Audit Book 4 Chapters

CA Clues
Auditing & Assurance
Chapter-1
Nature of Auditing
AUDITING MEANING
The word Auditing has been derived from Latin word audire which means to
hear.
Audit is an independent examination of financial information of any entity whether
profit making or not irrespective of its size & legal structure, when such an audit is
conducted with a view to express an opinion thereon.
The audit is not confined to financial audit alone. It may be extended to other areas
also such as management audit, operational audit, internal audit and environmental
audit etc.
The audit is conducted for a stated purpose, for example, the financial audit may be
conducted to ascertain whether they present a true and fair view of the financial
position and the operating result of the enterprise.
Every audit has to be based on some evidence.
The audit findings have to be communicated to those who have appointed the auditor.
For example, in case of a company the audit report is made to the shareholders.
AUDITING FEATURES
1- Examination of books & statements
The Preparation of financial statements is the responsibility of management of

entity.
The audit of financial statement does not relieve the management of its liability.
Auditor's opinion is on financial statements.
General purpose financial statement includes: [Nov 05- 4 Marks]
Statement of Profit & Loss: Which indicates profits earned or loss incurred during a
particular financial year.
Balance sheet: Which shows position of assets & liabilities at a particular date.
Cash flow & fund flow Statement: Which shows movement of cash/funds during a
particular financial year. (However these are not prepared by all entities).
Notes to accounts: Disclosures or explanatory notes.
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2- On the basis of proper evidence

An audit examination is to be made on the basis of evidential documents such as
invoices, money receipts, and other records, including information and explanations
supplied by authorized representatives of the client.
It is the duty of the auditor to carefully assess and evaluate every piece of evidence
relevant for his examination.
3- By a properly qualified person

In India, audit is to be conducted by a professional having good accounting &
auditing background.
A chartered accountant having certificate of practice is eligible to conduct audit.
4- In a Systematic &Independent manner
Audit has to be conducted in a proper way.
Auditor should be completely objective (unbiased) in his approach.
He should not be influenced by the client.
5- Entity
His client can be any entity whatever is the legal form i.e., it proprietorship,
partnership trust or company etc.
The entity may be profit oriented or a charitable one (For Example- Trust, Section 25
Companies)
6- Opinion
His opinion is on 'true &fair view' of financial statements.

For this, it is necessary that
(i) Financial statement have been prepared using acceptable policies which are
consistently applied
(ii) Financial statements have" been prepared as per regulations,
(iii) There is appropriate disclosure of all material items.
CONCEPT OF TRUE & FAIR
[May 2005 -8 Marks, Nov 2012- 6 Marks]
What Constitutes "true and fair", however, has not been defined in any legislation.
Section 211(5) of the Companies Act provides that the accounts of a company shall be
deemed as not disclosing a true and fair view, if they do not disclose any matters are
required to be disclosed by virtue of provisions of Schedule VI of that Act, virtue of a
notification or an order of the Central Government modifying the disclosure
requirements.
The concept of true and fair is a fundamental concept in auditing.
The phrase true and fair" in the auditor's report signifies his opinion as to whether the
state of affairs and the results are truly and fairly represented in the accounts under
audit.
It is a matter of an auditors judgment in the particular circumstances of a case. An
auditor has to see:
That the assets are neither undervalued nor overvalued,
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No material assets are omitted;

The charge, if any, on assets are disclosed
The liabilities are not under or overvalued and the same are properly classified.
Material liabilities should not be omitted
The statement of profit and loss discloses all the matters required to be disclosed by
Part II of Schedule VI and the balance sheet has been prepared in accordance with
Part I of Schedule VI;
Accounting policies have been followed consistently.
All unusual, exceptional or non-recurring items have been disclosed separately.
(Extra ordinary items)
INDEPENDENT AUDIT
[RTP, Nov 89, May 92, May 93, Nov 91, May 97, May 01, May 07, May 05, May 08, Nov
09,May 10, May 2012 5-8 Marks]
The need for auditor independence is provided in Standard on auditing.
The Companies Act, 1956 also contains specific provision to ensure auditors
independence.
As per The chartered Accountants Act, 1949 as amended by The Chartered Accountants
(Amendment) Act, 2006, independence of auditor is required.
Independence means that the judgment of a person is not subordinate to wishes of
another person.
It requires that he should not act under any influence.
If auditor maintains high degree of independence, credibility of financial statements is
enhanced.
Independent audit report will be accepted and respected by all the stakeholders.
Advantage of Independent Audit
It safeguards the financial interest of persons not associated with the management
like shareholders.
It acts as a moral check on the employees from committing fraud.
It is helpful in setting tax liability.
It ensures maintenance of adequate books and records, statutory registers etc.
Audited financial statements are the basis for determining amount receivable or
payable in certain circumstances.
ASPECTS TO BE COVERED IN AUDIT
[May 96-6 Marks]
The principal aspects to be covered in an audit concerning the final statements of accounts
are as follows
1) Accounting and Internal Control System
The auditor should obtain an understanding of the accounting and the internal control
system operating in the enterprise. Such an understanding will enable the auditor to
ascertain the degree to which reliance can be placed on the information obtained
during the audit.
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The auditor should review the system from time to time to ascertain its adequacy and
comprehensiveness.
2) Examination of books, records etc.

The auditor should check the arithmetical accuracy, authenticity and the validity of
transactions entered in to the books of accounts.
He should ensure that the entries in the books of accounts are adequately supported by
underlying papers, documents, and other audit evidences.
3) Compliance with the Generally Accepted Accounting Standards and Applicable
Statutory Regulation
The financial statements should be prepared in accordance with the requirements of
applicable laws and should comply with the relevant accounting standards, guidance
notes issued by the ICAI etc.
4) Reporting
Once the audit is carried out, the audit findings need to be communicated to the
appropriate person/body.
An audit report states that the opinion of the auditor as to the true and fair view of the
financial position and operating results of the enterprise.
OBJECTIVE OF AUDIT
The objective of an audit may be classified into two categories
(a) Primary Objective and
(b) Secondary Objective.
Primary Objective (As per SA 200 Revised)

Audit is conducted to express an opinion on financial statements. Thus primary
objective is Reporting.
The auditor reports whether financial statements represent true and fair view.
True and fair view can be examined by considering whether:
(a) Financial statements have been prepared using consistent & acceptable accounting
policy.
(b) Financial statements comply with relevant rules & regulation and
(c) Financial statements contain disclosure of all material matters.
Secondary Objective
[Nov 2004, 8 Marks]
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Secondary objective is detection of misstatement in financial statements.

These misstatements may be fraud and errors.
SA 240 (Revised) on The Auditors Responsibility to consider Fraud in an Audit of
Financial Statements states that primary responsibility for the prevention and
detection of fraud rest with both TCWG and management. For this purpose
management must ensure for a culture of honesty and ethical requirement.
The term fraud refers to an intentional act by one or more individuals among
management, those charge with governance, employees or third parties, involving the
use of deception to obtain an unjust or illegal advantage.
Responsibility of Auditor
Auditor is concerned with those frauds that cause a material misstatement in the
financial statement of the entity.
For example- (a) Fraudulent financial reporting (b) Misappropriation of Assets.
The responsibility of the auditor is to obtain a reasonable assurance that the financial
statement of the entity are free from material misstatement.
Auditor should perform following risk assessment procedure to identify and assess
the risk of material misstatement in financial statement
a) Inquiry with management
b) Inquiry with TCWG
c) Inspection
d) Observation
e) Evaluating of unusual relationship
f) Discussion with engagement team
If Auditor finds misstatement as fraud, then auditor should communication at
appropriate level on timely basis.
If Many Material Frauds as found, then consider whether to continue or not. If
auditor continues he will consider the matter in Audit Report, if auditor does not
continue then after discussing with Those Charged with Governance, he will
withdraw and communicate the reason to appointing authority, incoming auditor
and regulatory authority.
Auditors responsibility for failure to detect fraud: Auditor may not reveal all
misstatement, but if auditor performs his work in accordance with basic principles
governing an audit, he cannot be held liable for those misstatements in financial
statements of client detected after submission of audit report.
Errors may be classified as follows
As per accounting aspects:

1. Errors of omission- It occurs when a transaction is not recorded in the books of
account, either wholly or partially. Full omission does not affect the trial balance
but partial omission does.
2. Errors of Commission- It may be committed either at the stage of recording a
transaction in the books of original entry or while posting it to the ledger. Errors in
totaling and balancing accounts or in carrying forward totals to the trial balance
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are also called errors of commission. These types of errors may or may not affect
the trial balance.
[May 2001, 5 Marks]
3. Errors of principle- An error of principle occurs when the generally accepted

principles of accounting are not observed while recording any transaction in the
books of account. These types of errors do not affect the trial balance.
4. Compensating errors- when there are two or more errors, but they compensate the
effect of each other. These problems do not affect the trial balance.
As per nature
1. Self revealing errors- The existence of these errors becomes apparent during
compilation of accounts. A few illustrations of such errors are given hereunder,
showing how they become apparent
1
2
Omission to post a part of a

journal entry to the ledger
A failure to record in the cash
book paid into or withdrawn
from the bank
A mistake in recording amount
received from X in the account of
Y
Trial Balance is thrown out of agreement

Bank reconciliation statement will show up
error
Statement of account parties will reveal the
mistake
2. Non Self revealing error- The existence of these errors is not revealed
automatically by routine accounting procedures. These can be revealed by
detailed analysis and normal audit procedures. Example- Revenue expenditure is
charged as capital expenditure.
3. Unintentional errors- These are unintentional mistake. Example- Wages paid to
X; a casual laborer has not been recorded in the books of account.
4. Intentional errors- These are intentional mistakes / fraud. Example- Fictitious
purchases of Rs. 10,000 have been recorded by cashier to misappropriate cash.
5. Procedural errors- These are the errors in the implementation of procedures or
frauds. Example- Payment of a purchase invoice without sufficient purchase
documents.
BASIC PRINCIPLES GOVERNING AN AUDIT

[Nov 2000, Nov 2002, Nov 2003, Nov 2006, 10 Marks, May 2013-8 Marks]
The basic principles govern the auditors professional responsibilities and should be
complied with whenever audit is carried out. The basic principles as stated in this
guideline are:
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1- Integrity, Objectivity, Independency

Auditor should be straightforward, honest and sincere in his professional work.
He should be fair and must not be biased.
He should maintain impartiality. He should be free of any interest
2- Confidentiality
He should maintain confidentiality of information acquired during his work.

