UNIT – 3

1.PREPARATION BEFORE THE COMMENCEMENT OF AUDIT

Proper execution of any work requires appropriate planning and programme of action.
Before commencing a new audit an auditor should take the following steps :
1.Ascertain the Scope of Duties :
First of all an auditor should ascertain the precise nature and scope of his duties. In the
case of a statutory audit the scope of duties can be ascertained by referring to the statue
e.g. to ascertain the scope of duty under Companies Act, and auditors should understand
what is expected from him.
2.Procure Engagement Letter :
When auditor decides to accept an audit engagement, he should procure an Engagement
Letter from the client. The letter is for all purposes an audit contract. It should lay down
terms of the audit contract and the understanding reached between the auditor and the
client.
3.Knowledge about business :
An auditor should clearly understand the nature of business. He can make a beginning by
going through the documents available e.g. Memorandum of Association in case of a
company and partnership deed in case of partnership firm. He should also understand the
broad economic environment in which the client operates. This will require to know the
economic policies (e.g. price regulation or import restrictions), tax and other regulatory
provisions applicable to the business.
4. Knowledge of the Accounting System :
The auditor should obtain a list of all books maintained by the client along with
information relating to internal control system. The extent of his work will be greatly
influenced by the reliability of internal control and accounting system.
5.List of Principal Officers :
The auditor should also obtain the list of the principal officers of the organization. He
should also acquire knowledge about the extent and scope of authority of each one of
them.
6.Knowledge of Technical Details :
He should also acquire some knowledge about the technical details, if any, of the
business. This enables him to grasp the nature of transaction which will be subject matter
of the audit.

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 7.Enquiry into Special Circumstances, if any :
An auditor should also enquire into special circumstances, surrounding his appointment.
He is required to be careful about the implication of such special circumstances.
8.Instructions to the client :
After completing the aforementioned steps, he should issue clear instructions to his
client on the following lines :
a) Accounts should be finalized and kept ready for audit.
b) The necessary schedules be prepared and made available. The schedules required
are schedule of debtors and creditors.

2.AUDIT PROGRAMME
Introduction :
Audit programme represents an outline of procedure to be followed to support an
opinion on financial statements. It is the auditor’s plan of action. It provides a plan of the
work of examination and a set of audit procedures specifically designed for each audit.

Definition :
Settler defines an audit programme as, “ an outline of all procedures to be followed in
order to arrive at an opinion concerning client’s financial statements.”

Specimen of Audit Programme

Name of client :
Date of Commencement of Audit :
Date of Completion of Audit :
Any special information from previous audit :
Nature of Organisation :
Year/ Cash Bank Cash Bought Sales Returns Journal Stock Bought Trial General P&L Balance
Month book book book ledger books book examin sheet ledger balance ledger a/c Sheet
balan balan vouch vouche additi postings ed check balance checked checked check checked
ced ced ered rs ons & ed checked ed
posti
ngs

January
February

March
April
May

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June
July
August
Septemb
er
October

Novemb
er
Decemb
er

Advantages of Audit Programme :

1.Audit assistants know their clear cut duties.
2.Efficiency of the audit assistants increases.
3.It enables the auditor to keep in touch with the work and general progress of the work.
4.Fixing of the responsibility of audit assistants becomes easier.
5.It provides a check against the possibility of certain important items requiring verification
which are being omitted.
6.Continuity is not lost even if the person on duty is changed.
7.The chief auditor is saved from botheration of issuing instructions to the staff repeatedly.

Disadvantages of Audit Programme

1.The task becomes mechanical, as a result initiative and efficiency are adversely effected.
2.The task may be finished hurriedly to complete it within the scheduled time.
3.It does not serve any purpose in the audit of a small organisation.
4.Uniformity of the audit programmes can not be applied extensively, as the nature of work
in the audit of different organisations cannot be exactly the same.
5.It tends to introduce rigidity.

Types of Audit Programmes

Broadly, there are two types of audit programmes, namely :
a) Fixed audit programme
b) Flexible audit programme
Another type of classification can be :
a) Audit programme for independent audit

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 b) Audit programme for internal audit
a)Audit Programme for Independent Audit
An audit programme for independent audit will emphasis on features like existence,
valuation, accounting principles and disclosure, cut-off and compliance.
b)Audit Programme for Internal Audit
Internal audit staff is well advised to develop long-range planning programmes as well as
individual assignment audit programmes. A long range planning programme is necessary for
scheduling assignments, assigning staff personnel, supporting the funding allocation for the
internal audit function.

3.AUDIT NOTE BOOK

Audit Note Book is a diary or register maintained by audit staff to note errors, doubtful
queries and difficulties. The purpose is to note down various points which need to either
clarified with the client or the chief auditor.

Contents of an Audit Note Book

An audit note book usually contains the following information about the audit work
performed by the audit staff :
1.A list of books of accounts maintained.
2.The names, duties and responsibilities of principal officers.
3.The particulars of missing receipts and vouchers.
4.Mistakes and errors detected.
5.The points calling for clarifications and explanations.
6.Various tools and balances.
7.Extracts from the minutes and contracts.
8.The points to be part of the Auditor’s Report.
9.Date of commencement and completion of the audit.

