AUDITING · Chapter 4 Vouching 38-58 4.0 Introduction 4.1 Important points to be considered while Vouching 4.2 Vouching of Cash Transaction 4.3 Vouching of payment side 4.4 Trading

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AUDITINGAND

CORPORATE GOVERNANCE

Dr. Biswa Mohana Jena M.Com., M.Phil., Ph.D., UGC-NET

Head, Department of Commerce & Economics,Netaji Subhas Chandra Bose

(Govt. Lead) College,Sambhalpur, Odisha.

[As per New CBCS Syllabus, w.e.f. 2018-19]

Dr. Braja Kishore Das M.Com., M.Phil., Ph.D.

Senior Faculty in Commerce,Nimapara Autonomous College,

Nimapara, Odisha.

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PREFACE

Audits are first and foremost intended to give comfort to shareholders or

investors on the integrity and quality of a company’s financial statements. However,

in principle, auditors also work hand in hand with regulators to provide prudential

oversight over the financial markets. This alignment of interests requires a far broader

perspective from the accountancy profession than it did 20 years ago. External auditing

has evolved from a routine checking of the books of account to a vital part of the

governance process of companies. Factors such as the volume of transactions,

information technology, globalization and the constant increase in the complexity and

number of laws, regulations and standards governing entities and their auditors have

all impacted drastically on the evolving role of the registered auditing profession. The

corporate collapses, business failures and fraudulent financial reporting scandals of

the late 1990s and early 2000s led to a very turbulent time and resulted in a credibility

crisis for the auditing profession. One of the consequences of this was the demise of

Arthur Andersen and the resultant decrease in the number of big audit firms from

five to four. A further consequence was the drastic intervention by governments,

regulators and the auditing profession itself, which have given rise to various and

onerous new laws, regulations and standards that govern financial reporting and the

auditing thereof.

This book is an adventure into the world of auditing, business ethics, corporate

governance and corporate social responsibility. Only I have made humble attempt to

fill up the gap and help the students and teachers community giving them a suitable

textbook catering to their special needs. The subject matter of the textbook has been

presented in a logical order. The language is simple, lucid, convincing and easy to

understand. I wish to express my gratitude to Mr Bijay Ojha, Himalaya Publishing

House Pvt. Ltd. for his cooperation and making resources available to complete this

book. Constructive suggestions for the improvements in the quality and utility of the

book from teachers, students and other readers will be greatly appreciated.

Dr. Biswa Mohana JenaDr. Braja Kishore Das

UNIT – I AUDITING

Chapter 1 Concept of Auditing 1-121.0 Evolution of Auditing 1.1 Definition of Audit 1.2 Advantages of Auditing1.3 Audit Planning 1.4 Objectives of Auditing 1.4.1 Primary objects1.4.2 Secondary objects 1.5 Review Questions

Chapter 2 Types of Auditing 13-272.0 Types or Classification of Auditing 2.1 Classification on the basisof the Organization 2.2 Classification based on the method ofperformance 2.3 Basic principles of Auditing 2.4 Techniques of Auditing2.5 Review Questions

Chapter 3 Internal Control, Internal Check and Internal Audit 28-373.0 Introduction 3.1 Features of Internal Control System3.1.1 Objectives of Internal Control System 3.1.2 Advantages of InternalControl System 3.1.3 Disadvantages of Internal Control System3.2 Internal Check 3.3 Fundamental Principles of Internal Check3.4 Advantages of Internal Check 3.5 Distinction between InternalCheck and Internal Control 3.6 Internal Audit 3.7 Need for InternalAudit 3.8 Scope or function of Internal Auditing 3.9 Review Questions

Chapter 4 Vouching 38-584.0 Introduction 4.1 Important points to be considered while Vouching4.2 Vouching of Cash Transaction 4.3 Vouching of payment side4.4 Trading Transaction 4.5 Vouching of Purchase and Sales Book4.6 Vouching of Impersonal Transactions 4.7 Outstanding Liabilities4.8 Contingent Liabilities 4.9 Contingent Assets 4.10 Review Question

