Assets
• Those fixed assets which have income producing ability but cannot be seen or
touched are known as intangible assets. For example, goodwill, patents, copyrights,
licenses and trade names etc.
• These test assets cannot be seen or touched or verified like land and building,
furniture and machinery etc.
5. Fictitious Assets
• Preliminary expenses, deferred revenue expenditure and discount on the issue of
shares etc. are some of the examples of fictitious assets. The total expenditures
incurred on each of these assets is treated as assets and this should be shown in
the balance sheet until they are written off.
2.33
Auditing Checking, Vouching and Audit Report

2.6.6 Auditors Position regarding Valuation of Assets

• “The auditor is not expected to have detailed knowledge and experience of
specialists in other disciplines. In such cases, he can seek audit evidence from
experts. One such area is the valuation of assets such as land and building, precious
stones, stock valuation of work of art etc.”
(I) Audit of Fixed Assets/ Property
• The audit procedure to be followed by an auditor for the verification of some of the
fixed assets is given below.
1. Plant and Machinery
(a) Existence
• The auditor should examine the existence of plant by inspecting the plant register
that contains information regarding the original cost, rate and amount of
depreciation. All the expenses incurred on custom duty, freight, erecting charges
etc. should be debited to the machinery account. In case a part of machinery is
sold, he should verify the authorization to sell, carbon copy or counterfoil of cash
receipt.
• The auditor, if possible, may conduct physical verification himself. If it is not
possible, he must examine the internal control system. He must find out if
management conducted physical verification periodically.
(b) Ownership
• For the new purchase of fixed asset the vouching of cash book with the cash
receipt, authorization to purchase, i.e. resolution of the board, contract between
the supplier and the client can be checked.
• For the ones bought in at some previous year, the plant register and last year’s
balance sheet may be examined.
(c) Possession and Lien
• If the client is in possession of the asset then physical inspection would reveal it. If
machinery is in possession of someone else like some other business etc. then the
auditor needs to find out the reason. It may be possible that the plant has been
given on hire, in which case he should examine the agreement and other records
and ensure that hire charges received on machinery have been credited to the
revenue account.
• He can confirm the existence of any charge, fixed or floating, on the asset by
looking into the register of charges, approval of a responsible officer and
confirmation from the mortgagee.
2.34
Auditing Checking, Vouching and Audit Report

(d) Valuation and Disclosure

• Plant has to be valued at cost less depreciation. The auditor should ensure that
depreciation method has been consistently followed by the client. In case of profit
or loss on sale of machinery, the computation is correct and the profit or loss is
disclosed properly in the profit and loss account.
2. Building
• Building may be bought or may be constructed. The procedure to be adopted for
the verification of building is stated below.
(a) Existence and Ownership
• The auditor should examine the original title deeds and make sure that the building
is in the name of the client. In case of purchase of new building, he should vouch
the purchase transactions. In case of sale of building, he should verify the
authorization letter, invoice, correspondence and agreement with the buyer etc.
• The profit or loss on sale should have been computed correctly and the auditor
should check whether the profit or loss has been treated as per the requirements
of GAAP.
(b) Determine Lien
• The auditor should go through the register of charges to confirm lien on the asset.
He must see if proper disclosure to this effect has been made in the balance sheet
or not.
3. Freehold Property
(a) Existence and Ownership
• The auditor should at first check if the land is in the name of the client. For this
purpose the original title deed and purchase deed should be examined. Both
should be in the name of the client. If new land has been purchased, the auditor
should vouch the payments.
(b) Valuation
• Land is a non-depreciable asset, hence is shown in the balance sheet at historical
cost. The cost of land should include all charges of acquisition like broker’s
commission, stamp duties, registration fees, legal charges and also levelling,
clearing and draining charges.
(c) Possession
• The title deed should be in the custody of the client. In case land is mortgaged, the
title deed would be in possession of the mortgagee. The auditor may get the
confirmation from the mortgagee. Besides, the details of the charge created should
be appropriately disclosed in the balance sheet.
2.35
Auditing Checking, Vouching and Audit Report

4. Furniture and Fixture

• Furniture is purchased not with a view to resale but to help in running and
managing the business activities. Fixtures are either fitted on the walls or the
ground.
• The auditor should check the stock register to ascertain the current holdings of
both the furniture and fixtures.
(a) Existence and Ownership
• Organizations keeps a stock register to record the details of furniture and fitting
bought by it. Each item of furniture is allotted a number for easy verification. The
auditor should go through the register and check the cost, rate of depreciation,
location and stock number allotted to the furniture. He must ensure that the
management prepares a statement of inventory on the basis of physical verification
and reconciles it with details in the register.
(b) Valuation of Furniture
• Furniture is to be valued at cost less depreciation. The cost of furniture should
include the invoice price and all incidental charges.
• Furniture sold or those that have become useless must be written off to profit and
loss account.
(II) Audit of Current Assets
1. Inventories
• Inventories are goods that are held for resale or are used in the process of
production for producing finished goods.
• Inventory consists of:
(a) Raw Material (b) Work-in-Progress
(c) Finished Stock (d) Components
(e) By-products (f) Stores and Spare Parts
(g) Maintenance Supplies (h) Loose Tools
2. Debtors
• Sundry debtors fall in the category of current assets. The task of verifying this asset
would be reduced to a great extent in case there is an efficient internal check
system for recording sales and writing off the sales ledger in operation.
3. Cash in Hand
• The most common practice to verify cash-in-hand is to obtain a certificate from the
accountant about the actual cash balance in hand as adopted by the professionally
qualified auditor to verify this item. The council feels that is not a correct
appreciation of an auditors responsibility in regard to the verification of cash
therefore, the auditor should actually count the cash-in-hand.
2.36
Auditing Checking, Vouching and Audit Report

4. Cash at Bank
• The auditor should compare the balances as shown in the bank pass book with the
balances as shown in the column of the bank cash book.
• In order to ascertain the correct position with regard to cheques issued by the
organization but not yet presented for payment or the cheque deposited by the
organization but not yet cleared, the auditor should prepare a bank reconciliation
statement.
5. Bills Receivable
• Receivables are given a very important place in the sale of loans. In order to verify
the receipts in the balance sheet, the auditor should ask for a certified appendix of
the receipts in hand. All amounts in the appendix and balance sheet should be
checked. The auditor must ensure that each letter is properly written and signed by
the recipient.
(III) Audit of Intangible Assets
1. Goodwill
• Goodwill is an intangible asset. It is the value of the reputation of the firm, which
enables the firm to earn more than the normal rate of profit.
• Goodwill has been defined as “the excess of the price paid for a business as a
whole over the book value, or over the computed or agreed value of all tangible
net assets purchased. Normally, goodwill thus acquired is the only type appearing
in the books of accounts and in financial statement”.
• Prof. Dickess says, “When a man pays for goodwill he pays for something which
places him in the position of being able to earn more money than he would be
able to do by his unaided efforts”.
2. Copyright
• This is a right to produce or reproduce literary work. The effects of such a copyright
is that the author or the publisher gets an exclusive right to publish or reproduce
the work for a certain number of years or even it may be on life time basis for the
author or the publisher as the case may be.
• The procedure of verification of this item is more or less the same as that of patent
rights. The auditor should also inspect the agreement between the author and the
publishers. It is usually seen that the value of the copyright is not stable because
they lose their value with the passage of time. Copyright must be revalued at the
date of the balance sheet. If the sale of the publication is not worth mentioning,
the copyright should be written off.
• Generally, copyright must be shown at cost less amounts written off from time to
time.
2.37
Auditing Checking, Vouching and Audit Report

3. Patent Right
• The patent rights should be verified with the certificates granting such rights or in
case where patents have been purchased, the assignment of the interest or the
assignment deed should be inspected. The auditor should see and be assured that
they have been registered in the name of his client and are the property of the
client.
• The auditor should also examine the last renewal fee payment certificate to satisfy
himself that the patents have been renewed at the prescribed time.
4. Preliminary Expenses
• Preliminary expenses are all expenses relating to the formation of an enterprise
such as registration fees, cost of printing documents like 'Memorandum of
Association' and ‘Articles of Association’ and other expenses related to the
formation of a company.
• The auditor should examine the statutory report and relevant supporting
documents such as agreements, bills etc. to ascertain the amount of preliminary
expenses.
• The expenses however, should not include expenses on issue of shares and
debentures.
5. Trademarks
• A trade mark is verified by examining the assignment deed duly endorsed by the
office of the registering authorities.
• The auditor should see that they are registered in the name of the client and is the
property of the client.
• In case a trade mark has been purchased, the auditor should also vouch the
payment thereof. But where it is registered by the proprietor of the business
himself, he should examine registration documents and certificates issued by the
office of the registrar of trademarks and the last renewal payment fee receipt.
• He should also see that proper distinction between capital and revenue
expenditure is maintained. Any expense incurred in the acquisition of the trade
mark should be treated as capital expenditure but any renewal charges must be
treated as revenue expenditure. All research expenses in this connection should
also be capitalized. The procedure for its valuation is the same as that of patent
rights.
2.38
Auditing Checking, Vouching and Audit Report

2.6.7 Verification of Different Items of Liabilities

• The verification of liabilities is of equal importance as that of an asset. The auditor
has to satisfy himself that all liabilities whether existing or contingent, have been
properly determined and disclosed in the balance sheet. In case liabilities are over-
stated or under-stated, the balance sheet shall not represent a true and fair view of
the state of affairs of the company.
• Liabilities are the financial obligations of an enterprise to the outsiders. These are
classified as long-term and short-term liabilities. Long-term liabilities are payable
over a long period of time, whereas short-term liabilities are to be paid within a
years’ time. Debentures, expenses outstanding etc. are short-term liabilities.
Definition
“Verification of liabilities is the process of examination of legal and official
documents to ensure the existence, completeness, valuation and disclosure of
liabilities of an entity”.
Objects of Verification of Liabilities
1. Existence
• To ensure that the liabilities shown in the balance sheet are actually payable.
2. Completeness
• All liabilities have been accounted for in the books of the enterprise.
3. Valuation
• Liabilities stated in the financial statement indicate fair and reasonable amounts.
4. Disclosure
• Liabilities have been disclosed in the financial statements in accordance with the
accounting principles and as per the requirements of the acts governing the
enterprise.
Verification of Different Items of Liabilities
1. Capital
• Capital is the amount of money invested in an enterprise by its owner. The owners
may be sole proprietors, partners and shareholders in case of a public limited
company.
• In case of a partnership firm, the auditor should examine the Partnership
Agreement (Partnership Deed). He must find out the original capital contributed by
each partner and the rate of interest payable on capital. He should see that capital
accounts of the partners are correctly maintained and verify all transactions
affecting the capital accounts. He should examine the cash book, pass book,
withdrawals of the partners and profits and loss earned by the firm.
2.39
Auditing Checking, Vouching and Audit Report

2. Loans
• The auditor must ascertain the borrowing powers of the company and for this
purpose, he should examine the Memorandum of Association and Articles of
Association of the company. He should also see that any restriction on the
borrowing powers of the company is not exceeded. He should check the
agreements pertaining to borrowings as they may be loans secured or unsecured
or may be for a short or a long period.
3. Trade Creditors
• The auditors will verify trade creditors more or less on similar lines as in case of
sundry debtors. He should take a statement of balances of the trade creditors duly
signed by the authorized officer of the organization and should verify these
balances with the bought ledger or the purchase ledger.
• He may also obtain confirmatory statements from the creditors. He should also
examine the invoices as sent by suppliers, and an ‘Inward Goods Book’ if it is
maintained.
• For any purchases returns, he should examine the ‘Returns Outward Book’ and
verify them with the help of the credit notes as sent by the supplier.
4. Outstanding Liabilities for Expenses
• The auditor should obtain certificates from the authorized officer of the company,
stating that all outstanding liabilities for goods purchased or for expenses incurred,
have been brought into account.
• Expenses which have been due but remain unpaid by the close of the year, must in
all cases, be provided for and shown as outstanding liabilities.
5. Bills Payable
• These are acknowledgements of debts payable.
• The auditor should get a statement of bills payable and compare it with the bills
payable book and bills payable account.
• For bills which have been met after the date of the balance sheet but before the
time of audit, he should examine the cash book and the bank pass book.
• The bills payable already paid should be checked from the cash book and the
auditor should examine the returned bills payable.
6. Contingent Liabilities
• A future uncertain liability which is dependent on the happening of some other
event is known as a contingent liability. In other words, liabilities which have not
arisen up to the date of the balance sheet, but may arise out of the contingent
contracts, such liabilities are called as contingent liabilities.
• According to Montgomery, “The term contingent liability should be used in the
accounting sense to designate a possible liability of presently determinable or
indeterminable amount which arises from past circumstances or actions which may
not become a legal obligation in the future and which, if paid, gives rise to a loss or
expense or assets of doubtful value”.
2.40
Auditing Checking, Vouching and Audit Report

2.6.8 Difference between Valuation and Verification

Points Valuation Verification
1. Meaning Valuation is a process which Verification is a process which
certifies the correct value of proves the existence, ownership
the assets and liabilities at the and title to the assets.
date of balance sheet.
2. Evidence In valuation an auditor has to Verification is made on the basis of
depend upon the certificates evidence such as the title deeds,
of the owners/ directors. receipts and payments etc.

3. By whom It is done by the management It is done by the auditor himself or

of organisation but the by his senior partner.
accuracy of this valuation is
done by the auditor.
2.7 Audit Report
• The final stage in audit process is audit report. Audit report is a document prepared
by an auditor to certify the financial position and accounting records of a firm.
• Audit report is the written opinion of an auditor regarding company’s financial
statements.
• Audit report is the statement included in the financial statements. The auditor has
to provide his opinion on the truth and fairness of financial statements. Thus, the
auditor protects the interest of shareholders through audit report.
• The results of the audit are communicated through audit report
Definitions of Audit Report
1. Joseph Lancaster
“A report is a statement of collected and considered facts, so drawn up as to give
clear and concise information to persons who are not already in possession of the
full facts of subject matter of the report.”
2. According to Cambridge Business English Dictionary
“Audit report is defined as a formal document that states an auditor’s judgment
of a company’s accounts.”
• Under Sec. 143(3), auditor of a company must report to its members.
1. The accounts examined by him;
2. Balance Sheet, Profit and Loss Account and Cash Flow statement, which are laid in
general meeting of a company during his tenure of office; and
3. The document declared to be attached to the Balance Sheet and Profit and Loss
Account.
2.41
Auditing Checking, Vouching and Audit Report

2.7.1 Form of Audit Report

1 Title of the report

2 Name of the addressee

Form of Audit Report

3 Introductory paragraph

4 Scope

5 Opinion

6 Signature

7 Place of signature

8 Date of the report

Fig. 2.6 : Form of Audit Report

1. Title of the Report
• The title of audit report should disclose the name of client to help the reader to
identify the report. The title distinguishes the audit report from other reports.
2. Name of the Addressee
• The person who appoints the auditor is called as an addressee. If a company
appoints the auditor, the addressee should be shareholders. The complete address
of the addressee is required as per law. Addressee for the statutory audit shall be
shareholders and in case of Special Audit, it is Central Government.
3. Introductory Paragraph
• Auditor’s opinion on the Financial statement should be included in the introductory
paragraph which is audited by him. The period covered by financial statements
should be stated with exact dates.
4. Scope
• The audit examination should cover company’s accounts, Profit and Loss Account,
Balance Sheet and Cash Flow Statements This part should include the matter-of-
fact relating to the manner in which audit examination was made. The examination
should be as per the relevant law. The auditor should not curtail any examination
task.
2.42
Auditing Checking, Vouching and Audit Report

5. Opinion
• The auditor’s opinion on the books of account and financial statements examined
by him is based on the information and should be free from any bias because many
internal and external parties depends on his opinion.
• The auditor has to give his opinion as follows:
(a) Whether the financial statements are arithmetically correct and correspond to the
figures recorded in the books of accounts.
(b) Whether the financial statements represent a true and fair view of the state of
affairs and the results of operations.
(c) If the Balance Sheet and Profit and Loss Account do not present a true and fair
view, the reasons for what and where is wrong.
6. Signature
• The personal name and signature of the auditor should be given. If the auditor is a
firm, the signature in the personal name and firm name should be given.
7. Place of Signature
• This should include the location of the auditor or the auditor firm.
8. Date of the Report
• The date of completion of the audit work should be mentioned.
2.7.2 Types of Audit Report

Types of Audit Report

Clean or Qualified Adverse or Disclaimer

Unqualified Report Negative Report
Report Report

Fig. 2.7 : Types of Audit Report

1. Clean or Unqualified Report
• An unqualified opinion is considered as a clean report. This type of report indicates
that the auditors are satisfied with the company’s financial reporting.
• Clean or Unqualified report will be given by the auditor if the auditor is satisfied
about the accounts, Balance Sheet, Profit and Loss Account and Cash Flow
statement. Most companies expect to receive this type of report.
• An unqualified opinion doesn’t have any kind of adverse comments or any
disclaimers about any clauses.
• The auditor believes that the company’s operations are in good compliance with
governance principles and applicable laws.

