Here is an essay on ‘Auditing’ for class 11 and 12. Find paragraphs, long and short essays on ‘Auditing’ especially written for school and college students.
1. Essay on Auditing: (Components of an Audit)
The above flowchart represents the major components of an audit in a highly condensed form. The preparation of audit working papers necessary to document the evidential matter collected during the audit is also an important component of the total auditing process.
ADVERTISEMENTS:
Auditing does not mean ‘Ticking’ or ‘Checking Totals’:
The given expression underlines that auditing does not confine itself merely to the task of verifying the arithmetical accuracy of the statements of accounts by the routine procedures of ‘ticking’ or ‘checking totals’. It is something more than this.
It should inquire into the substantial accuracy and ascertain that the accounting and financial statements have been properly drawn up so as to depict the attributes of truth and fairness, objectivity, disclosure and consistency.
ADVERTISEMENTS:
It is ‘a systematic examination of the books and records of a business or other organisation in order to ascertain or verify and to report upon the facts regarding its financial operation and the results thereof. It should be undertaken ‘to increase the reliability of information where reliability may be defined as congruence between the message transmitted and the reality being described’.
The concept of an audit suffers from the following limitations:
(1) The auditor of a company is appointed by the shareholders as per the Companies Act. But in reality, he is appointed by the directors and remains responsible to the latter.
(2) The auditor’s report, in most cases, depends on the genuineness of the explanations and information given by the client or its responsible officials. Incorrect or inaccurate information affects the report.
ADVERTISEMENTS:
(3) The auditor does not guarantee the discovery of all fraud. He cannot approach his work with suspicion or with a foregone conclusion that there is something wrong. He has to believe the tried servants of the company in whom confidence is placed by the company.
(4) The auditor needs to seek opinion of the experts in the areas not falling within his expertise and has to rely upon the certificates issued by engineers or geologists or architects.
2. Essay on Auditing: (Techniques)
Auditing techniques change but principles do not:
Auditing principles are comprehensive, generally accepted, and laid down by the professional bodies, like Institute of Chartered Accountants of India (for statutory financial audit), Institute of Cost and Works Accountants of India (for statutory Cost audit), Institute of Company Secretaries of India (for statutory secretarial audit), etc. An individual auditor cannot change these principles and is committed to follow them.
ADVERTISEMENTS:
Again, irrespective of the classifications of audit: statutory or non-statutory, continuous or interim or periodical, partial or total, external or internal, the auditing principles are common. These principles do not even change with the category to which an organisation belongs (e.g., sole trader, partnership, co-operative, limited company).
But the auditing techniques are subject to change due to the following, among others:
(i) Class to which an organisation belongs (e.g., sole trader, partnership, co-operative, company).
(ii) Nature of business entity (e.g., trading, industrial, commercial, constructions, etc.)
ADVERTISEMENTS:
(iii) Size, scale and complexity of operations (i.e., small, medium, large).
(iv) Statutes that govern the business (e.g., Central or State laws, Acts relating to Banks, Insurance, Electricity, Co-operative Societies, etc.).
(v) Methods of accounting — their changes and improvements, such as mechanisation and computerisation of accounting systems and records.
(vi) Auditor’s experience and skill and his own work methodology.
3. Essay on Auditing: (Concept of Materiality)
ADVERTISEMENTS:
The concept of materiality is closely related to that of truth and fairness. It is essentially a matter of professional judgment. Materiality may be defined as a ‘state of relative importance’. The state of ‘relative importance’ is understood in varying dimensions in relation to time, place, and circumstance.
So, the perception about materiality varies from auditor to auditor. What is material in one environment may be quite immaterial to another environment. It is difficult to draw a boundary line to judge a particular item as being material or immaterial.
Materiality depends on some allied factors that guide and evaluate the particular items of expenditure or incident or happening as being material or immaterial. Generally, an item is considered as material if there is a reason to believe that knowledge of it could reasonably be deemed to have influenced the decision or attitude of an informed investor i.e., if it alters the true and fair view. So, to have a demarcation between the two (i.e., materiality and immateriality), much depends on the ‘absolute integrity, judgment and knowledge of the environment, on the part of person making the decision’.
On the questions of ‘materiality’, the Institute of Chartered Accountants of India observes the following circumstances:
ADVERTISEMENTS:
(i) When mistakes are discovered by the auditors in the accounting books and records, such as in the calculation of depreciation, estimation of liabilities, valuation of stock, etc.
(ii) When the question of disclosure of nonrecurring or unusual items of income or expenditure in the accounts arises.
(iii) The manner and extent to which prior adjustment need to be shown in the accounts and
(iv) Whether any item of income or expenditure or assets or liabilities is of such an amount that, apart from statutory requirements, it is necessary to disclose it separately.
