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CHAPTER 1- BASIC CONCEPTS

1. Define Auditing. State its features.


Definition
The term Auditing refers to the process of systematic and independent
examination of books of accounts, data, statements, records, operations and
performance of an enterprise for a stated purpose.
The auditor perceives and recognizes the propositions before him for
examination, collects evidence, evaluates the same and on this basis forms his
opinion/judgement which is communicated through his audit report.
Auditing is necessary for all organizations -whether profit - oriented or not and
whether it is required by law or not, whether small or large organization,
whether sole proprietor, partnership firm or company.
Auditing is done with the purpose of forming an opinion whether the financial
statements disclose true and fair view or not.

Features of Auditing
 Systematic and scientific examination
 Independent examination
 By a qualified person (Auditor)
 Purpose forming an opinion whether the financial statements (profit and
loss account, balance sheet, cash flow statements) disclose true and fair
view or not.
 It involves critical review of the system of accounting and internal control.
 It involves inspection, verification, vouching of various documents, vouchers,
minutes books,AOA,MOA, minutes books etc.

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2. What are the Objectives of Audit?


Objective of Audit Can be classified as
(i) Primary object is to form opinion on the true and fair view disclosed by
financial statements.

Financial statements include Balance Sheet, P & L

accounts and cash flow statements.


(ii) Secondary object is to detect and prevent frauds and errors.
The auditor should ensure that the financial statements do not contain
misstatement on a/c of fraud and error. Both objectives are interdependent and
not independent.

3. What is the Scope of Audit


Scope of audit refers to the extent and coverage of Auditing. While the object is
the end of Auditing, scope refers to means/areas/domain of Auditing.
Audit scope determines the time involved in audit exercise, depth of auditing,
aspects to be covered etc.

Determinants of Scope
The following are the 4 sources through which scope can be determined
A. Statute
It means the relevant legislation I Act passed in the parliament. In case of Cos,
Banking Cos and insurance Cos the scope of Auditor is determined Act eg.
Companies Act, 2013.
B. Terms of Engagement:
In the case of sole traders/Partnerships, the scope is determined by terms of
engagement arrived at mutually between the Auditor and client. Upon receipt
of appointment letter from the client, the Auditor issues a letter of engagement
to the client laying down his understanding of the scope of the work.
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C. Pronouncements of ICAI
ICAI issues pronouncements on various matters such as Accounting and
Auditing through
1.
2.
3.
4.

AS - Accounting Standards.
AAS - Auditing Assurance Standards.
Guidance Notes.
Statements.

D. Nature of Audit
Whether it is internal audit, statutory audit, tax audit, investigation etc based
on it the scope of auditing would defer.
Can the scope of audit be MODIfied?
The scope determined by statue is minimum requirement and it cannot be
reduced even by passing special resolution or by engagement terms. On the
other hand it can be expanded based on mutual agreement.

4. State the Basic Principles governing an Audit (AAS 1)


1)

Integrity
i) Honest and straight forward
ii)Auditor

not

to

practice

dishonest

means

for

satisfying

clients

requirement
2)

Objectivity:
i)

Refers to purposefulness

ii)

To conduct audit keeping in mind secondary and primary objectives

3)

Independence:

i)

Should not be capable of being influenced by anybody

ii)

Relevant for judging opinion on view presented by Financial Statements

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4)

Confidentiality
i)

Not to divulge information about the clients to third parties

ii)

If required by law, he may disclose information with the consent of

client.
5)

6)

7)

8)

9)

10)

Skill and Competence


i)

Be capable of applying the skill in practical situation.

ii)

Update and upgrade knowledge in the relevant fields.

Audit planning
i)

Audit be based on proper planning

ii)

The plan of Audit must be developed before commencement of Audit

iii)

It also includes programming

Audit evidence
i)

Audit be conducted by considering evidences

ii)

Evidence is available in the form of books and records, voucher.

iii)

It is available form from internal and external sources.

Audit Documentation
i)

Auditor to record his observation of findings in working paper

ii)

To be maintained at Auditors Office

Using the work of others


i)

Involvement of other experts in the Audit of financial statement

ii)

Auditor to use the work of other intelligently

Evaluation of ICS(Internal Control System) and AS (Accounting Standards)

i)

Clients responsibility to introduce ICS which includes AS

ii)

Auditor to evaluate the system before commencing Audit

iii)

It is useful for Audit to determine the extent of checking and nature

of Audit procedure
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11) Audit conclusion and reporting


i)

Formation of Opinion (whether accounting policies consistently


applied, whether financial information complies with statutory
requirements, whether material matters adequately disclosed)

ii)

Report in specific format

iii)

Address to specific authority (Shareholders/board/Govt.as case be)

5. List Down The Advantages Of Independent Audit


1 Improves the reliability of financial statements.
2. Statutory requirements are fulfilled -filing returns, holding meetings,
declaring dividends
3. It helps in detecting internal control weaknesses.
4. Enables settlement of trade disputes.
5. In case of change in constitution it enables settlement of accounts.
6. Useful for determination of losses.
7. Enables assessment of net worth of the entity for the investors.
8. Satisfies requirements for borrowings from financial Institutions
9. Acts as a basis for settlement of statutory dues like taxes, duties, E.S.I, P.F. etc

10. Useful for financial planning in subsequent years.

6. List down various advantages and limitations of auditing


Advantages of Auditing
1. Unbiased professional opinion
2. Acts as a moral check on employees
3. Highlighting of weakness in the internal control system
4. Enables timely tax assessments and quick disposal of tax returns.
5. Financial assistance made easier.
6. Solutions to trade disputes and labour disputes
7. Enables sanctioning of license by Govt.
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8. Enables early settlement of Insurance claims


9. Determination of purchase consideration at the time of Amalgamation,

Inherent Limitations of an audit:


Audit has the following limitations:
a. Audit is test natured
b. Audit evidence is more persuasive rather than conclusive
c. Limitations of Internal control system
d. Use of judgement

7. What is the difference between True & Correct and True & Fair View?

Difference between True and Correct and True and Fair


True and Correct means that audit can be relied upon to ensure arithmetical
accuracy of books and records and detection of frauds and errors and is in the
nature of investigation or certification
whereas
True and Fair means discovery of frauds and errors is not the main objective
of an audit and auditing includes examination of items whose values cannot be
determined

with

substantial

accuracy

and

therefore auditing

is

mainly

concerned with the reliability of financial statements and true and fair financial
position and operating results of an enterprise.

8. What is Investigation and how is it different from Auditing?


Investigation is an exercise carried out with a specific objective. It means indepth analysis of books of accounts, transaction and event. Investigation
exercise is voluntary in nature and used extensively by auditors.

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Reasons for carrying out Investigation :1. Proposed purchase/sale of business


2. Reasons for low profitability, high labour turnover
3. Borrowing/Lending funds
4. Suspected fraud, suspected misfeasance against directors/trustees
5. Detection of undisclosed income for tax purposes.
Difference between auditing and investigation - P3 - LODER
Legal binding
Object
Documents
Extent of work
Report
Period covered
Parties for whom conducted
Person performing work.

9. What are the various types of Audit?


The Companies Act, 2013 is focused on transparency and disclosure. In the
new Act, attempt has been made to cover each aspect of corporate functioning
under audit by prescribing various types of audits like internal audit and
secretarial audit.
The various types of audits prescribed under the Companies Act, 2013 are:
Statutory Audit
Internal Audit
Secretarial Audit
Cost Audit
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CHAPTER 2 STATUTORY AUDIT

Question 1 - Bring out various Provisions relating to Statutory Audit


w.r.t appointment, removal and rotation of statutory auditor

Statutory audit means any audit which is required compulsorily under any law.
Here statutory audit refers to mandatory audit to be done as per Companies
Act by a Statutory Auditor

Sec 139 to 147 under Chapter X of the Companies Act,2013 along with the
Companies(Audit and Auditors) Rules, 2014 contain provisions regarding audit
and auditors.
Section 139 contains provision regarding Appointment of auditors.
Removal, resignation of auditor,giving of special notice is provided in Sec 140.
Sec 141 prescribes eligibility, qualifications and disqualifications of auditors.
Section 142 deals with the provisions of Remuneration of auditors.
Powers and duties of auditors and auditing standards is provided in Sec 143.
Section 144 provides a list of certain services which auditor is not to render.
Section 145 deals with signing of Audit Reports.
Section 146 deals with Auditors to atteng General Meeting
Section 147 deals with punishment for contravention

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Appointment of Statutory Auditor (Sec 139(1))


1. Regular Auditor [Sec 139]
a. Every company shall, at the first AGM, appoint an individual/firm as an
auditor who shall hold office from the conclusion of that meeting till the
conclusion of its 6th AGM. Auditor, thereafter, would be appointed at every
6th meeting. (The meeting where he is appointed being counted as 1st
meeting)
b. The company shall seek a formal approval(ratification) by members(ordinary
resolution) at every AGM about the appointment of auditor.
c. Before the appointment is made, the written consent of the auditor and a
certificate from him/it that the appointment, if made, shall be in accordance
with the conditions as may be prescribed, shall be obtained from the auditor.
[The certificate shall also state whether the auditor satisfies the criteria
provided in Sec 141.]
d. Company shall inform the auditor concerned of his/its appointment, and also
file a notice of such appointment with ROC within 15 days(in Form ADT-1) of
the meeting in which the auditor is appointed.
e. The appointment includes reappointment.

2. First Auditor Sec 139(6)


(a)

The first auditor is one who is appointed for the first time after the

incorporation of the co.


(b)

The first auditor(other than for Govt.Company) is appointed by BODs

within 30 days from the date registration of the co.


(c)

If the BOD fails to appoint such auditor, it shall inform the members of

the company, who shall within 90 days at an EGM appoint such auditor who will
hold office till the conclusion of the first AGM.
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(d)

The co. cannot appoint the first auditor by mentioning his name in the

A.O.A of the co.


Mandatory Rotation of Auditors (Sec 139)
U/s 139(1), the system of rotation of auditors has been introducted for the
auditors of listed companies and other class of companies.
Other class of companies means following classes of companies excluding
OPC and small companies as prescribed in Rule 5 of Companies (Audit and
Auditors) Rules.
a) all unlisted public companies having paid-up capital of Rs.10 crore or more
b) all private limited companies having paid-up capital of Rs.20 crore or more
c) all companies having paid-up share capital of below threshold limit given
above, but having public borrowings from financial institutions, banks, or public
deposits of Rs.50 crores or more

Provisions for rotation of auditors


If the auditor is an individual, he cannot be auditor of such a company for
more than 5 consecutive years.
If an audit firm/LLP is auditor of the company, it cannot be auditor of such a
company for more than two terms of 5 consecutive years (i.e. 10 years)
If an individual auditor who has completed his one term of 5 years, shall not
be eligible for reappointment as auditor in the same company for 5 years from
the completion of his term.
In an audit firm/LLP which has completed its one term of 10 years, shall not
be eligible for reappointment as auditor in the same company for 5 years from
the completion of its term.

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It may be noted that any firm/LLP which has one or more partners who are
also partners in the outgoing audit firm/LLP cannot be appointed as auditors
during this 5 year period.
There is a transition period of three years, from date of enactment of the
2013 Act, to comply with this requirement. All listed companies or specified
companies will have to comply with the above provisions relating to rotation of
auditors within 3 years from the date of commencement of this Act i.e. within
31st March 2017. (The term of the auditor before commencement of this Act
will be considered)
However there will be no effect on the right of the company to remove an
auditor or the right of the auditor to resign from such office of the company
because of the provisions mentioned above.
The members of a company may also provide for the rotation of auditing
partner and his team at specified intervals in the audit firm appointed by the
company.
The members of a company may also provide that the audit shall be
conducted by more than one auditor.

Removal of Auditors
New Section 140 provides for Removal, Resignation etc. of Auditors.
(i) Under new section 140 an auditor can be removed from his office before
the expiry of his term only after obtaining the previous approval of the Central
Government and after passing a Special Resolution by the Members. For this
purpose the company will have to comply with the prescribed rules.