2.43
Auditing Checking, Vouching and Audit Report

2. Qualified Report
• When an auditor isn’t satisfied or confident about any specific process or
transaction that prevents him from issuing an unqualified, or clean report, then he
may issue a qualified opinion.
• Qualified report are not acceptable from Investors point of view, as it has negative
opinion about a company’s financial status.
• Auditor write up a qualified opinion in much the same way as an unqualified
opinion, with the exception that it state the reasons that he is not able to present
an unqualified opinion.
• A common reason for auditors issuing a qualified opinion is that the company
didn’t present its records with GAAP.
• The common reasons for giving Qualified Report are as follows:
(a) The books of accounts, Profit and Loss Account and the Balance Sheet do not
represent the true and fair view of the state of affairs.
(b) The auditor is not able to verify the value and existence of certain assets.
(c) The company didn’t present its records with GAAP.
(d) The information requested by the auditor is not furnished.
(e) Proper books of account are not maintained by the company as required by law.
3. Disclaimer Report
• The auditor may disclaim or refuse opinion on the accounts, Profit and Loss
Account and the Balance Sheet, when he does not have sufficient information to
give his opinion.
• This may happen on the following grounds:
(a) The auditor has not been able to obtain sufficient information to form his opinion.
(b) The audit examination is not adequate to form an opinion.
(c) There are some material un-determined item in audit examination.
(d) The auditor may not have been able to depict the correct nature of some
transactions or to secure enough evidence to support good financial reporting.
(e) Auditors that aren’t allowed an opportunity to observe operational procedures or
to review particular procedures may feel like they’re not able to express a definite
opinion.
• As a result, it creates an adverse image of the company.
2.44
Auditing Checking, Vouching and Audit Report

4. Adverse Opinion-Adverse Audit Report

• The final type of audit opinion is an adverse opinion. An adverse audit report
usually indicates that financial reports contain gross misstatements and have the
potential for fraud. An auditor’s adverse opinion is a big red flag. Auditors who
aren’t at all satisfied with the financial statements or who discover a high level of
material misstatements or irregularities know that this creates a situation in which
investors and the government will mistrust the company’s financial reports.
• Auditors use all types of qualified reports to alert the public as to the transparency,
reliability and accountability of companies.
• Adverse opinions send out a high alert that the company’s records haven’t been
prepared according to GAAP. External parties, financial institutions, creditors, and
investors take this opinion seriously and will reject doing any kind of business with
the company.
2.8 Audit Certificate
• A certificate issued under the signature of a person implies that the person issuing
or signing it vouchsafes the truth of the matters stated in the certificate. In other
words, the person states that the facts are true. There is no room for the expert
opinion of the person. If it is found later on that the certificate was wrong, he will
be held responsible.
Examples
• Auditors is called for issuing certificate for the following:
1. Import and export certificate.
2. Bonus computation certificate.
3. Deposit return certificate.
4. Newspaper circulation certificate.
Points to be considered while Preparing Audit Certificate
1. Limitations of the examination should be stated.
2. Indicate the specific record covered by the auditor.
3. Fundamental assumption made for certifying.
4. Manner of the conduct of audit.
5. The information and explanations obtained.
6. Title of the certificate should be mentioned.
7. Certificate should be a self-contained document.
2.45
Auditing Checking, Vouching and Audit Report

8. If figures from audited statements are made, then it should be mentioned in the
certificate.
9. Auditor should addressee the certificate to the client or the public authority, or
person requiring it as the case may be.
Specimen of a Certificate
(On Income and Expenditure Accountant)
CERTIFICATE
Certified that to the best of may knowledge and according to the information
and explanations given to me and as shown by the records examined by me, the
figures of ‘Incomes’ and ‘Expenditures’ as shown in the Income and Expenditure
Account of ………………………………………, for the year ended …………… are correct.

Date:
Sd.
Place:
Seal Chartered Accountant
2.8.1 Distinction between Audit Report and Audit Certificate

Point Audit Report Audit Certificate

1. Meaning It is a statement usually It is a written confirmation of
made after an inquiry, the accurancy of the facts
examination or review of stated in the certificate and
speficed matters under does not involve an opinion.
report and includes the
reporting auditor’s opinion
thereon.
2. Nature It is an opinion of auditor It gives guarantee of
regarding reliability of the absolute accuracy of the
assertions made by the information, for which
management. It provides certificate has been issued.
reasonable assurance.
2.46
Auditing Checking, Vouching and Audit Report

Point Audit Report Audit Certificate

3. Scope Its scope is wide. A financial Its scope is limited as it
audit report covers the entire covers only a certain part of
accounts and internal control the system of an
systems related to accounts. organisation e.g. certificates
Auditor does not merely on figures of deposits and
assure the accuracy of the interest rates.
accounts but conducts an in-
depth examination to ensure
that the transaction is fair.
4. Form There is a prescribed format There is no standardized
for company audit report. format for audit certificate.
5. Responsibility Auditor is not responsible for Auditor’s responsibility is
misstatements in the absolute.
financial statements, if he
has exercised reasonable
care and professional skill or
if company has not suffered
loss or if the matter is not
significant to the audit.
2.9 Auditing and Assurance Standards (AAS : 1, 2, 3, 4, 5)
2.9.1 Auditing and Assurance Standards in India
• Auditing and Assurance standards are issued by ICAI. ICAI set-up Auditing and
Assurance Standard Board in 1982. The Central Government may prescribe the
standards of auditing recommended by Institute of Chartered Accountants of India
(ICAI) as per the Section 143(10) of the Companies Act, 2013.
• As constituted under section 3 of the Chartered Accountants Act, 1949, in
consultation with and after examination of the recommendations made by the
National Financial Reporting Authority, these standards are set.
Compliance with Auditing Standards
• Every auditor shall comply with the auditing standards, as per section 143 (9) of the
Companies Act, 2013. For any reason, if the member is unable to perform an audit
in accordance with the generally accepted auditing standards, he would be held
guilty of professional misconduct under clause 9 of Part 1 of the Second Schedule
to the Chartered Accountants Act, 1949.
2.47
Auditing Checking, Vouching and Audit Report

2.9.2 Objectives and Functions of the Auditing and Assurance

Standards Board (AASB)
• Following are the Objectives and Functions of the Auditing and Assurance
Standards Board (AASB):
1. To review the existing Standards and Statements on Auditing to assess their
relevance in the changed conditions and to undertake their revision, if necessary.
2. To review the existing and emerging auditing practices worldwide.
3. To identify areas in which Standards on Quality Control, Engagement Standards
and Statement on Auditing need to be developed.
4. To formulate Standards on Quality Control, Engagement Standards and Statement
on Auditing.
5. To develop guidance notes on issues arising out of any Standard.
6. To review the existing Guidance Notes to access their relevance in the changed
circumstances and to undertake their revision, as per suggestions.
7. To formulate General Clarifications, where necessary, on issues arising from
Standards.
1. AAS-1 : Basic Principles Governing an Audit
• This Auditing and Assurance Standard (AAS) was the first standard on auditing
issued by the (ICAI).
• This standard is effective for all audits relating to accounting periods beginning on
or after April 1, 1985.
• As the name suggests, it seeks to lay down and briefly explain the basic principles
which govern the auditor‘s professional responsibilities and which should be
complied with when an audit is carried out.
• These principles are as follows:
(a) Integrity, objectivity and independence,
(b) Confidentiality, skills and competence,
(c) Work performed by others,
(d) Documentation,
(e) Planning,
(f) Audit evidence,
(g) Accounting system and internal control, and
(h) Audit conclusions and reporting.
2.48
Auditing Checking, Vouching and Audit Report

2. AAS-2 : Objective and Scope of the Audit of Financial Statements

• This Standard describes the overall objective and scope of the audit of general
purpose of financial statements of an enterprise by an independent auditor.
• The Standard is effective for all audits relating to accounting periods beginning on
or after April 1, 1985.
• The Standards deals with the following important aspects of an audit:

Expression of opinion, the concept of true and fair view

Objective of
an Audit

Responsibility
Responsibility of the management and auditor
for
Financial
Statements

Factors determining scope, reliability and sufficiency of audit

evidence, disclosure aspects, undiscovered material misstatements, etc.
Scope of
Audit

Fig. 2.8 : AAS-2

3. AAS-3 : Documentation
• AAS 3 is about whether the auditor should document matters which are important
in providing evidence that the audit was carried out in accordance with the
generally accepted auditing standards in India.
• This AAS is effective for all audits relating to accounting periods beginning on or
after July 1, 1985.The Standard explains as to what constitute working papers, need
for working papers. The Standard also touches upon the following areas:
• Form and Content: Factors affecting form and content, quantum of working papers,
permanent audit file and current audit file.
• Ownership and Custody of Working Papers
2.49
Auditing Checking, Vouching and Audit Report

4. AAS–4 : The Auditor's Responsibility to Consider Fraud and Error in an Audit

of Financial Statements
• As the name indicates, the purpose of this AAS is to establish standards on the
auditor's responsibility to consider fraud and error in an audit of financial
statements. The AAS is effective for all audits relating to accounting periods
beginning on or after April 1, 2003. The appendices to this AAS contain examples
of risk factors relating to misstatements resulting from fraud/ error, examples of
modifications in auditor's procedures and indicators of possible fraud or error.
• The following would give an overview of the contents of the AAS 4:
(a) Fraud and error and their characteristics
(b) Responsibility of those charged with governance
(c) Responsibility of management
(d) Responsibility of the auditor
(e) Indication of possible misstatement
(f) Evaluation and disposition of misstatements.
(g) Effect on auditor's report
(h) Documentation
(i) Management representations
(j) Communication
5. AAS-5 : Audit Evidence
• The purpose of this AAS is to establish standards that the auditor should obtain
sufficient appropriate audit evidence through compliance and substantive
procedures to enable him to draw reasonable conclusions on which to draft his
opinion on the financial information.
• This AAS is effective for all audits relating to accounting periods beginning on or
after January 1, 1989.
• The AAS also explains:
(a) The concept of sufficient appropriate audit evidence and factors affecting.
(b) Various types of assertions, internal and external evidence.
(c) The Standard also deals with the methods of obtaining evidence namely,
inspection, observation, inquiry and confirmation, computation and analytical
review.
2.50
Auditing Checking, Vouching and Audit Report

Points to Remember
• Prof. Meigs- Test Checking
“Test checking means to select and examine a representative sample from a large
number of similar items”.
• Occasional Inspection
“Occasional inspection is to check the mathematical accuracy or precision of
transaction records is called as Routing Checking”.
• Definition of Voucher
“A voucher in any documentary evidence in support of transaction in the books of
accounts”.
• Dicksee
“Vouching consists of comparing entries books of accountant with documentary
evidence in support thereof”.
• Definition of Internal Check- F.R. Mepaula
“Internal check means practically a continuous internal audit Carried on by the staff
itself, by means of which the work of each individual is independently checked by
other members of the staff.”
• Verification Meaning
Verification means to confirm the truth or accuracy and to substantiate. It is a
process by which the auditor satisfies himself not only about the actual existence,
possession, ownership and the basis of valuation but also ensures that the assets
are free any charge or lien.
• Definition of Valuation : Battleboy
“Assessment or valuation is a meticulous examination and verification of assets in
accordance with the general accounting principles of the business.”
• Audit Report Joseph Lancaster.
• “A report is a statement of collected and considered facts, so drawn up as to give
clear and concise information to persons who are not already in possession of the
full facts of subject matter of the report.”
• Audit Certificate
It is a written confirmation of the accuracy of the facts stated in the certificate and
does not involve an opinion.
2.51
Auditing Checking, Vouching and Audit Report

• Audit Report
• It is a forms statement usually made after an inquiry, examination or review of
speficed matters under report and includes the reporting auditor’s opinion thereon.
• Auditing and Assurance Standards in India,
Auditing and Assurance standards are issued by ICAI. ICAI set up Auditing and
Assurance Standard Board in 1982. The Central Government may prescribe the
standards of auditing recommended by Institute of Chartered Accountants of India
as per the section 143(10) of the Companies Act 2013.
1. AAS-1 Basic Principles Governing an Audit
2. AAS-2 Objective and Scope of the Audit of Financial Statements
3. AAS-3 Documentation
4. AAS–4 The Auditor's Responsibility to Consider Fraud and Error in an Audit of
Financial Statements
5. AAS-5 Audit Evidence
Questions For Discussion
1. What is Test Checking ? State its Advantages and Disadvantages.
2. Define Vouching. State the Objects of Vouching.
3. Describe about Vouching of Cash Book in detail.
4. Explain about Auditor's position regarding Valuation of Assets.
5. What is Audit Report ? State its Types.
6. Explain about the Basic Principles Governing an Audit.
7. Distinguish between : Routine Checking and Test Checking.
8. What is Verification ? State its objectives. Distinguish between Verification and
Vouching.
9. Write Short Notes
(A) Voucher
(B) Valuation of Assets
(C) Audit Certificate
(D) AAS-1
(E) AAS-3
(F) AAS-4
(G) Audit Report v/s. Audit Certificate
(H) Objectives/and Functions of AASB
❂❂❂
2.52
Chapter 3…
Company Audit and Tax Audit
Contents …

3.1 Company Audit

3.1.1 Company Auditor
3.1.2 Qualification and Disqualifications of Company Auditor
3.1.3 Appointment and Removal of Company Auditor
3.1.4 Rights or Powers of Company Auditors
3.1.5 Duties of Company Auditor
3.1.6 Liabilities of Company Auditor

3.2 Tax Audit

3.2.1 Definition of the term Accountant
3.2.2 Tax Audit Applicability Provision under Income Tax Act, 1961 (Section 44AA,
44AB, 44AD, 44ADA, 44AE)
3.2.3 Recent Amendment made as applicable as per Income Tax Act, 1961

• Points to Remember

• Questions for Discussion

Learning Objectives..
After reading this chapter, the students should able to understand:
1. To understand provision for work as Company Auditor as per Companies Act, 2013
2. To study enhance provisions under Income Tax Act, 1961used for conduct of Tax
Audit

3.1
Auditing Company Audit and Tax Audit

3.1 Company Audit

Introduction
• Sections 138 to 148 of the Companies Act deal with accounts, audit and auditors.
These provisions will have far reaching implications for the audit profession. In case
of corporate entity, an Audit is a the statutory requirement under Companies Act,
1956
• Every company is required to appoint auditor, when it is:
1. One Person Company 2. Private Company
3. Public Company 4. Section 8
• We know that all big companies other than serving to society operate to earn
profit.
• The person who is responsible for financial working of the company is known as an
auditor.
• Auditor is eligible person, who audits the financial part and working of a company.
• The purpose of the auditors in the company is to protect the interests of the
shareholders.
• The auditor is obligated by law to examine the accounts maintained by the
directors and inform them of the true financial position of the company.
• Auditor gives his independent opinion to the owners or shareholders of the
company to protect and keep the company in a safe financial condition. Hence,
every company needs to appoint auditor.
1. Auditors can determine whether the financial statements and records accurately
depict the company's true financial profile.
2. Auditing provides assurance to investors and creditors that company funds are
handled appropriately.
3. Auditors protect the public from investing in companies that use corrupt business
practices. Auditor protects investors with false financial statements by reviewing
financial statements and digging into accounting records.
• In simple terms, an auditor is an individual who is appointed to inspect the books
of accounts of a company, the validity and accuracy of the transactions contained
therein. He also forms an opinion on the overall view of the financial statements,
whether the statements depict a true and fair view of the entity’s financial position.
• Let’s us now understand the basic information relating to auditor i.e. Appointment
and removal, duties and power, qualification and disqualification under
the Companies Act, 2013.
3.2
Auditing Company Audit and Tax Audit

3.1.1 Company Auditor

Definitions

1. Company Auditor is an individual appointed for preparing an

independent audit report of the company. They can be either appointed by
the company's Board of Directors, Shareholders, Central Government or
Comptroller and Auditor General of India (C&AG)
2. An auditor is a person authorized to review and verify the accuracy of financial
records and ensure that companies comply with tax laws. They protect businesses
from fraud, point out discrepancies in accounting methods and, on occasion,
work on a consultancy basis, helping organizations to spot ways to
boost operational efficiency. Auditors work in various capacities within different
industries.
3. An official whose job is to carefully check the accuracy of business records. An
auditor can be either an independent auditor unaffiliated with the company
being audited or a captive auditor, and some are elected public officials.
4. An auditor is a body who organizes an audit process. He is the one who creates
an audit report after due examination of accounting records and accounting
statements of the company forming his impression/assumption regarding
financial statements fairness and reliability.
• From the above definitions, we can say auditor is appointed to check the accuracy
of financial statements of the company. It is auditors job to ensure about true and
fair view or authenticity of financial statements. Many investors invest their money
into company, audited statements assures them about the safety of their
investment.
• In short,
1. The main duty of an auditor is to determine whether financial statements
follow Generally Accepted Accounting Principles (GAAP).
2. The Securities and Exchange Board of India (SEBI) requires all public companies to
conduct regular reviews by external auditors, in compliance with official auditing
procedures.
3. Auditor ensures about honesty and accuracy about financial statements.
4. The final judgment of an audit report can be either qualified or unqualified.
3.3
Auditing Company Audit and Tax Audit

3.1.2 Qualification and Disqualifications of Company Auditor

• Section 141(1) of the Act prescribe the qualification and disqualification of
company auditor.
• According to law, no specific qualification is recommended for the auditor in case
of the proprietary concern, but in the case of the Companies, the following
qualification is must:
1. According to Provisions of Section 141(1) of the Companies Act, 2013, a chartered
accountant having a certificate of practice from the Institute of Chartered
Accountants of India (ICAI) can be a qualified auditor of a company.
2. According to Provisions of Section 141(2) of the Companies Act, 2013, a firm
including Limited Liability Partnership who are chartered accountants shall be
authorised to act as auditor and sign on behalf of the such limited liability
partnership or firm.
3. As per “Part B” of the State Law Act, 1953 a person holding a certificate stating that
he is designated to act as an auditor.
• In short,
(a) A person shall appointed as an auditor if he is chartered accountant within the
meaning of Chartered Accountants Act, 1949 and holding valid certificate of
practice and acting in capacity as:
(i) Individual (ii) Partnership Firm (iii) Limited Liability Partnership.
(b) Along with qualification auditor must possess some qualities.
• Qualities of an Auditor are divided into two parts:
1. Professional Qualities 2. Personal Qualities.
Professional Qualities Required for the Successful Performance of Audit Work
• Some relevant professional qualities that an auditor should possess are as follows:
1. The auditor must have a complete and thorough knowledge of the principles,
theory and practice of accountancy. The auditor must be familiar with the different
system of accounting and their aspects.
2. He should have a thorough knowledge in various legislation regulating business
such as Companies Act, the Indian Partnership Act, Banking and Insurance Act, Sale
of Goods Act, Foreign Exchange Management Act, the Indian Contract Act, etc.
3.4
Auditing Company Audit and Tax Audit

3. The auditor should have a thorough knowledge of the techniques of auditing. He

should be fully aware of new changes and developments in the principles and
practice of auditing.
4. The auditor must be familiar with the computer accounting and other latest
automatic machine devices used in the office.
5. In addition to the knowledge of commercial laws, an auditor should have a
thorough knowledge of the various provisions relating to income tax, wealth tax
and GST.
6. An auditor should have a sound knowledge in business organization, financial
administration and industrial management.
7. The auditor should have knowledge on the technical details of business under
audit.
Personal Qualities/General Qualities of an Auditor