He should not disclose any such information to a third party without specific
permission of client or legal or professional duty to disclose.
3- Skills and competence
He should perform work with due professional care.
Audit should be performed by persons having adequate training, experience and
competence.
4- Work performed by others [May 2000- 4 Marks]
The auditor can delegate work to assistants or use work performed by other auditors
and experts.
The Auditor is entitled to rely on work performed by others, provided he exercises
adequate skills and care and there is nothing to doubt.
In respect of work delegated to assistants, auditor should carefully direct, supervise
and review the work.
In respect of work performed by other auditors and experts, auditor should obtain
reasonable assurance that such work is adequate for his purpose.
But he will continue to be responsible for his opinion on financial information.
5- Documentation
He should document matters relating to the audit (maintain working papers).

Working papers are maintained to demonstrate that the audit was carried out in
Accordance with the basic principles.
6- Planning
He should plan his work to conduct audit in effective and timely manner.
Plans should be based on knowledge of the clients business.
Plans should be further developed and revised during audit if circumstance requires so.
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7- Audit Evidence
Auditor should obtain sufficient and appropriate audit evidence by performing
compliance and substantive procedures.
Evidences enable the auditor to draw reasonable conclusion.
Compliance procedures mean the tests designed to obtain reasonable assurance that
internal controls have been properly designed & operating effectively throughout the
year.
Substantive Procedures are performed to obtain evidence as to the completeness,
accuracy and validity of data produced by the accounting system.
8- Internal controls
Internal control system ensures that the accounting system is adequate and that all the
accounting information has been duly recorded.
The auditor should understand the accounting system and related internal controls
adopted by the management.
He should study and evaluate internal controls system to determine the nature, timing
and extent of other audit procedures.
9- Audit conclusion and Reporting
The auditor should review and assess the conclusions drawn from the audit evidences
obtained through performance of procedures.
The audit report should contain clear written expression of opinion on the financial
statements.
His report is on whether:
The financial information has been prepared using acceptable accounting policies
which have been consistently applied;
The financial information complies with relevant regulation and statutory
requirements; and
There is adequate disclosure of all material matters.
The report should be as per legal requirement. When other than opinion is given, the
audit report should state the reasons thereof.
QUALITY OF AUDITOR
[Nov 2004- 4 Marks]
1. Integrity: Auditor should be honest, sincere and straightforward while performing his
professional duties.
2. Communication Skill: During the conduct of audit, he has to interact with various
officers and staff of organization & third parties, thus he requires good oral & written
communication abilities.
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3. Confidentiality: He should not disclose confidential information acquired during

conduct of his professional duties to any third party except when permitted by client
or required by law.
4. Independence: He should not be subordinates his judgment to the will of others. He
should conduct the audit in unbiased way.
5. Knowledge: He should have general knowledge of clients business and economic
trends etc. He must continuously update his knowledge to conduct audit effectively.
6. Logical Skills: He must be able to analyses & interpret problem so that he can
accordingly deal with the same.
7. Judgment: He should be capable to taking firm judgments as to which items are to be
checked and what should be the sample size.
DIFFERENCE BETWEEN ACCOUNTING & AUDITING

BASIS
MEANING
FUNCTION
BY WHOM
ACCOUNTING
Accounting is the art of
Recording,
Classifying
&
Summarizing
financial
information.
It records financial aspects of
entity
Any person having good
knowledge of accounting
[May 99]
AUDITING
It is independent Examination of
financial information of an entity
to express an opinion thereon
It reviews the accounting system
Statutory audit can only be

conducted by a chartered
accountant.
PRINCIPLES
As, per accounting standards.
As per auditing standards.
PRIMARY
To maintain accounts & To conduct audit in an effective
RESPONSIBILITY prepare financial statements is way and form an opinion is the
the
responsibility
of responsibility of auditor
management
EXPERTISE
TIME OF
OCCURRENCE
Accounting expertise
Accounting & auditing Expertise

(both)
Accounts are prepared by the
Auditing is examination of
Management prior to get them financial information, thus cant
audited.
be conducted prior to accounting
DIFFERENCE BETWEEN AUDITING & INVESTIGATION

[RTP, May 99-10 Marks, Nov 2012- 8 Marks]
BASIC
AUDITING
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INVESTIGATION
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MEANING
It is Independent Examination
of Financial information of an
entity to Express an opinion
thereon
OBJECTIVE
To ascertain the truthfulness
and fairness of the state of
affairs.
NATURE OF
Conclusions are drawn on the
EXAMINATION basis of test checking of
accounts and records.
Investigation implies systematic,

critical and special examination
of the records of a business for a
specific purpose.
Aims at establishing a fact or is
carried out for some particular
purpose.
It is a detailed examination.
PERIOD
An audit covers a period of one Not necessarily restricted to a
UNDER
year.
financial year. It can extend for a
EXAMINATION
period consisting of a number of
years.
SCOPE
The scope of audit is very wide. However,
the
scope
of
In statutory audit the scope of investigation is limited as regards
audit is determined by the the activity or areas to be covered.
relevant law and in private
audit,
by
the letter
of
engagement.
CONDUCTED
A CA within the meaning of CA Any person, who need not
BY
Act 1949.
necessarily be a CA.
FINANCIAL
Generally
covers
financial Covers both financial and non
ASPECTS
aspects only
financial aspects.
NATURE OF
Audit is concerned only with But in an investigation, conclusive
EVIDENCE
prima facie evidence which is evidence is required.
sufficient and appropriate
SUBMISSION
The audit report is submitted to The investigation report is to be
OF
the owners of the business.
submitted to person (s) on whose
REPORT
behalf it is being conducted.
INHERENT LIMITATIONS OF AUDIT

[Nov 1998, Nov 2001, May 2003, Nov 2005, May 2011 4-8 Marks]
Meaning
The limitations which cannot be overcome irrespective of the nature and extent of a
procedures. The limitations of audit arise from:
1. Involvement of judgement
Auditors work involves exercise of judgment, for example, in deciding the extent of
audit procedures and in assessing the reasonableness of the judgment and estimates
made by the management in preparing the financial statements. The judgement by
auditor may not always be correct.
2. Nature of evidences
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The evidences obtained by the auditor are persuasive rather than conclusive and they
cannot ensure the auditor in a certain way.
Because of these factors, the auditor can only express an opinion and absolute
certainty in auditing is rarely attainable.
There is also likelihood that some material misstatements of the financial information
resulting from fraud or error, if either exists, may not be detected.
3. Test checking
Auditor uses sampling during performance of audit.
It is not possible for him to conduct detailed checking due to time constraints.
As he does not check each & every item, it's impossible for him to detect all fraud &
errors.
4. Inherent limitations of internal controls
Internal controls suffer from limitation such as collusion among employees or wrong
use of authority by management etc.
It is clearly evident that there always is some risk of an internal control system failing
to operate as designed.
If internal controls are weak, auditor may not be in a position to obtain assurance.
ACCOUNTING CONCEPT- FUNDAMENTAL ACCOUNTING ASSUMPTION

[Nov 2003, May 2007, May 2008, 4 Marks]
Meaning- Certain fundamental accounting assumptions underlie the preparation &
presentation of financial statements. Their use is assumed.
Three fundamental accounting assumptions- Going Concern, Consistency and Accrual.
Going Concern:
The enterprise is normally viewed as a going concern that is as continuing in operation for
the foreseeable future. It is assumed that the enterprise has neither the intention nor the
necessity of liquidation.
Consistency:
It is assumed that accounting policies are consistent from one period to another.
Accrual:
Revenues and costs are accrued, that is recognized as they are earned or incurred (and not
as money is received or paid) and recognized in the financial statements of the periods to
which they relate.
Disclosure requirement as per AS-1 If the fundamental accounting assumptions, viz.,
Going concern, Consistency and Accrual are followed in financial statements specific
disclosure is not require fundamental accounting assumption is not followed, the fact
should be disclosed.
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MEANING & DISCLOSURE OF ACCOUNTING POLICIES

[May 1999, Nov 2002- 4 Marks, Nov 2007 -5 Marks, Nov 2011- 6 Marks, Nov 2012 -10
Marks]
Meaning- It refers to specific accounting principles & methods of applying those

principles, adopted by entity in preparation & presentation of financial statements.
Examples- The following are example of the areas as given in AS 1, Disclosure of
Accounting policies in which different accounting policies may be adopted by different
enterprises.
Treatment of goodwill
Valuation of fixed assets
Methods of depreciation ,depletion and Amortization
Valuation of investments
Valuation of inventories
Treatment of deferred revenue expenditures
Treatment of retirement benefits
Treatment of provision
Treatment of contingent liabilities
Conversion or translation of foreign currency items
Recognition of profit on long-term contracts
Requirement of AS-1 regarding disclosure of Accounting Policies
To ensure proper "understanding of financial statements, it is necessary that all
significant accounting policies adopted in the preparation and presentation of financial
statements should be disclosed
Such disclosure should form part of the financial statements.
They should be disclosed at one place instead of being scattered over several
statements.
Any change in an accounting policy which has a material effect should be disclosed
with the following disclosures:
Old policy
New policy
Reason of change
Impact on current financial year profit or loss (If it is material)
Accounting policy may be changed in the following circumstances:
If required by Law
For compliance with accounting standards
On the opinion of the management.
AUDITING AND BEHAVIOURAL SCIENCE
The field of auditing as a discipline involves review of various assertions both in
financial as well as nonfinancial terms. Thus it is quite logical and natural that the
function o audit can be performed if and only if the person also possess a good
knowledge about the fields in respect of which he is conducting such a review.
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The discipline of behavioural science is closely linked with the subject of auditing.
While it may be said that the financial auditor deals basically with the figures
contained in the financial statements but he shall be required to interact with a lot of
people in the organisation.
The knowledge of human behaviour is indeed very essential for an auditor so as to
effectively discharge his duties.
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State True or False with Reason
1) Auditors primary responsibility is to detect errors and frauds.

