Audit Unit 1 Notes RA

PRINCIPLES AND PRACTICE OF AUDITING (B.
COM 6TH SEM AS PER CBCS SYLLABUS)
UNIT-1
INTRODUCTION TO AUDITING
Introduction
The practice of auditing existed even in the Vedic period. Historical records show
that Egyptians, Greeks and Roman used to get this public account scrutinized by and
independent official. Kautaly in his book ―Arthashastra has stated that ―all
undertakings depend on finance; hence foremost attention should be paid to the
treasury.
Meaning
The word audit is derived from the Latin word “AUDIRE” which means to hear,
one who hears from Accountant is called Auditor.
Auditing is a process of Examining books of Accounts by an External force or
Independent force for the Accuracy of books of accounts.
Auditing and Assurance Standard (AAS1) by ICAI: “Auditing 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 expression an opinion thereon”
According to Ronald Irish: “Auditing in its modern concept, is a scientific and
systematic examination of books, vouchers and other financial and legal records in
order to verify and report upon the facts regarding the financial condition disclosed
by the balance sheet and the net income revealed by the profit and loss account.”
❖ OBJECTIVE OF AUDITING
“The main object of an audit is to ascertain that the Balance Sheet and Profit & Loss
Account of an undertaking is showing true and fair view of its financial positions
and earnings.” However objectives of audit can be divided into two different parts:
1. Primary objectives
2. Secondary objectives
Primary Objectives / Basic Objectives
The main or primary objective of Auditing is to find out the reliability and validity
of the financial statements so as to render opinion on the truthfulness and fairness of
the presentations in those statements. The auditor has to give an opinion on financial
statements whether they are True and Fair view i.e. whether
a) Balance sheet shows true and fair view of the concern,
b)the profit and loss accounts give a true and fair view of the profit or loss of the
concern,
c)all the material facts has been disclosed,
RAGHAVENDRA K ADHYAPAK
1
KLS GOGTE COLLEGE OF COMMERCE ,BELAGAVI
PRINCIPLES AND PRACTICE OF AUDITING (B.COM 6TH SEM AS PER CBCS SYLLABUS)
d) the organization has followed all the compliance with regarding to legal
requirement and
e) Final accounts are made according to the recognized accounting principles and
auditing standards laid down by professional bodies, like ICAI.
Secondary Objectives / Incidental Objectives

