PRINCIPLES AND PRACTICE OF AUDITING

MODULE – 2
RISK ASSESSMENT AND INTERNAL CONTROL

Introduction;
Audit risk assessment is the process that we perform in the planning stage of the audit. As
auditors, we perform audit risk assessment by identifying the risks of
material misstatement and responding to such risks with suitable procedures. We usually
perform an audit risk assessment after obtaining an understanding of the client’s business and
control environment. In this case, we usually try to identify the risks while gaining an
understanding of the client’s business and control environment. Then, we assess how those
risks could impact financial statements and make a proper response to such risks by designing
suitable audit procedures. Risk assessment is performed in the risk-based approach of auditing;
in which we focus our audit process on those high-risk areas.

Audit risk;

The audit risk refers to a type of risk in the business in which the auditors may not issue a
correct opinion about the true financial condition of the business.

Audit risk is the risk that auditors face, when they issue an incorrect opinion on the financial
statements, leading to the possibility that the statements are materially misstated.

In this type of risk, the auditor may be unable to point out any misstatement in the financial
statement or unable to identify an important error or fraud. This will lead to inappropriate
audit opinions about the financial statement. This risk may arise due to any one or both of the
two – Clients or Auditors. This risk may be due to two reasons – mistakes/errors or a
deliberate misstatement.

Components of audit risk;

 Inherent risk; refers to the risk that could not be detected or protected by the entity’s internal
control. It is influenced by factors such as complexity, industry features and inherent
weaknesses in the accounting processes.
 Control risk; control risk is the risk that internal controls will fail to prevent or detect
material misstatements in the financial statements.
 Detection risk; detection risk is the risk that audit procedures will fail to detect material
misstatements that exist in the financial statements.

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Assessment of audit risk;
The assessment of risk involves identifying, evaluating and addressing risks that could affect
the accuracy and reliability of an organizations financial statements.

Assessing risk in auditing involves evaluating the errors or misstatement in financial statement.
It includes understanding the client’s industry, internal controls, and potential areas of
misstatements. Factors like a complexity, changes in regulations and management integrity are
considered to determine the level of risk.

Process of risk assessment;

1. Understanding the entity’s and environment.

a. Gain an understanding of the clients business, industry and operations.

b. Consider external factors that could impact the financial statements.

2. Identifying risks.

a. Identify potential risks that could lead to material misstatements.

3. Assessing inherent risks.

a. Evaluate the inherent risk for various accounts and assertions.

b. Assessing factors such as complexity, subjectivity and susceptibility of fraud.

4. Assessing control risk.

a. Evaluate the effectiveness of internal controls.
b. Consider the design and operation of controls
5. Determining detection risk.
a. Determine the level of detection risk needed to achieve the desired level of audit risk.
b. Adjust detection risk based on the assessed inherent risk and control risk.

Benefits of risk assessment in auditing;

1. Efficient resource allocation.
2. Effective audit planning
3. Enhanced audit quality
4. Informed- decision making
5. Increased credibility
6. Identify and eliminate gaps in processes and procedure
7. Maintain efficiency and productivity throughout the year
8. Identify weakness in internal control
9. Educates business owner
10. Increase stakeholder confidence
11. Strengthen the reliability and accuracy of audit opinion.

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Components of audit risk assessment;

o Identification of risk

o Risk analysis

o Risk evaluation

o Risk mitigation

o Monitoring and review

Application of risk assessment;

o Financial risk assessment

o Project risk assessment

o Health risk assessment

o Cybersecurity risk assessment

o Environmental risk assessment

Tools and methods;

▪ Risk matrices

▪ Risk registers

▪ Scenario analysis

▪ Quantitative models

▪ Expert judgment

Challenges in risk assessment;

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 Uncertainty

 Interconnected risk

 Subjectivity

 Data limitation

 Complexity

Internal control;

Internal controls are accounting and auditing processes used in a company's finance
department that ensure the integrity of financial reporting and regulatory compliance. Internal
controls help companies to comply with laws and regulations, and prevent fraud. They also
can help improve operational efficiency by ensuring that budgets are adhered to, policies are
followed, capital shortages are identified, and accurate reports are generated for leadership.
Internal control is a process for assuring achievement of an organization's objectives in
operational effectiveness and efficiency, reliable financial reporting and compliance with laws,
regulations and policies.