The concept of materiality is extremely important to the auditor in that it assists him in determining whether the true and fair view has been distorted.
4. Essay on Auditing: (Steps for Commencement of an Audit of a Company)
Before commencement of the audit work on the books of accounts of a company, the auditor should:
ADVERTISEMENTS:
1. Verify the validity and legality of his appointment in terms of provisions under Section 224 (as the first auditor) or Section 225 (as auditor replacing the retiring auditor) or of the Central Government’s order;
2. Obtain confirmation as to the fixation of remuneration by the appropriate authority of the company and under the company law;
3. Obtain and study the following books, documents and statutory registers for a knowledge about the company and its nature of business and activities:
Memorandum of Association
Articles of Association
Prospectus or Statement in lieu of prospectus
Certificate of Incorporation
Certificate to commence business
Previous Years’ Audited accounts & Audit Report.
Preliminary Contracts & Agreements,
e.g., Vendors’ Contract, Underwriters’ Contract,
Fixed Assets’ purchases contracts,
Collaboration agreements, Agreements with promoters, etc.
Statutory Books of Accounts and Registers, such as:
Account books relating to:
Sales and purchases, assets and liabilities, money received and expended.
Registers of:
Investments, Deposits, Charges, Members, Debenture-holders, Directors, Contracts, Loans, Directors’ shareholdings.
Index of Members.
Minute Books:
Shareholders and Directors
Lists of: Managerial personnel including
Accounts department their powers and duties, records kept by them.
5. Essay on Auditing: (Duties of an Auditor)
“An auditor is not a valuer though he is intimately connected with values.”
The expressions: “An auditor is not a valuer” and “It is no part of an auditor’s duty to take stock…. In the case of a cotton mill he must rely on some skilled person for the materials necessary to enable him to enter the stock-in-trade at its proper value in the balance sheet” were made by the Court in the course of a judgement in a leading case: The Kingston Cotton Mills Co. Ltd., (1896).
A misfeasance action was taken by the liquidator against the company auditor to recover the amounts due for dividends which, it was alleged, were paid by the company out of inflated profits arising from over-valuation of closing stock and non-allowance for depreciation in the value of Mill plant and machinery. It was alleged that the auditor was negligent in his duties as he relied upon the stock made out by the manager who intentionally exaggerated the stock and thereby over-valued the stock with an ulterior motive of earning higher commission on the inflated profit.
Although the Court observed in this case: ‘the auditors do not guarantee discovery of all fraud’, it also remarked that the auditor’s duty was to ascertain and certify the true financial position of the company and that in the discharge of his duty he was bound to exercise reasonable amount of care and skill in verifying the values of assets and liabilities, at which these were stated in the balance sheet.
Again, in Barchris Construction Case the focus of the trial was on the overstatement of earnings and of the current ratio. The alleged overstatement of earnings was due to recording the gain on a sale- leaseback as current revenue rather than its amortization over the life of the lease. The alleged overstatement of current ratio was due to inclusion of an accounts receivable item from the consolidated summary and the commission of a liability.
The Court held that the registration statement contained false statement of material facts and that an overstatement of current ratio (15 per cent) was highly material. In retrospect, it can thus be implied the Barchris decision was critical about the auditor’s role in the over-valuation of earnings and the current ratio.
Similarly, The West-minister Road Construction Case held the company auditor responsible for his failure to ascertain true valuation of the work-in- progress even when sufficient evidential matter was available.
The above case laws together with the following provisions and recommendations demonstrate the fact that the auditor, though not a valuer, is definitely concerned with values:
1. The mode of valuation of the stocks of raw materials, stores and spares, stock-in-trade and the work-in-progress should be properly stated [Part I of Schedule VI of the Companies Act, 1956],
2. If loans and advances, and current assets do not have any value on realisation in the ordinary course of the business at least equal to the amount at which they are stated, the fact should be stated [Footnote’s’ ibid].
3. The values of the opening and closing stocks of the goods produced, and of the work-in-progress at the commencement or end of the accounting period should be stated. The Profit and Loss Account should also state the amount, if materials, by which any items shown therein, are affected by any change in basis of accounting (i.e., valuation) [Part II of Schedule VI of the Companies Act],
4. Provision for diminution in value should not exceed the amount required to reduce cost to market value at the date of the balance sheet in the case of investments which are current assets or to long- term value in the case of investments which are fixed assets [I.C.A. of England & Wales on: Treatment of investment in the balance sheet].
5. The historical cost of manufactured inventories should include a systematic allocation of production overhead [Statement on Valuation and Presentation of Inventories in the context of the Historical Cost System — International Accounting Standards Committee].
6. The auditor should also obtain from the management a certificate concerning the existence title, and value of inventories, and the details of charges, if any, created on them [I.C.A. of India in the Statement of Auditing Practices, 1977].