Chapter 5 Verification of Assets and Liabilities 59-865.0 Introduction 5.1 Valuation and Verification of Fixed Assets 5.2 Auditof Fixed Assets 5.3 Valuation and Verification of Intangible Assets5.4 Valuation and Verification of Current Assets, Loans and Advances5.5 Liabilities 5.6 Verification and Valuation of Liabilities 5.7 Verificationof Financial Statements 5.8 Scrutiny of Income Accounts 5.9 ServiceOrganization 5.10 Capital Profit 5.11 Scrutiny of Assets Account5.12 Scrutiny of Liability Accounts 5.13 Analytical Methods 5.14 BalanceSheet 5.15 Verification of Profit and Loss Account 5.16 Review Questions

UNIT – II AUDIT OF LIMITED COMPANIES

Chapter 6 Company Accounts 87-1036.0 Introduction 6.1 Qualif ication 6.2 Disqualif ication6.3 Appointment and Removal of Auditors 6.4 Ceiling on number ofAudit 6.5 Remuneration of Auditor 6.6 Powers of a Company Auditor6.7 Rights of a Company Auditor 6.8 Duties of Auditor 6.9 ReviewQuestions

7.0 Introduction 7.1 What is an auditor’s report? 7.2 Reliance on theinformation furnished or obtained by the Auditor 7.3 Maintenance ofbooks and records 7.4 Role of a Company Auditor with respect tobranches 7.5 Duties while conducting the audit 7.6 Applicability ofSection 143 7.7 Caro 2016 7.8 Review Questions

CONTENTS

Chapter 7 Audit Reports 104-120

UNIT – III SPECIAL AREAS OF AUDITING

Chapter 9 Special Areas of Auditing 131-1659.0 Introduction 9.1 Audit of Clubs 9.2 Audit of Cinema Halls 9.3 Auditof the Charitable Societies 9.4 Audit of Cooperative Societies 9.5 Auditof Hotels 9.6 Audit of Educational Institutions 9.7 Audit of Hospitals9.8 Audit of Nursing Homes 9.9 Introduction on Cost Audit9.10 Importance of Management Audit 9.11 Concept of Social Audit9.12 Definition of Tax Audit 9.13 Environmental Audit 9.14 Trends andIdeas in Accounting and Auditing 9.15 Review Auestions

Chapter 10 Auditing using Computer Tool 166-17510.0 Introduction 10.1 Auditing around the Computer10.2 Auditing with the Computer 10.3 Auditing through the Computer10.4 Characteristics of Auditing through the Computer 10.5 InternalControls in an Auditing through the Environment 10.6 Classification ofControl Procedure 10.7 Computer Assisted Audit Techniques10.8 Review Questions

Chapter 11 Auditing Standards 176-21511.0 Glimpses of Standards 11.1 Auditing and Assurance Standards11.2 New Auditing Standards 11.3 Accounting Standards11.4 Standards on Auditing

12.0 Introduction 12.1 Meaning 12.2 Definition 12.3 Why CorporateGovernance? 12.4 Need for Corporate Governance 12.5 Features ofCorporate Governance 12.6 Objectives of Corporate Governance12.7 Importance of Corporate Governance 12.8 Factors influencingquality of Corporate Governance 12.9 Elements of CorporateGovernance 12.10 Mechanism of Corporate Governance 12.11 Principlesof good Corporate Governance 12.12 Role of SEBI in CorporateGovernance 12.13 Secretarial Standards 12.14 Good CorporateGovernance companies in India 12.15 Models of Corporate Governance12.16 Theories of Corporate Governance 12.17 Review Questions

Chapter 13 Reforms, Committee and Scandals 230-24313.0 Corporate Governance Reforms in India 13.1 Types of CommitteeReports on Corporate Governance 13.2 Whistle Blower Policy13.3 Indian Experiences 13.4 Composition of Committee of CorporateGovernance 13.5 Codes and Standards on Corporate Governance13.6 Corporate Scandals 13.7 List of Scandals without Insolvency13.8 Corporate Governance Failure at Enron 13.9 Corporate GovernanceFailure at WAL-MART 13.10 Corporate Governance Failure at SATYAM13.11 Corporate Governance Failure at CADBURY 13.12 Major Scandalsin India/abroad 13.13 Review Questions

Chapter 8 Liabilities of Company Auditor 121-1308.0 Introduction 8.1 Professional Negligence 8.2 Civil Liabilities8.3 Liability under Consumer Protection Act 8.4 Liability for UnauditedStatement 8.5 Liability for negligence of Assistants 8.6 Criminal Liability8.7 Liabilities under Income Act. 1961 8.8 Punitive provisions relatingto Statutory 8.9 Review Questions

