INTRODUCTION TO AUDITING

Earlier, the term 'audit' referred only to financial audit with a limited
scope (narrow concept). Now, it includes any evaluation process
undertaken to establish adherence to certain norms for accomplishing a
stated object (broad view). Different individuals and associations have
defined auditing in either a narrow or a broad sense. A few of the
important definitions have been taken up for discussion below.

Definitions of Auditing

Narrow concept of auditing

Montgomery has defined auditing as,

"A systematic examination of the books and records of a business or
other organisations in order to ascertain or verify and to report upon
the facts regarding the financial operations and the results thereof."

Auditing in a broad sense

The Institute of Chartered Accountants of India in its publication,
General Guidelines on Internal Auditing, gives one such definition.
According to it
"Auditing is a systematic and independent examination of data,
statements, records, operations and performance (financial or
otherwise) of an enterprise for a stated purpose. In any auditing
situation, the auditor perceives and recognises the propositions before
him for examination, collects evidence, evaluates the same and on this
basis, formulates his judgment which is communicated through his
audit report."
Several key phrases in the above definition merit attention. These are
discussed
below:-
(1) systematic - The word 'systematic' implies that an audit should be
care- fully planned.
(2) independent - The core idea of any audit exercise is an independent
 evaluation of the available evidence. In any audit situation,
the auditor while forming and expressing his opinion should
not be susceptible to any influence or pressure from client or
anybody else.
Example - A present director of a limited company is appointed as
an auditor. In this case, the audit of accounts prepared by co-
directors and report thereon would add little to the confidence of
the shareholders. Therefore, directors are not thought to be
properly qualified to act as auditors of a limited company.

(3) data, statements, records, operations and performance - This phrase

indicates the scope of audit. It extends from examination of books,
accounts and vouchers to review of operations and performance con-
nected with non-financial area also. For example, review of the
effective- ness of an advertising programme (through operational audit)
can also be included in the term 'audit'.
(4) stated purpose - The object or 'stated purpose' of audit should be clearly
defined. The audit process and procedures should be designed according

to the stated purpose. For example, the 'stated purpose' of a financial

audit is to express an opinion about the truthfulness and fairness of
financial statements. To take another example, the 'stated purpose' of an
environ- mental audit is to examine and report on verifiable quantitative
and qualitative information in the areas of environmental concern. Thus,
the definition has not specified any purpose. It will vary from one
situation to another.
(5) perceives and recognises the propositions before him for examination -

The auditor should have a clear idea about propositions he is examining

i.e. he must know 'what he has to prove'. It may be noted that 'stated
purpose' is a broader term than 'propositions'.
Example - 'Stated purpose' of a financial audit is to ascertain a true
and fair view of the state of affairs and working results of an
enterprise. In this situation, 'propositions' before an auditor are (a)
whether assets and liabilities shown in the balance sheet actually
exist with the business (b) whether entity has a legal title to
its assets (c) whether liabilities are incurred for the purposes of
business (d) whether recognised accounting principles and
statutory requirements, if any, have been followed for valuation of
 assets and so on.
(6) collects evidence, evaluates the same - Evidence consists of books of
account, tax returns, direct confirmations, departmental budgets, human
resource records, etc. In any audit situation, the auditor should collect
relevant evidence depending upon the proposition he needs to examine.
After collecting the evidence, the auditor should evaluate it on the basis
of his professional knowledge and skill.
(7) formulates his judgment which is communicated through his audit
report - The last stage in audit examination is formulation of opinion by
the auditor which is communicated to the users of information through
an audit report. The format and contents of audit report depend upon
many factors including the type of audit, statutory requirements and
purpose of audit. For example, in India, the form and contents of audit
report of financial audit of a limited company are given under section
227 of the Companies Act, 1956.

Another similar and comprehensive definition is given by the American

Accounting Association's (AAA) Committee on Basic Auditing
Concept' - According to this definition,
"Auditing is a systematic process of objectively obtaining and
evaluating evidence regarding assertions about economic actions and
events to ascertain the degree of correspondence between those
assertions and established criteria and communicating the results to
interested users."