False- Auditors primary responsibility as per SA 200 is to express an opinion on
financial statements.
2) The fundamentals accounting assumptions followed for preparing financial
statements should be disclosed.
False- It is assumed that fundamental accounting assumptions have been followed
while preparing financial statements. In case any one of these has not been followed
specific disclosures should be made.
3) The primary responsibility for preparation of financial statement is of the
management.
True- SA 200 has asserted this.
4) The scope of financial audit extends to all type of entity.
True- The scope of audit extends to all entities commercial as well as non commercial.
5) Financial statements include P&L accounting and Balance Sheet but not notes to
accounts.
False- Financial statements mean whole set of accounts including P&L account, Balance
sheet and disclosure i.e. notes to accounts.
6) Auditor needs to be independent
True- Independence means that the judgment of a person is not subordinate to wishes
of any person. Independent audit enhance credibility of financial statements of client.
7) Auditor does not need communication skills, as he is concerned only with financial
information.
False During conduct of audit, he has to interact with various officers and staff of
client & third parties, which requires good written & oral communication skills.
8) Auditor must maintain confidentiality subject to certain exceptions.
True- Auditor should not disclose any confidential information relating to client.
However he can disclose if it is permitted by client or required by law.
9) Documentation is required to be kept by auditor
True- Auditor should document matters relating to the audit. Working papers are
maintained to demonstrate that the audit was carried out accordance with the basic
principles.
10) Sampling is a major inherent limitation of audit.
True- Auditor uses sampling during performance of audit. It is not possible for him to
conduct detailed checking due to time constraints and other practical problems. As he
does not check each & every items. It is impossible for him to detect all fraud & errors.
11) Auditor is not an insurer. [Nov 2008]
True- The auditor does not insures the interest of users of accounts but only states his
opinion after taking all reasonable care and skill that the statement show a true and fair
picture.
12) Procedural error arises as a result of transactions having been recorded in a
fundamentally in correct manner. [May 2008]
False- When transactions are recorded in fundamentally incorrect manner it is known
as error of Principle. For e.g. a distinction not being made between capital and revenue
income or expenditure.
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13) When an auditor identifies a misstatement resulting from fraud, it is his

responsibility to communicate it to the regulatory and enforcement authorities apart
from those charges with governance. [May 2010]
True- According to SA-240 The auditor Responsibilities Relating to Fraud in an Audit
of Financial Statement an auditor identifies a misstatement resulting from the fraud or
error it is his responsibility to communicate the matter with those charged with
governance and, in some circumstances, when so required by laws or regulation, to
regulatory and enforcement authorities also.
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Chapter-2
Basic Concepts in Auditing
CONCEPT OF MATERIALITY
[Nov 86, Nov 96, May 2007, Nov 2007-4 Marks, Nov 2009-6 Marks, May 2013]
According to AS-1 Material items are those items, the knowledge of which might
influence decisions of the user of financial statements.
SA 320 is applicable on Materiality in Planning and Performing an Audit. It deals
with the auditors responsibility to apply the concept of materiality in planning and
performing an audit of financial statement.
Materiality is therefore, an important and relevant consideration for an auditor who
has constantly to judge whether a particular item or transaction is material or not.
The auditors determination of materiality is a matter of professional judgement.
Judgement of materiality is affected by circumstances and size of the business.
Both the amount and nature i.e. quantity and quality should be considered
Material is a relative term and what may be material in one case may not be material in
another. Even insignificant items in terms of quality may also be material in special
circumstances. For example:- In a company having turnover of Rs. 50 Lakhs p.a. and
profit of Rs. 2 lakhs p.a. The damages paid of Rs. 1 lakhs may be material and may
require separate disclosure because of quantity (size). However, the same information
may not be material for a company having turnover Rs. 100 corers p.a. and profit of Rs.
12 Crore p.a. Here the materiality has been judged by its amount with reference to size
of the company. However , in case of a company having the turnover of Rs. 100 Crore
p.a. and profit of Rs. 10-12 Crore p.a. the violation of law even of small amount may be
material , like- if company pays the remuneration to its managerial person in excess of
section 198 of the Companies Act, 1956. Even excess managerial remuneration, in this
case may be Rs. 50,000, will be material because of non-compliance of law.
Performance Materiality: It means the amount or amounts set by the auditor at less
than materiality for the financial statements as a whole to reduce to an appropriately
low level the probability that the aggregate of uncorrected and undetected misstatement
exceeds materiality for the financial statements as a whole.
There is an inverse relationship between materiality and audit risk.
Materiality decided earlier may be revised during the performance of the audit.
Materiality should be considered by the auditor when:
Planning the audit (When establishing over audit strategy as per SA-300)
Evaluating the effect of misstatement. (Regarding any revision in materiality which
was considered at the time of planning while evaluating the effect of misstatement as
per SA-450)
Auditor should document the following:
Material level considered for financial statement as a whole
Performance material considered
Any revision made in material level considered earlier.
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AUDIT EVIDENCE [SA-500]
The information, which may be oral or written obtained by the auditor for the purpose
of audit, is known as audit evidence.
Auditor needs evidences to obtain information for arriving at his judgement.
Audit evidence is necessary to support the auditors opinion and report.
Audit evidence includes both information contained in the accounting records
underlying the financial statements and other information
The auditor should obtain sufficient & appropriate audit evidence through the
performance of compliance and substantive procedures to enable him to draw
reasonable conclusion there from on which to base his opinion on the financial
information.
Sufficiency refers to the quantum of audit evidence obtained.
Appropriateness refers the relevance and reliability of the evidence.
Followings are the factors to determine the sufficient and appropriate
[RTP, May 90, May 07, May 09, Nov 2010-6 Marks]
The factors that influence the Auditors judgement as what is sufficient and appropriate
audit evidence area) The materiality of the item.
b) Type of information available.
c) Experience gained during previous audit.
d) Trends indicated by accounting ratios and analysis.
e) The degree of risk of misstatement
Types of audit evidences

1. Depending upon Naturea) Visual evidence- These are the evidences in the form of observation. ExampleObserving stock taking by the management.
b) Oral evidence- These are the evidences having no physical existence. ExampleDiscussion with management
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c) Documentary evidence- These are the evidences in the form of written

documents. For example- Copy of invoices, agreement, vouchers.
2. Depending upon Source- Internal and External.

[May 89, May 94, May 95, May 98, Nov 08]
Particulars
Internal Evidence
External Evidence
Meaning
Internal Evidence is one that External Evidence originates
has been created used and outside
the
Clients
retained within the clients organisation
organisation
Examples
Wage
sheet,
Inventory Purchase
invoice,
Lease
report,
Minutes
Book, Agreement, Bank Statement,
Duplicate copy of sales Insurance Policies.
invoice.
Auditors Role
It is provided to the Auditor It
may
sometimes
be
by the sources internal to obtained directly by the
the organisation
Auditor.
For
exampleExternal Confirmation.
Reliability
It is not reliable as external It is considered more reliable
evidence
than internal evidence.
RELIABILITY OF AUDIT EVIDENCE
[May 2008- 5 Marks, Nov 2011 -4 Marks, Nov 2013-5 Marks]

The reliability of audit evidence is influenced by its source (Internal or External)
and by nature (Visual, Documentary or Oral)
While the reliability of audit evidence is dependent on the circumstances under
which it obtained the following generalizations may be useful in assessing the
reliability of audit evidence:
1. External evidence (e.g., confirmation received from a third party) is more reliable
than internal evidence.
2. Internal evidence is more reliable when related internal control is satisfactory.
3. Evidence obtained by the auditor himself is more reliable than that obtained
from the entity.
4. Evidence in the form of documents and written representations is more reliable
than oral representation.
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5. Evidence provided by original documents is more reliable than those provided

by photocopies of documents
AUDIT PROCEDURES TO OBTAIN EVIDENCES

The audit procedures to obtain the audit evidence, to daw reasonable conclusion on
which to base the auditors opinion, are acquired by performing:
a) Risk assessment procedures; and
b) Further audit procedure, which comprise
i. Test of controls (Compliance Procedure)
ii. Substantive procedures
a) Risk Assessment procedure

As per SA-315, The auditor should perform the following risk assessment
procedures to obtain an understanding of the entity and its environment
including its internal control
Observation and inspection
Discussion among the engagement team
Inquiry of management and others within the entity
Analytical procedures
To understand the entity and its environment the auditor shall obtain an
understanding of the following:
Nature of entity
Types of regulation applicable
Type of industry
Entitys selection and application of accounting policy
To understand the entitys internal control the auditor shall obtain an
understanding of the following:
Information system
Control environment
Risk assessment procedure of entity
Activity relating to control
Monitoring of control
b) Further audit procedure

i. Compliance Procedure- [May 2013- 2 Marks]
Compliance procedures are tests designed to obtain reasonable assurance that
those internal controls on which audit reliance is to be placed are in effect.

Compliance tests are conducted in areas governed by the internal control e.g.
Purchase, Sales etc.
In obtaining audit evidence from compliance procedures, the auditor is
concerned with assertions that the internal control exists, the internal control
is operating effectively and the internal control has so operated throughout the
period of intended reliance. So the auditor is concerned with the existence,
effectiveness and continuity of the control system
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ii. Substantive Procedure-
[May 2004, May 2007, May 2010, 4 Marks]
Substantive procedures are tests designed to obtain evidence as to the

completeness, accuracy and validity of the data produced by accounting
system. They are of two types
(1) Tests of details of transactions and balances.
(2)Analysis of significant ratios and trends including the resulting
investigation of unusual fluctuations and items. (Analytical Review)
In obtaining audit evidence from substantive procedures, the auditor is
concerned with following assertions.
[Nov 2007, May 2008-6 Marks, June 2009-10 Marks, May 2013-4 Marks]
a) Assertion about classes of transactions and events for the period under audit:
i. Occurrence- Transactions and events that have been recorded have occurred
and pertain to the entity
ii. Completeness- All the transactions and events that should have been recorded
have been recorded.
iii. Accuracy- Amounts and other data relating to recorded transactions and events
have been recorded appropriately
iv. Classification- Transaction and events have been recorded in the proper
accounts
b) Assertions about account balances at the period end:
i. Existence- Assets, liabilities and equity interest exist
ii. Rights and obligations- The entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
iii. Completeness- All assets, liabilities and equity interest that should have been
recorded have been recorded.
iv. Valuation- Assets, liabilities and equity interest are included in the financial
statement at appropriate amounts.
c) Assertions about presentation and disclosure
i. Classification- Financial information is appropriately presented and described,
and disclosures are clearly expressed.
ii. Accuracy and valuation- Financial and other information are disclosed fairly
and at appropriate amounts.
iii. Completeness-All disclosures that should have been included in the financial
statements have been included.
METHODS (TECHNIQUES) TO OBTAIN AUDIT EVIDENCE

[Nov 1997, Nov 2001, May 2003-8 Marks, May 2011- 8 Marks]
One or more of the following methods:
1. Inspection
2. Observation
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3. Inquiry and confirmation