UNIT – IV CORPORATE GOVERNANCE

Chapter 12 Corporate Governance: Concept, Theory and Models 216-229

UNIT – V Coporate Social Responsibility

Chapter 14 Concept of Corporate Social Responsibility 244-26214.0 Introduction 14.1 Relationship of CSR with Corporate Sustainability14.2 Components of Strategic Planning and CSR 14.3 CorporateGovernance vs. Corporate Social Responsibility 14.4 CSR and BusinessEthics 14.5 Corporate Philanthropy 14.6 Companies doing CorporatePhilanthropy 14.7 Types of Corporate Philanthropy 14.8 Companieshaving highest Corporate Social Responsibility 14.9 Environmentalaspects of Corporate Social Responsibility 14.10 Review Questions

Chapter 15 Provisions, Models and Standards 263-27715.0 Introduction 15.1 The Pyramid of CSR 15.2 Theoretical Assumptions15.3 Scope of Responsibilities 15.4 Total CSR 15.5 Order of Importance15.6 The role of Philanthropy 15.7 The Intersecting Circle Model ofCSR 15.8 The Concentric Circle Model of CSR 15.9 Provision of CSRRules under Companies act, 2013 15.10 Strategic Corporate SocialResponsibility 15.11 International Standard for CSR 15.12 ISO 26000– Social Responsibility 15.13 ISO 26000:2010 15.14 Corporate Codes15.15 Committees on Corporate Social Responsibility 15.16 ReviewQuestions

Multiple Choice Questions 278-284Interview Questions and Answers 285-291Big 4 Accounting Firms 292Test Your Knowledge 293-295

Concept of Auditing 1

LEARNING OUTCOME

Going through the chapter carefully, we could

••••• Understand the origin and concept of audit planning

••••• Be aware with the different objectives of auditing

CHAPTER OVERVIEWEVOLUTION-DEFINITION-ADVANATGES OF AUDITING –

AUDIT PLANNING – OBJECTIVES OF AUDITING

1.0 EVOLUTION OF AUDITING

Historically the word “Auditing” has been derived from the Latin word “Audire” whichmeans “to hear”. Such an expression conveys the steps of evolution of auditing in ancient days.However, in the post-ancient period auditing has explored dramatic changes. According to Dixie,traditional auditing can be understood as an examination of accounting records undertaken with aview to establishing whether they completely reflect the transaction correctly for the relatedpurpose but this is not the end of the story. In addition to it, the auditor also expresses his opinionon the financial character of the statements of accounts prepared from the accounting records soas to examine whether they portray true and fair view of financial statements. The term audit isused in this sense ever since the days when public accounts were accepted and approved on thebasis of leaving the accounts read. It was Luco pacilo who introduced double entry book keeping.He defined and described the duties and responsibilities of an auditor. Since then, there have been

CONCEPT OF AUDITING

Chapter 1

Unit - I AUDITING

2 Auditing and Corporate Governance

far reaching changes in the scope and definition of audit. Further, the industrial revolution inEngland compelled the necessity of auditing. When first companies act of 1913 came in to force,made it obligatory on the part of every company registered under it, to have the accounts auditedat least in every year.

1.1 DEFINITION OF AUDITConcept of Auditing dates back to ancient Egyptian, Roman and Greek Civilizations, where

commercial transactions were systematically checked and counter checked by financialadministrators. In India, Pre-Vedic literature makes references to the existence of well developedsystem of accountancy. In ancient times, auditing was coupled with the levy of tax. Whenever taxeswere levied on commercial transactions, auditing became inevitable. When a person was appointedto administer finance, the amount received and payments made by him were checked by anotherofficial either periodically or at the time of expiry of his term of office. The objective, technique andapproach of today’s audit are entirely different from that of the past. One can say that the change inthe technology, expansion of business organization, diversification of activities have influenced andaltered the auditing scope and techniques. Present day Auditing has come a long way fromtraditional auditing Traditional auditing involved vouching of all transactions, verification ofposting to ledgers, detailed verification of documents, subsidiary books and the principal books ofentries. This was possible because the business entities were small, the transactions were not many,the activities were localized and traditional method of book keeping was followed.

In the contemporary world, businesses organizations have expanded and diversified theiractivities .The transactions have become numerous. The fast developing communication technologyhas shrunk the earth into a global village. Transactions are made through internet across the world.Rates are fixed over telephone. Receipts and payments are made on line. Use of paper work has beenreduced greatly .in these circumstances, it is impossible to apply the traditional methods of auditing.

