Principles of Auditing · 2020-04-19 · Principles of Auditing 1 Ranjith Kumar.A, St.Anne’s...

Principles of Auditing

1 Ranjith Kumar.A, St.Anne’s Degree College for Women

AN OVERVIEW OF AUDITING

Economic decisions in every society must be based upon the information available at the time

the decision is made. For example, the decision of a bank to make a loan to a business is

based upon previous financial relationships with that business, the financial condition of the

company as reflected by its financial statements and other factors.

If decisions are to be consistent with the intention of the decision makers, the information

used in the decision process must be reliable. Unreliable information can cause inefficient use

of resources to the detriment of the society and to the decision makers themselves. In the

lending decision example, assume that the barfly makes the loan on the basis of misleading

financial statements and the borrower Company is ultimately unable to repay. As a result the

bank has lost both the principal and the interest. In addition, another company that could have

used the funds effectively was deprived of the money.

As society become more complex, there is an increased likelihood that unreliable information

will be provided to decision makers. There are several reasons for this: remoteness of

information, voluminous data and the existence of complex exchange transactions

As a means of overcoming the problem of unreliable information, the decision-maker must

develop a method of assuring him that the information is sufficiently reliable for these

decisions. In doing this he must weigh the cost of obtaining more reliable information against

the expected benefits.

A common way to obtain such reliable information is to have some type of verification

(audit) performed by independent persons. The audited information is then used in the

decision making process on the assumption that it is reasonably complete, accurate and

unbiased.

ORIGIN AND EVOLUTION

The term audit is derived from the Latin term „audire,‟ which means to hear. In early days an

auditor used to listen to the accounts read over by an accountant in order to check them

Auditing is as old as accounting. It was in use in all ancient countries such as Mesopotamia,

Greece, Egypt. Rome, U.K. and India. The Vedas contain reference to accounts and auditing.

Arthasashthra by Kautilya detailed rules for accounting and auditing of public finances.

The original objective of auditing was to detect and prevent errors and frauds. Auditing

evolved and grew rapidly after the industrial revolution in the 18th

century with the growth of

the joint stock companies the ownership and management became separate. The shareholders

who were the owners needed a report from an independent expert on the accounts of the

company managed by the board of directors who were the employees.

The objective of audit shifted and audit was expected to ascertain whether the accounts were



true and fair rather than detection of errors and frauds.

In India the companies Act 1913 made audit of company accounts compulsory. With the

increase in the size of the companies and the volume of transactions the main objective of

audit shifted to ascertaining whether the accounts were true and fair rather than true and

correct. Hence the emphasis was not on arithmetical accuracy but on a fair representation of

the financial efforts.

The companies Act. 1913 also prescribed for the first time the qualification of auditors. The

International Accounting Standards Committee and the Accounting Standard board of the

Institute of Chartered Accountants of India have developed standard accounting and auditing

practices to guide the accountants and auditors in the day to day work.

The later developments in auditing pertain to the use of computers in accounting and

auditing.In conclusion it can be said that auditing has come a long way from hearing of

accounts to taking the help of computers to examine computerized accounts.

Introduction

Initially auditor was a person appointed by the owners to check account whenever the

suspected fraud, he was to hear explanation given by the person responsible for financial

transactions. Emergence of joint stock companies changed the approach of auditing as

ownership was pestered from management. The emphasis now is clearly on the verification

of accounting date with a view on the reliability of accounting statement.

Auditing is defined as a systematic and independent examination of data, statements,

records, operations and performances (financial or otherwise) of an enterprise for a stated

purpose. In any auditing the auditor perceives and recognizes the propositions before him

for examination, collects evidence, evaluates the same and on this basis formulates his

judgment which is communicated through his audit report

Definitions

Spicer and Peglar define auditing as “An examination of the books, accounts and vouchers

of a business‟s shall enable the auditor to satisfy himself whether or not the balance sheet is

properly drawn up so as to exhibit a true and correct view of the state of affairs of the

business according to his best of the information given to him and as shown by the book.

Mautz defines auditing as being “Concerned with the verification of accounting data with

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



The international auditing practices committee defines auditing as “the independent

examination of financial information of any entity whether profit oriented or not and

irrespective of size/legal form when such an examination is conducted with a view to express

an opinion thereon”.

Scope of Audit

The scope of audit is increasing with the increase in the complexities of the business. It is

said that long range objectives of an audit should be to serve as a guide to the management

future decisions.

Today most of the economic activities are largely conducted through public finance. The

auditor has to see whether these larger funds are properly used. The scope of audit

encompasses verification of accounts with a intention of giving opinion on its reliability.

Hence it covers cost audit, management audit, social audit etc. It should be remembered that

an auditor just expressed his opinion on the authenticity of the account. He has no power to

take action against anybody, in this regard its said that “an auditor is a watch dog but not a

blood hound”.

Objectives of Auditing

Auditors are basically concerned with verifying whether the account exhibit true and fair

view of the business. The objectives of auditing depend upon the purpose of his appointment.

1. Primary Objective

The main objectives of audit are known as primary objectives of audit. They are as follows:

1. Examining the system of internal check.

2. Checking arithmetical accuracy of books of accounts, verifying posting, costing,

balancing etc.

3. Verifying the reality and validity of transactions.

4. Checking the proper distinction of capital and revenue nature of transactions.

5. Confirming the existence and value of assets and liabilities.

6. Providing true and fairness of operating results presented by income statement and

financial position presented by balance sheet.

2. Secondary Objectives

The following objectives are incidental to the main objective of auditing.

1. Detection and prevention of errors

Errors are mistakes committed unintentionally because of ignorance, carelessness. Errors

are of many types:



a. Errors of Omission: These are the errors which arise on account of transaction into

being recorded in the books of accounts either wholly partially. If a transaction has

been totally omitted it will not affect trial balance and hence it is more difficult to

detect. On the other hand if a transaction is partially recorded, the trial balance will

not agree and hence it can be easily detected.

b. Errors of Commission: When incorrect entries are made in the books of accounts

either wholly, partially such errors are known as errors of commission. Eg: wrong

entries, wrong Calculations, postings, carry forwards etc such errors can be located

while verifying.

c. Compensating Errors: when two/more mistakes are committed which counter

balances each other. Such an error is know an Compensating Error. Eg: if the amount

is wrongly debited by Rs 100 less and Wrongly Credited by Rs 100 such a mistake is

known as compensating error.

d. Error of Principle: These are the errors committed by not properly following the

accounting principles. These arise mainly due to the lack of knowledge of accounting.

Eg: Revenue expenditure may be treated as Capital Expenditure.

e. Clerical Errors; A clerical error is one which arises on account of ignorance,

carelessness, negligence etc.

1. Deduction and Prevention of Fraud: A fraud is an Error committed intentionally to

deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.

1. Misappropriation of Cash: This is one of the majored frauds in any organisation it

normally occurs in the cash department. This kind of fraud is either by showing more

payments/ less receipt.

The cashier may show more expenses than what is actually incurred and misuse the

extra cash. Eg: showing wages to dummy workers. Cash can also be misappropriated

by showing less receipts

Eg: not recording cash sales. Not allowing discounts to customers. The cashier may

also misappropriate the cash when it is received. Cash received from 1st customer is

misused when the 2nd customer pays it is transferred to the 1st customer‟s account.

When the 3rd customer pays it goes forever. Such a fraud is known as “Teaming and

Lading”. To prevent such frauds the auditor must check in detail all books and

documents, vouchers, invoices etc.

2. Misappropriation of Goods: here records may be made for the goods not purchase

not issued to production department, goods may be used for personal purpose. Such a

fraud can be deducted by checking stock records and physical verification of goods.



3. Manipulation of Accounts: this is finalizing accounts with the intention of

misleading others. This is also known as “WINDOWS DRESSING”. It is very

difficult to locate because its usually committed by higher level management such as

directors. The objective of WD may be to evade tax, to borrow money from bank, to

increase the share price etc.

2. Other objectives

1. To provide information to income tax authority.

2. To satisfy the provision of company act.

3. To have moral effect

Features of Auditing

1. Audit is a systematic and scientific examination of the books of accounts of a

business;

2. Audit is undertaken by an independent person or body of persons who are duly

qualified for the job.

3. Audit is a verification of the results shown by the profit and loss account and the state

of affairs as shown by the balance sheet.

4. Audit is a critical review of the system of accounting and internal control.

5. Audit is done with the help of vouchers, documents, information and explanations

received from the authorities.

6. The auditor has to satisfy himself with the authenticity of the financial statements and

report that they exhibit a true and fair view of the state of affairs of the concern.

7. The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting

the transactions and examine correspondence, minute books of shareholders,

directors, Memorandum of Association and Articles of association etc., in order to

establish correctness of the books of accounts.

ADVANTAGES OF AUDITING

1. Verification of Books and Statement

The main object of audit is the verification of the books of Accounts and the financial

statements of the company concerned.

2. Discover and Prevention of Error

Auditors discover or find the errors and give suggestions about prevention of errors in future.

3. Discovery and Prevention of Fraud

Fraud means false representation made intentionally with a view to defraud somebody. It is

the duty of the auditor that he should detect the fraud. So audit‟s main object and advantage is



to detect and prevent fraud. Auditor may also suggest various methods of internal check

which will prevent fraud.

4. Moral Check

Each staff member of the company knows that the financial transactions will be examined by

the auditor and he will have moral fear of committing frauds. Therefore, fear of their

detection acts as a moral check on the staff members of the company.

5. Independent Opinion

Auditing is very useful to obtain the independent opinion of the auditor about :he business

condition. The accounts are audited by the independent auditor and Audit report will be

submitted to the management. The Audit Report gives true facts about the company

Accounts. Management of the business will be able to prevent r'rauds and errors in future

keeping in view of the audit process.

6. Protects the Interest of Share Holder

Audit protects the interest of shareholders in the case of Joint Stock Company. Shareholders

are assured that the accounts of the company are maintained properly through audit and the

interests of share holders are protected.

7. Check on Directors

Audit acts a check upon the directors and precaution against fraud on the part of the

management.

8. Proper Supervision

Sometimes owner of the business cannot look after the business personally. Audit acts as a

check on employees and it saves the owner from losses.

9. Valuable Advice

The auditor has expert knowledge about the procedures and process of accounts and finance.

Therefore, he may be consulted about the clarifications and suggestions.

10. Disputes Settlement

In case of partnership, audit is very useful in settling the disputes among the partners. If any

partner dies or retires, than the audited balance sheet will be very useful in estimating the

value of goodwill.

11. Loan Facility

Audited financial statements are very useful in obtaining loans from banks and financial

institutions.

12. Insurance Claim

The fire insurance claims and fraud claims can be settled on the basis of audited financial

accounts of the previous years.



13. Property Value Assessment

Audited financial Accounts ensure smooth valuation or assessment of property during the

sale of business or organization. Audited accounts are considered more reliable in the eyes of

Law.

14. Correct Information about Business

Audit reports provide correct information about the accounts and business of the company

well in time.

15. Advantage for General Public

Audited financial statements present the real position of the company before the general

public. Audited financial statements help the assessment of companies to make investments.

16. Useful For Tax Department

Assessment of tax becomes very easy job for the tax department. Audited accounts will be

the basis of imposing the taxes.

17. Information about Economic Conditions

Economic conditions of various companies can be judged through their audited accounts. If

these companies are improving their economic conditions, than it is a good sign for the

economy.

LIMITATIONS OF AUDITING

It must be clear that the objective of an audit of financial statements is to enable an auditor to

express an opinion on such financial statements. In fact, it is the auditor‟s opinion which

helps determination of the true and fair view of the financial position and operating results of

an enterprise.

It is very important to understand these inherent limitations of an audit since understanding of

the same would only provide clarity as to the over all objectives of an audit. The inherent

limitations are:

First of all, auditor‟s work involve exercise of judgment, for example, in deciding the

extent of audit procedures and in assessing the reasonableness of the judgment and

estimates made by the management in preparing the financial statements. Further much of

the evidence available to the auditor can enable him to draw only reasonable conclusions

there from. The audit evidence obtained by an auditor is generally persuasive in nature

rather than conclusive in nature. Because of these factors, the auditor can only express an

opinion. Therefore, absolute certainty in auditing is rarely attainable. There is also

likelihood that some material misstatements of the financial information resulting from

fraud or error, if either exists, may not be detected.



The entire audit process is generally dependent upon the existence of an effective system

of internal control. Further, it is clearly evident that there always be some risk of an

internal control system failing to operate as designed. No doubt, internal control system

also suffers from certain inherent limitations. Any system of internal control may be

ineffective against fraud involving collusion among employees or fraud committed by

management. Certain levels of management may be in a position to override controls; for

example, by directing subordinates to records transactions incorrectly or to conceal them,

or by suppressing information relating to transactions. Such inherent limitations of internal

controls system also contribute to inherent limitations of an audit.

Generally following are the Limitations of auditing

1. Non-detection of errors/frauds:- Auditor may not be able to detect certain frauds which

are committed with no intentions.

2. Dependence on explanation by others:- Auditor has to depend on the explanation and

information given by the responsible officers of the company. Audit report is affected

adversely if the explanation and information prove to be false.

a. Dependence on opinions of others:- Auditor has to rely on the views or opinions given

by different experts viz Lawyers, Solicitors, Engineers, Architects etc. he can not be an

expert in all the fields

b. Conflict with others: - Auditor may have differences of opinion with the accountants,

management, engineers etc. In such a case personal judgement plays an important role. It

differs from person to person.

c. Effect of inflation: - Financial statements may not disclose true picture even after audit

due to inflationary trends.

d. Corrupt practices to influence the auditors :- The management may use corrupt

practices to influence the auditors and get a favourable report about the state of affairs of

the organisation.

e. No assurance: - Auditor cannot give any assurance about future profitability and

prospects of the company.

f. Inherent limitations of the financial statements: - Financial statements do not reflect

current values of the assets and liabilities. Many items are based on personal judgement

of the owners. Certain non-monetary facts can not be measured. Audited statements due

to these limitations can not exhibit true position.

9. Detailed checking not possible: - Auditor cannot check each and every transaction. He

may be required to do test checking.

Difference between an Accountant and an Auditor



Often one of the first questions asked by individuals interested in pursuing accounting careers

is what the difference between an accountant and an auditor is. If you fall into this category,

don‟t feel alone. While these two occupations are similar and often confused, there are some

noticeable differences between being an accountant and an auditor. Learn more below.

What Do Accountants Do?

Accountants take care of the daily financial transactions for a company or business. Their

duties can cover various tasks that range from incoming earnings to outgoing payments. They

may be in charge of figuring payrolls and tax deductions, paying vendors, implementing cash,

check and electronic payments, preparing tax returns and reconciling the books at year end.

An accountant‟s duties may also vary depending on what type of accountant they are. For

instance, Princeton Review states that the duties of a tax accountant are very difference from

that of a general accountant.

What Do Auditors Do?

Auditors often perform many of the same tasks as accountants, although they also have very

different responsibilities. The Houston Chronicle states that while auditors and accountants

have similarities and differences, many companies use these two individuals interchangeably.

So, what exactly is the difference between an accountant and an auditor? The best answer to

this question is that while both these professionals are responsible for the accounting

processes of a company, an auditor is generally responsible for reviewing the work of the

accountant.

Differences between Accounting and Auditing

Sl.

No Point of difference Accounting Auditing

1 Meaning

Accounting means the

maintaining of the books of

accounts.

Auditing means examining the

books of accounts and reporting

their accuracy.

2 Performance of

Work

Accountant job is performed

by the accountant.

Auditing job is performed by

the auditor.

3 Appointment

Accountant is appointed by the

management as an Employee.

Auditor is appointed by the

Management as an Expert from

outside the organization.

4 Qualification

Accountant does not require

specific qualification. Auditor requires specific

qualification.

5 Responsibility

The responsibility of

Accountant is fixed by the

management.

The responsibility of Auditor is

fixed by law.



6 Submission of

Report

Accountant is not required to

submit any report.

Auditor is required by law to

submit the report.

7 Time

In case of accounting, period is

usually one year.

The period of auditing may be

one year or half year or

quarterly.

8 Purpose

The purpose of Accounting is

to show the financial position

of the business.

Auditing verifies the true

picture of the financial

statement.

9 Record / Data

Accounting is related with the

present record.

Auditing is related with the past

record.

10 Nature of

Employment

Accountant is a permanent

employee.

Auditor is not a permanent

employee.

11 Reward

Reward of Accountant is called

as salary.

Reward of Auditor is called as

fee.

12 Liability

Accountant has no liability

after preparing the final

accounts.

Auditor has liability after

presenting the audit report.

13 Importance

Accounting is necessary for

every business.

Auditing is not necessary for

every business.

14 Knowledge

Accountant must have the

knowledge of accountancy.

Auditor must have the

knowledge of accounting as

well as auditing.

15 Removal

Accountant can be removed

from his job at any time.

Auditor cannot be removed till

he completes his period of

appointment.

Usually an auditor confines his work only to the verification of accounts. In small

organizations he may also be asked to finalize accounts. In this case he acts both as an

accountant and as an auditor but the audit work commences only when the accounting work

is over. Hence, its said that “Audit begins where accounting ends”.

TYPES OF AUDIT

1. Statutory Audit

Any audit carried on as per the requirement of law is called as a statutory audit. eg: all

companies have to get their accounts audited as per the provision of the company‟s Act of

1956.

2. Periodical/ 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. Eg: 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. Infact while verifying BS

items the auditor verifies/ checks all related items/accounts.

6. 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.

7. 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 management

audit is to see how far the objectives of management are fulfilled. It aims to ascertain

whether sound management prevails throughout the organisation and evaluates its

efficiency in the system of its operation.

8. Continuous audit

A continuous audit is one in which the auditor visits his clients 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.

Advantages:

1. Errors and frauds are discovered and rectified quickly.

2. The chances of fraud are reduced.

3. The workers will be careful in their work.



4. Continuous audit acts as a valuable morale check on the staff.

5. Final audit becomes easier and faster.

6. If the company wants to declare interim dividend it‟s easier to prepare interim

account.

7. It increases the efficiency and accuracy in the accounts.

Disadvantages:

1. After the auditor‟s visit is over, alternative may be made.

2. It affects the regular work.

3. It‟s not suitable for small organizations.

4. The auditor may lose the line of work if he does not complete his work in a visit.

Precautions to be taken for continuous audit:

1. He should record important balances; totals etc. and verify the same in his next

visit.

2. Strict instructions should be given prohibiting the alteration of figures after

checked by the auditor.

3. For each visit special ticks should be used.

4. It‟s always better to verify the nominal account at the end of the year.

5. An exhaustive audit programme must be prepared.

6. He should ensure that normal working is not affected.

7. As far as possible, he should pay surprise visits.

PREPARATION BEFORE COMMENCEMENT OF NEW AUDIT

An audit is generally conducted with some definite objects in view. This object should

be kept in mind by the auditor before commencing the new audit. In other words, an auditor

has to take the following steps, before he starts his work.

1. Obtaining the letter of appointment

He must have a proper letter of appointment from the appropriate authority and ensure that

his appointment is an order. Further, if he has been appointed in place of another auditor, he

should enquire from the retiring auditor, the reasons for the changes. This fact has been

upheld by many cases.