Duties of an auditor in relation to interim and final dividends.
The duties of an auditor are:-
1. To refer the Articles of Association of a company to ascertain whether they allow the declaration and payment of an interim dividend.
2. To check up the resolutions passed at the meetings of the Directors and Shareholders.
3. To verify the rate and amount of dividend proposed by the directors and see to the justifications against the proposals.
4. To seek confirmation on the amounts transferred to Reserve as per the Companies (Transfer of Profits to Reserves) Rules 1975.
5. To ensure that the declaration and payment of interim dividend are not out of capital and do not adversely affect the liquidity position of the company.
6. To examine whether the provisions contained in Sections 205, 205A, 205B, and 207 of the Companies Act have been duly complied with.
7. To check up the Register of Members, the Dividend List, the Dividend Warrants, the Unclaimed or unpaid amounts of dividends, the Bank Account to which the unclaimed dividend amounts were transferred and the mode of ultimate disposal of such unclaimed dividends for over three years by way of transfers to the General Revenue Account of the Central Government.
8. To refer the resolutions of the Board where a Dividend Equalisation Reserve is created.
6. Essay on Auditing: (Audit of Accounts of a Bank)
The auditor should take into consideration the following points in the audit of accounts of a bank:
1. The category to which a bank belongs; that is, whether nationalized or not.
2. The approval of the auditor’s appointment by the Reserve Bank of India.
3. The compliance by a bank with the provisions of the Banking Regulations Act, 1949 and the Companies Act, 1956 and also of the provisions under Section 228 of the Companies Act regarding branch audit.
4. Internal accounting and administrative controls in operation relating to the receipt and payment of cash.
5. The systems and practices followed for routine transactions.
6. Inspection of the Books of Account, such as: General Ledger, Personal Ledgers (for Savings/Current) Deposit Accounts, Loans and Overdrafts, Registers (for Bills, Demand Drafts, Letters of Credit/Guarantee), Cash Book, Cheques Clearance Book, and other records connected with the banking functional activities.
7. Examination of the powers exercised by different officers.
8. Verification of the items appearing in the Balance Sheet and the Profit and Loss Account.
7. Essay on Auditing: (Social Audit: Objectives)
The term ‘social audit’ is understood in different connotations by different scholars to include various practices, such as:
1. Inventory of ‘social programmes’ undertaken by a company and of their ‘social impacts’.
2. Estimates in terms of money of various company activities having ‘special social significance’.
3. Results of surveys on environmental pollution, employment discrimination, occupational health and safety, etc., undertaken at the instance of the Govt.’s regulatory measures.
4. Critical reports of surveys made on an area external to a company or industry, for example, sexual discrimination, case discrimination, etc.
“Social auditing is defined as a systematic attempt to identify, analyse, measure (if possible), evaluate and monitor the effect of an organisation’s operations on society (that is, specific social groups) and on the public well-being”. [According to Blake, Fredick and Myers].
Social audit via social responsibility accounting may, therefore, be defined as a systematic assessment of and reporting on those parts of the activities of the company that have a social impact. A firm should earn a satisfactory profit no doubt but it must also assume its social responsibility as a member of society. The concept of social audit via social responsibility is, thus, a counter-weight to that of an enterprise’s profit.
The main objectives of which the social audit should be undertaken are:
1. To identify and measure the periodic net social contribution of an individual firm, which includes not only the costs and benefits internalised to the firm, but also those arising from externalities affecting different social segments.
2. To help determine whether an individual film’s plans, strategies and practices that directly affect the relative resources and earnings are consistent with social principles.
3. To make available in an optimum manner to all social commitments, relevant information on a firm’s objectives, ultimate goals, policies, programmes, performances and contributions to the social goals. Relevant information is that which should provide for a scheme of public accountability and public decision-making regarding capital choices and social resources allocation.
8. Essay on Auditing: (Environment Audit)
All industries seeking authorisation under the Air, Water, and Environmental Protection Acts are required to effect environmental audit on an annual basis and submit the report in the prescribed form under the Environment Protection Rules to the State Pollution Control Board.
Outline of environment audit report.
The report specifies various details of pollutants and wastes, pollution control measures, investment proposals for environment protection, abatement of pollution, etc.
The Report contains nine parts. Of them, main parts are stated as below:
Part B: Water and Raw material consumption during the current year/previous year for each of the products and per unit of product.
Part C: Pollution generated, pollutants-wise (e.g., air, water) quantity and percentage variation from prescribed standards with reasons.
Part D: Hazardous Wastes from process/pollution control facilities, quantity during the current year/previous year.
Part E: Solid wastes from process/pollution control facilities/recycling, quantities during the current year/previous year.
Part F: Disposal practices as to hazardous/solid wastes.
Part G: Impact of pollution control measures.
Part H: Additional investment proposal for environment protection!