Elements of financial audit

If the generalised definition (broad concept) is applied to financial audit,
the following elements emerge:
(I) It is a systematic and independent examination by qualified
persons.The auditor should arrange the audit procedures to be
adopted by him during such examination in a logical sequence.
He should complete the audit work in an unbiased manner.
(ii) The stated purpose of such an audit is to express an opinion as to
the truthfulness and fairness of the financial statements.
(iii) The auditor should have clear idea of the propositions to be
examined to achieve the audit objective(s).
(iv) The auditor collects and evaluates the evidence to examine
 propositions before him. Besides books, accounts and
vouchers, evidence may take different forms including oral
testimony of the client, written communication with
outsiders and observation and physical inspection by the
auditor.
(v) The opinion or judgment of the auditor on the assertions made by
the management in financial statements is communicated
through audit report to the client or the shareholders.

(VI) The scope of audit extends to all types of entities - commercial as

well as non-commercial.

Objectives of auditing
The object of audit depends on the type of audit to be conducted. This in
turn, depends on the nature of propositions which an auditor is required to
review. For example, an auditor may be called upon to evaluate the
efficiency of operations (in case of operational audit) or to ascertain the
propriety of transactions (in case of propriety audit).

1. Primary objective of an audit - Expression of opinion as to

truthfulness and fairness of financial statements
According to De Paula "The main object of an audit is to ascertain
that the balance sheet and profit and loss account of an undertaking
to show true and fair view of its financial position and earnings. "
The main objective of financial audit is, thus, expression of
opinion as to the truthfulness and fairness of financial statements.
Accordingly, an audit process for all business entities, including a
limited company, must culminate in a similar expression of
opinion. This object has statutory recognition in India and has
been clearly stated in section 227 of the Companies Act, 1956. It
requires the auditor of a company to state whether in his opinion
the accounts give a 'true and fair view' in case of balance sheet, of
the state of company's affairs as at the end of the financial year
and in case of the profit and loss account, of the profit or loss for
the financial year.
There is no authoritative definition or interpretation of the term 'true
and fair' view. It is the auditor's professional judgment that is of
utmost importance in applying the concept to facts and
circumstances of each case.

Generally speaking, the presentation of a true and fair view in

financial statements requires that those statements comply with:
(a) recognized accounting principles which have been consistently
applied,
(b) relevant legislation, and
(c) are correctly extracted from books and records.
However, auditor's opinion on the truthfulness and fairness of
financial statements is no guarantee to the future viability of the
business or of regularity and prudence of decisions taken by the
management.
TRUE AND FAIR VIEW. An audit of accounts by an independent
expert assures the outside users that the accounts are proper and reliable.
The outsiders can rely on the accounts if the auditor reports that the
accounts are true and fair. The accounts are said to be true and fair:
1. When the profit and loss shown in the profit and loss account is true
and fair, and
2. Also when the value of assets and liabilities shown in the balance
sheet is true and fair. What constitutes true and fair is not defined under
any law. However the following general guidelines may be laid down in
connection with true and fair.
a) Conform to accounting principles: The books of accounts must be
kept according to the normally accepted accounting principles such as
the concept of entity, continuity, periodical matching of costs and
revenue, accrual and double entry system etc.
b) No window dressing or secret reserves: The accounts must show the
financial position and the profit or loss as they are. I.e. there is neither an
overstatement nor an understatement. There should be in other words
neither window dressing nor secret reserves. In window dressing the
accounts are made in such a way as to show a much better condition than
the actual condition. The profit and the net worth are overstated The
accounts are said to show true and fair view when the accounts show
only the actual conditions as it is. i.e. the profit and the net worth are
shown as they are. In order to show a true and fair view the auditor
should ensure that:
1. The final accounts agree with the books of accounts.
2. The provision for depreciation is proper.
3. The closing stock is physically verified and valued properly.
4. Intangible assets like goodwill, patents, preliminary expenses or other
deferred revenue expenses are written off properly.
5. Proper provision is made for bad and doubtful debts.
6. Capital expenses is not treated as revenue expenses and vice versa.
7. Capital receipts are not treated as revenue receipts.
8. Effect of changes in rate of foreign exchange on value of assets and
liabilities is recorded in the books properly.
9. Contingent liabilities are not treated as actual liabilities and vice
versa.
10. Provision is made for all known losses and liabilities
11. A reserve is not shown as a provision and vice versa
12. Cut off transactions are recorded properly, so that all sales invoices
are matched with goods delivered and all purchase invoices are matched
with goods received.
13. Transactions are recorded on accrual basis, i.e. outstanding
expenses, prepaid expenses, income accrued and advance income are
recorded properly.
14. Expected or anticipated gains are not credited to the profit and loss
account.
15. Effect of events after the balance sheet date on the value of an asset
and liability is disclosed in the accounts properly
16.The books of accounts must disclose all material facts regarding
revenue, expenses, assets and liabilities. Material means important and
essential. The disclosure of important matters in the accounts helps the
users in taking business decisions. There should be neither suppression
of vital facts nor mis-statements.
4. Legal requirements: In case of limited company the account must
disclose the matters required to be disclosed under the Companies Act.
The final accounts must be in the format prescribed under Schedule VI
of the Companies Act, 1956. Special companies such as banks,
insurance, electricity supply companies prepare accounts as prescribed
 under special laws. A co-operative society, a trust etc. must also prepare
the accounts as required under relevant laws.
5. Requirements of Institute of Chartered Accountants of India: The
accounts must also be in accordance with the various guidelines
prescribed by the ICAI. These guidelines are contained in the statements,
standard and guidance notes issued by the institute from time to time.