2. Knowing the nature and scope of his duties

He should obtain definite instructions from his client about the' nature and scope of his work

i.e whether he is to do continuous audit or final audit, whether he is to do the accountancy

work or audit work or both. This question will not arise in the case of companies, as his

duties, powers and, liabilities are laid down by the companies act itself.



3. Knowledge of the system of accounting employed

He should examine the system of accounting employed by his client. If he finds any weak

point, he must study it thoroughly and make recommendations to his client to remove these

weak spots.

4. Obtaining of the list of principal officers of the client’s organization

He should obtain a list of the principal officers of the client‟s organization together with their

authorities and responsibilities. This will help him to obtain the required information from

them.

5. Knowledge of internal control in force in the client’s business

“He should obtain a written statement of internal control system in force in the client‟s

organization. It will help him in determining the extent of his audit work.

6. Obtaining of the list of books

He should obtain a list of all the books maintained in the office, together with the names of in

charge persons and their specimen signatures. Such a list should be duly signed by a

responsible official of the company.

7. Study of the previous year’s financial statements

He should study the previous year‟s financial statements as well as the auditor‟s report. This

will help him to know the state of affairs of the concern.

8. Study of the important documents

He should study all the documents viz., M/A, A/A etc, which have a bearing on the accounts.

9. Giving instructions to the client

He should give clear instructions to his client in regard to the following:

The books should be closed before audit.

The vouchers should be arranged date wise.

If this has not been done, he should never begin his work until the documents are arranged as

per the instructions given by him

10. Ascertain the nature of business

He should ascertain the nature of the business of his client i.e whether it is manufacturing or

trading or service. Such knowledge helps the auditor in planning of the audit procedure.

11. Knowledge of the organization structure

He should get organization structure present in the client‟s business. This will help the

auditor in planning his work procedure wisely.

After all the above steps are taken, he should prepare his audit program i.e a complete

program of his audit work.



Audit Programme

Planning of audit work is called 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. Audit work can be started immediately in a systematic manner once an audit

program is made ready.

2. It ensures that each part of audit work is completed, and nothing is omitted.

3. It provides guidelines to the audit staff for the performance of the audit work allotted

to them.

4. It facilitates proper distribution of works among the audit staff.

5. It fixes up responsibilities among the audit staff for any omission or commission.

6. It helps the auditor to exercise effective control over his audit staff.

7. It helps to complete the audit work within the scheduled time.

8. It helps the auditor in assessing the cost of audit.

9. It helps to increase the efficiency of the audit staff.

10. It serves as a guide for audit in succeeding years.

Disadvantages of Audit Programme

1. It makes the work of the audit staff stereotyped and mechanical.

2. It discourages the initiative and interest of the efficient audit staff, as they have

to simply act according to the audit program and are not allowed to exercise their

own judgment and discretion in the performance of the audit work.

3. As it fixes a time limit for the completion of the audit work, the work may be

hurried up by the audit staff. "Consequently, the efficiency of the audit staff may

suffer.

4. When there is an Audit Program, there is the danger that the audit program may

be followed from year to year without any alteration. This will reduce the

effectiveness of the audit work.



5. A rigid audit program is useless.

The above disadvantages can be minimized if the audit programme is made more flexible and

audit staff encourages to go 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 comman 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.

An audit note book is a book, register or diary maintained by the audit staff during the

course of audit for recording his observations during the course of audit, the points to be

discussed with the senior audit clerk or auditor, the points which require further

clarifications, explanations, and investigation and also the enquiries made and the replies

received thereto.

Contents of Audit Note Book

Generally the following information is incorporated in audit note book:

1. Nature of the business.

2. Organization structure of the enterprise.

3. Names of principal officers, their powers, duties and responsibilities.

4. Instructions from the management regarding the audit. List of books of maintained

by the business

5. The systems of internal check and internal audit in force in the business.

6. The system of accounting followed in the business.

7. Technical details and terms used in the business.

8. Extracts from minutes and contracts.

9. Provisions of the memorandum and articles of association affecting the accounts

and audit.

10. Extracts from all correspondence entered into with the bankers, debtors and

creditors.

11. Queries made and replies received.



12. Dates of commencement and completion of audit.

13. Complete record of the exact nature of the work done.

14. Progress of the audit work.

15. Record of suggestions made by the audit staff.

16. Particulars of errors and fraud discovered.

17. Particulars of all documents, vouchers and invoices.

18. Points which are too discussed with the senior audit clerk or the auditor.

19. Important points which required further explanations and clarifications & Points to be

included.

20. Notes which may use in audits of future.

21. Extracts from various certificates given by the officials and bankers.

22. Totals and balances of important books of accounts already checked and bank

reconciliation statement.

23. Particulars of missing vouchers the duplicates of which have to be obtained.

24. Queries made and replies received.

25. A copy of audit program.

An audit note book should be preserved by the auditor as it contains valuable information in

respect of the work done by its staff.

Objectives of Audit Note Book

Various objectives of Audit Note Book are:

1. To know about the nature of business.

2. Detection and prevention of frauds and errors effectively.

3. To make the future audit work easier.

4. To know the facts where clarification and explanation are essential.

5. To check the list of debtors and creditors.

6. To present as a proof by the auditor to clearance over the cases.

Advantages of Audit Note Book

1. It helps the auditor to have a record of important points which arise during the course

of audit.

2. It is helpful in the preparation of audit report.

3. It is helpful in assessing the efficiency, ability and sincerity of the audit staff.

4. It can serve as evidence in the court of law, if a suit is filed against the auditor for

negligence of duty.



Disadvantages of Audit Note Book

1. If it is not prepared carefully and properly, it can be used in a court of law as an

evidence of negligence on the part of the auditor.

2. It promotes a fault-finding attitude in the minds of the audit staff.

3. It may create misunderstanding between the staff of the client and audit staff.

The audit note book is of great importance to the auditor. The importance of maintaining the

audit note book is emphasized by many case laws. For instance, London and general bank.

Special Matters to Be Recorded in the Audit Note Book

1. Routine queries not cleared, i.e., missing receipts and vouchers etc.

2. Details of mistakes and errors discovered.

3. The points raised during the course of audit, to which the attention of the auditor must

be drawn, i.e., failure of the company to comply with the provisions of the Companies

Act or of the Memorandum of Association and other legal requirements.

4. Extracts from minutes books and contracts and other correspondence with various

government agencies, financial institutions, debtors, creditors etc.

5. The points to be incorporate in the audit report.

6. The points which needs further explanation and clarification e.g., a change in the basis

of valuation of finished stocks or in the computation of depreciation, etc.

7. Date of commencement and completion of the audit.

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

All organizations are subject to fraud risks and there have been several instances in the past

couple of decades when frauds have led to the downfall of organizations as a whole.

As the demands of traditional audits responsibilities and the growing burden of information

security evolve, the industry is beginning to see emerging trends in internal auditing

departments across many organizations.

According to Chartered Institute of Internal Auditors, the role of internal audit is to provide

independent assurance that an organization‟s risk management, governance and internal

control processes are operating effectively. Unlike external auditors, they look beyond

financial risks and statements to consider wider issues such as the organization‟s reputation,

growth, its impact on the environment and the way it treats its employees.

TAX AUDIT

Tax audit is the audit carried out as per the provisions of section 44AB of the Income tax Act,

1961 i.e. the tax audit needs to be carried out if gross receipts exceed the prescribed limit (40

lakhs in case of business and 10 lakhs in case of profession). Tax audit is applicable to both

Residents and Nonresidents.

Chartered accountants or a firm of chartered accountants in full time practice can be

appointed as tax auditor, but internal auditor cannot be appointed as tax auditor.

The Income tax department cannot verify each and every detail of provisions complied by the

assessee. In this regard expertise of auditors is utilized, who certify the compliance of

provisions of Income tax Act.



Meaning

A tax audit is an examination of a taxpayer‟s business records and financial affairs to

ascertain, whether the right amount of income is declared and the right amount of tax is

calculated and paid in accordance with tax laws and regulations.

Objectives of Tax Audit

1. To ensure that proper books of accounts and other records are maintained, which

reflects the true income of the assesse.

2. To ensure that the correct amount of income has been reported and the right amount

of tax has been paid-in accordance with the tax laws and regulations.

3. To ensure that a higher tax compliance rate is achieved under the Self-Assessment

System.

4. To educate and create awareness among taxpayers towards their rights and

responsibilities under the provisions of the IT Act.

5. To assist the taxpayers in fulfilling their obligations.

Nature of Tax Audit

The tax auditor shall be guided by auditing standards and guidance notes as issued from time

to time by ICAI.

1. Obtaining books of accounts, financial statements and other statements of particulars

duly authenticated.

2. Evaluation of internal control system on the basis of which extent of vouching and

verification can be determined. While conducting tax audit the provisions and

objectives of section 44 AB shall be kept in mind

3. The auditor shall have thorough knowledge of taxation provisions and judicial

Pronouncements. The tax auditor in his audit report has to give his opinion as to

whether financial statements give true and fair view for the given period.

4. The auditor has wide knowledge and experience in tax matters and can provide

valuable service to his clients.

5. Tax auditor shall not be removed during the specified period of his appointment. But,

assessee can remove such auditor on some valid grounds.

COST AUDIT

Cost audit is the audit of cost records of a business to ensure that the records are accurate md

are maintained in accordance with the cost accounting principles, the cost statements are

properly drawn up as per the cost records and the cost of production of goods is correctly

calculated.



Cost audit is an internal audit used for enterprise governance to assess operational

efficiencies and resource management. Special attention is given to verification of cost

records and adherence to acceptable cost accounting procedures.

Nature of Cost Audit

1. Cost audit is compulsory for certain companies like the companies engaged in

production, processing, manufacturing and mining activities.

2. Cost audit is covers the cost as well as the financial side of accounts

3. Cost audit suggests the ways and means to eliminate wastage and to increase profits.

4. Cost audit serves the interest of the shareholders and other stake holders like

management, government etc.

5. Cost audit may be conducted only for a particular year.

6. The job of the cost audit is done in the factory

7. The cost auditor mainly concentrates on the items of cost structure.

8. Cost auditor examines the records in detail.

9. Cost auditor submits the report to the BOD .

10. Cost auditor measures the efficiency of an organization.

Significance of Cost Audit

1. Detects errors, frauds and misappropriation and hence enhances efficiency.

2. Ensures that valuation of closing stock and work in progress are correct. Hence,

helps in the computation of more accurate profit.

3. Customers may obtain more benefit, if the cost is reduced due to effective

control, implemented as a result of cost audit.

4. Cost accountants, who are the employees of a company, obtain a share of all

benefits derived by the company from a cost audit.

5. Cost audit provides reliable data to the government for fixing up prices of the

various commodities.

6. Cost audit helps the government to take necessary measures to improve the

efficiency of sick industrial units.

Management Audit

Management audit is a systematic assessment of methods and policies of an organization‟s

management in the administration and the use of resources, tactical and strategic planning,

and employee and organizational improvement.

Management audit is an act of evaluation of all the activities of all the departments with a

view to provide appropriate suggestions to the management to help their work. In other

words, management auditing is a future oriented task which evaluates timely in all the levels



of management like production management, sales management etc.

Management audit is a new development in the field of auditing. It had its origin in USA.

Today, management audit has gained importance in the management of big organization. It is

considered as an important tool in the hands of management.

Meaning

Management audit is the critical review of the process of management and giving suggestions

for improving the performance of the management in future.

Objectives

1. To assist the management to achieve the most efficient administration of the

operations

2. To suggest to the management the ways and means to achieve the objectives, if

the organization itself lacks in the knowledge of efficient management.

3. To aid the management at all levels in the effective and efficient discharge of their

duties and responsibilities

4. To help the management in achieving co-ordination among the various

departments

5. To stream line the managerial activities according to the requirements of the

business.

6. To help management in taking vital decisions for maximization of profits

7. To assist management in the preparation of budgets

It is a kind of internal audit to find out the deficiencies and defects in the managerial working

of the organization and to suggest ways and means for further improvements.

Importance of Management Audit

1. Management audit, as its name signifies, attempts to evaluate the performance of

various management processes and functions. It is an audit to examine, review and

appraise the various policies and actions of the management on the basis of certain

objectives standards.

2. It goes beyond the conventional audit which involves a scrutiny of financial

transactions and the books of accounts. It is a comprehensive and a critical review of

all aspects of management.

3. The term “operational auditing” is used by certain authors almost synonymously with

the term “management audit”. The operational or management auditor examines the

policies and actions of available resources. The scope of management or operational

audit is defined by the Federal Financial Officers‟ Institute in Canada as follows:



4. “A systematic independent appraisal activity within an organisation for a review of

the entire departmental operations as a service to management. The overall objective

of operational auditing is to assist all levels of management in the effective discharge

of their responsibilities by furnishing them with objective analyses, appraisals,

recommendations and pertinent comments concerning the activities reviewed. ”

5. Management audit is a complex task closely linked with the process of management

It usually involves the following steps:

1. Identification of the objectives of the organisation. Sometimes the objectives are stated in

specific terms but in most cases they remain undefined. It is important that the objectives are

clearly perceived and identified.

2. The overall objectives of the organisation are to be broken up into detailed targets and

plans for various segments.

3. The organisational structure is to be reviewed to assess whether it can effectively fulfil the

overall objectives and the detailed targets. If possible, specific responsibility centres may be

identified in the organisation.

4. The performance of each functional area or responsibility centre is to be examined. In

many cases the performance can be expressed in quantitative terms. It should be compared

with the objectives and targets.

5. On the basis of the above examination, realistic course of action is to be suggested. A

motivation system is operated whereby incentives are given to various personnel on the basis

of the results of the management audit.

INTERNAL CONTROL

Internal control is a broad term which is normally used to control financial and non-financial

activities. It involves a number of checks and controls exercised in a business to ensure

efficient and economic working.

A system of internal control consists of policies and procedures designed to provide

management with reasonable assurance that the organization achieves its objectives and

goals. These policies and procedures are often called controls, and collectively they comprise

an organization‟s internal control. Traditionally referred to as “hard controls,” these include

segregation of duties, limiting access to cash, management review and approval, and

reconciliations. Other types of internal controls include “soft” controls such as management

“tone at the top,” performance evaluations, training programs, and maintaining established

policies, procedures, and standards of conduct.



Internal control, as defined in accounting and auditing, is a process for assuring

achievement of an organization's objectives in operational effectiveness and efficiency,

reliable financial reporting, and compliance with laws, regulations and policies. A broad

concept, internal control involves everything that controls risks to an organization.

It is a means by which an organization's resources are directed, monitored, and measured. It

plays an important role in detecting and preventing fraud and protecting the organization's

resources, both physical (e.g., machinery and property) and intangible (e.g., reputation or

intellectual property such as trademarks).

Internal control is not a separate process, but it is integrated into the company's day-to-day

operations. Internal control covers all processes, policies and organisational structures that

help to ensure that the company is achieving its objectives, that the business conduct is

ethical, that the assets are managed responsibly and that financial reporting is organised

properly. It includes for example reporting, approval practices and information on the

compliance with the policies.

Objectives of Internal Control:

An internal control system comprises the whole network of systems established in an

organisation to provide reasonable assurance that organisational objectives will be achieved.

Specifically, the general objectives of internal control are as follows:

1. Authorization

The objective is to ensure that all transactions are approved by responsible personnel in

accordance with specific or general authority before the transaction is recorded.

2. Completeness

The objective is to ensure that no valid transactions have been omitted from the accounting

records.

3. Accuracy

The objective is to ensure that all accounting transactions are fully and accurately recorded,

that assets and liabilities are correctly identified and valued.

4. Physical Safeguards & Security

The objective is to ensure that access to physical assets and information systems are

controlled and properly restricted to authorized personnel.

5. Error handling

The objective is to ensure that errors detected at any stage of processing receive prompt

corrective action and are reported to the appropriate level of management.



6. Segregation of Duties

The objective is to ensure that duties are assigned to individuals in a manner that ensures that

no individual can control both the recording function and the procedures relative to

processing the transaction.

A well designed process with appropriate internal controls should meet most, if not all of

these control objectives.

Advantages of Internal Control:

1.From the clients point of view.

a. Internal control system provides authentic and reliable data useful to take business

decisions.

b. It safeguards the physical and non-physical assets in the form of records,

documentation etc.

c. It promotes operational efficiency, by preventing waste, duplication of work and

inefficient use of resources.

d. A good system of internal control provides that the company follows the procedures

and rules as required by the law.

2.From auditors point of view.

An auditor evaluates a system of control before commencing an audit work his work

becomes easier if the control system is efficient. He can also decide whether detail

verification is necessary or not.

Disadvantages of Internal Control:

1. It involves expenditure which may not be affordable by the small organizations.

2. Internal control is concerned with routine transactions many times unusual transactions

may be over looked.

3. The system of internal control may be weakened due to inefficiency in handling of the

system.

4. There are chances of diverse objectives among employees in the departments and staff in

charge of internal control.

5. Management may manipulate the operation of internal control system.



Elements, features characteristics principles of a good Internal Control System:

An effective internal control system should have the following factors:

1. Competent and trust worthy staff: people in charge of internal control system must be

reliable and highly competent about the work. Lack of knowledge and dishonesty will

spoil the efficiency of the system.

2. Records of financial and other organizational plans: A good internal control system

must have good documentation system. Filing, recording, classifying, etc will help in this

regard.

3. Segregation of duties: normally, there should be a separate department for internal

control this reduces frauds, bias etc. normally, a clerk in charge of accounting function

should not be in charge of assets also.

4. Supervision: proper reviewing of the operations of the company regularly makes the

control system effective.

5. Authorization: all transactions must be properly authorized. In other words, the authority

of each person should be well defined.

6. Sound practices: the company should have well established procedures, policies,

delegations organizational manuals etc.

7. Internal Audit: it‟s a part of internal control and it should be independent of internal

check.

8. Accounting Controls: proper accounting information systems should be established so

that the information relating to accounts is properly collected, recorded and accounts

prepared.

Scope of Internal Control or Areas of Internal Control:

a. General financial Control: It‟s concerned with control over all finance functions i.e.,

planning, acquiring and investing funds and management of profits. It deals with

accounting supervision recording etc of the finance department.

b. Cash Control: it‟s concerned with proper control over receipts payments and balance of

cash. The control system must ensure that misappropriation of cash is prevented.

c. Control over wages: this includes maintenance of time records, wage records, and

payment to workers. The main area of concern in this regard is the check payment to

wages for the work not done and misappropriations of cash.

d. Control over purchases: the system of internal control regarding purchases should be

developed in such a manner that purchasing accounting, handling and issuing of goods

are properly controlled.



INTERNAL CHECK

An internal check is a part of internal control. The term internal check implies that the work

of various members of the staff is allocated in such a way that the work done by one person is

automatically checked by another. It is defined as “such an arrangement of book keeping

routine where in errors and frauds are likely to be prevented or discovered by the very

occupation of book keeping itself‟.

