AUDITING NOTES

Audit
An audit is the independent examination of financial information of any entity, whether
profit oriented or not, and irrespective of its size or legal form, when such an examination
is conducted with a view to expressing an opinion thereon.
Major Aspects to be covered in Audit:
The principal aspect to be covered in an audit concerning
final statements of account are the following:
(i) An examination of the system of accounting and internal control to ascertain whether
it is appropriate for the business and helps in properly recording all transactions.
(ii) Reviewing the system and procedures.
(iii) Checking of the arithmetical accuracy of the books of accounts.
(iv) Verification of the authenticity and validity of transactions in the books of accounts
(v) Ascertaining that a proper distinction has been made between items of capital and of
revenue nature.
(vi) Comparison of the Balance Sheet and Statement of Profit and Loss or other
statements with the underlying record.
(vii) Verification of the title, existence and value of the assets appearing in the Balance
Sheet.
(viii)Verification of the liabilities stated in the Balance Sheet.
(ix) Checking the result shown by the Statement of Profit and Loss and to see whether the
results shown are true and fair.
(x) Where audit is of a corporate body, confirming that the statutory requirements have
been complied with.
(xi) Reporting to the appropriate person/body.
Basic principles governing an Audit
The basic principles as stated in this guideline are:
(i) Integrity, objectivity and independence: The auditor should be straight forward,
honest and sincere in his approach to his professional work. He should maintain an
impartial attitude and both be and appear to be free of any interest which might be
regarded, whatever is actual effect, as being incompatible with integrity and objectivity.
(ii) 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 a legal or professional duty to disclose.
(iii) Skills and Competence: The audit should be performed and the report prepared with
due professional care by persons who have adequate training, experience and
competence in auditing. The auditor requires specialised skills and competence along

with a continuing awareness of developments including pronouncements of the ICAI on

accounting and auditing matters, and relevant regulations and statutory requirements.
(iv) Work performed by others: When the auditor delegates work to assistants or uses
work performed by other auditors and experts, he continues to be responsible for forming
and expressing his opinion on the financial information. However, he will be entitled to
rely on work performed by others, provided he exercises adequate skill and care and is
not aware of any reason to believe that he should not have so relied.
(v) Documentation: The auditor should document matters which are important in
providing evidence that the audit was carried out in accordance with the basic principles.
(vi) 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 the
clients business.
(vii) Audit evidence: The auditor should obtain sufficient appropriate audit evidence
through the performance of compliance and substantive procedures to enable him to draw
reasonable conclusions therefrom on which to base his opinion on the financial
information.
(viii) Accounting system and Internal Control: The auditor should gain an
understanding of the accounting system and related controls and 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.
(ix) Audit Conclusions and Reporting: The auditor should review and assess the
conclusions drawn from the audit evidence obtained and 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.
Types of Audit
Audit is not legally obligatory for all types of business
organisations or institutions. On this basis audits may be of
two broad categories i.e.,
1. Audit required under law.
2. Voluntary audit.
Detection of Fraud
As per SA 240, the primary responsibility for the prevention and detection of fraud rests
with both those charged with governance of the entity and management. It is important
that management, with the oversight of those charged with governance, place a strong
emphasis on fraud prevention, which may reduce opportunities for fraud to take place,
and fraud deterrence, which could persuade individuals not to commit fraud because of
the likelihood of detection and punishment. Such a system reduces but does not eliminate
the possibility of fraud and error.

An auditor conducting an audit in accordance with SAs is responsible for obtaining

reasonable assurance that the financial statements taken as a whole are free from
material misstatement, whether caused by fraud or error. Owing to the inherent
limitations of an audit, there is an unavoidable risk that some material misstatements of
the financial statements will not be detected, even though the audit is properly planned
and performed in accordance with the SAs. The risk of not detecting a material
misstatement resulting from fraud is higher than the risk of not detecting one resulting
from error. This is because fraud may involve sophisticated and carefully organized
schemes designed to conceal it, such as forgery, deliberate failure to record transactions,
or intentional misrepresentations being made to the auditor. Such attempts at
concealment may be even more difficult to detect when accompanied by collusion.
The subsequent discovery of material misstatement of the financial information resulting
from fraud or error existing during the period covered by the auditors report does not, in
itself, indicate that whether the auditor has adhered to the basic principles governing an
audit. The question of whether the auditor has adhered to the basic principles governing
an audit (such as performance of the audit work with requisite skills and competence,
documentation of important matters, details of the audit plan and reliance placed on
internal controls, nature and extent of compliance and substantive tests carried out, etc.)
is determined by the adequacy of the procedures undertaken in the circumstances and
the suitability of the auditors report based on the results of these procedures. The
liability of the auditor for failure to detect fraud exists only when such failure is clearly
due to not exercising reasonable care and skill. Thus, in the instant case after the
completion of the statutory audit, if a fraud has been detected, the same by itself cannot
mean that the auditor did not perform his duty properly. If the auditor can prove with the
help of his papers (documentation) that he has followed adequate procedures necessary
for the proper conduct of an audit, he cannot be held responsible for the same. If
however, the same cannot be proved, he would be held responsible
Factors Causing Risk Under Statutory Audit:
the purpose of an audit is to enhance the degree of confidence of intended
users in the financial statements. This is achieved by the expression of an opinion by the
auditor on whether the financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting framework. In the case of most general
purpose frameworks, that opinion is on whether the financial statements are presented
fairly, in all material respects, or give a true and fair view in accordance with the
framework. An audit conducted in accordance with SAs and relevant ethical requirements
enables the auditor to form that opinion.

Factors which may cause such risk in conducting an audit are discussed below(i) Exercising judgement on the part of the auditor: The auditors work involves
exercise of judgement, for example, in deciding the extent of audit procedures and
in assessing the reasonableness of the judgements and estimates made by
management in preparing the financial statements.
(ii) Nature of audit evidence: Much of the evidence available to the auditor can enable
him to draw only reasonable conclusions therefrom. The auditor normally relies
upon persuasive evidence rather than conclusive evidence. Even in circumstances
where conclusive evidence is available, the cost of obtaining such an evidence may
far exceed the benefits.
(iii) Inherent limitations of internal control: Internal control can provide only
reasonable, but not absolute, assurance on account of several inherent limitations
such as potential for human error, possibility of circumstances of control through
collusion, etc.
On account of above, it is quite clear that an audit suffers from control risk on account of
inherent limitations of internal control and detection risk on account of test nature of
audit and judgement and estimates involved in formulating accounting policies.

Conditions Which Increases the Risk of Fraud or Error

(i) Weaknesses in the design of internal control system and non-compliance with the laid
down control procedures, e.g., a single person is responsible for the receipt of all dak
and marking it to the relevant sections or two persons are responsible for receipt of dak
but the same is not followed in actual practice, etc.
(ii) Doubts about the integrity or competence of the management, e.g., domination by one
person, high turnover rate of employees, frequent change of legal counsels or auditors,
significant and prolonged understaffing of the accounts department, etc.
(iii) Unusual pressures within the entity, for example, industry is doing well but the
company
is not performing accordingly, heavy dependence on a single line of product, inadequate
working capital, entity needs raising share prices to support the market price in the wake
of public offer, etc
(iv) Unusual transactions such as transactions with related parties, excessive payment for
certain services to lawyers, etc.
(v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting records
and confirmation received from third parties, etc.

Operational Audit:
Operational Audit involves examination of all operations and activities of the entity.
The objects of operational audit include the examination of the control structure and of
the relation of department controls to general policies. It provides an appraisal of whether
the department is operating in conformity with prescribed standards and procedures and
whether standards of efficiency and economy are maintained. It is concerned with
formulation of plans, their implementation and control in respect of production and
marketing activities.
Traditionally, internal audit focused on accounting operations of the entity. However,
operational audit covers all other operation such as marketing, manufacturing, etc.
Thus, operational audit in its initial stages developed as an extension of internal auditing.
The need for operational auditing has arisen due to the inadequacy of traditional sources
of information for an effective management of the company where the management is at
a distance from actual operations due to layers of delegation of responsibility, separating
it from actualities in the organisation.
Specifically, operational auditing arose from the need of managers responsible for areas
beyond their direct observation to be fully, objectively and currently informed about
conditions in the units under control.
Operational audit is considered as a specialised management information tool to fill the
void that conventional information sources fail to fill. Conventional sources of
management information are departmental managers, routine performance report, internal
audit reports, and periodic special investigation and survey
Qualities of an Auditor:
The auditor should possess specific knowledge of accountancy,
auditing, taxation, etc. which are acquired by him during the course of his theoretical
education.
The auditor should also have sufficient knowledge of general principles of law of
contracts,partnership; specific statutes and provisions applicable, e.g. Companies Act,
2013, Cooperative Societies Act, etc.; clients nature of business and its peculiar features.
Apart from the knowledge acquired by the auditor in the formal manner, the auditor
should also possess certain personal qualities such as, tact; caution; firmness; good
temper; judgement; patience; clear headedness and commonsense; reliability and trust,
etc.

