Unit 1

Meaning of auditing
Auditing is the process of checking a company’s financial records and activities to make sure
everything is accurate, honest, and follows the rules. It helps confirm that the company’s
financial statements, like balance sheets and income reports, are correct and reliable.

Audits can be done by people inside the company (internal auditors) or by independent
professionals from outside (external auditors). The goal is to catch any mistakes or fraud and
ensure that the company is operating fairly and legally.

Definition

Mautz

“Auditing is concerned with the verification of accounting data, with

determining the accuracy and reliability of accounting statements and reports."

International Auditing guidelines

An audit is the independent examination of financial statements, 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."

Features ---

1) Auditing is the systematic, and scientific examination

of the accounts of business.

2) It is intelligent and critical examination of the accounts of

business

3) Auditing is concerned with verification of accounting data

with determining the accuracy and reliability of accounting

statements and reports.

(4) Auditing is done by an independent person or body of persons

qualified for the job.

(5) Auditing is concerned with verification of results shown by profit and loss
account and the state of affairs shown by balance sheet

(6) It is concerned with physical verification of the assets and liabilities of a

business as shown in the balance sheet.

(7) Auditing is a critical review of the system of accounting and internal

control.

(8) Auditing is done with the help of vouchers, documents, information and
explanations received from the authorities.

(9) Auditing is undertaken in any entity both profit oriented and non profit
oriented.

(10) Auditing work may be undertaken periodically or throughout

the financial period.

Objectives of Auditing

The objectives of auditing are changing with the advancement of business techniques. Earlier
it was only to check the correctness of receipts and payments. The objectives of the auditing
have been classified under three heads: -

1) Main objective

2) Subsidiary objectives

3.) specific objective

1. Main Objective (primary objective):The main objective of the auditing is to find reliability
of financial position and profit and loss statements. The objective is to ensure that the
accounts reveal a true and fair view of the business and its transactions. The objective is to
verify and establish that at a given date balance sheet presents true and fair view of financial
position of the business and the profit and loss account gives the true and fair view of profit
or loss for the accounting period. It is to be established that accounting statements satisfy
certain degree of reliability. Thus the main objective of auditing is to form an independent
judgement and opinion about the reliability of accounts and truth and fairness of financial
state of affairs and working results.

2 Subsidiary objectives(secondary objective)

The subsidiary objectives of the auditing are: 1. Detection and prevention of fraud: the one
of the important subsidiary objective of auditing is the detection and prevention of fraud.
Fraud refers to intentional misrepresentation of financial information. Fraud may involve:

a. Manipulation, falsification or alteration of records or documents

b. Misappropriation of assets.

c. Suppression of effect of transactions from records or documents.

d. Recording of transactions without substance.

e. Misapplication of accounting policies

2. Detection and prevention of errors: is another important objective of auditing. Auditing

ensures that there is no mis-statement in the financial statements. Errors can be detected
through checking and vouching thoroughly books of accounts, ledger accounts, vouchers and
other relevant information.
Errors refer to unintentional mistakes in financial statements or accounting records. These
can occur due to various reasons such as oversight, miscalculation, or misunderstanding of
accounting principles. The common types of errors in auditing are:
Errors of Omission: When a financial transaction is completely left out of the
records. For example, if a sale is made but not recorded in the books.
Errors of Commission:These are errors caused by recording the transaction in the
wrong account or incorrect entry of amounts. For instance, if a transaction is
recorded in the wrong customer's account.
Errors of Principle:When accounting principles are not followed, leading to
incorrect classification or recording of a transaction. For example, recording a
capital expense as a revenue expense.
Compensating Errors:These errors occur when two or more mistakes cancel each
other out, making it harder to detect. For instance, an under-recording of income may
be offset by under-recording of expenses.
Errors of Duplication:These errors occur when the same transaction is recorded
more than once in the books.
Errors of Original Entry: Errors made at the source of entry, such as when an
incorrect amount is recorded initially and carried through in the books.
Clerical Errors:These are mistakes made in the mechanical process of recording
transactions, such as transposing numbers (e.g., writing 65 instead of 56) or errors in
adding and subtracting.
Errors of Posting: Errors made when transactions are posted to the ledger. For
example, recording the wrong amount, posting to the wrong account, or failing to
post a transaction entirely.

