NAME-HERSH RIJHSINGHANI

BATCH-A-1
SUBJECT-ENTREPRENEURSHIP & SMALL
BUSINESS MANAGEMENT.
INSTITUTE-IIPM (PGP-B-SS-13/15)

TOPIC-ROLE OF THE AUDITOR IN SMALL

BUSINESS ORGANISATION

AGENDA
What is an Auditor.
External Auditor vs Internal Auditor.
Salient features of an Auditors
report.
Audit procedures & techniques for an
Internal Audit.
The importance of Internal Audit
function in a Company.
Common areas of Audit.
Conclusion.

What is an auditor?
Definition: In accounting, an auditor is someone who is responsible for
evaluating the validity and reliability of a company or organizations financial
statements.
The auditor is an individual who is trained to review and verify that the
accounting data provided by an audited company accurately corresponds to
the activities that have been partaken by the company.

The auditor's job is to write a report at the conclusion of the audit which
determines the level of accuracy and clarity that the organization has
accounted for.

For instance, if all accounting moves made by the company are reflected in

the books (such as the general ledger), and all data that appears in the
records correspond to the course of business in the company, then the audit
will have shown no misstatements .
External vs. internal auditors
Auditors of financial statements can be externally or internally located in
reference to the company or organization whose financial statements they
are auditing.
External auditors
External auditors are independent accounting/auditing firms that are hired by
companies subject to an audit. External auditors express their own opinions
on whether the financial statements of the company in question are free of
material misstatements (these could be due to fraud, error or otherwise).

For publicly-traded companies, external auditors could also be required to

provide an opinion on the effectiveness of internal controls over financial
reporting.
Internal auditors
Internal auditors are those who are employed by the company that they
audit. They primarily provide audits related to the effectiveness of the
company's internal controls over financial reporting.

Since the Sarbanes Oxley Act of 2002 was placed into effect, they must also
assess the effectiveness of managements internal controls over financial

reporting.

Internal auditors are not independent of the company they perform audit
procedures for, but they usually do not report directly to management, in
order to reduce the risk that they will be swayed to produce biased
assessments.

Salient features of an auditors report.

Features of the Audit Report: According to section 227(3) of the Companies Act, the
Auditors Report shall state:
(1) Whether, in his opinion and to the best of his information and according to the
explanations given to him, the said accounts give the information required by this Act in
the manner so required and give a true and fair view:
(1) In the case of the Balance Sheet, of the state of the companys affairs as at the end of
its financial year; and
(ii) In the case of the Profit and Loss Account, of the Profit or Loss for its financial
years.
Explanation:

This reveals a set of two duties to be performed by the auditor. On the one hand, he has
to certify that the accounts give the information required by the Companies Act, 1956 in
the manner so required, and on the other hand, he has to declare that the accounts give
a true and fair view of the companys affairs and its profit or loss for its financial year.
These are two important duties of an auditor. He must ascertain that the information as
required by Schedule VI has been disclosed in the Balance Sheet and the Profit and Loss
Account.
So far as his second duty relates, he has to certify that the accounts reveal a true and fair
view of the companys affairs. The Auditors Report shall also state:
(2) Whether he has obtained all the information and explanations which to the best of
his knowledge and belief were necessary for the purpose of his audit.
Explanation:
The Act has empowered the auditor to inspect all the books, accounts and vouchers of
the company at all times whether they are kept at the Head Office of the company or
elsewhere and the auditor shall be entitled to require from the officers of the company
such information and explanations as he may think necessary for the performance of his
duties as an auditor.
What type of information and explanations the auditor thinks necessary to obtain from
the officers of the company will depend upon the circumstances of a particular case. He
may rely on them if he gets them from the responsible officers of the company.
(The concept, true and fair has already been explained in the preceding Chapter).
(3) Whether in his opinion, proper books of accounts as required by law have been kept
by the company so far as appears from the examination of those books and proper
returns adequate for the purpose of his audit have been received from branches not
visited by him.
Explanation:

Here, again, a company is required to keep proper books of accounts as prescribed by

the Act and the auditor should, therefore, report specifically whether it has been done
so. In case of non-compliance, he should qualify his report.
Secondly, he should confirm and report that proper returns are being submitted by the
branches and these returns are adequate for the purpose of his audit. This provision is
applicable for those branches which have not been visited by him.
(4) Whether the report on the accounts of any Branch Officer audited under section
228 by a person other than the companys auditor has been forwarded to him as
required by Clause (c) of sub-section (3) of that section and he has dealt with the same
in preparing the Auditors Report.
Explanation:
Further, the auditor should confirm that the accounts of any Branch office have been
audited under section 228 by a person other than the companys auditor and the report
of such an auditor has been forwarded to him.
He has to state clearly that he has taken full note of the said report in preparing his own
report.
(5) Whether the companys Balance Sheet and Profit and Loss Account dealt with by
the report are in agreement with the books of accounts and returns.
Explanation:
Lastly, he has to confirm in his report whether the Balance Sheet and Profit and Loss
Account of the company are in full agreement with its books, accounts and returns.

This needs no comment. In every business, the final accounts are prepared in
accordance with the books of accounts, returns, etc. The auditor of every company is
required specifically to mention this fact in his report that it has been actually done.

Audit Procedures & Techniques for an Internal Audit .

A semi-annual or annual internal audit is a common method used to assess the

effectiveness of a businesss internal control system. Unlike an external audit, which
focuses on determining whether financial statements conform to generally accepted
accounting principles, an internal audit focuses on uncovering internal control
weaknesses and evidence of fraud, waste or abuse. Internal audit procedures and
techniques are essential to effective risk-management implementation.
Audit Procedures and Objectives
The main objective of an internal audit is to assess and, when necessary,
improve the effectiveness of internal business controls, risk-management
plans and overall business processes. Audit procedures typically start by
assessing current processes and procedures. Auditors then analyze and
compare results against internal control objectives to determine whether
audit results comply with internal policies and procedures as well as federal
and state rules and regulations. As a final step, auditors compile an audit
report to present to the business owner.
Assessment Techniques
Assessment techniques are designed to ensure internal auditors fully
understand internal control procedures and determine whether employees
are complying with internal control directives. Auditors try to avoid disrupting
the daily workflow by starting the internal audit process using indirect
assessment technique. These include reviewing existing documentation such
as flowcharts, manuals and departmental control policies. Creating audit
trails that trace specific processes from start to finish are another common
assessment technique. Techniques in the second phase, including one-onone interviews and process observations, are techniques internal auditors
use if audit trails or document reviews dont fully answer auditors questions.
Analysis Techniques
Internal audit analysis techniques include substantive procedures that are
designed to determine whether work products contain data entry errors or
whether financial statements contain misstatements. Analysis techniques
can be used to test random data or target specific data if an internal auditor
feels an internal control process is at risk. Substantive procedures include,
but arent limited to, transaction matching, a physical inventory count, audit
trail calculations and recalculating already-reconciled financial statements
such as a monthly bank reconciliation.

Reporting Procedures
A final internal audit report marks the end of the internal auditing process.
Although reporting always includes a formal report, it can also include a
preliminary or memo-style interim report. An interim report generally
includes sensitive or significant results the auditor feels are necessary to
share immediately with the business owner. A final report is significantly
more formal and includes a summary of the procedures and techniques used
in completing the audit, a description of audit findings and suggestions for
changes or improvements to internal controls and control procedures.

The Importance of the Internal Audit Function in a Company .

Internal audits provide a number of important services to company management. These
include detecting and preventing fraud, testing internal control, and monitoring
compliance with company policy and government regulation. Smaller companies may
require these functions even more than large companies. A small business simply
cannot afford employee fraud, waste, or a government fine. Establishing an internal
audit function provides a vital step in the growth of a small business.
Fraud
Small businesses lose millions of dollars every year to employee theft. Types
of fraud committed by employees include skimming payments from
customers, check tampering, cash theft and misuse of company credit cards,
and improper payroll transactions.
Many small-business owners may believe they lack the staff to create an
internal audit policy or carry out audits to combat these problems. However,
even with a small staff, a small business may create a program for
monitoring employees and their behaviour. An announced policy of internally
auditing financial transactions for fraud may inhibit an employee from
misusing company resources.
Monitoring Internal Controls
A formal internal audit policy, even if conducted part time by individuals
normally assigned other duties, performs other tasks besides detecting
fraud. Examining policies and procedures on a regular basis ensures that the
company minimizes its exposure to fraud and other losses.
Extension of credit to customers provides one such area of loss prevention. If
you have formulated a policy regarding extension of credit, internal audits
test compliance with that policy. Designing a credit policy with the intention
of reducing bad debt does no good if not followed.