In short, all those personal qualities required to make a good person contribute to the
making of a good auditor. In addition, the auditor must have the shine of culture for
attaining a great height. He must have the highest degree of integrity backed by adequate
independence. In fact, SA 200 mentions integrity, objectivity and independence as one of
the basic principles.
Going Concern :
Disclosure of Accounting Policies, lays down that the
Going Concern, is one of the fundamental accounting assumption underlying financial
statements. This Going Concern concept envisages that the entity will continue for the
foreseeable future. Accounts are prepared on this concept unless there are indication
that going concern concept is not holding good for a particular entity. On account of this
basic concept of going concern, assets and liabilities are recorded on the basis that the
entity will be able to realise its assets and discharge its liabilities in the normal course of
business. If this assumption is unjustified, the entity may not be able to realise its assets
at the recorded amounts and there may be changes in the amounts and maturity dates of
liabilities. AS 1, Disclosure of Accounting Policies, also requires that no specific
disclosure is required in case the same has been followed in the preparation of financial
statements. In case this assumption is not followed, the fact should be disclosed
Audit versus Investigation.
Overall Objectives of the Independent Auditor and the conduct of an audit in accordance
with standards on auditing, the purpose of an audit is to enhance the degree of
confidence of intended users in the financial statements. This is achieved by the
expression of an opinion by the auditor on whether the financial statements are prepared,
in all material respects, in accordance with an applicable financial reporting framework.
Audit is generally objected to find out whether the accounts show true & fair view. It is a
critical examination of books of accounts. Investigation on the other hand is critical
examination of the accounts with a special purpose. For example if fraud is suspected and
an accountant is called upon to check the accounts to whether fraud really exists and if
so, the amount involved, the character of the enquiry changes into investigation.
Investigation may be undertaken in numerous areas of accounts, e.g., the extent of waste
and loss, profitability, cost of production etc. It extends scope beyond books of accounts.
For auditing on the other hand, the general objective is to find out whether the accounts
show a true and fair view. The auditor seeks to report what he finds in the normal course
of examination of the accounts adopting generally followed techniques unless
circumstances call for a special probe. Fraud, error, irregularity, whatever comes to the

auditors notice in the usual course of checking, are all looked into in depth and
sometimes investigation results from the prima facie findings of the auditor.
Inherent Limitations of Audit
(i) The Nature of Financial Reporting: The preparation of financial statements involves
judgment by management in applying the requirements of the entitys applicable financial
reporting framework to the facts and circumstances of the entity. In addition, many
financial statement items involve subjective decisions or assessments or a degree of
uncertainty, and there may be a range of acceptable interpretations or judgments that
may be made. Consequently, some financial statement items are subject to an inherent
level of variability which cannot be eliminated by the application of additional auditing
procedures.
(ii) The Nature of Audit Procedures: There are practical and legal limitations on the
auditors ability to obtain audit evidence. For example:
(1) There is the possibility that management or others may not provide, intentionally or
unintentionally, the complete information that is relevant to the preparation and
presentation of the financial statements or that has been requested by the auditor.
(2) Fraud may involve sophisticated and carefully organised schemes designed to
conceal it. The auditor is neither trained as nor expected to be an expert in the
authentication of documents.
(3) An audit is not an official investigation into alleged wrongdoing. Accordingly, the
auditor is not given specific legal powers, such as the power of search, which may
be necessary for such an investigation.
(iii) Timeliness of Financial Reporting and the Balance between Benefit and Cost:
Therelevance of information, and thereby its value, tends to diminish over time, and there
is a balance to be struck between the reliability of information and its cost. There is an
expectation by users of financial statements that the auditor will form an opinion on the
financial statements within a reasonable period of time and at a reasonable cost,
recognising that it is impracticable to address all information that may exist or to pursue
every matter exhaustively on the assumption that information is in error or fraudulent
until proved otherwise.
(iv) Other Matters that Affect the Limitations of an Audit: In the case of certain
assertions or subject matters, the potential effects of the limitations on the auditors
ability to detect material misstatements are particularly significant. Such assertions or
subject matters include:
- Fraud, particularly fraud involving senior management or collusion.
- The existence and completeness of related party relationships and transactions.
- The occurrence of non-compliance with laws and regulations.
- Future events or conditions that may cause an entity to cease to continue as a going
concern.
Because of the limitations of an audit, there is an unavoidable risk that some material

misstatements of the financial statements may not be detected, even though the audit is
properly planned and performed in accordance with SAs.
Advantages of having the Accounts Audited by an Independent Auditor
(i) It safeguards the financial interest of persons not associated with the management like
partners or shareholders.
(ii) It acts as a moral check on the employees from committing fraud.
(iii) It is helpful in settling tax liability, negotiations for loans and for determining
purchase consideration for sale/merger.
(iv) It is also helpful in settling trade or labour disputes for higher wages/bonus.
(v) It helps in detection and minimizing wastages and losses.
(vi) It ensures maintenance of adequate books and records, statutory register etc.
Factors Affecting Form, Contents and Extent of audit:
(i) The size and complexity of the entity.
(ii) The nature of the audit procedures to be performed.
(iii) The identified risks of material misstatement.
(iv) The significance of the audit evidence obtained.
(v) The nature and extent of exceptions identified.
(vi) The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained.
(vii) The audit methodology and tools used.

Matters indicating to the auditor about non-compliance with laws and regulations
by management:
(i) Investigations by regulatory organisations and government departments or
payment of fines or penalties.
(ii) Payments for unspecified services or loans to consultants, related parties,
employees or government employees.
(iii) Sales commissions or agents fees that appear excessive in relation to those
ordinarily paid by the entity or in its industry or to the services actually
received.
(iv) Purchasing at prices significantly above or below market price.
(v) Unusual payments in cash, purchases in the form of cashiers cheques
payable to bearer or transfers to numbered bank accounts.
(vi) Unusual payments towards legal and retainership fees.
(vii) Unusual transactions with companies registered in tax havens.
(viii) Payments for goods or services made other than to the country from which
the goods or services originated.
(ix) Payments without proper exchange control documentation.
(x) Existence of an information system which fails, whether by design or by
accident, to provide an adequate audit trail or sufficient evidence.
(xi) Unauthorised transactions or improperly recorded transactions.
(xii) Adverse media comment.
Written Representations:
Is a statement by management provided to the auditor to confirm certain matters or to
support other audit evidence. These representations are an important source of
audit evidence. If management modifies or does not provide the requested written
representations, it may alert the auditor to the possibility that one or more
significant issues may exist. Further, a request for written, rather than oral,
representations in many cases may prompt management to consider such matters
more rigorously, thereby enhancing the quality of the representations.
Requested Written Representations not provided by Management: If management
does not provide one or more of the requested written representations, the auditor
shall(i) discuss the matter with management;
(ii) re-evaluate the integrity of management and evaluate the effect that this may
have on the reliability of representations (oral or written) and audit evidence in

general; and
(iii) take appropriate actions, including determining the possible effect on the
opinion in the auditors report.
The auditor shall disclaim an opinion on the financial statements if management
does not provide the written representations.
Operating Conditions Casting Doubt About Going Concern Assumption
(i) Management intentions to liquidate the entity or to cease operations.
(ii) Loss of key management without replacement.
(iii) Loss of a major market, key customer(s), franchise, license, or principal
supplier(s).
(iv) Labour difficulties.
(v) Shortages of important supplies.
(vi) Emergence of a highly successful competitor.

Audit Evidence:
As per SA 500 Audit evidence, it is the information used by the
auditor in arriving at the conclusions on which the auditors opinion is based.
Audit Procedures to Obtain Audit Evidence
1. Inspection: Inspection involves examining records or documents, whether internal
or external, in paper form, electronic form, or other media, or a physical
examination of an asset. Some documents represent direct audit evidence of the
existence of an asset, for example, a document constituting a financial instrument
such as an inventory. Inspection of such documents may not necessarily provide
audit evidence about ownership or value
2. Observation: Observation consists of looking at a process or procedure being
performed by others, for example, the auditors observation of inventory counting
by the entitys personnel, or of the performance of control activities.
3. External Confirmation: An external confirmation represents audit evidence
obtained by the auditor as a direct written response to the auditor from a third
party (the confirming party), in paper form, or by electronic. External confirmation
procedures frequently are relevant when addressing assertions associated with
certain account balances. However, external confirmations need not be restricted
to account balances only. For example, the auditor may request confirmation of the
terms of agreements or transactions an entity has with third parties; the
confirmation request maybe designed to ask if any modifications have been made
to the agreement and, if so, what the relevant details are.