Auditing is concerned with the verification of accounting data, with determining theaccuracy and reliability of accounting statements and reports. - R.R. Moutz

Auditing is an intelligent and a critical scrutiny of the books of accounts of a business withthe documents and vouchers from which they are written up, for the purpose of ascertainingwhether the working results for a particular period, as shown by the profit and loss account, as alsothe exact financial condition of the business, as reflected in the balance sheet are truly determinedand presented by those responsible for their compilation. - J.R.Batiboi

An audit is an exploratory, critical review by a public accountant of the underlying internalcontrols and accounting records of a business enterprise or other economic unit, precedent to the

expression by him of an opinion of the propriety of its financial statements. - Eric L. Kohler

According to the INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA, generalguidelines in internal auditing defines auditing as the independent examination of financial informationof any entity, whether profit oriented or not, and irrespective of its size or legal form, when suchexamination is conducted with a view to expressing an opinion thereon “In brief, auditing involvestesting the reliability, competency and adequacy of evidence in support of monetary transactions. Ithas its principal roots in accounting with it reviews, on which it leans heavily for idea and methods.


S.K. Satapathy & B.M.Jena – “ Auditing signifies the spiraling functions of auditors who certifythe true and fair view of financial statements by delving through the process of checking,vouching and verification with its operational efficiency, economy and effectiveness.

According to B.M.Jena, Auditing means “SEE IT , HEAR IT AND DO IT”

As per AAS-1, “An audit is the independent examination of financial information of an entitywhether profit oriented or not and irrespective of size or legal form when such examination isconducted with a view to expressing opinion thereon”.

Auditing is a systematic process of objectively obtaining and evaluating evidence regardingassertions about economic actions and events to ascertain the degree of correspondence betweenthose assertions and established criteria and communicating the results to interested users. Auditingis the analysis of the financial accounts/records, by a qualified accountant, and procedures of a firmor organization.

1.2. ADVANTAGES OF AUDITING

Ü Audited accounts are of great help to the partnership at the time of admission or deathof partner

Ü It assesses the adequacy of the accounting system in order to ascertain itseffectiveness in maintaining accounting records of an organization.

Ü It is helpful to government to verify before granting assistance or issues a license for aparticular trade.

Ü Audited accounts are more reliable as evidence in the court of lawÜ It act as a basis for negotiating higher wages or bonus for the employeesÜ It serves as a check on the integrity of person at the helm of affairs.Ü It is useful for settling trade disputes with workers and settling disputes by arbitration.Ü It serves as a basis for determining amount receivable or payable in certain situation.Ü It serves as a basis for obtaining loans from banks and financial institutions, for

preparation of tax returns and various similar purposes.Ü It serves as a basis for establishment and improvement in the control system.Ü It acts as a moral check on the employees from committing defalcations or

embezzlement.Ü It safeguards the financial interest of persons who are not associated with the

management of the entity, whether they are partners or shareholders.Ü An audit can also help in the detection of wastages and losses to show the different

ways by which these might be checked.Ü Audited statements are necessary to fulfill certain legal obligations. For example for

raising capital in primary markets, for fulfilling listing requirements on stock exchangesetc.

Ü The future trend of the business can be assessed with certainty from the audited booksof account.


Ü The audited account serves as a basis to determine action in bankruptcy andinsolvency cases.

Ü Comparison can be made between the accounts of the current year and other years.Ü Audited accounts are helpful in claiming reasonable compensation from the insurance

company in respect of loss by fire or burglary etc.Ü Errors and frauds are detected and rectified.Ü Audited accounts are more reliably accepted as a correct and authentic record of the

transaction

1.3 AUDIT PLANNING

Ü Audit planning is one of the basic principles governing an audit.Ü Auditor should plan his work to enable him to conduct an audit in an effective, efficient

and timely manner.Ü Planning should be based on knowledge of the organization.Ü Whatever may be the type of audit? The auditor should know what preparatory steps

are to be taken before the commencement of the work of audit.However the different steps to be taken before the commencement of a new audit are

discussed below:Ü Receiving the appointment letter or letter of engagement to verify the objectives, scope

and coverage of the audit.Ü Enquiring into the reasons for not appointing the previous auditor.Ü Acceptance of appointment.Ü Nature and scope of the work of audit, e.g I case of a statutory audit, the audit must

be conducted as per the provisions of the statute concerned. In case of tax audit itmust be according to the tax act and for others audits the auditor must know exactscope, coverage and objective of his audit.