4. Computation
5.Analytical review
6.Reperformance
1-Inspection
Inspection
consists
of
examining
records,
documents
or
tangible
assets.
Four major categories of documentary evidence which provide different degrees of

reliability to the auditor are:
Documentary evidence created and held by the third parties;
Documentary evidence created and held by the entity.
Documentary evidence created by third parties and held by the entity; and
Documentary evidence created by entity and held by third party.
Inspection of tangible assets provides reliable evidence with respect to their existence but
not necessarily as to their ownership or value.
2-Observation
Observation consists of looking at a process a procedure being performed by the

others. For example, the auditor may observe the counting of inventories by client
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personnel. Observation provides audit evidence about the performance of a process

or procedure.
3-Inquiry and confirmation [Inquiry- May 2013 4 Marks]
Inquiry consists of seeking appropriate information from knowledgeable

person inside or outside the entity.
Queries may range from formal written inquires addressed to third parties to
informal oral inquires addressed to persons inside the entity.
Responses to inquiries may provide the auditor with information which he did not
previously possess or may provide him with corroborative evidence. (Confirmatory
evidence).
Confirmation consists of the response to an inquiry to corroborate (Confirm)
information in the accounting records. For example, the auditor normally requests
confirmation of receivable by direct communication with debtors.
External Confirmation-
[Nov 2011, Nov 2012- 8 Marks]
It means audit evidence obtained as a direct written response to the auditor from
a third party (the confirming party) in paper/ electronic/ other form. Auditor
should carefully plan & control external confirmation
Generally external confirmation is used for the following:
Bank balances
Accounts receivables balances
Account payable balances
Property title deed held by third party
Loan from lenders
While selecting items for confirmation the auditor should consider the materiality
of account balances.
Procedure of external confirmation
Selection (To whom confirmation letter is to be sent)
Design the communication request (Positive Form or Negative Form)

Communicating the confirmation request to selected third party
Obtaining the response from third party
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Evaluating the information
Positive Form In positive form external party always responds whether they agree with auditors
understanding or not.
If auditor does not receive any reply, he may send an additional confirmation
request.
If still request is not replied then he has to do additional procedure alternate
procedure.
If alternate procedures do not provide sufficient evidence, he should determine its
effect on audit report (Qualify/Disclaimer)
Positive form is more reliable than negative form.
Negative Form
In negative form external party responds only when they disagree with auditor
understanding.
This form is generally used when risk of misstatement is low because internal
controls are effective and low exception rate is expected.
These are less reliable than positive form
Evaluation
If response indicating disagreement of third party, the auditor shall investigate
exception to determine whether these are indicative of misstatement by performing
additional audit procedures.
In case of positive form confirmation request there is no response by third party the
auditor should perform alternative procedures.
If management request auditor not to seek external confirmation, auditor should ask
management for written presentation. Auditor should consider whether there are valid
ground for the same. If there are valid grounds then he may accept the management
request and adopt alternative procedure. If there are not valid grounds then he may not
accept the management request as it is a limitation on scope of his work.
4-Computation
Computation consists of checking the arithmetical accuracy of source documents,

accounting records or of performing independent calculations.
5-Analytical Review (SA-520)
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Analytical procedures consist of evaluations of financial information made by a study

of relationship among data. These relationships may be between financial data and
between financial and non financial data.
Analytical review may be the followings:
- Ratio analysis
- Trend analysis
- Comparison of actual with budget
- Comparison of current year figure with corresponding figure of previous year.
Analytical review consists of studying significant ratios and trends and investigation
unusual fluctuation and item.
Auditor may use analytical review at planning stage.
The main purpose to use analytical procedures is to determine the nature, timing and
extent of other audit procedures.
Its objective is to obtain evidences using substantive procedures.
If auditor identifies fluctuation or a significant difference between recorded & expected
values, he shall investigate by inquiring of management and thereafter obtaining
evidences to corroborate the same and performing other procedures as necessary in the
circumstances
The extent of reliance on the results of analytical procedures will depend on factors like:
Materiality of items involved
- When inventory balances are material analytical reviews alone will not be
sufficient in forming the audit conclusion
- Where certain individual items of income or expenditure are not material,
comparison with previous year data may provide sufficient audit assurance.
Accuracy of prediction
- If the expected results of analytical procedures can be predicted with reasonable
accuracy, such procedure will be more reliable
- For example, the Gross profit percentage over various periods would be consistent
and give more audit reliance than R & D expenditure or Advertisement
expenditure etc.
Nature of risk
- If internal control over sales order processing is weak and hence control risk is
high, more reliance will have to be placed on test of details of transactions and
balances.
6. Reperformance- Re-performance involves the auditors independent execution of
procedure or controls that were originally performed as part of entitys internal
control.
AUDITORS DUTIES WHEN AN INFORMATION TO BE USED AS AUDIT

EVIDENCE
When designing and performing audit procedures, the auditor shall consider the
relevance and reliability of the information to be used as audit evidence.
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When information to be used as audit evidence has been prepared using the work of a
managements expert, the auditor shall to the extent necessary, having regard to the
significance of that experts work for the auditors purpose
a) Evaluate the competence, capabilities and objectivity of that expert.
b) Obtain an understanding of the work of that expert
c) Evaluate the appropriateness of that experts work as audit evidence for the
relevant assertion.
When information to be used as audit evidence has been produced by the entity the
auditor should
a) Obtain audit evidence about the accuracy and completeness of the information
b) Evaluate whether the information is sufficiently precise and detailed for the
auditors purpose.
AUDITORS DUTIES IN CASE OF INCONSISTENCY IN, OR DOUBT OVER

RELIABILITY OF AUDIT EVIDENCE
If audit evidence obtained from one source is inconsistent with that obtained from
another or the auditor has doubts over the reliability of information to be used as
audit evidence the auditor shall determine what modification and addition to audit
procedures are necessary to resolve the matter.
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1) Evidence should be sufficient and appropriate.

True- Auditor should obtain sufficient & appropriate evidence. Sufficiency refers to
quantum of audit evidence. Appropriateness refers to quality of audit evidences.
2) Auditor should consider consistency of evidence.
True- The audit evidences obtained through different sources or of different nature
should be consistent. If there is inconsistency among different evidences relating to a
single item, auditor should perform additional procedures to resolve inconsistency.
3) Compliance procedure is undertaken to check transaction and balances.
False- Compliance procedure is undertaken to check designing, operating effectiveness
and continuity of internal control system.
4) Substantive procedures are carried out to check data produces by accounting system.
True- Substantive procedures are undertaken to check completeness, accuracy and
validity of data produces by accounting system.
5) Auditor may use analytical review procedure at planning stage.
True The auditor should apply analytical procedures at planning stage for
understanding the business and in identifying areas of potential risk. It uses both
financial and non financial data.
6) Material items are only quantitative in nature.
False- Material items are those which may influence the judgement the judgement of
users of financial statements. It may be quantitative and qualitative as well.
7) There is inverse relation between materiality & audit risk.
True- Generally management / employees do not commit fraud in high value items.
Moreover, as a general practice, auditor checks high value items in detail. Thus it is less
risky that high value fraud and error may not be detected. So high materiality level
leaves audit risk at lower degree.
8) External confirmation means representation from management.
False- It is the process of obtaining and evaluating audit evidences through a direct
communication from a third party in response to a request for information about a
particular item.
9) Reply is required in all cases in positive confirmation request.
True- It asks the respondent to reply the auditor in all cases either by indicating the
respondents agreement/ disagreement with the given information or by asking the
respondent to fill in information.
10) Auditor should carefully plan & control external confirmation.
True- The auditor should maintain control the process of selecting those to whom a
request will be sent, the preparation and sending of confirmation request and responses
to those requests.
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Chapter-3
Preparation for an Audit
AUDITORS ENGAGEMENT
[May 2003, Nov 2009, Nov 2010, May 2012]
The conduct of the members of ICAI is governed by set of rules. One of these rules
forbids CA to solicit the client. Client must themselves find their auditors. It is
important for both the auditors and the client that they should be clear about nature of
engagement.
Letter of Engagement refers to the letter written by the auditor to his client
documenting and confirming his acceptance to the appointment, the objective, scope
and extent of his responsibilities to his client. The auditor should send an engagement
letter, preferably before the commencement of the engagement, to help avoid any
misunderstanding with respect to the engagement.
In case of recurring audit, the auditor may decide not to send a new engagement letter
each period. However, the auditor shall send a new engagement letter each year in the
following situations:
Any indication that the client misunderstands the objective and scope of the audit.
Any revised and special terms of engagement.
Any recent change in BoD or senior Management.
A change in legal or regularity requirement.
Any change in the business of the client that is significant.
Any change in reporting requirement.
If the auditor is of the opinion that change in terms of engagement is reasonable, he
must issue the audit report according to the changed terms. However if the auditor is of
the opinion that change in terms of engagement is unreasonable and is not allowed by
the client to original engagement, he should withdraw and communicate the reason of
withdrawal to the BoD or the shareholders.
QUALITY CONTROL FOR AUDIT WORK AT FIRM LEVEL [5 Marks, Nov 2007]
SA 220 on Quality Control For Audit Work requires that the audit firm should
implement quality control policies and procedures to ensure that audits are conducted
in accordance with SA. The requirements are:-
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1) Professional requirements: Firms personnel should adhere to the principle of

independence and professional competence.
2) Skill & Competence: Personnel should have attained and maintain technical
standard and professional competence.
3) Assignment: Audit work is to be assigned to personnel who have degree of technical
training as per the requirement.
4) Delegation: Direction, supervision and review of work at all level to meet standard
of quality.
5) Consultation: Consultation within or outside the firm with experts wherever
necessary.
6) Acceptance and relation of clients: Evaluation of prospective clients and review of
existing to accept or retain a client based on firms independence and ability to serve.
7) Monitoring: Adequacy and operational effectiveness of quality control policies to be
continuously monitored.
Audit Process
Audit process refers to the sequence of activities performed in the formulation of
audit opinion on the financial statement.
It is a well defined methodology for organizing an audit and is adopted to
accomplish audit objectives.
Audit process can be viewed as a four step exercise
Step-1 Planning (SA-300)
Step-2 Performing procedures: Following 2 types of procedures are performed:
Risk Assessment Procedure (As per SA 315)
Further audit procedures (As per SA 330)
Step-3 Obtaining audit evidence on the basis of procedures performed.
Step-4 Concluding and Reporting (SA 700, 705, 706)
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STEP 1- PLANNING AN AUDIT OF FINANCIAL STATEMENT [SA-300]
Audit planning refers to planning by the auditor to enable him to conduct an effective
audit in an efficient and timely manner and includes planning about area, scope, depth
of transaction to be audited, time to be devoted, person to be deployed for audit etc.
The engagement partner and other key members of the engagement team shall be
involved in planning the audit.
Need for audit planning/objective of audit planning
Appropriate attention to important areas of audit.