Internal control refers to the various methods and procedures adopted for the control of
production, distribution and the whole system (financial and nonfinancial) of the enterprise.

Internal control is a broad term which is normally used to control financial and non-financial
activities. It involves a number of checks and controls exercised in a business to ensure efficient
and economic working.

In other words, internal control system - the whole system of controls financial or otherwise,
established by the management in order to carry on the business of the enterprise in an orderly
and efficient manner- ensures adherence to management policies, safeguards the assets and
secures as far as possible the completeness and accuracy of the records.

Definition of Internal Control;

According to W.W. Bigg “Internal control is best regarded as indicating the whole system of
controls, financial and otherwise, established by the management in the conduct of a business,
including internal check, internal audit and other forms of Control".

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American Institute of Certified Public Accountants defines "Internal control comprises the plan
of organization and all the co-ordinated methods and measures adopted with in a business to
safeguard its assets. Check the accuracy and reliability of its accounting data, promote
operational efficiency and encourage adherence to prescribed managerial policies".

Basic/ Fundamental / Essential Elements of Internal Control;

A system of internal control will have the following features or characteristics.

1. Plan of organization.
2. Authorization, recording and control procedures.
3. Sound practice in performance of functions.
4. Competency of personnel.

1. Plan of organization: It should establish clear line of duties, responsibilities, segregation

of operations, and subordination of each member of the staff. Organization structure must
provide for adequate independence for various functions performed at different levels. The
division of duties should be such that activities of a department are controlled by records
maintained outside it.

2. Authorization, recording and control procedures: They should ensure that

(a) Every item of expenditure has been properly authorized and accounted for.
(b) Every item of receipt has in fact been received and accounted for.
(c) There is proper custody of the funds and assets.
(d) There is no misapplication or misuse of any property of the enterprise.

3. Sound practice in performance of functions: An effective system of internal check

should lie down that no single person should alone handle any transaction completely from
beginning to end. The system should provide that the work of one person will be checked
by another, the management shall be able to detect errors and frauds.

4. Competency of personnel: It means the competency of departmental heads, key personnel

and all persons performing routine tasks at different levels. This will require proper
selection, training, effective direction, supervision and control, quick corrective action to
avoid violation of prescribed procedures.

Duties of Auditors regarding Internal Control;

The auditor's duties regarding internal control are as follows:

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1. To assess the adequacy of the accounting system as a basis for preparing the financial
statement.

2. To identify the types of potential misstatement that could occur in the financial statement.

3. To consider the factors that affects the risks of misstatements.

4. To design appropriate audit procedure.

The auditor should rely on internal controls only after ascertaining and evaluating these
controls. If the auditor has reasons to believe that a client has set up a strong system of internal
control, the reliance on that system will help the auditor to reduce the detailed checking which
would otherwise be undertaken.

Objectives of Internal Control

1. To evaluate the efficiency of performance in the various activities of the business.

2. To ensure orderly, efficient and economic conduct of the business.

3. To see that access to and use of assets are made only with proper authorization .

4. To safe guard the assets of the organization by preventing frauds, wastes and
inefficiency.

5. To ensure that there is periodical verification and comparison of assets in existence with
those of accounting records.

6. To ensure that transactions are recorded in the proper books of accounts regularly,
correctly and systematically according to the accounting policies and procedures.

7. Timely preparation of financial statements.

8. Segregation of duties and responsibilities

9. Prevention and detection of errors and frauds.

10. Controlling internal activities.

Characteristics of internal control;

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 Competent and trustworthy
 Records, financial and other organization plan
 Segregation of duties
 Supervision
 Authorization
 Sound practice
 Internal audit

principles of Internal Control;

An effective internal control system should have the following factors:

1. Competent and trust worthy staff: People in charge of internal control system must be
reliable and highly competent about the work. Lack of knowledge and dishonesty will spoil
the efficiency of the system.

2. Records of financial and other organizational plans: A good internal control system
must have good documentation system. Filing, recording, classifying etc. will help in this
regard.

3. Segregation of duties: Normally, there should be a separate department for internal

control this reduces frauds, bias etc. Normally a clerk in charge of accounting function
should not be in charge of assets also.