4. Recalculation: Recalculation consists of checking the mathematical accuracy of

Documents or records. Recalculation may be performed manually or
electronically.
5. Reperformance: Reperformance involves the auditors independent execution of
Procedures or controls that were originally performed as part of the entitys internal
Control.
6. Analytical Procedures: Analytical procedures consist of evaluations of financial
Information
7. Inquiry: Inquiry consists of seeking information of knowledgeable persons, both,
Financial and non- financial, within the entity or outside the entity. Inquiry is used
extensively throughout the audit in addition to other audit procedures. Inquiries may
Range from formal written inquiries to informal oral inquiries.

Reliability of Audit Evidence

Audit Evidence provides that the reliability of information to be used as audit evidence,
and therefore of the audit evidence itself, is influenced by its source and its nature, and
the circumstances under which it is obtained, including the controls over its preparation
and maintenance where relevant.
Even when information to be used as audit evidence is obtained from sources external to
the entity, circumstances may exist that could affect its reliability. For example,
information obtained from an independent external source may
Not be reliable if the source is not knowledgeable
The following generalizations about the reliability of audit evidence may be useful:
(1) The reliability of audit evidence is increased when it is obtained from independent
Sources outside the entity.
(2) The reliability of audit evidence that is generated internally is increased when the
related controls, including those over its preparation and maintenance, imposed by the
entity are effective.
(3) Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or by
inference (for example, inquiry about the application of a control).

(4) Audit evidence in documentary form, whether paper, electronic, or other medium, is
More reliable than evidence obtained orally (for example, a contemporaneously
Written record of a meeting is more reliable than a subsequent oral representation of
The matters discussed).
(5) Audit evidence provided by original documents is more reliable than audit evidence
Provided by photocopies or facsimiles, or documents that have been filmed, digitized
Or otherwise transformed into electronic form,

Audit Working Papers

Audit working papers constitute the basic records for the auditor in respect of the audit
carried out by him. They constitute the link between the auditor's report and clients'
record.
These include retention of permanent record in the nature of a document to show the
actual audit work executed, the extent of the work carried out and important points, facts
The working papers, if properly maintained, can be used as defense in case of need.
The audit working papers are found very useful in the following aspects
(i) aid in the planning and performance of the audit;
(ii) aid in the supervision and review of the audit work;
(iii) provide evidence of the audit work performed to support the auditor's opinion; and
(iv) act as an evidence in the Court of law when a charge of negligence is brought against
the auditor.
Retention of working papers: Working papers should be retained, long enough, for a
period of time sufficient to meet the needs of his practice and satisfy any legal or
professional requirement of record retention.
The retention period for audit engagements
ordinarily is no shorter than seven years from the date of the auditor's report, or, if later,
the date of the group auditor's report.
Misappropriation of cash in a trading concern
Some of the methods through which cash may be misappropriated include-

(a) Omission cash receipts:

(i) cash sales not recorded;
(ii) casual receipts of miscellaneous nature not entered
(iii) sale proceeds of fully written off assets not recorded.
(b) Recording of less amounts than that actually received.
(c) Recording of more amounts than that actually expended, e.g., discounts or rebates not
taken into account while making payments, etc. Inclusion of fictitious payments in cash
book e.g. wages paid to dummy workers, salary paid to apprentices whose
tenure of services expired, etc.
With a view to check misappropriation of cash, the existence of internal check system is
quite essential. In particular, the following may be noted(i) Ascertaining the existence of system of cash receipts and disbursements of cash sales
and purchases and existence of internal checks at various stages is quite important. In
particular, the separation of duties and incompatible functions, e.g., an employee who
receives and deposits cash and cheques should not prepare sales invoices, or reconcile
bank accounts, and authorised signatory should not approve vouchers for payment.
(ii) Checking of cash receipts with counterfoils of the receipts issued.
(iii) Checking of date of each receipt as it is entered in the cash memo or the counterfoil
of the receipt issued in respect thereof corresponds with the date on which it is entered in
the Cash Book. If there is a time lag between them, it is possible that the person who had
collected the amount had failed to deposit it with the cashier immediately thereafter.
When such a discrepancy is observed, the cause thereof should be ascertained.
(iv) Check receipt of cash from the customers against price of goods sold with the
counterfoils of receipt issued to them. Also compare entries of amounts deposited in the
bank account with those on counterfoils of the Pay-in-Slip Book. If the composition of
the deposits is different from that shown on the counterfoils of the Pay-in-Slip Book, it
would be a prima facie evidence of the fact that the amounts collected were not deposited
as soon as these were received.

Concept of True and Fair.

The concept of true and fair is a fundamental concept in auditing. The phrase true and
fair in the auditors report signifies that the auditor is required to express his opinion as

to whether the state of affairs and the results of the entity as ascertained by him in the
course of his audit are truly and fairly represented in the accounts under audit.
This requires that the auditor should examine the accounts with a view to verifying that
all assets and liabilities, incomes a0nd expenses are stated at the amounts which are in
accordance with accounting principles and policies, and no material item has been
omitted.
It may be noted that where the financial statements of a company do not comply with
the accounting standards referred to in sub-section (1), the company shall disclose in
its financial statements, the deviation from t he accounting standards, the reasons for
such deviation and the financial effects, if any, arising out of such deviation.

Going Concern - Conditions Casting Doubt About Going Concern Assumption Financial
Net liability or net current liability position.
Fixed-term borrowings approaching maturity without realistic prospects of renewal or
Repayment
Indications of withdrawal of financial support by trade payables.
Negative operating cash flows indicated by historical or prospective financial
statements.
Adverse key financial ratios.
Substantial operating losses or significant deterioration in the value of assets used to
generate cash flows.
Arrears or discontinuance of dividends
Inability to pay trade payables on due dates.
Inability to comply with the terms of loan agreements.
Change from credit to cash-on-delivery transactions with suppliers.
Inability to obtain financing for essential new product development or other essential
investments.
Operating
Management intentions to liquidate the entity or to cease operations.
Loss of key management without replacement.
Loss of a major market, key customer(s), franchise, license, or principal supplier(s).
Labour difficulties.
Shortages of important supplies.
Emergence of a highly successful competitor.

Other
Non-compliance with capital or other statutory requirements.
Pending legal or regulatory proceedings against the entity that may, if successful, result
in claims that the entity is unlikely to be able to satisfy.
Changes in law or regulation or government policy expected to adversely affect the
entity.

Accounting Estimates
accounting estimate means an approximation of a monetary amount in the absence of a
precise means of measurement
Because of the uncertainties inherent in business activities, some financial statement
items can only be estimated.
Some accounting estimates involve relatively low estimation uncertainty and may give
rise to lower risks of material misstatements, for example:
Accounting estimates arising in entities that engage in business activities that are not
complex. ( Ex Trading convern with few debtors and creditors, Low Debt etc)
For some accounting estimates, however, there may be relatively high estimation
uncertainty,
particularly where they are based on significant assumptions, for example:
Accounting estimates relating to the outcome of litigation.
Allowance for doubtful accounts.
Obsolete Inventory.
Warranty obligations.
Depreciation method or asset useful life.
Auditor's Independence
Independence is the keystone upon which the respect and dignity of a profession is based.
Independence implies that the judgement of a person is no subordinate to the wishes or
directions of another person who might have engaged him or to his own self interest.
In the context of auditors, his independence is necessary so as to enable him to express
unbiased opinion on financial statements. The user of the financial statement will rely on
the opinion of the auditor only when he is convinced about his independence.

The chartered accountant is not known personally to the third parties who rely on
professional opinion and accept his opinion principally on a larger faith on the entire
accounting profession.
The Companies Act, 2013, has therefore enacted specific provisions to give concrete
shape to this vital concept:
(i) The provisions disqualifying certain types of persons from undertaking audit of
limited companies.
(ii) Provisions relating to ceiling on the number of audits that can be undertaken by a
chartered accountant.
(iii) Provisions requiring special resolution for appointing auditors in certain cases.
(v) Power to qualify his report is yet another weapon in the armory of the auditor to
protect his independence.
(vi) Provisions relating rotation of auditor/audit firm.