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(ii) If an auditor resigns from his office, he is required to file, within 30 days,
a statement in the prescribed form with the company and ROC. In the case of a
Government company, this form is also required to be filed with C& AG. In this
statement the auditor has to give reasons and other facts relevant for his
resignation.
For failure to comply with this requirement, the auditor is punishable with a
minimum fine of Rs. 50,000/- which may extend upto Rs. 5 lakh.
(iii) If the auditor is found to have, directly or indirectly, acted in a fraudulent
manner or abetted or colluded in any fraud by the company or any of its
officers, the Tribunal can direct the company to change the auditors.
The auditor who is removed by the Tribunal cannot be appointed as an auditor
of that company for 5 years. Further, under the new section 447 the auditor
who is guilty of fraud will be punishable with imprisonment for a minimum term
of six months which may extend to 10 years and shall also be liable to pay a
minimum fine of an amount involved in the fraud which may extend to 3 times
the said amount. If the fraud involves public interest the minimum period of
imprisonment will be 3 years.
Rules 7 and 8 provide for procedure for removal and resignation of an Auditor

Question 2 State qualifications and disqualification of Statutory auditor

Qualifications of Auditors Sec 141


A Chartered Accountant holding a certificate of practice(COP) or a firm of
Chartered Accountants (only) can be appointed as auditor(s) of a company.
A firm of Chartered Accountants or Limited Liability Partnership (LLP) can be
appointed as an auditor of a company only if majority partners practicing in
India are qualified for appointment as an auditor of a company.
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Where a firm including a limited liability partnership is appointed as an


auditor of a company, only the partners who are chartered accountants shall be
authorised to act and sign on behalf of the firm.
Disqualifications
According to the section 141 (3) of the Companies Act 2013, the following
persons shall not be eligible for appointment as an auditor of a company:
(a) a body corporate (other than LLP);
(b) an officer or employee of the company;
(c) a person who is a partner/employee of an officer or employee of the
company;
(d) a person who, or his relative or partner
is holding (directly or indirectly) any security of or interest in the company or
its subsidiary. Provided that the relative may hold security or interest in the
company of face value not exceeding rupees one lakh;
is indebted to the company, or its subsidiary (or its holding or associate
company or a subsidiary of such holding company) in excess of Rs.5 Lacs or
has given a guarantee/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) in excess of one lakh rupees
(e)

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 subsidiary of such holding company or associate company.
The term business relationship shall be construed as any transaction entered
into for a commercial purpose, except

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commercial transactions which are in the nature of professional services


permitted to be rendered by an auditor or audit firm under the Act and the
Chartered Accountants Act, 1949 and the rules or the regulations made under
those Acts;
commercial transactions which are in the ordinary course of business of the
company at arms length price - like sale of products or services to the auditor,
as customer, in the ordinary course of business, by companies engaged in the
business of telecommunications, airlines, hospitals, hotels and such other
similar businesses.
(f) a person whose relative is a director or is in the employment of the
company as a director or key managerial personnel;
(g) a person who is in full time employment elsewhere or a person or the
concerned partner of a firm is holding appointment as auditor of more than 20
companies;
(h) a person who has been convicted by a court of an offence involving fraud
and a period of ten years has not elapsed from the date of such conviction;
(i) any person whose subsidiary or associate company or any other form of
entity, is engaged as on the date of appointment in consulting and specialised
services as provided in section 144.

A person who is appointed as an auditor of a company incurs any of the


disqualifications mentioned above after his appointment, he shall vacate his
office as such auditor and such vacation shall be deemed to be a casual
vacancy in the office of the auditor according to section 141(4) of the
Companies Act 2013.

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Remuneration of Auditors:
According to section 142 of the Companies Act 2013, the remuneration of the
auditor of a company shall be fixed in its general meeting or in the manner as
determined in the general meeting.
The remuneration of the first auditor appointed by the board may be fixed by
the Board.
The remuneration shall be in addition to the fee payable to an auditor,
including the expenses, if any, incurred by the auditor in connection with the
audit of the company and any facility extended to him but does not include any
remuneration paid to him for any other service rendered by him at the request
of the company.

Question 3 State various rights, powers and duties of a Statutory Auditor

Rights and Powers of a company Auditor:

1. Right to receive information and explanation from the co/management:

1. It should be noted that the auditor shall seek only such information which
is required for conducting the audit.
2. In addition to above AAS-11 (representation by management) also
requires an auditor to obtain a letter of representation from management
duly signed by directors supporting the various matters included in the
financial statements
3. In case an auditor does not obtain information & explanation which is
material in nature he has right to draw the attention of shareholders in his
report.

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Amongst other matters inquire into the following matters, namely:


(a) whether loans and advances made by the company on the basis of security
have been properly secured and whether the terms on which they have been
made are prejudicial to the interests of the company or its members;
(b)whether transactions of the company which are represented merely by book
entries are prejudicial to the interests of the company;
(c)where the company not being an investment company or a banking
company, whether so much of the assets of the company as consist of shares,
debentures and other securities have been sold at a price less than that at
which they were purchased by the company;
(d)whether loans and advances made by the company have been shown as
deposits;
(e)whether personal expenses have been charged to revenue account;
(f)where it is stated in the books and documents of the company that any
shares have been allotted forcash, whether cash has actually been received in
respect of such allotment, and if no cash has actually been so received,
whether the position as stated in the account books and the balance sheet is
correct, regular and not misleading:

2. Right of access to books of accounts


1. The following are the books which the auditor can have access to:
Cash book, ledger , Journal, etc are books of a/cs
Statutory registers
Memorandum records
Statistical records
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2. He also has to right to take extracts from the above records


3. While checking the records, he can place his signature/ identification
marks therein.
4. The right of access also includes the records maintained in branches in
other locations
5. This right can be exercised at reasonable time and not odd hours

3. Right to visit branches:


1. An auditor has right of visiting the branch offices of the co.
2. This right is available irrespective of the fact whether a branch auditor has
been appointed u/s 228
3. According to AAS-10, using the work of other auditor, the co. auditor can
also have the right of holding discussion with the branch auditor

and

branch manager and he may perform additional audit procedures by


himself
4. This right is given to the auditor for enabling him to discharge his duties
to share holders
5. The management of the entity shall not restrict a statutory auditor from
visiting the branches

4. Right of Lien
1. The term lien refers to right of retaining physical possession of properties
belonging to the debtor
2. When the auditor des not receive remuneration, he has a right to retain
possession of books of accounts on which he has exercised due skill, care
and diligence

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3. The following are the conditions for exercising right of lien;


(a)

The lien shall cover only fees and not out of pocket exps

(b)

The lien shall be exercised only on the books of a/cs and vouchers on

which the auditor has exercised skill, care and diligence.


(c)

The lien shall not be exercised on statements, registers and records

(d)

The lien is a specific and particular lien and shall not be assigned in

favor of a third party


(e)

The lien extinguishes when the client pays the amount due

(f) The books of a/cs on which lien is exercised shall be relating to the year
for which the client owes money.
(g)

The auditor should get hold of the books of a/cs on the basis of

permission from the directors of the co.

5. Right to get notice of and attend AGM


6. Right to be heard at GM
7. Right to sign the audit report:
The auditor has a right to issue the audit report under his signature. He also
has to sign the B/S and P/L a/c not as an authority for an approval but as
attesting agency. While signing the audit report on behalf the firm he also
mention the fact that he is partner of the firm. There is no need to mention his
membership no and other qualifications. However u/s 44 AB of the IT Act while
issuing tax audit report, he should clearly mention his membership no. also

8.Right to receive remuneration

9.Right of indemnification i.e. the co. has an obligation to reimburse the loss
suffered by auditor while representing as company auditor.
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10. Right to receive notice of removal and right to make representation on


removal

11. The auditor of a company which is a holding company shall also have the
right of access to the records of all its subsidiaries in so far as it relates to the
consolidation of its financial statements with that of its subsidiaries

Duties of auditors sec 143(2)/(3)/(4)


1. Duty to make an audit report
2. Duty to make adequate disclosures in audit report
3. Duty to give reasons for qualifications/reservation/adverse remark
4. Duty to sign the audit report

The auditor shall make a report to the members of the company on the
accounts examined by him and on every financial statements which are to be
laid before the company in general meeting and the report shall after taking
into account the
- provisions of this Act,
- the accounting and auditing standards and
- matters which are required to be included in the audit report under the
provisions of this Act or any rules made thereunder and
- to the best of his information and knowledge, the said accounts, financial
statements give a true and fair view of the state of the companys affairs
- whether the company has adequate internal financial controls system in place
and the operating effectiveness of such controls;
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- whether the company has disclosed the impact, if any, of pending litigations
on its financial position in its financial statement;
- whether the company has made provision, as required under any law or
accounting standards, for material foreseeable losses, if any, on long term
contracts including derivative contracts;
- whether there has been any delay in transferring amounts, required to be
transferred, to the Investor Education and Protection Fund by the company.

-Auditors to attend general meeting:


Section 146 of the Companies Act 2013, provides that all notices of, and other
communications relating to, any general meeting shall be forwarded to the
auditor of the company, and
the auditor shall, unless otherwise exempted by the company, attend either by
himself or through his authorized representative, who shall also be qualified to
be an auditor, any general meeting and shall have right to be heard at such
meeting on any part of the business which concerns him as the auditor.

Question 4: Companies Act, 2013 makes an Auditor more responsible.


Discuss.
Fraud reporting by auditors Sec 143(12)
If an auditor of a company, in the course of the performance of his duties as
auditor, has reason to believe that an offence involving fraud is being or has
been committed against the company by officers/employees of the company,
he shall immediately report the matter to the Central Government immediately

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but not later than 60 days of his knowledge and after following the procedure
indicated herein below:
auditor shall forward his report to the Board or the Audit Committee, as the
case may be, immediately after he comes to knowledge of the fraud, seeking
their reply or observations within 45 days;
on receipt of such reply or observations the auditor shall forward his report
and the reply/observations of the Board or the Audit Committee along with his
comments (on such reply/observations of the Board or the Audit Committee) to
the Central Government within 15 days of receipt of such reply/ observations;
in case the auditor fails to get any reply or observations from the Board or
the Audit Committee within the stipulated period of 45 days, he shall forward
his report to the Central Government along with a note.
The report shall be sent to the Secretary, Ministry of Corporate Affairs in a
sealed cover by Registered Post with Acknowledgement Due or by Speed post
followed by an e-mail in confirmation of the same.
The report shall be on the letter-head of the auditor containing postal
address, e-mail address and contact number and be signed by the auditor with
his seal and shall indicate his Membership Number.
The report shall be in the form of a statement as specified in Form ADT-4.

The provisions of this section shall mutatis mutandis apply to


(a)the cost accountant in practice conducting cost audit under section 148; or
(b)the company secretary in practice conducting secretarial audit u/s 204.

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If any auditor, cost accountant or company secretary in practice does not


comply with the provisions of sub-section (12), he shall be punishable with fine
which shall not be less than Rs.1 lakh but which may extend to Rs.25 lakh.

Fraud in relation to affairs of a company or anybody corporate, includes any


act, omission, concealment of any fact or abuse of position committed by any
person or any other person with the connivance in any manner, with intent to
deceive, to gain undue advantage from, or to injure the interests of, the
company or its shareholders or its creditors or any other person, whether or
not there is any wrongful gain or wrongful loss.

Prohibition on the services to be rendered by the auditors:


Section 144 provides that Statutory audit shall not provide any of the following
services directly or indirectly to the company or its holding company or
subsidiary company, namely:
(a) accounting and book keeping services;
(b) internal audit;
(c) design and implementation of any financial information system;
(d) actuarial services;
(e) investment advisory services;
(f) investment banking services;
(g) rendering of outsourced financial services;
(h) management services; and
(i) any other kind of services as may be prescribed:

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This is a new provision and there was no restriction of this type in the
Companies Act 1956. Therefore, an auditor or audit firm who or which has been
performing any non-audit services on or before the commencement of this Act
shall comply with the provisions of this section before the closure of the first
financial year after the date of commencement of the Act i.e within 31st March
2015.
It is also provided in this section that the prohibited non-audit services cannot
be rendered by the following associates of the auditor.
(i) If the auditor is an Individual:The Individual himself, his relative any person connected or associated with
him, or any entity in which the Individual has significant influence or control or
whose name or trade mark/brand is used by the Individual.
(ii) If the auditor is a firm or LLP:Such firm/LLP either itself or through its partner or through its parent,
subsidiary or associate or through any entity in which the firm/LLP or its
partner has significant influence or control or whose name, trade mark or brand
is used by the firm/LLP or any of its partners.
Signing of Audit Reports:
Sec 145 of the Companies Act 2013, provides that the statutory auditor shall
sign the auditors report or sign/certify any other document of the company.
It also provides that the qualifications, observations or comments on financial
transactions or matters, which have any adverse effect on the functioning of
the company mentioned in the auditors report shall be read before the
company in general meeting and shall be open to inspection by any member of
the company.
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Penal Provisions:
Section 147 provides for punishment for contravention of the provisions of
sections 139 to 146. These penalty provisions are as under.
If a company contravenes any of the provisions of sections 139 to 146 it
shall be liable to pay minimum fine of Rs. 25,000/- which may extend to
Rs. 5 lakh. Further, every officer who is in default shall be punishable with
imprisonment upto one year or minimum fine of Rs. 10,000/- which may
extend to Rs. 1 lakh or with both.

