Classification of Audit | Company | India | Auditing

In this article we will discuss about the classification of audit:- 1. Financial Audit 2. Non-Financial Audit 3. Social Audit 4. Environmental Audit 5. Safety, Health and Environment (SHE) Audits.

Category # 1. Financial Audit:

There may be three broad classes of financial audit based on:

(a) Legal or other authority for audit,

(b) Periodicity of audit, and

(c) Nature and scope of audit.

The main features, merits and demerits of the various types or forms of audit are enumerated below:

Statutory audit is one that is authorised by and compulsory under a statute or law which lays down or prescribes in definite terms the nature, scope and extent of audit and also the auditor’s qualifications, duties and rights, e.g., in the case of a company including a government company or public sector enterprise/undertaking and other or­ganisations or public corporations governed by special statutes.

Non-statutory audit, on the other hand, is not obligatory under any legal provision; it depends on the discretion of the owners of a business or other inter­ested individuals or private bodies and is governed by the terms of contract between the auditor and his clients.

While aspects of a statutory audit are definitive and fixed under law, the terms of a non-statutory audit are purely contractual and are variable according to mutual agree­ment between the auditor and his employ­ers. The most important and common in­stance of a statutory audit is that of a company while private firms including part­nerships and sole traders constitute the predominant class of business covered by non-statutory audits.

Companies under special statutes:

Audit of companies established under spe­cial Acts other than the Companies Act, e.g., electricity supply or gas companies, friendly or cooperative societies, public corporations, public bodies or charitable institutions are governed by regulations incorporated in or rules, framed under the special legislation, and are of a too specialised and technical character to be discussed in this volume. Suffice it to say that as these institutions are engaged in public utility services involving expenditure of huge sums of money, proper audit is of greater necessity than in any other case.

Trust accounts:

In most cases admin­istration of trust properties is entrusted to private individuals. Beneficiaries are in, a majority of cases, widows and minors who are not in a position to examine the accounts made by executors or trustees.

Similarly, in case of public trusts for religious, charitable, educational and other purposes, members of the public are compelled to rely on the executors or trustees. Therefore, the Indian Trust Act provides for compulsory audit of trust accounts in order to prevent misuse or misappropriation of trust money.

Tax Accounts:

The Income Tax Act, 1961, provides for accounts of assesses to be audited by “accountants” as defined in the Act, under different sections thereof. These include compulsory, special and other tax audits.

Non-trading are non-profit-earning bodies:

Audit of clubs, educational insti­tutions, scientific, professional and cultural societies etc. organised other than as com­panies are governed by their respective constitutions or bye-laws and also by spe­cific instructions, if any, included in the terms of appointment of the auditor.

The nature of and differences between continuous and periodical audits and their respective advantages and disadvantages are set out below:

Continuous Audit Nature:

Auditor carries out the process of audit continuously throughout the year or other ac­counting period at regular or irregular intervals and checks the accounts simultaneously with the preparation thereof.

Periodical or Final Audit Nature:

Auditor attends at the close of the account­ing period and after the trial balance and the final accounts are completed and he finishes his work at a stretch without any break or interval.

A critical analysis of the two systems as enumerated above would reveal that con­tinuous audit is more useful than periodical audit.

Even the disadvantages or weak­nesses of the former may well be avoided if a proper system of work is followed based on the undernoted principles:

(a) No post-audit alternation of figures should be allowed; rectifications, if necessary, being made by means of journal entries.

(b) Special ticks or marks not known to the client’s staff should be used and notes kept for all pre-audit alterations.

(c) Each section or group of transac­tions for a specified period of time should be audited at a time and nothing in relation thereto should be left over for the next visit.

(d) All totals checked during a particu­lar visit should be entered in the audit note book and verified at the next attendance.

(e) List of queries and errors, cleared or not, as well as notes of all important matters should be simi­larly incorporated in the note book so that they may not be lost sight of at the time of subsequent audits.

(f) Checking of impersonal or general ledger (including private ledger, if any) should, if possible, be left until the end of the financial period in order to prevent tampering with them which is a common and suit­able method of covering-up or con­cealing fraudulent manipulations in personal accounts.

An ideal system of audit may be de­vised by combining continuous and periodi­cal methods through a process of one au­ditor performing continuous audit and an­other supplementing the same by a periodi­cal one; but, due to extra cost involved, this measure is not usually adopted.

Continuous audit subject to the safeguards mentioned above is by far the best for all big businesses having very large volume of transactions which no auditor can expect to tackle suc­cessfully and adequately under the periodi­cal or final audit system.

Complete Audit:

This means verifica­tion of the whole set of books and records with the object of confirming the final ac­counts prepared there from without any re­striction whatsoever on the auditor’s scope of work and freedom of decision. Audit of company accounts is always complete audit under statute.

Partial Audit:

This falls short of com­plete audit and involves checking of a particular set of transactions or of a special section of accounts, e.g., net sales of a newspaper or profit and loss account for taxation purposes, claims data and the like. Audit of partnership or sole trading con­cerns may be either complete or partial according to terms of contract between the auditor and his employers. Investigations for special purposes may also be described as partial audits.