2. Secondary objective - Detection and prevention of frauds and errors

A 'true and fair' view cannot be expressed by the auditor on the basis of

accounts which have material misstatements resulting from errors and

fraudulent manipulations. An incidental but, nonetheless, important
objective of financial audit is detection and prevention of frauds and
errors. For establishing the responsibility of the auditor for the same, it
is important that an error and a fraud is distinguished properly.

ERROR

The term 'error' in context of audit refers to unintentional mistakes in

the measurement or presentation of financial information. The errors,
in general, may be of the following types

(a) Clerical errors - Errors in recording, posting, totalling and balancing

are called clerical errors. There are two sub-types of clerical
errors - errors of omission and errors of commission

Errors of omission - Where a transaction is omitted wholly

or partially in the books of account. Some of the examples
of such errors are given below :-

1. Voucher for purchase of goods on credit may have been

overseen and was not entered in the journal (full omission
and would not affect trial balance).

2.Goods sold to X were correctly recorded in journal but while

posting to ledger X's account was not given credit in Goods
account (partial omission and would, therefore, affect trial
balance).

Errors of commission - Where there is wrong posting of

amounts, posting on the wrong side, posting in wrong
account, errors in totalling and balancing, errors in carry
forward totals to trial balance, etc. Some examples are
given below :-

1. A purchase of Rs. 10,000 was entered in the purchase

book as Rs. 1,000 (would not affect trial balance).

2. Goods were sold to X for Rs. 20,000. This amount is

posted to the debit of Y instead of X (would not affect
trial balance).

The debit balance of commission account of Rs. 550

may be carried forward to the debit column of trial
balance as Rs. 505 (would affect trial balance).

(b) Errors of principle - They occur when generally accepted accounting

principles are not observed while recording any transaction

in the books of account. For example, wrong account head
being chosen or recording of capital expenditure as
revenue or vice versa. These errors do not affect trial
balance. In order to detect them, the auditor should pay
particular attention to those items where an error of
principle is most likely to occur.

(c) Compensating errors - Compensating errors are those errors that result
in compensating the effect of other errors. For example, if a
person's account was to be debited by Rs. 100, he is debited
instead by Rs. 200 and other person who was to be debited by
Rs. 200, is debited by Rs. 100. These errors do not affect trial
balance and can be located by checking the totals,
 postings and castings.

(d) Errors of duplication - These errors occur when the same transaction is
recorded twice in the books of original entry and, hence, also
posted twice in ledger accounts. These do not affect trial
balance. In order to prevent them, clerks should distinctly mark
the invoices and other vouchers after having entered them in the
books of original entry and duplicate invoices should be
maintained in separate files and should be stamped 'duplicate'.

FRAUD
'Fraud' refers to intentional misstatement which is material to the financial
statements. Management, employees or third parties may get involved in
committing frauds to obtain an illegal advantage or personal gain.

Fraud generally involves either misappropriation of assets that may be

called 'employee fraud' or manipulation of accounts that is referred to as
'management fraud'.

(a) Employee fraud - It generally involves the theft of assets, mostly as

cash or goods from the firm. Transactions are recorded in a manner so
as to conceal theft. For example, fictitious purchases may be recorded
to misappropriate cash; actual sales may be shown as 'goods on
consignment' to misappropriate goods; good production may be
classified as defective or as scrap and then they may be used for
personal purposes and so on. Business relies on the system of internal
control to reduce the probability of occurrence of employee fraud.

