INTRODUCTION TO AUDITING

The role of auditor goes back many hundreds of years. There are records from ancient Egypt and
Rome, showing that people were employed to review work done by tax collector and estate
managers. The emphasis was very much on the detection of fraud and other irregularities

Anthropologists have found records of auditing activity dating back to early Babylonian times
(around 3,000 BC). The practice of modern auditing dates back to the beginning of the modern
corporation at the dawn of the Industrial Revolution.

Meaning of the term Audit:

There is no definition of an audit, per se, in the International Standards on Auditing. The definition
given in ISA 200 states the objective of an audit, “The objective on an audit of financial statements
is to enable the auditor to express an opinion whether the financial statements are prepared, in all
material respects, in accordance with an identified financial reporting framework of other criteria.
A better, more general definition of auditing is the definition put forth by the American Accounting
Association, “An audit is a systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree of correspondence
between these assertions and established criteria and communicating the results to interested
users.”

a. An audit is a systematic approach: the audit follows a structured, documented plan

(audit plan).
b. An audit is objectively conducted: an audit is an independent, objective and expert examination
and evaluation of evidence.

c. The auditor obtains and evaluates evidence. The auditor assesses the reliability and sufficiency
of the information contained in the underlying accounting records and other source data.

d. The evidence obtained and evaluated by the auditor regards assertions about economic actions
and events . The basis of evidence gathering objectives, the thing that the evidence must “prove”
are the assertions of management.

e. The auditor ascertains the degree of correspondence between assertions and established criteria.
The audit program tests most assertions by examining the physical evidence of documents,
confirmation, inquiry and observation.

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f. The goal, or objective, of the audit is communicating the results to interested users. The audit is
conducted with a view of expressing an informed and credible opinion, in a written report.

The role of an auditor is to provide with an independent and expert opinion on the fairness of the
financial reports.

Meaning of External Audit

Is an independent examination of financial information, with a view to expressing an opinion on

this information.

True and fair presentation

The term “true and fair” is not defined in the Companies Act, but if the accounts of an entity are
prepared in accordance with the facts, correct principles and applicable/accepted, the accounts are
said to be true and fair.

In simple terms, we can say that truth means something factually correct and fair means just,
equitable and not misleading. So, the auditor needs to ensure that the financial statements are not
only factually correct but are also just, equitable presented so as to be open and understandable,
and in accordance with accounting principles and standards.

Example;

King Co. has had its accounts audited by its auditor. The truck has been depreciated over a period
of ten years. Mathematically, the auditor has made the calculations correctly but the life of the
truck has not been estimated correctly. The life of the truck cannot be more than five years.
Therefore, the financial statements are true but are not fair: though arithmetically accurate they
mislead users about the state of the trucks.

Assurance engagement

An assurance engagement is where a professional accountant in public practice expresses a

conclusion designed to enhance the degree of confidence of the intended users, other than the
responsible party, about the outcome of the evaluation or measurement of a subject matter against
criteria.

Objectives of Audit

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The objectives of an 'Audit' may broadly be categorized as:

1. Primary objective
2. Secondary objectives

3. Specific objectives.

1. Primary objective

Expression of an independent opinion on accounts. In auditing accounting data, the main concern
is to determining whether recorded information properly reflects the economic events that
occurred during the accounting period. The dominant principle of audit is the examination of
financial information produced by an accountable party with a view to reporting to the person to
whom the information is rendered on its truth or otherwise.

2. Secondary objectives

Detection and prevention of errors and mistakes. As discussed above an auditor has to examine the
books of account and relevant supporting documents with a view to express his opinion and
relevant supporting documents with a view to express his opinion on the financial state of affairs
of the company. During the process of such an examination of accounts, certain errors and frauds
may be discovered.

3. Specific objectives

From the analysis of various definitions given by different authorities on the subject and latest
developments in the field of auditing, it should be clear that the term audit should not be convened
to financial audit alone. The area of operation of audit is quite wide and such other areas like
review of cost, operations, efficiency, management and tax liability, etc. fall under the purview of
audit. Accordingly there would be specific objectives in respect of each type of such specified
audit. For example, in cost audit which is concerned with verification of cost records and
examination of cost accounting procedures, the object of audit is to verify the truth, accuracy and
fairness of costing data and to serve as an effective tool of cost control. Similarly, in a management
audit, the aim of audit is to promote the efficiency of managerial functions and to enhance the
operational efficiency besides identifying areas of weakness in internal control. This depending
upon the nature and subject matter of specific audit, there would be specific and different
objectives in respect of each specific audit.