Analytical Procedures
the term analytical procedures means evaluations of financial information through
analysis of plausible relationships among both financial and non-financial data ( New
MD joined a co and we are expecting results of the company to get better).
Analytical procedures include the consideration of comparisons of the entitys financial
information with, for example: comparable information for prior periods; anticipated
results of the entity, such as budgets or forecasts.
Analytical procedures also include consideration of relationships, for example: among
elements of financial information that would be expected to conform to a predictable
pattern based on the entitys experience, such as gross margin percentages, payroll costs
to number of employees.
Analytical procedures are mainly used near the end of the audit that assist the auditor
when forming an overall conclusion as to whether the financial statements are consistent
with the auditors understanding of the entity.

Materiality
1. Misstatements, including omissions, are considered to be material if they,
individually or in the aggregate, could reasonably be expected to influence the
economic decisions of users taken on the basis of the financial statements
2. Judgments about materiality are made in the light of surrounding circumstances,
and are affected by the auditors perception of the financial information needs of
users of the financial statements, and by the size or nature of a misstatement, or a
combination of both
3. The auditors determination of materiality is a matter of professional judgment,
and is affected by the auditors perception of the financial information needs of
users of the financial statements.
In this context, it is reasonable for the auditor to assume that users
(a) Have a reasonable knowledge of business and economic activities and
accounting and a willingness to study the information in the financial
statements with reasonable diligence;
(b) Understand that financial statements are prepared, presented and
audited to levels of materiality;
(c) Recognize the uncertainties inherent in the measurement of amounts
based on the use of estimates, judgment and the consideration of future
events; and
(d) Make reasonable economic decisions on the basis of the information in
the financial statements.
4. The concept of materiality is applied by the auditor both in planning and
performing the audit, and in evaluating the effect of identified misstatements on
the audit and of uncorrected misstatements, if any, on the financial statements
and in forming the opinion in the auditors report.
External Confirmation:
external confirmation is an audit evidence obtained as a direct written response to the
auditor from a third party (the confirming party), in paper form, or by electronic or other
medium.

The auditor should determine whether the use of external confirmation is necessary to
obtain sufficient appropriate audit evidence to support certain financial statement
assertions.
Following are examples of situations where external confirmations may be useful(i) Bank balances and other information from bankers
(ii) Account receivables balances
(iii) Inventory held by third parties
(iv) Account payable balances.

Few areas in which different accounting policies may be encountered

(i) Method of depreciation, depletion and amortization Straight Line Method, Written
Down Value method.
(ii) Valuation of inventories FIFO, LIFO, weighted average etc.
(iii) Treatment of goodwill write off, retain.
(iv) Cash Flow Method Direct or Direct
(vi) Valuation of fixed assets historical cost, revaluation price.,

Assertions while Obtaining Audit Evidence

(i) Existence - that an assets or liability exists at a given date.
(ii) Rights and obligations - that an asset is a right of the entity and a liability is an
obligation at a given date.
(iii) Occurrence - that a transaction or event took place which pertains to the entity.
(iv) Completeness - that there are no unrecorded assets, liabilities or transaction.
(v) Valuation - that an asset or liability is recorded at an appropriate carrying value.
(vi) Measurement - that a transaction is recorded in the proper amount and revenue or
expenses are allocated to proper period.
(vii) Presentation & disclosure - that an item is disclosed, classified and described in
accordance with recognized accounting policies, practices and statutory requirements.

Internal evidence and External evidence

Evidence which originates within the organization being audited is internal evidence.
Example sales invoice, goods received notes, inspection report, debit and credit notes,
etc.

External evidence on the other hand is the evidence that originates outside the clients
organization; for example, purchase invoice, quotations, confirmations.

Assertions about classes of transactions, account balances and disclosures need to be

considered
(a) Assertions about classes of transactions and events for the period under
audit:
(i) Occurrencetransactions and events that have been recorded have occurred
and pertain to the entity.
(ii) Completenessall transactions and events that should have been recorded have
been recorded.
(iii) Accuracyamounts and other data relating to recorded transactions and events
have been recorded appropriately.
(iv) Cut-offtransactions and events have been recorded in the correct accounting
period.
(v) Classificationtransactions and events have been recorded in the proper
accounts.
(b) Assertions about account balances at the period end:
(i) Existenceassets, liabilities, and equity interests exist.
(ii) Rights and obligationsthe entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
(iii) Completenessall assets, liabilities and equity interests that should have been
recorded have been recorded.
(iv) Valuation and allocationassets, liabilities, and equity interests are included in
the financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
(c) Assertions about presentation and disclosure:
(i) Occurrence and rights and obligationsdisclosed events, transactions, and
other matters have occurred and pertain to the entity.
(ii) Completenessall disclosures that should have been included in the financial
statements have been included.
(iii) Classification and understandabilityfinancial information is appropriately
presented and described, and disclosures are clearly expressed.
(iv) Accuracy and valuationfinancial and other information are disclosed fairly and

at appropriate amounts.

Various factors that help the auditor to ascertain as to what is sufficient appropriate
audit evidence
(i) Degree of risk of misstatements which may be affected by factors such as the nature of
items, adequacy of internal control, nature and size of businesses carried out by the
entity, situations which may exert an unusual influence on management and the financial
position of the entity.
(ii) The materiality of the item.
(iii) The experience gained during previous audits.
(iv) The results of auditing procedures, including fraud and errors which may have been
found.
(v) The type of information available.
(vi) The trend indicated by accounting ratios and analysis.

Audit Sampling
Audit Sampling means the application of audit procedures to less than 100% of items
within a population of audit relevance such that all sampling units have
a chance of selection in order to provide the auditor with a reasonable basis on which to
draw conclusions about the entire population.
There are many methods of selecting samples.
a) Random Selection: This method is applied through random number generators, for
example, random number tables. Stratified Sampling is one of the methods of Random
Sampling. This method involves dividing the whole population to be tested in a few
groups called strata and taking a sample from each of them. Each stratum is treated as if it
were a separate population and if proportionate items are selected from each of the
stratum. The groups into which the whole population is divided is determined by the
auditor on the basis of his judgement e.g. entire expense vouchers may be divided into:
(i) Vouchers above ` 1,00,000
(ii) Vouchers between ` 25,000 and ` 1,00,000

(iii) Vouchers below ` 25,000

The auditor can then decide to check all vouchers above.
(b) Systematic Selection: In this method, the number of sampling units in the population
is divided by the sample size to give a sampling interval, for example 50, and having
determined a starting point within the first 50, each 50th sampling unit thereafter is
[Link] the starting point may be determined haphazardly, the sample is more
likely to be truly random if it is determined by use of a computerised random number
generator or random number tables.
(d) Haphazard Selection: In this method, the auditor selects the sample without
following a structured technique. Although no structured technique is used, the auditor
would nonetheless avoid any conscious bias or predictability and thus
attempt to ensure that all items in the population have a chance of selection.

Audit Note-book
An audit note book is usually a bound book in which a large variety of
matters observed during the course of audit are recorded. Audit note books form part of
audit working papers and for each year a fresh audit note book is maintained. In case an
auditor classifies his working paper into permanent and current, then audit note book
shall form part of the current file.
The audit note book also provides a valuable help to the auditor in picking up the links of
work when the concerned assistant is away or the work is stopped temporarily. It is also
used for recording the various queries raised in the course of the work and their state of
disposal. In respect of disposed queries, explanation obtained and evidence seen would
be recorded in the said book, while queries remaining undisposed of would be noted for
follow up.
Contents of Audit Note Book:
(i) Audit queries not cleared immediately.
(ii) Mistakes or irregularities observed during the course of audit.
(iii) Unsatisfactory book-keeping arrangements, costing method.
(iv) Important information about the company which is not apparent from the accounts.
(v) Special points requiring consideration at the time of verification of annual accounts.
(vi) Important matters for future reference.