• Personal qualities are essential for successful auditor. These are as follows:

Honesty

Inquisitive Tactful

Sensitivity Hardworking

Conversation
Impartial
Skills

Trace out
Communicate Facts and
Figures

Maintain Common
Secrets Sense

Fig. 3.1 : Personal Qualities/General Qualities of an Auditor

3.5
Auditing Company Audit and Tax Audit

1. Honesty
• An auditor must be honest in his work if he has to carry out his duties honestly. He
is responsible for true and fair view in financial statements.
2. Tactful
• The auditor should be tactful in dealing with the client’s staff.
3. Ability to Work Hard
• The auditor must have a painstaking attitude and willingness to work hard.
4. Impartial
• The auditor should not be influenced by any bias in discharging his duties. He
should be impartial.
5. Ability to Trace out Facts and Figures
• Auditor should possess a realistic attitude towards his work. He should be able to
trace out true facts and figures.
6. Always Inquisitive
• The auditor should not be suspicious. He should always be inquisitive. He should
not always adopt an attitude of suspicion.
7. Sensitivity
• The auditor has to deal with different persons while performing his duties. He has
to handle his subordinates as well as various clients; thus, he should have the
intelligence to handle them in any situations.
8. Conversation Skills
• In the course of managing a process of audit, the auditor has to collaborate with
numerous officers and parties; thus, he should have excellent conversation skill.
9. Ability to Communicate
• An auditor must have the ability to prepare audit report correctly, forcefully,
precisely, concisely and clearly.
10. Common Sense
• An auditor should possess a good common sense. The auditor should have a full
share of the most valuable commodity i.e.; common sense.
11. Ability to Maintain Secrets
• The auditor should have the ability to maintain secrets and should not disclose the
secrets of his client to anybody.
3.6
Auditing Company Audit and Tax Audit

Disqualification of Auditors [Section 141 of Company Act, 2013]

• The following person/(s) or firm shall not be eligible for appointment as an auditor
of a company:
• Following persons are not qualified for the appointment as auditor of a company:
1. A Body Corporate, other than a limited liability partnership registered under the
Limited Liability Partnership Act, 2008;
2. An Officer or Employee of the company.
3. A person who is a partner, or who is in the employment of an officer or employee
of the company
4. A person who, or his relative, or his partner is holding any security in the company
or subsidiary company or holding company or associate company or subsidiary of
such holding company. (Note – Security means an instrument which carries voting
rights).
5. A person who, or his relative, or his partner is indebted, is indebted to the
company, or its subsidiary, or its holding or associate company or a subsidiary of
such holding company, in excess of ` Five Lakh (` 5,00,000).
6. A person who, or his relative, or his partner has given a guarantee or provided any
security in connection with the indebtedness of any third person to the company,
or its subsidiary, or its holding or associate company or a subsidiary of such
holding company, of ` one lakh (` 1,00,000).
7. A person or a firm who, whether directly or indirectly, has business relationship
with the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company or associate company.
8. A person whose relative is a director or is in the employment of the company as a
director or key managerial personnel.
9. A person who is in the employment elsewhere or a person or a partner of a firm
holding appointment as its auditor, if such persons or partner is at the date of such
appointment or reappointment holding appointment as auditor of more than 20
companies.
10. A person who has been convicted by a court of an offence involving fraud and a
period of 10 years has not been elapsed from the date of such conviction.
• Further according to Provisions of Section 141(4) of the Companies Act, 2013,
where a person appointed as auditor of the company incurs any of the
disqualification mentioned in Section 141(3) of the Companies Act, 2013 after his
appointment, he shall vacate his office as such auditor and such vacancy shall be
deemed to be casual vacancy in the officer of the auditor.
3.7
Auditing Company Audit and Tax Audit

3.1.3 Appointment and Removal of Company Auditor

(A) Appointment of Company Auditor

Appointment of Auditors

Appointment Re- Appointment

of first Appointment of Casual
Auditor of of retiring subsequent vacancy
Company Auditor auditors

Fig. 3.2 : Appointment of Auditors

1. Appointment of First Auditor of Company
• Non-Government companies
• Listed / specified companies
• Government Companies
2. Re-Appointment of retiring Auditor
3. Appointment of subsequent auditors
4. Casual vacancy
• How is the appointment of an Auditor for different kinds of Companies done?
• Section 139(6) lays down that the first auditor or auditors of a company shall be
appointed by the Board of Directors within thirty days of the date of registration of
a company. The auditor should hold office till the conclusion of first annual general
meeting.
Non-Government Listed / Specified Government Company
Company Company
1. Appointed by the 1. Appointed by Board 1. Appointed by the
Board of Directors. of Directors. This has Comptroller and
This has to be done to be done within 30 Auditor General of
within 30 days from days from the date India. This has to be
the date of of Registration done within 60 days
Registration from the date of
Registration
3.8
Auditing Company Audit and Tax Audit

Non-Government Listed / Specified Government Company

Company Company
2. Appointment can 2. Appointment can 2. Appointment can
also be done by also be done by also be done by
Members at Members at Board of Directors
Extraordinary Extraordinary within 30 days of
General Meeting General Meeting incorporation.
within 90 days of within 90 days of the Members can also
information information appoint at an
Extraordinary
General Meeting
within 60 days of
Information
Auditor at First AGM. The written Consent and a Certificate
• Please note, the appointment shall be in accordance with the conditions laid down
by the auditor.
Non-Government Listed / Specified Government Company
Company Company
The appointment is done The appointment is done The appointment is done
by the members -He will by the members for a by the Comptroller and
hold office till the end of maximum term of 5/10 Auditor General of India -
the AGM consecutive years -Cooling He should be appointed
off period of 5 years within 180 days from the
before next appointment 1st of April
will be there
Appointment Notice
• The company should issue an appointment notice to the auditor and a Form, ADT-
1 is required to be submitted with the Registrar within 15 days of the meeting in
which the auditor is appointed.
• Sometimes the first auditor of a company are named in the Articles of Association.
Such appointment of the auditor cannot be held valid since the Act grants it no
recognition.
• The first auditor would be validity appointed only by a resolution of the Board of
Directors or that of the company in the general meeting.
3.9
Auditing Company Audit and Tax Audit

2. Re-Appointment of Retiring Auditor

• The retiring auditor may re-appoint by complying provision under Section 139(9).
According to Section 139 and the rules made there under, a retiring auditor may be
re-appointed at an annual general meeting, if:
(a) He is not disqualified for re-appointment.
(b) He has not given the company a notice in writing of his unwillingness to be re-
appointed.
(c) A special resolution has not been passed appointing some other auditor or
providing expressly that he shall not be re-appointed.
• Appointment and re-appointment are governed through provisions of Section
139(1).
• The procedure for re-appointment of Auditor is similar to appointment of the
Auditor at the first instance . However, following additional things needs to be kept
in mind:
(i) The Board has to check the eligibility norms mention in Section 141 of Company
Act, 2013.
(ii) With the Board’s consent on the re-appointment as well as on the remuneration,
the intended resolution to be passed could be mentioned in the AGM Notice itself.
(iii) The company shall thereafter file an E form in ADT–1 intimating the Registrar about
the appointment of the Auditor within 15 days from the date of his appointment.
(iv) The company shall also inform the Auditor about his appointment in the AGM
within 15 days of his appointment.
3. Appointment of Subsequent Auditors
• Section 139(1) provides that “every company shall, at the first annual general
meeting, appoint an individual or a firm as an auditor who shall hold office from
the conclusion of the meeting till the conclusion of its sixth annual general meeting
and thereafter till the conclusion of every sixth meeting”
• The subsequent auditor is appointed by the members in annual general meeting by
passing an ordinary resolution.
• Before any such appointment is made, the written consent of the auditors propose
to be appointed shall be obtain along with certificate.
3.10
Auditing Company Audit and Tax Audit

• According to Companies Act, the auditor has to certify:

(a) He is eligible to appoint under the Act of Chartered Accountant 1949 and the rules
and regulations made under that.
(b) The proposed appointment is as per the term provided under the Act.
(c) The proposed appointment is within the limit laid down under the Act.
(d) The list of proceeding against the auditor or audit firm or any partner of the audit
firm pending with respect to professional matter to conduct, as disclosed in the
certificate is true and correct.
• Within fifteen days of the meeting in which auditor is appointed should inform to
auditor and also registered with register.
Appointment of Subsequent Auditor
Non-Government Listed / Specified Government Company
Company Company
The appointment is done The appointment is done The appointment is done
by the members and he by the members for a by the Comptroller and
will hold office till the Maximum term of 5/10 Auditor General of India
conclusion of the consecutive years within 180 days from the
6th meeting 1st of April
4. Casual Vacancy
• As per section 139(8)(i), any casual vacancy shall be filled by the Board within 30
days. If the vacancy has arisen due to resignation of auditor then such appointment
shall also be approved by the company at a general meeting convened within 3
months of the recommendation of the Board.
Instances of Casual Vacancy
(a) Death
(b) Resignation
(c) Disqualification
• If an existing auditor gets disqualified under Section 141 then he shall inform the
Company and the situation will be treated as casual vacancy (Section 141(4)).
Failure of Ratification at AGM
• If the ratification resolution fails at the AGM of company then this also treated as
casual vacancy (explanation to rule 3).
Tenure
• Till conclusion of forthcoming annual general meeting.
3.11
Auditing Company Audit and Tax Audit

Casual Vacancy due to Resignation and Other Reasons

Non-Government Listed / Specified Government Company
Company Company
The appointment is by the The appointment is by the The appointment is done
members within 3 months members within 3 months by the : CAG (Comptroller
of the recommendations of of the recommendations of and Auditor General)
Board and he will hold Board and he will hold within 30 days
office till the next AGM office till the next AGM
(B) Removal of Company Auditor
• There are two possibilities for removal of Company Auditor:
1. Removal of Auditor after Expiry of the Term
2. Removal of Auditor before Expiry of the Term

Removal of auditor after Removal of auditor

expiry of the term before expiry of the
term

Fig. 3.3 : Removal of Company Auditor

1. Removal of Auditor after Expiry of the Term
• After the expiry of the term of office, an auditor is usually automatically
reappointed.
• The Company may not reappoint the Retiring Auditor at its AGM if such auditor has
served consecutively for a term of 5 years or 10 years, as provided by Section 139
and may appoint another entity to act as its auditor.
Procedure for Removal
• The following procedure has to be followed:
(a) Special Notice
• In such cases, a Notice is required to be sent for considering the Resolution for an
appointment at the AGM for:
(i) Appointment of a person to act as an auditor other than the auditor who is retiring;
(ii) Notice should state that the retiring auditor is not eligible for re-appointment.
• The company is also required to send the copy of a notice to the retiring auditor.
3.12
Auditing Company Audit and Tax Audit

(b) Communication to the Retiring Auditor

• The Company on receipt of such notice, should send a copy to the retiring auditor.
(c) Representation by Retiring Auditor
• The retiring auditor can make a written representation, not exceeding a reasonable
length, to the company, regarding his proposed removal. He may also request the
company to circulate his representation to the members.
• The company should send a copy of the representation of the auditor to the
shareholders, either along with the notice to meeting or subsequently.
• The company is required to send the representation to the shareholders only if the
representation is made by the auditor within a reasonable time.
• A copy of the representation made will be sent to all those who are entitled to
receive the notice of the meeting. In case, the company is unable to send the same,
then the auditor’s representation may be read out at the meeting.
• Where the representation is not sent as mentioned above, a copy of the same shall
be filed with the ROC.
2. Removal of Auditor after Expiry of the Term
• As per Section 140(1) of the Companies Act, 2013, the auditor appointed under
section 139 may be removed from his office before the expiry of his term only by a
special resolution of the company, after obtaining the previous approval of the
Central Government in that behalf in the prescribed manner
• The Companies Act, 2013 lays the provision for the removal or change of auditor
before the completion of his tenure. This happens in those cases where the
organization is not satisfied with the services of the auditor.
• The procedure of the removal of the auditor has been given in the sub-section (1)
of Section 140 of the Act.
• The application to the Central Government has to be done in the form ADT-2 as
prescribed in Rule 7 of the Companies (Audit & Auditors) Rules, 2014. A prescribed
fee provided under Section 12 of the Companies (Registration Offices and Fee)
Rules, 2014 needs to be submitted along with this form.
Procedure to Remove the Auditor
• The following process is required:
(a) Deciding the Board Meeting along with agenda to be discussed in meeting.
3.13
Auditing Company Audit and Tax Audit

(b) Auditor has to be given reasonable opportunity of being heard.

(c) Drafting of petition to be made to Regional Director (deleted by Central
government by MCA notification dated 21st May, 2014).
(d) Holding of Board meeting and considering the petition.
(e) Filing of petition to Regional Director in ADT-2 as an attachment to e-form RD-1
within thirty (30) days from the passing of Board resolution.
(f) After getting approval from Regional Director, fixing the Board meeting for taking
the note of same and approving as well as fixing the Extra-ordinary General
Meeting of members/ Annual General Meeting for removal of auditor before their
term within sixty (60) days.
(g) Holding of Extra-ordinary General Meeting of members/ Annual General Meeting
and passing of special resolution for same.
(h) Filling of MGt-14 once, the Special resolution is filled within thirty (30) days from
the date of its passing.
Forms involved in Removal of Auditor
• Not many forms are required in removal of auditor before their term, only
following forms are required:
1. MGT-14 2. ADT-2 3. RD-1
• In short,
1. If the auditor is being removed before the completion of his term, an approval
from the Central Government is necessary before passing a special resolution by
the company.
2. The application has to be made within thirty days of the resolution passed by the
board.
3. The company can hold a general meeting within sixty days of receipt of the
approval of the Central Government for passing the auditor appointment
resolution.
3.1.4 Rights or Powers of Company Auditors
• Every auditor of a company shall have the right to access at all time to book of
accounts and vouchers of the company. The Auditor shall be entitled to require
from officers of the company such information and explanation as he may consider
necessary for performance of his duties.
3.14
Auditing Company Audit and Tax Audit

• Following are the important rights of auditors:

1. Right to Access Books and Vouchers
• The auditor has a right to access, at all times the books of accounts & vouchers of
the company, whether kept at head office or elsewhere. It is an absolute right and
is not subject to any restriction, exception or qualification.
• Books include financial, accounting, statutory and statistical books of the company.
An auditor can inspect the books, accounts and vouchers of the company during
the normal business hours of the company.
2. Right to Obtain Information and Explanation
• An auditor has the right to seek information and explanation from the directors
and officers of the company. This will enable him to perform his duties successfully.
• Every officer of the company must furnish the necessary information to the auditor.
If the officer refuses to do so, the auditor may report to the members of the
company.
3. Right to Sign Audit Report [Sec.145]
• The auditor has right as well as duty to sign the audit report and the balance sheet
and the profit and loss account including all the documents attached or annexed
therewith.
4. Right to Receive Notices and Attend General Meeting [Sec.146]
• The auditor has the right of receiving all the notices and other communications
relating to any general meeting of a company which any member of the company
is entitled to have. He is entitled to attend any general meeting and to be heard at
any general meeting which he attend on any part of the business which concerns
him as an auditor.
5. Right to Visit Branches
• Where the accounts of any branch office are audited by a person other than the
company’s auditor, the company’s auditor is entitled to visit the branches, if he
deemed it necessary to do so for the performance of his duties as an auditor.
• However, the auditor does not have right to visit foreign branches of a banking
company and it will be adequate if he is allowed access to such copies of extracts
from the books or accounts of the branch as have been sent to the principal office
in India.
3.15
Auditing Company Audit and Tax Audit

6. Right to Get Remuneration

• The remuneration of the auditor of a company shall be fixed in its general meeting
for auditing the books of accounts of the company. The auditor can claim
remuneration from the appointing authority.
• At the time of winding-up of the company, he can claim remuneration as creditor
of the company.
7. Right to Report to Members
• The auditor has the right and duty to report to the members of the company
regarding the accounts examined by him. He is also required to give his opinion
about whether the financial statements give a true and fair picture of the state of
affairs of the company.
8. Right to Seek Legal and Technical Advice
• The auditor has the right to seek expert advice in respect of legal or technical
matters wherever he finds it is necessary. Auditors are not expert in valuation so
they can take help and expert advice in such cases.
9. Right to Give Suggestions to the Board
• The auditor has the right to suggest some modifications in the books of accounts
to the Board. The Board should comply with the suggestions made by the company
auditor. If not, the auditor should report the same to the members. But the auditor
cannot make changes in the books of accounts of his own.
10. Right to Correct Wrong Statements
• The auditor has the right to correct wrong statements made by the directors
relating to the accounts. But it should be remembered that any statement by him
to this effect will not relieve himself for any omission or incompleteness in his
report.
11. Right to be Indemnity
• The auditor has the right to be indemnified out of the assets of the company
against any liability incurred by him in defending himself against the civil or
criminal proceedings by the company if it is proved that the auditor has acted
honestly.
12. Right to Lien on Working Papers
• Working papers contains confidential information gathered by the Auditor while
Audit. Auditor prepare working paper in audit process. The auditor can claim the
possession of such working papers.
3.16
Auditing Company Audit and Tax Audit

3.1.5 Duties of Company Auditor

• Powers and duties of auditors and auditing standards are defined under Section
143 of Indian Companies Act, 2013. Provisions under these sections are as follows:
• Section 143 of Indian Companies Act, 2013 "Powers and Duties of Auditors and
Auditing Standards".
• An auditor is an authorised personnel that reviews and verifies the accuracy of
financial records and ensures that companies comply with tax norms.
• The role of an auditor, in general, is no walk in blindly. Having been regarded as a
certified professional, the auditor has placed himself responsibilities to various
parties and the duties that go with it.
• The auditor’s opinion basically makes or breaks the reliability of the financial
statements and the information they provide. Audited financial statements have an
extremely high degree of reliability and validity in comparison with unaudited
statements.
1. Section 143(1) : Duty to Access Books of Accounts
• This section provides that the auditor of the company shall have the right to have
access at all the times to the books of accounts and vouchers of the company,
whether kept at the registered place or at some other places of the company.
• Auditor can obtain all the information and explanations which to the best of his
knowledge and belief were necessary for the purpose of his duties as an auditor of
the company.
• The auditor of the holding company shall have the right to have access to all the
records of the subsidiary company also.
• The auditor should also enquire about the following things:
(a) Whether loans and advances made by the company are shown as deposits.
(b) Whether loan and advances made by the company on the basis of security are
properly secured and the terms and conditions on which it is made are prejudicial
to the interest of the company or its members.
(c) Where it is stated in the books of accounts that shares are issued in cash then
whether the cash in respect of these shares have actually been received or not and
in case the cash is not received, then whether it is clearly shown in the books of
accounts or not.
3.17
Auditing Company Audit and Tax Audit

(d) Whether personal expenses have been charges to revenue account.