Interim Audit:

Continuous audit should be carefully distinguished from interim audit; the two are often confused. Under the former there is no fixed date up to which audit is completed at a time and no trial balance or final account is prepared each time the auditor comes.

Interim audit, on the other hand, refers to an audit which is completed for a fixed period of time before expiry of the regular financial period for some special purpose e.g., to enable directors to declare an interim dividend. Interim audit is more akin to periodical audit than to continuous audit.

Internal Audit:

In modern business houses, very often a process of continuous checking of accounting entries is adopted and is conducted daily by separate internal staff. This is known as internal audit which is carried put in much greater details than external audit.

It differs from continuous audit in the sense that the latter is carried out by an external and independent auditor responsible to the shareholders or owners only, whereas the former is done by internal staff who may be responsible to the direc­tors, managers, or other officials.

Even when internal audit is in operation, final audit is conducted by an external auditor. Internal audit is somewhat similar to internal control and checking except that the former has a distinctly audit bias although it is entrusted to internal staff and the latter is more concerned with sys­tems or methods of efficient working than with actual verification of financial opera­tions.

Internal audit in many cases includes internal control and checking. Even if an external auditor often retained by manage­ment whom he advises on financial mat­ters, his primary responsibility is to safe­guard the interest of third parties like share­holders, employees, creditors, government authorities, consumers etc.

Internal audit, on the other hand, is a tool of management for ensuring efficient working, compliance with plans, policies, procedures and rules, reach­ing of targets set, dependable information, safeguarding of property etc., which are particularly significant in view of increasing size and complexities of modern business and the ever-widening separation between top management and routine current opera­tions.

MAOCARO requires an auditor to re­port on the existence of an internal audit system commensurate with the size and nature of business of a company. Closely associated with internal audit are systems audit and management audit. This method of internal audit is now widely used, particularly by organi­sations of considerable magnitude.

Category # 2. Non-Financial Audit:

Conventional financial audit refers to scrutiny of transactions to report on true and fair view of financial statements. It is not concerned with propriety of transactions, efficiency of performance or management or social contribution of business operations.

Certain new developments, however, have been taking place with the result that new concepts and kinds of audit have been developed to meet the fast-changing socio­economic conditions.

Some of them are enumerated below:

(a) Propriety Audit:

It is an audit by which actions and decisions leading to trans­actions rather than supporting evidence for such transactions alone are scrutinised to ascertain their Tightness, i.e., whether they are in the interest of the business or its owners or other stakeholders or of the public or whether they are as per accepted norms of conduct, custom or policy.

Consequently, in course of propriety audit, an auditor does not merely verify documentary evidence in support of trans­actions as entered in the books of account but also tries to find out whether or not the various decisions and actions of manage­ment and resulting transactions and/or expenditure are duly authorised, regular, proper, prudent and bona fide.

In some specified matters, though lim­ited, an auditor is required to overstep his reporting function and consider the propri­ety of the transaction, e.g., in the case of a company, whether or not terms and condi­tions of loans and advances (including rate of interest) or any transaction(s) as per the books of account prejudicial to the interest of the company or its members.

Propriety audit is mostly applicable to government companies including public sector undertakings for whom’ such audit is conducted by the Comptroller and Auditor- General of India.

(b) Performance Audit:

“Performance Audit” or “Operational Audit” is an audit which attempts to ascertain whether the performance or operations of an enterprise has/has been or is/are up to the standard laid down or accepted.

This is generally outside the scope of statutory financial audit with one exception, viz., cost audit in speci­fied companies, where under an auditor has to verify the performance of management in the use of resources or inputs incurring cost and report, inter alia, as to whether a com­pany’s funds have been used in negligent or inefficient manner, which could have been avoided. Man­agement audit may also be considered a kind of internal performance audit.

The areas and scope of “propriety” and “performance” audit are likely to expand.

(c) Efficiency Audit:

Efficiency Audit means verification of the degree of efficiency or competence with which the operations and performance of an enterprise are carried on.

Such audit is aided by an effective system of cost accounting supported by proper maintenance of cost records. For this reason the Companies Act makes it obliga­tory on the part of a company belonging to a class of companies engaged in produc­tion, processing, manufacturing or mining activities to maintain proper books of ac­count containing prescribed particulars of raw materials, labour and any other item of cost, if so required by the Central Govern­ment.

Well-maintained cost accounting records are helpful for efficiency audit by serving the following purposes, viz., to:

(a) Furnish accurate cost of jobs, proc­esses, materials, labour, finished products, work-in-progress;

(b) Compare present cost with past experience;

(c) Make accurate periodical financial statements for information and guidance of management;

(d) Help fixation of finished products’ prices by furnishing all relevant data;

(e) Determine evaluation of production process and find out what are prof­itable or non-profitable items and their exact cost;

(f) Help in distributing overhead cost;

(g) Help in planning operations and controlling cost; and

(h) Determine efficiency of operation based on data as to cost volume of production.