Continuous Audit:
A continuous audit is one in which the auditors staff is engaged
continuously in checking the accounts of the client, during the whole year round or when
for the purpose, the staff attends at quite frequent intervals say weekly basis during the
financial period.
A continuous audit is preferred for the following reasons:
(i) It makes it possible for the management to exercise a stricter control over the
accounts in as much as one is able to check sooner the causes of any errors of frauds
uncovered by such an audit.
(ii) The frequent attendance by the staff deters persons so inclined, from committing a
fraud.
(iii) The accounting staff of the client is motivated to keep the books of account up-to
date.
(iv) The constant association of the auditor with the accounts and the affairs of the client
provides him with an opportunity to obtain a more detailed knowledge of the clients
affairs, one of the effects thereof is that he is able to discharge his duties more
efficiently.
There are certain drawbacks also, in the continuous audit
(i) Due to the audit being carried out in several installments, the audit staff may fail to
keep track of things which they had not checked on their last or an earlier visit as a
result whereof some of the transactions may escape audit scrutiny. The safeguard
against such a position can be that on each visit, elaborate notes and check-lists
should be prepared and audit should be completed up to a definite stage each time
so as not to leave any loose ends.
(ii) The books of account, after these have been checked, may be tampered by the
clients staff.
(iii) The audit may be uneconomic if the size of the concern is small since a great deal of
time and effort would be wasted each time in preparing for the audit and in attending
to the requirements of the audit party

Letter of Engagement
The legal requirement to get the accounts audited so far extends only
to companies, co-operative societies, and registered societies. In these cases, the
respective law governs the appointment of auditors and their duties. In all other cases, it
is a matter of contract.
The client tells the auditor the nature of service he requires and the auditor, if he is
agreeable to undertake the assignment, specifies his terms. He must sign an agreement, if
he accepts the work in terms of the agreement subject to professional standards.
Clients who are not statutorily required to get their accounts audited may require
preparation of accounts for tax returns, checking of the sales tax -returns, etc. besides
audit. In such cases, there may be a misunderstanding about the exact scope of the work;
the auditor may think that he is merely required to prepare accounts while the client may
think audit of accounts, is also covered. It is, therefore, of the greatest importance, both
for the accountant and client, that each
party should be clear about the nature of the engagement. It must be reduced in writing
and should exactly specify the scope of the work.
The audit engagement letter is sent by the auditor to his client which documents, the
objective and scope of the audit, the extent of his responsibilities to the client and the
form of report.

(a) X, a Chartered Accountant was engaged by PQR & Co. Ltd. for auditing their
accounts. He sent his letter of engagement to the Board of Directors, which was
accepted by the Company. In the course of audit of the company, the auditor was
unable to obtain appropriate sufficient audit evidence regarding receivables. The client
requested for a change in the terms of engagement.
An auditor who is required to change the engagement which requires lower
level of assurance before the completion of engagement should consider the
appropriateness of doing so. But when the terms of engagement are changed, both the
auditor and the client should agree on the new terms. However, the auditor should not
agree to a change in terms where there is no reasonable justification for doing so.

If the auditor is unable to agree to a change of the terms of the audit engagement and is
not permitted by management to continue the original audit engagement, the auditor
shall:
(i) Withdraw from the audit engagement where possible under applicable law or
regulation; and
(ii) Determine whether there is any obligation, either contractual or otherwise, to report
the circumstances to other parties, such as those charged with governance, owners or
regulators.
In the instant case, the auditor was unable to obtain sufficient evidence regarding
receivables. The client requested him for a change in the terms of the agreement to avoid
qualified/adverse opinion. Hence there is no reasonable justification for change in the
terms of engagement.
Thus, the auditor should not agree for change in the terms of engagement letter. He may
withdraw from the engagement if possible under law; and determine any obligation to
report accordingly.
Issue of Audit Engagement Letter in Recurring Audits:
The auditor shall assess whether circumstances require the terms of the audit engagement
to be revised and whether there is a need to remind the entity of the existing terms of the
audit engagement.
It is not necessary to issue audit engagement letter each year for repetitive audit. It is
enough if the same had been issued at the time of taking initial engagement.
However, in the following situations it is appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms(i) Any indication that the entity misunderstands the objective and scope of the audit.
(ii) Any revised or special terms of the audit engagement.
(iii) A recent change in senior management or board of directors.
(iv) A significant change in ownership.
(v) A significant change in nature or size of the entitys business.
(vi) A change in legal or regulatory requirements.

Obtaining Knowledge of the Clients Business:

The auditor needs to obtain a level of knowledge of

the clients business that will enable him to identify the events, transactions and practices
that, in his judgment, may have significant effect on the financial information.
the auditor shall obtain an understanding of the following:
(a) Relevant industry, regulatory, and other external factors including the applicable
financial reporting framework
(b) The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make, including
investments in special-purpose entities; and
(iv) the way that the entity is structured and how it is financed;
to enable the auditor to understand the classes of transactions, account balances, and
disclosures to be expected in the financial statements.
(c) The entitys selection and application of accounting policies, including the reasons for
changes thereto. The auditor shall evaluate whether the entitys accounting policies are
appropriate for its business and consistent with the applicable financial reporting
framework and accounting policies used in the relevant industry.
(d) The entitys objectives and strategies, and those related business risks that may result
in risks of material misstatement.

An auditor can obtain this information from(i) Clients annual report to shareholders;
(ii) Minutes of shareholders/board of directors;
(iii) Internal financial management reports of current & previous year;
(iv) Previous year audit working papers;
(v) Discussion with client;
(vi) Clients policy and procedure manual;
(vii) Publications like trade journals, magazines, news papers; and
(viii) Visit to clients premises.

Audit Programme:

An audit programme is a detailed plan of applying the audit procedure in

the given circumstances with instructions for the appropriate techniques to be adopted for
accomplishing the audit objectives. It is framed keeping in view the nature, size and
composition of the business, dependability of the internal control and the given scope of
work. Audit programme provides sufficient details to serve as a set of instructions to the
audit team and also helps to control the proper execution of the work. On the basis of
experience while carrying out the audit work, the programme may be altered to take care
of situations which were left out originally, but found relevant for the particular audit
situation. Similarly, if any work originally provided for proves beyond doubt to be
unnecessary or irrelevant, that may be dropped. There should be periodic review of the
audit programme.
For the purpose of framing an audit programme the following points should be kept in
view:
Audit objective
Audit procedure to be applied
Extent of check
Timing of check
Allocation of work amongst the team members
Special instructions based on past experience of the auditee.
The Role of Audit Programme in Audit Plan and Performance:

(i) The audit programme lists down areas of audit before commencement.
(ii) The audit timing is built therein; thereby it becomes a schedule of audit plan.
(iii) The staff who are entrusted with the audit assignment is also specified. It is a plan of
resource allocation of the firm.
(iv) It specifies the procedures to be checked during the audit.
(v) As the audit work is split into various elements of procedures to be performed, the
audit programme acts as a guiding chart or check list during the performance of audit.
(vi) Since the staff in charge of each work is specified and they sign the programme, it
extracts the responsibility from the audit assistants.
(vii) The working papers of the audit staff can be reviewed against the audit programme
which helps a base of reference for evaluation of the performance before reporting on the
financial statements.
(viii) It also helps in preparing a diary of the performance and plan and also base for
billing the clients for the time and manpower involved in the audit.
Audit Programme for Receipts of Cinema Theatre of a firm:

(i)The partnership deed should be first scrutinized.

(ii)The receipts of the cash from partners on capital and current accounts should be
vouched with reference to the relative terms in the deed

(iii) The internal control for collections from sale of tickets should be checked.
(iv) See that the tickets are serially numbered and effective custody of un-issued tickets
are in existence.
(v) Check the rough cash book and reconcile from the inventory of ticket books issued,
the cash to be collected each day.
(vi) Check that the cash balance and ticket sales from inventory is daily checked by the
manager.
(vii) Check that the collections are banked daily, the very next day.
(viii) See rates for each class and the ticket rates are as per current prices.
(ix) The entertainment tax collected should be separately accounted for its subsequent
payment to the government agencies.
(x) Check the relation between the amounts of tax collected and sales.
(xi) The collections from the advertising and publicity materials should be checked with
reference to the terms of agreement.
(xii) Income from canteen, stalls, parking facilities should also be checked and see that
the income are fairly booked without any seepage.
(xiii) The cash collections should not be used for meeting petty cash expenses. There
should be separate impressed system.
(xiv) Do surprise checking of cash balances.
(xv) See that cash collections are insured and the policy is in force.

Medical Council of India organised a three-day International Conference of Doctors in

Delhi. You are asked to audit the accounts of the conference. Draft the audit programme
for audit of receipt of participation fees from delegates to the conference. Mention any six
points, peculiar to the situation, which you will like to include in your audit programme.
(I) Internal Control System
(i) Examine the organization structure of special cell created for the International
Conference, if any, and division of responsibilities amongst persons and
control/custody over receipt books.
(ii) Verify the internal control system for restricting the participation of unregistered
delegates.
(II) Rate of Participation Fees
(i) Verify with reference to resolution passed by the Organizing Committee/Medical
Council of India.
(ii) Also verify the rate from the literature/registration form circulated for promotion of
conference.
(III) Receipts of Participation Fees
(i)
Verify counter foil of the receipts issued for individual registration.
(ii)
Ensure that receipts are issued for all the registration received in cash.