4. Supervision: Proper reviewing of the operations of the company regularly makes the
control system effective.

5. Authorization: All transactions must be properly authorized. In other words, the authority
of each person should be well defined.

6. Sound practices: The Company should have well established procedures, policies,
delegations, organizational manuals etc.

7. Internal Audit: It’s a part of internal control and it should be independent of internal
check.

8. Accounting Controls: Proper accounting information systems should be established so

that the information relating to accounts is properly collected, recorded and accounts
prepared.

Scope of internal control;

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▪ Cash
▪ Control over the sales and purchase
▪ Financial control
▪ Employee’s remuneration
▪ Capital expenditure
▪ Inventory control
▪ Control over investment

Advantages of Internal Control;

The various advantages that may be derived from internal control system are summarized as
follows:

1. Identification of defects: Under internal control system, the total activities are segregated
in such a way that the work performed by one employee is automatically checked by
another employee. So, if there is any defect in the system, it is easily detected.

2. Flexibility: In this system, year-wise comparative analysis is done, so, if there is any
change in the mode of operation, the changes in the system can easily be accommodated.
Therefore, the opportunity for flexibility is available.

3. Time savings: If the internal control system is in operation in an organisation, there is no

need for the preparation of separate audit programmes for each and every audit
engagement. Thus, it saves time to a great extent.

4. Lesser risk of omission: Under this system, the total work is sub-divided into a number
of activities and each employee is assigned with a particular type of activity. So, there is
least chance of oversight or omission of any matter.

5. Revision for training facility: Due to lack of adequate experience, the auditor may face
difficulty in establishing a close relationship between audit programme and the internal
control system. This system itself provides training facilities to auditors to overcome this
difficulty.

Limitations of internal control

1. Cost: The management thinks that the cost of a control procedure must not be in excess
of potential loss due to error or frauds.

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2. Transactions: The internal control tends to be directed an anticipated types of transactions
and not at unusual transactions.

3. Possibility of error: There is possibility of human error due to carelessness, distraction,

mistake of judgment or the misunderstanding of instructions.

4. Circumstances: There may be collusion with parties outside the entity, employees of the
entity. Due to such collusion there is possibility of circumvention of control.

5. Responsibility: There is a chance that a person responsible for exercising control could
abuse that responsibility, for example, a member of management over riding a control.

6. Conditions: There is a possibility that procedure may become inadequate due to changes
in conditions and compliance with procedure may deteriorate.

Internal Check

Meaning

Internal check is an arrangement of the duties of the staff members of the accounting functions
in such a way that the work performed by a person is automatically checked by another.

Internal check is a part of the whole system of internal control and is best regarded as the
checks on the day to day transaction. It is an arrangement of routine book keeping, where the
work of one person is automatically checked by another so that errors and frauds are prevented
or discovered without delay and without any additional financial burden for the firm.

It is the arrangement of accounting duties under which the work of one person comes under
the scrutiny of another person, so that it is not possible to commit fraud without collusion/
misunderstanding between two or more persons.

Internal check is a part of the whole system of internal control system. And it is the best
regarded as the checks on the day to day transactions.

Definition
According to Spicer and Pegler "A system of internal check is an arrangement of staff duties
whereby no one person is allowed to carry through and to record every aspect of a transaction
so that, without collusion between two or more persons, fraud is prevented and at the same
time the possibilities of errors are reduced to a minimum."

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According to D. R. Davar,"Internal check is a system or method introduced with defined
instructions given to staff as to their place of work with a view to control and verification of
their work and also maintenance of accurate records as the ultimate aim.

Principles of Internal Check

1. Sufficient staff: The principle of internal check is sufficient staff. The employees can
be appointed according to the workload. The management can determine the amount
of work, which is distributed among the departments. The persons are hired to perform
their duties. The overloading can create trouble for management.
2. Division of Work: Division of work is a principle of internal check. The management
can determine the total amount of work. The whole work is divided among the
departments. The heads of such departments are responsible for completion of work
according to timetable.

3. Co-ordination: Coordination is a principle of internal check. All departmental

managers are bound to coordinate with others in order to achieve organization
objectives. When there is fault in one department, the work of other department suffers.
The objectives cannot be achieved. Internal check determines the degree of
coordination among the managers.