(b) Management fraud - It involves manipulation of accounts by the

upper level management for the purpose of deliberately
misrepresenting the firm's financial position or results of operations
to evade taxes, to receive higher remuneration (when it is based on a
percentage of profits), to show better performance of management,
etc. This process is also called "window dressing". The internal
control procedures may be overridden by the management's directive
to perpetuate this kind of fraud.

Frauds affecting financial statements may involve one or more of the

 following:
1. Manipulation, falsification or alteration of books of account or
other records or documents

Example 1 - Evasion of income-tax may be accomplished by showing

deductions such as contributions to political campaigns, depreciation on
non-existent assets,
etc.

Example 2 - Increasing sales by fictitious entries to earn more

commission.

2. Omission of the events, transactions or other significant

information from books of account.
Example - Sending cheques to creditors before the balance sheet
date but not entering them in cash records until the beginning of
next financial year. This will improve current ratio as creditors will
not exist at the date of balance sheet and cash at bank will also not
get reduced.

3. Misapplication of accounting policies

Example - Income of preceding year may be recorded in the
current year and expenses of current year being shown as of next
year in violation of the matching concept of accounting.

Auditor's duty with reg ard to detection and prevention of

frauds and errors

Auditor's duty with regard to detection and prevention of frauds and

errors has been largely laid down by various legal decisions and
professional pronouncements.
Legal perspective: The perception of auditor's duty with regard to
detection and prevention of frauds and errors has undergone various
changes in the last century, Initially, It was based on the decision given
in Kingston Cotton Mills Co. [1896] case

The learned Judge Lopse summed up auditor's duty by stating,

"Auditor is . watchdog, not a blood hound. "This statement implies
(a) An auditor is appointed by the shareholders in case of a limited
company. He is expected to play the role of a watchdog on their
behalf and should look after their interests.

(b) Unlike a blood hound the duty of the auditor is verification and not
detection. If he discovers something suspicious, during the course of
audit, he should probe the matter thoroughly and apprise the
shareholders about it. In the absence of such suspicious circumstances,
he is fully justified in believing and relying on representations made by
the 'tried servants' of the company. In short, in case of frauds and
errors, the auditor has a duty of 'reasonable care' only.

Later, the decision given in Westminster Road Construction and

Engineering Co. [1932] case emphasized adoption of audit procedures
to confirm the facts stated through management representations. Thus,
it widened the scope of auditor's duty with regard to frauds and errors
and laid down more strict standards of reasonable care. In recent years,
this scope has been further extended to include auditor's duty in such
cases, besides shareholders, to third parties also provided his
negligence is proved. The primary responsibility for the prevention and
detection of fraud rests with both those charged with governance of
the entity and management. A financial audit is conducted by the
auditor to obtain reasonable (not absolute) assurance that financial
statements are free from material misstatements caused by fraud
and/ or error.

THE AUDITOR CAN SUSPECT FRAUD UNDER THE

FOLLOWING CIRCUMSTANCES.

1. When vouchers, invoices, cheques, contracts are missing etc.

2. When control account does not agree with subsidiary books.
3. When the difference in trial balance is difficult to locate.
4. When there are greater fluctuation in G.P. and N.P. ratios.
5. When there is difference between the balance and the confirmation of the
balance by the parties.
 6. When there is difference between the stock as per records and the stock
physically counted.
7. When the explanation given by the client is not satisfactory.
8. When there is a overwriting of some figures.
9. When there is a contradiction in the explanation given by different
parties.

PROCEDURE TO BE FOLLOWED TO DETECT ERRORS.

Following procedures may be adopted by the auditor to detect the errors.
1. Check the opening balances from the balance sheet of the last year.
2. Check the posting into respective ledger accounts
3. Check the total of the subsidiary books.
4. Verify all the castings and the carry forwards.
5. Ensure that the list of debtors and creditors tally with the ledger accounts.
6. Make sure that all accounts from the ledger are taken into accounts.
7. Verify the total of the trial balance.
8. Compare the various items from the trial balance with that of the
previous year.
9. Find out the amount of difference and see whether an item of half or
such amount is entered wrongly.
10. Check differences involving round figures as Rs. 1,000; Rs. 100 etc .
11. See where there is misplacement or transposition of figures that is 45 for
54; or 81 for 18 etc.
12. Ultimately careful scrutiny is the only remedy for detection of errors.
13. See that no entry of the original book has remained unposted.