[Link] objective
 The last imprtant objective of an auditing is specific [Link] does not imply
finaccial audiy alone. Itmay include such areas like review of operation ,
performance, cost record, and so on . Accordfingly , threre will be specific objective
in respect of each type of such specific audit

Accounting vs auditing
BASIS FOR
ACCOUNTING AUDITING
COMPARISON

Meaning Accounting means systematically keeping the records of the Auditing means inspection of the books
accounts of an organization and preparation of financial of account and financial statements of
statements at the end of the financial year. an organization.

Governed By Accounting Standards Standards on Auditing

Work performed by Accountant Auditor

Purpose To show the performance, profitability and financial position To reveal the fact, that to which extent
of an organization. financial statement of an organization
gives true and fair view.

Start Accounting starts where bookkeeping ends. Auditing starts where accounting ends.

Period Accounting is a continuous process, i.e. day to day Auditing is a periodic process.
recording of transactions are done.

Advantages of Auditing:
1. Ensures Accuracy and Reliability:
Audits help verify the accuracy of financial records, ensuring that the financial
statements present a true and fair view of the company’s financial position.
2. Detects Errors and Fraud:
Auditing can uncover both unintentional errors and deliberate fraud, helping to
maintain the integrity of financial information.
3. Enhances Credibility:
Audited financial statements are more credible, which helps build trust with
stakeholders such as investors, creditors, and regulatory bodies.
4. Improves Internal Controls:
 The audit process often highlights weaknesses in internal controls and provides
recommendations for improvement, helping the organization manage risk more
effectively.
5. Helps in Compliance:
Auditors check whether the company complies with laws, regulations, and
accounting standards, ensuring legal and regulatory compliance.
6. Assists in Decision-Making:
Reliable financial information from an audit helps management make informed
decisions about budgeting, investments, and business strategies.
7. Increases Efficiency:
Auditors often provide feedback that can help streamline processes and improve
operational efficiency by identifying areas of waste or inefficiency.
8. Boosts Investor Confidence:
Audited accounts reassure current and potential investors, giving them confidence
in the company’s financial health and stability.
Limitations of Auditing:
1. Possibility of Undetected Errors and Fraud:
Audits are not fool proof and may not detect all errors or fraud, especially if
sophisticated fraud schemes are in place or if collusion is involved.
2. Dependence on Sampling:
Auditors often rely on sampling techniques rather than checking every transaction,
which may result in missing some irregularities or errors.
3. Subjectivity in Judgment:
Auditors rely on their professional judgment, which can vary. Interpretation of
accounting policies or financial disclosures can sometimes lead to subjective
conclusions.
4. Costly and Time-Consuming:
Audits can be expensive and time-consuming, especially for small businesses. The
process involves detailed examination, which requires significant resources.
5. Limited Scope:
The scope of the audit is restricted to financial matters, and it may not cover
operational or strategic aspects of the business that could also be important.
6. Dependence on Information Provided:
Auditors depend on the information provided by management and staff. If
management withholds information or provides false data, the audit may not be
effective.
7. Historical Focus:
Audits focus on past financial transactions and may not provide insight into future
risks or challenges the business might face.
8. Not an Absolute Guarantee:
 An audit opinion does not guarantee that the financial statements are completely
error-free. It only provides reasonable assurance that they are free from material
misstatement.

Classification of audit
Basis of Classification Type of Audit
1. Based on Purpose 1. Financial Audit
2. Compliance Audit
3. Operational Audit
4. Internal Audit
5. External Audit
2. Based on Timing 1. Continuous Audit
2. Interim Audit
3. Final Audit
3. Based on Scope 1. Complete Audit
2. Partial Audit
3. Balance Sheet Audit
4. Cost Audit
4. Based on Who Conducts it 1. Internal Audit
2. External Audit
5. Based on Legal Requirement 1. Statutory Audit
2. Non-Statutory Audit
6. Based on Specific Focus 1. Information Systems Audit
2. Forensic Audit
3. Social Audit
4. Performance Audit