Part I: Abatement of pollution.
9. Essay on Auditing: (Special Audit)
It is one that is conducted:
(i) Under the specific directions of the Central Government, and
(ii) Tinder Section 233A of the Companies Act, 1956 in certain cases.
The Central Government appoints either a chartered accountant in practice (as defined in the Chartered Accountants Act, 1949) or the company’s auditor himself to conduct such special audit.
This special audit is ordered by the Central Government in any of the following circumstances:
1. When the affairs of the company are not managed in accordance with sound business principles.
2. When the company is managed in a manner likely to cause serious injury or damage to the interest of the trade, industry or business to which it pertains.
3. When the financial position of the company is such as to endanger its solvency.
10. Essay on Auditing: (Functions of Audit Committee)
It is a committee or sub-group of the full Board of Directors of a company, formed for overseeing and monitoring on behalf of the Board preparation of meaningful financial statements and reports, relying on the senior-level finance manager, internal auditors, and external auditors. The composition of an audit committee depends on relevant provisions/requirements of the regulatory authority like SEBI and the Companies Act.
An Audit Committee’s basic function is to act as a catalyst for efficient and transparent financial reporting and as a bridge between the Board of Directors, Internal Auditors, and External Auditors.
The major functions of an audit committee include:
(i) Overseeing the process of financial reporting and disclosure of financial information to ensure correct, adequate, and reliable financial statements;
(ii) reviewing draft annual financial statements with reference, inter alia, to changes in accounting policies and practices, compliance with ‘going concern’ assumption, accounting standards, legal and stock exchange requirements, qualifications in the draft form of the Auditors’ report before submission to the Board;
(iii) discussing with management and the internal and/or external auditors the adequacy or otherwise of internal control and internal audit systems, important findings of the internal auditors and follow-up actions thereon; and
(iv) Checking material defaults, statutory or otherwise.
Provisions of the Companies Act relating to Audit Committees.
The new Section 292A (introduced in the year 2000) of the Companies Act contains the provisions relating to Audit Committee.
These are summarised below:
(1) Every public company having a paid-up capital of Rs. 5 crores or more must constitute an audit committee.
(2) The audit committee shall comprise a minimum of three directors and such other number of directors as the Board may determine; two-thirds of the total number of members of such a committee must be directors other than the managing or whole-time directors. The members shall elect a chairperson of the committee from among themselves.
(3) The committee shall act according to the terms of reference set in writing by the Board. The auditor, the internal auditor (if any), and the director-in- charge of Finance, must attend and participate at meetings of the committee without any voting rights. The committee should interact periodically with the auditors about internal control systems, scope of audit including the auditor’s observations, review half-yearly and yearly financial statements before submission to the Board and also ensure compliance with internal control systems.
(4) The committee is empowered to probe into any matter specified in the terms of reference, and for that purpose, to have full access to information contained in the company’s records, and if required, external professional expert advice.
(5) The audit committee’s recommendations on financial management and audit report shall be binding on the Board. The Board must record reasons for non-acceptance of such recommendation, if any, and communicate the same to shareholders.
(6) The annual report of the company must disclose the composition of the audit committee.
(7) The chairperson of this committee must attend the company’s annual general meeting (AGM) to provide any clarification on matters regarding the audit.
11. Essay on Auditing: (Special Audit Techniques to Verify Computer-Based Records)
In a computerised recording and accounting system the greatest problem, the auditor is confronted with, is in the missing ‘audit trails’ and in keeping a track of the calculations made inside the computer which ultimately result in output documents.
Normally once the input data have been fed into a computer, the auditor does not know what will go on inside the computer. He can only expect to obtain the output and try to relate input data—which is not very often possible because of the transformation.
Further, the auditor not being present always in EDP premises to watch the stages of processing must have to have a satisfactory audit on the actual data processing system in operation. He also needs evidence with which he can evaluate computer—based records. For this, he has to make use of special audit techniques called ‘computer- assisted audit techniques’ (CAATs).
12. Essay on Auditing: (Frauds and Errors in Auditing)
Until the beginning of the 20th century, the detection of errors and prevention of fraud were the major objectives of auditing. But the objectives of modern auditing are not simply to guarantee the accuracy of the accounts against fraud and error. The auditing function attempts to ensure, via the medium of current disclosure requirements and reporting standards, that the information contained in the accounts is relevant and objective to meet the needs of the shareholders.
In view of the apparent misconceptions which exist in the public mind concerning the nature and objectives of audit, International Auditing Guideline on fraud and error states that “the responsibility for the prevention and detection of fraud and error rests with the management. The responsibility is fulfilled principally through the implementation and continued operation of an adequate system of internal control”.