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Why do we need auditing?

By the audit process, the auditor enhances the usefulness and the value of the financial statements,
but he also increases the credibility of other non-audited information released by management.

Comparison between auditing and accounting

Many financial information users and members of the public often think of auditing as being part
of accounting. The confusion results because most auditing is concerned with accounting
information (i.e., examination thereof) and almost all auditors are accountants also. Giving the title
“chartered accountants” to individuals performing a major portion of the audit function increases
the confusion. Therefore, in order to understand the true nature and role of auditing as a discipline,
one must know how auditing is different from accounting besides what relationship it maintains
with the latter.

Accounting; accounting is the process of recording, classifying, and summarizing business

transactions in monetary terms, accounting aims at providing financial information for decision
making. The person who performs this function is called an accountant. His job includes;

(a) Recording business transactions in monetary terms

(b) Classifying and summarizing them

(c) Preparing financial statements

(d) Communicating the final information in a summary form to management and other users to
make decision.

Whereas;

Auditing; “Auditing begins where accounting ends.” This implies that an auditor comes into the
picture only when the accountant has done his job. While auditing accounting data, the auditor has
to determine whether the recorded information properly reflects the economic events that occurred
during the accounting period. Thus auditing is basically a review function. An auditor examines
the final product of the accounting system and, on the basis of his examination and audit evidence,
accumulated by him, expresses (through a formal report) his impartial opinion – whether the
accounting information is properly recorded and fairly reflects the states of affairs of firm’s
business.

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From the above discussion, it should be clear that auditing is not a part or subset of accounting;
albeit the two maintain a close relationship. Auditing, being primarily a review of accounting
information, a thorough knowledge of accounting is a prerequisite to carry out an audit effectively.
This, however, does not mean that to be an effective auditor, the person concerned should involve
himself in the process of accounting, in that case; the audit cannot be an independent assessment.

The main points to differentiate accounting from auditing are as follows:

1. Subject matter.

Accounting is concerned with collection, classification, and summarization of economic events in

a logical manner for the purpose of providing financial information for decision-making. Auditing,
on the other hand, is concerned with examination or review of financial information so furnished.

2. Object.

The main object of accounting is to know the trading results or state of affairs of a business during
the accounting period. Whereas the object of audit is to judge the correctness and reliability of
financial statements prepared by the internal staff of the business enterprise.

3. Hierarchy.

Auditing begins where accounting ends. There can be no auditing without the prior existence of
accounting data.

4. Nature.

Accounting is constructive in nature as it measures business events in terms of profit or loss and
communicates the financial condition of the business as depicted by financial statements. Auditing
on the other hand, is referred as analytical and critical aspect of accounting since it reviews the
measurement and communication of financial results and condition of business.

5. Expertise required.

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An accountant may not be comfortable with audit techniques and procedures, but an auditor must
be well versed with the principles and techniques of accounting. It is this expertise that
distinguishes auditors from accountants.

6. Process.

Accounting is a four-step process that involves collection and record, classification, summarization
and communication of accounting information and results thereof. Auditing, on the other hand,
includes three principal steps, viz., preliminary planning, performing the audit work, and reporting
the findings.

TYPES OF AUDIT

Audits are typically classified into three(3) types;

 Audit of financial statements

 Operational audits

 Compliance audit

 Audit of financial statements

Audit of financial statements examine financial statements to determine if they give a true and fair
view or fairly present the financial statements in conformity with specified criteria.

 Operational audits

An operational audit is the study of a specific unit of an organization for the purpose of measuring
its performance. Operational audits review all or part of the organization’s operating procedures to
evaluate effectiveness and efficiency of the operation.