THE AUDITOR SHOULD PERFORM THE FOLLOWING DUTIES

IN RESPECT OF FRAUD.
1. Examine all aspects of the finance.
2. Vouch all the receipts from the counterfoils or carbon copies or cash
memos, sales mart reports etc.
3. Check thoroughly the salary and wages register.
4. Verify the methods of valuation of stocks.
5. Check up stock register, goods inwards notes, goods out wards books
and delivery challans etc
6. Calculate various ratios in order to detect fraudulent manipulation of
accounts
7. Go through the details of unusual items.
8. Probe into the details of the problems when there is a suspicion.
9. Exercise reasonable skill and care while performing the duty.
10. Make surprise visit to check the accounts.

DIFFERENCE BETWEEN ERROR AND FRAUD

As indicated by definition and examples, intent is the underlying
difference between an error and a fraud. The auditor's responsibility, as
discussed in the following section, for detecting errors and frauds is
identical as both results in misstatements in financial statements.
However, the distinction is important in practice because fraud raises
doubt about the integrity of management and those
charged with governance.

Difference between Error and Fraud

Basis Error Fraud

(I) Meaning (Error is an unintentional ( Fraud refers to inten-
mistake in the measure- tional
ment or presentation of which is material
financial information financial
(il) Intent (Error is unintentional ( Fraud is committed with
an intention to derive
some personal
(iil) Consequence (The auditor should en- ( The auditor should con-
an the audit sure financial statements sider-
work are adjusted for its effect on finan-
detected errors cial
reliability of man-
agement's repre-
sentation;
whether we should
withdraw en-
gagement .
(iv) Possibility of (More ( Less:
detection makes deliberate
attempts to conceal it.
Advantages of Auditing
To owners - Present and potential

(1) Serves as a basis for relying on financial statements - An

audit, in particular, independent financial audit
provides a basis for assessing reliability of financial
statements in case of all forms of business
organisations. Examples of situation where audited
statements can be helpful are-

(a) Determination of purchase consideration in case

running business is to be purchased.

(b) Settlement of accounts in a partnership firm in case of

admission, retirement or death of a partner or
any other dispute.

(a) In case of a joint stock company, to assess the

reliability of the financial statements prepared by
board of directors.

(d) In case of non-trading organisations like schools,

hospitals, clubs and other similar entities, to
know or to verify whether the money
received in various forms such as grants,
donations and subscription fees has been utilised
properly.

(2) Serves as a check on the integrity of person at the helm

of affairs - An audit besides lending credibility has
another important aspect - control dimension. For
example, in case of joint stock companies, an
independent financial audit gives the shareholders a
basis for satisfying themselves that the affairs of the
company are being run smoothly and honestly by
the management. In case of trusts, co-operative
societies etc., audited statements serve as an evidence
for the beneficiaries or members that their interests
are being looked after properly and efficiently by
board of trustees and managing committee.

.
To Management

L!,ures are
affected
ff . example,
audit
"'? vi -nting
system
....., T! r for them.
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(I) Serves as a basis for establishment of and improvement in the
control system - Managers at various levels of management use
financial data produced by firm's accounting system to make
decisions on questions such as budgeting, pricing of the
products or services and so on. An important tool for ensuring
reliability of the figures generated by the accounting system and
its efficient operation is internal audit, which is performed by
the employees of the entity. The external auditor also evaluates
the internal control system before placing reliance on it and
may suggest improvements in it.
(ii) Helps in dealing with lenders, insurers, Government and such
other third parties - Audited statements can help the
management in establishing and settling claims against the
insurers in case of loss or damage to business property by way
of fire, theft, burglary and other unforeseen events. It can also
serve as a basis for obtaining loans from banks and financial
institutions, for preparation of tax returns and various similar
purposes.
(iii) Ensures compliance with legal requirements in certain
situations -
Audited statements are necessary to fulfil certain legal
obligations, for example, for raising capital in primary market,
for fulfilling listing requirements on stock exchanges, etc.
(iv) Serves as a basis for determining amount receivable or
payable in certain circumstances - In order to determine
amount receivable or payable in case of - bonus based on profits
to workers, cost- plus contracts and other such decisions.
 (v) Settlement of disputes - Audited financial statements are useful
for settling trade disputes with workers and settling disputes by
arbitration.