4. Rotation of duties: Rotation of duties is a principle of internal check. The workers feel
bore by doing the same work from year to year. There is a need of rotation of duties. It
is in the interest of concern as well as employees. The efficiency is improved due to
changes is duties.

5. Responsibility: Responsibility of each individual must be properly defined and fixed.

The work of the business should be allocated amongst various clerks in such a manner
that their duties and responsibilities are clearly and judiciously divided.

6. Automatic Machines: According to the principles, machines must be used to do

accounting work if permissible. The machines can do a lot work without delay. The
changes of fraud and error are reduced to a minimum. The working of machines
improves efficiency of accounting staff.

7. Checking: The principle of internal check is to check the work of other employees.
Many persons perform the work. The officers can put his signatures to verify the work
done by his subordinate. In this way one work passes many hands. The chances of error
and fraud are minimized due to checking and counter checking.
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8. Simplicity: The principle of internal check is that it is simple in working. The
employees can understand the working of internal check system. A person can work
under the supervision of other employees. The line of authority moves from top to
bottom level. All workers can understand their duties in the organization.

9. Documents classification: The classification of documents is the principle of internal

check. The business documents are prepared, collected, recorded and placed in proper
files. The index is prepared to compile the data. The hiring system is useful to place the
latter, in case if needed documents are traced at once.

10. Dependent work: Dependent work is a principle of internal check. The work of one
employee is dependent upon others. One work passes in the hands of two or three
persons till it is complete.

11. Harmony

12. Control errors and frauds

13. Specialization

14. Recreation leave

Objectives of Internal Check

 Fraud and error detection and prevention

 Assets protection
 Ensure accurate recording
 Fixing responsibility
 Moral check on the work of employees
 Easy to prepare final accounts
 To protect business from carelessness, inefficiency .
 Speed up audits.

Why to have internal check? / Purposes of Internal Check / Advantages of Internal Check

Advantages from business point of view:

(1) Proper allocation of work: Rational allocation of work among the different staff
members of the organisation brings precision in work.

(2) Control device: The distribution of work under this system is such that it acts as a
control device against unscrupulous employees.
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(3) Increase in efficiency and skill: A good system of internal check increases the
efficiency of work among the staff due to its proper planning for assigning the right job
to the right person.

(4) Easy preparation of final accounts: Since no individual worker is allowed to handle
a job completely and the work is divided among the employees in a proper manner, the
books of accounts can be kept up to date, as a result, the final accounts can be prepared
easily.

(5) Creation of moral check: Knowledge of subsequent checking of each employee's

work by another act as a great check to commission of errors and frauds.

From the owner's point of view:

(1) Reliability on accounts: If there is a good system of internal check, the owner of the
concern may rely upon the genuineness and accuracy of the accounts.

(2) Orientation of accounting: As the responsibility of each staff is clearly defined and
fixed, it develops a system of accounting which is known as responsibility accounting.

(3) Economical operation: Although it seems that the introduction of well integrated
system of internal check is costly in actual practice, it is observed that the staff patterns
are so arranged that the existing staff be properly filled in different operating areas
involving no extra cost.

From the auditor's point of view:

(1) Facilitation of audit work: Sound and efficient internal check system may facilitate
to a greater extent, the work of the auditor by relying on “test check”.

(2) Attention to other important matters: As the auditor gains confidence on the internal
check system, he can avoid the basic routine checking work to some extent and can
give attention to other important matters.

Other advantages are:

a) It is very easy and convenient to assign duties to staff in a precise way.

b) It is quite easy to detect and prevent errors and frauds in accounting records.

c) It acts as a scientific tool to increase the efficiency in operation by alerting the staff at
all times.

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d) Accounting records can be kept intact and it will be helping the organization to finalize
the accounts quickly.

e) By imposing moral check on the staff, it leads to economy in operation.

f) An effective internal check system eases the work of an auditor.

g) If it is operated efficiently in all parts of the concern, it automatically results in increase

of profitability and economy.