If an auditor of a company contravenes any of the provisions of sections


139, 143, 144 or 145, the auditor shall be punishable with minimum fine of
Rs.25,000/- which may extend to Rs. 5 lakh.
If it is found that the auditor has contravened the provisions of sections 139,
143, 144 or 145, knowingly or willfully with the intention to deceive the
company, its share holders, creditors or tax authorities, he shall be punishable
with imprisonment for a term upto 1 year and with a minimum fine of
Rs.1 lakh which may extend upto Rs. 25 lakh.
If any auditor contravened any of the provisions of sections 139, 143,144 or
145, he shall also be liable to(a) refund the remuneration received by him to the company and
(b) pay for damages to the company, statutory bodies/authorities or to any
other persons for loss arising out of incorrect or misleading statements of
particulars made in his audit report.

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Other Penalties on Auditor under Companies Act 2013:


(a) Class action suit against the Auditors u/s 245:
To protect investor interest, Section 245 of Companies Act 2013 has introduced
the concept of class action suits, through which shareholders, depositors can
initiate legal action against the company and auditors in the event of fraudulent
activity. A class of shareholders or deposit holders can now claim damages or
compensation or demand other suitable action against the auditor, including
the audit firm, by filing an application with the NCLT.

(b) Prosecution by NFRA (National Financial Reporting Authority) U/s


132: NFRA may investigate either suo moto or on a reference made to it by the
Central Government on matters of professional or other misconduct committed
by any member or firm of chartered accountants. If professional or other
misconduct is proved, NFRA has the power to make order forimposing penalty of (I) not less than one lakh rupees, but which may extend
to five times of the fees received, in case of individuals; and (II) not less than
ten lakh rupees, but which may extend to ten times of the fee received, in
case of firms;
debarring the member or the firm from engaging himself or itself from practice
as member of the Institute of Chartered Accountant of India referred to in
clause (e) of sub-section (1) of section 2 of the Chartered Accountants Act,
1949 for a minimum period of six months or for such higher period not
exceeding ten years as may be decided by the National Financial Reporting
Authority.

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(c) Punishment for fraud U/s 447:


Any person who is found to be guilty of fraud, shall be punishable with
imprisonment for a term which shall not be less than six months but which may
extend to ten years and shall also be liable to fine which shall not be less than
the amount involved in the fraud, but which may extend to three times the
amount involved in the fraud. Provided that where the fraud in question
involves public interest, the term of imprisonment shall not be less than three
years.

(d) Punishment for false statement U/s 448:


If any return, report, certificate, financial statement, prospectus,
statement or other document required by, or for, the purposes of any of the
provisions of this Act or the rules made thereunder, any person makes a
statement which is false in any material particulars, knowing it to be false; or
which omits any material fact, knowing it to be material, he shall be liable
under section 447.

Question 5: Write a short note on Brach Audit Sec 143(8)

Every branch office shall maintain proper books of a/cs for accounting the
transactions which have taken place in the branch.
The branch office may be subjected to audit either by statutory auditor himself
or by an independent auditor.

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While appointing co. auditor, if no separate resolution is passed appointing


some other person as branch auditor, then the co auditor is deemed to be
branch auditor also. In such case, the co. auditor can visit the branch and
check the transactions entered in the branch books and finally consolidate the
branch trial balance with H.O he will not prepare a separate report on audit of
branches.
On other hand, if a separate auditor is appointed as branch auditor he will act
independently and conduct the audit of the branches and forward his report to
H.O auditor

Qualification same as statutory auditor

Appoinment:
The branch auditor shall be appointed by the shareholders of the co. in the
AGM and the nature of resolution to be passed shall be the same which is
applicable for co. auditor, sometimes the shareholders may pass a resolution
delegating the power to BOD to appoint the branch auditor in consultation with
the statutory auditor.

Rights and duties:


The branch auditor enjoys similar rights and those similar duties as that of a
company auditor except that
He cannot visit other branches
He cannot attend AGM
He has submit his report to statutory auditor

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Scope
The scope of the branch auditor is restricted to the operations of the branch. He
shall covers same matters which are covered by the co. auditor in his report.
The provisions of Section 143(12) read with rule 12 hereunder regarding
reporting of fraud by the auditor shall also extend to such branch auditor to the
extent it relates to the concerned branch.

Qualifications In Branch Auditors Report


The branch auditor may qualify his report and include same in his report
to the statutory auditor. The latter may drop the qualifications based upon:
(a)

Concept of materiality

(b)

Availability of adequate information & explanation at the H.O

Question 6 Can branch audit be exempted?

Exemption of branch auditor


Under the branch auditor exemption rules 1961, a branch may be exempted
from audit under the following conditions:
(a)

Automatic exemption

(b)

Exemption based on application to the Central Govt

(a) Automatic Exemption


According to the above rules, if the average quantum of activity of the
branch does not exceed 2% of the turnover of the co. or Rs.200000 whichever
is higher, the exemption is automatically granted. For this purpose, average
quantum of activity refers to the highest of following 3 items:
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(a) Aggregate value of the goods sold by branch


(b) Aggregate value of goods traded
(c) Aggregate expenses incurred for both capital revenue purposes

(b) Application to central Govt.


(i) Where proper arrangements have been made for scrutiny of branch
accounts person competent to be the branch auditors
(ii) Where satisfactory arrangements are being made for review of branch
a/cs by a person qualified to be the branch auditor even though he is the
employee of the co.
(iii) Where no branch auditor is available, at reasonable cost considering the
quantum of activity of the branch
(iv) Where it is considered & deemed fit by central Govt

Question 7 Write a short note on Joint Audit


1. Joint audit refers to audit of accounts of one single company by more than
one auditor or firm of auditors.
2. Generally applicable in PSUs and banks
3. Object is to get additional profession opinion
4. The joint auditors are responsible for giving a joint audit report after
carrying out audit.
5. There is a need for division work among the joint auditors which may be
carried out in following manner.
a. Period wise
b. Activity wise
c. Component of financial statements wise.
d. Location wise
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6. The purpose of division of work is to fix the responsibility on each of the


joint auditors.
7. One the work is divided, it should be communicated to the management
with the idea of ensuring the management to provide necessary
assistance to audit.
8. Management has no say with regard to manner of division of work

Obligations of Co-Auditors
1. To maintain proper working paper file
2. To draft audit programme covering his area
3. To exercise due skill, care and diligence in performance of audit
4. No to give direction or review the work of other co-auditor
5. To convey the information received during the course of audit which may
be found useful to other co-auditor.
6. To hold discussion with the other auditor regarding matters of common
interest on
a. Compliance with AAS
b. Accounting policies
c. Adjustments arising at the year end
7. To audit the accounts of branches which fall within his jurisdiction

Joint and several liabilities


1. Where there is a division of work, the liability of joint auditors is individual
in nature
2. In the following cases, the liability of joint auditor is joint and several
a. Where there is no division or work
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b. When one co-auditor has conveyed the information to other coauditor in which there is concurrence.
c. Disclosure requirements
d. Compliance with statutory requirements

Difference of opinion between auditors


1. Not always necessary for total concurrence between the auditors
2. If there is non concurrence on certain matters, each auditor may issue
separate audit report expressing their individual views.
3. Majority opinion does not bind individual co-auditor.

Advantages of joint Audit


1. Timely completion of audit
2. Extensive coverage in a systematic manner
3. Pooling of expertise.
4. Mutual consultations and thereby increasing the quality

Limitations
1. Ego problem
2. Sharing of fees
3. Difficulty in fixing responsibility in common areas.

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CHAPTER 3 - INTERNAL AUDIT(SECTION 138)

Question 1: Bring out the meaning and importance of Internal Audit

Meaning: Refers to independent appraisal of management activities within the


organization as a service to management and it acts as control over other
controls.
Definition
"Internal auditing is an independent, objective assurance and consulting
activity designed to add value and improve an organizations operations. It
helps an organization accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk
management, control and governance processes."

It is a risk management tool in regard to


a. Effectiveness and efficiency of operations
b. Reliability and integrity of financial and operational information
c. Safeguarding the assets
d. Compliance with laws, regulations and contracts.

Features:It is an appraisal function on behalf of management


Its a risk management tool
It is a part of control system of the organisation
Continuous audit activity
May be done by an individual who is an employee or by a firm of
accountants
Report to management or audit committee.
The management decides about scope of the work of internal auditor.

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Qualifications for the internal auditor: The internal auditor shall either be a chartered accountant whether engaged in
practice or not or a cost accountant, or such other professional as may be
decided by the Board to conduct internal audit of the functions and activities of
the company.
The report of internal audit shall be submitted to the Board of the company.

Internal audit is very useful to management for


a. Review of Internal control system
b. Review of procedures adopted for safeguarding assets
c. Review of organizational structures
d. Review of management information system
e. Review of implementation of policies, plans and strategies
f. Review of accomplishment of result by line managers.

It is useful to statutory audit in the following areas.


1. Evaluation IC system
2. Carrying out physical stock taking procedure
3. Obtaining evidences for contingent liability
4. While sending out request for confirmation of

balance debtors and

creditors
5. Ensuring correctness of FINANCIAL STATEMENTS through a system of
pre-audit.

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Companies required to appoint internal auditor:


The following class of companies shall be required to appoint an internal auditor
or a firm of internal auditors, namely:(a) every listed company;
(b) every unlisted public company havingpaid up share capital of Rs.50 crores or more during the preceding financial
year(PFY); or
turnover of Rs.200 crores or more during the PFY; or
outstanding loans or borrowings from banks or public financial institutions
exceeding Rs.100crores or more at any point of time during the PFY; or
outstanding deposits of Rs.25 crores or more at any point of time during the
PFY; and
(c)every private company havingturnover of Rs.200 crores or more during the PFY; or
outstanding loans or borrowings from banks or public financial institutions
exceeding Rs.100 crores or more at any point of time during the PFY

Other Provisions:
All the companies covered under any of the above criteria will have to comply
with the requirements of Section 138 and this rule within six months of
commencement of such section.
The internal auditor may or may not be an employee of the company.
The Audit Committee of the company or the Board shall, in consultation with
the Internal Auditor, formulate the scope, functioning, periodicity and
methodology for conducting the internal audit.
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Question 2 Discuss the nature of Internal Audit

1. A Management tool:
Internal Audit is management tool performed by the employees of the
organization or the engaged professional firm to check the appropriateness of
internal checks and control in the organisation. The reporting authority is
generally board of directors and audit committee.
2. A continuous Exercise:
Internal Audit is a continuous and systematic process of examining and
reporting the operations and records of a concern by its employees or external
agencies specially assigned for this purpose. It is, in essence, auditing for the
management and its scope may vary depending upon the nature and size of
the concern.
3. A Control System:
It is a control system concerned with examination and appraisal of other control
mechanisms.
4. A Risk Management Tool:
The internal audit work encompasses fostering the creation of a risk
management process and ensuring it addresses key objectives, and the
subsequent evaluation of the process. The internal audit work also
encompasses an identical role in the creation and subsequent evaluation of, the
business continuity planning process, and the information security and privacy
system.