 Compliance audit

A compliance audit is a review of an organization’s procedures to determine whether the

organization is following specific procedures, rules or regulations set out by some higher authority

QUALIFICATIONS AND QUALITIES OF AN AUDITOR

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An auditor must be professionally qualified, i.e., he must be a chartered accountant and should
possess the certificate of practice. Without above-mentioned qualification, he cannot be appointed
as an auditor of a joint stock company. Apart from the statutory qualifications, an auditor should
also possess certain other traits and qualities. If we expand the term. ‘AUDITOR’ it highlights the
following qualities required of an auditor.

A Stands for Active and Accurate

U Stands for Up-to-date

D Stands for Diligent and Decisive

I Stands for Intelligent, Impartial and Independent

T Stands for Tactful and Transparent

O Stands for Objective and Honest

R Stands for Responsible

A brief discussion of the qualities required of an auditor is given below;

1. Knowledge of accounting.

Audit, being primarily an examination of the accounting data, cannot exist independent of
accounting. An auditor, therefore, must possess thorough knowledge of accounting to carry out an
audit effectively.

2. Knowledge of theory and practice of auditing and relevant laws.

He should possess thorough knowledge of theory and practice of auditing. He should have mastery
in his field. Besides, he should be familiar with various relevant laws of the country governing a
business such as tax law, corporate laws, and economic laws, etc.

3. Intelligence and tactfulness.

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He must be capable of making intelligent and exhaustive inquiries till he ascertains the information
required to understand the state of affairs of client’s business.

4. Responsible and prudent.

An auditor should be prudent enough. When asked by the client to offer suggestions or advice on
matters relating to financial policy or to put forth suggestions for improvements in the accounting
system and internal control prevailing in the organization, an auditor must be prudent. He should
be responsible in terms of his attitude as well as approach to work.

5. Familiarity with the latest development/amendments affecting audit.

He should be familiar with the latest developments/amendments as to techniques of

auditing/accounting and laws affecting him and his work. This will help him to modify the
procedure of audit work and carry out an effective audit.

6. Integrity.

An auditor should be honest and possess high moral standards. Lord Justice Lindley very aptly
described the honesty on the part of auditor re London and general bank in the following words:

7. Objectivity, independency and transparency.

An auditor should maintain objectivity and be free of conflict of interest in discharging

professional responsibilities. He should carry out his duties cheerfully, conscientiously and
independently. He must show transparency in his approach. He should prove himself to be an
indecent person and must not compromise on important issues with his client in case of difference
of opinions between two.

8. Vigilance.

An auditor should be vigilant and cautious. He should be able to detect errors and frauds. An
auditor should remember that one of his main duties is to spot errors and frauds so that their re-
occurrence can be prevented and it is possible only when he remains constantly vigilant.

9. Positive attitude and reliance upon client’s staff.

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He should not be unduly suspicious. In the words of lord justice lopes, “an auditor is not bound to
be a detective or to approach his work with suspicion or with foregone conclusion that there is
something wrong. He is a watchdog and not a bloodhound. He is justified in believing tried
servants of the company, and is entitled to rely upon their representations, provided he takes
reasonable care.

10. Diligence.

Auditing job is analytical and critical in nature and requires auditor’s time, energy, attention and
patience. The auditor should work diligently so as to set an example before his professional peers.

11. Confidentiality and loyalty.

Maintaining confidentiality is an integral part of professional ethics. An auditor should maintain

complete secrecy of the business of his client and should not disclose any confidential information
gathered during the course of his work to an outsider unless there is a legal or professional duty
contrary to it.

12.Communication skill.

It is quite essential for an auditor that he could communicate well with all the concerned. He should be able to
write audit report properly and without ambiguity. He should be competent to convey his message in a clear,
concise and precise manner.

Advantages of Audit

There are numerous advantages of having accounting recording audited, no matter whether there is hardly any
requirement of audit.. Nowadays business people get their accounts audited by a professional auditor with a view
to make the accounting information transparent and reliable. Audit is useful for every business organization. Some
of the important advantages associated with audition are given below.

1. Detection and prevention of errors and frauds becomes easier.

Audit helps a business to detect and prevent the fraud and errors. Errors and frauds can be located and rectified at
an early and initial stage.

