Auditing Basics

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Module -

1

IntroductionTo

Audit


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SyllabusOrigin of audit, meaning, definition, purpose and functions of

audit, factors responsible for the growth of auditing, advantages

and limitations of audit. Difference between book keeping,

accountancy and audit, Objects of Audit Main object &

Secondary objectives, Errors , Location of errors, Position of

Auditors in relation to errors & frauds, different types of audit

and their relative advantages, statutory audit - partial audit -

cash audit - interim audit, balance sheet audit, cost audit and

occasions audit.


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

information used in the decision processmust be reliable.

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

unreliable informationwill be provided to decision makers. There are several

reasons for this: remoteness of information, voluminous data and the existence

of complex exchange transactions.

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

maker must develop a method of assuring him that the information is

sufficiently reliable for these decisions.

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

against the expected benefits.A common way to obtain such reliable

information is to have some type of verification (audit) performed by

independent persons.The audited information is then used in the decision

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

unbiased.


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Origin and EvolutionThe term audit is derived from theLatin word audire, which

means to hear.

In early days anauditor used to listento the accounts read

over by an accountant in order to check them.Auditing is as

old as accounting.

It was in use in all ancient countries such as Mesopotamia,

Greece, Egypt, Rome, U.K. and India.

The Vedas contain reference to accounts and auditing.

Arthasashthra by Kautilya had emphasized the importance of

accounting and auditing.


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ContiThe original objective of auditing was todetect and prevent errors

and frauds.

Auditingevolved and grew rapidly after the industrial revolution

in the 18th centurywith the growth of the joint stock companies

the ownership and management became separate.

The shareholders who were theowners needed a reportfrom an

independent expert on the accounts of the company managed by the

board of directors who were the employees.

The objective of audit shifted andaudit was expected to ascertain

whether the accounts were true and fair rather than detection

of errors and frauds.


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Historical background

It can be traced back from Ancient China, Greece and Rome.

The attitude of profit maximization from end middle ages -

merchant houses in Italy.

Double-entry bookkeeping was first described in Italy(Pacioli 1494).

Industrial Revolution Great-Britain 1780 lead to the

emergence of large industrial companies. 1853 the Societyof Accountants in Edinburgh was founded.


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The function of auditing is to lendcredibility to the financial statements Is the company a going concern?

Is it free of fraud?

Is it managed properly?

Is there integrity in itsdatabase? Do directors have proper and adequate information to make

decisions?

Are there adequate controls?

What effect do the company's products and by-products

have on the environment?

Can an unfortunate mistake bring this company to its

knees?


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In India In India, thecompanies Act 1913 made audit of company accounts compulsory

with the increase in the size of the companies and the volume of transactions.

The main objective of audit shifted to ascertaining whether the accounts were

true and fair rather than true and correct.

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

the financial efforts.

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

auditors.

The International Accounting Standards Committee and the Accounting Standard

board of the Institute of Chartered Accountants of India have developed standard

accountingand auditing practices to guide the accountants and auditors in the day to

day work.

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

auditing.

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

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


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MeaningThe word audit is derived fromLatin word audire which means to

hear.

Auditing is a critical examination of the records and books of

account of a business by an independent qualified person for

ascertaining the authenticity and the accuracy of entries

appearing in the books of account and financial statement.

Definition

Montgomery defined auditing as examination of the books and

records of a business in order to ascertain or verify and report up on

the facts regarding the financial operations and the results thereof.


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Features of Auditing1. Audit is asystematic and scientific examination of the books of accountsof a

business;

2. Audit isundertaken by an independent person or body of personswho are duly

qualified for the job.

3 Auditis a verification of the resultsshown by the profit and loss account and the state

of affairs as shown by the balance sheet.

4. Auditis a critical review of the system of accountingand internal control.

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

received from the authorities.

6. Theauditor has to satisfy himself with the authenticityof the financial statements

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

7. Theauditor has to inspect, compare, check, review, scrutinize the vouchers

supporting the transactionsand examine correspondence, minute books of share

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

establish correctness of the books of accounts.


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True and Fair ViewAn audit of accounts by an independent expert assures the outside users

that the accounts are proper and reliable. The outsiders can rely on the

accounts if the auditor reports that the accounts are true and fair. The

accounts are said to be true and Fair;

1. When the Profit or Loss shown in the Profit or Loss Account is

true and fair, and

2. Also when the value of assets and liabilities shown in the balance

sheet is true and fair.

3. Disclose all material facts.

4. Legal requirements.

5. Requirements of Institute of Chartered Accountants of India.


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Objectives of AuditingThere are two main objectives of auditing. The primary objective and the

secondary or incidental objective.

a. Primary objective as per Section 227 of the Companies Act 1956, the

primary duty (objective) of the auditor is to report to the owners whether the

balance sheet gives a true and fair view of the Companys state of affairs and the

profit and loss A/c gives a correct figure of profit of loss for the financial year.

b.Secondary objective it is also called the incidental objective as it is

incidental to the satisfaction of the main objective. The incidental objective of

auditing are:i. Detection and prevention of Frauds, and

ii. Detection and prevention of Errors.

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Auditing Basics