Ü Nature and characteristics of the organizations under audit.Ü Verification of important documents like constitutional document(e.g memorandum and

articles in case of a company, partnership deed in case of a partnership firm etc.Ü Complete list of the books of account and registers maintained by the company.Ü Concepts of methods of maintaining accounts.Ü A list of containing the names and signatures of the key personnel.Ü Understanding the nature and extent of the internal control / internal check system

working in the organization.Ü Framing of audit program.


1.4 OBJECTIVE OF AUDITING

The main object of auditing is to verify the accounts and to report whether the BalanceSheet and Profit and Loss account have been prepared as per the Companies Act and whether theyshow true and fair view of the state of affairs of the concern. Besides, there are certain subsidiaryobjects also to conduct an audit. They are as follows:

(A) Detection and prevention of errors.(B) Detection and Prevention of Frauds.

The various objects of an audit as shown in fig. 1.4 are detailed below.

1.4.1 Primary Objects There are two objectives, which are considered as chief objective of auditing. They are as below-

Objectives of Audit

Primary Objectives

Confirmity with Law

True and Fair view of state o f affairs

of business

Detection and Prevention of

Fraud

Clerical Errors

Errors of Duplication

Secondary Objectives

Detection and Prevention of

Errors

Embezzlement o f

Cash

Misappropriation of

goods

Manipulation of

Accounts Error of principle

Compensating errors

Errors of Ommission

Error of Commission

Complete Ommission

Partial Ommission

1.4.1 PRIMARY OBJECTSThere are two objectives, which are considered as chief objective of auditing. They are as

below-

(A) To see whether the Financial Statements are Prepared in Conformity with law-Ü Business concerns prepare Balance Sheet to portray their financial position.Ü They also prepare Profit and Loss account to disclose the operating results of the

period covered in the statement.Ü These statements are submitted to the Auditor for checking and comment.Ü He checks the accounts with utmost diligence and care and also with professional

competence.Ü He verifies the accounts to whether they are prepared as per the recognized accounting

policies and practices, and also in conformity with the relevant statue.


(B) To see whether the Financial Statements Reveal the True and Fair view of theState of Affairs of the Business ConcernÜ Auditor checks the financial statements submitted to him as to whether the facts given

in Balance Sheet and Profit & Loss account are true.Ü Based on the checking the forms and independent judgment and opinion about the

reliability of the accounting records and true and fair view of financial state of affairsand working results.

1.4.2 SECONDARY OBJECTSThe secondary objectives as depicted in Fig. 1.4 are detailed here under.

(A) Detection and Prevention of errors

Generally, errors arise out of the innocence or carelessness on the part of those responsiblefor the preparation of Accounts. Sometimes, errors may be the outcome of fraudulent manipulationof accounts. Therefore, the auditor must pay particular attention, to every error. The following arethe various types of errors:

(a) Clerical Errors

Clerical errors are those that are committed in posting, totaling and balancing. Such errorsmay again be subdivided into two namely.

(i) Errors of Omission-Ü The errors of omission arise when a wholly or partly omitted from being properly

recorded in the books.Ü Usually, it arises due to the mistake of clerks.Ü When a transaction is totally omitted from the books, it is completed “Complete

Omission”.Ü It will not affect trial balance and hence becomes more difficult to detect. This type of

errors can be detected by careful scrutiny.Ü Omission of entering purchases and sales entirely resulting in complete omission of the

both aspects of an entry, omitting the entry for charging depreciation in the books, rentoutstanding for the 12th month has not been recorded in the books, etc. can be cited asexamples here.

Ü Due to mistake, carelessness or oversight clerks may omit to enter these transactionstotally. They are unintentionally made. Hence can be detected only by careful checkingand verification.

Ü On the other hand, when a transaction is practically recorded, it is called “Partialomission”. Such kind of errors may affect Trial balance. They can be easily detectedbecause of the disagreement of the trial balance

Ü Omission of cash receipts/ Cash payments to be posted to the ledger from the cashbook, entry from sale omitted from the account of the customer, total of sales daybook omitted to be posted to sales account, etc. can be cited as examples here.


Ü In all these cases, as only one aspect has been omitted it will affect the Trial and theomission will easily be detectable.Some of the errors omission is easily detectable.

For example, if the number of rent or salary entries for a year is less than 12, the auditor caneasily locate the omission. The errors of omission whether intentional or otherwise, will affect theprofit or loss of the year.