For example, staffs record the expenditure in a book and another staff posts them into ledger,

another staff checks and verifies the ledger and payment is made by another staff. So, the

work of one staff is checked by another staff while performing their works so that errors and

frauds committed by one staff are detected and prevented by another staff.

Internal check is a system under which accounting methods and details of an establishment

are laid out that the accounts and procedures are not under the absolute and independent

control of any one person or the contrary the work of one employee is complementary to that

of another.

The system of internal check is based upon the principle of division of labor, where in

performance of each individual is automatically checked by another. This is possible by

properly allocation the work and integration of function of the employees in such a manner

their work complements each other.

Meaning:

Internal check means that checks imposed in such a way on day to day transactions that

work of one person is checked by other person automatically. In this way the chances of

fraud and errors minimizes. Because the mistake made by one person is checked by the

other.

Definitions:

According to The council of the Institute of chartered accountants of England and Wales:

“Internal check is best regarded as indicating checks on the day-to-day Transactions which

operate continuously as a part of the routine systems whereby work of one person is proved

independently or is complementary to the work of another, the object being the prevention of or

early detection of errors and frauds”

According to „F.R.M. De PAULA‟, “Internal check means practically a continuous internal

audit carried on by the staff itself, by means of which the work of each individual is

independently checked by other members of the staff.”



According to D.R. DAVAR,‟ “Internal check is a system or method introduced with defined

instructions given to staff as to their sphere of work with a view to control and verification of

their work and also maintenance of accurate records as lie ultimate aim.”

Objectives of internal check

The main objective of internal check is prevention of errors and frauds and/or detection of

errors and frauds at the earliest. Internal check is a continuous process and is part of the day-to-

day routine. It relates to all the transactions that take place every day. Internal check is achieved

by complementary allocation of duties and by dependent verification of the work of one person

by another.

Following are the objectives of internal check system:

1. To eliminates frauds and errors

2. To prevent misappropriation of goods or cash.

3. To allocate duties and responsibility to every clerk in the organization so that, he may be

held responsibility for their particular fraud & errors.

4. To encourage specialization of labor.

5. To reduce the time spent on a particular work.

6. To exercise moral pressure over staff members.

7. To make accounting system more reliable.

Points to be considered in framing a Good Internal Check

1. No single employee should have independent control over any important aspect of the

business. In other words the work of employed should be automatically received by

another.

2. The duties of the employees should be changed from time to time without prior notice.

3. Employees who control physical assets should not have assets to goods of account.

4. It‟s better to follow a system of self-balancing ledger.

5. Account must be periodically verified.

6. The allocation of work must be carefully done and the position must be reviewed

periodically.

7. While stock taking the pricing and evaluation of stock should be done by the people who

are not connected to stores department.

8. A cashier should not be in charge of maintaining accounts complete bank transactions etc.



Principles of Internal Check

1. Sufficient Staff

The principle of internal check is sufficient staff. The employees can be appointed according

to the workload. The management can determine the amount of work, which is distributes

among the departments. The persons are hired to perform their duties. The overloading can

creates trouble for management.

2. Division of Work

Division of work is a principle of internal check. The management can determine the total

amount of work. The whole work is divided among departments. The heads of such

department are responsible for completion of work according to timetable.

3. Co-Ordination

Coordination is a principle of internal check. All departmental managers are bound to

coordinates with other in order to achieve organization objectives. When there is fault in one

department, the work of other department suffers. The objectives cannot be achieved. Internal

check determines the degree of coordination among the managers.

4. Rotation of Duties

Rotation of duties is a principle of internal check. The workers feel bore by doing the same

work from year to year. There is a need of rotation of duties. It is in the interest of concern as

well as employees. The efficiency is improved due to changes is duties.

5. Recreation Leave

The recreation leave is a principle of internal check. The employee can check recreation

leave. It is necessary for mental health. He can commit fraud as the new employee in his

place can disclosed teh matter. The internal check system can work in the interest of business.

The weakness is of one person is disclosed due to leave.

6. Responsibility

The responsibility is a principle of internal check. The employee can enjoy recreation leave.

It is necessary for mental health. He can enjoy recreation leave. It is necessary for mental

health. He cannot commit fraud as the new employee in his place can disclose the matter.

There internal check system can work in the interest of business. The weakness in of one

person is disclosed due to leave.

7. Automatic Machines

The principle of internal check is that machines must be used to do accounting work if

permissible. The machines can do a lot work without delay. The changes of fraud and error

are reduced to a minimum. The working of machines improves efficiency of accounting staff.



8. Checking

The principle of internal check is to check the work of other employees. Many persons

perform the work. The officers can put his signatures to verify the work done by his

subordinate. In this way one work passes many hands. The changes of error and fraud are

minimized due to checking and counter checking.

9. Simple

The principle of internal check is simples in working the employees can understand the

working of internal check system. A person can work under the supervision of other

employees. The line of authority moves from top to bottom level. All workers can understand

their duties in the organization.

10. Documents Classification

The classification of documents is the principles of internal check. The business documents

are prepared, collected, recorded and placed in proper files. The index is prepared to compile

the data. The filing system is useful to place the latter. In case of need the documents are

traced at once.

11. Dependent Work

Dependent work is a principle of internal check. The work of one employee is dependent

upon others. One work passes in the hand of two or three persons till it is complete. Another

person checks the passes done by one person. No person is all in all to start and complete the

transactions.

12. Harmony

The principles of internal check are harmony among the employees and departments. The

understanding is essential for business goals. The management is to achieve other social and

national objectives. The harmony is basis for successful internal check.

Internal check and the Auditor:

The auditor before starting audit work evaluates the system of internal check. If it is efficient

he may avoid detailed checking of the transactions and he can carry out a few test check of

the transactions to what extent should an auditor rely upon the system of internal check will

depend upon the degree of effectiveness with which, the system is followed as well as the

size of the business. If the internal check system is inefficient, he had to check in detail all

transactions. It should be remembered that even if the internal check system is efficient he

should still test its existence and efficiency.



Efficient internal check system reduces his work but not his responsibility. If in the process of

examination of accounts if he finds any weakness in his system, he should report it to his

client. Thus the existence of a good internal check system may help an auditor to a great

extent, but does not reduce his legal liability. If any fraud is discovered subsequently he may

be held quietly of negligence. He can‟t defend himself saying that he relied upon the efficient

internal check system that existed in the business.

Internal check regarding Wages:

In a large organization, expenses on wages with form one of the major portions of expenses.

The chances of frauds are also high in this regard. In this background, a good system of

internal check assumes significance.

1. Frauds might be in the form of recording more wages than actually paid.

2. Payment of wages to dummy/ghost workers.

3. Recording wages for which no payment has been made etc.

The design of internal check system should try to prevent the above fraud. The following

internal check system is suggested in this regard.

1. Maintaining Time Records: A department is in charge of recording the time spent by

the workers should be constituted as far as possible. Manual system of time keeping must

be avoided. This brings down the fraud regarding the payment of wages for which no

work is done.

The time keeping check and the foremen should separately prepare the time recorded

sheet recording the name of the worker, time of entry, names of absentees etc.

In case if the workers are paid on piece rate system proper system of time booking must

be followed each worker should be given a job and counter assigned by the supervisor.

In case if workers work overtime, the overtime slips must be issued which is authorized

by the concerned official. No worker should be allowed to work Over Time if he is not

authorized to do so.

2. Preparation of Wage Sheets:

Large scale organizations should evolve in an internal check system in such a manner that

the chances of over payment, under payment, wrong payment to workers are minimized

and prevented. Preparation of wage sheets should be the responsibility of a separate

department. Separate wage sheets should be maintained for workers under time rate

system and price rate system.



Two clerks should examine the time and price wage records. Over time records etc

another clerk should be in charge of preparing wage sheets of individual works. The 4th

clerk checks the calculations deduct amount for PF, IT, etc to arrive at net amount to be

paid to workers. All officials involved in the process, should sign the statements which

will be approved by the work manager/ the production manager.

Payment of Wages: a person is not involved either in maintaining time records

preparation of wage sheets should be in charge of payment of wages. Usually the cashier

in the accounts department will allot the wages, according to the information given by the

wage sheet. As far as possible wages should be distributed personally to the workers who

sign the Wage Register. Absentee workers should be paid through others workers only

after written authorization is received. A list of unpaid wages should be prepared after the

distribution of wages. If there are casual workers, payment should be made to them

separately on a different day.

Internal Check as Regards Purchase

The purchase department will be responsible for proper control over purchases as far as

possible. Purchases must be centralized for the purpose of internal check. The purchase

process may be divided as:

a. Purchase.

b. Storage.

c. Issues of Materials.

1. Internal Check regarding Purchase of Materials: The concerned department, head

will send requisition letter to the purchase department, for each department, a separate

file must be maintained for requisitions. Based on the requisition the purchase

committee, purchase department, calls for tenders from approved suppliers. These

tenders must be opened by the purchase committee and the least bidder will be

chosen.

Purchase order has to be sent to the selected suppliers. Usually, purchase order will be

prepared by the purchase department, a copy of which will be sent to the supplier,

second to the stores, third to the accounting department, and the fourth is retained by

the purchase department.

When goods are received the stores keeper inspects them and compared with the

purchase order. If goods are acceptable he enters them in goods inward book and

issues the acceptance letter. A copy of the acceptance letter will go to the accounts



department, which will again compare goods approved letter with the purchase order.

The accounts manager if satisfied authorizes for its payment.

2. Internal Check over Storage of Goods: The stores keeper should maintain proper

records, regarding storage of goods. He usually maintains bin cards and stores ledger

surprise.

3. Internal Check as regards to issue of Materials: Materials should always be issued

against material requisition note. After each issue, and purchase proper record must be

made in bin cards and stores ledger.

Internal check regarding CASH SALES

The following is the internal check system regarding sales over the counter.

1. Each counter should have a separate salesman.

2. Each salesman should be given a separate sales memo book. Usually different color is

used for different counters,

3. Sales memo should be prepared by the salesman in 4 copies.

4. The sales memo is checked by another clerk before being handed it over to customer. A

copy is retained by the clerk.

5. Payment is made at the cash counter.

6. One copy of cash memo is returned to the internal duly stamped as cash paid 2 copies are

return the cashier.

7. The cashier records days total sales in cash sales register.

8. Every salesman should prepare total sales summary of the respective counters. At the end

of the day total sales as recorded by salesman, total cash received and total sales as per

register must agree with each other.

INTERNAL AUDIT

Audit in simple words is the checking done in order to ensure whether the financial

statements which are prepared by the company are correct or not. Auditing is compulsory for

listed companies and it is done by the external auditor. However some companies also

undertake internal audit which implies that employees within the company audit the financial

statements of the company.

Internal audit is a review of operations and records undertaken within a business by specially

assigned staff. It is a post-transaction review to evaluate the correctness of records and the

effectiveness of operations on a continuous basis in an organization by the paying staffs. The

term 'internal audit' has been defined as the independent appraisal of activity within an



organization for the review of accounting, financial and other business practices as a

protective and constructive arm of management. It is a type of control which functions by

measuring and evaluating the effectiveness of other types of controls. Internal audit deals

primarily with accounting and financial matters, but it may also properly deal with matters of

an operating nature.

The work of internal auditor is more or less the same as that of external or professional

auditor. Being the employee of the organization, s/he has to see that there is no waste and

inefficiency in the organization. An auditor has to ensure that the organization incurs

liabilities in respect of its valid and legitimate activities. S/he has to make efforts to find out

the weakness of the internal control and internal check system followed in the organization

and suggests necessary improvements.

Many large organizations have a system of internal audit within the organization as a integral

part of internal control. Internal auditing is a staff function rather than a line function and the

internal auditor does not exercise direct authority over other persons in the organization.

Objectives of Internal Audit

The objectives of the internal audit can be summarized as follows:

1. To verify the correctness, accuracy and authenticity of the financial accounting and

statistical records presented to the management.

2. To confirm that the liabilities have been incurred by the organization in respect of its

valid and legitimate activities.

3. To comment on the effectiveness of the internal control system and the internal check

system in force and to suggest ways and means to improve these systems.

4. To facilitate the early detection and prevention of frauds.

5. To examine the protection afforded to company's assets and use of them for business

purpose.

6. To identify the authorities responsible for purchasing assets and other items as well as

disposal of assets.

7. To ensure that the standard accounting practices which have to be followed by the

organization are strictly followed.

8. To undertake special investigation for the management.

9. To assist management in achieving the most efficient administration of the operation

by establishing procedures by complying with company's operating policies.

10. Internal audit detects the misuse of resources in time which helps to reduce

unnecessary expenses.



Advantages of Internal Audit

The advantages of internal audit are as follows:

1. Staffs remain alert because their work shall be checked by the internal auditor. So,

accounting remains correct.

2. Internal audit helps to detect errors and frauds and provides suggestions to improve

them which help the management to take corrective action.

3. Internal audit detects the misuse of resources in time which helps to reduce

unnecessary expenses.

4. Internal audit checks the efficiency of staffs which helps to increase the efficiency of

them.

5. Internal audit checks the books of accounts, detects errors and frauds and helps in its

correction which makes the act of final auditor easier.

6. Internal audit increases the morale of honest staff because evaluation of performance

of any staffs will be made at any time.

Disadvantages of Internal Audits

1. Internal audits report is not accepted by either the shareholders or tax authorities, it is

the external auditor report which is required to be submitted to these parties.

2. Since internal audit is done by the employees of the company chances are that it may

be biased and therefore company cannot depend on such reports.

3. Since an internal audit is not done by the professional auditor chances of internal

auditor not detecting the errors are high.

4. Small organizations cannot afford to have internal audit system as it‟s expensive.

5. The regular work of the organization will be affected.

Difference between internal checks and internal audit

Internal Check Internal Audit

It is an arrangement of duties allocated in such

a way that the work of one person is

automatically checked by another.

It is independent appraisal of operation and

records of the company.

The purpose of Internal Check is to prevent

minimize possibilities of errors and frauds.

The purpose is to detect errors and frauds

that are already committed.

Internal Check doesn‟t require separate staff. It

represents only the arrangement of duties.

It requires separate staff employed only for

this purpose.



Internal Check is a continuous process. The Internal auditor has to report

periodically about various inefficiencies

and suggest improvements.

Internal Check begins along with the recording

of transactions.

It begins when the accounting process

ends.

It is devices of doing the work. It is a device for monitoring the work.

Scope of Internal Check is limited especially to

the accounting department.

The scope of internal audit goes on beyond

accounting department.

VOUCHING

After preparing Audit note book, audit planning, auditing working papers, audit preparations

etc., the next step is to proceed with the examination of accounting entries passed in the

books of account during the period under review. In this step the auditor has to check the

entries with its supporting documents to determine the accuracy and authenticity of the

entries passed by verifying the vouchers, bills and other supporting documents. This process

of checking the evidence of the entries called vouching. It may relate to cash as well as

trading transactions.

Auditor is required to certify the financial statements prepared by the accountant as the

statement shows the true and fair view of the results of operations and the state of affairs of

the business. Unless he tries to establish the accuracy and authenticity of all the transactions

recorded in the books of account, auditor will be falling from discharging his duty. The

exercise of establishing and verifying the accuracy and authenticity of the accounting entries

passed in the book of account with reliable evidences are technically called 'vouching'. It

means vouching is the testing the truth of all the entries made in the book of accounts.

Meaning of Vouching

Vouching is the essence of auditing and is also the most important duty of an auditor.

Examination of the vouchers is called „vouching‟. The term vouching means a careful

examination of the original documentary evidence, such as invoices, receipts, statements,

correspondence, minutes, contracts, etc, with a view to prove the accuracy of the entries in

the books of account and to ascertain as far as possible that no transactions have been omitted

from books. „Vouching‟ implies the substantiation of the entries in the books by reference to

any documentary or other evidence of an authoritative nature offered in support of the

transactions. It is a method of verifying the accuracy and the authenticity of the entries



recorded in the books. To vouch a statement is to confirm it by evidence. Vouching helps an

auditor in establishing the truth of entries in the books of account and completeness of the

record.

Definition of Vouching

Some of the important definitions by well-known authors are giving below:

Lawrence Dicksee had defined vouching as an act of comparing entries in the books of

accounts with documentary evidence in support thereof.

Ronald A. Irish has defined vouching as a technical term which refers to the inspection by

the auditor of documentary evidence supporting and substantiating a transaction.

According to F R M De Paula, Vouching does not mean merely the inspection of receipts

with the cash book, but includes the examination of the transactions of a business together

with documentary and other evidence of sufficient validity to satisfy an auditor that such

transactions are in order, have been properly authorized and are correctly recorded in the

books.

According to Arthur W Holmes, Vouching is the examination of the underlying evidence

which is in support of the accuracy of the transaction. The process of vouching is intended to

substantiate an entry by providing authority, ownership, existence and accuracy.

From the above definitions we can conclude that vouching is a method of examination to not

only substantiates an entry in the books of account with documentary evidences, but also to

see that these evidences are adequate, reliable and really connected with the business. For

this, the auditor should go beyond the books of account i.e. he should go to the very source of

the transaction to see that it is related to the business and is properly authorized.

Objectives of Vouching

Main objective of vouching is to find out the regularity or irregularity of transactions, frauds

and errors. Regularity means maintaining record and performing the work compliance with

the rules, regulation and law. But irregularity means doing the work crossing to the line of

rules, regulation and laws. Some of the major objectives of vouching are given below:

1. To detect errors and frauds

All transactions are to be supported by evidence. Each document should be proved

by authorized authority. With the help of vouching we can detect errors and frauds by

verifying each transaction. Planned fraud can be detected through vouching.

2. To know the truth of account



Each and every transaction is checked and ratified on the basis of support document. So, we

can easily know the truth of account.

3. To find the unrecorded transactions

Each and every transaction is checked and ratified on the basis of document. Vouching helps

to find out the unrecorded or missing transactions. If any voucher is found unrecorded auditor

can suggest recording such transactions.

4. To know that all the transactions are authorized

If the transactions are made on the consent of concerned authority, such transactions are

known as authorized transactions. If transactions are not authorized, such transactions can be

fictitious transactions. So, such fictitious transactions can be found with the help of vouching.

5. To know that only the business transactions are recorded

Sometimes, transactions are performed for individual purpose but payment is made out of

business. Such transactions should not be recorded in account of business. If such

transactions are recorded, we can find it with the help of vouching. To know the real profit or

loss of business, such transactions are to be separated.

Importance of vouching

Vouching is the act of checking evidential documents to find out errors and frauds and to

know the authenticity, accuracy and reliability of books of accounts. Thus, it is important for

an auditor due to the following reasons:

1. Vouching is the backbone of auditing

Main aim of auditing is to detect errors and frauds for proving the true and fairness of results

presented by income statement and balance sheet. Vouching is only the way of detecting all

sorts of errors and planned frauds. So, it is the backbone of auditing.

2. Vouching is the essence of auditing

Auditing not only checks the accuracy of books of accounts but also checks whether the

transactions are related to business or not. All the transactions are performed after the prior

approval of concerned authority or not, transactions are real or not because an accountant

may include fictitious transactions to commit frauds. All these facts can be found with the

help of vouching. So, vouching is essential for auditing.