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Question 3 What is the scope of Internal Audit


Scope Of Internal Audit
The Institute of Internal Auditors defines scope of internal auditing as The
examination and evaluation of the adequacy and effectiveness of organizations
system of internal control and the quality of actual performance
Thus Internal auditing is concerned with an evaluation of both internal control
as well as the quality of actual performance.
According to The Institute of Internal Auditors, internal audit involves five areas
of operations, which can be discussed as follows:
1. Reliability and Integrity of Financial and Operating Information:
Internal Auditors should review the reliability and integrity of financial and
operating information and the means used to identify, measure, classify and
report such information.
2. Economical and Efficient Use of Resources:
Internal Auditor should ensure the economic & efficient use of resources.
3. Compliance with Laws, Policies, Plans, Procedures, and Regulations:
Internal Auditor should review the systems established to ensure compliance
with policies, plans and procedures, law and regulations which could have a
significant impact on operations and should determine whether the organization
is in compliance thereof.
4. Accomplishment of Established Goals for Operations:
Internal Auditor should review operations, programmes to find whether results
are consistent with established objectives and goals and whether the operations
or programmes are being carried out as planned.
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5. Safeguarding of Assets:
Internal Auditor should verify the existence of assets and should review means
of safeguarding assets.

Question 4 Distinguish between Internal Audit and Statutory Audit

Relationship between internal auditor and statutory auditor.


Statutory Auditor and Internal Auditor both are independent entity. A statutory
Auditor of a company cannot be the internal auditor of the same company. In
certain cases, statutory auditor refers the report of internal auditor and he
expresses his opinion based on the report of internal auditor. Similarly in
certain cases, internal auditor also refers the report of statutory auditors. The
relationship between statutory auditor and internal auditor may be summed up
as given below:
1. Comment on the Internal Audit System in place:
The statutory auditor has to comment upon the effectiveness and suitability of
internal audit system laid down by the management. To discharge this
responsibility statutory auditor should evaluate the internal audit system. He
should evaluate the strength of the internal audit staff, their qualification and
experience.
2. Evaluation of the actual work of internal auditor:
After studying the internal audit system and structure actual work of the
internal auditor should also be evaluated. Statutory auditor has to make use of
the work of internal auditor. This he can do only when he himself puts faith in
the work of internal auditor.
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3. Relying on the work of internal auditor:


Statutory auditor has to decide that up to what extant he can rely upon the
work of the internal auditor. This will decide the extent of checking by statutory
auditor. If he feels that internal auditor has properly done his work he can
reduce the extent of his checking.
4. No reduction in responsibility:
Relying on work of internal auditor in no way reduces the responsible for the
discharge of his duties as statutory auditor. Relying on the internal auditor can
only reduce the burden of the statutory auditor. For all his works statutory
auditor would remain responsible.

Difference between Internal Audit and Statutory Audit


There are some differences between statutory audit and internal audit. The
details are as given below:
1. Appointment:
Internal Auditor is appointed by the management of the organization while the
statutory auditor is appointed by owners i.e. shareholder for a company. First
statutory auditors of a company are appointed by the board of directors.

2. Term of Office:
Internal auditor appointment is continuous until he is removed or resigns.
However, Statutory auditor(in some cases) is appointed for 5/10 years with
cooling off period of 5 years(rotation provisions).

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3. Qualification:
Qualifications of the statutory auditor are prescribed in the Companies Act,
2013. In case of a company, a Practicing CA or a firm of Practicing CA can only
be appointed as a statutory auditor. There are no fixed qualifications for the
position of an internal auditor.

4. Objects:
The main object of the statutory audit is to form an opinion on the financial
statement of the organization. Auditor has to state that whether the financial
statements are showing the true and fair view of the affairs of the organization
or not. The main object of the internal audit is to detect and prevent the errors
and frauds.
Proprietary oriented approach towards auditing by internal auditor.
Compliance oriented approach towards auditing by statutory auditor.

5. Scope:
The scope of the statutory audit is fixed by the Companies Act. It cannot be
changed by mutual consent between the auditor and the management of the
audited business unit. The scope of the internal audit is fixed by the mutual
consent of the auditor and the management of the unit under audit.
6. Report:
The statutory auditor submits his report to the shareholder of the company in
its general meeting. The internal auditor submits his report to the management
of the company who is also his appointing authority.

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7. Removal:
The procedure of removal of the statutory auditor is very complex. Only the
company in the general meeting can remove the auditor. It also has to take the
permission of the central government. The management of the entity can easily
remove internal auditor. No permission of Central Government is required.

8. Audit Ceiling
Internal audit is not considered for upper ceiling under Companies Act, whereas
statutory audit is considered for ceiling limit.

Question 5: State techniques of conducting internal audit (Refer ICSI


Text for detail explanation of each point)
i.

Review of operating environment

ii.

Review of Controls

iii.

Testing controls

iv.

Account Details

Question 6 Why internal audit is required/advantages of internal


audit?
Management is responsible for establishing and maintaining a system of
internal controls within an organization.
Internal controls are those structures, activities, processes, and systems which
help management effectively mitigate/reduce the risks to an organizations
achievement of objectives. Management is charged with this responsibility on

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behalf of the organizations stakeholders and is held accountable for this


responsibility.
A dedicated, independent and effective internal audit activity assists
management in fulfilling their responsibilities by bringing a systematic
disciplined approach to assessing the effectiveness of the design and execution
of the system of internal controls and risk management processes.
The objective assessment of internal controls and risk management processes
by the internal audit activity provides management and external stakeholders
with independent assurance that the organizations risks have been
appropriately mitigated. Because internal auditors are experts in understanding
organizational risks and internal controls available to mitigate these risks, they
assist management in understanding these topics and provide
recommendations for improvements.
Beside above, Internal Audit has become an important management
tool for the following reasons
1. Internal Auditing is a specialized service to look into the standards of
efficiency of business operation.
2. Internal Auditing can evaluate various problems independently in terms of
overall management control and suggest improvement.
3. Internal Audits independent appraisal and review can ensure the reliability
and promptness of MIS and the management reporting on the basis of which
the top management can take firm decisions.
4. Internal Audit system makes sure the internal control system including
accounting control system in an organization is effective.

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5. Internal Audit ensures the adequacy, reliability and accuracy of financial and
operational data by conducting appraisal & review from an independent angle.
6. Internal Audit is an integral part of Management by System.
7. Internal Audit can break through the power ego and personality factors and
possible conflicts of interest within the organization.
8. It ensures compliance of accounting procedures and accounting policies.
9. Internal Auditor can be of valuable assistance to management in acquiring
new business, in promoting new products and in launching new projects for
expansion or diversification of business

Question 7: Internal audit is not free from limitations. Discuss

Limitation of internal audit


Despite numerous benefits, internal audit has got some limitations Extra expenditure therefore might not be affordable for small companies
Lack of independence & objectivity and ability to report fraud/error to senior
management because of fear of losing employment.
Since no legal qualification is prescribed the audit may not be conducted that
effectively and efficiently.

Internal auditors are not required to be

professionally qualified and so there may be limitations in their knowledge


and technical expertise.
There might be time lag between recording of transactions and audit
The tool by itself depends upon how it is used by the manager. There are
occasions when managers cannot accept the finding of internal audit and
take consequent actions.
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Question 8 State Functions and Responsibilities of Internal Auditor

Functions and responsibilities of internal auditors


Internal auditing is an independent, objective assurance and consulting
activity designed to add value and improve an organisations operations. It
helps an organisation in accomplishing its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk
management, control,and governance processes.

Major roles and responsibilities of internal auditor are summarized below


1. To work with board and management to ensure that a system is in place
which ensures that all major risks are identified and analyzed. Evaluate and
provide reasonable assurance that risk management, control, and governance
systems are functioning as intended and will enable the organisations
objectives and goals to be met.

2. To plan, organize and carry out the internal audit function including the
preparation of an audit plan which fulfils the responsibility of the department,
scheduling and assigning work and estimating resource needs.

3. Report risk management issues and internal controls deficiencies identified


directly to the audit committee and provide recommendations for improving the
organisations operations, in terms of both efficient and effective performance.

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4. Evaluation of information security and associated risk exposures. Evaluation


of the organisations readiness in case of business interruption.

5. Evaluation of regulatory compliance program with consultation from legal


counsel.

6. Maintain open communication with management and the audit committee.


Team with other internal and external resources as appropriate. Engage in
continuous education and staff development. To report to both the audit
committee and management on the policies, programmed and activities of the
department.

7. Provide support to the companys anti-fraud programs.

8. To coordinate coverage with the external auditors and ensure that each
party is not only aware of the others work but also well briefed on areas of
concern.

9. To make recommendations on the systems and procedures being reviewed,


report on the findings and recommendations and monitor managements
response and implementation.

10. To review and report on the accuracy, timeliness and relevance of the
financial and other information that is provided for management.
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Question 9 Can statutory auditor rely on the work of Internal Auditor?


Reliance on work on internal Audit (AAS 7)
1. Not mandatory for statutory auditor to compulsorily rely on work of internal
audit.
2. Even if he relies on the work of internal audit, he is still not protected from
liability
3.

CARO 2003 requires statutory auditor to mention in his report whether

internal audit system is commensurate with size and nature of business.

In

case of company having share capital + reserves at Rs.50 Lacs or the average
annual turnover has crossed Rs. 5 Crores for last 3 financial years.

Question 10 Discuss the role of internal auditor in an organisation.

Role Of Internal Audit In Different Areas:


1. Role of Internal Audit in Internal Control
The

Internal

effectiveness

auditor
of

recommendations.

the

should

examine

internal

control

However,

the

and

contribute

system

internal

to

through

auditor

is

the

ongoing

evaluation

not

vested

and
with

managements primary responsibility for designing, implementing, maintaining


and documenting internal control. Internal audit functions add value to an
organizations internal control system by bringing a systematic, disciplined
approach to the evaluation of risk and by making recommendations to
strengthen the effectiveness of risk management efforts.
The internal auditor should focus towards improving the internal control
structure and promoting better corporate governance.

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The role of the internal auditor encompasses:


Evaluation of the efficiency and effectiveness of controls
Recommending new controls where needed or discontinuing unnecessary
controls
Using control frameworks
Developing Control self-assessment

2. Role of Internal Audit in risk management


Internal auditor needs to monitor and evaluate the effectiveness of the
organizations Risk management processes. Risk management relates to how
an organization sets objectives, then identifies, analyzes, and responds to
those risks that could potentially impact its ability to realize its objectives.
Under the COSO Enterprise Risk Management (ERM) Framework, risks fall
under strategic, operational, financial reporting, and legal/regulatory
categories. Management performs risk assessment activities as part of the
ordinary course of business in each of these categories.
Internal auditors may evaluate each of these activities, or focus on the
processes used by management to report and monitor the risks identified. For
example, internal auditors can advise management regarding the reporting of
forward-looking operating measures to the Board, to help identify emerging
risks.

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3. Role of Internal Audit in corporate governance


Internal auditing activity as it relates to corporate governance is generally
informal, accomplished primarily through participation in meetings and
discussions with members of the Board of Directors. Corporate governance is a
combination of processes and organizational structures implemented by the
Board of Directors to inform, direct, manage, and monitor the organizations
resources, strategies and policies towards the achievement of the organizations
objectives. The internal auditor is often considered one of the four pillars of
corporate governance, the other pillars being the Board of Directors,
management, and the external auditor.
A primary focus area of internal auditing as it relates to corporate governance
is helping the Audit Committee of the Board of Directors (or equivalent)
perform its responsibilities effectively. This may include reporting critical
internal control problems, informing the Committee privately on the capabilities
of key managers, suggesting questions or topics for the Audit Committees
meeting agendas, and coordinating carefully with the external auditor and
management to ensure the Committee receives effective information.

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CHAPTER 4 VARIOUS OTHER TYPES OF AUDIT

Question 1: Write a brief note on Secretarial Audit

The Companies Act 2013 has introduced a new requirement of Secretarial Audit
for bigger companies, which has been prescribed under Section 204 of the Act.
The provisions regarding secretarial audit of the company according to section
204 of the Companies Act, 2013 and the Companies (Appointment and
Remuneration of Managerial Personnel) Rules, 2014 are discussed below-

Companies required conducting secretarial audit:


(1) Every listed company and
(2) Company belonging to other class of companies:
The other class of companies are
every public company having a paid-up share capital of Rs.50 crore or more;
or
every public company having a turnover of Rs.250 crore rupees or more.

Qualifications for the secretarial auditor:


Secretarial Audit has to be conducted by a Practising Company Secretary(PCS)
in respect of the secretarial and other records of the company.