Disadvantages

Internal check suffers from certain limitations, which are listed as under:

a) It is an expensive system for a small scale concern, and hence it cannot afford in all
divisions of the organization.

b) It may develop complexity among staff particularly with the top management, which
may damage the entire organization if anything goes wrong.

c) It may create unhealthy environment in the organization, if it is not properly designed

and adopted.

d) The auditor's work may become very difficult, if the system is defective and
unorganized.

e) Collusion among employees

f) Disorder in the working of the business

g) Carelessness on the part of the owner and top level officials.

 Internal check as regards to wage payments:

The system of internal check for wages should be devised in a careful and planned way
especially in a manufacturing concern. Usually, wages are paid to the workers on the basis of
time spent by each worker in the production process. So, correct recording of time is essential
for the purpose of determining proper wages. For the purpose of efficient control over the
payment of wages, a separate wage department headed by responsible official of the
organisation should be there.

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For the purpose of recording correct time and to avoid frauds and errors, different time
recording devices are used. To implement the effective internal check system for wage
payment, it is suggested that the following system be introduced.

To minimize the fraudulent manipulations of wage records, cash and the other risks, the
following internal check system can be adopted.

Maintenance of wage records:

1. Time work recording: Workers are paid their wages normally on the basis of time. Thus
the time spent by each worker should be correctly recorded in the time record-book and for
this purpose the following methods are used.

• Time Recording Clock: At the time of entering into the factory the worker puts his
entry card in the slot of time recording clock, kept at the entry of the gate. The clock
records the date and the actual time of his entry in the factory. At the time of leaving
the factory, he has to put his card in the slot of the clock again for recording his actual
time of departure.

• Brass Metal Token: Under this system, each worker is given a brass metal token duly
numbered. The workers at the time of entering into the factory put their respective token
in the appropriate place of the board. On the basis of this token, the timekeeper records
the attendance of the worker in the attendance register.

• Attendance Card: Here, the workers are given attendance cards. At the time of
entering into the factory, the workers put their attendance cards in the box kept near the
gate. The gatekeeper collects the same for the purpose of recording time in the
attendance register.

2. Piece work recording: When the workers are paid on the basis of work performed, they
are provided with cards known as 'job cards' which contain information relating to workers
and their jobs, in the name of the worker, nature of work allotted, the volume of work done
and the wage or job rate. This card is checked by the piece work reviewer along with the
quality and quantity of goods. This card helps in the preparation of wage sheet.

3. Overtime recording: The question of payment for overtime to workers arises only when
it is sanctioned by the proper authority. The overtime slip

is to be given to each worker, who has been allowed to do the same. This slip contains

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various information, viz. The name of the workers, details about the job and the rate at
which wages are to be paid. The overtime record should be maintained separately and it
should be passed either by foreman or by the works manager. After that, the slip should be
sent to the accounts department for the preparation of wage sheet.

4. Pass-out recording: Normally the workers are not allowed to leave the factory during the
hours of work, Sometimes the workers are compelled to leave the factory during the
working period on some personal grounds. In that case, pass-out slips are to be issued to
the workers. Two copies of the slip are prepared. The original copy is to be handed over to the
worker who at the time of leaving the factory hand over the same to the gatekeeper and the other
copy is to be sent to the wage department for the preparation of wage sheet.

5. If any workers wants to go to out of the factory, he should take written permission from
the authorized person.

6. If casual workers are also employed in the organization, a list of such workers must be
prepared by the foreman of each department. The list so prepared must be certified by the
officer, who is authorized to appoint casual workers.

Preparation of wage sheets

The preparation of wage sheets should be done by a separate department. This work should be
assigned to a number of employees of the wage department to minimize the irregularities.
Information regarding attendance is available from the attendance registers, job cards, overtime
ships, pass-out ships etc. For time workers and piece workers, separate wage sheets should be
prepared.

All essential particulars should be entered in the wage sheet, which should have separate
columns for;

(1) Name of the worker.

(2) Identification number allotted and the department in which he is working.

(3) Total time worked in the production process.

(4) Details of work done.

(5) Applicable rate of wages.

(6) Total amount of wages payable.

(7) Bonus entitlement, if applicable.

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(8) Overtime wages, if any.

(9) Deductions.

(10) Net amount of wages payable.

The work of preparation of wage sheets should be done by a separate department. This work
should be done at least by four clerks, so that irregularities may be minimized.

• An employee of the department should examine the time and piece wage records,
overtime records and other statements relating to wage payment.