3. Vouching is important to see whether evidences are correct or not

An auditor checks the books of accounts to detect errors and frauds. Frauds may be

committed presenting duplicate vouchers. All the small and big amounts of frauds can be

detected with the help of vouching. So, all the evidential documents and records are to be

checked carefully and in detail by an auditor which is the scope of vouching.



Therefore, it can be said that vouching is the heart of auditing because without the work of

vouching, the work of auditing cannot be performed.

FACTORS TO BE CONSIDERED WHILE VOUCHING

Vouching helps to prove the truth and fairness of account by detecting errors and frauds. So,

while conducting the test of vouchers, following factors are to be taken into consideration:

1. An auditor should check the records whether they are supported by evidential documents

or not.

2. All the documents related to income and expenditures are to be separated and separate files

should be maintained. If not, auditor should ask to do so.

3. An auditor should use special sign in tested vouchers so that they cannot be used again.

4. While vouching, an auditor should check whether the general principles of accounting

have been followed or not and clear cut demarcation of capital and revenue is made or not.

5. Whether the documents presented for testing are related to the current year or not.

6. All the documents which are presented for auditing must be authorized by the concerned

authority. An auditor should check whether it is done or not.

7. An auditor should ask duplicate copies of missing vouchers, but if important vouchers have

been missed and auditor is not satisfied with the reasons presented, s/he should write in report

to this fact.

8. If an auditor finds the correction in the evidential document, then such figures should be

verified with documents and to be noted down in audit note book for consideration while

preparing report.

9. All the documents are to be reviewed before closing the work of audit which helps to

check again those facts where special sign is given.

Principles or Techniques of Vouching

1. Arranged Voucher

In the books of accounts the vouchers are based an entry. A voucher is helpful to support any

transaction, which may be cash memo fill, voucher, ticket or others.

2. Checking of Date

The voucher date can also be checked; it must be related to the current year. The date of the

last or future year must not be adopted.



3. Checking of Authority

The vouchers are considers correct only when the proper authority signs on them. For the

approval of the dealing the owner or the management must put the signatures for the approval

of dealing if the vouchers are without the signatures of the proper authority. They are not

considers the true.

4. Cutting or Change

There should be no changes in the vouchers. Any person for making the fraud can change the

time, date, amount and name of concern. So, these changes cannot be acceptable till the

approval authority has made the signature.

5. Compare the Words and Figures

The auditor should satisfy himself amount written on the vouchers, it figures and words are

same or not.

6. Transaction Must Relate to Business

For the correctness of the vouchers it is necessary that it relate with the business. Concern,

the vouchers must be in the name of the business and also the manager. If it does not the

vouchers are not acceptable and doubtful.

7. Case of Personal Vouchers

The auditor should not accept the voucher in personal name. There is a chance than an officer

of the company has purchased any item in his personal capacity.

8. Checking of Account Head

Auditor must be satisfied about the head of account in which cash is deposited and drawn. He

should examine the documentary evidence in these regards.

9. Revenue Stamps

For the stamps, the stamps act 1899 is applicable while fixing the revenue stamps. The

stamps are required according to the valuation of the amount or cash memo. There is no need

of vouchers if amount is less than twenty rupees.

10. Case of Cancelled Voucher

The auditor should not accept the cancelled vouchers because it has already served the

purpose of payment. There will be a danger of double payments, if it is accepted.

11. Important Notes

For finding the correct decision, the auditor can also take help from the working papers of the

previous year and others paper or note related to business and available with the

management.



12. Minutes Book

When the meeting of shareholders is held, All the resolutions and decisions of the directors

and shareholders are recorded in the minute's book. This minutes book must be examine by

the auditor. He has to check that these decisions have been implemented in the books of

accounts or not.

13. By Laws

In case of company the article of association and memorandum are basically the rules and

regulations. But on the other hand in the societies and clubs the by-laws are used to determine

the powers of management. The auditor goes through these rules and regulations to find the

true and fair view.

14. Agreements

The auditor must examine all the related papers of the business such as the agreement,

correspondence and others. The basic information can be received to the auditor by such

papers.

15. Deed of Mortgage

Sometimes, you are the sale or purchase of any assets, the management can enter into the

agreement is prepare in this case. If the agreement is prepare in this case. If the agreement is

made for a loan against the immovable property then the mortgage deed is signed. It is

compulsory for the auditor to study the content of the deed.

Procedures of Vouching

1. Reading Out

The vouching is a task of the auditor. The junior audit can read out the contents of the

vouchers. He can inform the senior auditor about the data name of organization, number of

voucher and amount of vouchers.

2. Comparison

The senior can head the contents called out by junior auditor. He tally each and every item

stated in the voucher with entries in the books of accounts. Thus comparison is a part of

vouching procedure.

3. Ticking

The senior auditor can use various ticks or symbols to clear the items checked. The ticks may

be an abbreviation of words. Such ticks or symbols may differ from auditor to auditor

because these are code words.



4. Stamping

The senior auditor instead of signature or initials he can use stamps for checking the vouchers

can use the rubber stamps. The rubber stamp may have the wording checking and cancelled

on it.

5. Signatures

The senior auditor can vouch the entries with the help of vouchers. He can put his signature

or initials on every voucher for safety measures. The signed vouchers cannot be presented

again for another entry.

6. Query

The voucher may be missing. The entries may be doubtful due to over writing and erasing.

The audit staff can make the word "Q" against such entry. This entry is recorded in working

papers.

7. Management

The audit staff can be giving sometime to the management for clearing the objections. The

doubtful entries are handed over in written form. The management can examine the record in

detail.

8. Reply

The management may reply after one or two days about the doubtful entries. The auditor can

examine the reply of the managers. The auditor can judge whether the reply is right or wrong.

9. Clearance

The audit staff can clear the query for which proper answer is made available. The auditor

may not be satisfied with the answer of objections. He can inform the management about this

query.

10. No Satisfactory

The auditor may reject the unsatisfactory reply. He has skill, training and experience. He can

use all available means to test the truth. He can note down poor clarification in working

papers.

11. Objections

The objection stated in the working papers can be discussed with the management at the end

of audit. He can form an opinion on the basis of such objections. He can submit his report

either clear or qualified.



ROUTINE CHECKING

Regular checking of all the daily transactions is known as Routine Checking. Routine

checking incorporates the following tasks:

Checking of record in primary books, costing, transfer etc.

* Checking transfer of transactions from original books of accounts to ledger account.

* Checking debit and credit side of various accounts.

* Checking transfer of balances of various accounts to other pages or accounts or statements.

Various signs are used while conducting routine check. Such signs provides the proof of

routine checking of transactions.

Signs which are used in audit should be small and clear. Generally red or pink color is used

while conducting routine check. But green color is used while conducting final audit.

Advantages of Routine Checking

Following benefits can be obtained from the routine checking:

1. All the original entries will be checked; so all the errors and frauds can be detected easily.

2. All the entries and posting will be tested.

3. Routine checking helps to conduct final audit because all the balancing and totals have

already been checked.

4. Separate and specific staffs are not needed because it is a regular process.

Disadvantages of Routine Checking

Followings are the limitations of routine checking:

1. Routine checking is a mechanical test, so the staff who performs this work does not have

inspiration. So, there are chances of leaving errors and frauds.

2. Routine checking can only detect small errors and frauds but not the planned frauds.

3. Routine checking is not needed where self-balancing system is applied.

4. Routine checking cannot detect principle and compensating errors.

VOUCHER

Meaning of Voucher

‘Voucher’ is the original documentary evidence in support of any payment or receipt of

money by the business. It would be with the help of the voucher that the accuracy of entry

can be checked. It can be a receipt invoice cash memo, bank paying slip , agreements or

contract , a resolution passed at a meeting of board of directors or shareholders, a minutes

of a meeting correspondence with parties etc.



Voucher alone can tell us about the nature and sources of the transaction, its value and

authority. It substantiates the book entries and confirms their reality. Such evidence may be

primary and collateral. Certain Vouchers provide primary evidence while others constitute

collateral evidence.

The auditor has to depend and rely upon the vouchers to a great extent in order to form an

expert opinion about the accuracy and authenticity of the recorded transactions. All vouchers

relevant to the business transactions should be carefully filed and preserved to enable the

auditor carry out vouching.

Voucher can be in three different forms. These are mentioned below:

Proof: Vouchers are a proof that specific transaction has been carried and the audit trail of

transaction is available in the relevant books of the entity

Written record: Voucher is often a written record for an expense, or a completed

transaction, and it is properly recorded

Written authorization: Voucher is often a written authorization that establishes the fact that

voucher holder is entitled to the amount of the money mentioned on the voucher (in case of a

cash voucher) or voucher holder is entitled to spend the mentioned amount of money on the

future expenditures (in case of a credit voucher)

Types of Vouchers

All the vouchers in terms of their nature can be classified into two broad categories

1. Primary voucher:

It is an original voucher, which is produced in support of a trails- action such as purchase

order, original invoices, goods received notes, etc.

2. Collateral voucher:

It is a subsidiary voucher which is produced in support of a transaction in the absence of an

original voucher such as carbon copies of cash memo, copies of purchase order, etc.

3. Other types of Vouchers

Payment: These types of vouchers is a proof of payment by cheque or cash

Receipt: These vouchers help in the recording of the receipts. If the payment is

received from a customer, then a voucher will be prepared as a proof to the

transaction

Purchase: This voucher is made as a proof to the purchase. This helps in determining

whether the entity has actually carried out the purchase



Sales: These vouchers are a proof of the sale of inventory to the customer and help in

establishing that sale is not fictitious

Journal: These are the vouchers when the account is neither a cash nor cheque

Adjustments voucher: Changes in the business stock or any other changes are

accounted by adjustment vouchers

Loss statements: These vouchers are made to determine the losses incurred

VOUCHING OF CASH TRANSACTIONS

Vouching of cash transactions is by far the most important job in every business irrespective

of its size and type of business etc. Before setting the programme for vouching the cash

book, an auditor should examine carefully the whole system of internal check in operation

in respect of cash transactions. (Internal check has already been explained in detail

previously).

Vouching of receipts of the debit side of the cash book

It is rather very difficult to vouch the receipt of cash than to vouch payments as some entries

might have been omitted altogether and therefore only an indirect evidence like counterfoils

of receipts issued, carbon copies of receipts, contracts and letter from debtors etc. are

available. He should check a few items at random and if he finds them to be in order, he may

assume that the others will be correct but he must not forget to compare the rough cash

book or the diary with the cash book. If he fails to do so and later on a fraud is detected, he

might be held responsible. If he finds that there is a time gap between the two dates, he

should go deeper into the matter as it is possiblethat money might have been received in

between the two dates and misappropriated.

Some of the important items which usually appear on the debit side of the cash book

and the duty of an auditor in that connection are given below:

1. Opening balance:

This can be vouched by comparing it with the balance shown in the duly audited balance

sheet of the previous year. By doing this, it is verified that the actual balance has been

brought down.

2. Cash sales:

Under this head, the chances of fraud are comparatively greater, for example the salesman

may sell goods but may not record the same in the cash book thus misappropriating the

money. Therefore the auditor should examine the effectiveness of the internal control

system in operation in regard to cash sales. Assuming an effective internal check system in



operation, the auditor should take the following steps to verify the correctness of the amount

of cash sales.

(a) Check the counterfoils of the cash sales books with the salesman's sun maries or

abstracts.

(b) Note that each salesman's abstracts agree with the analysis of the cash received by the

receiving cashier.

(c) Check the details of cash received with the cash sales counterfoils.

(d) Compare the daily totals of the receiving cashier's memorandum cash books with their

corresponding entries in the main cash book. If the auditor fails to do so and later on fraud is

discovered, he will be held liable.

Points to be considered while vouching of cash transactions

Vouching of cash transaction is the most important job of an auditor. Before setting the

program of vouching, an auditor should inquire carefully into whole system of internal

control. An auditor should examine and understand the system and should pay attention in the

following points.

1. Responsible officer for cash received and authority to sign check should not be given to the

cashier and a copy of counterfoil should be kept for record of office. The receipts should be

numbered serially.

2. All the receipt of cash should be recorded in the cash book.

3. Amount of cash received should be deposited into bank daily.

4. The cashier should not have any control over ledgers.

5. Drawer of check should present it to responsible officer to sign.

6. All unused receipt books and check books must be kept under lock.

7. System for recording cash sales and miscellaneous income should be different.

8. All the payments except petty cash expenses must be made by check.

VOUCHING OF CASH SALES

Cash sales can be vouched by the auditor in the following way:

1. Internal Check:-

Auditor should evaluate the internal check and if it is proper system then he should rely on it.

2. Checking of memos:-

Auditor should check the cash sales memos and compare it with the daily summaries of

salesman and cashier.

3. Entry in cash book:-



Auditor should also check the figures of the salesman and cashier summaries entry in the

cash book.

4. Checking of cash register:-

If cash register is used, auditor should check the total daily rolls with the entries in the cash

book.

5. Checking of cash book:-

Auditor should compare the cash book with the general ledger.

6. Checking of price lists:-

Auditor should obtain and verify it price lists and other instructions by the authorize persons

regarding the cash sales.

7. Guidance to client:-

If internal check system is not effective than auditor should inform the client about the

dangers of frauds. He should also suggest some measures.

Cash received from debtors

The cash received from customers to whom good have been sold on credit in the past can be

vouched with the help of the counterfoils of the receipts issued to them. But it is often noted

that a smaller amount than actually received is shown on the counter foils or receipts are

issued to the debtors from old but unused counterfoil receipt books, the auditor should take

the following steps in vouching receipts from debtors:

1. Check the internal check system with regard to the sales as a whole.

2. Ensure that the unused counterfoil receipts are kept in safe custody.

3. See that all spoiled receipts are attached to the counterfoils and he has cancelled them.

4. Verify the dates on the counterfoils with those in the cash book.

5. The practice being followed with regard to receipts through cheques should be noted and if

no official receipts are being issued, he should verify the daily lists of such receipts with the

entries in the cash book.

6. In respect of discount allowed to debtors, the auditor should ascertain the terms on which

discount is allowed and test check a certain number of entries to ascertain whether the

discount allowed is in order.

7. Special attention should also be paid to the amount shown as bad debts written off as cash

can be misappropriated by writing off the whole or a part of the debit balance as bad. He has

to ascertain as to who is responsible for writing off debts as bad. He should, with the

permission of the client, establish direct contracts with the debtors by sending them the



statements or verification slips from time to time and asking them to send their confirmation

directly to him.

With regard to receipts from debtors fraud may be committed by the process of "teeming and

lading”, which is not entering cash in the cash book received from a debtor and entering it

only when a similar amount is received from another debtor and so on. Of course, no

misappropriation is committed but the practice should be checked because there is the loss of

interest for the period money is misappropriated and the cashier may be tempted to commit

such a fraud of bigger amount and may not be able to replace the same. To detect such a

fraud the auditor should:-

1. Examine the accounts of those debtors which show part payments from time to time.

2. Check the amount and date on the counterfoil receipts to compare it with the dateand

amount deposited in the bank.

3. Should send verification slips to the debtor requesting them to send the confirmation

directly to him.

Deferred Revenue Expenditure

Deferred revenue refers to payments received in advance for services which have not yet

been performed or goods which have not yet been delivered. These revenues are classified on

the company's balance sheet as a liability and not as an asset.

Sometimes, some expenditure is of revenue nature but its benefit likely to be derived over a

number of years. Such expenditure is called deferred revenue expenditure. The two examples

of deferred revenue expenditure and their treatment in final accounts are as explained below:

Example 1:

An example of deferred revenue is when a cleaning company accepts the prepayment of its

monthly fee for its services in advance for a whole year. The company agrees to provide

cleaning services for that year. If the cleaner cannot provide the service at any point during

that year, the "unearned" fee must be refunded. The "unearned" portion of that fee is treated

as deferred revenue until the monthly service is performed. At that point, the fee is earned

and is converted into an asset. Other examples of deferred revenues are advance payments to

a software company before the software is completed, advance payment to a plumbing

contractor before the installation is completed, or prepayment for an annual subscription to an

online service. In each of these cases, the payment is treated as deferred revenues.



Example 2:

When a new firm enters in to market, it undertakes special advertising campaign on which it

spends heavy amount. The benefit of this expenditure will certainly come in some future

years. Hence it will not be justified to charge this expenditure only in the profit and loss

account of the year in which it incurred. This expenditure must be spread over the period over

which the benefit is likely to lose. Suppose this expenditure will cover 3 years. Hence 1/3 of

the expenditure must be charged to each year Profit and Loss Account.

Auditor’s Duties

1. The auditor should note that only the genuine deferred revenue expenses are written off

over a number of years.

2. The auditor should guard against the writing off of the illegitimate expenses over a number

of years just to inflate the profits of the organisation.

3. The auditor should check calculations and examine all related vouchers to ascertain the

correct amount to be amortised.

4. The auditor should see that all such expenses have been correctly and properly spread over

a number of years and debited to Profit and Loss Account.

5. Tire auditor should see that the balance of such expenditures (not written off) are shown

on the asset side of the Balance Sheet until they are written off fully.



Verification and Valuation of Assets and Liabilities

Concept and Meaning of Verification

Verification means proving the correctness. One of the main works of auditor is verification

of assets and liabilities. Verification is the act of assuring the correctness of value of assets

and liabilities, title and their existence in the organization. An auditor should be satisfied

himself about the actual existence of assets and liabilities appearing in the balance sheet is

correct. If balance sheet incorporates the incorrect assets, both profit and loss account and

balance sheet do not present true and fair views.

Thus, verification means to confirm the truth or accuracy and to substantiate. It is a process

by which the auditor satisfies himself not only about the actual existence, possession,

ownership and the basis of valuation but also ensures that the assets are free from any charge.

While verifying the assets, an auditor should consider the following points:

Ensuring the existence of assets.

Acquiring the assets for business.

Ensuring the proper valuation of assets.

Ensuring that the assets are free from any charge.

Objects of Verification

1. Correct valuation of assets and liabilities.

To ascertain whether the assets and liabilities have been shown in the Balance Sheet at

their correct, value, the valuation should have been made on the principles of accounting.

2. True and fair financial position.

To certify whether the Balance Sheet exhibits a true and fair financial position and for this

he has to verify the assets and liabilities.

3. Existence of Assets.

To ascertain the existence of the particular asset appearing in the Balance Sheet.

4. Ownership and title of the assets.

To certify the ownership and title of the assets appearing in the Balance Sheet.

5. Detection of fraud and irregularities.

To detect the fraud and irregularities in the books of accounts

6. Arithmetical Accuracy.

To ensure the arithmetical accuracy of the accounts books.



Concept and Meaning of Valuation

Valuation is the act of determining the value of assets and critical examination of these values

on the basis of normally accepted accounting standard. Valuation of assets is to be made by

the authorized officer and the duty of auditor is to see whether they have been properly

valued or not. For ensuring the proper valuation, auditor should obtain the certificates of

professionals, approved values and other competent persons. Auditor can rely upon the

valuation of concerned officer but it must be clearly stated in the report because an auditor is

not a technical person.