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Report of the secretarial audit:


A secretarial audit report shall be annexed with the Boards report of the
company. The Board of Directors, in their report made in terms of section
134(3), shall explain in full any qualification or observation or other remarks
made by the company secretary in practice in his report. The format of the
Secretarial Audit Report shall be in Form No.MR.3.

Other Provisions:
It shall be the duty of the company to give all assistance and facilities to the
PCS, for auditing the secretarial and related records of the company.
If a company or any officer of the company or the PCS, contravenes the
provisions of this section, the company, every officer of the company or the
PCS, who is in default, shall be punishable with fine which shall not be less than
Rs.1 lakh but which may extend to Rs.5 lacs. As per Section 143(14), all
provisions regarding rights, duties and obligations of statutory auditors shall
also apply to Company Secretary in Practice conducting secretarial audit.

Question 2 Write a short note on Cost Audit


Section 148 of the Companies Act provides that the Central Government may,
by order, in respect of such class of companies engaged in the production of
such goods or providing such services as may be prescribed, direct that
specified cost particulars shall also be included in the books of account kept by
that class of companies.
Certain class of companies are compulsorily required to get their cost books
audited by a Cost accountant in practise.

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The Cost Accountant in practice who shall be appointed by the Board on such
remuneration as may be determined by the members in such manner as may
be prescribed: Provided that statutory auditor of the company cannot be a cost
auditor.
Provided further that the auditor conducting the cost audit shall comply with
the cost auditing standards(issued by ICWAI)
An audit conducted under this section shall be in addition to the audit
conducted under section 143(Secretarial audit).
The qualifications, disqualifications, rights, duties and obligations applicable
to auditors under this Chapter shall, so far as may be applicable, apply to a
cost auditor also.
The report on the audit of cost records shall be submitted by the cost
accountant in practice to the Board of Directors of the company.
A company shall within 30 days from the date of receipt of cost audit report
furnish to the Central Government such report along with full information and
explanation on every reservation or qualification contained therein.
If, after considering the cost audit report the Central Government is of the
opinion that any further information or explanation is necessary, it may call for
such further information and explanation and the company shall furnish the
same within such time as may be specified by that Government.
If any default is made in complying with the provisions of this section,
(a) the company and every officer of the company who is in default shall be
punishable in the manner as provided in sub-section (1) of section 147;
(b) the cost auditor of the company who is in default shall be punishable in the
manner as provided in sub-sections (2) to (4) of section 147.
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Question 3: Write a note on Special Audit (Sec 233A of Companies Act, 1956)

1. Meaning
Special audit is ordered by C.Govt in some cases and therefore it is not
mandatory for all the companies.
Special audit may be ordered by CG without providing an opportunity of being
heard to the company.

2. Circumstances for appointment


As per sec 233A (1) under the following circumstances, special audit may be
ordered by Central Government
Where the Central Government is of opinion that
(a) the affairs of the company are not being managed in accordance with sound
business principles or prudent commercial practices; or

(b) the company is being managed in such a manner that it would cause
serious injury or damage to the interests of the trade, industry or business to
which it pertains; or

(c) the financial position of the company is such as to endanger its solvency

3. Who can be a special auditor?


Special auditor is appointed by CG. The person appointed can be the companys
auditor or any other CA (whether in practice or not)

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4. Scope
The scope of special auditor is determined by sec 227 of cos Act,(which is the
same the regular auditor), however, Central Govt may direct the special auditor
to extend his scope to other areas.

5. Rights and duties


He enjoys similar rights as co. auditor except he cannot attend AGM, he also
owes similar duties as co. auditor except that his report shall be addressed to
Central Govt and not to shareholders

6. Reporting
The special auditor addresses his report to the central govt. The copy of the
report need not addressed to company.

7. Remuneration Fixed by CG and paid by Company

8. Central Govts Obligation


On the basis on special audit report, Central Govt shall take appropriate action
as considered deemed fit .It can also ask the special auditor to clarify any
matters of qualification included by the auditor. In any case Central Govt shall
forward to the co: within 120 days a copy/extract of the report and may direct
the co. to forward a copy thereof to all the shareholders or get the contents of
the report read in the AGM.

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Question 4 Write a short note on Propriety Audit

Propriety Audit
Kohler has defined propriety as that which meets the test of public interest,
commonly accepted customs and standard of conduct and particularly as
applied to professional performance, requirements of Government regulations
and professional codes. Propriety Audit carry out to check, mean whether the
transactions have been done in conformity with established rules, principles
and established standard.
The Propriety Audit means the verification of following main aspects to find out
whether:
(i) Proper recording has been done in appropriate books of accounts.
(ii) The assets have not been misused and have been properly safeguarded.
(iii) The business funds have been utilized properly.
(iv) The concern is yielding the expected results.

The system of Propriety Audit is applied in respect to Government companies,


Government Department because public money and public interest are involved
therein. It is an essential function of audit to bring to light not only cases of
clear irregularity but also every matter which in its judgement appears to
involve improper expenditure or waste of public money or stores, even though
the accounts themselves may be insufficient to see that sundry rules or orders
of competent authority have been observed. It is of equal importance to ensure
that the broad principles of orthodox finance are borne in mind not only by
disbursing officers but also by sanctioning authorities.
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The CAG should bring out cases of improper avoidable expenditure even though
they are as per the rules.
To protect the interest of public, mere regular audit of expenditure is
inadequate.
It should be subject to principle of propriety i.e. whether it is wasteful in
nature.
Audit

should

look

into

the

wisdom,

faithfulness

&

economy

of

govt.

transactions.
The following broad principles are normally followed:
a. Expenditure should not be prima facie more than the occasion demands.
b. The Government officials not to sanction expenditure that will directly or
indirectly accrue advantage to them.
c. Public money should not be wrongly utilized for a particular person or section
of community.

Question 5 Write a short note on Performance Audit

Performance Audit
It covers efficiency, economy and effectiveness audit.
Efficiency audit looks into whether the Government projects are executed &
their operations are conducted as per the expected results. Efficiency indicates
how best an organization uses its given resources . Efficiency audit focuses on
input, output and productivity. It refers to comparing and analyzing actual
output with the desired/expected output.
It brings out deficiencies/negatives in the system and how it can be improved.

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Economy audit looks into whether the Government has acquired the financial,
human and physical resources in an economical manner and also whether
sanctioning authorities have observed economy.
Effectiveness audit refers to appraisal of the performance of the projects with
reference to a predetermined target.

The procedure for performance audit includes the following:


a. Identification of the projects.
b. Preliminary studies
c. Planning & execution of audit
d. Reporting

The auditor determines the circumstances by exercising his professional


judgement to come to a conclusion whether he has to perform both types of
audit.

Question 6 - Write a brief note on CAG AUDIT/GOVT AUDIT

The Comptroller and Auditor General (CAG) of India is an authority,


established by the Constitution of India, who audits all receipts and expenditure
of the Government of India and the state governments, including those of
bodies and authorities substantially financed by the government.
C&AG shall hold office for a term of 6 years or upto the age of 65 years, which
is earlier. He can resign at any time through a resignation letter addressed to
the President.

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Organizations subject to the audit of the CAG


The organisations subject to the audit of the Comptroller and Auditor General of
India are: All the Union and State Government departments and offices including the
Indian Railways and Posts and Telecommunications.
About 1500 public commercial enterprises controlled by the Union and State
governments, i.e. government companies and corporations.
Around 400 non-commercial autonomous bodies and authorities owned or
controlled by the Union or the States.
Over 4400 authorities and bodies substantially financed from Union or State
revenues

Question 7: Write a short note on audit of government companies.


Audit of Government Companies(Commercial Audit)
The CAG is also the external auditor of Government-owned corporations and
conducts supplementary audit of government companies, i.e., any nonbanking/ non-insurance company in which the state and Union governments
have an equity share of at least 51 per cent or subsidiary companies of existing
government companies. The report of CAG is submitted to the Parliament.
The audit done by CAG is broadly classified into Regularity Audit and
Performance Audit.
Regularity Audit (Compliance)
Audit against provision of funds to find whether the moneys shown as
expenditure in the Accounts were authorized for the purpose for which they
were spent.
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Audit against rules and regulation to see that the expenditure incurred was in
conformity with the laws, rules and regulations framed to regulate the
procedure for expending public money.
Audit of sanctions to expenditure to see that every item of expenditure was
done with the approval of the competent authority in the Government for
expending the public money.
Propriety Audit which extends beyond scrutinizing the mere formality of
expenditure to it wisdom and economy and to bring to light cases of improper
expenditure or waste of public money.
While conducting the audit of receipts of the Central and State Governments,
the Comptroller & Auditor General satisfies himself that the rules and
procedures ensure that assessment, collection and allocation of revenue are
done in accordance with the law and there is no leakage of revenue which
legally should come to Government.

Regularity Audit (Financial)


In regularity (financial) audit and in other types of audit when applicable,
auditors analyze the financial statements to establish whether acceptable
accounting

standards for financial reporting and disclosure are complied with.

Analysis of financial statements is performed to such a degree that a rational


basis is obtained to express an opinion on financial statements.
Performance Audit
Performance audit is done to see that Government programmes have achieved
the desired objectives at lowest cost and given the intended benefits.

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Question 8 - Write a brief note on Compliance Audit


A compliance audit is a comprehensive review of an organizations adherence to
regulatory guidelines.
What, precisely, is examined in a compliance audit will vary depending upon
whether an organization is a public or private company, what kind of data it
handles and if it transmits or stores sensitive financial data.
It is common to us that the business undertakings require some certified
statement on various matters and the auditors certify such statements after
carrying out audit which might be necessary under the particular cases. All
such audits are called Compliance Audit. Suppose when a company applies to a
bank for some loan, a certified statement showing the turnover of the company
for the past two or three years along with the current year might be necessary,
and for this purpose the certified statements are to be attached with the
application, otherwise the application will be rejected. So these certified
statements showing the turnover of the company fall under the category of
compliance audit. Internal audit for compliance could be more broad base to
include compliance with documented procedures/policies, compliance with
statutory requirements in the relevant areas etc.

The objective of a compliance audit is to determine whether the auditee is


following prescribed laws, regulations, policies, or procedures. These audits can
be performed within a business organization for internal purposes or in
response to requirements by outside groups, particularly government.

Benefits of Compliance Audit


1. Adherence to the established standards.
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2. Improvement of internal processes and technologies.


3. Maintenance of Certifications.
4. Adherence to governmental regulations.
5. Cost recovery.
6. Elevate fraud awareness and deter fraudulent activity.
7. Manage contract areas of risk.

Audit conducted with the objective to report whether the company is in


compliance

with

internal

procedures/rules/regulations/policies/standards,

corporate
external

regulatory

requirements such as Companies Act, or compliance with industry codes of


conduct such as ISO 14001. Effective compliance audit can protect a company
against potential litigation, financial implications and reputational damages. It
is a tool to manage risk and prevent errors and frauds.

Question 9: Write a short note on Efficiency Audit

In essence, efficiency indicates how well an organization uses its resources to


produce goods and services. It focuses on resources (inputs), goods and
services (outputs), and the rate (productivity) at which inputs are used
to produce or deliver the outputs. To understand the meaning of efficiency, it
is necessary to understand the following terms: inputs, outputs (including
quantity and quality), productivity, and level of service.
Inputs are resources (e.g., human, financial, equipment, material, facilities,
information, energy and land) used to produce outputs.

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Outputs are goods and services produced to meet client needs. Outputs are
defined in terms of quantity and quality and are delivered within parameters
relating to level of service.
Quantity refers to the amount, volume, or number of outputs produced.
Quality refers to various attributes and characteristics of outputs such as
reliability, accuracy, timeliness, service courtesy, safety, and comfort.
Productivity is the ratio of the amount of acceptable goods and services
produced (outputs) to the amount of resources (inputs) used to produce them.
Productivity is expressed in the form of a ratio such as cost or time per unit
of output.
Efficiency is a relative concept. It is measured by comparing achieved
productivity with a desired norm, target, or standard. Output quantity and
quality achieved and the level of service provided are also compared to targets
or standards to determine to what extent they may have caused changes in
efficiency. Efficiency is improved when more outputs of a given quality are
produced with the same or fewer resource inputs, or when the same amount of
output is produced with fewer resources.
Efficiency audit refers to comparing the actual results with the desired or
projected results. It is directed towards the measurement of whether plans
have been effectively executed. It is concerned with the utilisation of the
resources in economic and most remunerative manner to achieve the
objectives of the concern. It comprises of studying the plans of organisation,
comparing actual performance with plans and investigating the reasons for
variances to take remedial action

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Objectives Of Efficiency Audit


Objectives of efficiency audit include assessing one or more of the following:
the level of efficiency achieved by an organization or operation in relation to
reasonable standards;
the adequacy and reliability of systems or procedures used to measure and
report efficiency;
an organizations efforts to explore and exploit opportunities to improve
efficiency; and
whether the management processes and information systems, operational
systems, and practices of an organization help to achieve efficiency.