(iii) Trace the receipts in Bank Statement or Cash Book as the case may be.
(iv) Verify Bank Reconciliation Statement and list out dishonoured cheques.
(v) Verify subsequent recovery in respect of dishonoured cheques.
(IV) Overall Checking
(i) Verify the total receipts of participation fees shown in the financial statements with
reference to total number of receipts issued to participants.
(ii) Cross check the total number of delegates with reference to the following:
(a) Kits distributed to participants.
(b) Bill of caterer for providing meals during conference.
(c) Capacity of the Hall.
(d) Participation Certificate if any issued.
(V) Foreign Delegates: In case of foreign delegates if registration fees are higher
ensure that they are registered at higher fees.
(VI) Special Issues
(i) Take out list of absentees and in case of nil absentees, probe the issue further.
(ii) If certain participants are exempted from payment of fees obtain the list along with
proper authorization in this regard.

Types of audit files

(1) Permanent Audit file: It includes-

(i) Information concerning the legal and organisational structure of the entity. In the case
of a company, this includes the Memorandum and Articles of Association. In the case
of a statutory corporation, this includes the Act and Regulations under which the
corporation functions.
(ii) Extracts or copies of important legal documents, agreements and minutes relevant to
the audit.
(iii) A record of the study and evaluation of the internal controls related to the accounting
system. This might be in the form of narrative descriptions, questionnaires or flow
charts, or some combination thereof.
(iv) Copies of audited financial statements for previous years.
(v) Analysis of significant ratios and trends.
(vi) Copies of management letters issued by the auditor, if any.
(vii) Record of communication with the retiring auditor, if any, before acceptance of the
appointment as auditor.
(viii) Notes regarding significant accounting policies.
(ix) Significant audit observations of earlier years.
(2) Current Audit file: The current file normally includes-

(i) Correspondence relating to acceptance of annual reappointment.

(ii) Extracts of important matters in the minutes of Board Meetings and General
Meetings, as are relevant to the audit.
(iii) Evidence of the planning process of the audit and audit programme.
(iv) Analysis of transactions and balances.
(v) A record of the nature, timing and extent of auditing procedures performed and the
results of such procedures.
(vi) Evidence that the work performed by assistants was supervised and reviewed.
(vii) Copies of communications with other auditors, experts and other third parties.
(viii) Copies of letters or notes concerning audit matters communicated to or discussed
with the client, including the terms of the engagement and material weaknesses in
relevant internal controls.
(ix) Letters of representation or confirmation received from the client.
(x) Conclusions reached by the auditor concerning significant aspects of the audit.
(xi) Copies of the financial information being reported on and the related audit reports.

Precautions While Applying Test Check Techniques:

(i) The transactions of the concern should be classified under appropriate heads and may
be stratified in case of wide variations between the transactions of the same kind.
(ii) Authorizations, documentations, recording of the transactions should be studied right
from the beginning to end.
(iii) Evaluating the system of internal control for its efficiency, soundness and capability
to produce reliable accounting and financial data.
(iv) Preparation of test check plan with clear audit objective understood by the audit staff.
(v) Un-biased selection of the transactions with reference to the random number tables or
other statistical methods.
(vi) Identification of the areas where test check may not be done.
(vii) Setting up criteria to judge what constitute material or immaterial errors. Further
investigation of only material errors be carried out and all immaterial errors may be
avoided.
Surprise Checks:
Surprise checks are a part of normal audit procedures. An element of
surprise can significantly improve the audit effectiveness. Wherever practical, an element
of surprise should be incorporated in the audit procedures.

The element of surprise in an audit may be, both in regard to the time of audit, i.e.
selection of date, when the auditor will visit the clients office for audit and selection of
areas of audit.
Surprise checks are mainly intended to ascertain whether the internal control system is
working effectively and whether the accounting and other records are kept up to date as
per the statutory regulations. Surprise checks can exercise good moral check on the
clients staff. It helps in determining whether errors or frauds exist and if they exist,
brings the matter promptly to the managements attention, so that corrective action can be
taken at the earliest. Surprise checks
are very effective in verification of cash and investments, test checking of inventory,
verification of accounting records, statutory registers and internal control system. The
frequency of surprise checks may be determined by the auditor in the circumstances of
each audit but should normally be at least once in the course of an audit.
Normally, areas over which surprise check can be employed are(i) Verification of cash
(ii) investments.
(iii) Inventory.
(iv) Internal control and internal checks.
The management of Ankita Limited suggested for quick completion of the statutory
audit that it would give its representation about the receivables in terms of their
recoverability. The management also acknowledged to the auditors that the
management would give their representation after scrutinizing all accounts diligently
and they own responsibility for any errors in these respects. It wanted auditors to
complete the audit checking all other important areas except receivables. The auditor
certified the account clearly indicating in his report the fact of reliance he placed on
representation of the management. Comment.
The management representation cannot substitute other audit evidence that the auditor
could reasonably expect to be available to the auditor.
The audit evidences available for checking receivables- say, invoices, debt
acknowledgement documents, receipts, statement of accounts, confirmations etc., are
available evidences which auditor is duty bound to verify.
In the given case, the management of Ankita Limited wants the auditor to carry out audit
on all areas except on area of receivables. The management of the company also
committed to give representation and further owned responsibility for any errors in these
respects. However, just because management had owned responsibility for the correctness
of its evaluation of receivables, the auditor cannot shirk his responsibility. This is
negligence on his part if he relies on the management representation without assessing

the corroborative available evidences. There cannot be any restriction on scope of audit in
case of statutory audit.
(b) M/s Health Zone, a partnership firm, running a nursing home have decided to

discontinue you as an auditor for the next year and requests you to handover all the
relevant working papers of the previous year.
The working papers are the property of the auditor and the auditor has right to retain
them. He may at his discretion can make available working papers to his client. The
auditor should retain them long enough to meet the needs of his practice and legal or
professional requirement.
Working papers are the important records of the auditor. They serve as evidence of the
auditors exercise of due care and conclusion reached regarding significant matters. The
client does not have a right to access the working papers and it is up to the discretion of
the auditor to make them available or not to others including the client.
Hence in the instant case, management of M/s Health Zone cant insist upon the auditor
to handover the working papers of the previous year.

Instructions given by the Auditor to the Client Before the Start of Audit:
(i) The accounts should be totaled up and trial balance and final accounts to be kept
ready.
(ii) Vouchers should be serially arranged.
(iii) Schedule of trade receivables and trade payables should be prepared.
(iv) Schedule of outstanding expenses, prepaid expenses and accrued income to be kept
ready.
(v) A list of bad and doubtful debts should be prepared.
(vi) Schedule of investments should be prepared.
(vii) Certified list of goods returned to be prepared.
(viii) Statement of permanent capital expenditure to be prepared.
(ix) Names and addresses of managers and other officers should be kept ready.

Audit Risk:
An auditors judgement as to what is sufficient and appropriate audit evidence
is affected by the degree of risk of mis-statement. Audit risk is the risk that an auditor
may give an inappropriate opinion on financial information which is materially misstated.
For example, an uditor may give an unqualified opinion on financial statements without
knowing that they are materially misstated. Such risk may exist at overall level, while
verifying various transactions and balance sheet items.
Types of risk
(i) Inherent risk: It is the susceptibility of an account balance or class of transactions to
misstatement that could be material either individually or, when aggregated with
misstatements in other balances or classes, assuming that there were no related internal
controls. External circumstances giving rise to business risks may also influence inherent
risk. For example, technological developments might make a particular product obsolete,
thereby causing inventory to be more susceptible to
overstatement.
(ii) Control Risk: It is the risk that a misstatement that could occur in an assertion about
a class of transaction, account balance or disclosure and that could be material, either
individually or when aggregated with other misstatements, will not be prevented, or
detected and corrected, on a timely basis by the entitys internal control. It is a function of
the effectiveness of the design, implementation and maintenance of internal control by
management to address identified risks that threaten the achievement of the entitys
objectives relevant to preparation of the entitys financial statements.
(iii) Detection Risk: It is the risk that the procedures performed by the auditor to reduce
audit risk to an acceptably low level will not detect a misstatement that exists and that
could be material, either individually or when aggregated with other misstatements.
Detection risk relates to the nature, timing, and extent of the auditors procedures that are
determined by the auditor to reduce audit risk to an acceptably low level. It is therefore a
function of the effectiveness of an audit procedure and of its application by the auditor.