An auditor should consider the following points regarding the assets while making valuation

off assets:

Original cost

Expected working life

Wear and tear

Scrap value

Importance of verification and valuation of assets and liabilities

Assets and liabilities are very important aspects of business. Balance sheet is prepared on the

basis of them and an auditor should prove the true and fairness of information provided by

balance sheet. So it is very important for an auditor. Its importance can be highlighted as

follows:

1. To show the actual financial position

Balance sheet is prepared to show the actual financial position of a business. If proper

valuation is not made, such balance sheet does not provide true and fair information. So, to

provide information about the real financial position, verification and valuation of assets are

essential.

2. To know the real position of profit and loss

Depreciation and other expenses on assets will be incorrect if proper valuation of assets is not

made. So, to calculate the actual amount of profit and loss, proper valuation of assets and

liabilities is necessary.

3. To increase goodwill

Proper valuation gives fair information about profitability and financial position of a

business.So, people can get information which creates positive attitude towards company.

Positive attitude of public increases goodwill.



4. To assure shareholders

Valuation and verification provide actual information about assets and liabilities to the

shareholders which assure the safety of their investment.

5. Easy for sale

At the time of sale of the company, it can be sold at the price which is enlisted in the balance

sheet, but the assets whose valuation is not made need valuation before selling the company.

6. Easy to get loan

Company discloses the balance sheet proved by auditor for public knowledge which increases

the trust of the company. Financial institutes provide loan easily to such companies.

7. Easy to get compensation

Whenever the loss occurs due to any incident, insurance company provides compensation on

the basis of valuation of assets. So, the company can easily get compensation.

Differences between Verification and Vouching

Verification is made on the basis of vouching. So, verification is a part of vouching. Even

though they have some differences which are as follows:

Point of Difference Vouching Verification

Meaning

Verification is the act of checking

title, possession and valuation of

assets.

Vouching is the act of checking the

records with the help of evidential

documents.

Nature of work It examines the entries relating to

transactions

It examines the assets & liabilities

in the balance sheet

Person

Generally, assistant staff or

auditor performs the work of

vouching

Auditor himself performs the work

of verification.

Time It is done throughout the year It is done at the end of the year

Basis It is based on documentary

examination

It includes personal as well as

documentary examination

Valuation Vouching does not include

valuation It includes valuation

Differences between Valuation and Verification of Assets

Valuation and verification of assets arecomplementary to each other. Until and unless the

valuation of assets is made, verification is impossible even though they have some

differences which are as follows:

1. Verification is a final work but valuation is needed to the verification.

2. Verification is the work of auditor but valuation is the work of concerned authority or

board.



3. Valuation checks the amount shown in accounts but verification checks the items shown in

the balance sheet.

4. Valuation is made throughout the year but verification is made at the end of the year.

5. Valuation is based on evidence but verification is based on individual check.

Difference between Vouching, Verification & Valuation

Point of

Difference Vouching Verification Valuation

Meaning

It consists of

comparing entries in the

books of accounts

It proves the existence,

ownership & title

It certifies the correct

value of Asset &

Liability

Subject

matter

In this entries are

recorded in the original

books and their posting

Its verifies assets &

liabilities

Its verifies assets &

liabilities

By whom It is done by senior

Auditors & audit clerks It is done by Auditor It is done by Auditor

When After the entry of the

transaction End of the financial year

End of the financial

year

Evidence Vouchers Title deeds, receipts &

payments

Certificate from

owners/directors

Methods of Valuation of Assets

Valuation of various assets can be made by using different methods. Valuation of fixed assets

can be made in different ways. Some of the major methods are as follows:

1. Cost Method

In this method, valuation of assets is made on the basis of purchase price of the assets. It is

very simple method of valuation of assets. Sometimes, existence of one assets depends on the

existence of another. Then it is difficult to use this method.

2. Market Value Method

Valuation of assets can be made on the basis of market price of such assets. But if same

nature of assets is not available in the market, it is very difficult to determine the value of

such assets. So, there are two methods related to it. They are:

Replacement Value Method

If same asset is to be purchased then on the basis of same value, valuation of assets can be

done.

Net Realizable Value

It refers to the price in which such asset can be sold in the market. But expenditure incurred

at the sale of such asset should be deducted.



3. Base Stock Method

Under this method of valuation, company should maintain certain level of stock and valuation

of stock is made on the basis of valuation of base stock.

4. Standard Cost Method

Some of the business organizations fix the standard cost on the basis of their past experience.

On the basis of standard cost, they make valuation of assets and present in the balance sheet.

5. Average Cost Method

It is a simple method for the valuation of such assets which cannot be distinguished. Like

petrol, petrol is kept in the tank but e cannot separate its stock on the basis of lot. So,

valuation of stock is made adding to all the cost and dividing by the quantity.

Mode of valuation of different types of assets

The mode of valuation of different types of assets differs depending upon the nature of the

business and the purpose for which the assets are held. The basis of valuation for different

types of assets is given as below:

1. Fixed assets:

These assets are of a permanent nature with which the business is carried on and which are

held for earning income and not for re-sale in the ordinary course of the business. For

example, land and building, plant and machinery and furniture etc. These assets are to be

valued at cost price less total depreciation in their value by constant use. Additions and sales

should be taken into account.

2. Wasting Assets:

These assets are of fixed nature and are depleted gradually lose a part of their value in the

process of working such as mines, quarries and oil wells etc. The common method of

valuation in such a case is that the value of such assets must be shown in the balance sheet at

its original cost and provision is made for depreciation and depletion according to the

estimated exhaustion of these assets.

3. Intangible assets:

There are the assets which have income producing ability but cannot be seen of touched. For

example, goodwill, patents, copyrights, licenses etc. They are generally valued in the same

manner in which fixed assets are valued, that is at the cost price.

4. Current Assets:

These are the assets which are acquired in the business held for purposes of consumption,

resale or subsequent conversion into cash. For example, stock-in-trade, book-debts, cash and



bills receivable etc. These assets should be valued at original or the market price whichever is

lower.

Auditor's position as regards valuation of assets:

It is not an auditor's duty to determine the values of various assets. It has been judicially held

that he is not a valuer or a technical man to estimate the value of an asset. But he is definitely

concerned with values set against the assets. He has to certify that the profit and loss account

shows true profit or loss for the year and balance sheet shows a true and fair view of the state

of affairs of the company at the close of the year. Therefore he should exercise reasonable

care and skill, analyse all the figures critically, inquire into the basis of valuation from the

technical experts and satisfy himself that the different classes of assets have been valued in

accordance with the generally accepted assumptions and accounting principles. If the market

value of the assets are available i.e., in the case of share investment then he should verify the

market value with the stock exchange quotations. If there is any change in the mode of the

valuation of an asset, he should seek proper explanation for it. If he is satisfied with the

method of valuation of the assets he is free from his liability.

Verification and Valuation of assets

1. Property:

In order to verify this item, the auditor should distinguish between two types of property.

(a) Freehold Property :

Where Freehold property has been purchased, he should examine the title deeds e.g., the

purchase deed, the certificate of registration, the broker's note and the auctioneer's account

etc., in order to verify the correct position. However, an auditor cannot guarantee that the title

is good; all he can do is to see that the deeds are in client's possession and appear to be in

order. In case of any doubt on any point, he should refer the matter to the client's solicitors.

In case where property has been mortgaged, the auditor should obtain a certificate from the

mortgagee regarding the possession of title deed and outstanding amount of loan. In case the

property has been acquired in the current year the cost may be verified with the help of the

bank pass book. He should also vouch all the payments made in this connection. He should

see that the property account should be shown in the balance sheet at cost price including the

legal and registration charges less depreciation up-to-date. He should also see that a separate

account for building and land on which it is constructed is maintained. It is necessary because

depreciation is provided for building and not for the land.



(b) Leasehold Property:

The auditor should verify this by inspecting the lease contract to find out value and duration.

He should see that the terms and conditions of lease are properly complied with. In case

property has been mortgaged, the auditor should obtain a certificate from the mortgagee

regarding the possession of title deed. Where the leasehold property has been sub-let, the

counter part of the tenant's agreement should also be examined. Wherever possible, the

auditor should physically inspect the properties. He should also note that proper provision

has been made for depreciation of leases and for any possible claims arising there under.

2. Furniture, Fixtures and Fittings:

In case the assets have been acquired during the current accounting period, the auditor should

examine the invoice of the dealers. It should be noted that adequate depreciation has been

written off, based upon the working life. In the case of fixture and fittings on lease hold

premises, the whole cost should be written off over the period of the lease of their estimated

working life, whichever is shorter. A stock register to record furniture etc., purchased should

be maintained. The old and unserviceable furniture must be discarded by a responsible

officer. He should ask the management to prepare an inventory and reconcile it with the stock

register.

3. Plant and Machinery:

In case the machines are purchased in the current accounting period, the invoices and the

agreement with the vendors should be verified. The auditor should ` examine the plant

register in which particulars about the cost, records about sales, provision for depreciation,

etc., are available. He should prepare a list of each machine from the plant register and should

get the list certified by the works manager as he is not a technical man and therefore he has to

depend upon the advice of the works manager regarding their valuation, etc. He should see

that plant and machinery account is shown in the balance sheet at cost less depreciation after

making proper adjustment regarding purchases and sale of some parts affected during the

year under audit. In case any plant and machinery has been scrapped, destroyed or sold, he

should ascertain that the profit or loss arising thereon has been correctly determined.

4. Goodwill:

Goodwill should be shown as an asset in the balance sheet only if it has been purchased. In

such a case goodwill should be shown at cost. But if the price paid for goodwill has not been

fixed specifically in the contract of sale, the amount of goodwill will be the difference

between the total purchase price and the other assets at agreed valuations, less any liabilities

taken over from the vendors.



Here it should be noted that the real value of the goodwill of any business can be said to

fluctuate almost daily and it is not part of an auditor's duty to consider whether this value is

greater or smaller that its book value at a balance sheet date. The auditor should see that the

goodwill account represent the actual cost only, that is, improper items should not have been

included therein.

Sometimes a question is raised about the depreciation of goodwill. Legally, it is not binding

on a company or a firm to write off goodwill, but, however, it is advisable from the financial

point of view to write it off gradually within a reasonable period out of current profits or

reserves. But it is for the proprietors or directors to decide. An auditor cannot interfere with

this decision, though he may give advice, if asked for. However the auditor should very

carefully look to the reasonableness of appreciation in its value, if any.

5. Patents:

The auditor should first of all examine the patents and verify them with the help of the

certificates which have granted for such patent rights. Where the patent has been purchased,

the assignment as well as the patent should be inspected.

If the number of patents is considerable, the auditor should call for a schedule thereof from

the client giving particulars of each patent the register number, dates etc. and examine the

same.

Here it is important to note that the actual patent should be examined and it must be duly

registered. He should also examine the last renewal fee receipt to satisfy himself that the

patents have been renewed at the prescribed time. He should note that the cost of renewal fee

should be debited to profit and loss account.

6. Trade Marks:

The auditor should see that they are registered in the name of the client and this can be done

by examining the certificate issued by the Registrar. In case a trade mark has been purchased

he should also vouch the payment.

Where it is registered by the proprietor of the business himself he should examine the

registration documents and the certificates issued by the office of the registrar of trademarks

and the last renewal payment fee receipt. He should also see that any expense incurred in the

acquisition of the trade mark has been treated as capital expenditure but any renewal charges

has been treated as revenue expenditure.

7. Copy rights:

This is a right to produce or re-produce some kind of literary works. Its effect is that the

author or the publisher gets an exclusive right to publish or reproduce the work for a certain

number of years of for the life time of the author or the publisher as the case may be the



auditor should inspect the agreement between the author and the publishers. It is after seen

that the value of the copyright is not stable because they lose their value by passage of time.

Hence, in this case, the revaluation method of charging depreciation is considered to be most

appropriate. The auditor may rely on the certificates of experts responsible for revaluation.

If the sale of the publication is very low or nil, the copyright should be written off. Generally,

copyright must be shown at cost less amounts written of from time to time.

8. Loose Tolls:

The auditor should obtain a list of loose tools duly authorized by some responsible officer

and examine the same. Revaluation of loose tools is the most appropriate method of

valuation. The difference between the cost price and the current price should be treated as

depreciation or loss to be charged to the profit and loss account.

9. Motor Vehicles:

Motor Vehicles account is to be separately maintained. The auditor should compare it with

the balance sheet in which it should be clearly stated under separate head. He should also see

that they are shown in the balance sheet at cost less depreciation.

If the number of vehicles is very large, a separate register maintained should be checked and

compared with a schedule of motor vehicles by the auditor. He should check the registration

books and licenses to ascertain that vehicles are registered in the name of client. He should

check the premium receipts to ensure that they are fully insured.

10. Investments:

Investments include government securities, shares, debentures, etc.When the number of

investments is very large, the auditor should ask for a schedule of investments held by the

client containing various particulars like name of the securities, date of purchase, nominal

value, cost price, market price, etc., and examine the same. He should see that the asset has

been shown separately in the balance sheet.

The auditor should verify the existence of investments by his personal inspection. At the

same time, he should also ensure that the investments are registered in the name of the client

and they are free from any charge. He should rely on the relevant vouchers and certificates to

do so.

If the securities are with the trustees on behalf of the concern the auditor should examine the

trust deed. In case they are under the safe custody of the banker then he should obtain the

certificate from the banker and examine the same. If they are with the broker, he should

examine the certificate received from the broker.

Having verified the securities, the auditor has to find out that the investments are properly

valued. Generally, investments are valued at cost price of market price whichever is lower. In



case there is a temporary fall in the price of the shares, it should be ignored. But where such a

fall is permanent, depreciation must be provided. Actually the basis of valuations of

investment will depend upon the purpose for which they are held. For instance, in case of

trust company the sole purpose of which is to earn interest and dividend, then such

investment must be treated as fixed asset. In such cases even the permanent fall in their value

should be ignored.

11. Book Debts (Sundry Debtors):

The task of verifying this asset would be reduced to a great extent in case there is an efficient

internal check system regarding sales and writing the sales ledger. The auditor should,

however take the following steps to verify this asset:

1. He should see that the debts as disclosed in the balance sheet are recoverable.

2. He should obtain a certified statement of book debts clearly distinguishing between

good debts, secured debts, unsecured debts, current debts, bad and doubtful debts, and

debtors outstanding for a period exceeding six months and other debts.

3. He should check the balances of the sales ledger with the schedule of the book debts

by test checking.

4. In case where certain amount of debt has been written off the auditor should enquire

into the details. He should also examine the correspondence or any documentary

evidence or the authority of any insolvency court regarding the payment of debt.

5. In case of hire purchase debts, the auditor should see that installment yet to be paid by

the customers should not be treated as book debts because the customer has a right to

return the goods.

6. Debts due by directors or other senior officers of the company jointly of individually

should be separately stated. The maximum amount due by directors and senior

officers should be stated by way of a foot note in the balance sheet.

7. In case of debts from a subsidiary company under the same management, „he should

examine the relevant documents to ascertain the genuineness of the debt and the name

of such companies must be disclosed.

8. He should also write to the parties and get balances confirmed by them which will

enable him to know the accuracy of the amount receivable.

9. He should ensure that book debts in the balance sheet of a company are shown

according to schedule VI of part I of the Companies Act.

12. Bad and Doubtful Debts:

The adequacy of the provision for bad and doubtful debts made by the management can be

checked by an auditor by considering the following points:



1. All time barred debts must be treated as bad. So an auditor must check up the period

of the debt and see that necessary provision has been made for such bad debts.

2. He must check the cases of those individual debtors who are not regular in payment of

debts according to the terms of agreement and ascertain the collectivity of the debts in

each case. Amounts that are definitely not collectible should be written off.

3. In case of those debtors, who have been adjudicated as insolvent or whose cheques or

bills have been dishonoured proper provision must be made.

4. Provision must also be made for the amounts owing from those debtors against whom

suits for realisation of debts are pending in the law courts.

5. It is not desirable that debts should be written off until there is no further spoke of

recovering anything. Bad debts should not be written off without the function of some

official which will prevent the possibility of misappropriations. As regards the

amounts of provision to be made in respect of bad and doubtful debts not written off it

is suggested that full provision should be made for those debts actually regarded as

bad while the doubtful debts should be provided for according to their estimated value

depending upon the circumstances of each cash.

13. Bill Receivable:

In order to verify the bills receivable, the auditor should take the following steps:

1. The bills receivable should be compared and counted with the actual bills in hand at

the date of balance sheet by examining the bills receivable book.

2. In case the bills have matured and honoured subsequent to the date of the balance

sheet but prior to the date of audit, he should vouch the cash received as shown in the

cash book or the bank pass book. Similarly, the bills discounted after the date of

balance sheet must be vouched with reference to cash collection.

3. He should see that the bills are properly drawn, stamped and duly accepted and they

are not overdue. In case of the renewal of any bill, he should examine the new bill

with the old bill. Where the part of the original bill has been paid he should vouch the

cash received and see that a new bill of the balance amount has been obtained.

4. Where the number of bills is large and they are usually kept with bankers or agents for

collection he should obtain a detailed certificate from them and examine the same.

5. In respect of bills discounted or endorsed but remaining outstanding at the time of

audit, any contingent liability in respect of such bills should be mentioned as a foot

note in the balance sheet.

6. Bills which have been dishonoured before the date of the balance sheet should not be

included in the balance sheet as bills receivable in hand as they are no longer



assets.The acceptor, dishonouring the bill, should be shown as debtor in the books of

accounts.

14. Cash-in-hand:

The auditor should carry out cash verification at the end of the year and or by way of a

surprise check any time during the year. In the former case, he should visit the clients office

on the last day of the closing of the financial period and count the cash-in-hand and compare

it with the balance as shown in the cash-book. He should also count the balances of the petty

cash book, stamps and I.O.U's in hand. In case there is any shortage, he must report it to the

accountant and obtain a certificate to that effect from him. He should insist on the production

of all funds in the same location simultaneously. If the cashier has access to funds belonging

to other entities like associated companies, staff clubs", etc., the auditor should seek the

cooperation of these entities in ensuring that all funds are checked simultaneously as there is

a danger that shortages in one account may be made up from the balance in another account.

Where the whole or a part of the cash is maintained either at an upcountry branch or factory

and is not therefore conveniently accessible to the auditor for verification, the client may be

advised to deposit the entire amount of cash in hand on the last day in the bank. The auditor

should carry out surprise cash verification whenever he visits such an up country branch or

factory during the course of his audit.

15. Cash-at-Bank:

The auditor should compare the balance as shown in the pass book with the balance as shown

in the bank column of the cash book. In case of difference, bank reconciliation statement

should be prepared. In order to avoid the presentation of fictitious pass book, he should also

obtain a letter of confirmation from the bankers. Separate certificates should be obtained for

fixed deposits, current account and saving bank account, etc., from the bank.

16. Stock-in-Trade:

The verification and valuation of the stock-in-trade is one of the most important duties of an

auditor in order to arrive at the correct profit and loss of the concern under audit. In various

cases, it has been decided that the auditor cannot be asked to take the stock or value it.