• One employee should prepare individual worker's statement of wage payment.

• Another employee should check the calculations and deductions of rent, provident fund,
income tax and installment of loans etc. from the gross wages to arrive at the net amount to be
paid to the workers.

• One other employee should check the whole work thoroughly.

• All the employees involved in the process should put their initials on the wage sheets
and finally, the wages sheets should be forwarded to the cash department for payment
by some responsible official.

Payment of wages;

(1) The employees associated with the preparation of wage sheets must not be given the
assignment of making payment of wages to avoid collusion between them.

(2) On receipt of wage sheets from the wage department, the chief cashier makes necessary
arrangements with the bank for the withdrawal of necessary cash for payment.

(3) Each worker, who is to receive the wages, should be present personally. Thumb
impression may be taken as an evidence of wage receipt by the workers.

(4) The foreman or the concerned officer of each department should be present at the time
of payment to identify the worker.

(5) Proper arrangements should be made with regard to unclaimed wages.

(6) Advances to the workers should be discouraged, and if it becomes unavoidable, they
should be given and these should be deducted later on from the wages of the respective
workers.

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(7) The cashier should with draw the net amount as shown in the wage sheets,

(8) The payment of wages must be made by a person, who is in no way concerned with
the preparation of wage sheets.

(9) The signature of the workers must be obtained, when they receive the amount of
wages.

(10) Special arrangements should be made to pay to the absentee workers.

(11) A list of unpaid workers should be prepared by the cashier and foreman of each
department.

(12) As far as possible casual workers should be paid wages on a day different from
the payment day of regular workers.

(13) A surprise visit of a senior officials, while the wages are disturbed will be an
effective measure of control.

 Internal check as regards

1. Sales over the counter

2. Postal sales
3. Sales by travelling agents

1. Sales over the counter;

for efficient working of the sales department, its acticities can be arranged in the
following manner:

a. for each counter, a separate salesman should be appointed to look after his counter.
b. Each salesman should be given a separate sales memo book. Such books should be of
different colours for different counters.
c. The salesman when he sells the goods to the customers, he should prepare three copies of
cash memo. One copy should be retained for preparing sales summary and the remaining two
copies should be handed over to the customer and instruct the customers to make payment at
the cash counter.
d. The cashier, after having received the price of the goods from the customer, should give one
copy duly stamped as cash paid to the customer and other copy must be retained by him.
e. At the end of the day, the cashier should prepare statement prepare statement showing total
cash received and salesman should prepare sales summary to know the total sales. Then both
the statements should be sent to the officer in charge for verification.

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II. postal sales;

a. A separate register should be maintained for recording sales made by VPP( value payable by
post)
b. The goods returned should also be recorded in the VPP register.
c. The total receipts on this account should be entered in the VPP register.
d. Any advance received should be enterted in the VPP register.

III. sales by travelling agents;

a. The travelling agents should be allowed to issue rough receipts to the customer for cash
received on the sale of the articles. Final receipts should be issued only by the head office.
b. Agents should remit the entire proceeds to the head office or they should deposit the cash daily
in a bank.
c. Agents should not be allowed to deduct their commission out of sale proceeds collected by
them.

Other particulars of cash sales as under:

1) Counter Sales Book: The salesmen can sell products over the counter. The sales book
can be prepared on the basis of cash memos issued by the staff. The sales staff should
not handle cash. All cash receipts must be handed over to the cashier. Accountant can
make entries in the books of accounts. Another person can deposit cash.

2) Cash Register: Cash register is maintained in large retail shop. There is a need of
secrecy for its working. The main equipment and attachments must work without any
interference from employees.

3) Checking Copies: The auditor can check carbon copies of cash sales. The copies can
be used as a basis of determining total sales for a particular period.

4) Receipt of Goods: The goods are handed over to the customer along with cash memo.
The officer sales must check and sign the cash memo at the time of delivery of goods.
One copy is kept for determining total sales.

5) Sales Summary: The sales summary must be prepared and sent to sales manager. The
sales summary must tally with the cash received from the customers.

6) Cash Verification: The sales officer can check the cash memo for the day. The sales
summary should be examined. The cash collected must tally with the cash memo as
well as total sales summary for the day.

