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ASSIGNMENT SOLUTIONS GUIDE (2014-2015)

E.C.O.-12
Elements of Auditing
Disclaimer/Special Note: These are just the sample of the Answers/Solutions to some of the Questions given in the
Assignments. These Sample Answers/Solutions are prepared by Private Teacher/Tutors/Auhtors for the help and Guidance
of the student to get an idea of how he/she can answer the Questions of the Assignments. We do not claim 100% Accuracy
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these solutions and answers are prepared by the private teacher/tutor so the chances of error or mistake cannot be denied.
Any Omission or Error is highly regretted though every care has been taken while preparing these Sample Answers/
Solutions. Please consult your own Teacher/Tutor before you prepare a Particular Answer & for uptodate and exact
information, data and solution. Student should must read and refer the official study material provided by the university.

Answer the following questions.

Q.1. Two main objectives of an audit are prevention and detection of errors and frauds, Discuss this
statement.
Ans. An error means an innocent mistake made by a person while recording a transaction in the books of
accounts or other records like carrying wrong total from one page to another, carrying wrong total from subsidiary
books to ledger accounts, capital expenditure may wrongly be treated as revenue expenditure and vice versa etc.
A fraud is an error or mistake made willfully and knowingly with a view to deceive or cheat the other people.
Detection of error is comparatively an easy work because it is not done in a planned way. But detection of error is a
difficult task as it is done in a planned way.
Objectives of Audit
The objects of audit can be classified as Main Objects and Subsidiary Objects.
Main Objects: The main object of audit is to verify the accounts and to report whether the Balance Sheet and
the Profit and Loss Accounts have been drawn properly according to the Companies Act and whether they exhibit a
true and fair view of the state of affairs of the business. The verification of accounts is done to see if they are correct,
complete and in conformity with the law.
Subsidiary Objects: The subsidiary objects of the auditor are:
(a) Detection and Prevention of Errors
(b) Detection and Prevention of Frauds.
I. Detection and Prevention of Errors: Errors are of various types:
(a) Clerical Errors: Such an error arises due to the mistake of the clerk. Clerical errors are of three types:
(i) Error of Commission: Error of Commission arise through negligence in the matter of recording some
business transactions in the books of accounts. If an item is incorrectly recorded in the journal and posted in the
ledger, it is an error of commission. Examples are incorrect recording, incorrect posting or posting an item to a wrong
account, errors in totalling and balancing and errors in carrying forward totals to trial balance.
(ii) Error of Omission: If a transaction has been omitted from being entered in the book of accounts, wholly or
partially it is an example of error of omission.
Where items remain partially recorded.
If an item has been recorded in the journal but not posted in ledger.