Inherent limitations of Auditing

(i) Inconclusiveness of evidence - The evidence obtained by an
auditor is persuasive rather than conclusive. For example, an
architect's certificate of valuation for a newly constructed
building of a client may not be conclusive evidence of the
correct value of building. Therefore, an auditor can only draw
reasonable conclusions from such evidence.
(ii) Exercise of judgment - The nature, timing and extent of audit
procedures to be performed is a matter of professional judgment
of the auditor. Further, the auditor exercises judgment to ascertain
the various estimates made by the management in financial
statements. As a result, audit conclusions are based on judgment
and not reached through any scientific process.
(iii) The nature of audit procedures - Audit procedures used to gather
audit evidence may be ineffective for detecting an intentional
misstatement. For example, fraud may involve sophisticated and
carefully organized schemes designed to conceal it.

(iv) Dependence on explanation by others:- Auditor has to depend on

the explanation and information given by the responsible officers of the
company. Audit report is affected adversely if the explanation and
information prove to be false.

(V) Dependence on opinions of others:- Auditor has to rely on the

views or opinions given by different experts viz Lawyers, Solicitors,
Engineers, Architects etc. he can not be an expert in all the fields

(VI) Limited time - The need for the audit to be

conducted within a reasonable period of time and at a reasonable cost
puts pressure on the auditor.

(vii)Inherent limitations of the financial statements :-Financial statements do

not reflect current values of the assets and liabilities. Many items are based on
personal judgement of the owners. Certain non-monetary facts can not be
measured. Audited statements due to these limitations can not exhibit true
position.
(Viii)Detailed checking not possible :- Auditor cannot check each and every
transaction. He may be required to do test checking.

(IX)Corrupt practices to influence the auditors :- The management may

use corrupt practices to influence the auditors and get a
favourable report about the state of affairs of the organisation.

BASIC PRINCIPLES OF AUDIT AAS-1 describes the basic principles,

which govern the auditor's professional responsibilities and which should be
complied with whenever an audit is carried out. These are:-
1. Integrity, objectivity and independence: The auditor should be
straightforward, honest and sincere in his approach to his professional work.
He must be fair and must not allow prejudice or bias to override his
objectivity. He should maintain an impartial attitude and appear to be free of
any interest which might be regarded. Whatever it's actual effect, as being
incompatible with integrity and objectivity.

2. Confidentiality: The auditor should respect the confidentiality of

information acquired in the course of his work and should not disclose any
such information to a third party without specific authority or unless there is
legal or professional duty to disclose. It is remarked that an auditor should
keep his ears and eyes open but his mouth shut.
3. Skill and competence: The audit should be performed and the report
prepared with due professional care by persons who have adequate training,
experience and competence. This can be acquired through a combination of
general education, technical knowledge obtained through study and formal
courses concluded by a qualifying examination recognized for this purpose
and practical experience under proper supervision.

4. Work performed by others: When the auditor delegates work to assistant*

or uses work performed by other auditors or experts, he will continue to be
responsible for forming and expressing his opinion on the financial
information. At the same time he is entitled to rely on work performed by
others provided he exercises adequate skills and care and is not aware of any
reason to believe that he should not have relied. The auditor should carefully
direct, supervise & review work delegated by assistants. He should obtain
reasonable assurance that work performed by other auditors or experts is
adequate for this purpose.

5. Documentation: The auditor should document matters, which are

important in providing evidence that the audit was carried out in accordance
with the basic principles.

6. Planning: The auditor should plan his work to enable him to conduct an
effective audit in an efficient and timely manner. Plans should be based on
knowledge of client's business. They should be further developed and
revised, if required, during the course of audit.
7. Audit evidence: The auditor should obtain sufficient appropriate audit
evidence through the performance of compliance and substantive test
procedure. It will enable him to draw reasonable conclusions there from on
which he has to base his opinion on the financial information.

8. Accounting system & internal control: The auditor should gain an

understanding of the accounting system and related internal controls. He
should study and evaluate the operation of those internal controls upon
which he wishes to rely in determining the nature, timing and extent of other
audit procedures.

9. Audit conclusions and reporting: The auditor should review and assess the
conclusions drawn from the audit evidence obtained and from his knowledge
of business of the entity as the basis for the expression of his opinion on the
financial information.