(e) In case of a company other than banking company or an investment company so
much of the assets of the company consists of share, debentures or other securities
have been sold at a price less than the price at which these securities are purchased
by the company.
(f) Whether the transactions of the company are represented merely by books entries
are prejudicial to the interest of the company.
2. Sec 143(2) : Duty to Prepare Report
• The auditor should make a report to the company on the accounts examined by
him and in respect of the financial statement that are required to be laid before the
company in general meeting. The report shall be given after taking into
consideration the provisions of this Act.
3. Sec 143(3) : Additional matter to be stated in Audit Report
• The auditor report should state the following matters:
(a) Whether he has obtained all the information and explanations which to the best of
his knowledge and belief were necessary for the purpose of audit. In case proper
information are not received then the details thereof and effect of such information
on the financial statement should be stated in the auditor’s report.
(b) Whether proper books of accounts as required by law is maintained or not and
whether proper returns adequate for the purpose of audit have been received from
the branches not visited by him or not.
(c) Whether the report in respect of a branch which is audited by the auditor other
than company auditor has been sent to him.
(d) Whether the company balance sheet and profit and loss account are in agreement
with the books of accounts and returns.
(e) Whether financial statement comply with the accounting standards.
(f) The observations and comments of the auditor on the financial transactions or
matters which have adverse effect on the company.
(g) Whether any director is disqualified to be appointed as a director.
(h) Any qualifications, reservations or adverse remarks in respect of the maintenance of
the books of accounts or other matters connected herewith.
(i) Whether the company has adequate internal financial control system in place and
operative effectiveness of such control.
(j) Whether the company has disclosed the impact of any pending litigation if any in
the financial statement.
3.18
Auditing Company Audit and Tax Audit

(k) Whether the company has made provision in respect of any material foreseeable
losses as required by law or accounting standards including the derivative contracts
(l) Whether the company has made delay in transferring the amount required to be
transferred to the Investor Education and Protection Fund.
4. Duty to Report Fraud
• Section 143(12) of the Act imposes a duty on the auditor to report to the Central
Government if in the course of the performance of his duties as auditor .Generally,
in the course of performing his duties, the auditor may have certain suspicions with
regard to fraud that’s taking place within the company, certain situations where the
financial statements and the figures contained therein false information. When he
finds himself to be in such situations, he will have to report the matter to the
Central Government immediately and in the manner prescribed by the Act.
• It may be noted here that the duty of the auditor under section 143(12) is to report
any fraudulent activities that he observe in the performance of his duties. If the
auditor fails to comply with section 143(12) he will be punishable with fine which
shall be not less than rupees one lakh but may extent to rupees twenty lakhs.
5. Duty to Make Enquiry
• One of the auditor’s important duties is to make inquiries, as and when he finds it
necessary.
• A few of the inquiries include:
(a) Whether any personal expenses (expenses not associated with the business) are
charged to the Revenue Account
(b) Whether loans and advances made on the basis of security are properly secured
and the terms relating to the same are fair.
(c) Whether loans and advances made are shown as deposits.
(d) Whether the Financial Statements comply with accounting standards.
6. Comply with Auditing Standards
• The Auditing Standards are issued by Central Government in consultation with
National Financial Reporting Authority.
• These standards helps auditor in performing his audit duties with relevant ease and
accuracy. It is duty of the auditor to comply with the standards while performing
his duties as this increases his efficiency comparatively.
7. Duty to Provide Assistance to the Officers
• It is the duty of the auditor to provide assistance to the officers as required for the
same. Hence, it can be seen that the duties of the auditor are pretty diverse, it has
an all-round and far-reaching impact. The level of assurance provided by a set of
audited financial statements is comparatively far higher as compared to regular
unaudited financial statements.
3.19
Auditing Company Audit and Tax Audit

8. Duty to Attend General Meeting

• Under Section 146, the auditor has a duty to attend general meeting either by
himself or through authorized representative. The authorised representative shall
be person who is qualified to be an auditor.
9. Duty to Acquaint themselves with their Duties
• Auditors are bound to acquaint themselves with their duties under Companies Act.
They are also bound to see what additional duties by Articles of company imposed
on him.
3.1.6 Liabilities of Company Auditor
Liabilities of an Auditor
• An auditor must fully understand his obligations while presenting of the reports
prepared by him. Many internal and external parties relied on audit reports
prepared by him. An auditor must use his skill and care that the report should
reflect the true financial affairs of the company.
Types of Liability
Liabilities of an Auditor

Civil Liabilities Criminal Liability Liability for Liability

Liability under Liability under Professional towards
Companies under Income Tax Misconduct Third
Act Indian Act Parties
Penal Code

1. Liability for 1. Liability for 1. Liability for

Neligence Misss- Neligence
tatements
in the
Prospectus
2. Liability for 2. Criminal 2. Liability for
Misfeasance Liability of Frauds
Auditor
under
Companies
Act
3.20
Auditing Company Audit and Tax Audit

1. Civil Liability
(a) Liability for Negligence
• In case of optional audits the auditor is liable for his negligence. If the company
wishes to proceed against its auditor for his negligence, the following essentials are
to be fulfilled:
(i) The Company have the capacity to prove that the auditor is negligent;
(ii) There should be some loss due to the auditor’s negligence;
(iii) The loss should affect the shareholders.
(b) Liability for Misfeasance
• Misfeasance means breach of trust. If an auditor does something wrongfully in the
performance of his duties resulting in a financial loss to the company, he is guilty of
misfeasance. In such a case, the company can recover damages from the auditor or
from any officer for breach of trust or misfeasance of the company.
2. Liabilities under Companies Act
• The following are the liabilities of an auditor under the provisions of the Companies
Act:
(a) Liability for Misstatements in the Prospectus [Sec.35]
• An auditor shall be held liable to compensate every person who subscribes for any
shares or debentures of a company on the faith of the prospectus containing an
untrue statement made by him as an expert.
• The auditor may escape from liability if he proves that:
(i) The prospectus is issued without his knowledge or consent.
(ii) He withdrew his consent, in writing before delivery of the prospectus for
registration.
(iii) He should have withdrawn his consent after issue of prospectus but before
allotment of shares and reasonable public notice has given by him regarding this.
3. Criminal Liability of Auditor under Companies Act
(a) Untrue statement in Prospectus [Sec.34]
• The auditor is liable when he authorizes a false prospectus..
(b) Non Compliance by Auditor [Sec. 143 and 145]
• If the auditor does not comply regarding making his report or signing or
authorization of any document and makes wilful neglect on his part, then it is
criminal liability.
(c) Failure to Assist Investigation [Sec.217 (6)]
• When Central Government appoints an Inspector to investigate the affairs of the
company, it is the duty of the auditor to produce all books, documents and to
provide assistance to the inspectors otherwise he will be punishable under criminal
liability.
3.21
Auditing Company Audit and Tax Audit

(d) Failure to Assist Prosecution of Guilty Officers [Sec.224]

• An auditor is required to assist prosecution when Central Government takes any
action against the report submitted by the Inspector. If he fails to do so, he is
found guilty and is punishable.
(e) Failure to Return Property, Books or Papers [Sec.299]
• When a company is wound up the auditor is supposed to be present and subject
himself to a private examination by the court and is also liable to return to the
court any property, books or papers relating to the company. If the auditor does
not comply, he may be imprisoned.
(f) Penalty for Falsification of Books [Sec.336]
• An auditor when destroys, mutilates, alters or falsifies or secrets any books of
account or document belonging to the company, he shall be punishable with
imprisonment and also be liable to fine.
3. Criminal Liability under Indian Penal Code
• According to Sec.197 of the Indian Penal Code, the auditor is similarly liable for
falsification of any books, materials, papers that belongs to the company.
4. Liability under Income Tax Act [Sec.278]
(a) For tax evasion exceeds ` 1,00,000, there is rigorous imprisonment of six months
to seven years.
(b) A Chartered Accountant can represent his clients before the Income Tax
Authorities. However, if he is guilty of misconduct he can be disqualified from
practicing.
(c) An auditor can face imprisonment upto two years for furnishing false information.
5. Liability for Professional Misconduct
• The Chartered Accountant Act, 1949 mentions number of acts and omissions that
comprise professional misconduct in relation to audit practice. The council of ICAI
may remove the auditor’s name for five years or more, if he finds guilty of
professional misconduct.
6. Liability towards Third Parties
(a) Liability for Negligence
• It has been held in the court that auditor is not liable to third parties, as there is no
contract between auditor and third parties. He owes no duty towards them.
(b) Liability for Frauds
• The third parties can hold the auditor liable, if there is fraud on the part of auditor
even if there is no contractual relationship between auditor and third parties. In
certain cases negligence of auditor may amount to fraud for which he may be held
liable to third parties. But it must be proved that auditor did not act honestly and
he knew about it.
3.22
Auditing Company Audit and Tax Audit

Penalty Levied Against the Auditors

Penalty for non- If an auditor contravenes the provisions contained

compliance of in Section 139, Section 143, Section 144 and Section
the provisions of 145 of the Act, he shall be punishable with fine
Sections 139, ranging from ` 25,000/- to ` 5,00,000/-.
143, 144 and If an auditor contravenes such provisions knowingly
145 of the Act to deceive the company or its shareholders, he shall
be punishable with imprisonment for up to 1 year
along with the fine.

As per Section 143 (12), an Auditor is bound to

report against fraud to the Central Government if
Penalty for during performing his duties as auditor, he discovers
failure to report an offence involving fraud is being committed against
against fraud the company by its employee(s).
if he fails to comply with the duty, he shall be
punishable with fine raning from ` 1,00,000/- to
` 25,00,000/.

The National Financial Review Authority (NFRA)

Penalty for shall investigate any professional or other
professional misconduct committed by an auditor. If any
misconduct misconduct is proved, NFRA shall impose a penalty
up to five times of the fees received for individuals
and from ` 10,00,000/- to ten times of the fees
received, in case of firms.

Fig. 3.4 : Penalties Levied Against Auditor

3.2 Tax Audit
3.2.1 Definition of the term Accountant
• An accountant can be defined as:
1. Someone who keeps or examines the records of money received, paid and owed
by a company or person.
2. The term accountant refers to a professional who performs accounting functions
such as account analysis, auditing, or financial statement analysis. Accountants
work with accounting firms or internal account departments with large companies.
They may also set-up their own, individual practices.
• After meeting state-specific educational and testing requirements, these
professionals are certified by national professional associations.
3.23
Auditing Company Audit and Tax Audit

3. An accountant is a person whose job is to keep financial accounts.

4. An account is one who is skilled in the practice of accounting or who is in charge of
public or private accounts.
5. "Accountant" means a Chartered Accountant as defined in clause (b) of sub-section
(1) of section 2 of the Chartered Accountants Act, 1949 (38 of 1949) who holds a
valid certificate of practice under sub-section (1) of section 6 of that Act.
Tax Audit (Meaning)
• A tax audit is an examination of your tax return by an outside agency to verify that
income and deductions filed are accurate or not. The income tax law asks the
taxpayers to get the audit of accounts of their business or profession done
according to provision of income tax law.
• A Tax Audit is an audit, made compulsory by the Income Tax Act, if the annual
gross turnover/receipts of the assesse exceed the specified limit.
• Tax audit is conducted in Sec 44AB of the Income Tax Act, 1961 by a Chartered
Accountant.
• The provisions for tax audits in India are covered under Section 44AB of the Income
Tax Act, 1961.
Definition of Tax Audit

“The audit conducted by the chartered accountant of the accounts of the

taxpayer in pursuance of the requirement of section 44AB. The chartered
accountant then prepare the audit report and submit their findings in Forms No’s
3CA/3CB and 3CD”
• Simply Tax Audit means, an audit of matters related to tax.
3.2.2 Tax Audit Applicability Provision under Income Tax Act, 1961
(Section 44AA, 44AB, 44AD, 44ADA, 44AE)
(I) Section 44AA
• Section 44 AA of Income Tax Act gives directives on how to maintain the accounts
while carrying out a business or profession.
• This section explains maintenance of accounts by certain persons carrying on
business, limits for individuals and HUF for maintenance of accounts. It also
explains penalty for contravention of provisions related to maintenance of accounts
and important notes related to this section under Income Tax Act, 1961.
• Income Tax Act, 1961 Section 44 AA compulsory maintenance of books of
accounts.
3.24
Auditing Company Audit and Tax Audit

1. Maintenance of Accounts while carrying out Profession

• In case you are a professional practicing in a field such as medicine, law,
engineering, architecture, accountancy, technical consultancy, interior decoration
or film industry specific work and if your gross receipt is more than ` 1,50,000 in all
3 years preceding the previous year then you need to maintains such books of
accounts as may be prescribed under Rule 6F, otherwise you are require to
maintain cash book, journal, ledger, stock register, daily cash register from which
assessing officer is able to complete the assessment.
• If you do not have a specified profession and your receipts of gross income
exceeds ` 1,00,000 in any of the 3 years preceding the current year then you are
require to maintain books of accounts.
2. Maintenance of Accounts by Certain Persons carrying on Business
• If Profit or Gain from business and profession is more than ` 1,20,000, or
• Total sales exceeds ` 10,00,000 in any of the 3 years preceding the previous year.
• Assessee is required to maintain books of accounts from which assessing officer
will able to complete assement.
3. Maintenance of Accounts by Individual and HUF
• In case of business by individual or HUF, if total income is more than ` 2,50,000.
• In case of Profession by individual or HUF if turnover/Gross receipt is more than
` 25,00,000.
4. Maintenance of Accounts by Other Person
• If you are covered under Section 44DA/44AF/44BB/44BBA and your income is
lesser than the specified limit, the maintaining books to support your claim is
optional.
5. Penalty on Contravention
• As per Section 271 A, if assessee fails to maintain books of accounts as per section
44AA, penalty of ` 25,000 is levied on him.
(II) Section 44AB
• A tax Audit is an audit made compulsory by the Income Tax Act, is related to Tax
Audit Applicability. If the annual gross turnover/receipt of the assessee exceed the
specified limit, then Tax Audit is conducted under Section 44AB of Income Tax Act,
1961.
1. The following Persons Liable for a Tax Audit under Section 44AB:
(a) Business
• If annual gross turnover/receipts in business exceeds ` 2 crore then Tax Audit is
applicable.
3.25
Auditing Company Audit and Tax Audit

(b) Profession
• It means an assessee need to be audited under Section 44AB if his annual gross
receipt in profession exceeds ` 50 lakh in previous year.
2. What is Tax Audit under Section 44AB
• The audited accounts must be reported by a Chartered Accountant in the
prescribed forms.
• The Tax Audit limit under Section 44 AB is ` 1 Crore.
• It aims to ascertain the compliance of various provisions of Income Tax Law and
fulfilment of it.
• Audit report should be prepared in Form No. 3CB and particulars of the audit must
be reported in Form 3CD.
• It explains provisions related to the class of taxpayers who are required to get their
accounts audited by Chartered Accountant.
3. Forms to be filed for Tax Audit under Section 44 AB
(a) For persons or individuals conducting enterprises where accounts are to be audited
under Section 44 AB
Form No. 3CA - Audit Form
Form No. 3CD - Statement of relevant particulars
(b) Individuals with accounts which are not required to be audited as per the provision
stated under any law, with the exception of Income Tax laws.
Form No. 3CB - Audit Form
Form No. 3CD - Statement of relevant particulars
4. Due date for Tax Audit under Section 44 AB
• A Tax Audit report is electronically filed by the Chartered Accountant.
• A person covered under this section should get audited his account and should
reported before 30th September of relevant assessment year.
• Tax Audit report for Financial Year 2019-2020 should be obtained on or before
30th September, 2020.
3.26
Auditing Company Audit and Tax Audit

5. Penalty for Non-filing of Audit Report

• If assessee fails to comply with Section 44 AB, the assessing officer may impose a
penalty.
(a) 0.5 % of total turnover of gross receipt in the case of business or Gross Receipt in
case of Profession
(b) ` 1,50,000
• Whichever is lower of the above.
(III) Section 44AD
• As per the Income Tax Act, a person engaged in a business or a profession is
required to maintain his regular books of accounts.
• Books of accounts should be audited by an auditor.
• To give relief to small business, the Income Tax Act has formed presumptive
taxation scheme under Section 44 AD, 44 ADA and 44 AE.
• A presumptive income scheme allows the assessee to declare their income at a
prescribed rate under Income Tax Act.
• Businesses that are adopting the presumptive taxation scheme are not require to
maintain regular books of accounts.
1. Applicability of Section 44AD of Income Tax Act
• Below are the types of an assessee who covers under Section 44 AD
(a) Individual resident Taxpayer
(b) HUF (Hindu Undivided Family)
(c) Partnership Firms (excluding LLP)
• In other words, the scheme cannot be adopted by a non-resident and by any
person other than an individual, HUF and Partnership Firm (excluding LLP).
• This scheme cannot be adopted by a person who has made claim towards
deduction under Section 10 A/10 AA, 10 B/10 BA or under Section 80 HH to 80 RRB
in the relevant year.
2. Deduction and Allowances
• Any deduction allowable under Section 30 to 38 shall be deemed to be allowed,
the tax payer can not claim further deduction.
• Provision of Section 44 AD do not allow a firm to claim a deduction on account of
interest and salary paid to partners.
• No disallowances under Section 40, 40 A and 43 B.
3.27
Auditing Company Audit and Tax Audit

