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Practical Auditing – Sbax 1019 SCHOOL OF MANAGEMENT STUDIES UNIT I - PRACTICAL AUDITING – SBAX 1019 1 Meaning and Definition of Auditing The word Audit is derived from Latin word “Audire” which means ‘to hear’. Auditing is the verification of financial position as disclosed by the financial statements. It is an examination of accounts to ascertain whether the financial statements give a true and fair view financial position and profit or loss of the business. Auditing is the intelligent and critical test of accuracy, adequacy and dependability of accounting data and accounting statements. Different authors have defined auditing differently, some of the definition are: “Auditing is an examination of accounting records undertaken with a view to establishment whether they correctly and completely reflect the transactions to which they purport to relate.”- L.R.Dicksee “Auditing is concerned with the verification of accounting data determining the accuracy and reliability of accounting statements and reports.” - R.K. Mautz “Auditing is the systematic examination of financial statements, records and related operations to determine adherence to generally accepted accounting principles, management policies and stated requirement.” - R.E.Schlosser Objectives of Auditing The objectives of auditing are changing with the advancement of business techniques. Earlier it was only to check the correctness of receipts and payments. The objectives of the auditing have been classified under two heads: 1) Main objective 2) Subsidiary objectives Main Objective: The main objective of the auditing is to find reliability of financial position and profit and loss statements. The objective is to ensure that the accounts reveal a true and fair view of the business and its transactions. The objective is to verify and establish that at a given date balance sheet presents true and fair view of financial position of the business and the profit and loss account gives the true and fair view of profit or loss for the accounting period. It is to be established that accounting statements satisfy certain degree of reliability. Thus the main objective of auditing is to form an independent judgement and opinion about the reliability of accounts and truth and fairness of financial state of affairs and working results. 2 Subsidiary objectives: The subsidiary objectives of the auditing are: 1. Detection and prevention of fraud: the one of the important subsidiary objective of auditing is the detection and prevention of fraud. Fraud refers to intentional misrepresentation of financial information. Fraud may involve: a. Manipulation, falsification or alteration of records or documents b. Misappropriation of assets. c. Suppression of effect of transactions from records or documents. d. Recording of transactions without substance. e. Misapplication of accounting policies 2. Detection and prevention of errors: is another important objective of auditing. Auditing ensures that there is no mis-statement in the financial statements. Errors can be detected through checking and vouching thoroughly books of accounts, ledger accounts, vouchers and other relevant information. Importance of Auditing Importance of auditing can be judged from the fact that even those organizations which are not covered by companies Act get their financial statements audited. It has become a necessity for every commercial and even non- commercial organization. The importance of auditing can be summed in following points: a. Audited accounts help a sole trader in knowing the value of the business for the purpose of sale. b. Dispute over correctness of profits can be avoided. c. Shareholders, who do not know about day-to-day administration of the company , can judge the performance of management from audited accounts. d. It helps management in detecting and preventing errors and frauds. e. Management gets advice on financial affairs from the auditors. f. Long and short term creditors depend on audited financial statements while taking decision to grant credit to business houses. g. Taxation authorities depend on audited statements in assessing the income tax, sales tax and wealth tax liability of the business. h. Audited accounts are useful for the government while granting subsidies etc. i. It can be used by insurance companies to settle the claims arising on account of loss by fire. j. Audited accounts serve as a basis for calculating purchase consideration in case of amalgamation and absorption. k. It safe guards the interests of the workers because audited accounts are useful for settling trade disputes for higher wages or bonus. 3 Comparison Table Between Accounting and Auditing Parameter of Accounting Auditing Comparison Accounting is the process by which day-to-day Auditing is the process of a comprehensive monetary records of the organizations are evaluation of the financial statements or Definition maintained and are further utilized to prepare records prepared under the accounting the financial statements. These financial process. The main purpose is to verify the statements give a true picture of business health. reliability of the financial statements. Accounting takes the input from the books of Auditing starts when accounting work is account or bookkeeping i.e. daily transactions completed. The financial statements prepared Initiation that involve sale or purchase of something and by the accounts function are verified to check then utilize them to prepare financial statements the accuracy, completeness, and of the organization. trustworthiness. Mode of Daily i.e. continuous process Periodic i.e. quarterly or yearly Operation Current: The scope of work involves the Past: The scope of work involves validating Scope creation of current year financial statements. the past financial statements. The main objective of Accounting is to assess The main objective of Auditing is to verify the whether a company has earned profits or correctness of the organization’s account and Objective suffered losses, thus establish the current financial statements, thus certain or certify financial position of the organizations for that that they exhibit the true view. particular period. Very detailed as every financial transaction Level of Detail Sample-based need to be captured Financial statements e.g. Income Statement or Key statement of Profit & Loss, Balance Sheet, Cash Audit Reports Deliverables Flow Statement, etc. Carried by Bookkeepers and Accountants Qualified Auditing agency or auditors Performed By (internal employees of the organization) (external & independent to the organization) Regulated by Auditing Standards that are Regulated by Accounting Standards that are issued by Auditing Boards of the specific Regulated or issued by Accounting Boards of the specific country and also certain international Governed By country, and which need to adhere while compliance laws that need to adhere while preparing the financial statements. auditing the financial statements. Reports To management, the board of directors, and To the management of the organization Submission shareholders 4 Scope of Audit The scope of an audit is the determination of the range of the activities and the period of records that are to be subjected to an audit examination. Scope of an audit are; 1. Legal Requirements. 2. Entity Aspects. 3. Reliable Information. 4. Proper Communication. 5. Evaluation. 6. Test. 7. Comparison. 8. Judgments. 1. Legal Requirements The auditor can determine the scope of an audit of financial statements following the requirements of legislation, regulations or relevant professional bodies. The state can frame rules for determining the scope of audit work. In the same way, professional bodies can make rules to conduct the audit. 2. Entity Aspects The audit should be organized to cover all aspects of the entity as far as they are relevant to the financial statements being audited. A business entity has many areas of working. A small entity may have few functions while a large concern has many functions. The auditor has to go through all the functions of the business. The audit report should cover all functions so that the reader may know about all the workings of a concern. 3.Reliable Information The auditor should obtain reasonable assurance as to whether the information contained in the underlying accounting records and other source data is reliable and sufficient as the basis for the preparation of the financial statements. 5 The auditor can use various techniques to test the validity of data. All auditors while doing the audit work usually apply the compliance test and substance test. The auditor can show such information in the report. 4.Proper Communication The auditor should decide whether the relevant information is properly communicated in the financial statements. Accounting is an information system so facts and figures must be so presented that the reader can get information about the business entity. The auditor can mention this fact in his report. The principles of accounting can be applied to decide about the disclosure of financial information in the statements. 5.Evaluation The auditor assesses the reliability and sufficiency of the information contained in the underlying accounting records and other source data by making a study and evaluation of accounting systems and internal controls to determine the nature, extent, and timing of other auditing procedures. 6.Test The auditing assesses the reliability and sufficiency of the information contained in the underlying accounting records and other source data by carrying out
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