7) Cash Deposits: The cashier should not deposit the cash into the bank account. The total

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cash must be handed over to the accountant who should make arrangement for deposit
of cash.

8) Sales Discount: The sales discount rate can be examined from the price list. The
discount must not be in excess of the rates stated in the list. The discount allowed should
be posted to the sales discount accounts. The sales manager must approve the discount.

 Internal check as regards purchases

Following suggestions are given for a proper control over the purchases:

1. Supply of Requisition( an official order): requisition book must be kept by each

department in the organization. Whenever goods are needed in any department of the
company, the head of the department should send the purchase requisition to the purchase
department. He should mention the details about quality, quantity of the item and the time
by which the goods must be supplied and send it to the purchase department.

2. Purchase Order: after the receipt of requisition slip, the purchase department should
invite quotations from the vendors and select the vendor, who supplies quality goods at
reasonable price. PO should be given in writing. It should be given on printed and
numbered forms. It should be recorded in the purchase book.

3. Copies of Purchase Order: then the purchase department should prepare three copies of
purchase orders. One copy should be sent to the vendors. . One copy to the store clerk and
one should remain with purchase department or accounting department.

the fact to be noted at this stage is that the purchase order should be carefully written and
it must be approved by the head of the purchase department.

4. Receipt of goods: on receipt of goods, the purchase department should carefully inspect
the goods so received with the help of purchase order and invoice. Then the purchase
department must enter the goods received in the goods inward book and send the goods to
the stores and should also inform the concerned department about the receipt of the
goods.

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5. Comparisons: One copy of the received goods will be sent to the purchase department.
Purchase department will compare the quality and quantity with the invoice.

6. Invoice or invoice checking: the purchase department should check the supplier invoice
and then send it to the accounting department for payment. The accounting department
should compare the invoice with the purchase order and it should also verify the
calculations. If goods received are in order and the calculations are found to be correct,
proper arrangements should be made for making payment to the vendors.

7. Inspection: Before storing the goods, these should be inspected and quality should be
tested.

8. Purchase Returns: In case of any defect it should be immediately reported the purchase
department. Purchase department may take up the case. All returns out wards should be
duly authenticated.

9. Invoice Recording: Each invoice should be consecutively numbered and properly filed.

10. Payment: A responsible officer should pass on the payment of invoices. Before signing
the cheque he should assure himself about the correctness of the account.

 Internal check as regards credit purchases;

A separate department for credit purchases is usually maintained in business houses. The
efficiency of such a department depends upon its policy of purchasing best goods at the
cheapest Price. The Purchases Department should function separately and its work should be
sub-divided between small departments, each of which should be headed by a responsible
officer.

To facilitate its operation, the whole work Connected with purchases may be divided into five
heads:

(1) Assessment of Requirements

(2) Enquiry

(3) Placing Orders

(4) Receipt of Goods, and

(5) Recording and Making Payments.

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1. Assessment of requirements: This is the first important job to assess requirements of
goods. Requisition Books should be issued to the various departments of a concern. The

head of the department which is in need of goods should fill in a requisition slip duly
signed and then send it to the Purchases Department.

The details about the quantity, quality, the price (if it can be quoted) and the time by which
goods must be supplied, should be entered in the requisition slip, on receipt of similar
requisition slips from the various departments, the Purchases Department can know exactly
the volume of different goods to be purchased.

2. Enquiry: Then, the Purchases Department makes an enquiry about the terms and
conditions of purchases from different suppliers. For this, tenders or quotations are invited
from them. The lowest tender should be accepted, and accordingly, a decision can be taken
by an officer or by a subcommittee of the Purchase Department in it. His amount of
purchase is heavy and involves a huge expenditure.

3. Placing orders: The Purchases Department places orders which should be recorded in the
purchases Order Book. Three copies of such orders should be prepared. One each for the
supplier, the store and the purchases department itself. A responsible officer should sign
the order. After putting the number of the order on the requisition slip concerned and vice
versa, such requisition slip should be filled in the purchases department.

4. Receipt of goods: On receipt of goods, the gate-keeper should enter the particulars of all
goods received in the Goods Inward Book after having checked them properly. The goods
then should be sent to the Store where they should be carefully preserved.

