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7/30/2019 Objectives of Auditing
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OBJECTIVES OF
AUDITING
Ansi Basheer 10906
Antony John 10907
Arjun M Jimmy 10908
Arjun Sivarajan 10909
Ashems Unni 10910
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The objectives of auditing can be classified into :
i) Primary or main objective and
ii) Secondary or incidental objectives.
Primary Objective
The main of objective of auditing is to verify the
accounts and to report whether the Profits and LossAccount and Balance Sheet are properly drawn upaccording to the Companies Act and they exhibit a trueand fair view of the state of affairs of the concern (Sec.227 of the Companies Act of 1956). It is actually an
evaluation of financial statements to see whether theytruly and fairly represent the actual financial position.For this the auditor must carry out a process ofexamination and verification of various accounts andother related documents. The auditor has to produce a
report on the financial condition and working results of aconcern after satisfying himselfwith the accuracy of the
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For the purpose, he must
1) Examine the system of internal check.
2) Check the arithmetic accuracy of the books of accounts.
3) Verify the authenticity and validity of transactions.
4) See that proper distinction has been mad between items ofcapital and revenue nature.
5) Verify and value the assets and liabilities.
6) Should make sure the system of accounting has been
followed correctly while recording transactions.
7) Verify that all statutory books of accounts are maintained
and in the prescribed manner.
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Secondary or Incidental Objectives
1. Detection of Errors
Accounting errors are mistakes and omissions
made unknowingly while recording transactions in thebooks of accounts. They are innocently made mistakes,without any malicious intent. Errors can be classified intotwo categories:
i) Clerical errorsThese occur when transactions are recorded,
posted in ledgers and totalling and balancing of accounts.Clerical errors can be further divided into:
Errors of Omission : - When a transaction is notentered in the books of accounts or is not posted toledgers, error of omission occurs. When a wholetransaction is missed, then is complete omission andwhen either debit or credit aspect is left out, it is partial
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Errors of Commission :- Errors committed when
transactions are incorrectly recorded are called errors of
commission. These can be caused by wrong posting,
wrong totalling, wrong carry forwards etc.
Errors of Duplication :- An error of duplication
occurs when the same transaction is recorded twice inthe books of original entry and hence is also posted twice
in ledger accounts. Errors of this nature is difficult to
detect because there will not be any disagreement within
the trial balance.
Compensating errors :- Compensating errors are
those errors which compensate each other. When two or
more errors occur in a manner that their effect on debit
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ii) Errors of Principles :
If any principle is violated in recording of a
transaction, it is an error of transaction. Errors of
principle are committed when proper distinction
between revenue and capital items are not made, i.e.,a capital expenditure is taken a revenue expenditure
and vice-versa. For example, carriage paid on
purchase of a machinery, if instead of debiting it to
Machinery A/C, it is debited to P&L A/C it is an errorof principle. Another example for an error of principle
is debiting the purchase of an asset in the purchases
account, instead of the particular asset account. Such
errors by themselves do not affect the agreement of
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Duties of an Auditor with regard to detection oferrors
Ordinarily, it is not the duty of the auditor to locate an errorin the books of accounts. But the auditor is often calledupon to discover the difference in books of accounts whenthe accountant is unable to trace it.
The auditor takes the following steps to locate these errors:
1. Check and recheck the totals of trial balance.
2. When a difference is detected in trial balance, look forant excluded item having the same balance.
3. Check the total list of debtors and creditors. Check thecarry forwards of the ledger accounts from one page orperiod to another.
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Detection of Frauds
"A fraud is intentionally created mistake committed todefraud the proprietors of the concern. It is the wilful
misrepresentation or deliberate concealment of a
material fact with a view to deceive, cheat or mislead
somebody".f raud means false representat ion or entry made
intent ional ly or w ithou t bel ief in i ts truth. frauds are
more serious than errors as they are committed
intentionally by responsible officers who are presumedto be honest.
Frauds may of three types.
i. Misappropriation or embezzlement of cash.
ii. Misappropriation of goods.
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i. MISAPPROPRIATION OR EMBEZZLEMENT OF
CASH
Misappropriation or embezzlement of cash meansfraudulent appropriation of cash belonging to another
person by one who handles it. Misappropriation of cash
may take place in any of the following ways:
a. Suppression or non-disclosure of cash receiptsSuppression or non-disclosure of cash receipts takes
place in the following ways:
i. Omitting to record the full cash sale proceeds, and
pocketing the money received from it.
ii. Recording the cash sale proceeds at a figure lower
than the actual cash sale, i.e., under recording of the
cash sales or recording only a part of the cash sale
proceeds, and pocketing the balance of the cash sale
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iii. Omitting to record the credit sales and pocketing themoney received from the customers or debtors.
iv. Teeming and lading : this is one of the methods ofmisappropriation of cash. Under this method, the moneyreceived from the first customer is misused ormisappropriated by the cashier, The money received fromthe second customer is credited to the account of firstcustomer, the money received from the third customer iscredited to the accounts of the second customer and so on.This practice is continued till such time that the cashierfinds it possible to put back the money misused by him ortill the fraud is detected. This method of misappropriation of
cash is also called lapping.v. Cash received from sale by V.P.P. or sale or returns maybe pocketed.