Advantages of Efficiency Audit


Auditing efficiency enables the management/owner to know whether the
departments and agencies manage resources with due regard to efficiency. It
can also directly or indirectly help departments and agencies to identify
opportunities to provide more or better services at the same or lower cost.
More specifically, such audits can:
help managers and staff to be more sensitive to their obligation of due regard
to efficiency;
underline the importance of measuring efficiency and of using that
information for managing operations and providing accountability;
identify means for improving efficiency, even in operations where efficiency is
difficult to measure;

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demonstrate the scope for lowering the cost of delivering programs without
reducing the quantity or quality of outputs or the level of service;
increase the quantity or improve the quality of outputs and level of service
without increasing spending; and
identify needed improvements in existing controls, operational systems, and
work processes for better use of resources

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CHAPTER 5 - INTERNAL CONTROL

Question 1 Bring out the meaning of Internal Control System

Definition of Internal Control


Internal controls as a system comprising of controls environment and
procedures. It includes polices and ways adapted by management of an
enterprise to assist it in achieving its objectives. - The International
Standards of Auditors
The plan of organization and all the methods and procedures adopted by the
management of an entity to assist in achieving the managements objective of
ensuring, as far as practicable
- the orderly and efficient conduct of its business, including adherence to
management policies,
- the safeguarding of assets, prevention and detection of fraud and error,
- the accuracy and completeness of the accounting records,
- compliance of law and
- the preparation of reliable financial information.

Question 2 List the objectives of Internal control system


Objectives of Internal control
a) Authorization - the objective is to ensure that all transactions are approved
by responsible personnel in accordance with their specific or general authority
before the transaction is recorded.
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b) Completeness - the objective is to ensure that no valid transactions have


been omitted from the accounting records.
c) Accuracy - the objective is to ensure that all valid transactions are accurate,
consistent with the originating transaction data, and information is recorded in
a timely manner.
d) Validity - the objective is to ensure that all recorded transactions fairly
represent the economic events that actually occurred, are lawful in nature, and
have been executed in accordance with managements general authorization.
e) Physical Safeguards and Security- the objective is to ensure that access to
physical assets and information systems are controlled and properly restricted
to authorized personnel.
f) Error Handling - the objective is to ensure that errors detected at any stage
of processing receive prompts corrective action and are reported to the
appropriate level of management.
g) Segregation of Duties - the objective is to ensure that duties are assigned to
individuals in a manner that ensures that no one individual can control both the
recording function and the procedures relative to processing a transaction.

Question 3 State the different Nature/types of internal controls


Internal controls can be detective, corrective or preventive in nature.
Preventive controls not to let the errors/irregularities happen
following are such controls
Segregation of duties
Security of assets
Approvals, authorizations and verifications

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Detective controls controls to detect errors/irregularities following


are such controls
Review of performance
Reconciliation
Physical inventories
Internal Audit

Corrective controls controls to correct the errors/irregularities which


are detected.

Question 4 What are the elements of Internal Control


Elements of Internal Control
1. Control Environment
2. Risk Assessment
3. Control Activities
4. Information and communication
5. Monitoring

Question 5 What are the advantages of Internal Control System


a) Increase in operational efficiency
Internal controls bring efficiency in operation. Technological advances to
improve the accuracy of each transaction also streamline manual processes.
b) Accurate Recording
Internal controls help prevent errors and irregularities from occurring. If errors
or irregularities do occur, internal controls will help ensure they are detected in
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a timely manner. It creates confidence that only authorized transactions have


taken place.
c) Safeguarding Assets
It minimizes the risk of fraud and misappropriation of assets. It involves fraud
monitoring and prevention techniques. For example in case of a banking
internal control system, monitoring activities include security cameras and
security guards and prevention activities include cash counting by two
employees at a time and cash reconciliation by non-tellers..
d) Compliance
Another advantage of using internal controls includes increasing compliance
with regulatory agencies. Internal controls encourage adherence to prescribed
policies and procedures. It assures that adequate documentation supporting
transactions is created and retained.
e) Protection of Employees
Internal controls protect employees: 1) by clearly outlining tasks and
responsibilities, 2) by providing checks and balances, and, 3) from being
accused of errors, misappropriations, or irregularities
f) Benefits of Internal Control to the Auditor
If the audit client benefits from a sound system of internal control, it is likely
that the auditor will also be benefited.

All of the above stated benefits help to promote a situation where the financial
statements present a true and fair view. A good system of internal control will
make life easier for the auditor.

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Question 6 What are the limitations of Internal Control

Limitations of Internal control


No matter how well the internal controls are designed, they can only provide a
reasonable assurance that objectives will be achieved. Some limitations are
inherent in all internal control systems. These limitations include:
a) Judgment - the effectiveness of controls will be limited by decisions made
with human judgment under pressures to conduct business based on the
information available at hand.
b) Breakdowns - even well designed internal controls can break down.
Employees sometimes misunderstand instructions or simply make mistakes.
Errors may also result from new technology and the complexity of
computerized information systems.
c) Management Override - high level personnel may be able to override
prescribed policies or procedures for personal gains or advantages. This should
not be confused with management intervention, which represents management
actions to depart from prescribed policies and procedures for legitimate
purposes.
d) Collusion - control system can be circumvented by employee collusion.
Individuals acting collectively can alter financial data or other management
information in a manner that cannot be identified by control systems.
e) Others Control system may become redundant with passage of time.
Most controls tend towards transaction of usual nature.
A well designed process with appropriate internal controls should meet most if
not all of these control objectives
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Question 7: What are various techniques used in Internal Control


System
There are two types of techniques used in internal control system Preventive
internal control techniques and Detective internal control techniques. From a
quality standpoint, preventive controls techniques are essential because they
are proactive and emphasize quality. However, detective controls techniques
play a critical role by providing evidence that the preventive controls
techniques are functioning as intended.
Preventive Controls techniques are designed to discourage errors or
irregularities from occurring. They are proactive in nature that helps to ensure
departmental objectives are being met.
Examples of preventive controls techniques are:
1. Segregation of Duties:
Duties are segregated among different people to reduce the risk of error or
inappropriate action. Normally, responsibilities for authorizing transactions
(approval), recording transactions (accounting) and handling the related asset
(custody) are divided.

2. Approvals, Authorizations, and Verifications:


Management authorizes employees to perform certain activities and to execute
certain transactions within limited parameters. In addition, management
specifies those activities or transactions that need supervisory approval before
they are performed or executed by employees. A supervisors approval (manual
or electronic) implies that he or she has verified and validated that the activity
or transaction conforms to established policies and procedures.

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3. Security of Assets (Preventive and Detective):


Access to equipment, inventories, securities, cash and other assets is
restricted; assets are periodically counted and compared to amounts shown on
control records.

Detective Controls techniques are designed to find errors or irregularities


after they have occurred. Examples of detective controls techniques are:
1. Reviews of Performance:
Management compares information about current performance to
budgets,forecasts, prior periods, or other benchmarks to measure the extent to
which goals and objectives are being achieved and to identify unexpected
results or unusual conditions that require follow-up.
2. Reconciliations:
An employee relates different sets of data to one another, identifies and
investigates differences, and takes corrective action, when necessary.
3. Physical Inventories
4. Internal Audits

Question 8 How do you test and evaluate Internal Control in an


Organisation
Review/Evaluation of Internal Control by the Auditor
Internal Controls are to be an integral part of any organizations financial and
business policies and procedures.
Internal controls consists of all the measures taken by the organization for the
purpose of;
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(1) protecting its resources against waste, fraud, and inefficiency;


(2) ensuring accuracy and reliability in accounting and operating data;
(3) securing compliance with the policies of the organization; and
(4) evaluating the level of performance in all organizational units of the organization.
Internal controls are simply good business practices.
Review of internal control system is a very important task for an auditor. It is
required to ensure that any inefficiency or ineffectiveness in system is
captured. A statutory auditor us also required to evaluate the effectiveness of
internal control system and to state in his report to shareholders.

Testing of internal control


This is normally done by the application of procedural tests and examination in
depth
a) Procedural tests
It means testing the compliance of the procedures laid down by the
management in respect of each stage through which a transaction flows. The
purpose of such compliance procedures is to provide reasonable assurance that
internal controls are being applied as prescribed. The auditor should carry out
procedural tests in respect of all internal controls on which audit reliance is
desired to be placed. Based on such tests, the auditor is able to satisfy that a
system of internal control exists, which is effective and which has been so
operated throughout the period of intended reliance.

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b) Examination in depth
It means examination of a few selected transactions from the beginning to the
end.

It involves studying of the recording of the transactions at the various

stages, examination of the relevant records, documents, authorities etc. It also


involves satisfying that the person who has exercised the authority is fit to do
so in the first place and has done so in accordance with the prescribed norms.
On the basis of above tests and proper understanding the internal controls in
force, the auditor arrives at a conclusion as given below:
1. The degree, nature and extent of weaknesses in the system.
2. The areas and the extent to which audit reliance may be placed.
3. The nature, timing and extent of his substantive procedures.

Techniques for evaluation of Internal control system


1. Narrative record; 2. Check List; 3. Flow Charts; 4. Questionnaire.
Flow Charts
It is a pictorial representation of the internal control system showing the
various operations, controls and stages involved in such system. It gives a
concise and comprehensive view of what happens in the organization. E.g. how
and when documents are raised, how they are dealt with, the departments
through which they pass, the authorities / personnel responsible for the
maintenance of records/registers, how the flow of goods and cash take place,
what the various operations are and so on. This enables the user of such flow
chart to understand clearly what control systems are in place and gives a birds
eye view of the transactions so as to enable him to evaluate internal controls in
the right perspective and improvements could be suggested.

Flowcharts are

essentially a means of communication. Hence it should convey precisely and


clearly what it intends to convey.
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Internal control questionnaire


It lists the various questions which an auditor may ask to his client in order to
verify the existence and efficiency of internal control system. Its the most
convenient and widely used method for collecting information regarding the
internal control system. Generally the questions are pre-designed and, hence, it
can be ensured that all aspects of the system are covered. Questions are so
designed that the answer can be Yes or No or Not applicable. However
space may be provided below each answer for justifying/amplifying such
answers wherever necessary.
It is usually issued to the client who fills it. Based on the answers given by the
client, inherent weaknesses, if any, are noticed by the auditor, the matter is
further discussed and a report of deficiencies is given to the client with
suggestions for improvement.
This questionnaire is prepared taking into consideration broad categories like 1. Segregation and rotation of duties
2. Maintenance of records and documents
3. Accountability for, and safeguarding of, assets
4. Procedure for authorizations
5. Independent Checks.

Question 9 What do you understand by audit in depth?


It implies auditing a transaction extensively from the origin to the end. It is a
audit technique used to evaluate the effectiveness of internal control system in
an organization. Through check of the transaction like sanctity of the
transaction, validity of transaction, adherence to the procedures and polices
while executing the transaction, arithmetic accuracy, accounting treatment,etc.
It is also called as Vertical Vouching.
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Question 10 Who is responsible for installing a good Internal Control


System?
Responsibilities of Management vis--vis Auditors
It is the responsibility of the management for maintaining an adequate
accounting system incorporating various internal controls to the extent
appropriate to the size and nature of the business.
The management is also vested with the responsibility of closely monitoring the
system in place in order to ensure that the basic objectives of installing such
control systems are achieved.
Whereas the Auditor, to safeguard his own interest, might

resort to

examination and evaluation of the internal control that exist in the organization
so that his entire audit programme may be formulated only after he satisfies
himself that such control systems are adequate and in consonance with the
requirements of the business.
After a thorough examination and review of internal controls, if the auditor
becomes aware of weaknesses in such internal controls, he should make the
client aware of material weaknesses that have come to his attention. Such
communication is normally sent to the management in writing, which is termed
as a letter of weakness or management letter.