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The error which arise due to non-recording of certain items will not affect the trial balance and as such
omission can be detected by careful scrutiny of the books of accounts.
(iii) Compensating Error: It arises when an error is counter balanced or compensated by any other error so
that the adverse effect of one on debit or credit side is neutralised by that of another on debit or credit side. Compensating
errors will not affect the trial balance and as such will not be detected easily. Hence, their detection requires complete
and exhaustive preparation on the part of the auditor.
(b) Errors of Principle: They arise out of disregard for the principles of accountancy like incorrect allocation of
expenditure between capital and revenue, posting of revenue items to the wrong class of revenue account (Wages
posted to general expense), posting of an item of revenue or expenditure to the personal account, valuation of assets
against fundamental principles of accountancy.
Detection and Prevention of Frauds: Fraud is a false representation or entry, which is made always intentionally
with some fraudulent objectives.
(i) Mis-appropriation of Cash: Usually, cash is mis-appropriated by theft of cash receipts and petty cash, theft
of cheques and other negotiable instruments, payment made to fictitious creditors or workmen. Mis-appropriation or
defalcation of cash is a very easy affair. Anybody with a little skill on his part can mis-appropriate money, especially
in a big business house where the contacts between the proprietor and the persons handling the cash are not so close.
(ii) Mis-appropriation of Goods: Goods can be mis-appropriated by:
(i) The actual theft of stock and/or
(ii) The issuing of fictitious credit notes to customers where there is collusion of the employee with the customer.
The chances of mis-appropriation of goods is more where goods are less bulky, highly priced and easy to carry
without detection. Only detailed checking by the auditor can bring fraud to light. He should check up the stock
records, purchases and sales very carefully.
(iii) Manipulation of Accounts: The fraud is committed by persons holding high position in the organisation.
This can be done when a person:
(i) Makes a false entry;
(ii) Alters a true entry;
(iii) Omits to enter a true transaction.
Q. 2. (a) What is Internal Check? Differentiate between Internal Audit and Internal Check.
Ans. Internal check denotes such an arrangement of duties among the staff that the work performed by one
individual is independently checked by another in a routine course.
Under the system of Internal check, care is taken to ensure that no one person alone handles a transaction
completely from the beginning to the end and the work of every person is checked by another person in the same or
the other department.
According to Spicer and Pegler "Internal check is an arrangement of staff duties whereby no one person is
allowed to carry through and to record every aspect of a transaction so that, without collusion between two or more
persons, fraud is prevented and at the same time the possibilities of errors are reduced to a minimum."
According to De Paulas, "An internal check means practically a continuous internal audit carried on by itself, by
means of which the work of each individual independently checked by other members of the staff."
The system of Internal Check is based on the principle of Division of Labour. The method involves mainly four
things:
1. The work is properly divided in such a way that all duties are assigned to different clerks.
2. The clerk gets the work load according to their capacities and qualifications.
3. One person does not perform any single task from the beginning to the end.
4. The work done by one clerk is checked independently and automatically by another.

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The difference between Internal Check and Internal Audit are:

Basis

Internal Check

Internal Audit

1. Operation

It is an arrangement of duties allocated in

such a way that work done by one clerk
is automatically.

It is an independent review
of operations and records
checked by another.

2. Staff

There is no separate staff appointed especially for this purpose. Different clerks of
business are allocated their assignments
with which they proceed and carry on
checking at the same time.

Separate salaried staff of

internal auditor is engaged.

3. Errors and
Frauds

The system of internal check is so devised

that the possibilities of errors and frauds
are reduced to minimum.

In internal audit, errors and

frauds which have already been
committed can be discovered.

4. Time and
Checking

In Internal Check, the work is so distributed that the work of one clerk is automatically and independently checked by
another simultaneously.

In internal audit the work of

the clerk is checked by
internal auditor after the
former finished the work.

5. Object

The object is to prevent the errors and

frauds.

The object is to detect the

errors and frauds.

Internal Check is a process in itself under

which work goes on uninterruptedly and
checking too, is more or less automatic.

The work involved in internal

audit is just like that of a
watchman. Internal auditor
has to see how far the work of
the business is being done
correctly and according to the
rules prescribed for that purpose.

6. Work
Involved

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(b) What is Continuous Audit? Discuss its merits and demerits.

Ans. Continuous audit is an audit which is continuously done throughout the year. It involves detailed examination
of transactions, books of accounts including different supporting vouchers and documents by the audit staff continuously
throughout the year or at regular intervals say fortnightly, monthly or quarterly. Continuous audit enables completion
of audit at the quickest possible time after closing of accounts. According to R.C. Williams, "A Continuous Audit is
one where the auditor or his staff is continuously engaged in checking the accounts during the whole period or where
the auditor or his staff attend at regular or irregular intervals during the period."
Merits of Continuous Audit
1. Since the audit is conducted continuously, errors and frauds are detected early and quickly, with the result that
there is adequate time for making the necessary rectification.
2. Since the auditor is visiting his client frequently at short intervals, it is possible to check the accounts thoroughly
and closely.
3. Since the auditor may pay a surprise visit, he exercises a great moral check on the clients staff. The staff will
be afraid of committing errors and frauds as there are greater chances of their being detected.
4. Audit work in such a case continues throughout the year, therefore the accounting work is also done side-byside. This helps in the preparation of final accounts immediately after the end of the year.
Demerits of Continuous Audit
1. Those figures which have already be checked by the auditor in the books of accounts during his previous visit
may be altered and frauds may be perpetrated.