3. Applicability of Advance Tax

• An assessee covers under Section 44 AD must pay the advance tax to the extent of
the whole amount on or before 15th March of the Financial Year.
4. Features
• Following are the features of Section 44 AD of Income Tax Act:
(a) As per the provision of such scheme, the sum equal to 8 % of total turnover or
gross receipt of an assessee whichever is higher.
(b) In order to promote digital payment, the sum equal to 6 % of total turnover or
gross receipt of an assessee whichever is higher.
• This is applicable in a case where the amount of such turnover or gross receipt
received by Cheque, Draft, Credit card, Debit card, Net Banking, IMPS, UPI, RTGS,
NEFT.
• Taxable Income under Section 44 AD is computed as follows :
Turnover or Gross Receipt from Business xxxx
Less: Expenses incurred in relation to earning of the Income xxxx
Taxable Business Income xxxx
Maintenance of Books of Accounts
1. Compulsory Maintenance of Books of Accounts
• If a person declares his income below 8 %/6 % of total turnover or gross receipt.
• Total taxable income is above the exemption limit.
2. Maintenance of Books not Compulsory
• Total income is below exemption limit.
• Profits are also declared below 8 %/6 % of gross turnover or gross receipts.
(IV) Section 44ADA
• A scheme for presumptive taxation was introduced under Section 44 ADA from
Financial Year 2016-17.
• This section offers a scheme of presumptive taxation of profit and gains from
professionals mention under Section 44 AA (1) of Income Tax Act, 1961. This
section is applicable to professionals whose annual gross receipts are under ` 50
Lakh.
3.28
Auditing Company Audit and Tax Audit

Eligible Professional under Section 44 ADA

• Interior decorations, Engineers, Accounting, Medical, Technical consulting, Legal,
Architecture and other which are mention as below :
1. Movie artists such as producers, actors, music directors, directors, dance directors,
editors, story writer, singer, dialogue writers, costume designer.
2. Authorised representative means a person who represents another person for a fee
before a tribunal or any authority constitute under a law.
3. Any other notified professionals.
Latest Updates (Budget 2021)
• This scheme was previously applied to all resident professionals referred under
Section 44 AA. Now onwards, it applies only to the resident individual, HUF or
Partnership firm other than LLP.
Benefits to Assessee under Section 44 ADA
1. No need to maintain books under Section 44 AA.
2. No requirements of having accounts audited under Section 44 AB
When shall an Assessee Maintain Books and Get the Accounts Audited.
1. Total Income of the assessee is more than the basic exemption.
2. Income from the profession is offered at a lower rate than 50 % of the gross
receipt.
(V) Section 44AE
Applicability
• The scheme of Section 44AE is designed to give relief to small taxpayers engaged
in the business of plying, hiring or leasing goods carriages.
Eligibility
• The provisions of Section 44 AE are applicable to every person (individual, HUF,
firm, company etc.)
• The presumptive taxation scheme of Section 44 AE can be adopted by a person
engaged in the business of plying, hiring or leasing goods carriages and who does
not own more than 10 goods vehicles at any time during the year. If person owns
more than 10 goods vehicles during the year, then he can not take advantage of
this scheme.
3.29
Auditing Company Audit and Tax Audit

• Income of an assessee deemed as -

1. Light Goods Vehicles (Less than 12 MT - Gross Weight Vehicles) ` 7,500 per vehicle
per month.
2. Heavy Goods Vehicles (More than 12 MT - Gross Weight Vehicle) ` 1,000 per ton
per vehicle per month.
Other Provisions

• Income Tax Return for deemed income on a per vehicle basis can be filed by any
class of taxpayer. (Individual/HUF/Company/LLP/Partnership Firm).
• This section is not applicable for business showing income under Section 44 AE.
• ITR 4 would be applicable for income under Section 44 AE.
• For deemed income, taxpayer can not claim expenses (depreciation or other).
• The taxpayer can disclose higher income, but if he disclose lower income, he would
require to comply with provision of Section 44 AA and 44 AB.
• If taxpayer furnishes his PAN Card No., No TDS is required to be deducted on the
amount paid to the transporter.
3.2.3 Recent Amendment made as Applicable as per Income Tax Act,
1961

• Amendments are to be effective from April 1st 2021 for the Assessment Year 2021-
22, Financial Year 2020-21.
1. Section 6
• Residential Status - determined by number of days stay in India.
• The exception provided in explanation 1(b) to Section 6(1) for Indian citizens and
persons of Indian Origin visiting India in that year has reduced to 120 days in case
total income of such person exceeds ` 15 lakhs in financial year from other sources
other than foreign sources.
• The term 'income from foreign sources has been defined 'income which accures or
arises outside India.
3.30
Auditing Company Audit and Tax Audit

2. Relief to Tax Payers on Paying Advance Taxes on Dividend

• The coporate tax was reduced to 25 % and dividend in the hand of tax payer was

earlier exempted upto ` 10,00,000 but now it is taxable.

3. Reduction in the Time Limit for Assessment or Re-assessment

• The limit for issuing of notice for assessment or re-assessment has been reduce as

under :

(a) From six months to three years.

(b) In case of major/serious tax evasion, the notice can be issued upto 10 years, where

there is evidence and income is in excees of INR 50 lakh or more.

4. LLP to be excluded from the Scope of Section 44 ADA i.e. Presumptive Income

• Presumptive taxation under Section 44 ADA is not now applicable to LLP, LLP are

required to maintain books of account under LLP Act.

5. Tax Audit Requirements

• Tax Audit requirements have been changed from turnover of ` 5 crore to 10 crore

for business who have 95 % digitalize transactions.

6. Relief to Senior Citizens

• No filing is require for senior citizens for the income on pension and interest.

Senior citizens above 75 years of age and having income from pension and interest

will not required to file ITR.

7. Start-ups and Innovations

• Start-up incorporated upto April 01, 2022 will be eligable to avail tax holiday.

• Capital gains from the sale of residential property on or before 31st March, 2022

which is invested by assessee in the shares of eligible starters will be exempted.

3.31
Auditing Company Audit and Tax Audit

8. Section 115 BAC

• Alternative Tax rate slab for individuals and HUF are as follows:
Sr.No. Total Income (`
`) Rate of Tax
1 Upto 2,50,000 NIL
2. From 2,50,000 to 5,00,000 5%
3. From 5,00,000 to 7,50,000 10 %
4. From 7,50,000 to 10,00,000 15 %
5. From 10,00,000 to 12,50,000 20 %
6. From 12,50,000 to 15,00,000 25 %
7. From 15,00,000 30 %
Deductions under the Act
(a) Standard deduction of ` 50,000
(b) Leave Travel Allowance under Section 10 (5)
(c) House Rent Allowance under Section 10 (BA)
(d) Deduction of interest upto ` 2,00,000 under Section 24(b) for self occupied
property.
(e) Certain allowance under Section 10(14)
(f) Deduction allowance under Chapter VI-A (except the deduction under Section 80
CCD(2) and Section 80 JJAA including of ` 1,50,000 under Section 80 C for
Provident Fund, Life Insurance Premium, ` 50,000 for NPS under Section 80
CCD(1B).
(g) Allowance for minor child income allowable under Section 10 (32) on clubbing of
minor income.
9. Section 115 BBDA
• Tax on certain dividends received from domestic companies. Dividend received by
the specified assessee exceeding ` 10,00,000 was taxable @ 10 % under this
Section till Assessment Year 2020-21 but from Assessment Year 2021-22 this
Section will be inactive.
3.32
Auditing Company Audit and Tax Audit

10. Section 115-O : Dividend Distribution Tax

• Dividend Distribution Tax is removed from A.Y. 2021-22. According to amendment,
companies are not required to pay tax on dividend distributed by them,
shareholder will pay tax. In other words, it will be taxed in the hands of
shareholders.
11. Section 139
• Due date for filing of ITR is amended as:
(a) Date of filing Audit Report delinked from date filing return.
(b) For audit case due date is 31st October.
(c) Earlier due date was 31st October only for working partner but as per new
amendment, due date is 31st October for both sleeping and working partner.
Points to Remember
• Company Auditor is an individual appointed for preparing an independent audit
report of the company. They can be either appointed by the company's Board of
Directors, Shareholders, Central Government or Comptroller and Auditor General
of India (C&AG).
• Section 141(1) of the Act prescribe the qualification and disqualification of
company auditor.
• Section 139(6) lays down that the first auditor or auditors of a company, the
retiring auditor may re-appoint by complying provision under section 139(9). The
subsequent auditor is appointed by the members in annual general meeting by
passing an ordinary resolution - Section 139(1)
• The procedure of the removal of the auditor has been given in the sub-section (1)
of Section 140 of the Act. Forms required for the removal:
1. MGT-14 2. ADT-2 3. RD-1
• Powers and duties of auditors and auditing standards are defined under Section
143 of Indian Companies Act, 2013
• Accountant" means a chartered accountant as defined in clause (b) of sub-section
(1) of section 2 of the Chartered Accountants Act, 1949 (38 of 1949) who holds a
valid certificate of practice under sub-section (1) of Section 6 of that Act.
3.33
Auditing Company Audit and Tax Audit

• The provisions for tax audits in India are covered under Section 44AB of the Income
Tax Act, 1961. The definition of tax audit is:
“The audit conducted by the chartered accountant of the accounts of the taxpayer
in pursuance of the requirement of section 44AB. The chartered accountant then
prepare the audit report and submit their findings in Forms No’s 3CA/3CB and
3CD”.
• Section 44 AA is related to Provisions related to Maintenance of Accounts under
Income Tax Act.
• Section 44 AB is related to provisions related to Tax Audit Applicability under
Income Tax Act.
• Section 44AD, 44ADA and 44AE related on Presumptive Taxation Scheme under
Income Tax Act.
Questions For Discussion
1. Define Company Auditor. State the Qualification and Disqualification of Company
Auditor.
2. State the Personal Qualities of Company Auditor.
3. Describe the various provisions regarding Appointment of Company Auditor.
4. Explain the procedure for Removal of Auditor after Expiry of Term.
5. Explain the Rights of Company Auditor.
6. Explain the Duties of Company Auditor.
7. Explain the Liabilities of Company Auditor.
8. Write Short Notes
(A) Tax Audit provisions under Section 44 AA of Income Tax Act, 1961
(B) Tax Audit provisions under Section 44 AB of Income Tax Act, 1961
(C) Tax Audit provisions under Section 44 AD of Income Tax Act, 1961
(D) Tax Audit
(E) Tax Audit provisions under Section 44 AE of Income Tax Act, 1961
(F) Professional Qualities of Company Auditor
(G) Removal of Auditor before Expiry of the Term
❂❂❂
3.34
Chapter 4…
Audit of Computerized Systems
and Forensic Audit
Contents …
4.1 Audit in and EDP Environment
4.1.1 General EDP Control
4.1.2 EDP Application Control
4.1.3 Computer Assisted Audit Techniques (CAAT)
4.1.4 Factors and Preparation of CAAT
4.2 Forensic Audit
4.2.1 Forensic Audit Definition
4.2.2 Importance of Forensic Auditor
4.2.3 Services Rendered By Forensic Auditor
4.2.4 Process of Forensic Auditing
4.2.5 Forensic Audit Techniques
4.2.6 Forensic Audit Report
• Points to Remember
• Questions for Discussion
Learning Objectives..
After reading this chapter, the students should able to understand:
1. To acquaint one with various new concepts in computerized audit system such as
EDP, CAAP
2. To understand General and Application EDP control in depth
3. To study various techniques of Forensics Audit

4.1
Auditing Audit of Computerized Systems and Forensic Audit

4.1 Audit in and EDP Environment

• EDP is the practice of processing, storing, retrieving, sharing and maintaining
information electronically. There are many different ways to process data. The most
common way of data processing is the machine learning technique called
classification. It can be used for identifying issues in your data, finding patterns and
predicting outcomes.
• EDP control is a modern technique to process data. The data is processed through
a computer. Data and set of instructions are given to the computer as input and
the computer automatically processes the data according to the given set of
instructions.
• Audit around the computer can be done in the following situations:
1. The audit trail is complete,
2. Processing operations are straightforward,
3. Systems documentation is complete and readily available.
4. When the audit trail is incomplete and the computer processing operations are
complicated, it is inappropriate to audit around the computer.
• An audit trail is defined as a step-by-step sequential record which provides
evidence of the documented history of financial transactions to its source. An
auditor can trace the financial data of a particular transaction right from the
general ledger to its source document with the help of the audit trail.
• This technique should only be used when the audit trail is complete, computer-
processing operations are straightforward and systems documentation is complete
and readily available.
• Under the technique of auditing around the computer, auditors bypass the
computer and treat it as a giant book-keeping machine.
• This is acceptable in some situations but becomes unacceptable if the relationship
between the output and the input cannot be properly understood without
examining the intervening computer processing, e.g. when there is no visible audit
trail.
Meaning of the term Computer
• A computer is an electronic device for storing and processing data, typically in
binary form, according to instructions given to it in a variable program.
• A computer consists of five functionally independent main parts: input, memory,
arithmetic logic unit (ALU), and output and control unit.
4.2
Auditing Audit of Computerized Systems and Forensic Audit

It is Important to know Certain Technical Terminology

1. Input Unit
• This unit contains devices with the help of which we enter data into the computer.
This unit makes a link between user and computer. The input devices translate the
information into the form understandable by computer.
2. Central Processing Unit (CPU)
• CPU is considered as the brain of the computer.
• CPU performs all types of data processing operations. It stores data, intermediate
results and instructions (program). It controls the operation of all parts of the
computer.
• CPU itself has following three components:
(a) ALU (Arithmetic Logic Unit) (b) Memory Unit (c) Control Unit
3. Output Unit
• Output unit consists of devices with the help of which we get the information from
the computer. This unit is a link between computers and users. Output devices
translate the computer’s output into the form understandable by users.
4. Computer Hardware
• Hardware refers to the physical components of a computer. Computer Hardware is
any part of the computer that we can touch. These are the primary electronic
devices used to build up the computer.
• Examples of hardware in a computer are the Processor, Memory Devices, Monitor,
Printer, Keyboard, Mouse and the Central Processing Unit.
5. Computer Software
• Software is a collection of instructions, procedures, documentation that performs
different tasks on a computer system. We can also say Computer Software is
programming code executed on a computer processor. The code can be machine-
level code or the code written for an operating system.
• Examples of software are : Ms Word, Excel, Power Point, Google Chrome,
Photoshop, MySQL etc.
6. Computer Language
• A computer language is a method of communication with a computer. Types of
computer languages include: Construction language, all forms of communication
by which a human can specify an executable problem solution to a computer.
• Example of Computer Language are : BASIC, COBAL, PASCAL, LOTUS etc.
• The computer is also known as the Electronic Data Processing Machine.
4.3
Auditing Audit of Computerized Systems and Forensic Audit

Definition of EDP Audit

1. Weber
“EDP auditing is the process of collecting and evaluating evidence to determine
whether a computer system safeguards assets, maintains data integrity, achieves
organizational goals effectively, and consumes resources efficiently.”
Benefits of Electronic Data Processing
• The benefits of electronic data processing are numerous. These are as follows :
1. Electronic data processing helps to reduce the development and maintenance cost
of most business operations.
2. It is the fastest and best available method with highest reliability and accuracy.
Technology used is the latest as this method uses computers.
3. Due to computerization manpower required is minimal. Processing can be done
through various programs and a predefined set of rules. Processing a large amount
of data with high accuracy is almost possible which makes it best among the
available types of data processing.
Examples of EDP
• It is used in a telecom company to format bills and to calculate the usage-based
charges. In schools, they use EDP to maintain student records. In supermarkets, it is
used for recording whereas hospitals use it to monitor the progress of patients.
• Further, it is used for hotel reservations, learning institutions, in banks to monitor
the transactions. In the departments such as police, cybercrime and chemical
industry the electronic data processing is used to note the entries. It enables larger
organizations to collect the information and process the data.
• Accounting with a computer is different from manual accounting. Auditors must
study the client audit system carefully.
Characteristics of Audit in EDP Environment
• The following are the characteristics of audit in EDP environment:
1. Less Errors
• Under EDP environment programs are set in advance. The chance of error is less in
a computerized environment. One of the most important characteristics of EDP
audit is less errors.
2. Less Paperwork
• Under the EDP environment very few documents are kept. Under EDP environment
data is entered through the system so there is no need to keep separate
documents. It reduces paperwork and helps in an environment friendly
atmosphere.
4.4
Auditing Audit of Computerized Systems and Forensic Audit

3. Coding
• In the EDP, code based Accounting system is done. Codes are used for names and
descriptions.
4. Internal Control System
• In manual accounting system lots of people are involved, however, number of
persons involved in EDP environment are very few.
5. Avoidance of Duplication of Records
• The EDP accounting system is based on a program in which computer programs
are fed in such a way that entering one transaction, the effect will be automatically
recorded till the end result. By feeding one transaction all records are automatically
updated.
6. No Physical Audit Trail
• There is physical trail in computerized accounting system but we will not found
such trail in EDP audit system
7. Destruction of Data
• EDP requires less space to store data such as pen drive, hard disk, floppies etc.
• Storage space required is also less under EDP system.
4.1.1 General EDP Control
• Electronic Data Processing (EDP) is when a computer of any type or size is used in
the processing of a company's financial information that is significant for the audit.
• The procedure used by the auditor in obtaining an understanding and testing of
control over the accounting system and internal control relating to the audit
procedure.
• The control environment in complex EDP systems is even more critical than that in
more simple systems because there is greater potential for mis-statement.
• The types of controls in an EDP system are
1. General Controls and
2. Application control.