Question 11 What do you understand by Internal Check


Internal check is best regarded as indicating checks on the day-to-day
transactions which operate continuously as a part of the routine systems
whereby work of one person is proved independently or is complementary to
the work of another, the object being the prevention of or early detection of
errors and frauds.
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The main objective of internal check is prevention of errors and frauds and/or
detection of errors and frauds at the earliest. Internal check is a continuous
process and is part of the day-to-day routine. It relates to all the transactions
that take place every day. Internal check is achieved by complementary
allocation of duties and by independent verification of the work of one person
by another.
Internal check is a part of internal control system. It ensures that all financial
transactions are properly recorded.
It also ensures efficiency of the accounting system followed by the organization
and enables easy preparation of financial statements. It achieves its main
object of minimizing errors and frauds.
A sound system of internal check increases the reliability of financial
statements. Internal check discourages fraud and collusion among employees
by instilling a fear of detection in their minds. Internal check assigns
responsibilities to persons and enables maintenance of records and documents
properly and thereby ensures smooth flow of work.
Internal check is a part of Internal control system. Internal check refers to the
whole system established within the organization by which work of one
employee is automatically (& continuously, objectively, independently) checked
by another ensuring that the process accounting information is accurate.
Internal check vs. Internal Control System
Internal check is a smaller concept compared to a broader concept of internal
control. Internal check is a part of internal control system. Internal control
includes internal check, internal audit, quality control etc

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Question 12 - Internal check vs. Internal audit


Way of checking:
In internal check system work is automatically checked whereas in internal
audit system work is checked specially.
Cost involvement:
In internal check system checking is done when the work is being done.
Mistake can be checked at an early stage in internal check system.
Thrust of system:
Thrust of internal check system is to prevent the errors and whereas the thrust
of internal audit system is to detect the errors and frauds.
Time of checking:
In internal check system checking is done when the work is being done
whereas in internal audit system work is checked after it is done. Mistakes can
be checked at an early stage in internal check system.
Note: Same above difference between internal control and internal
audit.

Question 13 What do you understand by Compliance Test and


Substantive Tests
Auditor can gather evidences by testing. Following are the two categories of
tests
1. Compliance Test
1)

Compliance means adherence

2)

Management introduces IC system

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3)

Evaluation of ICS by auditor

4)

The auditor carries out auditing in depth and surprise check for this
purpose

5)

Object is to find whether the personnel have complied with ICS.

Objective of compliance test


1)

Existence of system

2)

Effectiveness of system

3)

Continuance of system

The Auditor is concerned with all the above concurrently

2. Substantive test
1)

Phrase substantive derived from the word to substantiate i.e. to prove

2)

It refers to
a)

Test of details of transaction

b)

Analytical test

Following are objective with reference to Balance sheet


1)

Existence

2)

Rights and obligations

3)

Valuation

4)

Disclosure

With regard to P & L account following are the objectives


a)

Occurrence of transaction

b)

Measurement of transaction

c)

Disclosure

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CHAPTER 6 AUDIT ENGAGEMENT AND DOCUMENTATION

Question 1: What do you understand by Audit procedure and process?


Audit procedures refer to the methodology adopted by an auditor in carrying
out an audit assignment.
Audit procedures have a very important role in the successful execution of an
audit assignment. The most successful audits are those involving sound
planning and those in which the auditee and the auditors have a constructive
working environment. In a conducive environment, auditee, should understand
what auditor has been doing and why. Although every audit is unique, the audit
process is similar for most engagements, and normally consists of three stages:
planning, executing and reporting

Question 2 Bring out the meaning and importance of Audit Planning


AAS 8- In order to ensure a high standard of performance, it is important that
the auditor should prepare adequately for his work. Planning for an audit, just
like every human endeavour, is essential for the smooth performance of the
audit work and its successful completion. Planning ahead for an audit work will
not only guarantee a valid audit opinion but will also help the auditor to ensure
that:
(a) The audit objective is established and achieved;
(b) The audit is properly controlled and adequately directed at all stages;
(c) High risk and critical areas of the engagement are not omitted but that
adequate attention is focused on these areas; and

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(d) The work is completed economically and expeditiously, hence, saving on


audit resources.
Points for Consideration in Audit Planning: In order to make the planning
more meaningful, the auditor should take into consideration the following
matters in relation to the audit engagement:
(a) Preliminary Work to be done in addition to the real audit work
This will include such matters as stocktaking, cash count,debtors circularisation
and review of previous years working papers. This will remind the auditor of
those matters brought forward from the previous year and any other points to
be resolved in the current year or problems anticipated.
(b) Changes in legislation, accounting or any auditing standards or guidelines
The auditor should acquaint himself with all the changes that took place during
the year in applicable legislation, accounting and auditing standard. This will
help an auditor in carrying out the auditing assignment in away that meets the
legislative requirement.
(c) Analytical review of available management accounts and other management
information that relate to the accounts.
This will assist in establishing valuable ratios and indicators that will guide the
auditor. For instance, the computation of the gross profit percentage compared
with that of the previous year will provide a good indicator to the auditor of the
accuracy and reliability of sales and cost of sales.
(d) Changes in the business or management
The appointment of a new finance controller and the establishment of a new
business line or the creation of a new branch are significant changes in the
circumstances of the company which will necessitate changes in the existing

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audit plans. There may be similary changes for which change may be required
in audit plan.
(e) Changes in the accounting system
The introduction of computers such that when a company introduces significant
changes in its operating procedures will require a review and evaluation of the
system of internal control.
(f) Deadlines established for the submission of audit report
Where a client has set deadlines for its statutory activities such as the annual
general meeting, it is important for the auditor to work in line with such
programmes.
(g) Use of Rotational Testing and Verification
In practice, the auditor may not carry out a hundred percent testing or
verification of the clients transactions or segments of the business. Where
rotational testing or verification is adopted, it will be necessary for the auditor
to determine ahead of the date of the engagement which aspects of the
business should be selected for testing or verification. An example of rotational
testing could be applied on the clients branches to be visited.
Coverage of Audit planning
It covers the following aspects:1)

Acquiring knowledge of clients accounts system accounts polices and IC


procedure

2)

Establishment of expected degree of reliance to be placed on IC

3)

Determination of nature, timing and extent of audit procedures through


proper programming

4)

Co-ordination of the audit.

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Constituents of Audit Planning:The planning process includes


a. Development of an overall audit plan
b. Development of an audit programme showing nature, timing and extent
of audit procedures
Advantages
a. Appropriate attention is devoted to important areas of audit
b. Identification of potential problems.
c. Completion of work expeditiously (on time)
d. Utilization of assistance properly
e. Coordinating work done by other auditors and experts.

Question 3 What do you understand by Audit Programme? State its


content and advantages.
Most of the time audit is conducted by a team instead of just an individual.
Depending on the audit, audit team can have different number of members.
Usually the team is structured in a Partner, Manager and Assistants which may
further be divided into senior assistants and juniors.
In order to properly assign work to each individual and what is required to be
done by whom there must be some kind of instructions set, otherwise, more
than one member might be auditing the same area or in other case some areas
may be left completely unaudited.
To ensure efficient and effective conduct of audit assignment, audit
programmes are used.
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Audit programme contains step by step instructions to be carried out by team


members i.e. it is simply a list of audit procedures to be executed by team
members.
Audit programme or audit program is not a name of any computer program.
Also it has nothing to do with computer programming in any way. However,
audit programmes can be made using computer software in computer assisted
auditing environment
Even though audit programme sets out the whole agenda for every member of
the team but the main users are juniors for whom it acts as a dictation to be
followed.
The main purpose of audit programme is that every material area has been
audited appropriately and sufficient appropriate audit evidence has been
obtained in respect of every important areas of audit.
Audit programmes are prepared on the basis of audit plan usually by the
auditor who in the audit team is either partner or manager. But sometimes,
audit firms have a basic audit programme and the same is used by the auditor
after making some modifications to it to make it according the audit
engagement in hand.
Mostly it is in the form of a checklist which can be used by the juniors to make
sure every required procedure has been implemented. This can also help in
monitoring the work of juniors in specific or assistants in general.
Audit programmes may be laid down in advance for the whole year for some
aspects of the audit which auditor expects to be audited after regular intervals
of time or when needed. For understandability and convenience, audit
programmes are written for each audit area separately and then assigned to
specific team members.

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What procedures shall be part of audit programme is to be decided by the


auditor and depends on the auditors judgement.
Contents of a Audit Programme:
1. Extent of checking i.e.% of checking of transactions as a test check.
2. Initial /Signature by audit staff
3. Remarks
4. Level of staff deputed
5. Audit procedures and techniques.
The Audit Programme normally covers both B/S and P & L audits.

Advantages:
1. Replaces mental plan
2. Effective monitoring device
3. Coverage (wide)
4. Systematic approach to audit
5. Source of planning for future
6. It provides guidance to audit staff
7. Acts as evidence in the court of law.
8. Enables fixation of responsibility on the audit staff
9. Ensures continuity of audit
10.

Compliance with Auditing practices

Limitations:
1. Rigidity
2. Monotony
3. Does not encourage creativity
4. Provides an easy way of escape for inefficient staff
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Question 4 Write a Specimen of audit programme for Cash Audit


Sample Audit Program For Cash Audit
1. Discuss and document with the cashier about the procedures for the
receiving and disbursement of cash.
A. sources of cash (funds)
B. frequency of deposits
C. who makes the deposits
D. the level of cash received
E. the nature of documentation of expenditures (invoices, check requests,
agreements...)
F. authorization procedures
2. Determine whether the level of cash held in the field and in the office is
appropriate.
3. For petty cash funds
Is an accurate petty cash voucher maintained?
Are physical cash counts
(a) Conducted routinely by a person or people who are not direct custodians of
the petty cash funds?
(b) Reconciled with the petty cash voucher? Can all variances be explained?
(c) Documented by those people who performed the counts and reconcile these
counts against the petty cash voucher?
Is access to petty cash funds restricted? Who has access to these funds?

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4. For all field checking accounts


(a)Determine the number of signatures required on each check.
(b) Determine the process by which cash is received for mission operations.
(c) Obtain bank statements for each bank account.
(d) Determine the frequency and timing of the preparation of bank
reconciliations.
Who does the reconciliations?
(e) Summarize a listing of deposits from the bank statements and reconcile the
amounts with reported home office transfers and other sources of income
reflected on the fields financial reports.
(f) Obtain bank reconciliations and test for accuracy.
(g) Verify whether a second party reviews bank reconciliations monthly. These
examinations should be documented with a date of examination and a
signature of the second party.

Question 5 List the differences between Vouching and Verification.

Vouching
Vouching is referred to as The art of examining vouchers. The objective of
vouching is to establish the authenticity of the transactions recorded in the
primary books of accounts. This is done by
a. Verifying transactions recorded in the books of account with relevant
documentary evidence (vouchereg cheque, invoices, goods received
note,challans,agreements,counterfoil,minutes book,MOA,AOA, deeds,bank
statement,registers).
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b. Verifying the authority on the basis of which the entry has been made
c. Confirming that the amount mentioned in the voucher has been posted
to appropriate account

The following are the essential points to be kept in mind while examining a
voucher:
a. Vouchers should be numbered
b. Voucher should be dated and fall within the accounting period
c. Vouchers should be Authorized
d. Should relate to clients business
e. Accounted under proper a/c that would clearly disclose the character of
the receipts or payments posted
f. Alterations in the voucher should be authorized
g. Amount in words and figures should match.
h. Cancelled vouchers should be retained in the book
i. Unused vouchers should be kept under lock and key
Objective of vouching to ensure genuine,valid,complete transactions are
properly recorded in the books and they have evidence in the form of vouchers.
To ensure only transactions relating to business are recorded. In the process of
vouching frauds and errors might be detected.

Verification- Verification implies an enquiry into the value, ownership and


title, existence, possession, presence of any charge on the assets of the
company.
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Points to be considered in verification existence, possession, ownership,


charge/lien,record,audit report, event occurring after the balance sheet date.

Techniques of verification
Inspection physical inspection of assets
Observation observing the verification done by others
Confirmation getting written confirmation from outsiders regarding the
existence of the assets.