(ii) Errors of Commission-Ü Sometimes, entries are made in the books of original entry or ledger incorrectly either

partially or wholly, such errors are called error of commission.Ü Usually these errors arise due to negligence in recording of transactions in the books of

accounts.Ü Such errors may or may not affect the Trial Balance, Profit & Loss account and

Balance Sheet.Ü They may be intentional or otherwise. Following are the errors examples of errors of commission:Ü A sale of ` 500 is entered in the sales book as ` 50 (i.e. Incorrect Recording). It does

not affect the Trial Balance.Ü Sale of ` 100 may be written as ` 10 to the debit of the customer’s account, thus

debiting ` 90 less than the real figure (i.e. Incorrect Posting). The effect of thiserroneous posting on the Trial Balance would be that the debit side would be short by` 90 and it would show the difference.

Ü The balance of ` 125 on the debit of an account may be carried forward to the debitcolumn of thee Trial Balance as ` 115 or ` 250, and even ` 125 may be written to thecredit column of the Trial Balance, thus entering the correct figure against this accountbut in the column (i.e. Errors in Carrying Forward Totals to Trial Balance).

(b) Errors of PrincipleÜ Errors of principle arise when the entries are recorded against the fundamental

principles of accountancy.Ü Wrong allocation of expenditure between capital and revenue, valuation of assets

against the principles of Book-keeping, providing inadequate depreciation, wrongprovision for doubtful debts, ignoring the outstanding assets and liabilities, posting thetransactions to wrong class of accounts, etc. can be cited as examples for errors ofprinciple.

Ü Such errors can be committed either intentionally or unintentionally.Ü If they are committed intentionally, the object here is to manipulate the accounts with

an ultimate purpose either inflating or deflating the profits.Ü As they affect the Profit & Loss account and Balance Sheet, the auditor must pay

particular attention towards this kind of error.Ü They are not disclosed by Trial balance or by Routine Checking.


Ü In order to detect them, auditor has to carry out independent searching and exhaustivescrutiny, as these are very serious mistake affecting business to a great extent.

(c) Compensating ErrorsÜ Compensating errors are also known as offsetting errors.Ü An error compensated or counter balanced by another error is called as Compensating

errors.Ü In case of compensating errors, the adverse effect of one on debit side or credit side is

neutralized by that of another on credit or debit side. Following are the examples ofsuch errors:

Ü A’s account is debited with 100 shorts and credit side of his account is under cast by‘ 100.

Ü Sales ledger is under cast by ‘ 1000 and purchase ledger also under cast by ‘ 1000.Ü Compensating errors will not affect the Trial Balance and as such, will not be detected

easily. These errors may or may not affect the Profit & Loss account. These errorscan be detected by checking the totals, posting and casting.Ü A thorough and exhaustive preparation on the part of the auditor will help todetect such errors.

(d) Errors of DuplicationÜ Errors of duplication arise when an entry in a book of original entry has been made

twice and has also been posted twice.Ü These errors so not affect the agreement of Trial Balance, hence can’t be located

easily.Ü For example, invoice sent in duplicate entered twice in the books and posted twice in

the Ledger.Ü Only thorough checking and comparing vouchers with entries in the books of original

entry will reveal such errors.

(B) Detection and Prevention of FraudsÜ Various terms like fraud, embezzlement, and defalcation misappropriations are often

used in a confused way. Hence it is desirable to understand the exact meaning of cacheterm.

Ü Fraud may be referred to intentional misrepresentation of financial information by oneor more individuals among management, employees, or third parties.It may involve-

Ü Manipulation, falsification, or alteration of records of documents.Ü Misappropriation of assets.Ü Suppression or omission of effect of transactions from records or documents.Ü Recording of transactions without substance.Ü Misapplication of accounting policies.


Errors are unintentional mistakes where as frauds are intentional mistakes. The term definedby Kohler in the “Dictionary for Accountants” complied by him. Other authors also define theterm fraud. We shall now see some of the definitions for the term fraud.

Detection of fraud is one of the important duties of an auditor. Infect auditing is conductedwith a view to detect fraud wherever it is suspected. Frauds may be divided in three categories asbelow:

(a) Embezzlement or misappropriation of Cash.(b) Misappropriation of goods(c) Fraudulent and manipulation of Accounts

(a) Embezzlement / Misappropriation of CashÜ Cash is misappropriated by theft or cash receipts, petty cash, cheques and other

negotiable instruments and showing fictitious payments to workers, creditors,purchasers etc.