The stores Department should prepare a 'Goods Received Note’ and send a copy thereof to
the purchase Department, the Accounts Department and the Production Control
Department

The goods received note should be prepared with the following details:

• The date when the goods were received.

• The name of the supplier.
• The advice note number
• The description and code number of goods.
• The quantity advised
• The quantity received.

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• The quantity rejected.
• The rejection note number.
• The quantity accepted into store.
• Signatures of employees concerned with having entered items on it.

5. Recording and making payments: Lastly, the Purchases Department should scrutinize
the requisition slip, the order; the goods received note and the invoice. Invoices are usually
checked by a separate person known as the Invoice Clerk

The number of the order should be entered on the invoice and so on. All these documents
should be marked as checked and signed. if necessary. The invoice should then be handed
over to the Accounts Department where steps will be taken to make payments. It is to be
seen that the invoices, when checked have been properly stamped.

Difference between internal check and internal audit

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Internal Audit

Internal audit is a review of operations and records undertaken within a business by specially
assigned staff.
Internal audit is a continuous and systematic review of the accounting, financial and other
operations of a concern by the staff specially appointed for the purpose.

Definition

According to Howard F. Stedler, "Internal auditing is an independent appraisal activity within

an organisation for the review of operations as a service to management."

According to W. B. Meigs, "Internal auditing consists of a continuous and critical review of

financial and operating activities by a staff of auditors functioning as full time salaried
employees."

Objectives of internal audit:

1. To keep proper control over business activities. When there is proper control there
is maximum efficiency. The internal auditor can determine the degree of control over
the work.

2. To evaluate the accounting system. It is concerned with checking proper authority

for transactions like purchase, retirement and disposal of fixed assets.

3. To help management by pointing out at the weaknesses. The internal audit can be
used as a tool to correct the situation.

4. To review the working of business. The working of current year can be reviewed in
detail just to note the successful area of working.
5. To undertake special investigation for the management.
6. To facilitate the early detection and prevention of frauds.

7. To protect the assets. This is done by inspecting the proper records of assets and to
examine the procedure of acquisition, disposal, valuation, verification and its
possession.

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Scope of Internal Audit

The primary objective of internal audit lies in helping the management attain maximum
efficiency by providing an important source of review of operations and records for the
assistance of at levels of management.

AS per AAS-7, following are the objectives of internal audit • Review of

accounting system and related internal control.
8. Examination of financial and operating system.

9. Examination of effectiveness and efficiency financial control.

10. Physical examination and verification.

Thus, internal audit carries out a thorough examination of the accounting transactions as well
as that of the system according to which these have been recorded with a view to reassuring
the management that the accounts are being properly maintained. It also ensures that the system
contains adequate Safeguards to check any leakage of revenue or misappropriation of property
and the operations have been carried out in conformity with the plans of the management.

Advantages of internal audit

Internal audit provides the following advantages:

1. Prevention of errors and frauds: It helps in the prevention of errors and frauds including
misappropriation of cash and goods.

2. Early detection of errors and frauds: It makes early detection of errors and frauds
possible.

3. Continuous review of internal control system: It undertakes continuous review of the

internal control system and as a result, it is capable of reporting irregularities for enabling
corrective action in time.

4. Assurance regarding accuracy of books and accounts: It checks books, records and
accounts to ensure correct recording and their maintenance up to date.

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5. Assistance to the statutory auditor: It can render direct assistance to the statutory auditor
by undertaking detailed checking of the accounting data and leave him free to concentrate
on more important issues of principle, presentation and policy on accounting.

Disadvantages

Internal audit suffers from the following limitations.

1) Extra cost: Internal audit system is not possible to be adopted by small organizations
because the cost of running an internal audit department is very high.

2) Biased opinion: Internal audit department employees are the paid-staff of the organisation.
In most cases, they have to work according to the directions of the management. So it is
not expected that they will provide unbiased opinion about the financial statements.

3) Possibility of becoming ineffective: If the employees of the internal audit department are
not efficient or if the internal audit is not conducted effectively it will provide no assistance
to the management

4) Inefficient staff members: As there is no prescribed qualification for the appointment of

internal auditors, less qualified persons may get appointment in the department. They will
not be able to discharge their duties properly.

Difference between internal control and internal audit

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