General
Control
Application
Control

Fig. 4.1 : General EDP Control

4.5
Auditing Audit of Computerized Systems and Forensic Audit

• The difference between general and application controls is illustrated in the

diagram below,
EDP Controls

Categories General Application

Specific Types of Organization and Input

Controls : operation Processing
Systems Development Output
and Documentation
Hardware and Systems
Software
Access
Data and Procedural
Nature : Pertain to EDP Pertain to specific
environment and all EDP tasks
EDP activities
Fig. 4.2 : EDP Control
1. General Control
Meaning
• General controls are those that control the design security and use of computer
programs and the security of data files in general throughout the organization.
• On the whole, general controls apply to all computerized applications and consist
of a combination of system software and manual procedures that create an overall
control environment. General controls affect all three applications.
Features of General Control
• The following are the features of general control :
(a) Separate application controls are developed for:
(i) Purchases, (ii) Cash payments, and (iii) Inventory.
(b) Auditors usually evaluate the effectiveness of general controls before evaluating
application controls.
(c) General controls relate to the environment within which systems are developed,
maintained and operated. Such controls are related to all parts of the EDP system
and they apply to any one application. The general controls must therefore be
evaluated early in the audit.
(d) General controls are to ensure the integrity of application development and
implementation and to ensure that computer operations are properly administered
to protect hardware, programs and data files.
(e) Some application controls affect one or only a few transaction related to audit
objectives. General controls procedures prevent or detect several types of mis-
statements in all phases of the application.
4.6
Auditing Audit of Computerized Systems and Forensic Audit

(f) Auditors usually evaluate the effectiveness of general controls before evaluating
application controls because, if general controls are ineffective, there may be
potential for material mis-statement in each computer-based accounting
application
Types of General Control
• There are five main types of general controls:

Organisation of
EDP department

Data or Application
Procedural Development
Controls and Maintenance
Controls

Access to
Hardware
Computer
Controls
Equipment

Fig. 4.3 : Types of General Control

(a) Organization of EDP Department
• When there is EDP control no individual should be able to
(i) access the data;
(ii) alter the computer system or programs; and
(iii) access the computer.
• General Controls, Relationship of General Controls and Application Controls to
Audit Applications.
• Purchases Application
• Cash Payments Application
• Inventory Application
• An application is a programmed or group of programs designed to process a
particular group of transactions such as payment of creditors.
(i) There should be segregation of duties within the EDP Department, so as to prevent
EDP personnel from authorizing and recording transactions to hide theft of assets,
and to minimize the possibility of recording and processing errors.
4.7
Auditing Audit of Computerized Systems and Forensic Audit

(ii)In principle, no one individual should be able to:

• access the data;
• alter the computer system or programme, and
• Access the computer.
(iii)Suppose that there is inadequate segregation of duties such that computer
operators are also programmers and have access to computer programs and data
files, then the auditors would be concerned about the potential for fictitious
transactions or unauthorized data and omissions in the accounts.
(iv) Assume that the auditors find that there are inadequate safeguards over data files,
they may then conclude that there is a significant risk of loss of data because the
general controls affect each application.
• The following functions should be separated within the EDP Department:

It is important that the programmer does not have access

to input data on computer operations, since his understanding
Applications and programming of the programme can easily be used for personal benefit.
(design and maintenance of
computer hardware and software) The librarian provides a means of important physical control
over the computer programmes, transaction files, and other
important computer records and release them only to authorized
personnel.

Ideally, the operator should be prevented from having

Operations (running the computer, sufficient knowledge of the programme to modify it
executing jobs) immediately before or during its use.

The function of the data control group is to test the

effectiveness and efficiency of all aspects of the
Data Control (data input and system. This includes the application of various
output) controls, the quality of the input, and the
reasonableness of the output.

Fig. 4.4 : EDP Department

(b) Application Development and Maintenance Controls
• The purpose of this general control area is to ensure that the client adequately
controls computer programs and related documentation.
• The primary controls are included in the design and use of systems manuals.
• Documentation is often the best source of information about control features
within computer programs.
• The auditor’s review of computer controls may depend, in part, on adequate
documentation.
• Common types of computer documentation include programmed flowcharts and
narratives, record and file layouts and operator instructions.
4.8
Auditing Audit of Computerized Systems and Forensic Audit

(c) Hardware Controls

• Hardware controls are built into the equipment by the manufacturer to detect any
equipment failure.
• Auditors are less concerned with the adequacy of the hardware controls in the
system than with the organization’s methods of handling the errors that the
computer identifies.
(d) Access to Computer Equipment
• Access to Computer equipment, Data Files and Programs are controls that are
important for safeguarding EDP equipment and records.
• It can be maintained by accomplished through locked doors, segregation of duties,
locked cabinets containing data files, passwords or security codes and reports of
jobs run on the computer.
(e) Data or Procedural Controls
• Copies of all important files and programs should be kept “off site”. This may
prevent losses due to accidental erasure, intentional vandalism, or catastrophic loss
(e.g. because of fire).
• One commonly used data storage method is the grandfather-father-son method.
4.1.2 EDP Application Control
Meaning
• Application controls are specific controls unique to each computerized application
such as payroll, accounts receivable and order processing. They consist of both
controls applied from the user functional area of a particular system and from
programmed procedures.
• Application control is a security practice that blocks or restricts unauthorized
applications from executing in ways that put data at risk.
• Application control includes completeness and validity checks, identification,
authentication, authorization, input controls and forensic controls.
Features of Application Control
1. Application controls are to ensure the completeness and accuracy of all processing
and the validity of the accounting entries made.
2. There are four main types of application controls, viz;
(a) Input controls, (b) Processing controls,
(c) Output controls, and (d) Controls over Master File information.
3. Application controls must be evaluated specifically for every audit area in which the
client uses the computer where the auditor plans to reduce assessed control risk.
4.9
Auditing Audit of Computerized Systems and Forensic Audit

Controls over input are designed to assure that the information on processed by the computer is valid, complete and accurate.
These controls are critical because a large number of errors in computer systems are the results from input errors.
Input Common input controls include check digits, batch totals, hash totals, limits or resonableness tests, validity checks etc.
controls

Controls over processing are designed to assure that data input into the system is accurately processed.
This means that all data entered in the computer are processed, processed only once, and processed accurately.
Most processing controls are also programmed controls, which means that the computer is programmed to do the checking.
Processing
Common examples include control totals, logic tests and completeness tests.
controls

Controls over output are designed to assure that data generated by the computer are valid, accurate and complete.
Moreover, outputs should be distributed in the appropriate quantities only to authorised people.
Output The most important output control is review of the data for reasonableness by someone who knows what the output
should look like.
Control

Many transactions depend on the accuracy of information in the Master File.

For example, all sales transactions depend on price list, or all payroll amounts depend on hourly rate or salary rate.
User departments should get periodic reports containing the contents of the Master File.
Controls over
Master File There should be procedures in place to verify that the correct version of the Master File is being used.
information

Fig. 4.5 : Types of Application Controls

Types of Application Controls
• How do Auditors Test Controls in an EDP Environment?
• Auditors obtain information on general and application controls by:
1. Interviewing EDP staff,
2. Reviewing flowcharts and documentation that describe the system and programs,
and
3. Reviewing internal control questionnaires they have given the client to complete.
4.1.3 Computer Assisted Audit Techniques (CAAT)
Meaning
• An assisted audit refers to CAATs, or computer-assisted audit tools and techniques
that use software and programs dedicated to the auditing process to help out
auditors, especially with large projects.
• Computer Assisted Audit Technique (CAATs) is a technical technique which is used
to test internally from an application of a good computer all directly or non-
logically used to process data.
• CAATs is the use of computers in auditing activities that are useful for collecting
and evaluating data in the form of electronics in order to be proven audit.
• Computer Assisted Audit Techniques (CAATs) provide auditors with many
advantages over traditional auditing techniques.
4.10
Auditing Audit of Computerized Systems and Forensic Audit

Advantages of CAAT over Traditional Audit System

1. Speed and Accuracy
• The main advantage to CAAT increased speed and accuracy. When an auditor uses
a computer program to run through financial statements and compile data and
figures, then the job is done very quickly. Also, auditing programs tend to come
with useful checks and balances that spot not only calculation errors in business
books but mismatched item entries and potential regulatory issues also.
2. Filtration of Data
• A comprehensive approach of testing, as the entire population of data can be
tested instead of just a sample.
• Filtering of data in large volumes to identify instances of financial leakage, policy
noncompliance and mistakes or errors in data processing.
3. Continuous Monitoring
• Continuous monitoring to identify and respond to operational risk, thus relieving
auditors from tedious manual activities.
• This will be helpful when conducting audit activities and has benefits for auditors
and management also.
• Management can be more confident in the data that they receive and report and
also enjoy the benefit of lowering the number of auditors needed and the person-
hours (man-hours) involved in conducting the audit activities.
4. Large Data
• Auditors can process more data and be more confident in the results and reports
than ever. This leads to better insights and abilities when it comes to detecting
inconsistencies or compliance risks.
5. Models
• This is very useful when an auditor is working to study the business financial
approach and how it can be restructured. The more complex auditing tools can
provide another level of aid by generating computer models and simulations for
the auditor.
• A computer model can run several different simulations, setting-up different
models to show how the accounting process will be affected. It can also use
models to judge the potential for risk (from mistakes, fraud and other problems) in
the current system.
4.11
Auditing Audit of Computerized Systems and Forensic Audit

6. Collaboration
• There are software programs that allow businessmen to set permission to access
data. Even businessmen can sync information with bank and credit accounts and
easily import it. It also allow to reconcile accounts.
7. Storage and Retrieval
• Computer based systems require a fractional amount of physical space as
compared to the books of accounts in the form of journals, ledgers and accounting
registers.
8. Works as a Motivator
• Employees using computer systems feel more valued as they are trained and
specialized for the job.
Disadvantages of CAAT
1. Heavy Cost of Installation
• CAAT is a computer based system. It requires updated software’s from time to time.
Cost of installation is also high.
2. Cost of Training
• The CAAT system requires effective utilization of updated software, which requires
training of the staff. The cost of training is high. It requires trained specialized
persons.
3. Fear of Unemployment
• Computerized systems require less staff in the organization. Staff is reluctant to
change systems such as computerized accounting systems. The staff fears
redundancy and show less interest in computers.
4. Disruption in Work
• When a computerized system is introduced, there might be loss in the work time
and certain changes in the working environment.
5. System Failure
• The danger of a system crashing due to some failure in hardware can lead to
subsequent loss of work. This occurs when no back-up is retained.
6. Time Consuming in Case of System Failure
• Sometimes there is a failure of the system in such cases, there is a need for
providing back-up arrangements which is a time consuming process.
4.12
Auditing Audit of Computerized Systems and Forensic Audit

7. Unanticipated Errors not Known

• Unlike human beings, computers do not have the capability to judge or detect
unanticipated errors in the system, so sometimes it is more difficult to detect errors
on a computer than by a manual system.
8. Breaches of Security
• The danger of viruses and hacking into the system from outside creates a strong
need for security of the system. Similarly, the person who has created the specific
program can easily defraud by tempering with the original records.
9. Health Problems
• More use of computers may lead to many health problems such as eye strain,
muscular complaints, backache etc. leading to reduced working efficiency as well as
increasing medical expenditure.
4.1.4 Factors and Preparation of CAAT
• CAAT is needed in order to obtain and evaluate data in electronic form. Therefore,
auditors must know the techniques by which they can experiment with analysing
electronic data called Computer Assisted Audit Techniques.
• CAATs can also be interpreted as the use of certain software tools that are carried
out to test control.
1. Test Data
• Audit test data is used to test the existence and effectiveness of controls built into
an application program used by a client. Dummy transactions are processed
through the client’s computerised system.
• The objective of this is to test the operation of application controls within the
system. The results of processing are then compared to the auditor’s expected
results to determine whether controls are operating efficiently and systems’
objectiveness are being achieved.
• To be successful, test data should include both data with errors built into it and
data without errors.
Examples of Errors
• Codes not exist, e.g. customer, supplier and employee;
• Transactions above pre-determined limits, e.g. salaries above contracted amounts,
credit above limits agreed with customer;
• Invoices with arithmetical errors; and
• Submitting data with incorrect batch control totals.
4.13
Auditing Audit of Computerized Systems and Forensic Audit

• Data may be processed during a normal operational cycle ('live' test data) or during
a special run at a point in time outside the normal operational cycle ('dead' test
data).
2. Black Box Testing
• It is also known as Behavioural Testing. It is a software testing method in which the
functionalities of software applications are tested without having knowledge of
internal code structure, implementation details and internal paths.
• Black Box Testing mainly focuses on input and output of software applications and
it is entirely based on software requirements and specifications.

Input

Blackbox

Output

Fig. 4.6 : Techniques (Factors and Preparation of CAAT)

Steps in Black Box Approach
(a) Initially, the requirements of the system is checked.
(b) Tester chooses valid inputs (positive test scenario) to check whether it processes
them correctly or not.
(c) Tester determines expected outputs for all those inputs.
(d) Software tester constructs test cases with the selected inputs.
(e) The test cases are executed.
(f) Software tester compares the actual outputs with the expected outputs.
3. Grey Box Security Audit
• Grey Box testing allows you to accurately simulate the threat from an attacker that
has been able to gain partial information about your infrastructure.
4.14
Auditing Audit of Computerized Systems and Forensic Audit

• The audit prepares you for a scenario where certain details or information have
been leaked by social engineering or other offline threats.
• This approach aims to deliver a cost-effective audit while focusing on areas that are
important to your organization.
• In a Grey Box Security Audit, the audit team would be given partial information
about the target environment, such that it could be identified by a motivated
attacker.
• Documents provided could include policy documents, network diagrams and other
valuable information.
4. White Box Testing
• It is a software testing technique in which internal structure, design and coding of
software are tested to verify flow of input-output and to improve design, usability
and security.
• In white box testing, code is visible to testers so it is also called Clear box testing,
Open box testing, Transparent box testing, Code-based testing and Glass box
testing.
• White box testing involves the testing of the software code for the following:
(a) Internal security holes.
(b) Broken or poorly structured paths in the coding processes.
(c) The flow of specific inputs through the code.
(d) Expected output.
(e) The functionality of conditional loops.
(f) Testing of each statement, object and function on an individual basis.
• One of the basic goals of white box testing is to verify a working flow for an
application. It involves testing a series of predefined inputs against expected or
desired outputs.
5. The Computer-Assisted Audit Program (CAAP)
• This program is helpful to taxpayers because using the CAAP leads to
Departmental review, analyses and verify taxpayer data more efficiently and
effectively.
• It provides a method of gathering and receiving data in electronic format rather
than paper.
4.15
Auditing Audit of Computerized Systems and Forensic Audit

• The use of CAAP benefits both the taxpayer and the Department of Revenue by
building an environment that uses technology to ensure efficient use of
government and taxpayer resources.
• Most taxpayers maintain at least a portion of their accounting records
electronically. CAAP allows for the electronic submission and review of this data. It
will help in reducing the amount of paper output in the process of audit. If those
records are maintained in an electronic format, they should be made available for
inspection in electronic format.
• The procedure is as follows:
The first stage of the process is a conference that will be scheduled to discuss
audit objectives and approach. The following topics will be discussed :
General audit procedures
Computer -assisted audit procedures
Opening Sampling techniques, if applicable
Conference Specific data needed in electronic format

A data integrity check is performed to verify that the electronic

data provided by the taxpayer to the Department is both
complete and accurate.

Data This is accomplished by reconciling the electronic data

Integrity with the taxpayer's books and records.

Sampling is the selection and analysis of a finite number of items

from a larger population to obtain information about that
population. Related to electronic data, a sampling approach is
typically used only when the entire population cannot be
Sampling efficiently reviewed.

Fig. 4.7 : Procedure Involved in CAAP

4.2 Forensic Audit
Introduction
• “Forensic” means suitable to use in the court of law.
• Forensic audit is a dynamic and strategic tool used in auditing. It helps to detect
corruption, frauds in the organization.
• After the fraud of Satyam Computers took place, the importance of forensic audit
increased. It helps to detect frauds and fraudulent activities in companies.
4.16
Auditing Audit of Computerized Systems and Forensic Audit

• Various kinds of illegal activities are investigated with the help of forensic audits.
Normally, instead of a normal audit, a forensic audit is used if there is a possibility
that the evidence gathered would be used in court.
• The forensic audit process is similar to a traditional financial audit planning,
gathering evidence and writing a report on that.
4.2.1 Forensic Audit Definition
Forensic Accounting
• Forensic accounting, forensic accountancy or financial forensics is the specialty
practice area of accounting that investigates whether firms engage in financial
reporting misconduct.
• Forensic accountants apply a range of skills and methods to determine whether
there has been financial reporting misconduct.
Forensic Auditing
• According to Bologna, It is the application of financial skills and investigative
mentality to unresolved issues conducted within the context of the rules of
evidence. As an emerging discipline, it encompasses financial expertise, fraud
knowledge and sound knowledge and understanding of business reality and
working of the legal system.
• But, the definition keeps changing according to need. In simple language, forensic
auditing includes use of accounting, auditing and investigative skills to assist in
legal matters.
Difference between Other Audit and Forensic Audit
Points Other Audit Forensic Audit
1. Objective It relates to True and Fair It relates to investigation
View. about fraud.
2. Techniques Substantive and compliance Investigative, substantive or
sample based techniques are depth checking techniques
used. are used.
3. Period Normally it is used for one No such limitations.
accounting period.
4. Adverse Negative opinion or qualified Legal determination of fraud
Finding opinion expressed in the impact and identification of
report. perpetrators depending on
scope.
5. Off Balance Used for arithmetic accuracy. Regulatory and propriety of
Dheet items these transactions are
examined.
4.17
Auditing Audit of Computerized Systems and Forensic Audit

4.2.2 Importance of Forensic Auditor

• A forensic auditor is often retained to analyses, interpret, summarize and present
complex financial and business related issues in a manner which is both
understandable and properly supported.
• Forensic audits are highly skilled and specialized and therefore forensic auditor
must possess knowledge about fraud investigation and legal framework.
• Forensic auditors are retained by Lawyers, Police force, Insurance companies,
Banks, Government regulatory bodies, Courts and Business communities.
• The main purpose of Forensic Auditor is:
1. Fraud prevention, 2. Fraud Detection, and 3. Risk management.
• Which can be done through:
(a) Filing requirement
(b) Internal control implementation and review.
(c) Evidence collection and analysis.
(d) Compliance and regulatory functions.
(e) Assignment with regulatory agencies like SEBI, RBI and EOW.
(f) Communicating with audiences from attorneys and judges to victims and suspects.
(g) Professional body to provide expertise and literature in fast growing fields.
(h) Fraud Detection: Investigation and analyzing financial evidence detecting financial
fraud and tracing misappropriation of frauds.
(i) Fraud Prevention: Review internal control to verify their adequacy or provide
consultation in the development and implementation of an internal control.
4.2.3 Services Rendered By Forensic Auditor
• The services rendered by forensic accountants are in great demand which include:
1. Criminal Investigation
• Forensic accountants are availed with matters related to financial implication of
services. The auditor prepares a report and presents evidence while presenting it.
2. Arbitration Service
• Forensic accountants provide arbitration and mediation services to the business
community. They are expert in collection of data and they provide evidence while
presenting data.
4.18
Auditing Audit of Computerized Systems and Forensic Audit