Ü Misappropriation of cash is easy affair.Ü A person with a little effort can misappropriate cash.Ü There is a greater possibility of embezzlement of cash in big business houses where

there is not much direct contact between the owners of the business and the personhandling the cash.

Ü Particularly when a person is not subject to any form of check, such person will havenumber of opportunities to commit fraud.

Ü However, in case of small business concerns, the possibility of frauds remainingundetected is remote because of close and direct contact between the owner and theperson handling the cash.

Ü Hence in big business concerns, strict control should be exercised over the receipt andpayment of cash so that the work of one clerk is automatically checked by anotherclerk. Such a system is known as “Internal Check system”. It shall be dealt elaboratelyin a subsequent chapter.

Following are the some of the examples of misappropriation of cashÜ Omitting to enter cash, which has actually been received?Ü Entering fewer amounts than what has been actually received.Ü Omitting to record sales and taking the money received from customers for such sales.Ü Concealing money received from first customer and entering in his account when the

cash received from second one and so on. This is popularly known as teeming andlading.

Ü Making fictitious entries for the items like discounts, returns, bad debts, etc., in theaccounts of customers.

Ü Recording fictitious purchases and misappropriating the cash involved.Ü Suppressing credit notes received from creditors for purchase returns and discount.


Ü Misappropriating money recorded as wages in the wages sheet by entering dummynames of worker therein.

(b) Misappropriation of GoodsÜ Sometimes, an employee may take away the goods of the company for his personal

use. It is known as misappropriation of goods.Ü Goods are generally misappropriated by actual theft of valuable goods and issuing of

fictitious credit notes to customers.Ü Misappropriation of goods is very difficult to detect when the goods are less bulky and

are of higher value.Ü Only the efficient system of record keeping, periodical checking, internal check, and

adequate security arrangements will be helpful to avoid misappropriation of goods.Ü Hence the auditor has to check thoroughly the inward and outward register, invoice,

sales memo, audit notes, etc to detect this kind of fraud.

(c) Fraudulent Manipulation of AccountsÜ Generally, upper level management commits this type of fraud in order to mislead

certain parties both internal and external to the organization.Ü Such frauds normally involve large amounts.Ü They are committed intentionally .So they are difficult to be detected.Ü There are two types of motives behind such manipulations

They are as follows:(i) INFLATING THE PROFITS: If profit is inflated, it benefits the company,

higher official etc, in the following ways:Ü The manager may get more commission if it is calculated on the basis of profits earnedÜ To sell the shares he holds in the company at a high price by declaring higher dividend.Ü The confidence of shareholders is maintained on the manager.Ü To declare higher rate of dividend.Ü The financial position of the business is shown better than what actually it is.Ü To show credit worthiness to creditors, bankers etc

(ii) DEFLATING THE PROFIT: showing less profit benefits the company as wellas the executives in the following ways:

Ü To give a wrong impression about success of the business to competitors.Ü To reduce / avoid payment of income tax.Ü To purchase shares at a lower price in the market.Usually, the following devices are resorted to for falsification of accounts.Ü Inflating or suppressing expenses or purchases.Ü Inflating or suppressing sales or other incomesÜ Over or under valuation of stocks.


Ü Under or over valuation of assets and liabilities.Ü Providing less depreciation or more depreciation or not providing for any depreciation.

1.5 REVIEW QUESTIONS

Short questions:1. Define auditing?2. Define Errors of commission and omission with examples?

3. State the characteristics of fraud?4. State the circumstances where misappropriation of cash takes place?

5. What are the objectives of an independent audit? (Madurai b.com)6. “Auditor is a watchdog and not a bloodhound”-Explain?

7. (a) Can a fraud is committed through an accounting procedure?(b) Is auditing a guarantee that there is no undisclosed fraud?

(c) What are commonly used measures for prevention of frauds?8. State the objectives of auditing (Utkal University, B.com.Pass.2009)9. Distinguish between fraud and eroor (GM University, B.Com 2018)Long Questions:1. Define auditing. Discuss its scope and nature or features.2. “Accounting is a necessity while auditing is a luxury for a business enterprise”. Do you agree? Give

reasons for your opinion and examine critically the role of auditing in the efficient , honest adeconomical conduct of a business ? (University of Jodhpur, B.Com. 1998), Govt. (A) College,Bhavani Patna B.Com (H), 2018

3. (a) Describe briefly the main classes of errors and frauds . Is the auditor expected to detect all errorsand frauds? (Delhi University, B.com hons. 2000), (B.com pass 2003) (Bombay University, B.com,2003)(b) Can the auditor prevent such errors and frauds?

or“Detection and prevention of errors are the main objects of auditing.” Discuss it fully and explain theduties of an auditor in this regard.