Identification of potential problems
Timely completion of work
Utilization of assistants in a better way
Co-ordination of work done by other auditors and experts.
The auditor should follow the following steps to plan an audit:

Preliminary Engagement Activity
Planning Activity
Documentation requirements
Additional consideration to be undertaken in initial audit engagement.
Preliminary Engagement Activity

The auditor shall undertaken the following activities at the beginning of current audit
engagement
i. Performing procedures required by SA-220 Quality Control of an audit of financial
statements regarding the continuance of the client and the specific audit
engagement.
ii. Evaluating compliance with ethical requirements as required by SA-220.
iii. Establishing an understanding of the terms of engagement as required by SA-210
Agreeing the term of Audit Engagements
Planning Activity
There are 2 types of planning activities
1. The auditor shall establish an overall audit strategy to determine the Scope, Timing
and Direction of the audit. It may be establish by followings:
i. Identify the characteristic of the engagement that define its scope.
ii. Ascertain the reporting objective of engagement
iii. Consider the factors that are significant in determining the engagements teams
efforts.
iv. Consider the result of the preliminary engagement activity
v. Ascertain the Nature, Timing and Extent of procedures proposed to be performed
2. The auditor shall develop an audit plan that:
i. The nature, timing and extent of planned risk assessment procedures as
determined under SA-315 Identifying and Assessing the Risk of Material
Misstatement Through Understanding the Entity and its Related Environment
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ii.

The nature, timing and extent of planned further audit procedures as determined
under SA-330 The Auditors Responses to Assessed Risks
Documentation requirements: The auditor shall documents

-
The overall audit strategy

The audit plan
Any significant changes made during the audit engagement to the overall audit
strategy or the audit plan, and the reasons for such changes.
Initial audit engagement: In case of first audit, the auditor should follow the
following activities before the above preliminary activities:
Communicating with the predecessor auditor
Knowledge of clients business.
KNOWLEDGE OF CLIENT BUSINESS

[May 2004-8 Marks, May 2005- 6 Marks, June 2009- 5 Marks]
Knowledge of client business can be obtained by the following sources:
Client annual report to shareholders
Minutes of shareholders/board of directors
Internal financial management reports of current & previous year

Previous year audit working paper.
Discussion with client

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Client policy and procedure manual
Publication like trade journal, magazines, news papers and

Visit to clients premises.
STEP 2: PERFORMING PROCEDURES [REFER TO CHAPTER-2]

STEP 3: OBTAINING AUDIT EVIDENCES [REFER TO CHAPTER- 2]
STEP 4:- CONCLUDING & REPORTING
Forming conclusion on the basis of Audit evidences.
Providing report on True & Fair representation of financial statements.
Ensuring that report complies with the statutory requirement, if any
Communicating the Report to the appropriate authority.
AUDIT TECHNIQUES
[May 2006, May 2007, May 2012]
For collection and accumulation of audit evidence, certain methods and means are
available and these are known as audit techniques. Some of the techniques commonly
adopted by the auditors are the following:
1. Posting checking
2. Casting checking
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3. Physical examination and count

4. Confirmation.
5. Inquiry
6. Year-end scrutiny
7. Re-computation
8. Tracing in subsequent period
9. Bank Reconciliation
AUDIT PROGRAMME
[May 88, Nov 92, Nov 2006, Nov 2008, Nov 2013]
Audit programme is the auditors plan of action.

Audit programme is a detailed plan of applying the audit procedures.
It constitutes the plan of work and provides a basis for the supervision and control of
the audit work.
There should be a periodic review of the audit programme to assess whether the same
continues to be adequate for obtaining requisite knowledge and evidence about the
transaction.
An audit programme contains the following elements:
Study of relevant legal requirements
Area of auditing
Extent of checking
Analytical review of past performance
Study and evaluation of internal control
Analysis and review of financial statements
Finalization of audit report
Advantage of audit programme
[May 81, May 88, May 91, Nov 06, Nov 07]
A written audit programme provides the assistants with a clear set of instructions
about the work to be done by them.
Selection of assistants for the jobs on the basis of capability becomes easier when the
work is properly planned and segregated.
The principal can control the progress of the various audits in hand by examination of
audit programmes.
A properly drawn audit programme serves as evidence in the event of any charge of
negligence brought against the auditors.
It serves as a guide for carrying out the current audit and as a basis for drawing the
future audit programme.
Disadvantage of audit programme
[May 81, May 91, Nov 06, May 07, May 2012]
A hard and fast audit programme may kill the initiative of efficient and enterprising
assistants.
An audit programme can make the audit exercise rigid and mechanical.
Inefficient assistants may take shelter behind the program saying that the matter does
not contain any instruction.
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AUDIT NOTEBOOK
[Nov 2001]
An audit notebook is a bound book containing the audit programme, significant audit
observations, objections, queries etc.
It is a part of permanent record of the auditor, available for reference later on, if
required.
Some of the important content recorded in the audit notebook are as follows:
Name of the business and its structure
List of books of accounts maintained by the enterprise
Errors and fraud discovered
List of missing vouchers and receipts
Matters to be specified in audit report
Date of commencement and completion of audit
Audit Program
The audit note-book has great evidentiary value in case of any charge of negligence is
brought against the auditor by the client.
Specimen of entries in an Audit Note Book to indicate the manner in which entries in
those books ought to be made:
Voucher No.
38
107
306
42
89
Account
Advertisement
Rent
Das & Co.
Machinery
Stores
Amount (Rs.)
1,600
1,500
3,474
1,49,160
7,403
Query
MD sanction required
Rent, bill & Receipt required
Receipt required
Boards sanction required
Invoice required
How disposed of
Sanction obtained
Receipt & bill obtained
Party reminded
Sanction obtained
Party reminded
AUDIT DOCUMENTATION [SA- 230]

[May 98, Nov 2003, Nov 2007, May 2008, May 2010, Nov 2010, May 2011, Nov
2011, Nov 2012, May 2013, Nov 2013]
SA 230 is applicable on Audit Documentation.

Audit working papers comprise all documents prepared or obtained by the auditor and
retained by him in connection with the performance of his audit.
Working paper should state
Clients name
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Type of engagement
Nature of clients business
Degree of reliance on internal control
Sources of information
Conclusion reached
Supervision and review of work performed by assistant
Factors governing the form and content of working paper
[May 2013-5 Marks]
Size and complexity of the entity

Nature of audit procedures to be performed
Significant of the audit evidence obtained
Identified risk of material misstatement
Nature and extent of exception identified
The auditor should document the matters which are important in providing evidence
that the audit was carried out in accordance with the basic principles.
The audit working papers constitute the link between the auditors report and the
clients records.
Audit documentation may be recorded on paper, on electronic or other media
Specific Documentation:
a) Documentation of discussion
The auditor should document discussion of significant matters with management
and those charges with governance. These documents should give the following
details:
Nature and particulars of the matters discussed
Date of discussion
With whom the matter was discussed
The auditors conclusion of the matter discussed.
b) Documentation of departure from a relevant requirement
In case there is any departure from specific requirement of any standard on auditing,
such reason of departure should be properly documented. This involves the auditor
documenting how the alternative audit procedures performed.
c) Documentation of matters arising after the date of auditors report
If in exceptional circumstances, the auditor performs new or additional audit
procedures, or draw new conclusion after the date of auditors report, the auditor
shall document:
The circumstances encountered
The new or additional procedures performed, audit evidences obtained and
conclusion reached, and their effect on auditors report.
When and by whom the resulting changes to audit documentation were made and
reviewed.
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Working papers should be designed and properly organised to meet the circumstances
of each audit.
Audit documentation serves a number of purpose including: [Nov 2013]
Assessing the engagement team to plan and perform audit
Enabling the engagement team to be accountable for its work
To enable the engagement partner for direction, supervision and review the work
performed by engagement team members.
For quality control review.
For future reference in case of recurring audit
External inspection. (Peer Review)
The extent of documentation is a matter of professional judgement. It is neither
necessary nor practical that every observation etc. pertaining to an audit is documented.
However the working paper should be sufficiently complete and detailed for an auditor
to obtain an overall understanding of an audit.
Auditor is the owner of working papers relating to audit.
An auditor should retain the working paper for a period of time sufficient to meet the
requirement of practice. As per the ICAI auditor should retain the paper for 7 years.
The auditor shall assemble the final audit file within 60 days after the date of auditors
report and after the assembly of the final audit file, the auditor shall not delete or
discard audit documentation of any nature before the end of its retention period of 7
years. If it is necessary to add new documentation after compilation the auditor will
document the specific reason for making them and when and by whom they were made
and reviewed.
Classification of working papers

Working paper file may be classified as follows
Permanent Audit File: Permanent audit files are those which are of continuing
importance and will be required in future audits. It only needs to be updated from time to
time. A permanent audit file normally includes the following: (May 90, Nov 90, Nov 92,
May 97, Nov 97, Nov 05, Nov 07)
Memorandum and Article of association of the Company

Record of study and evaluation of internal control
Copies of audited financial statement of previous years
Notes relating to significant accounting polices
Record of communication with retiring auditor
Important audit observation of earlier years
Current Audit File: Current audit files contain the information relating to audit of single
period. It includes the following:
[Nov 90, Nov 07, Nov 2012]
Correspondence relating to acceptance of annual reappointment
Audit programme
Letters of representations and confirmation from clients
Copies of communication with experts or other auditors
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Analysis of transactions and balances

Conclusion reached about significant aspects of audit
Copies of financial information being reported along with related audit reports
AUDIT SAMPLING [SA-530]
[May 98, May 99, Nov 2013]
The term test check stands for the method of auditing where instead of a complete
examination of all the transactions recorded in the book of account only some of the
transactions are selected and verified.
Test checking is an accepted auditing procedure where in only a part of it is checked
to form an opinion instead of checking all transactions.
Audit sampling means the application of audit procedures to less than 100% of items
within a population
Population means the entire set of data from which a sample is selected.
Sampling risk means the risk that auditors conclusion based on a sample may be
different from the conclusion if the entire population were subjected to the same audit
procedure.
Non Sampling Risk means the risk that the auditor reaches an erroneous conclusion for
any reason not related to Sampling Risk. For example use of inappropriate audit
procedures, misinterpretation of audit evidences etc.
There may be two types of sampling risk:
Type-1 That controls are more effective than they actually are and no material
misstatement exist
Type-2 That controls are less effective than they actually are and material
misstatement exist.
The auditor shall evaluate the result of sample and whether the use of audit sampling
has provided a reasonable basis for conclusion about the population that has been
tested.
Precautions to be taken in Adopting Test Checking Techniques
a) The transaction of the concern should be classified under appropriate heads and
may be stratified if wide variations are there between transactions of same kind.
b) Internal control relating to transaction should be reviewed.
c) Examination in depth should be done
d) Auditor should identify the item not suitable for test checking.
e) The number of transaction to be selected for each test check plan should be
predetermined.
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Circumstances under which test checks can be adopted
a)
b)
c)
d)
In case of a big concern where number of transactions are quite large

Where the auditor has very little time to check all the transactions
Number of the transactions should be identical in nature
Existence of satisfactory internal control system
Transactions not suitable for test checks

[May 97, RTP]
a) Opening and closing entries
b) Transactions involving calculations like depreciation, commission etc.
c) Transactions of exceptional or non recurring nature
d) Bank reconciliation statement
e) Balance sheet items
f) Compliance with statutory provisions
Test checking may either be judgemental or statistical.
[May 2000]
Auditor based on his judgement decides whether to use a statistical or non
statistical sampling method
Judgemental Sampling:
Under this method, the sample size and its composition are determined on the basis
of the personal experience and knowledge of the auditor.
This method has been in common application for many years because of its
simplicity in operation.
For example, March, June and September may be selected in year one and different
months would be selected in the next year.
An attempt would be made to avoid establishing a pattern of selection year after year
to maintain an element of surprise as to what the auditor is going to check.
It is a common practice to check large number of items towards the close of the year
so that the adequacy of cut-off procedures can also be determined.
In judgement sampling the auditors opinion determine the sample size but it cannot
be measured how far the sample size would fulfil the audit objective.
Statistical Sampling:
Statistical sampling is a method of audit testing which is more scientific than testing
based entirely on the auditors own judgement because it involves use of
mathematical laws of probability in determining the appropriate sample size.
Statistical sampling has reasonably wide application where a population to be tested
consists of a large number of similar items.
Advantages of statistical sampling are:
a) It is more scientific.
b) No personal bias
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c) Sample selection is more objective as based on mathematical law of probability.

