Nature of Auditing

1. a) Introduction; Nature ; Essential Features

Auditing Defined
Traditional (Narrow) Definition Modern (Broad) Definition
“An audit may be said to be “Auditing is a systematic
such an examination of and independent
books, accounts and examination of data,
vouchers of a business as statements, records,
will enable the auditor to
satisfy that the balance operations and
sheet is properly drawn up performances (financial or
so as to give a true and fair otherwise) of an enterprise
view of the state of affairs for a stated purpose. In
of the business and any auditing situation, the
whether the profit and loss auditor perceives and
account gives a true and recognizes the
fair view of the profit or
loss for the financial propositions before him
period according to the for examination, collects
best of his information and evidence, evaluates the
explanations given to him same and on this basis,
and as shown by the books formulates his judgement
and, if not, in what respect which is communicated
he is not satisfied.”
 BOOK KEEPING ACCOUNTANCY AUDITING

✔ Journalizing ✔ Preparation of Trial Auditor examines the

Balance financial statements
✔ Posting to Ledger ✔ Preparation of prepared by the
✔ Totaling of Accounts Trading and Profit accountant and
&Loss Account verifies items therein
✔ Balancing of Accounts ✔ Preparation of with the help of
Balance Sheet relevant documentary
✔ Making evidence an
Rectifications and explanations and
adjustment Entries information given to
It is concerned with the him.
An accountant Assures users of
systematic recording of
summarizes the results financial statements
transactions in the books
of transactions and as to their reliability.
of original entry and
events recorded by the
their posting to the
book-keeper.
ledger.
 Basis Accounting Auditing
1 Scope and Limited to preparation of Examines financial data and
Objective financial statements. expresses opinion re: truth
(compliance) and fairness of
financial statements.
2 Source of Position in the organizational Independent/Statutory Auditors:
authority hierarchy. The accountant is • Relevant Statute (e.g. Co.’s Act
(Status) usually an employee of the 2013)
organization. • Engagement Letter/Terms
Internal Auditors:
• If employee: Position in orgn.
• If outsider: Engagement Terms
3 Qualifications Not specified by statute. Specified by relevant statute.
(May or may not be a CA.) (E.g., an independent statutory
auditor under the Companies Act
2013, has to be a practicing CA.)
4 Expertise Accounting Accounting and Auditing.
5 Chronology Precedes auditing Post accounting
6 Accountability To Management/TCWG To Shareholders
7 Nature of work Constructive Analytical
8 Timing of work Round the year Year End or Continuously.
 Bases of AUDITING INVESTIGATION
Distinction
1 Compulsion Compulsory for companies. Not Compulsory. Unless specifically
required
2 Appointing Generally Shareholders. Usually Management/TCWG.
Authority By BoD or CG in some cases. CG in some cases.

3 Objective To form an opinion as to the truth To find out in detail the state of affairs
and fairness of FS. or answers to specific questions in
respect of some specific area.
4 Scope Determined by relevant statute or Determined by appointing authority.
terms of engagement.
5 Disclosure of Requires specific disclosure in case No specific disclosure required.
Remuneration of companies under Schedule VI Part
II of the Companies Act, 2013.
6 Qualifications Statutory Auditor of a Company No specific qualifications required.
should be a CA under the meaning of
the Chartered Accountants Act, 1949.
7 Coverage Wide/Overall Narrow /Focused
8 Time Frame Annual None . Usually more than one year.
9 Submission To shareholders. To appointing Authority.
of Report
 Independence of Auditor
Meaning of Independence

Independence implies that the judgement of the auditor is

not subordinate to the wishes or direction of another person
who might have engaged him or to his own self-interest.

It is not possible to define “independence” precisely. Rules

themselves cannot create or ensure the existence of
independence. Independence is a condition of mind as well as
personal character and should not be confused with the
superficial visible standards of independence which are
sometimes imposed by law. These standards may be relaxed or
strengthened but the quality of independence remains
unaltered.
 Definition of “Auditor’s Independence”
As per the Code of Ethics for Professional Accountants, issued by the
International Federation of Accountants (IFAC)

Independence in Mind Independence in Appearance

The state of mind that The avoidance of facts
permits the provision of an and circumstances that are so
opinion without being significant, a reasonable
affected by influences that informed third party, having
comprise professional knowledge of all relevant
information, including any
judgement, allowing an
safeguards applied, would
individual to act with integrity, reasonably conclude a firm’s
and exercise objectivity and or a member of the assurance
professional skepticism. team’s integrity, objectivity or
professional skepticism has
been compromised.
 Threats to Auditor’s Independence
Nature of Threat Description Example
1 Self Interest Occur when an auditing firm, Direct or indirect financial
its partner or associate could interest, loan or guarantee
Threat benefit from a financial from client, close business
interest in the client. relationships with client,
undue dependence on
client’s fee, potential
employment with client,
contingent fee for audit
engagement.

2 Self Review Occur when during a review of ❑ Auditor having recently

any judgement or conclusion been a director or
Threat reached in a previous audit or senior officer of the
non-audit engagement, or company.
when a member of the audit ❑ When the auditor
team was previously a director performs services which
or senior employee of the are themselves the
client. subject matter of audit.
 Nature of Threat Description Example
3 Advocacy Occur when the auditor ❑ When an auditor deals
promotes or is perceived to with the securities of the
Threat promote a client’s opinion to company.
a point where people may ❑ Becomes client’s
believe that objectivity is advocate in litigation
getting compromised. and third-party disputes.
4 Familiarity Are self-evident and occur ❑ Close relative of an
when auditors form auditor working in a
Threat relationships with the client senior position of the
where they end up being too client company.
sympathetic to the clients ❑ Former partner of the
interests. audit firm being a
director or senior
employee of the client.
❑ Long association
between specific
auditors and their
specific client
counterparts.
❑ Acceptance of significant
gifts or hospitality from
the client company, its
 Nature of Threat Description Example
5 Intimidation Occur when auditors are ❑ Threats of replacement
deterred from acting over disagreements
Threat objectively and adequate with the application of
degree of professional accounting principles.
skepticism. ❑ Pressure to
disproportionately
reduce work in
response to reduced
audit fees.
 Safeguards to Independence
The Professional Accountant (CA in our case) has a responsibility to
remain independent by taking into account the context in which they
practice, threats to independence and safeguards to eliminate the treats.
To address the issue, Members are advised to apply the following
guiding principles:
✔ For the pubic to have confidence in the quality of audit, it is essential
that auditors should always be and appear independent of the entities
they are auditing.
✔ In case of audit the fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be
independent.
✔ When such threats exist, the auditor must conscientiously consider
whether it involves threats to independence.
✔ When such threats exist, the auditor should either desist from the task,
or at the very least, put in place safeguards that will eliminate them. All
such safeguard measures need to be recorded in a form that can serve
as evidence of compliance with due process.
✔ If the auditor is unable to fully implement credible and adequate
safeguards, then he must not accept the work.