STRUCTURE OF AUDIT THEORY

Postulates are fundamental truths or assumptions of a theory which are
required to be accepted without proof. These assumptions help to explain
the meaning of auditing principles. The basic postulates of financial
accounting theory are:

(I) Potential conflict of interest exists between the auditors and the
preparers of financial information.
(ii) When examining financial data for the purpose of expressing an
independent opinion thereon, the auditor should act exclusively as
auditor.
(iii) The auditor adheres to identifiable professional obligation.
(iv) Financial statements and data are verifiable.
(v) The existence of a satisfactory system of internal control increases
the reliability of financial information.
(VI) In the absence of clear evidence to the contrary, what was held true
in the past for the enterprise under audit, will hold true for the future
as well.
(Vii) Application of recognised accounting principles would result in fair
presentation.

Concepts/Principles
Principles are abstractions necessary to perform the audit. They provide
the framework within which the auditor should work. In case these are
not followed, the reliability of auditor's work would be doubtful.

Standards
Standards are quality of performance criterion that the auditor must meet
in performing an audit. Concepts provide the primary framework within
which standard audit practices should be designed. Professional bodies
all over the world have set forth the rules of the practice for accountants
and auditors. In India, the Institute of Chartered Accountants of India
(ICAl) issues Auditing and Assurance Standards (AASs) from time to
time to ensure that the audit work is carried out in accordance with
established standards. To align them with international
standards these are now called Standards on Auditing.

Procedures
In the context of audit, procedures refer to specific acts to be performed to
ensure adherence to quality of performance criterion i.e., auditing standards.
They are summarised in an audit programme and vary depending upon
situation specific factors.

Techniques
Techniques refer to the methods used for carrying out a procedure. An
auditor obtains evidence by using various audit techniques. For example,
inspection, observation and enquiry are some of the audit techniques.

Difference between standards and procedures

(l) Standards are quality guides but procedures relate to acts to be performed

Procedures provide the means to adhere to audit standards. For

example, SA 500, Audit Evidence, requires the auditor to obtain
 sufficient appropriate evidence to form his opinion on financial
statements. In order to confirm the debtors as on balance sheet date,
the auditor can adopt various procedures such as direct confirmation
from debtors, computation and analytical review.

(ii) Standards are applied uniformly for all audits whereas procedures vary
depending on the type of business (whether manufacturing, trading
or services).
(iii) Standards remain the same through time while procedures are
affected by factors such as technology, legal requirements, etc. For
example, audit for a computerized accounting system and a manual
accounting system may require different procedures but standards do
not differ for them.

Accountancy
Accountancy begins, where book-keeping ends. According to Prixley, "the
foundation of accountancy is the theory and practice of book-keeping.
This implies that work of an accountant starts after the book-keeper has
completed his accounts. It involves:
(a) Preparation of trial balance
(b) Preparation of trading and profit and loss account
(c) Preparation of balance sheet, and
(d) Making rectification and adjustment entries.

An accountant, thus, summarises the result of transactions and events

recorded by the book-keeper. He should have expert knowledge of
accounting concepts and principles.

Auditing
Auditing begins, where accountancy ends. An auditor examines the financial

statements prepared by the accountant and verifies the items therein with the
help of relevant documentary evidence and explanations and information
given to him. In other words, he examines analytically and critically the
accounts and financial statements prepared by the accountant. In the absence
of auditing, such statements would not be reliable and would be of little use
Relationship with Accounting
Although auditing and accounting are closely related, they are distinct to the
disciplines. Accounting is the process of recording, classifying and interes
summarising the economic events and transactions that affect an ted
entity. The result of this process is the parties.
availability of financial information contained in the financial
statements or in any other manner which enables the management and
others to take decisions. Auditing uses the theory of evidence to verify
the financial information made available by accountancy. on the
truthfulness and available by accountancy. The auditor expresses his
opinion on the truthfulness and fairness of financial statements

Basis Accounting Auditing

1. meaning It is the critical
It is recording of all the day examination of the
to day transactions in the transactions recorded
books of accounts leading to in the books of
preparation of financial accounts.
statements.
2. nature It is concerned with It is concerned with
finalisation of accounts. establishment of
reliability of financial
statements.
3. objects The object is to ascertain the The object is to certify
trading results. the correctness of
financial statements.
4. commencement Accounting commences when Auditing begins when
book keeping ends. accounting ends.

5. scope It depends upon the

It involves various agreement or upon the
financial statements. It provisions of law. It
involves maintenance of goes beyond books of
books of accounts. It does not accounts.
go beyond books of accounts.

DISTINCTION BETWEEN ACCOUNTING

Analyses AND
and
AUDITING examines
financial data
contained
in financial
Accounting
statements
Auditing
Points of difference Accounting and Auditing