Topic 1: Nature of Auditing

a) Introduction; Nature ; Essential Features

b) Objectives of an Audit: Errors and Frauds in Auditing; Role of
Auditor in detecting errors and frauds.
c) Relation between accounting and auditing.
d) Basic Principles Governing an Audit.
e) Concept of Ethics in Auditing and Auditor’s Independence
f) Scope and Procedures of Auditing.
g) Changes in the concept of Auditing.
h) Social Objectives of Auditing.
i) Benefits Derived
j) Inherent Limitations of an Audit.
k) Auditing vs. Investigation
 1. a) Introduction; Nature ; Essential Features
Auditing Defined
Traditional (Narrow) Definition
“An audit may be said to be such
an examination of books,
accounts and vouchers of a
business as will enable the auditor
to satisfy that the balance sheet is
properly drawn up so as to give a
true and fair view of the state of
affairs of the business and
whether the profit and loss
account gives a true and fair
view of the profit or loss for the
financial period according to the
best of his information and
explanations given to him and as
shown by the books and, if not, in
what respect he is not satisfied.”
- Spicer and Pegler
Modern (Broad) Definition
“Auditing is a systematic and
independent examination of
data, statements, records,
operations and performances
(financial or otherwise) of an
enterprise for a stated purpose.
In any auditing situation, the
auditor perceives and recognizes
the propositions before him for
examination, collects evidence,
evaluates the same and on this
basis, formulates his judgement
which is communicated through
his audit report.”
- The ICAI in its publication,
General Guidelines to Internal
Auditing
 BOOK KEEPING ACCOUNTANCY AUDITING

 Preparation of Trial Auditor examines the

 Journalizing
Balance financial statements
 Posting to Ledger  Preparation of prepared by the
Trading and Profit accountant and verifies
 Totaling of Accounts
&Loss Account items therein with the
 Balancing of Accounts  Preparation of help of relevant
Balance Sheet documentary evidence
 Making an explanations and
Rectifications and information given to
adjustment Entries him.

It is concerned with the An accountant Assures users of

systematic recording of summarizes the results financial statements as
transactions in the books of transactions and to their reliability.
of original entry and their events recorded by the
posting to the ledger. book-keeper.
 Basis Accounting Auditing
1 Scope and Limited to preparation of Examines financial data and
Objective financial statements. expresses opinion re: truth
(compliance) and fairness of
financial statements.
2 Source of Position in the organizational Independent/Statutory Auditors:
authority hierarchy. The accountant is • Relevant Statute (e.g. Co.’s Act)
(Status) usually an employee of the • Engagement Letter/Terms
organization. Internal Auditors:
• If employee: Position in orgn.
• If outsider: Engagement Terms
3 Qualifications Not specified by statute. Specified by relevant statute.
(May or may not be a CA.) (E.g., an independent statutory
auditor under the Companies Act,
2013has to be a practicing CA.)
4 Expertise Accounting Accounting and Auditing.
5 Chronology Precedes auditing Post accounting
6 Accountability To Management/TCWG To Shareholders
7 Nature of work Constructive Analytical
8 Timing of work Round the year Year End or Continuously.
 Bases of AUDITING INVESTIGATION
Distinction
1 Compulsion Compulsory for companies. Not Compulsory. Unless specifically
required
2 Appointing Generally Shareholders. Usually Management/TCWG.
Authority By BoD or CG in some cases. CG in some cases.

3 Objective To form an opinion as to the truth and To find out in detail the state of affairs
fairness of FS. or answers to specific questions in
respect of some specific area.
4 Scope Determined by relevant statute or Determined by appointing authority.
terms of engagement.
5 Disclosure of Requires specific disclosure in case No specific disclosure required.
Remuneration of companies under Schedule VI Part
II of the Companies Act, 2013.
6 Qualifications Statutory Auditor of a Company No specific qualifications required.
should be a CA under the meaning of
the Chartered Accountants Act, 1949.
7 Coverage Wide/Overall Narrow /Focused
8 Time Frame Annual None . Usually more than one year.
9 Submission To shareholders. To appointing Authority.
of Report
 Independence of Auditor
Meaning of Independence

Independence implies that the judgement of the auditor

is not subordinate to the wishes or direction of another person
who might have engaged him or to his own self-interest.

It is not possible to define “independence” precisely.

Rules themselves cannot create or ensure the existence of
independence. Independence is a condition of mind as well as
personal character and should not be confused with the
superficial visible standards of independence which are
sometimes imposed by law. These standards may be relaxed or
strengthened but the quality of independence remains
unaltered.
 Definition of “Auditor’s Independence”
As per the Code of Ethics for Professional Accountants, issued by the
International Federation of Accountants (IFAC)

Independence in Mind Independence in Appearance

The state of mind that
permits the provision of an
opinion without being affected
by influences that comprise
professional judgement,
allowing an individual to act
with integrity, and exercise
objectivity and professional
skepticism.
The avoidance of facts
and circumstances that are so
significant, a reasonable
informed third party, having
knowledge of all relevant
information, including any
safeguards applied, would
reasonably conclude a firm’s or
a member of the assurance
team’s integrity, objectivity or
professional skepticism has
been compromised.
 Threats to Auditor’s Independence
Nature of Threat Description Example
1 Self Interest Occur when an auditing firm, its Direct or indirect financial
partner or associate could interest, loan or guarantee
Threat benefit from a financial interest from client, close business
in the client. relationships with client,
undue dependence on
client’s fee, potential
employment with client,
contingent fee for audit
engagement.

2 Self Review Occur when during a review of  Auditor having recently

any judgement or conclusion been a director or senior
Threat reached in a previous audit or officer of the company.
non-audit engagement, or  When the auditor
when a member of the audit performs services which
team was previously a director are themselves the
or senior employee of the subject matter of audit.
client.
 Nature of Threat Description Example
3 Advocacy Occur when the auditor  When an auditor deals
promotes or is perceived to with the securities of the
Threat promote a client’s opinion to a company.
point where people may  Becomes client’s
believe that objectivity is advocate in litigation and
getting compromised. third-party disputes.
4 Familiarity Are self-evident and occur  Close relative of an
when auditors form auditor working in a
Threat relationships with the client senior position of the
where they end up being too client company.
sympathetic to the clients  Former partner of the
interests. audit firm being a
director or senior
employee of the client.
 Long association between
specific auditors and their
specific client
counterparts.
 Acceptance of significant
gifts or hospitality from
the client company, its
directors or employees.
 Nature of Threat Description Example
5 Intimidation Occur when auditors are  Threats of replacement
deterred from acting over disagreements
Threat objectively and adequate with the application of
degree of professional accounting principles.
skepticism.  Pressure to
disproportionately
reduce work in response
to reduced audit fees.
 Safeguards to Independence
The Professional Accountant (CA in our case) has a responsibility to
remain independent by taking into account the context in which they
practice, threats to independence and safeguards to eliminate the treats.
To address the issue, Members are advised to apply the following
guiding principles:
 For the pubic to have confidence in the quality of audit, it is essential that
auditors should always be and appear independent of the entities they
are auditing.
 In case of audit the fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be
independent.
 When such threats exist, the auditor must conscientiously consider
whether it involves threats to independence.
 When such threats exist, the auditor should either desist from the task, or
at the very least, put in place safeguards that will eliminate them. All
such safeguard measures need to be recorded in a form that can serve as
evidence of compliance with due process.
 If the auditor is unable to fully implement credible and adequate
safeguards, then he must not accept the work.