Operational Audit
Operational audits examine the practices of a company, rather than its
finances. Is your business operating at maximum efficiency? Ineffective
operations add to overhead without increasing profit. An operational audit
may reveal these inefficiencies or point to unnecessary paperwork.
Is your business following applicable regulations? Finding out you do not
comply with a government regulation before the government discovers that
fact avoids fines or other legal actions. A rapidly expanding business needs
to monitor compliance with human resource laws as new employees join the
company. Internal audit performs a vital service in reviewing these functions.
Planning your Internal Audit
Your small business likely cannot afford to create an internal audit
department, but with careful planning, you can create a system for checking
up on your company and its employees. This less formal system, using
people you already have, can still provide the information you need to
improve your operations and financial controls. Such an internal audit
requires two people working as a team. This avoids personality conflicts and
prevents the auditor from simply checking his own work. It also provides an
opportunity for the team members to discuss results and prepare an
objective report to ownership.
An informal process helps employees understand that the internal audit
function provides an opportunity for the company to thrive and grow.

Common areas to audit:

Cash Handling
It is important to inspect how cash is handled within an organization. Areas
within an organization that deal with cash registers, petty cash or money
transactions should be audited to ensure compliance with internal cash
handling procedures.

Credit Card Usage

Credit card use in small business is becoming more common because of its
ease of use and necessity for internet purchases. Ensuring appropriate credit
card usage and accountability for compliance to policies is critical to
budgetary and fiscal responsibility. Credit card statements should be reviewed
and all purchases should have a business purpose explanation.

Vendor Billing
Vendor bills should be verified and approved for payment. This is done to
ensure that vendor charges correspond to the service provided. Billing errors
are common so it is important to double check accuracy of all vendor invoices.

HR Compliance
There are many laws that govern the HR function. Organizations should be
aware of those laws and have auditing procedures in place to ensure that the
HR department is compliant with maintaining accurate employee records.

Budget Control
Budgets are only as good as the process that manages them. A budget review
process can monitor budget spending and oversee large expenditures.
Management should be aware of how budget dollars are spent and of any
budget variances.

Process Improvement
When processes are changed as part of quality improvement initiative,
ongoing monitoring of new processes help to ensure compliance with
improvement effort changes.

Customer Service
Good customer service, coupled with a strategic customer service strategy,
can have a positive effect on customer loyalty. Auditing the customer service
function can help determine training needs, customer expectations and
improvement opportunities.

Vendor Comparisons
It is easy to fall in the relationship trap with vendors. There should be strict
conflict-of-interest policies and how the purchasing function interacts
with vendors. This area should be audited to make sure multiple bids are
submitted for large purchases.

Cost Savings
With the current economic situation, more and more organizations are feeling
pressure to reduce spending and manage costs. Establishing continual
improvement processes using FOCUS PDCA methodology should be in place
to continually look for cost saving opportunities.
Internal audit reports should be reviewed by senior management and
incorporated into a quality management process and used as part of a
global performance management system.

WHO ARE THE AUDIT DIRECTORS?

Berkeley Wanda Lynn
Riley Davis- Jeremiah Maher
San Francisco Rick Catalano
Santa Barbara Craig Whitebirch

Santa Cruz Barry Long

Berkeley Lab Terri Hamilton
Irvine Bent Nielsen
Los Angeles Ed Pierce
Riverside Mike Jenson
San Diego Stephanie Burke

WORKING WITH EXTERNAL AUDITORS

Experts urge business owners to establish proactive working relationships with external
auditors. In order to accomplish this, companies should make sure that they:

Select an auditing firm with expertise in their industry and a proven track record.

Establish and maintain efficient recordkeeping systems to ease the task of the
auditor.