3. Professional Negligence Cases

• Forensic accountants deal with professional negligence cases. Forensic deal with
non-confirmation of GAAP (Generally Accepted Accounting Standards) or non-
compliance of ethical code while conducting business and measurement of loss.
4. Dispute Settlement
• Business firms engaged in forensic accountants handle trade mark cases, contract
disputes, claim for product liability, construction claim etc.
5. Fraud Investigation and Risk Control
• Forensic accountant deals with risk assessment and risk mitigation.
• Forensic accountant also deals with investigation whenever there is fraud.
6. Settlement of Insurance Claim
• Insurance companies engaged in forensic accounting have accurate investigation
procedures while settling claims.
• Policyholders can also take help in claim settlement, if they want changes in
settlement of their claims.
4.2.4 Process of Forensic Auditing
• A forensic accounting audit requires a different type of handling than a financial
statement audit. Each situation requires a unique protocol. This process involves an
initial investigation, information reporting and a final litigation.
• The procedures that normally use to perform forensic audit:

Inquiries Analytical Recalculations Conclusion

Observations
Procedures and Inspections

Fig. 4.8 : Process of Forensic Audit

1. Inquiries
• Evidence is important in Forensic auditing. The Forensic auditor also inquiries to a
person who has resigned from the organization. Forensic auditors can inquire to
employees who are involved in transactions. This will help them to get adequate
information.
• Forensic auditors observe wrong things happening. In other words, it not only
allowed the auditor to obtain the information from other related personnel but also
let the auditor observe what might have happened.
4.19
Auditing Audit of Computerized Systems and Forensic Audit

Example
• Once the officers investigating are on leave. Then his daily job is done by someone
else. During this time, the forensic auditor would be able to notify if there is any
opportunity that fraud or any inappropriateness could have taken place. Yet, this
procedure does require the support from the top management of the company.
• The evidence from the inquiry might not be solid evidence to form the base for the
conclusion.
2. Analytical Procedures
• The result of the analytical review could not be used as an evidence as it could led
to make a wrong conclusion. In the analytical procedure, a forensic auditor before
performing any analytical review should always pay very strong caution to make
sure that the data they use for analysis is accurate.
• The analytical review may not be used to gather data since the result from the
analytical review is based on the best projection and estimate.
• The most important point of this procedure is, it could help the auditor to see the
trend or fluctuation of certain transactions.
Example
• Sales or expense auditors have an analytical investigation on the reason for
deviation.
Example
• If there is a concern about fraud related to salary expenses, the auditor will perform
an analytical review on the salary expenses over the period by incorporating other
financial data like the number of staff, output, attendant list etc.
3. Recalculations and Inspection
• The popular procedure used in gathering evidence is inspection of data and
records under forensic audit. It is collecting a sample of original invoices, receipts
and other important documents.
• The performance of this procedure should be alright with the result of the
analytical review and inquiry that the auditor already performs.
Example
• A detailed review of salary expenses for the months or period that are not
consistent with the other data or records.
4.20
Auditing Audit of Computerized Systems and Forensic Audit

4. Observations
• It is a very important part of the forensic audit should not be avoided otherwise the
performance of other procedures like inspections will not run smoothly or naturally.
• Other important things are that they might need some specific information from
the person who is involved in a specific procure, like payroll accountant the one
who is involved with calculating salary.
• Forensic auditors inquire information from the low level of staff to the top level or
from external parties if required like banks, suppliers or investors.
• Before performing some specific testing of the cause, it is required to understand
some specific procedure or function and to do so, they need to perform actual
observations.
5. Conclusion
• The forensic auditing procedure is similar to the audit procedure, but the evidence
need to be more specific and realistic.
• It also involves planning, detailed testing and conclusion, but the conclusion needs
to be more specific like how much the fraud or loss.
• Forensic accounting also needs to issue the report, but this report is going to be
used for legal purposes or dispute resolutions. This report is different from the
audit report.
4.2.5 Forensic Audit Techniques
• Fraud detestation is a critical task especially when there is misstatement in financial
statements. Techniques used in detection of fraud do not identify all frauds but it
helps in detecting majority of frauds.
Step 1 Step 2 Step 3
Analytical Steps Understand Identify possible Prescribed possible
business fraud exists fraud symptoms

Step 4 Step 8
Technology Steps Use of technology to Step 5
Analyse results Automate detection
collect data about procedures (optional)
symptoms

Step 6 Step 7
Investigative Steps Investigate Follow ups
symptoms (optional)

Fig. 4.9 : Forensic Audit Techniques

4.21
Auditing Audit of Computerized Systems and Forensic Audit

• Some techniques used in Forensic audit by forensic auditor are as follows:

1. General Audit Techniques
(a) Testing Defense
• This technique requires the auditor to attempt to put himself in the shoes and think
like a suspect. He must be able to find out weaknesses of the organization.
• It is a good initial forensic technique that attempted to circumvent these defenses
himself.
2. Statistical and Mathematical Techniques
(a) Trend Analysis
• Business organizations have cycles of seasons as well as economic cycles. Expenses,
volume of sales depend on the cycle of phase through which business is going on.
• Trend analysis helps to compare the differences in nature of expenses incurred by
businessmen.
• Historical data is compared against future data in trend analysis.
• Proper investigation is required for trend analysis techniques.
(b) Ratio Analysis
• Another useful technique in forensic audit is ratio analysis. Under this technique,
financial ratios are calculated to detect frauds by proper investigation.
• Ratios reflect the financial health of the company.
3. Digital Forensic Techniques
• According to Ec-Council, “Digital forensic science is a branch of forensic science
that focuses on the recovery and investigation of material found in digital devices
related to cybercrime”.
• Nowadays people are becoming more digital savvy, they like to do all activities
digitally. It opens the opportunity for financial auditors to collaborate with experts
in digital forensic in conducting the audit, internally or externally, in the
increasingly digitized business landscape to better safeguard the business’s
governance. This shifting to digital documents has created a demand for a new skill
in financial audits to ensure the governance of business operations.
(a) Requirement
• From Auditors Point of view: Digital forensic provides the auditor the capability to
reconstruct the digital evidence from the audited subjects that can be used as
digital evidence that is admissible for court proceedings.
4.22
Auditing Audit of Computerized Systems and Forensic Audit

• From Organizational point of view. For an organization to have this capability, the
key is employing human resources who have competencies in conducting digital
forensic and using the proven and well-known forensic tools.
4. Computer Assisted Auditing Techniques (CAAT)
• CAAT is a tool which is used by forensic auditors. It helps them to find irregularity
in data. It helps the internal auditor to get analytical results. These tools are used
by the business environment and industrial sectors.
• With CAAT forensic accounting can be done analytically. It’s really a helpful tool
that helps the audit firm to work in an efficient and productive manner. The audit
firm is well aware of the benefits of these tools and also making some
advancement in these tools in accordance with their need, in return all the large
raw data converted in statistical and analytical form.
• CAAP is useful to organization in various ways:
(a) It’s a time saving tool.
(b) The CAAT tool supports forensic accounting in which larger amounts can be
diverted to the analytical form and it also prompts where the tool detects the
fraud.
(c) This tool simplifies the data in the automated form.
(d) The name of CAATs tool is placed in almost every firm where the auditing or
advance level accounting takes place.
• Working with the CAAT tool involve:
(i) Accountant or the auditor has to select the right data. The selection process is very
tricky and there is a need for professionals.
(ii) After selecting the right data, import that to the CAAT tool.
(iii) The tool will automatically generate the analytical data.
5. Generalized Audit Software (GAS)
• GAS are for routine files, it include various calculations and printing of reports on
the information used in it. Standard audits are performed by analysis of samples
from the information of the company's record. In this process, investigation is time
consuming.
• This software is developed with the purpose of sorting large amounts of data in a
rapid manner. GAS helps to scan data for investigation purposes. It helps to
provide accurate data. Instead of random sampling, 100 percent data is examined.
Function
• GAS software is designed to examine financial information for quality,
completeness, correctness and consistency. It verifies all calculations, compares
data and print audit samples
4.23
Auditing Audit of Computerized Systems and Forensic Audit

6. Common Software Technique (CST)

• There are some lacunae in GAS that is why CST has become more popular. This
technique is used on a large scale due to lower cost and easy availability.
• Spreadsheets are easily versatile in nature. Auditor has to aware about nature of
data generation, the control environment resolving around the data and sources
from where the data samples are imported into CST.
Examples of CST
(a) Spreadsheets: MS EXCEL, Lotus etc.
(b) RDBMS: MS access
(c) Report writers: Crystal reports
7. Data Mining
Definition
Data mining is a technique that provides specific information that can detect
weaknesses in controls.
• An objective of data mining techniques is to uncover patterns indicating a broken
process and/or develop predictive patterns in business information.
• The first objective is for the auditors to know the purpose of each data element,
including how collective data patterns play a role in business decision making
• Potential financial benefits of using Data Mining Techniques depend upon the
organization.
• There are numerous methods that can be used to reduce the cost of external and
internal audits.
Example
• To reduce external audit fees, the IT internal auditor may use data mining to
validate interface software that performs data transfers between systems.
• Using data mining techniques is especially important when validating data transfers
between non-core systems which are created internally and an Enterprise Resource
Planning (ERP) system (e.g., SAP) used to record financial statement journal entries.
• In addition, data mining can validate the data transfer between the ERP (e.g.,
Lawson, Oracle) and a financial statement reporting package (e.g., ESSBASE) which
is essential to financial statement integrity.
4.24
Auditing Audit of Computerized Systems and Forensic Audit

8. Laboratory Analysis of Physical and Electronic Evidences

• Digital forensic is defined as “a branch of forensic science encompassing the
recovery and investigation of material found in digital devices, often in relation to
computer crime.”
• The term digital forensics was originally used as a synonym for computer forensics
but has expanded to cover investigation of all devices capable of storing digital
data.
• Digital forensics investigations include a variety of applications. It helps to support
criminal investigation, civil courts, corporate investigation, technical aspects etc.
• The technical aspect of this investigation is divided into several sub-branches,
relating to the type of digital devices involved i.e.; computer forensics, network
forensics, forensic data analysis and mobile device forensics.
4.2.6 Forensic Audit Report
• The Forensic Audit report is nothing but statements of observation gathered and
considered while providing conclusive evidence. It is a medium through which an
auditor expresses his opinion under forensic audit.
• Preparing the Forensic Accounting Report is part of the major responsibilities of a
forensic auditor. Reports are prepared at the final stage of investigation.
Objectives
• Main objective are as follows:
1. Forensic Accounting Engagements
• It normally investigates fraud, dispute, insurance claims and criminal cases. This
engagement is normally called by police, lawyer, or the parties in dispute.
2. Forensic audit reports are normally used as an evidence to resolve the case and
present to the person seeking forensic accounting service, normally lawyer, the
insurance company, etc.
Elements
• The main elements to be included are as follows:
1. Executive Summary of Report
• Forensic Audit Report should provide a summary which will help to understand in a
nutshell.
• The importance of opinion and findings that are found during the forensic audit
should be mentioned which will give clear idea about investigation.
4.25
Auditing Audit of Computerized Systems and Forensic Audit

• Executive Summary should include:

(a) Scope of Service
(b) Objective of Service
(c) Investigation Approach
(d) Summary of Finding (Key Finding)
2. Scope of Work in the Report
• The scope of forensic accounting work is really important for an accountant and
the party who engages with the accountant. Scope of work also helps forensic
accountants to prevent and protect their liabilities to the company or other parties
in case there are some problems.
• Make sure what should include this in his Forensic Accounting Report frauds that
are taking place in the organization.
3. State Findings in Report
• Findings are the weakness, errors, or fraud that the forensic auditor found during
the course of his work. All of the findings should be rated based on the nature of
finding, route cause and impacts.
• Finding should be attached with evidence otherwise it can not be taken into
account. Make sure that the findings are telling the true situation and represent the
true fact.
4. Provide the Conclusion in the Report
• All of the forensic accounting reports should have a good conclusion based on the
evidence found.
Points to Remember
• EDP is the practice of processing, storing, retrieving, sharing and maintaining
information electronically.
• Definition of EDP Audit
“EDP auditing is the process of collecting and evaluating evidence to determine
whether a computer system safeguards assets, maintains data integrity, achieves
organizational goals effectively, and consumes resources efficiently.”
• Characteristics of Audit in EDP Environment
1. Less Errors 2. Less Paperwork
3. Coding 4. Internal Control System
5. Avoidance of Duplication of Records
6. No Physical Audit Trail 7. Destruction of Data
4.26
Auditing Audit of Computerized Systems and Forensic Audit

• General Controls are those that control the design, security and use of computer
programme and security of data files in general throughout the organisation.
• EDP Application Control is a security practice that blocks or restricts unauthorised
applications from executing in ways that put data at risk.
• CAAT is the use of computers in auditing activities that are useful for collecting and
evaluating data in form of electronics in order to be proven audit.
• Advantages of CAAT Over Traditional Audit System
1. Speed and Accuracy 2. Filtration of Data
3. Continuous Monitoring 4. Large Data
5. Models 6. Collaboration
7. Storage and Retrieval 8. Works as a Motivator
• Techniques (Factors and Preparation of CAAT)
1. Test Data 2. Black Box Testing
3. Grey Box Security Audit 4. White Box Testing
5. The Computer-Assisted Audit Program (CAAP)
• Forensic Auditing : Definition
According to Bologna, It is the application of financial skills and investigative
mentality to unresolved issues conducted within the context of the rules of
evidence. As an emerging discipline, it encompasses financial expertise, fraud
knowledge and sound knowledge and understanding of business reality and
working of the legal system.
• Services Rendered by Forensic Auditor
1. Criminal Investigation 2. Arbitration Service
3. Professional Negligence Cases 4. Dispute Settlement
5. Fraud Investigation and Risk Control 6. Settlement of Insurance Claim
• Process of Forensic Auditing
1. Inquiries 2. Analytical Procedures
3. Recalculations and Inspection 4. Observations
5. Conclusion
• Forensic Audit Techniques
1. General Audit Techniques
(a) Testing Defense
2. Statistical and Mathematical Techniques
(a) Trend Analysis (b) Ratio Analysis
4.27
Auditing Audit of Computerized Systems and Forensic Audit

3. Digital Forensic Techniques

4. Computer Assisted Auditing Techniques (CAAT)
5. Generalized Audit Software (GAS)
6. Common Software Technique (CST)
7. Data Mining
8. Laboratory Analysis of Physical and Electronic Evidences
• The Forensic Audit report is nothing but statements of observation gathered and
considered while providing conclusive evidence. It is a medium through which an
auditor expresses his opinion under forensic audit.
Questions For Discussion
1. Define EDP Audit. State the Benefits and Characteristics of Audit in EDP
Environment.
2. What are the various Types of General Control ?
3. State the Advantages and Disadvantages of Computer Assisted Audit.
4. Define Forensic Audit. Explain the Process of Forensic Auditing.
5. Describe the various Forensic Audit Techniques.
6. Write Short Notes
(A) EDP Application Control
(B) Factors and Preparation of CAAT
(C) Services rendered by Forensic Auditor
(D) Forensic Audit Report.
❂❂❂

4.28
 APPENDIX
Multiple Choice Questions
(Useful for Online Examination)
Chapter 1 : Introduction Principles of Auditing and Audit Process
1. Cost audit primarily covers the ………………… aspects of the enterprise.
(a) Financial (b) Cost (c) Human (d) Behavioural
2. When the auditor's staff is engaged continuously in checking the accounts of the
client during the whole year round or when the staff attends audit work at same
intervals is called as …………………
(a) Balance Sheet Audit (b) Voluntary Audit
(c) Continuous Audit (d) Concurrent Audit
3. ………………… means examination of financial statement and express an opinion on
them.
(a) Financial Audit (b) Cost Audit
(c) Balance Sheet Audit (d) Concurrent Audit
4. Propriety and efficiency of decisions and managerial actions are studied in
………………… audit.
(a) Financial (b) Management (c) Cost (d) Human
5. Audit techniques refers to the methods and means adopted by the auditor for
collection and evaluation of …………………
(a) Financial Information (b) Audit Evidence
(c) Cost Data (d) Audit Procedure
6. The audit which is prescribed by law i.e. governing by statue or by regulation is
…………………
(a) Concurrent Audit (b) Statutory Audit
(c) Voluntary Audit (d) Financial Audit
7. An audit which is conducted between two annual audits is called as …………………
(a) Interim Audit (b) Balance Sheet Audit
(c) Concurrent Audit (d) Continuous Audit
8. ………………… implies verification of transactions of a year on a continuous basis.
(a) Concurrent Audit (b) Continuous Audit
(c) Statutory Audit (d) Cost Audit
9. The ………………… means Auditors review the Balance Sheet and works back to the
books of origin entry and other evidences.
(a) Balance Sheet Audit (b) Continuous Audit
(c) Concurrent Audit (d) Cost Audit
A.1
Auditing APPINDIX : Multiple Choice Questions

10. ………………… helps the company to publish interim financial statements detection of
interim dividend.
(a) Interim Audit (b) Balance Sheet Audit
(c) Continuous Audit (d) Cost Audit
11. The scope of Voluntary Audit is defined by …………………
(a) Law (b) Letter of engagement
(c) By ICICI (d) Prospectus
12. Auditor performs ………………… of the items in the financial statements.
(a) Analytical Review (b) Testing
(c) Sampling (d) Compliance Procedure
13. ………………… refers to the methods employed for carrying out the audit procedure.
(a) Sampling (b) Testing (c) Techniques (d) Materiality
14. ………………… is purely optional and at discretion of the governing body.
(a) Concurrent Audit (b) Statutory Audit
(c) Voluntary Audit (d) Financial Audit
15. In ………………… Assets and Liabilities are verified only at the time of finalization at
the year end.
(a) Concurrent Audit (b) Voluntary Audit
(c) Financial Audit (d) Statutory Audit
16. The Primary objective of Auditing …………………
(a) To detect errors and frauds
(b) To express true and fair opinion on books of accounts
(c) Both (a) and (b)
(d) To prepare books of accounts
17. The secondary objective of Auditing is to …………………
(a) To detect errors and frauds
(b) To examine the financial reports and express an opinion on them
(c) To express true and fair opinion on books of accounts
(d) Both (a) and (b)
18. Types of audits on the basis of duration/time/periodicity are …………………
(a) Annual Audit (b) Interim Audit
(c) Half Yearly Audit (d) All of the above
19. Posting in a wrong account is an example of …………………
(a) Errors of Commission (b) Errors of Principle
(c) Errors of Omission (d) None of these
A.2
Auditing APPINDIX : Multiple Choice Questions