Disadvantages of statistical sampling are:
a) It is complex to operate
b) It is not suitable for the audit staff having no knowledge of statistical technique.
Selecting the Sample

The auditor should select the sample item in such a way that the sample can be expected
to be representative of the population.
Samples can be selected either via random sampling or via systematically sampling.
Random Sampling
Random selection ensures that all items in the population or within each stratum
have a chance of selection.
It may involve use of random number tables.
Random sampling includes two very popular methods which are discussed below:
Simple Random sampling
[May 2012]
Under this method each unit of the whole population e.g. purchase or sales invoices
has an equal chance of being selected.
The mechanics of selection of items may be choosing numbers from table of random
numbers by computer or picking up numbers randomly drum.
It is considered that random number tables are simple and easy to use and also
provide assurance that the bias does not affect selection.
Stratified sampling
This method involves dividing the whole population to be tested in a few separate
groups called stratum and taking a sample from each of them.
Each stratum is treated as if it were a separate population.
The number of groups into which the whole population has to be divided is
determined on the basis of auditor judgement.
For example debtor balance may be divided into four groups as follows:
Balance in excess of Rs. 1,00,000
Balance in the range of Rs. 75,000 to Rs. 1,00,000
Balance in the range of Rs. 25,000 to Rs. 75,000
Balance below Rs. 25,000
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CA Clues
Systematic Sampling / Interval Sampling
It involves selecting items using a constant interval between selections.

The first interval having a random start.
The interval might be based on certain number of items (for example every 20 th
voucher).
When using systematic selection, the auditor should determine that the population is
not structured in such a manner that the sampling interval corresponds with
particular patterns in the population. For example if in a population of branch sales,
particular branch sales occur only as every 100th item and the sampling interval is
100. The result would be that either the auditor would have selected all or none of
the sales of that particular branch.
To minimise the effect of the possible known buyers through a pattern in the
population, more than one starting point may be taken.
Block Sampling
This method involves the selection of a defined block of consecutive items.
For example take the first 200 sales invoices from the sales day book in the month of
September; alternatively take any four blocks of 50 sales invoices.
Selection of month may be on random basis.
There is a close similarity between this method and judgemental sampling .
Cluster Sampling
This method involves dividing the population into groups of items known as
clusters.
A number of clusters are randomly selected from all the clusters rather than
individual items of the population.
E.g. 600 invoices are divided into 15 clusters having 40 invoices each, then selecting
6th, 8th, and 13th cluster.
SURPRISE CHECK
[May 2005, May 2013]
Surprise check refers to the out of routine check that is carried out in the normal course
of audit.
Such checks are the important part of the audit procedures.
The auditor in the circumstances of each audit may determine frequency of such checks.
These checks preferably should be at least once during of the audit.
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CA Clues
Surprise checks are mainly intended to ascertain whether the system of internal control
is operating effectively.
Surprise check may be with respect to the
[4 Marks, May 2008]
Verification of cash and investments.
Test verification of stores & stocks and records relating thereto
Verification of books of prime entry and statutory registers.
The result of surprise check should be communicated to the management if they reveal
any weakness in the system of internal control or any fraud or error or deficiency in the
maintenance of records. The auditor should satisfy himself that an adequate action has
been taken on the matter communicated by him to the management.
It is not necessary in all cases for the result of surprise check to be included in the auditor
report. They however should be included if in the opinion of the auditor they are material
effect and affect the true & fair view of financial statement.
EXAMINATION IN DEPTH
[Nov 94, Nov 95, Nov 97, May 2000, Nov 2007, May 09, Nov 2012 4 Marks, Nov
2013]
It implies examination of a few selected transactions from the beginning to the end
through the entire flow of transaction
It involves studying the recording of transaction at the various stages through which
they have passed.
At each stage, relevant records and authorities are examined, it also judged whether the
person who has exercised the authority in relation to the transaction is authorised to do
so in terms of the prescribed procedure.
Examination in depth of the transaction relating to the payment of a creditor for goods
supplied would involve verification of the following:
Purchase requisition
Invitations of the quotations and analysis of the same
Official purchase order
Receipts of goods along with delivery challan
Taking goods to store room after verification of quality and quantity
Entry into store records
Receipts of the suppliers invoices
Entries into purchase day book
Posting to purchase ledger and purchase ledger control account
Payment of cheque in settlement after discount, if any
Entries in cash book, ledgers.
AUDIT RISK
[Nov 99, Nov 2002, May 2004, Nov 2013]
Audit risk means that the auditor may give an inappropriate audit opinion when the
financial statements are materially misstated.
41
CA Clues
Audit risk is a function of the risk of material misstatement (Inherent risk & Control
risk) and detection risk.
Audit risk has three components:
Inherent Risk
[Nov 2012, 4 Marks]
It is the susceptibility of account balances or class of transaction to misstatement that

could be material, either individually or when taken together with misstatements in
other balances or classes, assuming that there were no internal controls.
Such risk can only be assessed and not reduced
The auditor should study and evaluate the degree of inherent risk in order to determine
the audit plan.
Control Risk-
[Nov 2005]
Control risk means the risk that a material misstatement could occur but would not be
prevented or quickly detected by the organisations control.
The preliminary assessment of control risk is the process of evaluating the likely
effectiveness of an entitys internal control systems in preventing or detecting and
correcting material misstatements.
Such risk can only be assessed and not reduced
Detection Risk
Detection risk means the risk that the auditor will fail to detect a material misstatement
in the financial information.
Detection risk relates directly to the effectiveness of audit procedures.
It is the risk relating to substantive procedure due to sample & test checking.
Auditor can increase or decrease it by changing nature, timing and extent of audit.
In the case where inherent and control risk are very low, the auditor should perform
some substantive procedures.
42
CA Clues
1) Term of engagement must not be decided in advance.

False Client and auditor should agree on terms of engagement by way of an audit
engagement letter to avoid any misunderstanding. Thus, auditor should send an
engagement letter, preferably before commencement of engagement.
2) Planning is indispensable part of audit process.
True- The auditor should plan his work to enable him to conduct an effective audit in
an efficient and timely manner. It should be based on knowledge of the client business.
3) Audit program helps the assistants in several ways.
True- It contains instruction for staff as to work to be done. Moreover due to properly
written program there is no chance of forgetting/ overlooking some important matter.
Program clearly sets out as to who is required to do a particular work, thus
responsibility can be fixed.
4) Audit program cannot be of any use in future.
False It serves as guide for audits to be carried out in succeeding years. Moreover, in
case auditor faces some case for negligence, he can defend himself by showing it.
5) Audit program does not suffer from limitations.
False The program often becomes rigid & inflexible. Assistants are not able to change it
as per requirements of specific case. Moreover hard and fast program hurts the
initiative & judgemental skills of hard working assistants.
6) Final audit reduces the chance of manipulation in accounts.
True- Final audit begins after the books have been closed at the end of accounting
period & then carried on continually till completion. Work is carried out in single
continuous sitting. Thus there will be no manipulation in accounts, once closed.
7) In continuous audit auditor goes to client site at end of year.
False When audit is conducted during the financial year i.e. accounts are checked the
whole year round it is termed as continuous audit. Usually audit staff is present at
clients site almost during the entire accounting period.
8) Continuous audit does not have any limitation.
False Continuous audit has many limitations like alteration of records after being
checked, not suitable for small business etc.
9) Working paper should be kept up to four years.
False As per the ICAI, documentation is the property of auditor & he should maintain it
at least up to seven years from the date of signing of audit report.
10) Results of surprise checks are always included in auditors report.
False It is not necessary in all cases for the results of the surprise checks to be included
in the auditors report on the accounts. They should however be included if in the
opinion of the auditor, they are material and effect the true & fair view of the accounts.
11) Test checks refer to out of routine checks that are carried out in the normal course
of audit.
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CA Clues
False Test checks refers to an audit procedure wherein only a part is checked to form an
opinion instead of checking all the transactions.
12) Audit procedures and audit techniques are not one and same thing.
True Audit procedures are two Compliance procedures and Substantive procedures. To
apply these procedure auditor uses some specific methods known as audit techniques.
13) Auditing in depth implies that the auditor vouches almost all transaction in a
manner that the chances of not checking any transaction are left at minimum.
False Auditing in depth does not mean the 100% vouching. It is checking selected
transaction from beginning to end to understand the entire system within which the
transaction passes through.
14) While auditing the accounts of a company, it is obligatory that the auditor must
adopt sampling technique.
False It is not obligatory that the auditor must adopt sampling technique while auditing
the accounts of a company.
15) The auditee firm has no right to compel the auditor to provide copies of the
working papers.
True Working papers are the property of the auditors so auditee has no right to compel
the auditor to provide copies of the working paper.
16) Analytical procedures are unable to help the auditor in determining the nature,
timing and extent of other procedures at the planning stage.
False- SA 520 Analytical Procedure puts forward that application of analytical
procedures helps the auditor to find the aspects of the business of which he was
unaware and it will also assist him in determining the nature, timing and extent of audit
procedures.
44
CA Clues
Chapter-4
INTERNAL CONTROL
INTERNAL CONTROL
Internal control is the process designed, implemented and maintained by TCWG &
management to provide reasonable assurance about the achievement of entitys
objectives with regard to
1. Carry on the business in an orderly manner,
2. Safeguard of the assets
3. Secure as far as possible the accuracy and reliability of its record
4. Prevention and detection of fraud and error
Component of Internal Control
1. Information system
2. Control environment
3. Risk assessment procedure of the entity
4. Activity related to control
5. Monitoring of control
The internal control also includes the system of internal check and internal audit.
The management is responsible for maintaining an adequate accounting system
incorporating various internal controls to the extent appropriate to the size and nature
of the business.
The system installed should be reviewed by the management to ascertain whether the
prescribed management policies are being properly interpreted by the employees and
are faithfully implemented.
Followings are the aims of internal control so far as financial and accounting aspects are
concerned [Nov 2003]
Providing the flow of work through various stages.
Segregation of accounting and custodian function.
Securing proper documentation at each stage.
Safeguard of the assets
Making the work simpler
Lowering the chances of occurrence of errors and frauds.
Minimising loss and wastage
Preparation of periodical accounting and financial report.
Encouraging employees to do willingly with best of this ability and knowledge
Discouraging employees from non- compliance with the prescribed procedures.
INHERENT LIMITATION OF INTERNAL CONTROLS