The secondary objective of audit is to detect and prevent the errors and frauds. An
error is generally taken to be innocent and not deliberate. Where it appears to be
willfully made, it assumes the character of a fraud.
The term “fraud” refers to an intentional act by one or more individuals of
management, employees or outsiders, severally or jointly, involving the use of
deception to obtain an unjust or illegal advantage. It’s not an objective of an audit to
give a guarantee that all is well with the concern. A clean audit report does not imply
that the management has efficient.
ERRORS AND FRAUDS
The accounting errors based on their nature can be of the following types:
1. Clerical Errors
2. Errors of Principle
1. Clerical Errors: The errors which are committed by accounting clerks are called
clerical errors. These errors are committed in the process of recording financial
transactions. These take place due to the carelessness of the clerk responsible for
recording financial transactions. Clerical errors are also called technical errors. The
principal types of clerical errors are as follows:
(a) Errors of Omission: The errors committed by not recording a transaction either
in the book of original entry or in the ledger book are errors of omission. Such an
omission may be either complete or partial. Errors
Error of principle/ Clerical Error
Error of duplicate
Error of Commission
Error of Omission
Compensating Error
Complete Omission: Complete omission takes place if a transaction is not recorded
in the journal at all. For example, goods sold to Mr. A for ` 10,000 were not recorded
in the sales book at all. A complete omission of transaction may occur due to many
reasons such as sales invoice misplaced or lost.
Partial Omission: Partial omission occurs if a financial transaction is recorded only
partially. For example, partial error of omission occurs if goods sold to Mr. A for `
4,000 is recorded in sales book but failed to be posted in John’s account.
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(b) Errors of Commission: The errors which are committed while recording or
posting a transaction are called errors of commission. Errors of commission may
take place either in the journal or in the subsidiary books, or in the ledger. Such
errors include posting wrong amounts, posting on wrong side of accounts, wrong
totaling or carrying forward, and wrong balancing. For example, if purchase of
goods for ` 10,000 is entered as ` 1,000 in the journal or in the ledger, such error is
called errors of commission.
(c) Compensating Errors: compensating errors refer to two or more errors which
mutually compensate the effects of one another. If one error balances the effect of
another error, then the two error are called compensating errors. For example,
goods sold for ` 5,000, but wrongly posted to the customer’s account as ` 500.
Similarly, goods purchased for ` 5,000, but by chance, wrongly posted to the
supplier’s account as ` 500. The errors in the personal account are compensated by
each other, as ` 4,500 short on the debit side of the customer’s account and on the
credit side of the supplier’s account.
(d) Errors of Duplication: Errors of duplication are those errors which arise
because of double recording. Double posting of a transaction from journal or
subsidiary books to ledger also create such errors. For example, goods sold to Mr.
A, but this transaction is wrongly entered twice or more in the sales book or wrongly
posted twice or more in John’s account then it is called the errors of duplication.
2. Errors of Principle: Errors of principle are those errors which occur by violating
the principles of accounting. Errors of principle may occur due to wrong allocation
between capital and revenue expenditure, or wrong valuation of assets. For example,
debiting the wage account instead of machinery account for the wage paid to the
mechanics used for the installation of machine and debiting the customer’s account
instead of cash account for the cash sales made. Errors of principle may also occur
due to wrong valuation of assets by higher level staff.
FRAUDS
Fraud means intentional misrepresentation of financial information by management,
employee or third parties. Fraud may be of following types:
1. Fraud through defalcation
(a) Misappropriation of cash
(b) Misappropriation of goods
2. Fraud through accounts
(a) Not recording a transaction
(b) Recording the dummy transaction
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1. Fraud through Defalcation

Following are the method of defalcation involving misappropriation of cash or
goods:
A. Misappropriation of Cash:
(a) Misappropriation of cash receipt by not recording the same,
(b) By suppressing the cash either not recording the cash or showing them as credit
sales,
(c) Showing payment twice in the cash book
(d) By teeming and lading procedure that is cash received from one debtor is
appropriated and deficiency in that accounts of debtors is made good when cash
received from second debtors and the deficiency in the second debtors is made
good when cash received from third debtors and so on…
B. Misappropriation of Goods:
(a) Goods may be misappropriated by showing dummy sales,
(b) Goods are actually received in the organization but are shown as not received
and good are misappropriated.
2. Fraud through Accounts
● Not Recording a Transaction: These types of errors are intentional like sales
take place but not shown in the books of accounts.
● Recording Dummy Transaction: examples of these types of errors are showing
wages or salary in the dummy workers accounts.
Difference Between Accountancy and Auditing.

Point of Difference Accounting Auditing
Meaning Accounting means the Auditing means
maintaining books of examining the books of
accounts. accounts and reporting
the accuracy.
Performance of Work Accountant job is Auditing job is performed
performed by by the auditor.
Accountant.
Appointment Accountant is appointed Auditor is appointed by
by the management as an the management as an
employee. Expert from outside the
company.
Nature of Job Accountant job is Auditor job is not so
mechanical in nature mechanical.
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Qualification Accountant does not Auditor requires specific