Matters that the auditor may consider when obtaining an understanding of the nature
of the entity:
(i) Business operations such as:

 Nature of revenue sources, products or services, and markets, including

involvement in electronic commerce such as internet sales and marketing
activities.
Conduct of operations (for example, stages and methods of production, or
activities exposed to environmental risks).
Alliances, joint ventures, and outsourcing activities.
Geographic dispersion and industry segmentation.
Location of production facilities, warehouses, and offices, and location and
quantities of inventories.
Key customers and important suppliers of goods and services, employment
arrangements.
Research and development activities and expenditures.
Transactions with related parties.
(ii) Investments and investment activities such as:
Planned or recently executed acquisitions or divestitures.
Investments and dispositions of securities and loans.
Capital investment activities.
(iii) Financing and financing activities such as:
Major subsidiaries and associated entities.
Debt structure

Internal control
The process designed, implemented and maintained by those charged with governance,
management and other personnel to provide reasonable assurance about the achievement
of an entitys objectives with regard to reliability of financial reporting, effectiveness and
efficiency of operations, safeguarding of assets, and compliance with applicable laws and
regulations.
Objective and Scope of an Audit in Computerised Information System (CIS)
Environment:
The principal objective of an audit of financial statements, prepared within a

framework of recognised accounting policies and practices and relevant statutory

requirements, if any, is to ensure that the financial statements reflect a true and fair view.
The overall objective and scope of an audit does not change in Computerised Information
System (CIS) environment but the use of a computer changes the processing and storage
of financial information and may affect the organisation and procedures employed by the
entity to achieve adequate internal control. Accordingly, the procedures followed by the
auditor in his study and evaluation of the accounting system and related internal controls
and nature, timing and extent of his other audit procedures may be affected by CIS
environment.
The computerisation of accounts would also have an impact on the increase in fraud and
errors. Thus, when auditing in CIS environment, the auditor should have sufficient
understanding of computer hardware, software and processing systems to plan the
engagement and to understand how CIS affects the study and evaluation of internal
control and application of auditing procedures including computer-assisted audit
techniques. The auditor should also have sufficient knowledge of CIS to implement the
auditing procedures, depending on the particular audit approach adopted.
Examination in Depth:
It implies examination of a few selected transactions from the
beginning to the end through the entire flow of the transaction, i.e., from initiation to the
completion of the transaction by receipt or payment of cash and delivery or receipt of the
goods. This examination consists of studying the recording of transactions at the various
stages through which they have passed. At each stage, relevant records and authorities are
examined; it is also judged whether the person who has exercised the authority in relation
to the transactions is fit to do so in terms of the prescribed procedure. For example, a
purchase
of goods may commence when a predetermined re-order level has been reached. The
ensuing stages may be summarised thus(i) Requisitions are pre-printed, pre-numbered and authorised;
(ii) official company order, also sequentially pre-numbered, authorised and placed with
approved suppliers only;
(iii) receipt of suppliers invoice;
(iv) receipt of suppliers statement;
(v) entries in purchases day book;
(vi) postings to purchase ledger and purchase ledger control account;
(vii) cheque in settlement;
(viii) entry on bank statement and returned paid cheque (if requested);
(ix) cash book entry;

(x) posting from cash book to ledger and control account, taking into account any
discounts;
(xi) receipt of goods, together with delivery/advice note;
(xii) admission of goods to stores;
(xiii) indication, by initials or rubber stamp on internal goods inwards note, of
compliance with order regarding specification, quantity and quality;
(xiv) entries in stores records.
Doing an audit in a Computerised Information System (CIS) environment is simpler
since the trial balance always tallies. Analyse critically.
Audit in a Computerised Information System (CIS) Environment: Though it is true
that in CIS environment the trial balance always tallies, the same cannot imply that the
job of an auditor becomes simpler. There can still be some accounting errors like
omission of certain entries, compensating errors, duplication of entries, errors of
commission in the form of wrong account head is posted. Possibility of Window
Dressing and/or Creation of Secret Reserves where the trial balance tallied. At present,
due to complex business environment the importance of trial balance cannot be judged
only upto the arithmetical accuracy but the nature of transactions recorded in the books
and appear in the trial balance should be focused.
The emergence of new forms of financial instruments like options and futures,
derivatives, off balance sheet financing etc have given rise to further complexities in
recording and disclosure of transactions. In an audit, besides the tallying of a trial
balance, there are also other issue like estimation of provision for depreciation, valuation
of inventories, obtaining audit evidence,
ensuring compliance procedure and carrying out substantive procedure, verification of
assets & liabilities their valuation etc. which still requires judgement to be exercised by
the auditor.
Responsibility of expressing an audit opinion and objectives of an audit are not changed
in the audit in CIS environment. Therefore, it can be said that simply because of CIS
environment and the trial balance has tallied it does not mean that the audit would
become simpler.
Different Design and Procedural Aspects of a Computerised Information System
(CIS):
(i) Consistency of Performance: Computerised Information Systems (CIS) perform
functions exactly as programmed and are potentially more reliable than manual systems,
provided that all transaction type and conditions that could occur are anticipated and
incorporated into the system.
(ii) Programmed Control Procedures: The nature of computer processing allows the
design of internal control procedures in computer programs. These procedures can be
designed to provide controls with limited visibility (e.g., protection of data against

unauthorized access may be provided by passwords). Other procedures can be designed

for use with manual intervention, such as review of reports printed for exception and
error reporting, and reasonableness and limit checks of data.
(iii) Single Transaction Update of Multiple or Data Base Computer Files: A single
input to the accounting system may automatically update all records associated with the
transaction (e.g., shipment of goods documents may update the sales and customers
accounts receivable files as well as the inventory file). Thus, an erroneous entry in such
a system may create errors in various financial accounts.
(iv) Systems Generated Transactions: Certain transactions may be initiated by the
Computerised Information System (CIS) itself without the need for an input document.
The authorisation of such transactions may neither be supported by visible input
documentation nor documented in the same way as transactions which are initiated
outside the CIS (e.g., interest may be calculated and charged automatically to customers
account balances on the basis of pre-authorized terms contained in a computer
program).
Internal controls in Computerised Information System (CIS) Environment:
General CIS Controls: The purpose of general CIS controls is to establish a framework
of overall control over the CIS activities and to provide a reasonable level of assurance
that the overall objectives of internal control are achieved. These controls may include(a) Organisation and management controls are designed to establish an organizational
framework over CIS activities, including:
(i) Policies and procedures relating to control functions.
(ii) Appropriate segregation of incompatible functions.
(b) Application systems development and maintenance controls are designed to establish
control over:
(i) Testing, conversion, implementation and documentation of new or revised systems.
(ii) Changes to application systems.
(iii) Access to systems documentation.
(iv) Acquisition of application systems from third parties.
(c) Computer operation controls are designed to control the operation of the systems and
to provide reasonable assurance that:
(i) The systems are used for authorised purposes only.
(ii) Access to computer operations is restricted to authorised personnel.
(iii) Only authorised programs are used.
(iv) Processing errors are detected and corrected.
(d) Systems software controls include:
(i) Authorisation, approval, testing, implementation and documentation of new systems
software and systems software modifications.

(ii) Restriction of access to systems software and documentation to authorised

personnel.
(e) Data entry and program controls are designed to provide reasonable assurance that:
(i) An authorisation structure is established over transactions being entered into the
system.
(ii) Access to data and programs is restricted to authorised personnel.
(iii) Offsite back-up of data and computer programmes.
(iv) Recovery procedures for use in the event of theft, loss or international or accidental
destruction.
(v) Provision for offsite processing in the event of disaster.
CIS Application Controls: The purpose of CIS application controls is to establish
specific control procedures over the accounting applications to provide reasonable
assurance that all transactions are authorised and recorded, and are processed completely,
accurately and on a timely basis. These include:
(a) Controls over input are designed to provide reasonable assurance that:
(i) Transactions are properly authorised before being processed by the computer.
(ii) Transactions are accurately converted into machine readable form and recorded in
the computer data files.
(iii) Transactions are not lost, added, duplicated or improperly changed.
(iv) Incorrect transactions are rejected, corrected and if necessary, resubmitted on a
timely basis.
(b) Controls over processing and computer data files are designed to provide reasonable
assurance that:
(i) Transactions, including system generated transactions, are properly processed by
the computer.
(ii) Transactions are not lost, added, duplicated or improperly changed.
(iii) Processing errors are identified and corrected on a timely basis.
(c) Controls over output are designed to provide reasonable assurance that:
(i) Results of processing are accurate.
(ii) Access to output is restricted to authorised personnel.
(iii) Output is provided to appropriate authorised personnel on a timely basis.