Distinction between Vouching and Verification (look into your ICSI for
detail of each point) Points of differences - Meaning, Nature, Person,
Time

Question 6 State meaning, purpose and importance of Audit


Documentation. Also state the types of audit files.
Documentation refers to the working papers prepared or obtained by the
auditor and retained by him, in connection with the performance of the audit.

AUDIT DOCUMENTATION: (AAS 3)


(i)

Meaning

Refers to various information provided to the Auditor by the client in support of


matters disclosed in financial statement.
Collectively known as working paper.
Also includes Audit note book
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(ii)

Purpose

It supports Audit conclusions reached


Evidence which can be presented in the court supporting nature of Audit work.
Provides guidance for future period audit staff
Fixes responsibility on the audit staff executing the Audit work
It is a proof that GAAP has been regularly followed
Classification / Kinds
1)

Broadly classified as (a) Permanent file & (b) Current file

Permanent file
Kept at Auditors office
Contains documents which are required for Audit of recurring nature
Members of Audit team refer to this for updating basic information about client.
Cannot be taken to clients location
Contents are updated periodically
CONTENTS OF PERMANENT FILE (few examples)
1)

Copies of MOA and AOA

2)

Copies of collaboration agreements

3)

Extract of legal provisions applicable

4)

Extract of legal pronouncements such as AS

5)

Published accounts previous periods

6)

Major frauds occurred and detected in previous period

7)

Organizational charts

8)

List of officers, their power and duties

9)

List of accounting policies followed

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10)

List of bank accounts operated

11)

Evidence that ICS has been evaluated

12)

Statement showing trend of accounting ratios

Current file
1)

Refers to papers linked to current period F.S.

2)

Generated at the clients office

3)

Information are either founded by clients or generated by Auditor


directly

4)

The contents support conclusions reached by Auditors

5)

Ultimately stored in Audits offices

6)

It is indexed and numbered in the systematic manner

Contents of Current File (Few examples):1)

Advance planning memorandum

2)

Audit programme

3)

Inventory sheet

4)

Confirmation letters

5)

Draft financial statements

6)

Draft Audit report

7)

Branch financial statement

8)

Management representation

9)

Statement of accounting ratios

10)

Audit conclusions

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Ownership and custody


Working papers are the property of the auditor. The auditor may, at his
discretion, make portions of or extracts from his working papers available to his
client.
The auditor should adopt reasonable procedures for custody and confidentiality
of his working papers

General guidelines for the preparation of working papers are:


1. Clarity and Understanding
As a preparer of audit documentation, step back and read your work
objectively. Would it be clear to another auditor? Working papers should be
clear and understandable without supplementary oral explanations. With the
information the working papers reveal, a reviewer should be able to readily
determine their purpose, the nature and scope of the work done and the
preparers conclusions.

2. Completeness and Accuracy


As a reviewer of documentation, if you have to ask the audit staff basic
questions about the audit, the documentation probably does not really serve
the purpose. Work papers should be complete, accurate, and support
observations, testing, conclusions, and recommendations. They should also
show the nature and scope of the work performed.
3. Pertinence
Limit the information in working papers to matters that are important and
necessary to support the objectives and scope established for the assignment.
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4. Logical Arrangement File the working papers in a logical order.


5. Legibility and Neatness
Be neat in your work. Working papers should be legible and as neat as
practical. Sloppy work papers may lose their worth as evidence. Crowding and
writing between lines should be avoided by anticipating space needs and
arranging the work papers before writing.
6. Safety Keep your work papers safe and retrievable.
7.Initial and Date Put your initials and date on every working paper.
8. Summary of conclusions Summarize the results of work performed and
identify the overall significance
of any weaknesses or exceptions found.

Question 7 - Distinction between Permanent file and Current File


Permanent File

Current File

1. It is static and kept in Auditor office

It is dynamic & generated at clients


office & finally kept at Auditor office

2. It is referred before commencement

Created after completion of Audit

of audit
3. It is useful for Audit staff to conduct Useful for Auditor to support his
Audit

Audit conclusion

4. The contents are updated every year Contents are static.

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Q 8 What do you understand by Audit Materiality and Sampling &


Sampling Risk?
Audit Materiality (AAS 13)
An information could be regarded as material if its misstatement, (may be
omission or erroneous) could influence the economic decisions of users taken
on the basis of the financial information.

Materiality depends on the size and nature of the item, judged in the particular
circumstances of its misstatement.

However, what is material in a given

situation is a matter of professional judgement. Some items, which individually


may not be material but collectively, might be material.

It could either be

qualitative or quantitative. The auditor should consider materiality from the


point of view of both the following:
a. Overall financial information
b. Individual account balances.

Relationship between Materiality and Audit risk


When planning the audit, the auditor considers what would make financial
statements materially misstated. His consideration of materiality at the
planning stage enables him to decide which items should be examined by
application of sampling and analytical procedures and thus to reduce the audit
risk.
There is an inverse relationship between materiality and the degree of audit
risk. Higher the materiality, lower is the audit risk. The auditor should
therefore, at the planning state itself consider the materiality and the risk
attached to it so as to carry out the audit more effectively.
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The audit should be planned so that audit risk is kept at an acceptably low
level. On assessment of the inherent and control risks, he should consider the
level of detection risk which he could afford and based upon his judgement,
select appropriate substantive audit procedures. The auditor reduces detection
risk by performing substantive procedures. The more extensive the procedures
performed, the lower the detection risk.
Audit Sampling (AAS 15)
In an audit, sampling procedures are used because it is not practical to
examine every single item in a population. For example, the auditor may select
an audit sample of non-current assets, and verify their existence, condition and
value. It would not be practical for the auditor to track down every single asset
on the books.
But, if all the items in the audit sample are verified then it may be appropriate
to draw the conclusion that all the assets are correctly recorded in the books
(assuming the audit sample has been selected correctly and is of sufficient size)
It means carrying out audit procedures in less than 100% of items within an
account balance or class of transactions. When using sampling methods, the
auditor should design and select an audit sample, perform audit procedures
thereon, and evaluate sample results so as to provide sufficient and appropriate
audit evidence. There are two methods in which the size of the sample and the
selection of individual items of the sample are determined. They are 1.
Judgemental sampling and 2. Statistical sampling.
Judgemental sampling
The auditor, on the basis of his personal experience and professional
judgement, will determine the size of the sample and express it in terms of
number of accounts or transactions to be checked. However, whether the
sample selected on the above basis would represent the population in order
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that the audit objective would be achieved is a questionable matter. This is


because of the risk of personal bias in selection of sample items cannot be
eliminated.

Statistical Sampling
It is a method of audit testing which is more scientific than testing based
entirely on the auditors own judgement because it involves use of theory of
probability. The sample should be selected in such a manner that it is truly
representative of the population from which it is being selected. Each item in
the population should have an equal chance of being included in the sample.
The most important method of selecting a sample using a statistical approach is
Stratified Sampling.

Stratified sampling
Stratification refers to the process of dividing a population into sub-populations,
each of which is a group of sampling units, which have similar characteristics.
Each such sub-population is known as a stratum. Each stratum is treated as if
it was a separate population and proportionate items are selected from each of
this stratum. From these groups, the auditor may pick up different percentage
of items for checking / verification or for applying his audit procedures.

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Question 9 What do you understand by Sampling risk and tolerable


error and expected error in Auditing

Sampling Risk, Tolerable Error and Expected Error


1. Sampling risk arises from the possibility that the auditor conclusion, based on
a sample, may be different from the conclusion that would be reached if the
entire population were subjected to the same audit procedure.
Sampling risk in test of control a) Risk of under reliance b) Risk of over reliance
Sampling risk in substantive test a) Risk of incorrect acceptance b) Risk of
incorrect rejection
Note:
The risk of under reliance and incorrect rejection would affect audit efficiency
The risk of over reliance and incorrect acceptance would affect audit effectiveness

2. Tolerable error is the maximum error in the population that the auditor
would be willing to accept and still concludes that the result from the sample has
achieved the audit objective. Tolerable error is considered during the planning
stage and, for substantive procedures, is related to the auditors judgement about
materiality. The smaller the tolerable error, the greater the sample size will need
to be.
3. Expected Error
If the auditor expects error to be present in the population, a larger sample than
when no error is expected ordinarily needs to be examined to conclude that the
actual error in the population is not greater than the planned tolerable error.
Smaller sample sizes are justified when the population is expected to be error
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free. In determining the expected error in a population, the auditor would


consider such matters as error levels identified in previous audits, changes in the
entitys procedures, and evidence available from other procedures

Question 10: What is the meaning of Test check


Test checks and techniques of test checking
Carrying out detailed check of each and every transaction of a large business
shall be time consuming for the auditor. In auditing the accounts of a business,
every single copy is not usually checked by the auditor; what is usually done in
practice is that a representative number of entries of each class are selected and
checked and if they are found correct, the remaining entries are taken to be
correct. This is known as Test Checking. In those organizations, where
satisfactory internal check system is in existence, the auditor need not carry out
detailed checking. He may adopt Test checking. It is a system of sampling
employed by the auditor for the purpose of reducing the volume of detail
checking involved in the audit. If, in Test Checking, he finds that the records
checked by him are correct then no further detail checking need be carried out.

Test Checking V/S Statistical Sampling


Selection of items for the purpose of checking can be done in two ways:
(i)Judgment (ii) Statistical Sampling.
When the judgment method is applied, the method of checking is called test
checking. When sampling techniques are applied it is called statistical sampling.
Precautions To Be Taken- While adopting the test check, the auditor must take
the following precautions:
1.Entries selected for test checking must be representative of all transactions.
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2.The selection of the items should be at random.


3.It cannot be adopted in case of vouching the cash book.
4.Clients staff should not come to know of the entries selected for test checking.
5.Period selected for test checking should differ from book to book and year to
year.
6.He should not adopt test checking where the law requires thorough audit.
7.A number of entries of the first and last month of the year must be checked
thoroughly.
8.Test should be so devised that a sizeable portion of the work done by each
employee is checked.
9.Control accounts or impersonal ledger should not be subject to test checking.
10.Auditor should select the test independently without regard to the suggestions
of the member of the clients staff.
11.Bank statement and entries for cash withdrawal and cash deposits should be
checked in full.
The extent of the test checking will depend upon the judgment and wishes of the
auditor but it must be remembered that time unnecessarily spent in routine
checking is a waste of resources. Caution must also be taken to see that the test
checking may not become insignificant in extent or automatic and
unrepresentative. Test checking will be of no use unless the representative items
selected for checking are chosen with great intelligence and imagination.

Advantages of Test Check


1. Volume of work is considerably reduced.
2. There is a saving in terms of time, cost and energy.
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3. The extra time available can be utilised for concentrating on areas of


considerable importance.
4. If done carefully, test checking can be quite effective.

Disadvantages of Test Check


1. The auditor always is under fear whether he has missed out certain important
items or that errors have remained undetected while test checking.
2. Where the clients staff is aware that the auditor resorts to test checking, the
staff may become careless.

Auditors Liability
If any errors are found in the accounts the auditor cannot take the shield against
the fact that he conducted test check. The auditor should very carefully select the
items for test check and ensure on the whole that the accounts show a true and
fair view of the Profit/Loss in the case of the Profit & Loss Account and of the
state of affairs of the organisation in the case of Balance Sheet.

Question 11: State in brief standard SA 230 on Audit Documentations.

SA 230: Audit Documentations


This Standard deals with the auditors responsibility to prepare audit
documentation for an audit of financial statements. It also deals with the
requirements of timely preparation of audit documentation; documentation of the
audit procedures performed and audit evidence obtained and assembly of the

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final audit file. It outlines about vesting of property of working papers with the
Auditor.
This Standard spells out two essential principles viz. period of maintaining
working papers and assembly of audit file by the auditor.
According to SA 230, Audit Documentation refers to the record of audit
procedures performed, relevant audit evidence obtained, and conclusions the
auditor reached. Preparing sufficient and appropriate audit documentation on a
timely basis helps to enhance the quality of audit and facilitates effective review
and evaluation of audit evidence obtained and conclusions reached before
finalizing auditors report. According to this standard, retention period for audit
engagements ordinarily is no shorter than ten years from the date of auditors
report, or, if later, the date of group auditors report

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