require specific qualification.
qualification.
Responsibility The responsibility of the The responsibility of the
accountant is fixed by the auditor is fixed by the
management. Law.
Submission of Report To the management To the shareholders
Time In case of accounting The period of may be one
period is usually one year. year or half year or
quarterly.
Purpose The purpose of Auditing verifies the true
accounting is to show the picture of the financial
financial position of a statement.
business.
Record/ Data Accounting is related Auditing is related with
with the present record. the past record.
Nature of Employment Accountant is a Auditor is not a
permanent employee. permanent employee.
Reward Reward of accountant is Reward of auditor is
called as Salary. called as Fee.
Liability Accountant has no Auditor has a liability
liability after preparing after presenting the
the final accounts. auditor report.
Importance Accounting is necessary Auditing is not necessary
for every business. for every business.
Rules Accounting is not Auditing is governed by
governed by the code of the code of conduct
conduct laid down by any specified by the Institute
institute. of Charted Accountants.
Removal Accountant can be Auditor cannot be
removed from his job at removed till he completes
any time. his period of appointment
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❖ TYPES OF AUDITS:
1. Statutory Audit: any audit carried on as per the requirement of law is called as a
statutory audit. E.g.: all companies have to get their accounts audited as per the
provision of the company‘s Act of 2013
2. Annual Audit: it is a kind of audit where the auditor verifies the account at the
end of the financial year. He starts the audit work after the closure of financial year.
This is a common audit and is mostly used by small organizations.
3. Interim audit: it‘s an audit conducted in the middle of the accounting year before
the accounts are closed. In other words any audit conducted between two financial
audits is known as interim audit. The objective is to get periodical results, to declare
interim dividend.
4. Partial Audit: when an auditor is asked to audit only a part of the account system.
It‘s called partial audit. E.g.: he may be asked to audit only the payment side of cash
book.
5. Balance sheet audit: it‘s a kind of partial audit and is concerned with the
verification of only those items appearing in the Balance Sheet. It is more popular
in the USA. In fact, while verifying BS items the auditor verifies/ checks all related
items/accounts.
6.Private Audit:
Where audit in the case of an enterprise is not compulsory by law, though it is opted
for by the enterprise in view of the several benefits resulting from it, it is called
private audit. In India, for example, sole proprietary concerns, partnership firms,
joint Hindu family businesses, etc., are not obliged under the law to get their
financial statements audited. However, according to the Income-tax Act, tax audit
by a professional auditor has been made compulsory in the case of all businesses
whose turnover exceeds Rs.40 lacs and all professional persons whose gross receipts
exceed Rs.10 lacs.
7.Internal Audit
Internal audit may be defined as a exercise in managerial control by means of an
independent appraisal by employees of the organization itself. In simple words this
audit is conducted by internal by the employees of the company to report the
management regarding good governance, follow up of laws, rules and regulations.
8. Cost audit: cost audit is defined as the verification of cost accounting records.
Data and techniques for its accuracy and authenticity. It gets as effective managerial
tool for the detection of errors and frauds in cost accounting records. The companies
act implies the central government to order cost audit in case of specifies companies.
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9. Management audit: Management audit may be defined as a comprehensive

examination of an organizational structure of a company, institution/government and
its plans and objectives it means of operations and use of human and physical
facilities. The main objective of mgt audit is to see how far the objectives of mgt are
fulfilled. It aims to ascertain whether sound mgt prevails throughout the organization
and evaluates its efficiency in the system of its operation.
10. Continuous audit: a continuous audit is one in which the auditor visits his
client‘s office at regular intervals throughout the year to verify the account. The
objective of Continuous audit may be-
a. To get final account audited immediately after the closure of accounting year.
b. When the business is very large.
c. When interval control system is into effective.
d. When regular final accounts are required.
“A continuous audit involves a detailed examination of all the transactions by the

auditor attending at regular intervals say weekly, fortnightly or monthly, during the
whole period of trading.” - T.R. Batliboi
Business where continuous audit is applicable:
* Where it is desired to present the account just after the close of the financial year,
as in the case of a bank.
* Where the volume of the transactions is very large.
* Where the statements of accounts is required to be presented to the management
after every month or quarter.
* Where no satisfactory system of internal check is in operation.
Advantages of Continuous Audit
1. Easy to quick discovery of errors
Errors and frauds can be discovered easily and quickly as the auditor checks the
accounts at regular intervals and in detail. As a auditor visits the client after a month
or two or so on, the number of transactions will be small and hence, the errors will
be detected easily and quickly.
2. Knowledge of technical details

Since the auditor remains more in touch with the business, s/he is in a position to
know its technical details and hence can be of great help to her/his clients by making
valuable suggestions.
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3. Quick presentation of accounts