Audit Trail:
Audit trail refers to a situation where it is possible to relate, on a onetoone basis,
the original input with the final output. In a manual accounting system, it is possible to
relate the recording of a transaction of each successive stage enabling an auditor to locate
and identify all documents from beginning to end for the purposes of examining
documents, totalling and cross referencing. In first and early second generation
computer systems, a complete audit trail was generally available. However, with the
advent of modern machines, the CIS environment has become more complex. This led to
use of exception reporting by the management which effectively eliminated the audit trail
between input and output. The lack of

visible evidence may occur at different stages in the accounting process, for example(i)
Input documents may be non-existent where sales orders are entered online. In
addition, accounting transactions such as discounts and interest calculations
may be generated by computer programmes with no visible authorization of
individual transactions.
(ii) The system may not produce a visible audit trail of transactions processed through
the computer. Delivery notes and suppliers invoices may be matched by a computer
programme. In addition, programmed control procedures such as checking customer
credit limits, may provide visible evidence only on an exception basis. In such
cases,there may be no visible evidence that all transactions have been processed.
(iii) Output reports may not be produced by system or a printed report may only contain
summary totals while supporting details are retained in computer files.

Computer Aided Audit Techniques (CAATs):

The use of computers may result in the design
of systems that provide less visible evidence than those using manual procedures. CAATs
are such techniques applied through the computer which are used in the verifying the data
being processed by it.
System characteristics resulting from the nature of Computerised Information System
(CIS) environment that demand the use of Computer Aided Audit Techniques (CAAT)
are:
(i) Absence of input documents: Data may be entered directly into the computer
systems without supporting documents. In on-line transaction systems, written evidence
of individual data entry authorization, e.g., credit limit approval may not be available.
(ii) Lack of visible transaction trail: Certain data may be maintained on computer files
only. In a manual system, it is normally possible to follow a transaction through the
system by examining source documents, books of account, records, files and reports. In
CIS environment, however, the transaction trail may be partly in machine-readable form,
and it may exist only for a limited period of time.
(iii) Lack of visible output: In a manual system, it is normally possible to examine
visually the results of processing. In CIS environment, the results of processing may not
be printed or only a summary data may be printed. Thus, the lack of visible output may
result in the need to access data retained on machine readable files.
(iv) Ease of Access to data and computer programmes: Data and computer
programmes may be altered at the computer or through the use of computer equipment at
remote locations. Therefore, in the absence of appropriate controls, there is an increased
potential for unauthorized access to, and allocation of, data and programmes by persons
inside or outside the entity.
Advantages of CAAT

(i) Audit effectiveness: The effectiveness and efficiency of auditing procedures will be
improved through the use of CAAT in obtaining and evaluating audit evidence, for
example
(a) Some transactions may be tested more effectively for a similar level of cost by using
the computer.
(b) In applying analytical review procedures, transactions or balance details of unusual
items may be reviewed and reports got printed more efficiently by using the
computer.
(ii) Savings in time: The auditor can save time by reviewing the CIS controls using
CAAT than through other audit procedures.
(iii) Effective test checking and examination in depth: CAAT permits effective
examination in depth of selected transactions since the auditor constructs the lost audit
trail.
Statutory Auditor versus Internal Auditor:
The extent of the work undertaken by
statutory auditor arises from the
responsibility placed on him by the
statutes.
The approach of this auditor is
governed by his statutory duty to
satisfy himself that the accounts to be
presented to the shareholder show a
true and fair view of the financial
position.
This auditor is responsible directly to
the shareholder.
External auditor is not the employee
of the company so he has
independent status.

The Board shall, in

consultation with the Internal Auditor,
formulate the scope, functioning,
periodicity and methodology for
conducting the internal audit.
The approach of this auditor is with a view
to satisfy that the accounting system is
efficient, so that the accounting
information presented to the management
is accurate and discloses material facts.
This auditor is responsible to
management.
If internal auditor is an employee of the
company. He cannot enjoy independence
that statutory auditor has.

Appointment of an Internal Auditor:

As per section 138 of the Companies Act, 2013, following class of companies shall be
required to appoint an internal auditor or a firm of internal auditors, namely:(A) every listed company;
(B) every unlisted public company having-

(1) paid up share capital of fifty crore rupees or more during the preceding
financial year; or
(2) turnover of two hundred crore rupees or more during the preceding financial
year; or
(3) outstanding loans or borrowings from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year; or
(4) outstanding deposits of twenty five crore rupees or more at any point of time
during the preceding financial year; and
(C) every private company having(1) turnover of two hundred crore rupees or more during the preceding financial
year; or
(2) outstanding loans or borrowings from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year.

Inherent Limitations of Internal Control System:

Internal control can provide only reasonable but not absolute assurance that its objective
relating to prevention and detection of
errors/frauds, safeguarding of assets etc., are achieved. This is because it suffers from
some inherent limitations, such as(i) Managements consideration that cost of an internal control does not exceeds the
expected benefits.
(ii) Most controls do not tend to be directed at unusual transactions.
(iii) The potential of human error due to carelessness, misjudgment and misunderstanding
of instructions.
(iv) The possibility that a person responsible for exercising control may abuse that
authority.
(v) Compliance with procedures may deteriorate because the procedures becoming
inadequate due to change in condition.
(vi) Manipulation by management with respect to transactions or estimates and
judgements required in the preparation of financial statements.
Internal Control Questionnaire (ICQ) and Internal Control Evaluation (ICE):
The internal control questionnaire show the area where weakness occur or likely to occur.
They do not give any idea of the importance of those weaknesses. The Internal Control
Evaluation brings to light importance of those weakness disclosed by ICQ.
Main points of distinctions are:

(i) ICQ incorporates a large number of detailed questions but does not attempt to
distinguish their relation in materiality. ICE isolates the main control objectives within
the area of review.
(ii) Weaknesses are highlighted by answer Yes on ICE compared with No on ICQ.
(iii) Answer no in ICQ indicates a weakness real or potential, but its significance is not
revealed. Whereas ICE requires audit personnel to state whether, an apparent weakness
may prove to be material in relation to the accounts as a whole.

Internal Control Questionnaire:

Internal control questionnaire is a comprehensive
series of questions concerning internal control. It is the most widely used form for
collecting information about the existence, operation and efficiency of internal control in
the organisation.
In the questionnaire, questions are generally so framed that a Yes answer denotes
satisfactory position and a No answer suggests weakness. Provision is made for an
explanation or further details of No answers. In respect of questions not relevant to the
business, Not Applicable reply is given.
The questionnaire is usually issued to the client and the client is requested to get it filled
by the concerned executives and employees. If on a perusal of the answers,
inconsistencies or apparent incongruities are noticed, the matter is further discussed by
auditors staff with the clients employees for a clear picture. The concerned auditor then
prepares a report of deficiencies and recommendations for improvement.
An important advantage of the questionnaire approach is that oversight or omission of
significant internal control review procedures is less likely to occur with this method.
With a proper questionnaire, all internal control evaluation can be completed at one time
or in sections. The review can more easily be made on an interim basis. The questionnaire
form also provides an orderly means of disclosing control defects. It is the general
practice to review the internal control system annually and record the review in detail.

Reliability of Internal Control System in CIS Environment:

For evaluating the reliability of internal control system in CIS environment, the auditor
would consider the following(i) That authorised, correct and complete data is made available for processing.
(ii) That it provides for timely detection and corrections of errors.
(iii) That in case of interruption due to mechanical, power or processing failures, the
system restarts without distorting the completion of entries and records.
(iv) That it ensures the accuracy and completeness of output.
(v) That it provides security to application softwares & data files against fraud etc
(vi) That it prevents unauthorised amendments to programs.

Letter of Weakness:
(i) The auditor does compliance procedure to ascertain that the internal control system
exist in the entity; it works effectively; it work continuously in the entity during review
period.
(ii) When he comes across any weakness in the control points, he issues letter of
weakness.
(iii) Letter of weakness is a report issued by auditor stating the weakness in internal
control mechanism. It also suggests measures by which the weakness in the system be
corrected and the control system be made better protected.
(iv) Lapses in operation of internal control too are reported in the communication of
weakness.
(v) The communication of weakness is reporting to management of such weakness in
design and operation of internal control as have come to notice of auditor during his
auditing and it should not be taken to be a review and comment on adequacy of the
control mechanism for management purpose.