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2. In case of continuous audit presence of the auditor and his staff creates hindrances in the regular work of the
business house.
3. Due to frequent visit by the audit staff, the clients staff may develop intimacy and friendship. Thus, audit staff
may fail to detect errors and frauds properly.
4. Continuous audit is more expensive. Since the auditor and his staff visits the organisation more frequently and
the management has to spend more of them, both in term of time and money. Auditor also charges higher fees for
continuous audit.
Q. 3. How would you vouch the following items:
(i) Preliminary Expenses
Ans.Preliminary expenses are those expenses which are incurred in business before incorporation and
commencement of business, like statutory fee, company logo, survey report, project report etc are called preliminary
expenses. In case of company we can say that all type of expenses which spent by promoters of company called
preliminary expenses.
In simple words preliminary expenses has covers all expenses before incorporation of business, if any expenses
has spent after commencement or incorporation of business doesn't considered preliminary expenses.
Examples of preliminary expenses:
1. Expenses to promoters of company.
2. Expenses paid for incorporation of company.
3. Printing expenses of Memorandum of association & Articles of Association
4. Payment to survey report, project report.
5. Stamp duty fees paid.
6. Any expenses paid to take the business into existence.
Accounting treatment of preliminary expenses: Preliminary expenses gives long term benefit so it is treated as
intangible assets and shown in balance sheet under miscellaneous assets:
1. When preliminary expenses are incurred /paid:
Preliminary expense (Current Assets) A/c Dr.
To Cash/Bank A/c
2. When part of preliminary expenses are considered as indirect expense:Preliminary Expenses written off A/c Dr.
To preliminary expenses A/c
3. Charge of preliminary expenses:
Profit & Loss A/c Dr.
To preliminary expenses A/c
(ii) Receipts from Debtors
Ans. Receipts from Debtors: The auditor should vouch from the counterfoils of daily receipts issued and

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posted to the customer's accounts. If he feels necessary, he should also have correspondence with the debtors.
There is a fraudulent practice on the part of cashier to misappropriate cash through the process of "Teeming and
Lading" i.e. not entering cash in the cash book received from the debtor and entering it only when a similar amount
is received from another debtor and so on. Teeming and lading will be easy to detect if the following points are
noted:
1. He should ascertain whether the name, amount and dates as shown on the receipt are in complete agreement
with relevant cash receipt records.
2. He should compare individual receipts as recorded in rough cash book with the receipts issued and posted to
individual customers.
3. He should compare the details of the rough cash book, main cash book, and the receipts issued to individual
customers.
4. He should ascertain whether the cash receipts are deposited in the bank on time.
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5. He should carefully examine the debtor's ledger, especially those accounts which show part payments, in
order to satisfy himself that the debtors concerned have indeed made part payment.
6. From time-to-time he should get the balances in the debtors ledger confirmed by individual debtors.
Q. 4. Differentiate between valuation and verification of assets. How would you verify the following
assets:
(i) Fixed Assets
Ans. Fixed Assets: Fixed asset may be defined as an asset which is held with the intention that it will be used

for production or provision of goods and services and not for sale in the normal course of business. Fixed assets
may be classified as:
1. Assets which are not subject to depreciation, e.g. Land.
2. Assets which are subject to depreciation, e.g. Building, Plant and Machinery.
3. Assets which are subject to depletion, e.g. Mines, oil wells etc.
A non-depreciable fixed asset such as land is valued at cost price, including purchase price, broker's commission,
registration fees, legal charges etc.
In case of depreciable fixed asset, the basis of valuation is the cost of purchase which includes all incidental
payments necessary to put the assets in condition, e.g. freight, cost of material, labour and services used in construction
and installation, and title examination and registration fees. Depreciation on fixed assets should be equitably distributed
over the entire working life of the asset that the Profit and Loss Account of each accounting year effectively shares
the proportionate loss for the period.
(ii) Fictitious Assets
Ans. Automobile, mining, petroleum, and steel industries which require very large capital investment in weighty
machinery and huge plants. A section of an economys secondary industry characterized by capital-intensive and
less labor-intensive operations. One way of characterizing heavy industry is that one unit of currency will buy more
heavy industry-produced products than it would buy light industry-produced products (for example, more steel can
be purchased for $1 than pharmaceuticals). Products made by an economys heavy industry tend are less likely to be
targeted toward end consumers. Steel manufacturing and chemical manufacturing are two types of heavy industries.
A section of an economys secondary industry characterized by less capital-intensive and more laborintensive operations. Products made by an economys light industry tend to be targeted toward end consumers rather
than other businesses. Consumer electronics and clothing manufacturing are examples of light industry.
Q. 5. How are the Auditors of a company appointed? Discuss their rights.
Ans. Appointment of an Auditor: The appointment of an auditor is dealt within Section 224 of the Companies