As most of the checking works are already performed during the year, the final
audited accounts can be presented to the shareholders soon after the close of the
financial year at annual general meeting.
4. Keeps the client's staff alert
As the auditor visits the clients at regular intervals, the clerks are very regular in
keeping the accounts up-to-date. They will see that there is no in accuracy or frauds
as it would be detected by the auditor at the next visit.
5. Moral check on the client's staff
If the auditor pays surprise visit, it will have a considerable moral check on the clerks
preparing the accounts as they do not know when the auditor may pay a visit to
check. Moral check will be more valuable to make staff alert and careful.
6. Complete checking of all the records: Since the audit is carried out throughout
the year, sufficient time is available for detailed checking. Any enquiry and doubt
arising in the course of audit can be tackled in a better way.
7. Proper planning: Auditor can plan his audit work in a systematic manner. He
can evenly spread his work throughout the year. It will improve efficiency of auditor.
8. Early detection of frauds and errors: The work of auditor becomes easier for
detecting frauds and errors, otherwise it will involve more time.
9. Up-to-date accounts: The efficiency of account staff will increase and their work
will be up-to-date and accurate.
10. Valuable suggestions: Continuous audit will help the auditor to understand the
technicalities of business. This will help the auditor to make suggestions for the
improvement of business.
Disadvantages of Continuous Audit:

1. Expensive: It is an expensive system as it may not suit the budget of small
organizations.
2. Dislocation of routine work: Frequent visits by auditor may dislocate the smooth
flow of office work.
3. Alteration of Figures: after the accounts have been audited, the figures may be
fraudulently altered by the staff.
4. Losing link in the audit work: As the work is not completed continuously, the
auditor may lose continuity and certain questions and inquires may be left
unanswered.
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❖ Preparation before commencement of the audit:

An auditor after receiving the appointment letter should communicate his
acceptance/otherwise in writing to the company. The following steps are necessary
to commence the audit work:
1. If it is not a statutory audit, he should find out the exact nature and scope of his
duties i.e., whether he has to audit the account/prepare accounts also.
2. He should inform his clients to close all the books of account and keep them ready
for verification
3. He should acquaint himself with the nature of his client business.
4. He should examine the efficiency of the internal control system.
5. He should obtain the names of directors their power duties etc.
6. He should obtain a complete list of all books and documents maintained by the
clients.
7. He should obtain a copy of previous year‘s audit report.
8. He should go through various documents like MOA, AOA, prospectus etc.
Audit Programme:
before commencing the audit he should plan his work so that is over without delay.
For this purpose the auditor chalks out a detailed programme explaining the
procedure to be followed for audit. It explains the work to be done by the audit staff.
An audit programme is defined as ―a detailed plan of the auditing work to be
performed, specifying the procedure to be followed in verification of each item in
the financial statements, and giving the estimated time required‘.
Hence an audit programme is a statement giving instructions and guidance to the
audit staff as to the audit procedure. It arranges and distributes the work among the
audit staff.
ADVANTAGES:
1. It provides the audit staff clear instructions about their duties.
2. It promotes division of work in a well-organized manner.
3. It helps the auditor to monitor the progress of the work.
4. It will be easier to fix responsibilities for omissions and commissions.
5. It serves as a valuable evidence for the work done.
6. It serves as a guide for future audit.
7. It ensures that audit process in a systematic manner.
8. It eliminates inefficiency and saves time.
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9. Incase if any audit assistant goes on leave, his work can be easily continued by
others.
10. It avoids duplication of work.
Disadvantages of Audit Programme.

1. The audit work becomes mechanical.
2. It kills the creativity of the audit staff.
3. Chances of work not done properly/ high as the scope are to be completed within
a scheduled time.
4. A rigid programme may not be suitable for all kinds of business.
The above disadvantages can be minimized if the audit programme is made more
flexible and audit staff encourages going beyond the work mentioned in the audit
programme. The auditors should also periodically review the programme in the light
of experiences gained in the previous year. He should impress upon the audit staff.
The audit programee is only guidance and they should use their initiatives,
intelligence and common sense at all times during the course of the audit.
Audit Note Book: an audit note book is one of the most important documents
maintained by the auditor. It is defined as a record used mainly in recording audit,
containing data on work done and comments made. Audit Note book contains
information regarding the day to day work performed by the audit staff, notes about
errors, explanations required etc. the auditor can use it as an authentic evidence in
the court if there is any case against him.
Contents of Audit Note Book:
1. Nature of business and important documents such as MOA, AOA, Partnership
deed etc.
2. List of books of accounts.
3. List of officials, their duties and responsibilities.
4. Copy of the audit programme.
5. Information on missing receipts, vouchers etc.
6. Details of errors discovered.
7. Explanations sought from the officials.
8. Points to be included in the audit report.
An audit note book should be preserved by the auditor as it contains valuable
information in respect of the work done by its staff.
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Audit Working Papers:

Audit working papers are those papers which contain essential facts about accounts,
which are being audited. It‘s defined as the file of analysis, summaries, comments
and correspondence build up by the auditor during the course of audit.
The auditor maintains papers as supporting evidence to the audit work. The institute
of chartered accountants of India states that ―an auditor is expected to maintain
evidence of work done by him and his staff‖.
Usually, audit working papers contains a copy of the trial balances, schedule of
debtors and creditors, reconciliation statements important correspondence etc.
Purpose of maintaining working paper:

1. They show the extent to which accounting principles and auditing standards have
adhered to.
2. They provide the required support for the auditor‘s report.
3. They also reveal the efficiency with which the audit work was done.
4. They can be used as evidence in the court to defend himself against negligence in
his duty.
5. They help the auditor in finalizing his report quickly.
6. They help the auditor to understand the efficiency of the accounting system,
internal check system etc.
Working papers should be clear complete, and contain the necessary information so
that they may be of maximum utility. They should be properly organized,
documented and signed. In this regard it‘s said that ―an auditor is often judged by
the quality of the working paper prepared by him under his guidance‖.
Working papers are confidential documents hence he should not disclose the facts
to others. Doing so results in professional misconduct. Working papers should be
preserved properly because they are important documents.
RECENT TRENDS IN AUDITING

➢ GST AUDIT
Audit under GST is the process of examination of records, returns and other
documents maintained by a taxable person. The purpose is to verify the correctness
of turnover declared, taxes paid, refund claimed and input tax credit availed, and to
assess the compliance with the provisions of GST.
When GST Audit is required to be conducted?
Any registered taxable person whose annual aggregate turnover exceeds 5 crore INR
during a financial year needs to get their accounts audited.
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Objectives Of GST Audit

Audit is examination of records, return and other documents. Those records,
returns and documents might have been maintained or furnished under GST law or
any other law. To verify the correctness of :-
1.Turnover declared
2.Taxes paid
3.Refund claimed
4.Input tax credit availed To assess auditee’s compliance with the provisions of
GST Act and Rules.
Types of GST Audit

Mandatory GST Audit (Section 35(5) Audit by professionals)
Departmental GST Audit (Section 65 Audit by Tax Authorities)
Special Audit (Section 66 Audit by Tax Authorities)
➢ Cost Audit( Nature & Significance)

It is an audit process for verifying the cost of manufacture or production of any
article, on the basis of accounts as regards utilization of material or labor or other
items of costs, maintained by the company.
In simple words the term cost audit means a systematic and accurate verification of
the cost accounts and records and checking of adherence to the objectives of the cost
accounting. As per ICWA London‘ ―cost audit is the verification of the correctness
of cost accounts and of the adherence to the cost accounting plan.
In cost audit, auditor has to perform the following duties –
• Examine the correctness of the cost records maintained by the concern and
• To report as to whether the cost accounting plans have been adhered to or not.
Advantage of cost Audit

(a) To the Management –
i. Management gets reliable data for its day-to-day operations like price fixing,
control, decision making, etc.
ii. A close and continuous check all wastage‘s will be kept through a proper system
of reporting to management.
iii. Inefficiencies in the working of the company will be brought to light to facilitate
corrective action.
iv. Management by exception becomes possible through allocation of
responsibilities to individual managers.
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v. System of budgetary control and standard costing will be greatly facilitated.

vi. Reliable check on valuation of closing stock and work-in-progress can be
established.
vii. Helps in detection of frauds and errors.
(b) To the shareholders –