But at the same time, the guideline observes that:
(i) The audit should seek reasonable assurance that fraud or error which is material to the financial information has not occurred;
(ii) If fraud or error has occurred, it is either properly accounted for or corrected;
(iii) The audit planning should have a reasonable expectation of detecting material misstatements in the financial information resulting from fraud or error;
(iv) The audit examination being based on the concept of selective testing, some material misstatement of the financial statements resulting from fraud or error, if either exists, will not be detected; and
(v) When fraud is coupled with certain acts on the part of certain members of the management and designed to conceal it, such as collusion, forgery, or failure to record transactions, these acts are intentional misrepresentations which are difficult and impossible to detect. However, it is important to note that an independent audit should be performed with an attitude of professional skepticism recognising that conditions or events……..could lead (the auditor) to question whether fraud or error exists.
We may classify them into three main categories as follows:
1. Embezzlement of cash:
This may take place in one or more of the following ways:
(a) Omission of cash receipts, e.g., cash sales not recorded, casual receipts of miscellaneous nature not entered, sale proceeds of fully-written off assets not recorded, etc.
(b) Recording of less amounts than that actually received.
(c) Inclusion of fictitious payments in the cash book, e.g., wages paid to ‘ghost’ or ‘dummy’ workmen, salaries paid to apprentices whose tenure of service expired, etc.
(d) Recording of more amounts than that actually expended, e.g., discounts or rebates not taken into account while making payments, etc.
Since the chances of fraud of this nature are more in big establishments, the independent auditor should examine the extent and effectiveness of the system of internal checks existing in the organisation.
2. Misappropriation of goods:
This involves pilferage of stores and stocks. Articles of smaller sizes but of higher value are generally susceptible to theft and pilferage.
The auditor should check the methods of:
(a) Accounts kept,
(b) Stock taking,
(c) Periodical stock verification, etc.
He should also examine the effectiveness of the existing systems of internal controls and internal checks.
3. Manipulation of accounts:
This is generally committed by the higher levels of management with the object of fulfilling their vested interests. The falsification of accounts also comes under this category.
The following types of vested interests are commonly found:
(a) Showing more profits than the actual to get more commission, to pay higher dividends, to obtain higher bank loans and credit facilities and to give a rosy picture before the shareholders for the sale of more number of shares, etc.
(b) Showing less profit than the actual to deceive shareholders and creditors and bankers, to reduce income tax burden, and to give a wrong impression to the competitors about the success of the firm.
The falsification of accounts is done in one or more of the following ways:
(a) Under or over-valuation of stocks,
(b) False entries of sales or returns or purchases,
(c) Providing more or less depreciation, or non-provision of depreciation,
(d) Booking capital expenditure to revenue account, or vice-versa, etc.
As these frauds are committed by the trusted officials of a firm, the auditor should undertake the work of vouching very seriously and his inquiries about these matters should be made tactfully.
Examples of errors which might exist in the books of account even after the agreement of the trial Balance:
Steps to be taken by an auditor to detect the errors:
Even after the agreement of the trial balance, the following types of errors (as illustrative examples) might exist in the books of account.
i. Errors of omission:
With the omission of a particular purchase transaction, there are corresponding omissions of ‘debit’ entry in the Purchase Account and ‘credit’ entry in the Supplier Account. That means, both the debit and credit aspects are equally omitted and the trial balance continues to agree.
ii. Auditor’s duty:
He should check the debit balance of the Suppliers Account and scrutinize the party’s ledger to see whether payment to the supplier has been made. There is an omission of both the debit and credit entries in the ledger even when the transaction is recorded in the books of original entry. So, trial balance agrees.
iii. Auditor’s duty:
He should compare the original books with the ledgers to verify whether any item was omitted for posting in the ledger.
iv. Errors of commission:
With the wrong entry of a particular purchase transaction in the Purchases Day Book, there are corresponding wrong debit entry in the Purchases Account and wrong credit entry of the same amount in the Suppliers Account. Hence, trial balance continues to agree with the equal wrong amounts in both debit and credit sides.
v. Auditor’s duty:
He should vouch the purchases with the original invoices and advise rectifications wherever necessary.
With the recording of a particular purchase transaction wrongly in the Sales Day Book, the Suppliers Account is debited and Goods Account credited. In fact, the entries should have been the other way round. This wrong accounting does not affect the trial balance.
vi. Auditor’s duty:
He should compare the Purchases or Sales Day books with the original documents for each of the transactions.
vii. Compensating errors:
The wrong total of purchases day book shows an excess by Rs. 400 (say). So, the debit to Purchase Account is more by Rs. 400. Similarly, for some of the ledger accounts, let us assume that the Commission Account (credit side) was wrongly totalled more by Rs. 200 and the Travelling Expenses Account (debit side) wrongly totalled short by Rs. 200. These three mistakes are different.
The position appears as under:
As a result, the trial balance agrees.
viii. Auditor’s duty:
He should check up the totals, postings and castings of ledger accounts.