Make sure that owners, executives, and managers know the basics of financial
reporting requirements.

Establish effective lines of communication and work processes between external

auditors and internal auditors (if any).

Recognize the value that external auditors can have as an objective reviewer of
existing and proposed operational processes. "Managers tend to dismiss auditors
as bean counters," Paul Danos, dean of Dartmouth's business school,
told Business Week . "However, auditors have seen many businesses and know
how they survive, grow, and prosper."

Focus on high-risk areas of operations, such as inventory levels

Focus on periods of change and expansion, such as transitions to public

ownership or expansion into new markets.

Build an effective audit committee that can provide cogent financial and
operational analysis based on audit results. "Aggressively seek its advice,
viewing it as an asset rather than a liability," counseled Beasley, Carcello, and

Hermanson. "Enlist the committee's help when you review financial reporting
related matters, and provide relevant and reliable data for it to review. The audit
committee's effectiveness is restricted by the quality and extent of information it
receives. It needs access to reliable financial and nonfinancial information,
industry, and other benchmarking data and other comparative information that's
prepared on a consistent basis."
"Some question whether auditors can take on more of a consulting role and still
maintain the independence required to effectively perform their auditing responsibilities,"
wrote Karen Kroll in Industry Week. She notes that some observers question whether
audit firms that fulfill consulting roles might compromise their auditing functions if they
become financially dependent on certain clients. Another concern, Kroll notes is that
"when auditors also act as consultants, the risk exists that they could end up reviewing a
system or process they helped to implement." But other analysts contend that auditing
firms are instituting operational practices to ensure that their auditing function remains
uncompromised.

CONCLUSION:

Audit is an effective tool for a Business Management, as internal audit is conducted in

order to ensure the policies are being followed. It enables to make valuable suggestions
for improvement and to formulate future policies of a business. Audit also helps
management to review the policies from time to time.
Since audit involves a detailed verification of accounting records, it helps greatly to
discover errors or frauds while it promotes a moral check on the employees through
which their efficiency may also be determined. To its more positive form, audit can
motivate the employee to maintain the efficiency leading to increase their performance
level. Aside from these, it is with the help of audit that misappropriation of goods and
manipulation of records may be identified.
Audit is of great importance to gain confidence in investors of a joint stock company.
Since the audited statements are very much useful, the investors can ensure whether or
not they need to invest capital.

It is no surprise to realize that auditors have historically utilized a substantive testing

approach to auditing small businesses. Past standards only required the auditor to
understand the internal control environment and flow of transactions. Once minimum
standards were met, auditors typically planned and executed the engagement with no
reliance on any controls.
However, the new standards for internal control significantly broaden the auditor's
minimum responsibilities. The new SAS expands the concept of internal control,
comprised of three elements: the control environment, the accounting system, and
control procedures. The minimum work to be done and working paper documentation
for the assessment of internal control have been expanded.
The new standards mandate that the auditor "obtain an understanding of the three
elements of the internal control structure sufficient to plan the audit." An understanding
of each element is now required before an auditor can plan the substantive audit
procedures.
As noted in Figure 3, the control environment of a client is comprised of a number of
important elements. This environment represents the collective effect of factors that can
dramatically impact the establishment, enhancement, and effectiveness of an entity's
control procedures. Especially for a small business engagement, it is essential that the
auditor assesses the potential impact of these factors on the audit scope.
For a small business the control environment is primarily a direct function of the
owner/manager. The owner's basic operating philosophy essentially determines the
viability of any control procedures established and, in effect, either supports or nullifies
controls that may be in place.
Understandably, management's concern for the integrity and accuracy of accounting
information has a direct impact on the auditor's substantive testing. The views of the
owner/manager relating to hiring of qualified accounting personnel and sufficient staffing
of accounting functions are other examples of how management's philosophy and
operating style directly impact the CPA's audit approach.
Professional standards also indicate that the entity's organizational structure and the
methods management uses to assign responsibility and monitor performance are key
factors in assessment of the control environment. While most small businesses lack the
employees to adequately segregate accounting functions, the manager's involvement in
the process and monitoring of accounting functions significantly impacts the
effectiveness of that control structure.