Cost Audit ensures that proper records are kept as to purchases and utilization of
material and expenses incurred on wages, etc. It also makes sure that the valuation
of closing stock and work-in-progress is on a fair basis. Thus, the shareholders are
assured of a fair return on their investment.
Disadvantage of Cost Audit

These are following disadvantages of cost accounting.
i. Accountants cannot estimate price of assets at current values.
ii. Only covers cost of business does not overcome overall profitability.
iii. Manipulations in accounts still exist.
iv. Standards of accounting vary from business to business.
➢ Tax Audit(Nature& Significance)

For maintaining transparency in the financial statements filed by the assesses with
the Income-tax department.
The tax audit u/s. 44AB of the Income-tax Act 1961 is significant practice area for
Chartered Accountants.
Since the introduction of tax audit, we have been given responsibilities to discharge
the duties as tax auditors for the proper compliance of tax law by the assesses. Under
the existing provisions of section 44AB, every person carrying on business is
required to get his accounts audited if the total sales, turnover or gross receipts in the
previous year exceed sixty lakh rupees. Similarly, a person carrying on a profession
is required to get his accounts audited if the total sales, turnover or gross receipts in
the previous year exceed fifteen lakh rupees.
In order to reduce the compliance burden on small businesses and on
professionals, it is proposed to increase the threshold limit of
i. total sales, turnover or gross receipts, specified under section 44AB for getting
accounts audited, from sixty lakh rupees to one crore rupees in the case of persons
carrying on business and
ii. from fifteen lakh rupees to twenty-five lakh rupees in the case of persons carrying
on profession.
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It is also proposed that for the purposes of presumptive taxation under section 44AD,
the threshold limit of total turnover or gross receipts would be increased from sixty
lakh rupees to one crore rupees.
➢ Management Mudit(nature & Significance)

Management audit is a comprehensive and thorough examination of an organization
or one of its components. This is also a Combination of Finance and Cost term
Audit. The audit is implemented to identify problems or significant weaknesses in
the organization or corporation, thus providing management with a tool to address
and repair the problem area.
The management audit is now widely accepted in the business field. For more than
40 years, corporations and non-profit organizations have utilized the
management audit as a comprehensive tool. The study team then develops
conclusions and recommendations which are communicated to the organization‘s
management. These final two stages—conclusions/recommendations and
communication—are essential to the management audit process.
The audit is expected to identify corporate strengths and weaknesses, sources of
problems, and potential problem areas.
Recommendations for correction are presented to top management. The final report
comes in the form of an overall plan of action, which includes prioritized
recommendations, the specific units and individuals expected to carry out the
recommendations, a schedule for action, and expected results.
When conducted with thoroughness, objectivity, and timeliness, the management
audit becomes a powerful tool for corporate and organizational executives who seek
to improve effectiveness and efficiency.
An important aspect of the management audit is the composition of the study team.
Both internal and external analysts are frequently used on audit teams; the
composition depends on several factors, including the need for independent
appraisal, the lack of human or financial resources to conduct the audit, and the need
to provide an external audit to contrast against internal findings. In some instances,
associations such as the American Institute of Management (AIM) provide audit
teams.
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PRINCIPLES AND PRACTICE OF AUDITING (B.

COM 6TH SEM AS PER CBCS SYLLABUS)

Secondary Objectives / Incidental Objectives

1. Fraud through Defalcation

Difference Between Accountancy and Auditing.

Qualification Accountant does not Auditor requires specific

9. Management audit: Management audit may be defined as a comprehensive

“A continuous audit involves a detailed examination of all the transactions by the

2. Knowledge of technical details

3. Quick presentation of accounts

Disadvantages of Continuous Audit:

❖ Preparation before commencement of the audit:

Disadvantages of Audit Programme.

Audit Working Papers:

Purpose of maintaining working paper:

RECENT TRENDS IN AUDITING

Objectives Of GST Audit

Types of GST Audit

➢ Cost Audit( Nature & Significance)

Advantage of cost Audit

v. System of budgetary control and standard costing will be greatly facilitated.

(b) To the shareholders –

Disadvantage of Cost Audit

➢ Tax Audit(Nature& Significance)

➢ Management Mudit(nature & Significance)

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