The auditor, when called upon to discover the errors responsible for the disagreement of a trial balance, should proceed along the following lines:
1. Check up the totals of the trial balance. The totals drawn up may be wrong.
2. Compare:
(a) The names of the accounts heads in the ledger with those recorded in the trial balance and
(b) The accounts’ items appearing in the trial balance between the current and previous years to find out any omissions.
3. Check up the totals of Debtors and Creditors and compare them with those appearing in the trial balance.
4. Examine the balances of subsidiary books (e.g., purchases/Sales day books, Cash book, etc.) and of the ledger accounts and compare them with the trial balance.
5. In case of the accounts books maintained under Self-balancing system, check up the totals of various accounts as well as the grand total of these accounts and compare the account balances with the figures taken in trial balance.
6. See whether there is any account item the value of which might be equal to the half of the trial balance difference and then verify if any debit balance included in the credit side of the trial balance or vice versa.
7. Examine the Ledger accounts’ opening balances with the last year’s trial balance and see whether the difference is equal to the difference in the closing balance also.
If the error cannot be detected in spite of the above checks, the following steps should be undertaken:
1. Whether there has been misplacement of figures, e.g., 64 for 46, 18 for 81, or 32 for 23 and so on.
2. Whether the difference is for a round sum of figure which may be due to wrong totalling.
13. Essay on Auditing: (Classes of Errors and Frauds in an Audit)
The following are the classes of errors and frauds in an audit faced by an auditor:
A. Classes of Errors:
In auditing the accounts of a firm, the following classes of errors are usually found:
1. Error of Omission:
It is a kind of clerical or technical error, where a transaction is omitted either wholly or partially while making entries in the books of account. It may arise either due to carelessness and over-sightedness on the part of the accounts assistant or due to ulterior motive of the accounts personnel to misappropriate cash and goods. The latter types of errors are difficult to be located even by an auditor.
The auditor in these cases should:
(i) Vouch the records of purchases, sales, etc.;
(ii) Examine relevant correspondence; and
(iii) Verify the stock physically.
2. Error of Commission:
It is a kind of clerical or technical error, where a transaction has been recorded incorrectly, either wholly or partially. Inaccuracy in calculations, postings, castings, extensions and carry forwards results in such errors. This kind of error may be intentional or unintentional. Mistakes in totalling, casting, posting or balancing an account are not deliberately done and thus they have an effect on the trial balance.
If there is a mistake in the Sales invoice, the same mistake will appear in the original books as well as in the ledgers. So, such error cannot be detected in the trial balance. The auditor, thus, should: scrutinize the invoices, vouch the books of original entry, and check the totals and extensions to detect errors, if any.
3. Compensating Error:
This is a kind of clerical or technical error. This is also known as ‘off-setting error’. In this case, one error is compensated by other error.
These errors usually have the following peculiarities, such as
(i) wrong debit entry being balanced by another wrong credit entry, or vice- versa;
(ii) Over-casting of an account being balanced by the under-casting of another account to the same extent;
(iii) Under or over-cast balances of debit and credit by the same amounts; etc.
So, these errors are difficult to be detected by a trial balance. These errors, depending on the types, may or may not affect the Profit and Loss Account. The auditor, in order to find out such errors, should undertake exhaustive scrutiny and check the totals, castings and postings.
4. Error of Principle:
Such error may be intentional or unintentional. When transactions are recorded in the books of original entry in disregard to the generally accepted accounting principles, these errors arise.
The following cases are examples of such errors:
(i) Incorrect allocation between revenue and capital expenditure.
(ii) Recording capital expenditure as revenue expenditure, or vice-versa.
(iii) Over-valuation or under-valuation of stocks.
(iv) Provision of depreciation in the accounts in complete disregard of the relevant rules.
(v) Non-consideration of outstanding assets and liabilities in the accounts.
(vi) Valuation of assets in a way contrary to the accounting principles.
These errors do not affect the trial balance and thus, are difficult to trace out by simple means of routine checking. The auditor should, therefore, be critical and vigilant. He should undertake a searching inquiry and independent methods of check for the detection these errors.
5. Error of Duplications:
When an entry is made twice in the original books as well as in the ledgers, and error of duplication is said to have been committed. Such error does not affect the trial balance as both the debit and credit aspects are posted twice in the ledger. So, the auditor should vouch the entries with the voucher with a view to ascertaining whether any entries remain un-vouched.
B. Classes of Frauds:
Fraud may be perpetrated in various ways. We may classify them into three main categories as follows:
1. Embezzlement of Cash:
This may take place in one or more of the following ways:
(a) Omission of cash receipts, e.g., cash sales not recorded, casual receipts of miscellaneous nature not entered, sale proceeds of fully-written off assets not recorded, etc.