Practically also, it is impossible for the auditor to physically verify every item of the stock-in-

hand because of various reasons i.e. limited time and the lack of technical knowledge etc.,

still he has to exercise reasonable care in regard to stock verification and valuation. He should

make enquiry into the system of internal check, the method of stock taking and the basis of

valuation.



The auditor should conduct some tests in order to ascertain the effectiveness of these systems.

He should compare the rough stock sheets with fair stock sheets. He should also check the

stock books to ascertain the correct position of the stock-in-hand. He should also obtain a

certificate from a responsible officer stating that the quantities and the valuation of the

various stocks are correct and all the items are the property of the concern. He should also

obtain a list duly certified about the obsolete goods which have been discarded.

Method of Stock Taking

The stock verifier goes to the godown and calls out the number and other relevant particulars

of the items of each class of goods and another clerk enters these particulars in the stock

sheet. Then two clerks of another batch will check the stock-sheet.

The Stock-sheet will then be sent to a responsible officer who fills in the rate of each item of

goods at which they are to be valued. The work of calculation is entrusted to a clerk who will

calculate the value of each class of goods and his work is then checked by a senior clerk. All

those connected with the stock-taking put their initials on the work done by them so that if

later on any mistake is found the concerned official may be held responsible for the mistake.

All stock-sheet are stand-by the general manager or partner as the case may be.

Care should be taken that goods-in-transit are included. Similarly balances of the unsold

stocks at the branches or with the approved agents or `sent on approval' should be included in

the stock-sheet. But goods received by the client on sale or return basis or as a consignee and

goods sold but not yet delivered should not be included. The auditor should obtain a

certificate with regard to the accuracy of the stock-sheet and its valuation from the senior

officer of the concern.

Valuation of Stock-in-Trade

The auditor should consider three principles while valuing the closing stock. One is that stock

should be value at cost or market price, whichever is lower at the date of balance sheet.

Another principle is that all anticipated losses should be taken into account but anticipated

profits should be ignored. Third principle is that the method once adopted should be

consistently followed.

The following are the different methods of finding out the cost price of the stock-in-hand :

1. Unit cost or Actual cost:

Under this method each article, batch and parcel of consignment is valued at its

individual cost, but it is not usually capable of application.



2. Average Cost:

Under this method, the average cost per unit is calculated. The average should be

weighted average. The total value of goods (quantity x price) held in stock and those

purchased and sold should be divided by the total number of units. This method is

adopted when the goods purchased at different times have been mixed upand it is not

possible to identify the goods.

3. First-in First-out (FIFO) :

In this method the whole of the stock is valued at the rate of the latest consignment

purchased. This method assumes that the goods issued out of the stores are those

which were received first. This method is easy to operate if the prices do not fluctuate

very frequently.

4. Last-in-First-out (LIFO) :

This method is the reverse of FIFO. In this method the whole of the stock is valued at

the rate at which the earliest purchases were made. This method assumes that the

latest receipts of the materials are issued first and the unsold stock represents the

earliest purchases and is priced accordingly.

5. Base Stock :

Here it is assumed that certain minimum or basis quantity of material should always

remain in the store. Therefore the stock should be valued at normal long period price,

and not on the basis of dost price or the market price whichever is lower. Excess stock

may be valued at cost price or market price whichever is lower.

6. Standard Cost :

In this method the stock is valued at a predetermined cost per unit, known as standard

cost. This method is convenient where goods pass through a number of processes and

are manufactured on large scale basis.

7. Adjusted Setting Price:

In this method the unsold stock is valued at the prevailing price out of which the

normal profit plus the estimated cost of disposal i.e., selling expenses and overhead

expenses, are deducted.

Market Value

For the calculation of market price there are two methods in use :

1. Replacement cost method:

It is the cost of replacing an asset at the date of the balance sheet. It means the price at

which similar types of goods can be presently purchased from the market.



2. Net Realisable value method:

Is means the price at which the goods can be sold in the market after deducting the

necessary selling expenses.

Whether net realisable value be used or replacement cost method be used, it will depend upon

the purpose for which the stock is held. If the purpose is to resale the stock, it may be valued

at net realizable value and if it is retained for use then replacement cost method be applied.

Valuation of different items of stock

1. Raw Materials:

Normally the raw material is purchased for manufacturing goods, hence it should be valued at

cost price plus a reasonable proportion of incidental expenses like carriage and freight and

excise duty etc. If the raw materials were purchased at different times and the lots could not

be identified then average price may be taken. It should be noted that such raw materials

should never be used at a higher price than the market price. But a provision for the write off

must be made in respect of damaged and obsolete raw materials.

Some materials like wine, timber etc., appreciate in value and hence may be valued at higher

price than the cost price. But such value should not be in excess of the market value.

2. Semi-Finished goods:

In case of semi-finished goods which are in the process of manufacture at the date of balance

sheet, they will be valued at the cost price of the raw materials used, plus the proportionate

amount of wages and other direct expenses and a percentage of overhead expenses. The

auditor should see that the amount in respect of selling and office expenses is not included.

3. Finished goods:

These goods may be of two types. Firstly, the goods which have been manufactured and are

in a deliverable state, will be valued at the manufacturing cost, that is, material, labour and a

proportion of factory expenses. If the cost price of the manufactured goods is higher than the

market price and they must be valued at market price.

Secondly, in some trading concerns goods are purchased for the purpose of resale. The cost

of such goods would be the aggregate of the invoice price (including sales tax, excise duty

etc.) and other direct expenses like carriage etc.

4. Stores:

These are goods which may be in hand at the date of the balance sheet stores are held for use

and not for sale in the original form. Examples are Coal, Oil, and Fuel etc. They should be

valued at cost price. If the market price of such stores has gone down, it has been suggested

that they must be written down.



5. Spare Parts:

Spare parts are used in connection with the maintenance of production facilities. The auditor

should get a list of such parts from the works manager. They should be valued at cost price

and are not required to be written down to the market value if that value is lower at the date

of the balance sheet.

6. Goods on Consignment:

It may happen that at the date of the balance sheet, the whole of the consignment or part of it

may not have been sold. Such unsold consignment of goods should be valued at cost price,

plus proportionate expenses, etc., but it should not be valued at higher price than market price

of similar goods. The anticipated losses should be considered while valuing such stock of

goods.

The Duty of an Auditor as regards Stock-in-Trade

The duty of an auditor in relation to the stock-in-trade can be understood from the following

two points of view:

(i) Physical Verification of Stock-in-Trade :

This part of auditor's duty is subjected to a great amount of controversy. As a matter of fact

an auditor may or may not possess the technical knowledge to verify that the stock-sheets are

correct and even if he possesses the necessary knowledge it is not possible for him to inspect

each and every item of the stock. The first guiding legal cases in this direction are Kingston

Cotton Mills Case and Irish Woolen Co. Ltd. V/s Tyson and others. It was held in these cases

it was held that an auditor is not a valuer and it is not his business to take stock and if there

are no suspicious circumstances, he is entitled to depend upon the representation of officials.

He is not guilty of negligence if he accepts a certificate of such persons as to the value of

stock. At the same time it was also stated that he must exercise reasonable care in regard to

stock verification and valuation. For instance, he should make enquiry into the system of

internal check, the method of stock taking and the basis of valuation compare the rough stock

sheets with fair stock sheets etc.

American accountants have not accepted the decision of Kingston Cotton Mills case in view

of the decision taken in the case of Mckesson and Robbins. It was decided in this case that

the auditor was responsible for the physical verification of the stock in-trade.

In India, the accepted practice of the American Accountants has not been accepted. In India,

it is held now that the auditor must present himself when the stock is counted by the

company's staff. He should also examine the effectiveness of the system of stock control. He

should check the stock sheets and if he does not do so, he will be held responsible. He should



also check the calculations, additions and castings as was held in the case of Henry Squire

Ltd.. Vs. Ball Baker and Co. As a result of these decisions, the practice of sending a

representative by the auditor at the time of stocktaking is growing in India.

(ii) Verifying the Valuation of the Stock-in-Trade :

The auditor should apply tests to see that the stock in trade has been appropriately and

correctly valued. If he fails in his duty he will be held responsible. Some of the duties of the

auditor in this connection are given below:

1. He should satisfy himself that the cost figures have been calculated on some acceptable

method and are applied consistently. If the method of valuation has been changed as

compared to the previous year, the auditor should mention this fact in his report and if

possible, should show the effect of the changed method on the financial position of the

concern.

2. He should see that the stock sheets are duly signed by the competent authority and

ensure that calculations, additions and castings are correct.

3. He must examine the stock sheets and see that only goods usually dealt in are included.

He should also see that fixed assets are not included. Similarly, goods on consignment

or sale or return should be included at cost.

4. If the bought and sold books contain quantity columns, the balance shows by them

should be compared with the stock sheets.

5. He should see that proper provision is made for the depreciation of the obsolete or

defective stock and that trade discounts are deducted.

6. He should compare that stock-sheets with those of the previous year and enquire into

major differences.

7. He should compare the prices at which finished goods have been sold and at which the

unsold stock has been valued.

8. He should check the percentage of gross profit on sales with that of the last year and

find out the causes of any material change.

9. He should see that the stock-in-trade in the balance sheet of a company is shown

according to Schedule VI, Part I of the Companies Act.

Verification of Liabilities

Verification of liabilities is equally as important as the verification of assets. If liabilities are

not properly verified and valued, the balance sheet will not reveal true and fair view of the

state of affairs of a business concern. Therefore, the auditor should examine that:



1. All the liabilities have been clearly stated on the liability side of the balance sheet;

2. All these liabilities relate to the business itself;

3. They are all correct and authorised, and

4. They are shown in the balance sheet at their actual figures.

The auditor should also obtain a certificate from some responsible official of the business to

the effect that all the liabilities for purchases or for expenses have been recorded in the books

of account and all the contingent liabilities have been disclosed by way of footnote in the

balance sheet.

The verification and valuation of various liabilities are given as below:

1. Capital:

In case of a partnership firm the auditor should examine the partnership agreement. He must

find out the original capital contributed by each partner and the rate of interest payable on

capital. He must see that capital accounts are correctly maintained and verify all transactions

affecting the capital accounts. He should examine the cash book, pass book, withdrawals of

the partners and profits and loss earned.

In case of a company while verifying the share capital, the auditor should examine the

Memorandum of Association, Articles of Association, Cash Book, Pass Book, and the Minute

Books of the Board of directors to find out the number and the different classes of shares

issued and the amount received on each type of share.

In case of a newly floated company he should undertake an exhaustive checking. If shares

have been issued to the vendors or to the promoters for consideration other than cash he

should examine the contracts between the vendors or promoters and the company. He should

also check the entries regarding the forfeiture of shares reissue if any, calls in arrears.

2. Loans:

Loans may be of two types:

A. Unsecured Loans and Advances :

In such a case the auditor should examine the correspondence and relevant documents, if any.

He should study the conditions for interest payable, repayment of loan, refund by

installments, etc. He should also ensure that the loans are taken for use in the business. He

should also get confirmation from the lenders concerned certifying the balance of principal

and interest outstanding at the date of the balance sheet.

B. Secured Loans and Advances :

In order to verify such loans, the auditor should note (a) Actual amount which has been

advanced, and (b) Security for the loan. So far as the actual amount is concerned, the auditor

should examine that this amount has been properly authorised and sanctioned by directors in



case of a company and by partners in case of a partnership firm. He should examine the

applications received and check the receipts which have been given in token of having

received the loans. He should also verify that the payment in form of instalment and interest

thereon has been received from the borrower himself.

3. Trade Creditors:

The auditor should take a statement of balances of trade creditors duly signed by a

responsible officer and should verify these balances with the bought ledger or the purchase

ledger. He may get confirmatory statements from the creditors. He should also examine the

invoices as sent by the suppliers and an `inward Goods Book' if it is maintained.

He should carry out test checking of all the purchases made during the year particularly those

made at the end of the year. He should also compare the percentage of the gross profit with

that of the previous year. If there is material deviation, he should enquire into the reasons.

For any purchases returns, he should examine the `Returns Outward Book' and verity them

with the help of the credit notes as sent by the supplier.

4. Outstanding Liabilities for Expenses:

The auditor should obtain a certificate from a responsible officer of the company stating that

all outstanding liabilities for goods purchased or for expenses incurred, have been taken into

account.

He should verify those items of expenses which usually constitute outstanding liabilities like

rent, rate, wages, salary, audit fee, legal expenses etc. He should ascertain the accuracy of the

accounting records and test the calculations of such liabilities.

5. Bills Payable:

The auditor should obtain a statement of bills payable and compare it with the bills payable

book and bills payable account. For bills which have been met after the date of the balance

sheet but before the time of audit, he should examine the cash book and bank pass book. He

should ensure that the bills which have been paid are not recorded as outstanding. He should

also obtain confirmations in respect of amounts due on the bills accepted by the client that are

held by them.

6. Contingent Liabilities:

Contingent liabilities are those liabilities which may or may not arise in the future for

payment, for example, the liability for calls on partly paid shares, liability on bills discounted

and the liabilities in respect of arrears of dividend of cumulative preference shares, etc.

Contingent liabilities are divided into two broad categories. One is for those liabilities in

respect of which provision has to be made in the balance sheet, for instance, liability which

may arise in connection with a suit, etc. Another is for liabilities for which no provision has



been made in the books but merely a note has been made at the foot of the balance sheet, for

example, bills receivable which have been discounted but not matured at the date of the

balance sheet, arrears of fixed accumulated dividends, etc.

The auditor should examine the director's minute book, correspondence made with the legal

advisers and the information obtained from the officials of the business. He has to ensure that

proper provision has been made for all such liabilities and if he is not satisfied, he should

mention the fact in his report.



COMPANY AUDITOR

The auditor is an individual who is trained to review and verify that the accounting data

provided by an audited company accurately corresponds to the activities that have been taken

by the company.

The auditor's job is to write a report at the conclusion of the audit which determines the level

of accuracy and clarity that the organization has accounted for.

For instance, if all accounting moves made by the company are reflected in the books (such

as the general ledger), and all data that appears in the records correspond to the course of

business in the company, then the audit will have shown no misstatements.

Definitions:

In general, an auditor is an official whose job it is to carefully check the accuracy of business

records. An auditor can be either an independent auditor unaffiliated with the company being

audited or a captive auditor, and some are elected public officials. The term is sometimes

synonymous with "comptroller." Auditors are used to ensure that organizations are

maintaining accurate and honest financial records and statements.

In accounting, an auditor is someone who is responsible for evaluating the validity and

reliability of a company or organization‟s financial statements.

External Vs Internal auditors

Auditors of financial statements can be externally or internally located in reference to the

company or organization whose financial statements they are auditing.

External auditors

External auditors are independent accounting/auditing firms that are hired by companies

subject to an audit. External auditors express their own opinions on whether the financial

statements of the company in question are free of material misstatements (these could be due

to fraud, error or otherwise).

For publicly-traded companies, external auditors could also be required to provide an opinion

on the effectiveness of internal controls over financial reporting.

Internal auditors

Internal auditors are those who are employed by the company that they audit. They primarily

provide audits related to the effectiveness of the company's internal controls over financial

reporting.

Since the Sarbanes Oxley Act of 2002 was placed into effect, they must also assess the

effectiveness of management‟s internal controls over financial reporting.



Internal auditors are not independent of the company they perform audit procedures for, but

they usually do not report directly to management, in order to reduce the risk that they will be

swayed to produce biased assessments.

According to Section 224 of the Companies Act, every company whether private or public

must appoint an Auditor or auditors to audit the final accounts. The provisions relating to the

appointment of auditor are as follows:

1. Board of Directors:

The first auditor of a newly floated company is appointed by the board of directors, within

one month of registration of the company. Such an auditor or auditors shall hold office till

the conclusion of the first annual general meeting.

The directors are also empowered to fill a casual vacancy of an auditor if it is not caused by

resignation. The auditor so appointed shall hold office till the conclusion of the next annual

general meeting. But in case, if the vacancy is caused by the resignation of an auditor, it

shall only be filled by the company in its annual general meeting.

2. Annual General Meeting:

The auditor or auditors are appointed in the annual general meeting under the following

circumstances:

1) If the board of directors fails to appoint an auditor, the shareholders shall make an

appointment in the annual general meeting.

2) Every company shall at each annual general meeting appoint an auditor to hold office

from the conclusion of that meeting until the conclusion of the next annual general

meeting.

3) The company has to give intimation to the auditor so appointed within seven days of his

appointment.

4) The auditor so appointed shall within 30days of the receipt of intimation from the

company regarding his appointment, has to inform the registrar of the company in

writing whether he has accepted or refused the appointment.

In every annual general meeting the appointment of the company‟s auditor is made by the

simple majority of votes by the present members.

3. Central Government:

According to section 224 (3), if the auditor has not been appointed in the annual general

meeting, the company has to inform within seven days to the Regional Director to whom

the Central Government‟s power to appoint an auditor in such an event has been delegated

under section 637.



The said application must disclose in sufficient detail the reasons why the company could

not appoint the auditor at its general meeting. In the case of default, the company and every

officer of the company who is in default shall be punishable with a fine which may extend

to Rs.500 as per section 224(4).

Appointment of Auditor by Special Resolution

In 1974, Companies Act 1974 was amended by adding sub section A to section 224. After

that, in some cases, the appointment of auditors or auditor requires special resolution. That is

in case of a company, in which not less than 25% of the subscribed share capital is singly or

jointly held by.

a. A public financial institution or a government company or the central government or any

state government or

b. Any financial or other institution established by any provincial or state Act in which a

state government holds not less than 51% of the subscribed share capital or

c. A nationalized bank or an insurance company carrying on general insurance business.

In the above mentioned circumstances, the appointment of an auditor shall me made by

passing a special resolution (that is 75% or more of the members present should agree for the

resolution). If not, it shall be deemed that the appointment has not been made and the central

government will get the right under section 224(3) of the Companies Act to make an

appointment.

Compulsory Reappointment

Section 619 of the Companies Act specifies that in the case of government companies, the

appointment or reappointment of an auditor by the central government can be made only on

the advice of the comptroller and Auditor General of India.

In other cases, that is, whether auditors are appointed by the board of directors in the annual

general meeting or by he central government, the retiring auditors are compulsorily

reappointed, unless

1. He is not qualified for reappointment.

2. He has given a notice in writing to the company of his unwillingness, to be reappointed

3. Where a notice has been given or an intended resolution to appoint some other person in

the place of the retiring auditor and by reason of death, in capacity or disqualification of

that person or of all the persons as the case may be, the resolution cannot be proceeded

with or



4. A resolution has been passed at that meeting, appointing somebody instead of providing

expressly that he shall not be reappointed. This is as per section 224(2) of the Companies

Act.

Ceiling on Number of Audits

In 1974, a group of young charted accountant, academicians and other sections of the public

argued that the opportunities of professional practice are concentrated in the hands of a few

well established and leading chartered accountants of the country. They demanded this

monopoly be liquidated in the general interest of the profession thereby providing an

opportunity to young chartered accountants also to earn their living. Therefore, the companies

act was amended in 1974, by introducing section 224 (1- B). This came into effect from

February 01, 1975 to ensure a more equitable distribution of audit work among all the

practicing chartered accountants and to avoid the concentration of audit work in few leading

firms of chartered accountants.