2. Audited accounting information: greater reliability and authenticity.

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Management exercises a great deal of subjectivity in preparing financial statements and allocating resources
entrusted to it in operating the entity. An audit provides reasonable assurance that management’s representations
on these activates are authentic. Thus, audited accounts carry a greater reliability and authenticity in comparison of
unaudited accounts.

3. Acceptability by the authorities.

Audited accounts are readily acceptable by the income tax. and such other statutory bodies.

4. Professional advice available.

Independent auditors also render services other than auditing. They do tax work, act as management consultants,
advise on internal control system in operation, and prepare reports required by government agencies and so on so
forth.

5. Speedy processing of loan.

Financial institutions consider audited accounts genuine and authentic and this helps them in speedy processing of
loan proposals.

6. Settlement of disputes

In case of partnership firm, disputes among the partners over such matters as profit sharing settlement of claims in
case of retirement/death of a partner may be less likely to arise when accounts are duly audited. All partners can
easily trust audited accounts.

7. Facilitates calculations of net worth and goodwill of business.

In case of sale of takeover of business as a going concern by other party, audited accounts carry greater reliability
to deciding out the net worth of the business and goodwill. A perspective purchaser of a business may place more
confidence in audited accounts as evidence of past profitability. The auditing function therefore plays an important
role in verifying whether an organization is profitable or not or whether its financial position is sound or not.

8. Settlement of insurance claims

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Audited accounts are likely to have more creditability and this helps in early and easy settlement of insurance
claims in case of losses by fire, misappropriation, embezzlement or any other reason.

9. Useful to compare the financial performance.

Audited financial statements are considered more reliable to compare the financial performance of a business
concern over the year.

10. Keeps accounts department vigilant.

A regular audit of accounts keeps the accounts department not only up-to-date but also careful and vigilant

11. Identifies the weak areas.

Audit reviews the internal control system of the audited and identifies the weak areas, which helps management
to get over the weaknesses and achieve their goal within stipulated time and at reasonable cost.

LIMITATIONS OF AUDIT

Auditing has numerous advantages but has certain limitations too. An auditor has to depend on the
books of account and records produced before him by the management of the organization.
Management could have an incentive to bias the information presented in financial statements, as
financial statements are one of the means used to evaluate management performance. Auditor may
not be in a position to uncover all sort of manipulation, in other words audit may not trace out all
types of errors, misappropriations or manipulations especially those ingeniously perpetrate.

As per the companies act, responsible officer must give true and correct information to auditor
who depends upon the information explanation even by the company, If such officer intentionally
does not give the true and correct information to the auditor, then the audit report will never show
a true an fair view.

Most of the times auditor has to take the information and explanation form the management and its
staff such as details regarding the stock in hand including finished, semi-finished, raw material,
scrap, etc. such information may be incorrect as valuation of stock may be greater or less form the
actual value.

Influence of management is another major limitation of audit. Though an independent auditor is

appointed by the shareholders, he depends upon the management for his fees and obviously has a

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close working relationship with the later. So an auditor is subject to conflicting pressures and
sometimes he intentionally ignores the actual facts and reports as desired by the management.
Every auditor suffers from a pre-conceived notion that he has been appointed to safeguard the
interest of management instead of to work as a financial police to prevent the misuse of power and
other financial irregularities. Thus sometimes an auditor finds it very difficult to achieve the real
goal of auditing.

A CRITICAL APPRAISAL OF AUDITNG

Question often arises in the minds of business people whether auditing is a luxury or necessity.
They frequently comment that accounting is important while auditing is wastage of resources.

The expenditure on accounting can be justified on the following ground.

1. Large number of unrecorded transactions cannot be recalled by businessmen for a long time.
Therefore, business transactions are recorded in books of account to remember them.
2. It is quite necessary for a businessman to know the correct profit, which only the written record
can furnish.

3. Accounting reflects the financial position of a business on a given date.

4. Written records are necessary to know the debtors and creditors of the organization.

5. Written accounting records are source of documentary evidence in case of a legal dispute

6. Accounting records facilitate valuation of goodwill

7. Written accounting records are needed to measure the productivity and growth of a business.

8. Written records finish the required data to calculate the tax liability and facilitate revenue
authorities in this regard

9. Comparative study of two accounting periods of various firms can be done only with the help
of written accounting records.