[N0v 07-7 Marks, Nov 2013-8 Marks]
The objective of internal control can only be reasonably, and not absolutely, achieved due
to the following limitations:
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CA Clues
Benefit expected from a control may not commensurate with cost of implementation.
The potential for human error such as due to careless, misunderstanding of
instructions.
Possibility that a person responsible could misuse the authority.
Manipulations by the management in the preparation of financial statement.
Most internal controls do not tend to be directed at transactions of unusual nature.
Possibility that procedures may become inadequate due to change in conditions.
REVIEW OF INTERNAL CONTROL BY THE AUDITOR
[May 1995- 8 Marks]
To facilitate the accumulation of the information necessary for the proper view and
evaluation the auditor should use any one of the following:
1) Narrative Record: This is a complete and exhaustive description of the system as
found in operation by the auditors. It is suitable where:
- No formal control system is in operation.
- The size of the business is small.
2) Check list:
A checklist is a series of instructions and questions which the auditor should
follow and answer.
The complete check list is studied by the principal/ manager/ senior to ascertain
the existence of internal control and evaluate its implementation and efficiency.
Answer to checklist is usually in form of Yes, No or Not Applicable
ExampleAre tenders invited before placing order- Yes/ No.
Are the purchases made on the basis of a written order?
Is the purchase order form standardised?
Are purchase order forms pre-numbered?
3) Questionnaire[May 2007, Nov 2010, May 2013]
Internal control questionnaire is a set of questions designed to provide a thorough
view of the state of internal control in an organisation.
This is most widely used for collecting information about the existence, operation
of internal control in an organisation.
The auditor may prepare a standard questionnaire to be used with suitable
modification in the case of all audit engagements or he may prepare a fresh one
for each audit engagement.
The questionnaire is usually issued to the client and client is requested to get it
filled by the concerned executives and employees.
The questions should be so designed that an answer can be provided by mere
ticking of the word YES or NO or NOT APPLICABLE. Usually questions
are framed in such a way that NO shows the weakness.
Example- Do you keep invoice pre numbered? Yes/No
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CA Clues
4) Flow Chart- [Nov 2013]
It is graphic presentation of each part of the companys system of internal control.

A flow chart is considered to be the most concise way of recording the auditors
review of the system.
It minimizes the time involved in getting narrative explanations.
It gives birds eye view of the system.
Its disadvantages are (i) its time consuming (ii) technical knowledge is required.
For example- Stock control procedure can be depicted in the form of diagram.
INTERNAL CONTROL EVALUATION

The ICE brings to light importance of those weakness disclosed by ICQ.
ICQ incorporates a large number of detailed questions but not attempt to distinguish
their relation in materiality. ICE isolates the main control objectives within the area of
review of their materiality.
ICE requires audit personnel to state whether, an apparent weakness may prove to be
material in relation to the account as a whole.
ICE is further an extension of ICQ; it is not the substitute of ICQ.
COMMUNICATION OF WEAKNESS IN INTERNAL CONTROL

[June 2009-5 Marks, May 2013-4 Marks]
The auditor should make management aware at appropriate level of responsibility of
material weakness in the design or operation of accounting and internal control
system, which has come to his attention.
This communication should be in writing through a letter of weakness or management
letter.
Lapses in operation of internal control too are reported in the communication of
weakness.
The communication of weakness is reported to management of such weakness in design
and operation of internal control as have come to notice of auditor during his auditing.
INTERNAL AUDIT
[RTP, May 88, May 92, Nov 2011]
Internal audit is an audit conducted on behalf of the management of an enterprise.

Internal audit involves an examination and evaluation of various activities of an
enterprise.
The exact scope of an internal audit in a particular situation is determined by the
management in the context of its specific requirements.
Objectives of Internal audit are
47
CA Clues
To verify the accuracy of the financial accounting.

To establish that there is a proper authority for every acquisition, disposal of assets.
To facilitate the prevention and detection of fraud
To make special investigation for management.
To provide new ideas to the management
To confirm that liabilities have been incurred for the activities of the entity.
Review of compliance with laws and regulations.
Internal audit is carried out by staff specially assigned for it.
INTERNAL CHECK
[May 2001, May 2006- 8 Marks, Nov 2006-6 Marks, May 2012-8 Marks]
It is type of control which focuses on drafting of procedures.
Internal check means the arrangement of duties of staff in such a manner that the work
of one person is automatically checked by another during the course of carrying out,
recording and processing of transaction.
The accounting of transactions has a number of processes such as posting to the
concerned books of accounts, recording receipts and payments of cash etc. These
processes are entrusted to various numbers of staff. Thus in an internal check
practically a continuous internal audit is carried on by the staff itself.
Internal check is valuable part of internal control.
Internal check is procedure oriented.
General consideration in framing a system of internal check:
[RTP, Nov 89, May 09, Nov 06, May 2012]
No single person should have an independent control over any important aspects of
the business.
The duties of the staff members should be changed from time to time without any
previous notice.
Every member of the staff should be encouraged to go on leave at least once in a
year. Frauds successfully concealed by the employees are unearthed when they are
on leave.
Persons having physical custody of the assets must not be permitted to have access
to the books of accounts.
Mechanical devices such as automatic cash counting machine may be employed.
Budgetary System should be implemented.
Internal Check
Internal check means the arrangement of
duties of staff in such a manner that the
work of one person is automatically checked
by another during the course of carrying out,
recording and processing of transactions
Objective is to minimize and detect errors
and frauds.
It is an integral part of the regular operations
Internal Audit
Internal Audit is an audit conducted on
behalf of the management of an enterprise
with the objective of assisting the
management to discharge its responsibility
effectively.
Main objective is evaluating the effectiveness
of organizational control.
Internal audit is carried out by staff specially
assigned for it
48
CA Clues
It is merely an arrangement of book keeping It involves evaluating the quality and

and clerical duties.
operation of the various other control
Internal checks are procedure oriented
Internal audit is control oriented
INTERNAL CONTROL IN THE SMALL BUSINESS

The auditor needs to obtain the same degree of assurance in order to give an unqualified
opinion on the financial statements of both small and large entities.

However, many controls which would be relevant to large entities are not practical in the
small business. For example in small business accounting work may be performed by only
a few persons.
These persons may have both operating and custodial responsibilities.
Segregation of function may be missing or severely limited.
As segregation of duties is limited or evidence of supervisory control is lacking, there is
high control risk.
Due to high control risk he has to perform substantive procedures in details to reduce the
detection risk.
INTERNAL CONTROL FOR COLLECTION OF TUITION FEES FROM STUDENT

OF COLLEGE [June 2009- 6Marks]
There must be a clear cut tuition fee structure approved by the college council.
The challan or paying in slip should contain necessary fields for identifying the roll
numbers of the student, class and period for which fees is paid.
The paying in slip when filled by the students should be checked for its correctness as to
applicable amount etc by one clerk and the amount should be entered in a scroll.
The cashier scroll and authorising officers scroll should be checked by an officer daily.
All remittance should be banked each day.
Alternatively the fees may be directly remitted into bank and bankers daily remittance
slip should be scrutinised by college officers.
Arrear list should be periodically prepared from the students rolls.
Delayed remittance should carry fines or compensating charges for delay.
INTERNAL CONTROL AND THE COMPUTERISED INFORMATION SYSTEM

(CIS) ENVIRONMENT
CIS Environment and audit in CIS Environment
[Nov 2000, May 2004, Nov 2005]
CIS audit is the process of auditing in a computerised environment.

49
CA Clues
The overall objective and scope of an audit does not change in a CIS environment.
The use of a computer changes the processing and storage of financial information and
may affect the organization and procedure employed by the entity to achieve adequate
internal control.
CIS environment affect the procedures followed by the auditor to obtain audit
evidences.
The auditor should have an understanding of computer hardware, software and
processing system. Specialised skills and competence may be required to:
Determine the effect of CIS environment on the assessment of overall audit risk.
Design and perform appropriate compliance procedures and substantive
procedures.
Evaluate the result of procedures performed.
When the auditor delegates work to assistance or uses work performed by other
auditor or expert, the auditor should have sufficient knowledge of CIS to:
Direct, supervise and review the work of assistants with CIS skills.
Obtain a reasonable assurance that the work performed by other or expert with CIS
skills is adequate for his purpose.
The auditor should gather information about CIS environment that is relevant to audit
plan, including the information: [May 2013-4 Marks]
1) How the CIS function is organized.
2) The computer hardware and software used by the entity
3) Each significant application processed by the computer
4) Nature of processing (Batch, Online real time)
INTERNAL CONTROL IN CIS ENVIRONMENT

