Introduction to Auditing and Company Auditor: A Comprehensive Guide | Study Guides, Projects, Research Auditing

AUDITING

UNIT 1

INTRODUCTION TO AUDITING AND COMPANY AUDITOR

Introduction: The industrial revolution has paved the way for introduction of the joint stock

company form of business organization, due to large scale operations, requiring huge amount of

capital. As sole proprietors / partners unable to invest the required amount of capital for large

scale business operations, company’s started collecting capital from general public by issuing

prospectus. Company form of organization, different from traditional form and separated

owners (shareholders) from management (board of directors). As a matter of fact, the

shareholders need to be informed about the results of business operations in the form of income

statements and financial statements duly audited by independent person. The person is called as

auditor and his work or task is called auditing, which is mandatory as per the provisions of the

companies act 2013.

Origin: The origin of auditing can be traced back to 1494 when Lucca Pacioli published his

book on double entry system of accounting Auditing is as old as accounting. In ancient time

Egyptians, Greeks and Romans practiced auditing to audit the public accounts. In India origin

of auditing was traced in the book “Artha shastra” written by Kautilya. It has been developed

gradually after the industrial revolution in 18

century

Meaning of Audit: Audit is the examination or inspection of various books of accounts by an

auditor followed by physical checking of inventory to make sure that all departments are

following documented system of recording transactions. It is done to ascertain the accuracy of

financial statements provided by the organisation.

Meaning of Auditing: The word audit has been derived from the Latin word ‘Audrie’ which

means to hear. Auditing is an examination of the books of accounts and vouchers of the business by

an independent person who should be qualified for the job, in order to ascertain

their accuracy. The process of auditing starts only when accounting ends.

Definition of Auditing: According to Montgomery, “Auditing is a systematic examination of

the books and records of a business organization to verify and report the facts of the financial

operation and the results thereof

An audit is an examination of accounting records undertaken with a view of establishing whether they

correctly and completely reflect the transactions to which the purport to relate.” –Lawrence R. Dickey

An auditor is a person authorized to review and verify the accuracy of financial records and ensure

that companies comply with tax laws. An auditor may be internal auditor or external auditor Internal

auditor is a person who has been appointed by the company for the purpose of company’s audit.

Whereas, external auditors are independent auditors having firms who are hire by the companies

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AUDITING

UNIT 1

INTRODUCTION TO AUDITING AND COMPANY AUDITOR

Introduction: The industrial revolution has paved the way for introduction of the joint stock company form of business organization, due to large scale operations, requiring huge amount of capital. As sole proprietors / partners unable to invest the required amount of capital for large scale business operations, company’s started collecting capital from general public by issuing prospectus. Company form of organization, different from traditional form and separated owners (shareholders) from management (board of directors). As a matter of fact, the shareholders need to be informed about the results of business operations in the form of income statements and financial statements duly audited by independent person. The person is called as auditor and his work or task is called auditing, which is mandatory as per the provisions of the companies act 2013. Origin: The origin of auditing can be traced back to 1494 when Lucca Pacioli published his book on double entry system of accounting Auditing is as old as accounting. In ancient time Egyptians, Greeks and Romans practiced auditing to audit the public accounts. In India origin of auditing was traced in the book “Artha shastra” written by Kautilya. It has been developed gradually after the industrial revolution in 18 th^ century Meaning of Audit: Audit is the examination or inspection of various books of accounts by an auditor followed by physical checking of inventory to make sure that all departments are following documented system of recording transactions. It is done to ascertain the accuracy of financial statements provided by the organisation. Meaning of Auditing: The word audit has been derived from the Latin word ‘Audrie’ which means to hear. Auditing is an examination of the books of accounts and vouchers of the business by an independent person who should be qualified for the job, in order to ascertain their accuracy. The process of auditing starts only when accounting ends. Definition of Auditing: According to Montgomery, “Auditing is a systematic examination of the books and records of a business organization to verify and report the facts of the financial operation and the results thereof An audit is an examination of accounting records undertaken with a view of establishing whether they correctly and completely reflect the transactions to which the purport to relate.” – Lawrence R. Dickey An auditor is a person authorized to review and verify the accuracy of financial records and ensure that companies comply with tax laws. An auditor may be internal auditor or external auditor Internal auditor is a person who has been appointed by the company for the purpose of company’s audit. Whereas, external auditors are independent auditors having firms who are hire by the companies

OBJECTIVES OF AUDITING

The Indian Institute of Chartered Accountants (ICAI) in its Auditing and Assurance Standard- 2 (AAS-2) specifies the following objectives of auditing: The purpose of an audit of books of accounts, inclining a structure of identified accounting policies, practices and appropriate statutory obligations, if any, is to authorize an auditor to articulate a point of view on such financial statements. The auditor’s point of view helps in determining the true and fair view of the economic condition and functioning outcomes of a company. The auditor must be an autonomous body who is authorized to examine the enterprise, its records and financial statements inclined from an enterprise and therefore, create a point of view on the efficiency and preciseness of the financial statements. The elementary target of auditing is to facilitate to harmonize that the books of accounts display a true and fair view or not. Thus, the auditing is performed to build-up effectiveness and certainty in the accounts before putting them in front of the shareholders and administration. It provides authentic information about the economic position of the business, which may help the overall management of the business enterprise. For the attainment of the elementary objectives of auditing, the following ancillary objectives are to be required:

Disclosure of errors
Disclosure of frauds
Avoidance of errors
Avoidance of frauds Besides, errors which occur because of innocence and negligence, are of three types:
Clerical error
Compensating error
Error of principles Again, clerical errors are of two types:
Error of omission
Error of commission However, the frauds which occur with a purpose to gain something by some influencing methods, they are of three types:

o Where total of purchase day book or sale day book omitted to be posted in purchase or sale account respectively. o Where payment or receipt transaction omitted to be recorded in ledger account from cash book. Errors of Duplication The detection of error of duplication is very difficult. It might be detected with proper and minute observation of accounts; for example, purchase may be recorded twice with original and duplicate copy of purchase invoice, etc. It is also possible to post the total of any ledger account twice in the trial balance. Errors of Commission Error of commission occurs the entry made in the books of the original entry or the ledger account is wrong. Let us see the following examples −

Purchase of goods for Rs. 25,000 wrongly entered as Rs. 2,500 in purchase book.
Credit purchase from AB Company wrongly credited to BA Company’s account.
Wrong totalling − total of purchase day book is totalled as Rs. 1,12,500 instead of 1,21,500.
Purchase from AB Company wrongly debited to AB company account instead of crediting AB company account and debiting purchase account. Compensating Errors When the effect of an error compensates with another error; it is known to be a compensating error. Such errors do not affect the trial balance; for example, total of a debit account as well as credit account totalled short by Rs. 7,500. This type of error will compensate both. Detection and prevention of frauds The main objective of auditing is to ensure the financial reliability of any organization; detection of fraud is just an incidental object. Independent opinion and judgement form the objectives of auditing. The job of an Auditor is to ensure that the books of accounts are kept according to the rules stipulated in the Companies Act; an Auditor also needs to ensure whether the books of accounts show a true and fair view of the state of affairs of the company or not. The following are the three distinct types of fraud −
Misappropriation of Cash
Misappropriation of Goods
Manipulation of Accounts Misappropriation of Cash Misappropriation of cash is the easiest way of fraud especially in large business houses where there is limited or no communication between the owner of an organization and the cashier. Following are some of the ways through which embezzlement or misappropriation can be done −
Theft of cash receipts and petty cash and showing fictitious payment to workers, creditors, purchases, etc.
Showing false payments or excess payments in cash book.
By using the Teeming and Lading method, the money received from any customer can be pocketed and the money received from another customer can be shown as money received from the former.
Cash sale can be shown as credit sale.

Strict internal control system should be followed in receipts and payments of cash so that the work done by one person should be automatically checked by another person. Misappropriation of Goods Misappropriation of goods can be done in the following ways −

Goods may be stolen by employees or with the help of employees.
By issuing false credit notes to customer on account of goods return. Detection of misappropriation of goods is more difficult rather than detecting misappropriation of money, especially where management is not much vigilant and sound system of book- keeping, internal control and adequate system of securities are not available. To keep control on the physical verification of goods, reconciliation of physical stock with books and careful checking of sale and purchase is must. Manipulation of Accounts Two types of manipulation of accounts are mainly done by top management to mislead some parties for some specific purpose.
Showing higher profits − Following are the reasons behind showing higher profit than actual − o To obtain credit or to enhance existing credit from financial institutions and also to show credit worthies to suppliers of the company. o To maintain confidence of shareholders. o To hike the market price of shares of the company and enable the sale of those at higher price, it may be done by declaring higher dividends on shares. o To get more commission where commission is calculated on the basis of profit earned. o To declare dividend at higher rate.
Showing low profits − Following are the reasons behind showing lower profit than actual − o To avoid or to reduce Direct Taxes of the company (Income Tax, Wealth Tax). o To purchase shares at lower price. o To give wrong impression to the other competitors of the business. Manner of Manipulation of Accounts Manipulation of accounts may be done in the following ways −
Window dressing is a manipulation or miss-representation of financial data in such a way that it seems better than what it actually is. Some of the method of window dressing is given as hereunder. o Over valuation of closing stock o Under valuation of Liabilities or Over-valuation of assets o Purchases and expenses of current year may be deferred to next financial year o Charging revenue expenses as capital expenditure o Sale and other incomes of preceding year may be shown as income or sale of the current year.
Secret reserves of previous years may be used in the current financial year to inflate the profit or secret reserves may be created to suppress the profit of the current financial year.
Stock may be under or overvalued. Income and sales may be suppressed or inflated. Expenses and purchases may be suppressed or inflated.

Creditors of an organization also rely on audited financial statements and accordingly grant credit limit to business entities. For Others

Audited accounts are easily accepted by insurance companies for settlement of claims.
Audited financial statements are acceptable by bank and financial institutions and helpful in getting loans and credit facilities. LIMITATIONS OF AUDITING
Rely on Experts − An Auditor has to rely on experts like engineers, valuers and lawyers for estimation and valuation of fixed assets and estimation of contingent liabilities.
Efficiency of Management − An Auditor does not comment on the efficiency of management working in client organization; no comments on future performance of an organization can be made through audited financial statements.
Checking of All Transactions − It is not possible for an Auditor to check all business transactions especially in big organizations where the number of transactions is very high. An Auditor has to rely on sampling and test checking.
Additional Financial burden − An organization has to bear additional financial burden on account of any fees and other such expenses for conducting an audit.
Not Easy to Detect Some Frauds − It is not easy for an Auditor to detect deeply laid frauds like forgery, misstatements and non-recording of transactions.

Introduction to Auditing and Company Auditor: A Comprehensive Guide, Study Guides, Projects, Research of Auditing

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AUDITING

UNIT 1

INTRODUCTION TO AUDITING AND COMPANY AUDITOR

OBJECTIVES OF AUDITING

DIFFERENCE BETWEEN AUDITING AND ACCOUNTING