Efficiency audit may be said to be a variant or extension of and complementary to performance audit.

Category # 3. Social Audit:

“Social Audit” may be defined as a kind of audit aimed at verifying and reporting on the extent of fulfilment by an organisation as an organ of society of its obligations to the society in different directions.

In other words, the object of social audit is a social object of finding out what contributions an enterprise which has diverse obligations to the society makes, and what it takes from others, and also ensuring that social or public interest is sub-served. Such audit has to be carried on by independent persons.

While no standard or widely accepted procedure for social audit has yet been devised the following principal factors have emerged as vital components of a special system for assessing social performance of organisations covering benefits and costs to society by reference to both quantum and money value of their various actions and operations:

(a) Contribution to national economic growth through expansion, employ­ment generation, wider ownership pattern etc.

(b) Relations with people including cordial industrial relations, training and employment in general and, in’ particular, of handicapped, back­ward and minority people, em­ployee welfare.

(c) Product relations including quan­tity, quality, safety and prices of products supplied or services ren­dered.

(d) Environmental relations including improvement of .or detriment to environment or ecology, control of environmental pollution of differ­ent kinds.

(e) Quality of life including social, family and community welfare schemes, employees’ self-reliance and self-dignity schemes like co­operatives of different kinds, pro­motion of education, community development, rural upliftment in­cluding adoption of villages, up­keep of gardens and parks, etc.

(f) Social or national development e.g., promotion of sports, music and games, art and culture, etc.

To enable assessment of money value of social contributions of an enterprise, spe­cially designed accounting systems have been or are being evolved to show various social costs and benefits in monetary terms of social performances as stated above.

Benefits and costs to employees, community, general public are ascertained and social balance sheet is prepared comprising contri­butions by public (equity) and employees on the one hand and social investments and assets, human assets, on the other. Social audit would involve checking of the said social accounts and social performances as stated in the directors’ reports or in other documents.

Social audit would enable business managers to keep in mind their social ob­ligations. This would help in improving the image of an enterprise as a socially respon­sible one; boosting employees’ morale and consumer and public acceptance and finally reaching the long term enterprise objectives.

Some companies, instead of going for social audit, include social achievements in the annual reports.

Category # 4. Environmental Audit:

All industries in India which need con­sent or authorisation under the Air, Water and Environment Protection Acts, are re­quired to effect environmental audit for every year ending 31st March, effective from 1993.

Every such industry must submit to the concerned Pollution Control Board within 15th May of every year an Environ­ment Audit Report in the form prescribed under Rule 14 of the Environment Protection Rules as amended from time to time.

The report should specify the amount of pollut­ants and wastes hazardous as well as solid and indicate disposal practices adopted for both, wastes generated from process, pollution control and quantity re­duced or reutilised, impact of pollution control, measures on conservation of na­tional resources, cost of production, invest­ment proposals for environmental protec­tion and abatement of pollution, quantities of wastes utilised for processing, cooling and domestic purposes, and consumption of raw materials per unit of production as compared to previous year.

Category # 5. Safety, Health and Environment (SHE) Audits:

SHE audit may be said to be an expan­sion or extension of environmental audit. The word audit has been increasingly used to cover non- financial areas like safety of consumers and the public, health of employees and others over the last three decades or so the world over led by USA and followed by other countries including India.

This has been necessitated by growing hazards of illness and injuries caused by accidents due to rapid industrialisation, deforestation, pollu­tion, greenhouse effect and natural calami­ties. Apart from aforesaid hazards, there are also risks of damage to expensive plant and machinery and loss of economical viability of an enterprise.

Therefore, in many coun­tries, legislations require and good corporate governance ensures satisfactory safety, health and environmental protection measures by industry and the state. SHE audit is con­cerned with verification of the efficacy of such measures.

Safety audit:

Safety audit may be defined as a sys­tem of critically examining and analysing every aspect of a safety system e.g., manage­ment policy, plant and process designs, lay­out and construction, operating procedures, emergency plans, personal protection sys­tems, accident prevention and management procedures. Such audit which is conducted by properly qualified persons like safety experts aims to focus on vulnerability or weaknesses of safety measures.

Health audit:

Health audit means systematic and criti­cal verification of and reporting on strengths and weaknesses of all aspects related to management of health of employees or of the public.

Environmental audit:

Environmental audit for industrial or commercial establishments refers to check­ing of the effectiveness or otherwise of systems or measures adopted for prevention or minimisation of soil, air and water pol­lution. The object of such audit is to ensure fulfilment by an undertaking of obligations relating to protection of environment legal or otherwise.

SHE auditors may be internal i.e. in- house personnel, or external, i.e., outside professionals or consultants.

SHE audit reports highlighting strengths and weaknesses/vulnerability of the various systems/measures for protection against risks of safety, health and pollution and sugges­tion on appropriate follow-up actions are to be submitted periodically to the manage­ment. SHE audit is mostly adopted by large public sector undertakings.