Therefore, according to section 224( 1-B) of the Companies Act, no individual and no partner

of the firm of auditors shall hold office as auditors of more than 20 companies of which not

more than 10 be companies with paid up share capital of Rs.25 lakhs or more.

Filling of Casual Vacancies [Section 224(6)]

1. A vacancy caused by the resignation of an auditor shall only be filled by the members in

the annual general meeting.

2. If a casual arises for any other reason (that is, death, insanity or insolvency) it can only be

filled by the board of directors.

3. An auditor appointed to fill up the casual vacancy shall hold office until the conclusion of

the next annual general meeting of the company.

Qualification of Auditor

According to Section 226(1) and 226(2) of the Companies Act, the prescribed qualifications

of an auditor are as follows:

1. A person who is a chartered accountant within the meaning of the Chartered Accountant‟s

Act 1949.(Section 26(1)]

2. A person who holds a certificate under the Restriction Auditors Certificate Rules 1956 is

also qualified to act as an auditor of a company. Such persons are also known as certified

auditors and are always subject to rules made in this behalf by the central government

[section 226(2)]

The central government in empowered to frame rules relating to granting renewals,

suspension or cancellation of such certificates.



Disqualifications of a Company Auditor

According to section 226(3) of the Companies Act, the following persons shall not be

appointed as auditors of a company.

1. A body corporate.

2. An officer or an employee of the company.

3. A person who is a partner in the business.

4. A person who is indebted to the company for an amount exceeding more than Rs.1000/-

or who has given any guarantee or provided any security in connection with the

indebtedness of any third person to the company for an amount exceeding Rs.1000/-.

If an auditor, after his appointment becomes a subject of any of the above mentioned

disqualifications, he shall be deemed to have vacated his office forthwith.

Removal of an Auditor

1. The first auditors appointed by the directors prior to the first annual general meeting of

the company may be removed by the members in the annual general meeting even if there

tenure of office has not expired.

The general meeting may in their place, appoint any other person, notice for whose

nomination has been given by any member not less than 14days before the date of the

meeting.

2. In any other case, the auditor may be removed from office before the expiry of his term by

the company in the annual general meeting after obtaining the previous approval of the

central government in this behalf. This provision is as per section 224(7) of the

Companies Act.

3. But section 225 of the Companies Act makes special provisions in this respect, in order to

safeguard the interests of an independent auditor against unfair and unjust removal at the

hands of an unscrupulous management.

The procedure so laid down is as follows:

a. Special notice of intention to make such resolutions to remove the existing auditor must

be given to the company by the shareholder not less than 14days before the annual

general meeting.

b. On receipt of such a notice, the company must forthwith send a copy to the retiring

auditor.

c. The retiring auditor has the right to send a representation to the company which he can

ask the company to send to the shareholders.



d. If a copy of the representation is not sent to the members, either because it was received

too late to be thus sent, or because of the default of the company, the auditor may insist

that the representation shall be read out in the meeting.

e. The auditor, who is proposed to be removed, has the right to attend the general meeting

where his removal is to be discussed. He also has the right to speak at such a meeting.

f. As a matter of professional conduct, the auditor so appointed in place o another should

communicate with the retiring auditor in writing before accepting the appointment. If he

does not do that, he may be held liable for disciplinary action as per the regulations of

the Institute of Chartered Accountants of India.

Remuneration of an Auditor

1. The general rule is that the appointing authority is authorized to fix the remuneration f an

auditor as per Section 224(8)

2. In the case of a new company where the auditors are appointed by the board of directors,

the remuneration will be fixed by the board of directors.

3. Similarly, if an auditor is appointed to fill a casual vacancy the remuneration will be fixed

by the board of directors.

4. When an auditor is appointed by the Central Government the remuneration will also be

fixed by the Central Government.

5. If the auditor‟s appointed at the annual general meeting, the remuneration is also fixed at

the annual general meeting.

6. Remuneration includes the sum paid by the company in respect of the auditor‟s expenses.

7. Where the auditor is reappointed in the next annual general meeting, the amount fixed in

the previous year is considered for the currency year also, if nothing more is specifically

provided as remuneration in the current annual general meeting.

8. A part from the routine audit work, if a chartered accountant is entrusted with the work of

taxation, writing up of the account books and other professional services then the auditors

and the board of directors can fix up the remuneration mutually for the additional work.

Moreover, the sanction of the shareholders is not needed for the same.

9. Any remuneration paid for services other than routine audit work should be explained in

the Profit and Loss account separately as under:

i. Remuneration as an Auditor of the company.

ii. In the capacity of an adviser in respect of:

a. Taxation representation.

b. Company Law matters



c. Management Services.

d. Internal Auditing

e. Other professional services and

f. For travelling and out of pocket expenses.

Rights of Company Auditors

According to Section 227(7) of the Companies Act, a company auditor has the following

rights.

1. Right of access the books of accounts:

As per Section 227(1) of the Companies Act every auditor of the company has the right to

access at all times to the books of accounts and vouchers of the company, whether kept at

the head office of the company or elsewhere.

Under section 209(1) (d), a company auditor has the right to examine the cost records also

which are required to be maintained by certain companies relating to production sales,

stores etc.

2. Right to obtain information and explanations:

An auditor can call for any information or explanation from different officers of the

company which he may think necessary for the performance of his duties.

Under section 221, apart from the auditor‟s right to obtain information and explanation it

is the duty of every officer of the company to furnish without delay the information to the

company auditor.

The power is so wide; the decision as to what information and explanation is left entirely

to the discretion of the auditor. If the directors or officers of the company refuse to supply

some information on the ground that in their opinion it is not necessary to furnish it, then

the auditor has the right to mention that in his audit report.

3. Right to receive notices and other communication relating to general meetings and to

attend them.

According to section 231, of the companies act an auditor of a company has the right to

receive notices and other communications relating to the general meetings in the same

way as that of the members of the company.

Similarly an auditor also has the right to attend any annual general meeting and also to be

heard at those meetings which he attends and which concerns him as an auditor.

The auditor also has the right to make a statement or explanation with regard to the

accounts he has audited. But he auditor is not expected to answer questions in the general

meeting.



4. Right to visit branches.

According to section 228 of the companies act the auditor of the company has the right to

visit the branch office or offices of the company.

He can also audit such accounts of eh offices of the company provided that there is not

qualified auditor to audit the accounts of the branch office or offices of the company, in

such cases, the auditor has the right to access at all times to the books of accounts and

vouchers that the company maintains at branch office or offices.

Moreover section 226 of the companies act provides that in case of the company gets the

branch accounts audited by some of the local auditors, even the auditor has access at all

times, to the books, accounts an vouchers of the company and he can also visit the

branches, if he feels necessary.

5. Right to correct any wrong statement.

The company auditor is required to make a report to the members of the company on the

accounts examined by him of the final accounts and the related documents which are laid

down before the company in the general meeting.

Similarly, the auditor can advise the directors to amend their system of maintaining

accounts. If the suggestions are not carried out, he has the right to refer the matter to the

members and also to report that in the audit report.

6. Right to sign the audit report

As per section 229 of the companies act only the person appointed as auditor of the

company or where a firm is so appointed, only a partner in the firm practicing in India,

may sign the audit report or authenticate any other document of the company required by

law to be signed.

7. Right to being indemnified.

Under Section 633 of the Companies Act, an auditor is considered to be an officer of the

company and he has the right to be indemnified out of the assets of the company against

any liability incurred by him in defending himself against any civil and criminal

proceedings by the company if it is proved that the auditor has acted honestly or the

judgment is delivered in his favour.

8. Right to seek legal and technical advice.

The company auditor has the full right to seek the opinion of the experts and to take their

legal and technical advice so as to discharge his duties efficiently.

9. Right to receive remuneration.

As per Section 224(8) of the Companies Act, the company auditor has the right to receive

remuneration provided he has completed the work which he has undertaken to do so.



Duties of Company Auditor

The various duties of the company auditor are as follows:

1. To make special enquiries and investigation: in connection with the following matters

under section 227(1-A) of the Companies Amendment Act 1965.

A company auditor shall enquire:

a. Whether loans and advances made by the company on the basis of security have been

properly secured and whether the terms of which they have been made are not

prejudicial to the interests of the company or its members.

b. Whether the transactions which are not supported by any fact or evidence, though

recorded in the books are not prejudicial to the interests of the company.

c. Whether personal expenses have been charged to the revenue account.

d. Whether it has stated in the books of accounts of the company that any shares have

been allotted for cash and whether cash has actually been received in respect of such

allotment, and if no cash has actually been received, whether the position as stated in

the account books and the Balance Sheet is correct and regular.

2. Duty to make a Report to the Shareholders.

Under Section 227(2,3,4&5) of the Companies Act, the auditor shall report to the

shareholders about the accounts examined by him. The report so mentioned shall contain

the following.

a. Whether in his opinion, the Profit and Loss Account referred to in his report exhibits

a true and fair view of the profit or loss.

b. Whether in his opinion, the Balance Sheet referred to in his report is properly drawn

up, so as to exhibit a true and fair view of the state of affairs of the business

according to the best of his information and explanations given to him and as shown

by the books of accounts.

c. Whether he has obtained all the information and explanation which to the best of his

knowledge and belief were necessary for the purpose of his audit.

d. Whether in his opinion, proper books of accounts as required by law have been kept

by the company and proper returns adequate for the purpose of his audit have been

received from branches he visited or not.

e. Whether report on branch accounts audited under section 28 by a person other than

the company‟s auditor has been forwarded to him as required by clause (c) sub

section (3) of that section and how he had dealt with the same in preparing the

auditor‟s report.



f. Whether the company‟s Balance Sheet and Profit and Loss Accounts dealt with by

the report are in agreement with the books of accounts and returns.

If the answer to any of the above mentioned questions is in the negative, the auditor

should submit his report accordingly.

3. Duty to comply with the Directives of the Central Government.

It is the duty of the auditor to comply with the various directives issued to the auditor of

the joint stock companies from time to time to give specific reports on the financial

accounts of the companies.

For example in 1975 it was made compulsory for some of the specified companies which

are engaged in any of the below mentioned activities to conduct cost audit, that is, those

companies engaged in

a. Manufacturing, mining or processing.

b. Supplying and rendering services

c. Trading

d. Business of financial investments, chit funds, nidhi or mutual benefit societies.

4. Duty to sign the Audit Report.

As per section 229 of the company‟s act 1956, it is the statutory duty of the company

auditor to sign the report prepared by him. Only a partner practicing in a firm in India can

sign the audit report for and on behalf of a partnership firm practicing as chartered

accountants.

5. Duty to give a Statement in the Prospectus.

As per section 56(1) of the companies act, the prospectus issued by an existing company

shall contain a report from the auditor of the company regarding

a. Profits and losses during the previous year.

b. Assets and liabilities of the company and its subsidiaries and

c. The rate of dividend paid by the company in respect of each class of shares in the

company for each of the five financial years preceding the issue of prospectus.

So it is the statutory duty of the company auditor to submit his report containing the

above mentioned points.

6. Duty to Certify the Statutory Report.

According to section 165(4) the auditor of the company has to certify the statutory report

regarding the shares allotted by the company, the cash received in respect of shares, and

the receipts and payments of the company. The statutory report should also be certified as

correct by two directors, one of whom shall be managing director.



Every company shall within a period of not less than one month and not more than

6months from the date which the company is entitled to commence business has to

conduct a general meeting of the members of the company which is known as the

statutory meeting.

7. Duty to make a declaration of Solvency, if the company Goes into Voluntary

Winding up

When a company goes into voluntary winding up, then a declaration of solvency is to be

made by the directors of the company. Under section 488(1) of the Companies Act, this

declaration is to be accompanied by the report of the auditor of the company under the

section 488(2) of the companies act. So it is the duty of the auditor to make such reports.

8. Duty to produce information and to assist the investigation, if any investigation is

conducted regarding the working of the company.

Under section 240(6) (b), it is the duty of an auditor to preserve and produce to the

inspector or any other person authorized by him in this behalf with the previous approval

of the central government, all books and papers of or relating to the company or as the

case may be, of relating to the other body corporate which are in their custody or power

and other wise to give to the inspector all the assistance in connection with the

investigation which they are reasonably able to give.

9. Duty to perform the contract

It is the duty of the auditor to discharge the duties according to the terms of contract

between the auditor and the party who has appointed him. It is to be remembered that the

scope of statutory duties of a company auditor cannot in any way be curtailed. But on the

other hand, the scope of duties of the auditor can be enlarged by passing a resolution at

the annual general meeting making a provision in the Articles of Association of the

company. If so, it is the duty of the auditor to perform the additional work.

10. Duty to care and caution.

The auditor is appointed in the capacity of an expert, therefore, he must act honestly and

exercises cure care and caution in the performance of his duties. The auditor can never

give ignorance as an excuse for defense. So the auditor must prove that in the course of

his audit work, he has employed skills that would reasonably be applied by any other

auditor.



Special Audit of Companies

As per section 233 A of the companies act, the central government has the power to direct

special audit in the following cases for a specified period. That is, when the central

government is of the opinion.

1. That the affairs of any company are not being managed in accordance with sound business

principles or prudent commercial practices or

2. That any company is being managed in a manner likely to cause serious injury or damage

to the interests of the trade, industry or business to which it pertains or

3. That the financial position of any company is such as to endanger its solvency.

Auditor appointed under this section under the above mentioned circumstances are known

as Special Auditors. Special audit is entirely different from investigation as per section

235. For example: the audit firm Lovelock and Lewies was asked by the central

government to conduct a special audit for ITC company for which they audited the

accounts and to submit a report when the ITC scam was reported.

Powers and Duties

The powers and duties of the special auditors are identical to the rights and duties of a

company auditor as specified in section 227.

Remuneration

Although the special auditor is appointed by the Central Government his remuneration is paid

by the company as determined by the Central Government.

Report

Special auditors have to submit their report to the Central Government to take necessary

action as per the provisions of the Companies Act. But if the Central Government does not

like to take any action on the submitted report within four months, in that case, the central

government will send the copy of the report or its relevant extracts with comments to the

company to be circulated to the members or to put such copy or extracts in the company‟s

next annual general meeting.

The Liabilities of a Company Auditor

1. Civil Liability of an Auditor for negligence.

The liability of an auditor to pay damages is known as Civil Liabilities. Every auditor in the

performance of his job is expected to exercise reasonable care and skill as per the

circumstances, because the shareholders of the company appoint the auditor as their agent and

therefore, he must exercise reasonable degree of skill and care in the performance of his

duties. If not, the auditor will have to face the consequences.



Therefore, we can conclude that an auditor can be held liable for negligence of his duty if it is

proved that

a. There has been negligence in the performance of his duty and it may be due to the

absence of requisite professional skills or failure to exercise it.

b. There happens to be a loss or damage as a result of his negligence and

c. The loss was suffered by his client.

However, the court has the power to grant relief, wholly or partly to an auditor. We

can also present the situation as given below.

1. Loss without negligence and

2. Negligence without loss.

a. Liability of the Auditor for Mis-statements in the Prospectus.

As per section 65 of the company‟s act 1956, an auditor may be held liable for damages

suffered by those persons who subscribed to the shares or debentures of a company or

debentures of a company proposing in the faith of the prospectus, which included auditor‟s

report containing some untrue statements or facts. The auditor and every person who has

authorized the issue of the prospectus shall be punishable with imprisonment for a term

which may extent of 2years or with fine, which may extend to Rs. 5000 or with both, for

the damages sustained directly resulted from those untrue statements. For the purpose of

this clause, even those statements shall be taken to be untrue which are misleading in form

and the context in which they are included.

But the auditor can escape from his liability if he is able to prove:

i. That he withdrew his consent in writing before the delivery of the copy of the

prospectus for registration.

ii. That he withdrew his consent in writing from such a prospectus on coming to know

of the untrue statement by giving a reasonable public notice before the allotment of

shares.

iii. That he was competent to make the statement and that he has reasonable grounds to

believe up to the time of allotment of the shares, that the statement was true or he

relied upon the opinion of an expert whose name he has quoted in his certificate.

b. Civil Liability of an Auditor for Misfeasance.

By misfeasance we mean breach of trust or duty imposed by law for negligence in the

performance of duties, which results in some loss or damage to the company. If an auditor

does something wrong in the performance of his duties resulting in financial loss to the

company he is guilty of misfeasance.



As per section 543 of the companies act. The liquidator can bring the suit in the name of the

company against the auditor, that is “in the course o winding up of a company, it appears that

any officer, including eh auditor or any other person associated with the promotion or the

management of the company has misapplied or retained wrongfully, any property of the

company or is guilty of breach of duty, he can be held liable for the damages caused to the

company”

But section 633 grants relief to directors, officers, and auditors of the company against

liability in respect of negligence, default, breach of duty, misfeasance or breach of trust. But

for getting any relief there under, it must be proved by the person concerned.

a. That he has acted honestly.

b. That he has acted reasonably and

c. That having regard to all the circumstances of the case, he ought fairly to be

excused.

2. Criminal Liabilities of a Company Auditor

The auditor of a company becomes criminally liable for various offences during the course of

his audit. Criminal liability of an auditor will arise when he is found to be guilty of willful

noncompliance under the provisions of law. Under the criminal liabilities, he may be

imprisoned, fined or punished with both as per the companies act, income tax act, and the

Indian Penal Code. Criminal liability of an auditor arises from errors in the performance of

audit.

The auditor can be held criminally liable under:

1. The Companies Act.

2. The Income Tax Act.

3. The Chartered Accountant Act

a) Criminal Liabilities under the Companies Act.

i. Section 233

If the auditor does not comply with the requirement of section 227 and 229 as to

make of his report, of signing or authenticating any document and if such default on

his part is willful, he shall be punishable with fine which may extend to Rs. 1000

ii. Section 240

If the auditor of a company doesn‟t give the required assistance to an inspector

appointed by the central government to investigate into the affairs of the company,

the auditor of the company is punishable with imprisonment up to 6months or fine



up to Rs.2000 or both. For persistent default a further fine at Rs. 200 per day may

also be charged.

iii. Section 242

When on the basis of the report submitted by an inspector, the central government

takes action and prosecutes any person connected with the affairs of the company is

required to assist the prosecution. If he does not do so, he is guilty of contempt of

court and punishable to the extent of imprisonment for 6months of fine of Rs 500 or

both.

iv. Section 477

When the company is wound up, the auditor is subjected to a private examination by

the court and is also liable to return to the court any books and documents of the

company in his possession. If he does not appear before the court he can be arrested.

v. Section 478

On an application from the official liquidator, the auditor of a company is

liquidation can be publicly examined in high court. Notes of the examination shall

be taken down in writing and that should be signed by the auditor which may

thereafter be used as evidence against him in any other civil or criminal proceedings.

vi. Section 539

If an auditor destroys, mutilates, alters, falsified or secretes or is a partly to the

destruction mutilation alteration or falsification or secreting of any books papers or

securities or makes or is a party to the making of any false or fraudulent entry in any

register books of accounts or documents belonging to the company, he shall be

punishable with imprisonment for a term which may extend to 7years and also be

fined.

vii. Section 545

The court may direct the liquidator of a company in winding up to prosecute the

auditor if he is found guilty of any criminal offence in relation to the company.

viii. Section 628

An auditor is also liable to criminal prosecution, if he in any return, certificate,

balance sheet, prospectus, statement or any other document required by or for the

purpose of the act makes a statement.