Advantages of Audit Note-Book

1.It ensures uniformity and helps in knowing the amount of work performed.
2.Important matters relating to the audit work may be easily recalled.
3.Facilitates the preparation of the audit report.

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4.In case the assistant incharge is changed, no difficulty is faced in continuing the
incomplete work.
5.The audit note book shows the extent of the interest and pains taken by the audit staff. It
helps in their appraisal.

Limitations of the Audit Note-Book

In case the audit work is conducted negligently by the staff of an auditor, the audit note-
book can act as an evidence against the auditor himself.

4.INTERNAL CONTROL
The internal control system is equally important to the management and the auditor
concerned. It aids the organisation to meet its own goals more effectively. To the auditor,
it extends a basis of reliance for the audit procedures to be undertaken. Thus,
a) Internal control comprises both financial and administrative controls.
b) It is established by the management to effectively run the business activities and
exercise checks.
c) The auditor is vitally concerned with it because the efficiency or otherwise of the
internal control will greatly influence the auditor’s method of working.

Why to have internal control ? or What are the purposes of internal control ?
A) From Client’s point of view
(i) Providing reliable data
(ii) Safeguarding assets and records
(iii) To promote operational efficiency
(iv) To encourage adherence to prescribed policies

B) From Auditor’s point of view

(i) To determine whether an audit is possible; if possible, then

(ii) To determine the scope of audit.

Elements (or) Characteristics (or) Principles of Internal Control

1.Competent and trustworthy personnel
Personnel is the most important element of any system of internal control. If employees
are competent and trustworthy, some of the other characteristics can be absent and
reliable financial statements can still result.

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2.Records, financial and other organisational plans
Documents perform the function of transmitting information throughout the client’s
organisation and between different organisations. The documents must be adequate to
provide reasonable assurance that all assets are properly controlled and all transactions
correctly recorded.
3.Segregation of duties
For the prevention of both intentional and unintentional errors, following types of
segregation of duties should be taken care of :
i)Separation of operational responsibility from record-keeping responsibility
If each department or division in an organisation is responsible for preparing its own
records and reports, there would be a tendency to bias the results to improve its reported
performance.
ii)Separation of the custody of assets from accounting
To protect the firm against frauds, it is required that the custody of assets and their
accounting should be done by different persons.
4.Supervision
Directors should review the company’s financial operations and position at regular and
frequent intervals. From time to time, special reviews of particular items such as stocks, or
the operation of the wages department, should be undertaken.
5.Authorisation-written
If control is to be satisfactory, every transaction must be properly authorised.
Authorisation can be of two types :
(i) General
(ii) Specific
6.Sound Practices
Sound practices of administration require that established procedures, policies and
delegation of responsibility should all be in black and white.
7.Internal Audit
Internal audit is a part of the whole system of internal control. It should operate
independently of the internal check.
8.Arithmetic and Accounting Controls : Chart of accounts i.e. Balance sheet and Income
statement is an important control because it provides the framework for determining the
information presented to management and other financial statement users.

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Areas/Scope of Internal Control
a) General financial control
b) Cash control
c) Control over trading transactions
d) Control over employees remuneration
e) Capital expenditure control
f) Others – i)Maintenance of staff relationships
ii)Stock maintenance
iii)Control over investment

Internal Control and Auditor

The ICAI has recommended that the auditor should critically review and evaluate the
existing internal control system to prepare his audit programme. There cannot be two
opinions that if there is a good system of internal control, the work of an auditor
automatically becomes quite easy. But it does not mean that he can take shelter under the
system and shirk to his duties. The entire responsibility lies on him and no one can protect
him if he does his work carelessly and negligently.

5.INTERNAL CHECK
Internal check is a valuable part of internal control. It is an arrangement of the duties of
members of staff in such a manner that the work performed by one person is automatically
and independently checked by the other. Each employee operates independently but it
does not involve duplicating the work of other.

Objectives :
1) To exercise moral pressure over staff.
2) To ensure that the accounting system produces reliable and adequate information.
3) To provide protection to the resources of the business against fraud, carelessness
and inefficiency.
4) To distribute the work in such a manner that no business transaction is left
unrecorded.
5) To allocate duties and responsibilities of each clerk in such a way that he may be
held responsible for particular fraud or error.
6) To increase the efficiency of clerks because the allocation of duties is based on the
principle of division of labour.
7) To detect errors and frauds easily if it is committed.

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ADVANTAGES :
1.For the Business
a)Proper division of work
Internal check entails a proper and rational distribution of work among the members of
staff of the enterprise keeping in view their individual qualifications, experience and area of
specialisation.
b)Detection of errors and frauds
Since no individual worker is allowed to handle a job completely from the beginning to
the end, and the work of each clerk is automatically checked by the other, this helps in the
early detection of errors and frauds.
c)Increased efficiency coupled with economy
A good system of internal check increases the efficiency of work among the staff and
leads to overall economy.
d)Moral check
Knowledge of subsequent checking of each employee’s work by others, acts as a great
check to commission of errors and frauds.