[Nov 98, Nov 2002, May 2003-8 Marks, May 2007- 4 Marks, May 2010-5 Marks]
The auditor should acquire the knowledge of accounting system to gain an understanding
of the overall control environment and the flow of transactions. The auditor should
consider:
General CIS Controls
50
CA Clues
CIS application controls
General CIS Controls The purpose of general CIS controls is to provide a reasonable level
of assurance that the overall objectives of internal control are achieved. It includes:
a) Organization and Management Controls: These are designed to establish an
organisational framework over CIS activities including
Policies and procedures relating to control functions
Appropriate segregate of incompatible functions
b) Application System Development and Maintenance Controls: These are designed to
provide reasonable assurance that system are developed and maintained in an
authorised and efficient manner. These are designed to control over
Changes to application system
Access to system documentation
Acquisition of application system from third parties
Testing, implementation and documentation of new or revised system.
c) Computer Operation Controls: These are designed to control the operation of the
system and to provide reasonable assurance that
Only authorized programs are used (Password control, personal identification No.)
Processing errors are detected and corrected
System are used for authorized purpose by authorized personnel
d) System Software Controls: These are designed to provide a reasonable assurance that
system software is acquired or developed in authorized and efficient manner, including:
Restriction of access to authorised personnel only
Authorization, approval, testing, implementation and documentation of new
system software and modifications.
e) Data Entry and Program Controls: These are designed to provide reasonable assurance
that
Access to data and programs is restricted to authorised personnel
An authorization structure is established over transactions being entered in to the
system.
There are other CIS safeguards that contribute to the continuity of CIS processing. These
may include:
Off site back up of data and computer programs
Provision of offsite processing in the event of disaster.
Recovery procedures for use in the event of theft, loss, destruction etc.
51
CA Clues
CIS Application Controls: The purpose of CIS application control procedure over the
accounting application in order to provide reasonable assurance that all transactions are
authorised and recorded and are processed completely, accurately and on a timely basis.
a) Control over Input: These controls provide reasonable assurance that
Transaction are properly authorised before being processed by the computer.
The system should devise controls to check that data input are accurate
Transactions are not lost, duplicated or improperly changed
Incorrect transactions are rejected or submitted after correction.
b) Controls Over Processing and computer data files: These are designed to provide
reasonable assurance that
Processing errors are identified and corrected on a timely basis
Transactions are not lost, added or improperly changed
Transactions are properly processed by the computers
c) Control over Output: These provide assurance that
Results of processing are accurate
Access to output is restricted to authorized personnel
Output is provided to appropriate authorised personnel on a timely basis.
AUDIT TRAIL
[Nov 2004- 4 Marks]
An audit trail refers to a situation where it is possible to relate, the original input with
the final output (i.e. on an one to one basis)
In other words, audit trail means a link between few records or a path for audit
Example- Approval of a transaction, its documentation, entry in a book of original
entry, posting to ledger, ledger account balancing, trial balance, classification and
summarisation of balances and presentation of in a financial statement.
Hence for each transaction there is an audit trail.
When there is significant visible audit trail, the work of auditor is not affected and he
not changes his approach to audit.
In CIS environment there is absence of audit trail due to factors such as
Direct data entry into the system
Direct posting of transactions to master file
Elimination of reports as information is supplied on-line
The auditor may use special technique to overcome the loss or changes in audit trail.
Some measure to overcome the loss of audit trail may include
Programmed Interrogation Facilities
Arranging for special printouts containing additional information
52
CA Clues
Reliance on alternative tests.

Audit Software/ Computer Aided Audit Technique (CAAT).
AUDITING AROUND THE COMPUTER (BLACK BOX APPROACH)

[Nov 99, May 2002, May 2005,]
The auditor determines his audit procedures without taking into account the fact of
use of computer for processing of information.
In the Black box approach, the auditor concentrate on input and output and ignores the
procedure of how computer process the data or transactions.
The auditor carries out the audit more or less in the same manner as in manual system
except that instead of handwritten books of account, he examines computer printouts.
The auditor can usually audit around the computer when either of following situation
applies to application system existing in the installation
The system is simple.
The system uses generalised software that is well-tested and widely used by many
institutions.
The primary advantage of this approach is simplicity. Auditor having little technical
knowledge of computer can be trained easily to perform the audit.
The disadvantage of this system is that it is not beneficial for complex system and this
system follows the pattern of historical audit.
AUDITING THROUGH THE COMPUTER (WHITE BOX APPROACH)

[May 98, Nov 99, May 2002, Nov 2003, May 2005]
53
CA Clues
The auditor evaluates the internal controls relating to CIS and on the basis of this
evaluation, determines the nature, timing and extent of his substantive procedures.
Situation where it must be used (May 2007)
The computer processes a large volume of input and resultantly produces a large
volume of output.
The significant parts of the internal control system are embodied in the computer
system itself.
The logic of the system is complex.
The auditor takes the computer as a target of audit
The auditor can used the computer to test
The logic and controls existing within the system
The records produced by the system
The primary advantage of this approach is the auditor has increased power to
effectively test a computer system.
The primary disadvantage of this approach is it need for extensive technical expertise.
COMPUTER ASSISTED AUDIT TECHNIQUES (CAATS)

[May 2006, Nov 2007, Nov 2011-8 Marks]
CAATs are those techniques which undertake assistance of computer for being applied
to an audit in a computerised environment.
The use of CAATs may be useful because of following reasons:
Internal Storage
Disappearance of Audit trail
Absence of input documents
Lack of visible output
CAATs can be used for both compliance procedures and substantive procedures
Benefit of CAAT
1) Time Saving: Auditor can check voluminous data in less time by using CAAT, so
there is a much time saving.
2) Audit effectiveness: The effectiveness and efficiency of auditing procedure will be
improved through the use of CAAT.
3) Effective test checking and examination in depth: CAAT permits effective
examination in depth of selected transactions.
CAAT's are very effective in performing ARP because the software can easily trace
unusual fluctuations and hard copy can be generated for auditor's ready reference.
54
CA Clues
When planning the audit, the auditor may consider an appropriate combination of
manual and computer assisted audit techniques.
Followings are CAATs :
Test Data: The auditor enters a set of data in to entitys system and compares the
result with predetermined results. These test data are chosen by the auditor.
Audit programme: This implies that a processing run is undertaken using a tested
programme under the control of the auditor.
55
CA Clues
1) Maintenance of internal control system is responsibility of auditor.

False- Internal control system is the plan of organisation and all policies & procedures
adopted by management to ensure, orderly & efficient conduct of business. Thus it is
responsibility management.
2) Internal control questionnaire easily shows weakness in internal control system.
True- In internal control questionnaire usually questions are framed on such a way that
NO shows weakness. Thus weakness is easily located.
3) Preparation of flowchart can be time consuming.
True- Flowchart is graphic presentation of each part of entitys internal control system.
It is time consuming to prepare a flowchart, which is concise yet showing every
important aspect of internal control.
4) Internal check is part of internal control system.
True- Internal check is check on day to day transaction, operating continuously as part
of routine system, whereby work carried out by one person is automatically checked by
another. Internal check is part of overall internal control system & operates as a built in
device.
5) Audit risk has three components.
True- Audit risk is the risk that auditor may give an inappropriate opinion when the
financial statements are materially misstated. Audit risk has three components viz
inherent risk, control risk, and detection risk.
6) Components of audit risk include sampling risk.
False- Audit risk is the risk that auditor may give an inappropriate opinion when the
financial statements are materially misstated. Audit risk has three components viz
inherent risk, control risk, and detection risk. It does not include sampling risk.
7) Inherent and control risk should be assessed on a combined level.
True- The auditor should make a combined assessment of the inherent risk and control
risk. This is because the management often reacts to inherent risk situation by designing
suitable internal control system to prevent or detect and correct material misstatement.
8) There is direct relationship between detection risk and combined level of inherent
risk and control risk.
False- There is an inverse relationship between detection risk and combined level
of inherent risk and control risk.
9) Auditor should not communicate weakness in the internal control system to the
management, as he checks only financial statement.
False- These should be communicated in writing to the management in a timely
manner.
10) Internal controls in CIS are of two types.
True There are 2 types of control in CIS (1) General CIS control, (2) CIS application
control.
11) Auditing around computer require computer expertise on part of auditor.
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CA Clues
False Under this approach, the auditor determines his audit procedure without
considering the fact of use of computers for processing of information. The auditor
carries out the audit work more or less in the same manner as in manual system. Thus,
he does not require computer expertise.
12) Auditing through the computer is required under many situations.
True It is required due to online data entry, Real time file updation, Reduction of
printouts.
13) Audit software is the property of client.
False- It is a set of computer programs used by the auditor as part of his auditing
procedures to process data of audit significance from the entity accounting system.
Thus it is the property of auditor.
14) Performing audit in CIS environment is always simpler than in manual
environment since trial balance always tallies.
False- While auditing in CIS environment, auditor has to face many hurdles like loss of
audit trail, unauthorised amendments to clients data and program. Moreover, here
auditor requires technical expertise also. Thus it is not simple to audit in CIS
environment even if trial balance tallies.
57

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CA Clues

Auditing & Assurance

The Preparation of financial statements is the responsibility of management of

Auditing & Assurance

2- On the basis of proper evidence

3- By a properly qualified person

His opinion is on 'true &fair view' of financial statements.

CONCEPT OF TRUE & FAIR

[May 2005 -8 Marks, Nov 2012- 6 Marks]

Auditing & Assurance

No material assets are omitted;

ASPECTS TO BE COVERED IN AUDIT

[May 96-6 Marks]

Auditing & Assurance

2) Examination of books, records etc.

Primary Objective (As per SA 200 Revised)

[Nov 2004, 8 Marks]

Auditing & Assurance

Secondary objective is detection of misstatement in financial statements.

As per accounting aspects:

Auditing & Assurance

3. Errors of principle- An error of principle occurs when the generally accepted

Omission to post a part of a

Trial Balance is thrown out of agreement

BASIC PRINCIPLES GOVERNING AN AUDIT

Auditing & Assurance

1- Integrity, Objectivity, Independency

He should maintain confidentiality of information acquired during his work.

He should document matters relating to the audit (maintain working papers).

Auditing & Assurance

[Nov 2004- 4 Marks]

Auditing & Assurance

3. Confidentiality: He should not disclose confidential information acquired during

DIFFERENCE BETWEEN ACCOUNTING & AUDITING

Statutory audit can only be

Accounting & auditing Expertise

DIFFERENCE BETWEEN AUDITING & INVESTIGATION

Auditing & Assurance

Investigation implies systematic,

INHERENT LIMITATIONS OF AUDIT

Auditing & Assurance

ACCOUNTING CONCEPT- FUNDAMENTAL ACCOUNTING ASSUMPTION

Auditing & Assurance

MEANING & DISCLOSURE OF ACCOUNTING POLICIES

Meaning- It refers to specific accounting principles & methods of applying those

Auditing & Assurance

Auditing & Assurance

State True or False with Reason

1) Auditors primary responsibility is to detect errors and frauds.

Auditing & Assurance

13) When an auditor identifies a misstatement resulting from fraud, it is his

Auditing & Assurance

Auditing & Assurance

AUDIT EVIDENCE [SA-500]

Types of audit evidences

Auditing & Assurance

c) Documentary evidence- These are the evidences in the form of written

2. Depending upon Source- Internal and External.

RELIABILITY OF AUDIT EVIDENCE

[May 2008- 5 Marks, Nov 2011 -4 Marks, Nov 2013-5 Marks]

Auditing & Assurance

5. Evidence provided by original documents is more reliable than those provided

AUDIT PROCEDURES TO OBTAIN EVIDENCES

a) Risk Assessment procedure