1. Which is false in any material, particularly knowing it to be false.

2. Which omits any material fact knowing it to be material.

The punishment on conviction is imprisonment for a term which may extend up to

2years and shall also be fined.



ix. Section 629

If any person including an auditor intentionally gives false evidence upon nay

examination up on oath or solemn affirmation authorized under the act or in any

affidavit, deposition or solemn affirmation in or abut he winding up of any company

under the act, he shall be punishable with imprisonment for a term which may

extend to seven years and shall be liable to fine also.

If the Articles of Association or any special agreement between the company auditor and the

company contains any provision which exempts the auditor from any of the above legal

liabilities for negligence, defaults, misfeasance, breach of trust, breach of duty etc it shall be

considered void. However, according to section 633 the company can indemnify such officers

including the company auditor for any of the losses suffered by him.

b) Criminal Liabilities under the Income Tax Act.

A qualified chartered accountant or the auditor of the company can act as authorized

representative and may attend the Income Tax Authority or the Appellate Tribunal in

connection with the proceedings under the Income Tax Act.

a. Section 288

This section provides that if a person who is convicted of an offence in connection

with taxation proceedings will be disqualified from representing an assesse. The

commissioner of Income Tax has been empowered to determine the period of such

disqualification.

If the council of the Institute of Chartered Accountants of India finds that any

chartered accountant is guilty in his professional misconduct, default in taxation

etc. the institute can also declare him disqualified for certain specified period.

b. Section 277

As per this section 2years imprisonment may be imposed on the auditor if he

auditor submits knowingly any false statements in the form of accounts for the

preparation of income tax returns.

c. Section 278

As per this section any person who induces in any manner any other person to

make and deliver to the income tax authorities, some false statements or

declaration relating to chargeable income tax, highlighting the fundamental

principle of criminal law that any person who aids, counsels or procures the

commission of an offence is liable to be punishable with rigorous imprisonment for

a minimum period of 3months and maximum of 3years with fine. In case the



amount of tax to be evaded is in excess of Rs. 100000 the minimum and maximum

period of rigorous imprisonment will be 6months and 7 years maximum with fine.

c) Criminal Liabilities of an Auditor under the Chartered Accountants Act 1949.

1. If a person not being a chartered accountant within the meaning of chartered

accountants act of 1949 acts as an auditor of a company and signs any documents,

then he may be held liable for criminal prosecution under section 29 of the chartered

accountants act 1949. The punishment for this is fine which may extend to Rs.1000

on first conviction and with imprisonment extending to 6months or fine amounting

to Rs.5000 or both on any subsequent conviction.

2. According to Part III of the first schedule of Chartered Accountants Act 1949 a

member of the institute whether in practice r not, shall be deemed to be guilty of

professional misconduct if he:

a. Includes in any statement return or form to be submitted to the council any

particulars knowing them to be false.

b. Not being a fellow styles himself as fellow

c. Does not supply he information called for or does not comply with the

requirements asked for by the council or any of its committees.

3. Auditors Liabilities to Third Parties.

Besides the client, the creditors, bankers, prospective shareholders, tax authorities etc

depend fully upon the final accounts certified by the auditor and do different dealings with

the company.

The liability of an auditor towards third parties can be discussed under the circumstances.

a. For Frauds.

If in case there is any fraud on the part of the company‟s auditor, the third parties can

however hold him liable. This 3rd

party can sue the auditor if the report of the auditor is of

such a nature, as amounts to fraud, even in there is no contractual obligation between the

auditor and the 3rd

party.

It was decided in the case of Derry Vs Peek (1882) that the auditor can be held liable to 3rd

partied only when the following facts are proved against him.

i. That the statement or balance sheet signed by the auditor was materially untrue

ii. That the statement or the Balance Sheet was made an intention that a 3rd

party should

act on it.

iii. That the auditor knew that the statement of balance sheet was untrue.

iv. That the 3rd

party acted upon such a statement and consequently suffered a loss.



v. That the auditor gave his consent for the inclusion of such a statement in the

prospectus.

b. For Negligence.

An auditor in general is not liable to 3rd

parties for negligence of duty as no contractual

obligation exists between the auditor and the 3rd

party. As he is not appointed by them, he

owes no duty towards them and hence there is no question of any type of liability.

Auditors’ code of Ethics

As promulgated by Auditors, Auditing should adopt and uphold the Code of Ethics. The

Code of Ethics states principles and expectations governing behavior of individuals and or-

ganizations in the conduct of auditing. It describes the minimum requirements for conduct,

and behavioral expectations rather than specific activities.

Auditors' Code of Ethics is a system or code of behavior based on moral responsibility and

obligation to explain how an auditor must behave.

Auditors' Code of Ethic was enacted as a guide for all audit personnel to enhance the

performance and professionalism. Auditor's General report helps to improve public

management efficiency and effectiveness. It is utmost important that the audits produced

followed a prescribed standard based on high work code of ethics to acquire the confidence

from the public.

Purpose of Code of Ethics

The purpose of Code of Ethics is to promote an ethical culture in the profession of auditing

and provides guidance to Auditors serving others.

Auditing is an independent, objective assurance and consulting activity designed to add value

and improve an organization's operations. It helps an organization accomplish its objectives

by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of

risk management, control, and governance processes.

Importance of the Code of Ethics

A code of ethics is necessary and appropriate for the auditing profession. Founded as it is on

the trust placed in its objective assurance about risk management, control, and governance.

The Code of Ethics extends beyond the definition of auditing to include two essential

components:

1. Principles that are relevant to the profession and practice of auditing;

2. The Rules of Conduct describe behavior norms expected of auditors. These rules are

an aid to interpreting the Principles into practical applications and are intended to



guide the ethical conduct of auditors. Below they are set out together with the

principle they interpret.

Applicability and Enforcement

This Code of Ethics is directed to internal, external and student auditors, as well as all other

individuals working on a company audit.

For association members, breaches of the Code of Ethics will be evaluated and administered

according to Disciplinary Procedures. The fact that a particular conduct is not mentioned in

the Rules of Conduct does not prevent it from being unacceptable or discreditable, and

therefore, the member liable to disciplinary action.

Principles

Auditors are expected to apply and uphold the following principles:

1. Integrity

The integrity of auditors establishes trust and thus provides the basis for reliance on their

judgment. Integrity requires auditors to observe both the form and spirit of auditing

standards. It also requires auditors to observe the principles of independence, objectivity,

standards of professional conduct, and absolute honesty in their work.

2. Objectivity

Auditors must exhibit the highest level of professional objectivity in gathering, evaluating,

and communicating information about the activity or process being examined. They must

make a balanced assessment of all the relevant circumstances and not to be unduly influenced

by their own interests or by others in forming judgments. It is essential that auditors are

independent and impartial, not only in fact but also in appearance.

3. Confidentiality

Auditors must respect the value and ownership of information they receive during audit and

do not disclose information without appropriate authority unless there is a legal or

professional obligation to do so.

4. Competency

Auditors must apply the knowledge, skills, and experience needed in the performance of

auditing services.

Rules of Conduct

1. Integrity

Auditors shall:

1. Follow high standards of fairness, integrity and ethical conduct;

2. Achieve their work with honesty, diligence, and responsibility;



3. Observe the law and make disclosures expected by the law and the profession;

4. Not knowingly be a party to any illegal activity, or engage in acts that are discreditable

to the profession of auditing or to the organization;

5. Respect the integrity of other auditors, recognizing their different experiences and areas

of expertise, and contribute to the legitimate and ethical objectives of the organization.

6. Not represent themselves as employees or contractors for the Construction Safety

Network at any time.

2. Objectivity

Auditors shall:

1. Conduct the audit as instructed by the Audit Protocol without bias, prejudice, variance

or compromise;

2. Not participate in any activity or relationship that may impair or be presumed to

impair their unbiased assessment. This participation includes those activities or

relationships that may be in conflict with the interest of the organization;

3. Remain free of any influence, interest or relationship that impairs professional

judgment, independence or objectivity while providing auditing services;

4. Auditors must not market their services at any time during the audit process;

5. Reveal any potential personal or perceived conflict of interest during initial contact or

communication with a client;

6. Auditors must avoid conflicts of interest at all times;

7. Auditors must not conduct two consecutive audits for a company;

8. Protect their independence and not accept any gifts of gratuities which could

influence, compromise or threaten the ability of the auditor to act and be seen to be

acting independently;

9. Uphold both the actual and perceived political neutrality in order to discharge their

duties and responsibilities in an impartial way.

3. Confidentiality

Auditors shall:

1. Sustain the confidentiality of information received during the audit;

2. Be prudent in the use and protection of information acquired in the course of their

duties;

3. Not use audit information for any personal gain or in any manner that would be contrary

to the law or detrimental to the legitimate and ethical objectives of the organization;

4. Take all reasonable steps to protect the confidentiality of the audit results, data collected



and the anonymity of interviewees;

4. Competency

Auditors shall:

1. Engage only in those services for which they have the necessary knowledge, skills, and

experience, and not assign or subcontract any obligation of the audit program;

2. Continually improve their proficiency and the effectiveness and quality of their skills;

3. Be consistent and accurate in their evaluations of data obtained through documentation,

interviews and observation;

4. Strive to be complete in their evaluations and avoid any omissions;

5. Separate fact from opinion clearly and concisely in their evaluations. Support for

auditor opinions must be derived from quantitative, measurable data;

6. Serve the client in a conscientious, diligent, respectful and efficient manner;

7. Assist clients with any post audit questions, such as recommendations or explanations

of results;

8. Commit to honest, thorough and straightforward communication in the performance of

audit activities;

9. Willingly and openly share their collective knowledge and always be in the pursuit of

the truth and enhancement of health and safety in the construction sector.

Auditor Violation and Disciplinary Process

During the audit process, the Code of Ethics is the accepted practices that surround the

auditor. Violations of these are considered to be serious in nature, and will result in swift

intervention by the Company. In particular, the following sanctions may be administered to

the auditor for violations of the Code depending on the situation:

1. Formal letter advising the auditor of the violation, a restatement of the required standard,

and a stipulation to not have this reoccur,

2. A requirement to have retraining undertaken by the auditor,

3. Suspension of the auditor's certification,

4. Permanent removal of the auditor's certification.

All sanctions against an auditor will involve a full investigation before any actions are taken.

The Company is not required to apply progressive discipline in situations which are serious in

nature and warrant severe penalties up to and including permanent removal of certification.



Audit of Educational Institutions

Audit of books of educational institutions like school, college, universities etc. or other such

institutions which are engaged in the educational field is known as audit of educational

institutions. Auditor should check income and expenditure account and balance sheet of such

institutes in order to verify and report the true and fairness of results presented by income

statements and financial position presented by the balance sheet. Generally, the methods and

procedures for vouching and auditing is same even though an auditor of educational

institution should perform following tasks:

1. The auditor should go through the University Act. Trust deeds and should note the rules

and regulations relating to accounts. The governing body may pass resolutions from time

to time in respect to accounts. A copy of minutes books should be made available to him

so that he may be able to confirm whether the decision of the government body have

been compiled with.

2. Auditor should obtain a copy of budget or financial statements to study of different

heads of income and expenditure.

3. Auditor should thoroughly assess the strength of internal check.

4. Auditor should vouch the grant-in-aid from the government carefully.

5. Auditor should verify the receipts of monthly fees from students, from counterfoils or

carbon copy of the receipts. He should also see whether cash received has been banked

daily or not.

6. Other charges from the students such as examination fees, laboratory fees, fines etc.

should be carefully verified.

7. Any fees received in advance should be properly adjusted.

8. The concession of fees and other charges should be duly authorised by the proper

authority. Any charges becoming irrecoverable should be written off only after proper

authority has recommended.

9. Any grant-in-aid or funds received for a particular purpose must be utilised for the same.

10. The donations and other subscriptions from the various authorities have been accounted

for and acknowledged.

11. The income from property, investment etc., should be properly verified from the

vouchers.

12. Auditor should vouch the amount of salaries paid with the Salary Register. Any

increment given to an employee shall be duly sanctioned.

13. The staff provident fund should be verified and it should be seen that it is invested as per

the rules.



14. The establishment expenses must be carefully vouched and it should be seen that capital

expenditure has not been treated as revenue expenditure or vice versa.

15. The payment of scholarship should be verified with the receipt from students and

Scholarship Register.

16. All the assets and liabilities should be properly exhibited in the balance sheet.

17. The stock of equipment, stationary, furniture should be carefully verified.

18. While making payment of staff salaries, income tax should be deducted at source and

shall be duly deposited with the Income Tax Department.

Audit of an insurance company:

Following special points have been considered while doing the audit of an insurance

company:

General

1. Auditor first of all should study the relevant provisions of the insurance act governing

the insurance company.

2. Auditor should evaluate the internal control system of the entity. He should decide

that up to what extent he can rely on this system.

3. He should check the minutes of the meeting of the shareholders and of board of

directors.

4. He should check the documents relating to the securities deposited with the reserve

bank of India.

5. It should be ensured that in preparation of the annual accounts the rules and provision

of the insurance act and companies act have been followed.

Receipt

1. The main source of income of an insurance company is the receipt of premiums from

policyholders. Auditor should vouch these carefully.

2. Outstanding premiums should be brought in to the books of account.

3. Premiums received in advance should be taken to the balance sheet as an asset and

should not be shown as income of the year.

4. Other source of income may be rents, dividends and interest on investment. It should

be checked carefully.

Payments

1. The main expenditure of an insurance company is the payment of claims on the

policies. Auditor should check these very carefully.



2. Claims admitted but not paid till the balance sheet date should be shown as a liability

in the balance sheet.

3. Other heads of expenditure should be checked with their respective vouchers.

Balance Sheet

1. Auditor should check the assets and liabilities appearing at the date of the balance

sheet. It should be verified that they are shown at the correct value. Proper

depreciation must be provided for on the assets.

2. Proper provision must be made for the unexpired risk on the policies, which may

attract claims in future.

Audit of Charitable Institution

Institutions which are established to perform social works or to help the disabled are known

as charitable institution like Scout, Red Cross etc. Such institutions must make audit of books

of accounts every years. An auditor should perform following works while conducting the

audit of charitable institutions.

1. The auditor should study the constitution, legal status, rules and regulations of the

charitable institutions.

2. Auditor should go through the minutes book of the governing body to see the decisions

affecting accounts.

3. Auditor should vouch all the receipts in respect to donations, subscriptions, etc., with the

subscription and donation.

4. Auditor should verify that a fund is received for a particular purpose and see that it has

been utilised for such purpose only.

5. In respect to legacies, auditor should verify the receipts with Legacy Register.

6. Any amount invested should be as per the rules of the institution.

7. The income from investment is properly accounted in the books.

8. Auditor should see that no income tax is deducted from the incomes of the client. The

incomes of charitable institutions are usually exempt from tax.

9. Auditor should verify the assets and liabilities on the date of balance sheet.

10. It should be seen that proper distinction is made between capital and revenue

expenditure.

11. The cash in hand and cash at bank should be verified.



Audit of Non-Governmental Organizations (NGOs)

Non-governmental organization (NGO) is an organization which is established by a group of

people to render service to the nation and people. NGOS should make audit of books of

accounts every year. An auditor should perform following tasks while conducting audit of

NGOS:

1. NGO has its own memorandum. An auditor should study it to know its activities.

2. NGOS may receive grant from foreign institutions. So, auditor should check whether

it is received as per the provision of financial rules and regulations of the nation or

not.

3. Auditor should check the use of government's grants and proper account is maintained

for the recording of such grants or not.

4. If such institution has received donation from any individual or organization, an

auditor should check accounting of such amount and its use.

5. Auditor should examine the amount received as subscription ratifying with

counterfoils of the receipts.

6. Auditor should study the decisions taken by the executives.

7. Auditor should make physical verification of assets ratifying with store ledger.

8. Auditor should check the liabilities and also that its assets and its transfer is proper or

not.

Meaning of audit report and points to be considered while preparing audit report

Audit Report

The preparation of audit report is the last work of audit. An auditor presents weakness,

strength and details of an organization by preparing audit report. Audit report accumulates all

the facts of audit. So, it is the proof of conducting audit properly.

Audit is related with the examination of books of accounts on the basis of regularity,

rationality, economy and efficiency. An auditor checks the books of accounts on the basis of

evidential documents. So, a financial statement is prepared by the auditor on the basis of

information collected from the examination of evidential documents and records. An auditor

should prepare report incorporating the facts found during the course of audit which is known

as audit report.

Audit report is an important document in which the auditor sets forth the scope and nature of

the audit and also gives his impartial opinion regarding the client's financial statement. It is

the last outcome of every audit. We can find vast difference in the reports which were

prepared previously and the reports prepared nowadays because the responsibility of an



auditor is increased highly. So, an auditor should prepare report considering the following

facts:

1. Address should be made to the authority that has appointed him.

2. Auditor should express his opinion in connection to financial statements.

3. Auditor should prepare report based on the facts found after the examination of all the

books of accounts.

4. Date must be written in report which shows the duration of audit.

5. Audit report may clean, qualified and adverse.

6. All the facts incorporated in report should be concise, clear and correct.

Contents of Audit Report

Auditor should check the books of accounts and balance sheet and need to prepare the audit

report addressing to the shareholders and present it to the concerned department and to the

company. Copy of such report should be sent to all the shareholders. Auditreport should

contain the following things.

1. Answer, clarification and explanation of furnished questions are given by the concerned

authority satisfactory or not.

2. Income statement and balance sheet is prepared by the company in prescribed structure or

not.

3. Accounts are maintained as per the provision of laid down rules and regulations or not.

4. Balance sheet of the company presents true and fair view of financial position or not.

5. High ranking official, representatives and staffs of the company have performed work as

per the provision of rules and regulations or not; they have committed fraud or not.

6. Transactions of the company are satisfactory or not.

7. Auditor should provide suggestion if necessary.

In addition to above facts, an auditor should include other facts using his own discretion.

Other facts which are to be incorporate in the report are given below:

1. An auditor should include all the facts demanded by the Company Act.

2. Auditor should include the true and fairness of books of accounts as well as facts where he

is not able to satisfy himself.

3. Auditor should include all the important facts which directly affect the financial position of

the company.

4. Some abnormal transactions which are found during the course of audit but they are

necessary for the company should be incorporated in the audit report.

5. If financial statements like income statement and balance sheet are not maintain properly,

an auditor should clearly state in the audit report.

6. An auditor should include in the report that the audit of books of account is made in detail

or applying test check.

7. If there is special situation, an auditor should include it in the audit report.

8. If auditor detects any frauds and errors during the course of audit, he must include in audit

report clearly stating their effect in financial statements. Like regarding valuation of stock,

depreciation system demarcation of capital and revenue etc.

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