2.For the Auditor

a)Quick preparation of final accounts
The Profit & Loss account and the Balance sheet are prepared without any loss of time.
b)Convenience to auditor
Where an organisation is operating system of internal check, the statutory auditor may
conveniently avoid detailed checking of the transactions.

3.For the Owner

a)Accuracy of the accounts can be relied upon
If there is a good system of internal check, the owner of the concern may rely upon the
genuineness and accuracy of the accounts.
b)Increase in profits
Overall efficiency and economy in operations result in more profits, thus ensuring larger
dividends for the owners or shareholders.

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DISADVANTAGES :
a)Costly for small business
A system of internal check is quite expensive especially for small business houses.
b)Quality is sacrificed for promptness
In an internal check system quality of work declines because the clerks of the business
attach greater importance to become quick rather than being accurate.
c)Carelessness among high officials
The possibility of some of the responsible and high officials being complacent, increases
as they believe, though not always rightly, that under a sound system of internal check
nothing can go wrong.
d)Disorder in the working of a business
In the absence of a properly organised system of internal check there will be chaos and
disorder in the working of business.
e)Risky for an auditor
If the auditor does not apply tests and procedures of his own and if he relies on the
output of the system his work cannot be free from irregularities if the system itself proves
to be defective.

6.INTERNAL AUDIT
Internal audit is a review of various operations and records of the company by staff
specially appointed for this purpose. It is a specialised service requiring not only expertise in
accounting but also in organisational behaviour and in functional areas of management.

Definition
According to Watter B.Meigs, “Internal auditing consists of continuous, critical review of
financial and operating activities by a staff of auditors functioning as full-time salaried
employees.”
The main object of internal audit, on the accounting side, is to ensure that the accounting
system and the internal check system in operation are working satisfactorily. Many large
organisations have a system of internal audit within the organisation as an integral part of
internal control.

Statutory Requirement of Internal Audit

As per section 138 of Companies Act, 2013
1)Such class or classes of company as may be prescribed shall be required to appoint an
internal auditor, who shall either be a chartered accountant or cost accountant.
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2)The Central Government may, by rules, prescribe the manner and the intervals in which
the internal audit shall be conducted and reported to the Board.

Objectives
a) To comment on the effectiveness of the internal control system in force and to
suggest ways and means to improve upon the system.
b) To verify the correctness, accuracy and authenticity of the financial accounting
records presented to the management.
c) To facilitate the early detection and prevention of frauds.
d) To ensure that the International Accounting Standards or the standard accounting
practices are followed by the organisation.
e) To take up an investigation at the special request of the management.
f) To ensure that the assets of the organisation are adequately safeguarded and
properly accounted for.
g) To ensure that the organisation incurs liabilities in respect of its valid and legitimate
activities.
h) To ensure that the acquisition and disposal of assets are under proper authority.
i) To ensure as to whether or not each unit of the organisation follows the policies and
procedures as laid down by the top management.

Internal Check Vs. Internal Audit

Similarities : Both internal check and internal audit are parts of the whole system of internal
control as such, both are complementary and go together.
Dissimilarities : There is a lot of difference between internal check and internal audit. Both
differ from each other in the following respects :
1.Meaning
Internal check is an arrangement of duties allocated in such a way that the work of one
person is automatically checked by another. Internal audit is an independent appraisal of
the operations and records of the company.
2.Object
The purpose of internal audit is to detect the errors and frauds which have already been
committed. The purpose of internal check is to prevent or minimise the possibilities of
errors, frauds or irregularities.
3.Need for separate staff
For carrying out internal audit, a separate staff of employees is engaged for the purpose.
For internal check, no new appointment is made. It, in fact, represents only the
arrangement of duties of the staff in a particular way.

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4.Nature of work
The work involved in the internal audit is just like that of a watchman. Internal auditor
has to report, from time to time, to the management about the various inefficiencies and
suggest improvements. Internal check, on the other hand, represents a process under
which the work goes on uninterruptedly and the checking too is more or less automatic.
5.Timing of work

Internal audit starts when the accounting process of different transactions is

finished. Internal check is an operation during the course of transaction.
6.Internal audit
It is a device for checking the work, whereas internal check is a device for doing the work.
7.Scope of work
The scope of internal check is very limited. The scope of internal audit is comparatively
broad.
8.Involvement
A large number of employees are needed for the implementation of internal check
system. A much smaller number of persons are needed for its implementations.
9.In Internal audit, errors and frauds are detected after the completion of work, whereas in
internal check the errors and frauds are discovered during the course of work.

Scope of Internal Audit

According to the Institute of Internal Auditors, scope of internal audit involves the
following areas :
a) Reliability and integrity of information.
b) Compliance with policies, plans, procedures, laws and regulations.
c) Safeguarding of assets.
d) Economical and efficient use of resources
e) Accomplishment of established objectives and goals for operations or programmes.

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