vi. Making fictitious or false entries in the customersaccounts for return, bad debts, discounts and allowances,
and pocketing the money, when the money is received from
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b. Inflated the payments or showing false cashpayments
The following are the examples of this type of
misappropriation:
i. Recording fictitious or false cash purchases, andpocketing the amount.
ii. Inflating the cash purchases, i.e., recording cashpurchases at a figure higher than the actual amountand pocketing the difference.
iii. Recording payment to fictitious creditors for
purchases, and pocketing the money.iv. Recording payments to creditors at a figure higherthan the actual amount, and pocketing the difference.
v. Not recording the purchase returns, discount and
allowances from suppliers and creditors, and pocketing
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vi. Recording payments to dummy workers and
pocketing the money.
vii. recording fictitious payments of expenses, such as
refreshments and pocketing the money.
viii. Recording payments on some accounts at figures
higher than the actual payments, and pocketing the
difference.
Misappropriation or defalcation of cash is an
easy affair especially in large concerns where
proprietor has no close contact with the cashier. Soin big business houses there must be good internal
check system to control and check system to
control and check cash receipts and payments.
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ii) Misappropriation of Goods
The chances of misappropriation of goods are greater in
the case of goods which are less bulky but are more
valuable, of which detection is not easy.
Goods can be misappropriated by:a) The actual theft of stock
b) By issuing fictitious credit notes to customers.
A detailed checking is necessary to detect
misappropriation of goods. There must be strict control
over the issue of materials, records of sale, purchases
and stock.
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iii) Manipulation or falsification if Accounts
Falsification of accounts without misappropriation
is not as common as misappropriation of cash and
goods. It is undertaken to conceal the true position of the
concern. This is often conducted by managers, directors
or other responsible officers to understate or overstate
the profit and financial standing to suit their purposes.
Reasons for overstating profit:
i) To earn more commission, if it is based onprofit.
ii) To increase prices of shares owned by
them.
iii) To increase the shareholders trust in
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iv) To attract more investors to their concern.
v) To improve their credit ratings.
Reasons for understating profits:
i) To reduce tax liability.
ii) To deceive the competitors by creating
wrong impression about the
performance of the business.
iii) To induce a fall in the price of shares with
a view to buying them in bulk at lower
prices.
iv) To avoid payment of higher bonus to
workers and commission tomana ers.
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Different methods of Manipulation of Accounts:
1. Charging more or less amount of depreciation andprovision.
2. Undervaluation or overvaluation of stock or other assetsand liabilities.
3. Showing fictitious sales or purchases or returns in orderto show as incorrect figure of profit.
4. Recording revenue expenditure as capital expenditure orvice-versa.
5. Showing income and expenditure of the previous year orof the next year in the current years account.
6. Creation or utilisation of secret reserves.
7. Window dressing It implies a practice by which theBalance Sheet figures are inflated or deflated to create a
favourable picture of the company. It tends to paint a
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Auditors duties in relation to the detection and
prevention of errors and frauds
The auditor should exercise reasonable care and
skill to detect errors and frauds to prevent their
recurrence in future. It is very difficult to detect fraudsas they are committed by officers who are presumed to
be honest, sincere and responsible. The auditor must
be all these in addition to being systematic in his work.
Routine checking and vouching must be done verycarefully. His duty is mainly confined to making
intelligent and careful enquiry. In doing so, it is not
necessary that he must be successful. But, if he feels
that he has exercised a great degree of skill, care andtact his ob is over.
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If a fraud is detected after completion of an audit, the
auditor cannot be blamed in all circumstances. If he
certified the accounts were correct in his best
knowledge, skill and care, he cannot be held
responsible for an error or fraud which is still in their
accounts.
An auditor is not supposed to be actively involved in
the prevention of frauds and errors. He can only givesuggestions for the prevention of recurrence of errors
and frauds in the future. It is the proprietor who is
responsible for getting things done.
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The auditors duty in regard to the detection of errors
and frauds is clearly pointed out in the case Kingston
Cotton Mill & Co., 1896. The presiding judge made thisfamous statement that An auditor is only a watchdog
and not a bloodhound.
There are two points to this argument:
1) An auditor is a watchdog means he isappointed to look after the interest of those who happen
to be the owners of the business. Like a watchdog, he
is supposed to look after the interests of the concern
sincerely, honestly and faithfully.
2) An auditor is not a bloodhound. He does not
have investigatory powers unless specially appointed
for the purpose. If he comes across any manipulation or
malpractice, he should nonetheless inform the
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The auditor has to do the following in connection with
the detection and prevention of errors and frauds:
1) Check the internal check system and verify its
effectiveness.
2) Ensure compliance with accounting standardsand policies of the management.
3) Make sure accounts are prepared in
conformity with Companies Act.
4) Check the balance sheet to ensure that itexhibits true and fair view of the state of affairs.
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His responsibility for non-detection of errors will depend
on the following factors:
1) He has fulfilled his duty with the prevailing
statndards of performance adopted by the
profession.
2) He has exercised reasonable care, skill andintelligent in his work.
3) He has not overlooked materials that should
have raised suspicion.
4) The loss has not actually arisen on account ofhis negligence.
5) He has verified the accuracy of statements in a
detailed manner, apart from just checking arithmetic
accuracy.
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