(b) Recording of less amounts than that actually received.
(c) Inclusion of fictitious payments in the cash book, e.g., wages paid to ‘ghost’ or ‘dummy’ workmen, salaries paid to apprentices whose tenure of service expired, etc.
(d) Recording of more amounts than that actually expended, e.g., discounts or rebates not taken into account while making payments, etc.
Since the chances of fraud of this nature are more in big establishments, the independent auditor should examine the extent and effectiveness of the system of internal checks existing in the organisation.
2. Misappropriation of Goods:
This involves pilferage of stores and stocks. Articles of smaller sizes but of higher value are generally susceptible to theft and pilferage.
The auditor should check the methods of:
(a) Accounts kept,
(b) Stock taking,
(c) Periodical stock verification, etc.
He should also examine the effectiveness of the existing systems of internal controls and internal checks.
3. Manipulation of Accounts:
This is generally committed by the higher levels of management with the object of fulfilling their vested interests. The falsification of accounts also comes under this category.
The following types of vested interests are commonly found:
(a) Showing more profits than the actual to get more commission, to pay higher dividends, to obtain higher bank loans and credit facilities and to give a rosy picture before the shareholders for the sale of more number of shares, etc.
(b) Showing less profit than the actual to deceive shareholders and creditors and bankers, to reduce income tax burden, and to give a wrong impression to the competitors about the success of the firm.
The falsification of accounts is done in one or more of the following ways:
(a) Under or over-valuation of stocks,
(b) False entries of sales or returns or purchases,
(c) Providing more or less depreciation, or non-provision of depreciation,
(d) Booking capital expenditure to revenue account, or vice-versa, etc.
As these frauds are committed by the trusted officials of a firm, the auditor should undertake the work of vouching very seriously and his inquiries about these matters should be made tactfully.
Auditor’s Responsibility for Non-Detection of Errors and Frauds:
While conducting an audit, the auditor should bear in mind the possibility of the existence of fraud or other irregularities in the accounts under audit. The responsibility of the auditor for failure to detect fraud (which responsibility may differ as to clients and others) arises only when such failure is clearly due to his not exercising reasonable skill and care.
The duty of safeguarding the assets of a company is primarily that of the management. The auditor is entitled to rely upon the safeguards and internal controls instituted by the management, although he will, of course, take into account any deficiencies he may note therein while drafting his audit programme.
If an audit is to be conducted with the object of discovering frauds, in the first place it would take a considerable time and it would not be possible to complete the audit within the time limit prescribed by law for the presentation of accounts to the shareholders.
If after the auditor has completed his audit a fraud is discovered pertaining to that period, it does not necessarily mean that the auditor has been negligent or that he has not performed his duties competently. The auditor does not guarantee that once he has signed the report on the accounts, no fraud exists.
If he has conducted his audit by applying due care and skill in accordance with the professional standards expected of him and has exercised reasonable skill and care, the auditor would not be held responsible for not having discovered that fraud.
14. Essay on Auditing: (Continuous Audit)
Meaning of Continuous Audit:
An audit where the audit staff is occupied continuously on the accounts the whole year round or where the auditor attends at intervals, fixed or otherwise, during the currency of the financial year and performs an interim audit.
Applicability of Continuous Audit:
(i) Where the businesses are relatively large in size and the audit work involved is considerable.
(ii) Where the management of the concern decides that the audited accounts should be available immediately after the end of the financial year.
(iii) Where the system of internal checks is either non-existent or not satisfactory.
(iv) Where the management of the concern is keen to have accurate monthly or quarterly statements of accounts.
Advantages of Continuous Audit:
a. To Shareholders:
(i) Interim accounts are possible to be prepared without delay. These can be used by the company directors to arrive at a decision on the interim dividend, to which the shareholders are interested.
(ii) The annual audit of accounts is possible to be completed very quickly. The shareholders come to know of the financial affairs of the business through the audited accounts which are presented at the annual general meeting soon after the close of the financial year.
b. To Auditors:
(i) Close and continuous touch with the business affords an opportunity to the auditors to gain knowledge of technical details.
(ii) Regular visits of the auditor induce the client staff to keep all accounts up to date.
(iii) The auditors’ surprise visits act as a moral check on the client staff.
(iv) As the work is evenly distributed over the year, planning and programming of audit with respect to audit staff and arrangement can be made better.
(v) The auditors’ attendance at regular intervals (say, fortnightly or monthly) requires examination of relatively smaller number of transactions. Hence, they are in a position to detect and prevent errors and frauds.
(vi) Sufficient time available before the close to the financial year enables the auditors to check the accounts with greater attention and in greater details. This way, the conduct of audit becomes thorough and efficient.
c. To Management:
(i) Interim accounts are audited.
(ii) Decision in respect of interim dividend is facilitated.