4. Auditing is a dynamic social science- comment.5. ”Fraud doesn’t necessarily mean misappropriation of cash or goods.” Discuss giving illustrations.

6. Define an audit and state the various objects of an audit ? (Osmania , Cal, Gauhati B.com)7. “Teeming and landing is a process of misappropriating cash”- Explain the statement with example.

8. “Auditing can be termed as accounting control.” Explain the statment.9. “Accounting begins where book-keeping ends and where accounting ends auditing begins”.

Discuss. ( Lucknow B.com), (Ravenshaw University, B.Com(H) 2017)10. Evaluate the following statements :

a) Every business entity should have an annual audit by a qualified auditor. To forgo an auditbecause of its cost is false economy.(Delhi University, B.com.Hons, 2004)


b) Although auditing and accounting are related , they are distinct from each other.(Delhi university,B.com. hons., 2004)

11. Define auditing? State the objectives of auditing and point out the limitation of auditing ?(RavenshawUniversity ,B.com.Hons.2016)

12. Distinguish betweena) Accounting and auditing (Ravenshaw University, B.Com Hons. 2017)b) Auditing and investigation (Ravenshaw University, B.Com.Hons. 2016)

13. Discuss about the Evolution, growth and development of audit and how is it associated withaccounting? Comment on limitations of this.(Ravenshaw University, B.com. Hons.2015)

14. State the meaning of auditing and discuss its advantages and limitations? (Ravenshaw University,B.com.Hons.2014)

15. What is importance of auditing and what are the major forces responsible for increasing scope ofaudit today? Outline the principles of governing an audit ? (Sambalpur University, B.Com. Hons.2018)

16. Define auditing? Discuss its objectives. (Utkal University, B.com.Pass.2018)(Ravenshaw University,B.Com Hons. 2019)

17. Describe briefly the main classes of errors and frauds. Is the auditor expected to detect all errors andfrauds? (Delhi University, B.com hons. 2000), (B.com pass 2003) (Bombay University, B.com,2003)

18. Define an audit and state the various objects of an audit? (Osmania, Cal, Gauhati B.com) (GMUniversity, 2018)

19. Write Brief Notes Ona) Accountancy vs Auditing (Utkal University ,B.com.Pass.2010)

20. Define auditing and discuss its objectives. What are the limitations of the auditing process?(Utkal University, B.com.Pass.2005)

21. What are the objectives of auditing? Explain the necessity , advanatgaes and disadvantages ofauditing? (Utkal University ,B.com.Pass.2007)

22. What do you mean by auditing? Discuss the advantages and diadvantages of auditing to apartnership firm? Utkal University ,B.com.Pass.2006) (Utkal University, B.com.Pass.2006) (Govt.(A) College, Bhawani, Patna, B.Com (H) 2018)

23. What is audit? And how is it distinguished from investigation? Who can be an auditor and what arethe qualities and qualifications required to be an auditor? (Sambalpur University, B.com.Pass.2018)

24. What do you understand by auditing ? Discuss the advantages and limitations of auditing?(N.C(Auto) College, Jajpur, B.Com, 2014)

25. An audit is not a complete safeguard and insurance against all financial ills? Comment (U.A. College,Adaspur, Cuttak, B.Com. Pass 2017)

26. Who is an auditor ? How does an auditor commence audit work? What are the documents requiredfor audit work? (Angul (A) College, B.Com Hons. 2018)

27. Wha tis an audit? Discuss the principle objects and basic principles of auditing. (RavenshawUniversity, B.Com (H) 2018)

28. State the essential features of statutory audit? (Ravenshaw University, B.Com(H), 2017)29. The concept of audit is not free from any limitation. Comment (Ravenshwaa University, B.Com(H),

2017).

Documents

AUDITING · Chapter 4 Vouching 38-58 4.0 Introduction 4.1 Important points to be considered while Vouching 4.2 Vouching of Cash Transaction 4.3 Vouching of payment side 4.4 Trading