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Act, 1956, the provision of which are as under; every company, even a private company, must appoint an auditor
or auditors to audit its annual accounts. There are following authorities to appoint auditors:
1. By Director: The first auditor of a newly floated company are appointed by the Board of Directors within one
month of the registration of the company, and the auditors so appointed shall hold office till the conclusion of the first
Annual General Meeting. If the board fails to appoint the first auditor, then the shareholders will appoint the auditor at
the general meeting who shall hold the office till the next Annual General Meeting.
2. General Meeting:
(a) If the board of directors fails to appoint the auditor, the company shall appoint the first auditor in the general
meeting.
(b) Every company shall at each general meeting appoint an auditor or auditors to hold office from the conclusion
of that general meeting until the conclusion of the next annual general meeting.
(c) The company shall within seven days of appointment give intimation thereof to every auditor so appointed.
(d) An auditor so appointed shall, within thirty days of the receipt from the company of the intimation of his
appointment, inform the registrar in writing that he has accepted or refused to accept the appointment.
3. Central Government: Where at an annual general meeting no auditors are appointed or
re-appointed the Central Government may appoint a person to fill the vacancy. The company shall file an application
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with the government giving reasons why it could not appoint an auditor, within seven days of the Annual General
Meeting. If a company fails to do so the company and every officer of the company who is in default shall be
punishable with a fine which may extend to Rs. 5000.
4. Appointment by a Special Resolution 224 A: In case of a company in which not less than 25% of the
subscribed share capital is held, whether singly or in any combination by:
(a) A public financial institution or Government or Central Government or any State Government;
(b) Any financial or other institution established by any Provincial or State Act or in which State Government
holds 51% of the subscribed capital;
(c) A nationalised bank or an insurance company carrying on general insurance business.
1. Right to access the books of accounts: Every auditor of the company has a right to access at all times to
the books oaccounts and vouchers of the company whether kept at the head office of the company or elsewhere.
2. Right to obtain information and explanation: He has a right to obtain from the directors and officers of the
company any information and explanation as he thinks necessary for the performance of his duties as an auditor.
3. Right to correct any wrong statement: The auditor is required to make a report to the members of the
company on the accounts examined by him and on every Balance Sheet and Profit and Loss Account and on every
other document declared by this act to be part of or annexed to the Balance Sheet and Profit and Loss Account which
are laid before the company in general meeting during his tenure of office.
4. Right to visit branches: According to Section 228, if a company has a branch office, the accounts of the
office shall be audited by the company's auditor appointed under Section 224 or by a person qualified forappointinent
as auditor of the company under Section 226.
5. Right to signature on Audit Report: Under Section 229, only the person appointed as the auditor of tlie
company or where a firm is so appointed, only a partner in the firm practising in India may sign the auditors report.
6. Right to receive notice and other communication relating to General Meeting and attend them:
Under Section' 231, an auditor of a company has a right to receive notices and other communications reiating to
General Meeting in the same way as a member of the company. He is also entitled to attend any general meeting
which he attends or any part of the business whicli concerns him as an auditor.
7. Right of being indemnified: An auditor has a right to be indemnified out of the assets of the company against
any liability incurred by him defending himself against any civil and criminal proceedings by the company if it is proved
that the auditor has acted honestly or the judgment delivered is in his favour.
8. Right to have legal and technical advise : He has a right to seek the opinion of the experts and thus take
legal and technical advice.
9. Right to receive remuneration: He has a right to receive remuneration provided he has completed the rork
which he undertook to do so.

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