Explanation of Each Classification:

i. Based on Purpose:
1. Financial Audit:
A financial auditis a check-up of a company’s financial records and statements. The goal is
to make sure that the numbers reported (like profits and expenses) are accurate and follow the
rules of accounting. This helps assure investors and stakeholders that the company’s financial
health is properly represented.
2. Compliance Audit:
A compliance audit looks at whether a company is following laws, regulations, and its own
policies. This type of audit ensures that the organization is operating within legal guidelines
and industry standards, helping to avoid fines and legal issues.
3. Operational Audit:
An operational audit reviews how well a company is running its operations. It examines
processes to see if they are efficient and effective. The aim is to find ways to improve
productivity and reduce waste, helping the company run better.
4. Internal Audit:
An internal audit is done by a company’s own staff to check how well it is managing risks
and controls. This type of audit helps the organization identify areas that need improvement
and ensures that everything is working as it should internally.
5. External Audit:
An external auditis performed by independent auditors who are not part of the company.
Their job is to provide an unbiased opinion on the company’s financial statements. This helps
build trust with investors and stakeholders by confirming that the financial information is
reliable and accurate.
ii. Based on Timing:
 Continuous Audit: Conducted regularly throughout the year to ensure ongoing
accuracy of financial transactions.
 Interim Audit: Performed during the financial year, typically at intervals, to review a
portion of the financial statements.
 Final Audit: Conducted at the end of the fiscal year to review and verify the annual
financial statements.
iii. Based on Scope:
 Complete Audit: Covers all aspects of the financial records and transactions.
 Partial Audit: Focuses on specific areas or transactions.
 Balance Sheet Audit: Reviews only the balance sheet items (assets, liabilities,
equity).
 Cost Audit: Verifies the accuracy of cost records and compliance with cost
accounting standards.
IvBased on Who Conducts It:
 Internal Audit: Conducted by the organization's own staff or internal audit
department.
 External Audit: Performed by external, independent auditors from outside the
organization.
v. Based on Legal Requirement:
 Statutory Audit: Required by law for certain organizations, such as companies
registered under the Companies Act.
 Non-Statutory Audit: Performed voluntarily at the discretion of management or
stakeholders.
vi. Based on Specific Focus:
 Information Systems Audit: Reviews the controls and security of the organization’s
IT systems.
 Forensic Audit: Focuses on detecting and investigating fraud or financial crimes.
  Social Audit: Assesses the organization's social responsibility, ethical practices, and
community impact.
 Performance Audit: Evaluates how well the organization is using its resources to
achieve objectives and goals efficiently.

Audit program
An audit program is a detailed plan that outlines the procedures and steps an auditor
will follow during an audit. It serves as a guide for what will be examined, how the
examination will be conducted, and the timeline for completing the audit
Appointment of Company Auditor:
 Initial Appointment:
The first auditor of a company is typically appointed by the Board of Directors
within 30 days of the company's incorporation. If the Board fails to appoint, the
members of the company must appoint the auditor at an extraordinary general
meeting within 90 days.
 Subsequent Appointments:
In subsequent years, the company’s auditor is appointed at the annual general
meeting (AGM) of the company. The appointment is usually for a term of five
years, subject to ratification by the shareholders.
 Eligibility:
The appointed auditor must be a qualified Chartered Accountant (CA) or a firm of
CAs, as per the relevant regulations and laws (e.g., Companies Act in India).

Qualification of Company Auditor:

The qualification of a company auditor refers to the necessary educational background,
professional credentials, and other attributes that an individual must possess to perform
auditing functions effectively. Below are the key qualifications required for a company
auditor:
1. Educational Qualifications:
 Degree in Accounting or Finance:
A bachelor's degree in accounting, finance, or a related field is typically required.
Some jurisdictions may require a master's degree.
2. Professional Qualifications:
 Chartered Accountant (CA):
In many countries, including India, the primary qualification for company auditors
is to be a Chartered Accountant. This involves passing rigorous examinations and
gaining relevant work experience.
 Certified Public Accountant (CPA):
In the United States, auditors often hold a CPA designation, which requires
passing a comprehensive exam and meeting state-specific requirements.
 Other Certifications:
 Other recognized qualifications may include Certified Internal Auditor (CIA),
Certified Management Accountant (CMA), or Association of Chartered Certified
Accountants (ACCA) certifications, depending on the country and regulatory
requirements.
3. Experience:
 Relevant Work Experience:
Auditors usually need to have practical experience in auditing or accounting.
Many jurisdictions require a certain number of years of experience under the
supervision of a qualified auditor before they can independently conduct audits.
4. Membership in Professional Bodies:
 Membership in Professional Accounting Organizations:
Auditors are often required to be members of professional accounting bodies (e.g.,
Institute of Chartered Accountants) that regulate the profession and enforce ethical
standards.
5. Independence and Objectivity:
 Independence:
Auditors must maintain independence from the companies they audit to ensure
unbiased opinions. They should not have any conflicts of interest, financial
relationships, or other ties that could affect their judgment.
6. Continuing Professional Education:
 Ongoing Training and Development:
Auditors are required to engage in continuous professional education to stay
updated with the latest accounting standards, auditing techniques, and regulatory
changes.
7. Knowledge of Relevant Regulations:
 Understanding of Laws and Regulations:
Auditors must be knowledgeable about relevant laws, regulations, and accounting
standards applicable to the companies they audit.
Removal of Company Auditor:
 By the Company:
An auditor can be removed before the completion of their term through a
resolution passed at a general meeting. The company must give special notice to
the auditor about the proposed resolution and allow them to present their case.
 Regulatory Approval:
In many jurisdictions, the removal of an auditor may require prior approval from
regulatory authorities, such as the Registrar of Companies (RoC) or equivalent in
the respective country.
 Resignation:
An auditor can resign voluntarily. In this case, the auditor must submit a
resignation letter, and the company must fill the vacancy as per legal
requirements.
  Disqualification:
An auditor may be disqualified for reasons such as failure to meet eligibility
criteria, being declared insolvent, or facing legal issues.
Powers of Company Auditors:
 Access to Records:
Auditors have the right to access all books, records, and documents of the
company relevant to the audit. This includes financial statements, ledgers, and
other necessary information.
 Conduct Investigations:
Auditors can conduct investigations and inquiries to gather evidence about the
financial position and operational activities of the company.
 Obtain Information:
They can request information from employees, management, and directors
necessary to perform their audit functions.
 Seek Legal Advice:
Auditors have the power to seek legal or professional advice when necessary to
fulfill their responsibilities effectively.
 Report Findings:
Auditors have the authority to report any discrepancies, irregularities, or
fraudulent activities they discover during the audit to the appropriate authorities or
stakeholders.
Duties of Company Auditors:
 Conduct Audit in Accordance with Standards:
Auditors must conduct their audits in compliance with established auditing
standards and ethical guidelines (such as the International Standards on Auditing
or national equivalents).
 Express an Opinion:
They are responsible for providing an independent opinion on the truth and
fairness of the company’s financial statements, ensuring that they comply with
applicable accounting standards.
 Examine Financial Statements:
Auditors must thoroughly examine financial statements and underlying records to
assess accuracy, completeness, and compliance with regulatory requirements.
 Evaluate Internal Controls:
Part of their duty includes evaluating the effectiveness of the company’s internal
control systems and making recommendations for improvement if necessary.
 Report to Shareholders:
Auditors must prepare an audit report that is presented to the shareholders during
the annual general meeting, detailing their findings and opinions.
 Maintain Confidentiality:
 Auditors are required to maintain confidentiality regarding any sensitive
information obtained during the audit process.
Liabilities of Company Auditors:
 Civil Liability:
Auditors can be held liable for negligence if they fail to perform their duties with
the expected level of care and diligence. This may result in claims for damages by
the company, shareholders, or third parties.
 Criminal Liability:
If auditors are found to have engaged in fraudulent activities or willfully
misrepresented facts in their audit report, they can face criminal charges, leading
to fines or imprisonment.
 Professional Disciplinary Actions:
Auditors can face disciplinary action from professional accounting bodies if they
violate ethical standards or professional conduct regulations.
 Liability for Misstatements:
Auditors may be held liable for damages resulting from misstatements or
omissions in their audit reports, especially if stakeholders rely on those reports for
decision-making.
 Indemnification:
Some companies provide indemnification clauses in their agreements with
auditors, which can protect auditors from certain liabilities, but this does not cover
gross negligence or wilful misconduct.