(iii) Discovery of errors and frauds can be made easily and quickly and set right in time.
(iv) Efficiency of the accounts staff increases.
(v) Final audited accounts can be presented at the annual general meeting soon after the close of the financial year.
Disadvantages of Continuous Audit:
i. An expensive system to operate.
ii. The auditors frequent visits cause inconvenience to the client staff.
iii. The client staff becomes dependent upon the audit staff for clarification.
iv. The client staff may, either innocently or fraudulently, alter the audited figures without the knowledge of the auditors.
v. The auditors are likely to lose the thread of continuity of work due to a long interval between two visits,
Steps to Overcome Disadvantages of Continuous Audit:
i. The audit programme, drawn up month-by- month and mutually agreed upon, should be made known to both the client staff and audit staff.
ii. The client staff should be suitably instructed not to alter the audited figures without the auditors’ permission.
iii. An ‘audit note book’ for recording queries should be maintained and the queries should be sorted out during next visits.
iv. The examination of Impersonal, General or private Ledger should be undertaken at the end of the financial year when the final trial balance is drawn up. This would obviate the possibilities of fraud being committed by the client staff by recording fictitious entries.
v. The auditors should use secret tick marks against the figures that have been altered and glance over the alterations during next visit.
15. Essay on Auditing: (Propriety Audit)
Meaning of Propriety Audit:
Audit concerning the decisions of the executives with an emphasis on public interest, financial discipline, basically to get audit satisfaction that such decisions are within the framework of sanction, authority, rule, procedure and law made by a competent authority and to advise the executives either in preventing or reducing losses and increasing productivity or improving performance by timely reporting.
This audit extends beyond the formality of expenditure to its wisdom, faithfulness and economy. It should not only ensure that an expenditure incurred is duly sanctioned by an appropriate authority but should also investigate the justifications and the necessity for it.
While conducting this audit, the auditor should ensure that the following ‘canons of financial propriety’ are strictly followed:
(i) The expenditure should not, prima facie, be more than the occasion demands.
(ii) Public money should not be utilised for the benefit of particular person or section of community unless:
(a) the amount is insignificant,
(b) a claim for that amount could be enforced in a court of law
(c) the expenditure is in pursuance of a recognised policy or custom.
(iii) The allowances granted to meet an expenditure should be so regulated that these are not on the whole sources of profits to the recipients.
(iv) No authority should exercise its power of sanctioning expenditure to pass an order which will be directly or indirectly to his own advantage.
Besides the scrutiny of individual transactions with a view to detect cases of improper expenditure, an auditor, while performing the task of propriety audit, should examine how far the transactions sanctioned are adequate in discharging the financial responsibilities with regard to the various schemes undertaken.
To assess the adequacy or otherwise of the effect of financial responsibilities, propriety audit should examine on the following guidelines:-
(a) Whether the technical estimates or detailed programme and cost schedules are being framed and that the same are adhered to or not ; whether there are adequate reasons for excess, delays, etc., or whether these are occasioned by inefficient handling, wastes, etc. or due to incorrect preparation of original estimates;
(b) Whether there have been any serious avoidable delays in the progress of the schemes resulting in increase in the total cost of the scheme;
(c) Whether there has been any wasteful expenditure including that resulting from lack of co-ordination;
(d) Whether there have been any losses of recurring nature;
(e) Whether the performance and cost compare with the results obtained in respect of similar schemes in other fields or in other public projects;
(f) How far the physical targets have been achieved within the estimated or sanctioned time;
(g) How far the ultimate objectives of the expenditure have been fulfilled.
Organisations having the Benefits of Propriety Audit:
Presently the forms of organisation which are having the benefits of propriety audit are:
(i) Government companies, such as the State and Central Government undertakings. The Comptroller and Auditor General of India has a right to conduct efficiency-cum-economy oriented propriety audit, in addition to the statutory audit under his guidelines and instructions.
(ii) Public limited companies, a chartered accountant in practice has also some right to conduct such propriety audit in a limited sense according to the provisions contained in Section 227 of the Companies Act, 1956.
(iii) Companies where cost accounting record rules have been made applicable compulsorily and where the Central Government specifically issues orders for the conduct of Cost Audit under Section 233B of the Companies Act, 1956. A Cost Accountant in practice has a right to conduct such audit and submits his report covering the points which are propriety based.
Limitations of Propriety Audit:
Propriety audit has its following limitations:
(i) In decision making process:
Since the auditor, examines and scrutinizes every decision of the executive, the executive often does not take quick and bold decisions.
(ii) In compliance with regulations:
The executives become inclined to function strictly according to rules and regulations. This does not ensure achievement of targets or objectives.
(iii) Timeless:
The audit and its report, if delayed, will not be of much use. It will be a futile report on an unprofitable contract after incurring losses.