10.Loans can be easily granted on the basis of financial position of the enterprises as reflected by
accounting records.

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Arguments against auditing

Auditing may be a luxury in the opinion of businessmen on the basis of following arguments:

1. The remuneration payable to the auditor unnecessarily burdens the profit and loss account and
reduces the net profit.
2. Too many formalities attached to auditing create difficulties for the accounting staff of the client.

3. The entrepreneurs take auditing as a means of wastage of time and creating obstructions in the
smooth functioning of business.

4. Audit is not a foolproof method of detecting errors and fraud

5. Management being appointing authority may influence the auditor. He may attempt to safeguard
the interest of the board of directors and the management instead of working as financial
policies force. Therefore, sometimes he is unable to prevent the misuse of power and other
financial irregularities.

Arguments in favour of auditing

Though, auditing has certain limitations but it would be unreasonable to consider auditing a waste
of resources or redundant. Auditing offers numerous advantages. Auditing may be luxury of small
entire preneurs but for a large and complex business organizations, it is a necessity for the under
mentioned reasons/advantages:

a. Audited accounts carry a greater reliability and authenticity in comparison of unaudited

accounts.
b. Audit helps to detect and prevent the errors and frauds

c. Auditor can render his advice and opinion to the management for improving the performance of
the enterprise.

d. A regular audit of a accounts keeps the accounts department not only up-to-date but careful and
vigilant as well.

e. Audit safeguards the interest of the investors, owners, employees, financial institutions, creditors
and the management.

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f. Public funds invested in private sector need to be thoroughly examined so as to ensure their
optimum utilization. This is possible though auditing

SCOPE OF AUDIT

Scope of audit refers to its subject matter. It includes its area of operations, various aspects to be
covered under the audit and the requirements of the relevant legislations. As per statement on
‘Auditing and Assurance Standard 2’ (ASS2) the scope of audit is mentioned below:

The scope of an audit is determined by the auditor, having regards to:

(a) The terms of the engagement;

(b) The requirement of the relevant legislation; and

(c) The pronouncements of the institute of chartered accountants.

However, the terms of the engagement cannot restrict the scope of an audit in respect of matter,
which are prescribed by the relevant legislation, and the pronouncements of the institute.

The audit should adequately cover all aspects of the enterprise, which are relevant to the financial
statements under audit. The auditor should be reasonably satisfied that the information contained
in the accounting records, etc. is reliable and sufficient for the preparation of financial statements
in respect of which he is to form his opinion. He should also see that the disclosure of information
is as per the legal requirement, if any.

Independence of an auditor

The concept of ‘independence of the auditor’ refers to the necessity of the auditor being not under
the influence of his client or appointing authority. Expression of I’ independent opinion’ on the
financial statement by an appointed auditor is the most basic objective of an audit. The primary
duty of an auditor is report to his client on the financial statements fly an appointed auditor is the
most basic objective of an audit. The primary duty of an auditor is report to his client on the
financial information examined by him. The companies act, requires that the auditor of a company
has to state whether in his opinion the financial statements disclose a ‘true and fair view’ of the
state to company’s affairs. An auditor should prove himself to be an independent person and must

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not compromise on important issues with his appointing authorities. His reports lend credibility to
the financial information upon which reliance can be placed by various sections of the society e.g.
owners (shareholders), creditors, trade union, governmental agencies and other possessing
legitimate interest in the business.

In view of the auditor’s extensive responsibilities to third parties, the auditor must be independent
of his client. The management of the enterprise under audit must not influence him.

Further, although auditing may be an important part of the work of a practicing chartered
accountant, he may render his services in other areas of work, such as:

Provision of accounting services;

 Advising the client on taxation matters

 Management consultancy;

 Financial advice;

 Investigations etc

Now the question arises if auditors get involved in such tasks, could this impair their independence
as auditor? The answer is in yes. As a matter of fact it is quite essential for auditor to maintain their
independence and only to accept or continue a professional appointment if they are satisfied that to
do so will not reflects adversely upon their integrity and objectivity in relation to that appointment.
The auditor should not subordinate his judgment to that of the management of the undertaking
under audit.

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