20. The accountant has not given the second effect of the transaction in the books of
account is an example of …………………
(a) Complete Omission (b) Partial Omission
(c) Fraud (d) None of these
21. ………………… errors are hard to detect from trial balance.
(a) Complete Omission (b) Partial Omission
(c) Both (a) and (b) (d) None of these
22. When the accountant has not following the accounting principle is the example of
…………………
(a) Errors of Commission (b) Errors of Duplication
(c) Errors of Omission (d) Errors of Principle
23. Unintentional misstatement in financial statements means …………………
(a) Fraud (b) Misappropriation
(c) Errors (d) All of the above
24. When the same transaction is recorded twice in the books of original entry the
error is called as …………………
(a) Misappropriation (b) Errors of Principle
(c) Errors of Duplication (d) Errors of Omission
25. The process of ………………… begins when the process of accounting completes.
(a) Book-keeping (b) Investigation (c) Auditing (d) All of the above
26. ………………… refers to the critical and analytical investigation of financial records.
(a) Auditing (b) Book-keeping (c) Accounting (d) Investigation
27. ………………… refers to intentional or omission of disclosure of amount in financial
statement.
(a) Errors (b) Fraud
(c) Misappropriation (d) All of the above
28. ………………… means the information based on which the auditor gives his opinion
and prepare audit report.
(a) Audit Note Book (b) Audit Working Papers
(c) Audit Evidence (d) All of the above
29. Internal Audit is also referred as …………………
(a) Operational Audit (b) Balance Sheet Audit
(c) Post and Vouch Audit (d) None of these
30. Which of the following is not employee fraud ?
(a) Embezzlement of cash (b) Misappropriation of goods
(c) Management Fraud (d) None of these
A.3
Auditing APPINDIX : Multiple Choice Questions

31. Types of Management Frauds are …………………

(a) Showing more Profit than Actual (b) Showing less Profit than Actual
(c) Falsification of Accounts (d) All of the above
32. Types of Audit on the basis of ownership …………………
(a) Private Audit (b) Government Audit
(c) Annual Audit (d) Both (a) and (b) only
33. Record of all details during the process of audit kept by the auditor is known as
…………………
(a) Audit evidence (b) Audit notebook
(c) Audit documentation (d) Audit Report
34. ………………… is defined as an investigation of some statements of figures involving
examination of certain evidence, so as to enable an auditor to make a report on the
statement.
(a) Audit (b) Book-keeping
(c) Accounting (d) Management Accounting
35. According to ICAI, "The term ………………… refers to an International Act by one or
more individuals, among management, those charged with governance, employee
or third parties involving the use of deception to obtain an unjust or illegal
advantage.
(a) Error (b) Fraud (c) Mistake (d) Embezzlement
36. ………………… is a unintentional mistake in the measurement or presentation of
financial information.
(a) Error (b) Fraud (c) Mistake (d) Embezzlement
37. According to Prof. Steller, "An ………………… is an outline of all procedures to be
followed in order to arrive at an opinion concerning the client's Financial
Statement".
(a) Audit Report (b) Audit Working Papers
(c) Audit Programme (d) Audit Note Book
38. ………………… is a register maintained by the audit staff to record important points
observed, errors, doubtful queries, explanation and clarification to be received from
the client.
(a) Audit Report (b) Audit Working Papers
(c) Audit Programme (d) Audit Note Book
39. ………………… are those papers which contain essential facts about account which are
under audit.
(a) Audit Report (b) Audit Working Papers
(c) Audit Programme (d) Audit Note Book
A.4
Auditing APPINDIX : Multiple Choice Questions

40. ………………… means the whole system of control, Financial or otherwise established
by the management in order to carry on the business of the company in an orderly
manner, safeguard its assets.
(a) Internal Control (b) Auditing
(c) Internal System (d) Audit Programme
Answers KEY
1 (b) 2 (c) 3 (a) 4 (b) 5 (b)
6 (b) 7 (a) 8 (a) 9 (a) 10 (a)
11 (b) 12 (a) 13 (c) 14 (c) 15 (a)
16 (b) 17 (a) 18 (d) 19 (a) 20 (b)
21 (a) 22 (d) 23 (c) 24 (c) 25 (c)
26 (a) 27 (b) 28 (c) 29 (a) 30 (c)
31 (d) 32 (d) 33 (b) 34 (a) 35 (b)
36 (a) 37 (c) 38 (d) 39 (b) 40 (a)
❂❂❂
Chapter 2 : Checking, Vouching and Audit Report
1. ………………… means to select and examine a representative sample from a large
number of similar items.
(a) Test checking (b) Auditing
(c) Examination (d) Routine checking
2. Occasional inspection is to check the mathematical accuracy or precision of
transaction record is called as …………………
(a) Test checking (b) Auditing
(c) Examination (d) Routine checking
3. A ………………… is any documentary evidence in support of transaction in the books
of accounts.
(a) Document (b) Voucher
(c) Working Paper (d) Internal check
4. The Act of examining documentary evidence in order to ascertain the accuracy and
authenticity of entries in the accounts books is called …………………
(a) Voucher (b) Document
(c) Working Paper (d) Vouching
A.5
Auditing APPINDIX : Multiple Choice Questions

5. The ………………… is method of organizing the entire operations, office, warehouse,

factory and the duties to the respective staff so that frauds and irregulaties are
impossible.
(a) Internal control (b) Auditing
(c) Internal check (d) Vouching
6. The ………………… of assets implies an enquiry into the value, ownership and title
existence and possession and the presence of any charge on the assets.
(a) Verification (b) Vouching
(c) Documentation (d) None of the above
7. ………………… is a process which proves the existence, ownership and title of the
assets.
(a) Verification (b) Vouching
(c) Documentation (d) None of the above
8. Setting of the exact value of an asset on the basis of utility is known as …………………
(a) Verification (b) Valuation
(c) Documentation (d) Vouching
9. The price which is paid for the acquisition of an asset is known as …………………
(a) Scrap Value (b) Market Price (c) Book Value (d) Cost Price
10. The value which an asset can fetch in the market when sold is known as
…………………
(a) Scrap value (b) Market value (c) Book value (d) Cost price
11. ………………… is an intangible asset, it is the value for the reputation of the firm,
which enables the firm to earn more than normal rate of profit.
(a) Patent (b) Copy right (c) Goodwill (d) Fixed Asset
12. ………………… is the process of examination of legal and official documents to ensure
the existence, completeness, valuation and disclosure of liabilities of an entity.
(a) Verification (b) Valuation
(c) Valuation of Assets (d) Verification of liabilities
13. ………………… is defined as a formal document that states an auditor's judgment of a
company's account.
(a) Audit Statement (b) Audit Report
(c) Audit Working Papers (d) Audit Notes
14. An unqualified opinion is considered as …………………
(a) Clean report (b) Qualified report
(c) Disclaimer Report (d) Adverse report
A.6
Auditing APPINDIX : Multiple Choice Questions

15. When a auditor is not satisfied or confident about any specific process or
transaction that prevent him from issuing an unqualified or clean report then he
may issue …………………
(a) Clean report (b) Qualified report
(c) Disclaimer report (d) Adverse report
16. It is a written confirmation of the accuracy of the facts stated in the …………………
and does not involve an opinion.
(a) Qualified Report (b) Adverse Report
(c) Audit Certificate (d) Audit Report
17. AASB stands for …………………
(a) Auditing and Assurance Standard Board
(b) Assurance and Auditing Standard Board
(c) Assurance and Auditing Setting Board
(d) Assurance and Auditing Setting Base
18. Objective and scope of the Audit of financial statement is …………………
(a) AAS-1 (b) AAS-2 (c) AAS-3 (d) AAS-4
19. AAS-3 is related with …………………
(a) Verification (b) Vouching (c) Auditing (d) Documentation
20. AAS-5 related to …………………
(a) Documentation (b) Audit Evidence
(c) Verification (d) Vouching
21. AAS-I deals with …………………
(a) Evidence (b) Documentation
(c) Basic Principles Governing an Audit (d) Vouching
Answers KEY
1 (a) 2 (d) 3 (b) 4 (d) 5 (a)
6 (a) 7 (a) 8 (b) 9 (d) 10 (b)
11 (c) 12 (d) 13 (b) 14 (a) 15 (b)
16 (c) 17 (a) 18 (b) 19 (d) 20 (b)
21 (c)
❂❂❂
A.7
Auditing APPINDIX : Multiple Choice Questions

Chapter 3 : Company Audit and Tax Audit

1. The person who is responsible for financial working of the company is known as
…………………
(a) Accountant (b) Director (c) Auditor (d) Employee
2. Section 138 to 148 of Companies Act deals with …………………
(a) Audit, Accounts and Auditors (b) Cost Accountant, Store, Purchase
(c) Director, Removal of Director (d) All of the above
3. ………………… requires all public companies to conduct regular reviews by external
auditor in compliance with official auditing procedures.
(a) RBI (b) SEBI (c) C and AG (d) GAAP
4. ………………… Section of the Companies Act, 2013 deals with qualification and
disqualification of an Auditor.
(a) 141 (1) (b) 142 (1) (c) 143 (1) (d) 144 (1)
5. Following is not the professional quality of an auditor.
(a) Conversation Skill
(b) Thorough knowledge of the Principles and Practice of Accountancy
(c) Knowledge about GST, Income Tax
(d) Knowledge of techniques of auditing
6. Section ………………… lays down that the first auditor of the company appointed by
the Board of Directors.
(a) 137 (6) (b) 138 (6) (c) 139 (6) (d) 140 (6)
7. Board of Directors within ………………… days should appoint first auditor of a
company.
(a) 32 (b) 42 (c) 40 (d) 30
8. The retiring auditor may re-appoint by complying provision under Section
…………………
(a) 139 (9) (b) 139 (8) (c) 139 (7) (d) 139 (6)
9. Following form is not required in removal of auditor before their term.
(a) ITR 1 (b) MGT 14 (c) ADT-2 (d) RD-1
10. Section ………………… of Indian Companies Act, 2013 deals with 'Powers and Duties'
of an Auditor.
(a) 140 (b) 141 (c) 142 (d) 143
11. A ………………… is an audit, made compulsory by the Income Tax, if the annual gross
turnover/receipts of the assessee exceeds specific limit.
(a) Tax Audit (b) Cost Audit
(c) Statutory Audit (d) None of the above
A.8
Auditing APPINDIX : Multiple Choice Questions

12. The audit which is conducted under Section 44 AB of the Income Tax Act, 1961 is
called …………………
(a) Cost Audit (b) Statutory Audit
(c) Tax Audit (d) None of the above
13. Section 44 AA is related to provisions related to …………………
(a) Tax Audit (b) Presumptive Taxation
(c) Maintenance of Accounts (d) Duties of an Auditor
14. An assesee needs to be audited under Section 44 AB is his annual gross receipt in
profession exceeds ………………… in previous year.
(a) ` 10 Lakh (b) ` 25 Lakh (c) ` 50 Lakh (d) ` 75 Lakh
15. As per Section 271 A, if assessee fails to maintain books of accounts as per Section
44 AA penalty of ………………… is levied on him.
(a) ` 25,000 (b) ` 50,000 (c) ` 75,000 (d) ` 1,00,000
16. As per Section 139 (8), any caused vacancy shall be filled by the board within
………………… days.
(a) 20 (b) 30 (c) 40 (d) 50
17. Auditor can claim the possession on working papers prepared by him according to
…………………
(a) Right to be Indemnity
(b) Right to report to members
(c) Right to Give suggestions to the board
(d) Right to Lien on working papers.
18. ………………… means a Chartered Accountant as defined in Clause (b) of Sub Section
(1) of Section 2 of Chartered Accountants Act, 1949.
(a) Auditor (b) Accountant
(c) Cost Accountant (d) Management Accountant
19. The company shall file ………………… Form in ADT-1 intimating the Registrar about
the appointment of the Auditor.
(a) A (b) B (c) C (d) E
20. The company shall intimate the registrar about the appointment of the auditor
within ………………… days from the date of his appointment.
(a) 15 days (b) 20 days (c) 25 days (d) 30 days
Answers KEY
1 (c) 2 (a) 3 (b) 4 (a) 5 (a)
6 (c) 7 (d) 8 (a) 9 (a) 10 (d)
11 (a) 12 (c) 13 (c) 14 (c) 15 (a)
16 (b) 17 (d) 18 (b) 19 (d) 20 (a)
❂❂❂
A.9
Auditing APPINDIX : Multiple Choice Questions

Chapter 4 : Audit of Computerized Systems and Forensic Audit

1. A ………………… is an electronic device for storing and processing data, typically in
binary form according to instructions given to it.
(a) EDP (b) Computer (c) ALU (d) Control Unit
2. CPU stands for …………………
(a) Central Processing Unit (b) Control Processing Unit
(c) Central Programme Unit (d) Control Program Unit
3. According to Weber, "………………… is the process of collecting and evaluation
evidence to determine whether a computer system safeguards assets, maintain
data integrity, achieves organizational goals effiectiveness and consumes resources
efficiently".
(a) Auditing (b) EDP Auditing
(c) Financial Auditing (d) Statutory Auditing
4. EDP stands for …………………
(a) Electronic Data Processing (b) Electrical Data Processing
(c) Electronic Demand Processing (d) Electrical Demand Processing
5. ………………… are those that control the design security and use of computer
programs and the security of data files in general throughout the organization.
(a) Application Control (b) General Control
(c) Electric Control (d) Electronic Control
6. ………………… is a security practice that blocks and restricts unauthorized application
from executing in ways that put data at risk.
(a) Application Control (b) Electric Control
(c) General Control (d) Electronic Control
7. Following is not the type of application control.
(a) Input Control (b) Output Control
(c) Processing Control (d) Hardware Control
8. ………………… is the type of General Control.
(a) Data and Procedural Control (b) Input Control
(c) Output Control (d) Processing Control
9. CAAT stands for …………………
(a) Controllable Applicable Audit Techniques
(b) Continuous Applicable Audit Techniques
(c) Computer Assisted Audit Techniques
(d) Computer Applicable Audit Techniques
A.10
Auditing APPINDIX : Multiple Choice Questions

10. ………………… testing is known as Behavioural testing.

(a) Grey Box (b) White Box (c) Black Box (d) Test Box
11. ………………… testing mainly focuses on input and output of software application and
it is entirely based on software requirements and specifications.
(a) Grey Box (b) White Box (c) Black Box (d) Test Box
12. ………………… testing allows you to accurately simulate the threat from an attacker
that has been able to gain partial information about your infrastructure.
(a) Grey Box (b) White Box (c) Black Box (d) Test Box
13. ………………… is called as clear box testing, open box testing, transparent box testing.
(a) Grey Box Testing (b) White Box Testing
(c) Black Box Testing (d) Test Box Testing
14. In ………………… testing, code is visible to tester.
(a) Grey Box (b) White Box (c) Black Box (d) Test Box
15. ………………… is selection and analysis of a definite number of items from a large
population.
(a) Data (b) Sampling (c) Grey Box (d) White Box
16. A ………………… check is performed to verify that the electronic data provided by the
taxpayer to department is both complete and accurate.
(a) Data integrity (b) Sampling
(c) Data (d) Opening Conference
17. ………………… is a dynamic and strategic tool used in auditing. It helps to detect
corruption, fraud in the organization.
(a) Statutory Audit (b) Interim Audit
(c) Forensic Audit (d) Data Integrity
18. GAS stands for …………………
(a) Generalized Audit Technique (b) Global Audit Technique
(c) Global Accuracy Test (d) General Accuracy Test
19. Historical data is compared against future data in ………………… under statistical audit
techniques.
(a) Testing defense (b) Computer Assisted Technique
(c) Trend Analysis (d) Ratio Analysis
20. ………………… is a branch of forensic science that focuses on recovery and
investigation of material found in digital devices related to cybercrime.
(a) Digital Forensic Science (b) Forensic Audit
(c) Ratio analysis (d) Trend analysis
A.11
Auditing APPINDIX : Multiple Choice Questions

21. The ………………… tool supports forensic accounting in which larger amounts can be
diverted to the analytical form and it also prompts tool to detect fraud.
(a) GAS (Generalized Audit Software)
(b) CAAT (Computer Assisted Audit Technique)
(c) ES-Council
(d) GAAP (Generally Accepted Accounting Principles)
22. ………………… software is designed to examine financial information for quality,
completeness, correctness and consistency.
(a) GAS (Generalized Audit Software)
(b) CAAT (Computer Assisted Audit Technique)
(c) ES-Council
(d) GAAP (Generally Accepted Accounting Principle)
23. Spread sheets, RDBMS are the examples of …………………
(a) Common Software Techniques (b) ES-Council
(c) Generalized Audit Software (d) Data Mining
24. ………………… is a technique that provide specific information that can detect
weaknesses in controls.
(a) Data Mining (b) ES-Council
(c) Common Software Techniques (d) Generalized Audit Software
25. ………………… is a statement of observation given by forensic auditor and express his
opinion through it.
(a) Financial Audit Report (b) Forensic Audit Report
(c) Statutory Audit Report (d) Cost Audit Report
Answers KEY
1 (b) 2 (a) 3 (b) 4 (a) 5 (b)
6 (a) 7 (d) 8 (a) 9 (c) 10 (c)
11 (c) 12 (a) 13 (b) 14 (b) 15 (b)
16 (a) 17 (c) 18 (a) 19 (c) 20 (a)
21 (b) 22 (a) 23 (a) 24 (a) 25 (b)
❂❂❂

A.12