Basic Concepts of Audit

The word "audit" is derived from the Latin word "audire" which means "to hear". As
the changes took place in duties and responsibilities of auditor, the change in the
meaning of audit came and hence, various definitions of audit are given by distinct
authors, thinkers and organizations which we are going to see in this section. An audit
is 'such an examination of the books, accounts and vouchers of a business, as will
enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so
as give a true and fair view of the state of affairs of the business, and whether the
Profit and Loss Account gives a true and fair view of the profit earned or loss suffered
for the financial period, according to the best of his information and the explanations
given to him and as shown by books, and if not, in what respects he is not satisfied."
According to Montegomery, "Auditing is a systematic examination of books and
records of a business or other organization, in order to ascertain or verify, and to
report upon, the facts regarding its financial operations and results thereof."
Scope of Audit:
1. Audit should cover the examination of all aspects of an entity relevant to financial
statements being audited.
2. To form an opinion on the financial statements, the auditor should be reasonably
satisfied 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.
3. In forming his opinion, the auditor should also decide whether the relevant
information is properly disclosed in the financial statements subject to statutory
requirements, where applicable.
4. The auditor assesses the reliability and sufficiency of the information contained in
the underlying accounting records and other source data by:
(a) making a study and evaluation of accounting systems and internal controls and
(b) Carrying out such other tests enquires and other verification procedures of
accounting transactions and account balances as he considers appropriate in the
particular circumstances.
5. The auditor is not expected to perform duties which fall outside the scope of his
competence. For example, the professional skill required of an auditor does not
include that of a technical expert for determining physical condition of certain assets.
6. Constraints on the scope of the audit of financial statements that impair the
auditor's ability to express an unqualified opinion on such financial statement should
be set out in his report, and a qualified opinion or disclaimer of opinion should be
expressed as appropriate.

Meaning of Books of Accounts

· Books of Accounts mean the financial records maintained by a business concern for
a period of one year. The period of one year can be either calendar year i.e., from 1st
January to 31st December or financial year i.e., from 1st April to 31 st March. Usually,
business concerns adopt financial year for accounting all business transactions.
· Books of accounts include the following: ledgers, subsidary books, cash and other
account books either in the written form or through print outs or through electronic
storage devices.
Meaning of Financial Statement
Financial Statement means the statements prepared at the end of the year taking
into account the business activities that took place for a year, for example,
transactions that takes place in a business concern from 1st April to 31st March.
Components of Financial Statement
Financial Statement includes the following:
· Trading and Profit and Loss Account, and
· Balance Sheet.
Elements of Financial Statements include the following:
Assets: Assets include cash and bank balance, value of closing stock, debtors, bills
receivable, investments, fixed assets, prepaid expenses and accrued income.
Liabilities: Liabilities include capital, profit and loss balance, creditors, bills payable,
outstanding expenses and income received in advance.
Revenue: Revenue includes sales, collection from debtors, rent received, dividend,
interest received and other incomes received.
Expenditure: Expenditure includes purchases, payment to creditors, manufacturing
and trade expenses, office expenses, selling and distribution expenses, interest and
dividend paid.
Errors
The Institute of Chartered Accountants of India defines an error as, “an
unintentional mistake in the books of accounts.” Errors are the carelessness on the
part of the person preparing the books of accounts or committing mistakes in the
process of keeping accounting records.
1. CLERICAL ERROR
Errors that are committed in posting, totalling and balancing of accounts are called
as Clerical Errors. These errors may or may not affect the agreement of the Trial
Balance.
Types of Clerical Errors:
(A) Errors of Omission:
When a transaction is not recorded or partially recorded in the books of account is
known as Errors of Omission. Usually, it arises due to the mistake of clerks. Error of
omission can occur due to complete omission or partial omission.
(1) Error of Complete Omission: When a transaction is totally or completely omitted to
be recorded in the books it is called as “Error of Complete Omission”. It will not affect
the agreement of the Trial Balance and hence it is difficult to detect such errors.
(2) Errors of Partial Omission: When a transaction is partly recorded, it is called as
“Error of Partial Omission”. Such kind of errors can be detected easily as it will affect
the agreement of the Trial Balance.

(B) Errors of Commission:

Errors which are not supposed to be committed or done by carelessness is called as
Error of Commission. Such errors arise in the following ways:
(1) Error of Recording: The error arises when any transaction is incorrectly recorded
in the books of original entry. This error does not affect the Trial Balance.
(2) Error of Posting : The error arises when a transaction is correctly journalized but
wrongly posted in ledger account.
(3) Error of casting, or Error of Carry-forward: The error arises when a mistake is
committed in carrying forward a total of one page on the next page. This error affects
the Trial Balance.
2. ERROR OF DUPLICATION
Errors of duplication arise when an entry in a book of original entry has been made
twice and has also been posted twice. These errors do not affect the agreement of
trial balance, hence it can’t located easily.
3. ERROR OF COMPENSATION (or) COMPENSATING ERRORS
When one error on debit side is compensated by another entry on credit side to the
same extent is called as Compensating Error. They are also called as Off-setting
Errors. These errors do not affect the agreement of trial balance and hence it cannot
be located.
4. ERROR OF PRINCIPLE
An error of principle occurs when the generally accepted principles of accounting are
not followed while recording the transactions in the books of account. These errors
may be due to lack of knowledge on accounting principles and concepts. Errors of
principle do not affect the trial balance and hence it is very difficult for an auditor to
locate such type of errors.

Detection and Prevention of Frauds

Fraud is the intentional or willful misrepresentation of transactions in the books of
accounts by the dishonest employees to deceive somebody. Thus detection and
prevention of fraud is of great importance and constituents an important duty of an
auditor. Fraud can be classified as:
1. MISAPPROPRIATION OF CASH
This is a very common method of misappropriation of cash by the dishonest
employees by giving false representation in the books of accounts intentionally. In
order to detect and prevent misappropriation, the auditor should verify the system of
internal check in operation and by making a detailed examination of records and
documents. Cash may be misappropriated in the following ways:
(1) By omitting to enter cash which has been received.
(2) By accounting less amount on the receipt side of cash book than the actual
amount received.
(3) By recording fictitious entries on the payment side of cash book.

2. MISAPPROPRIATION OF GOODS
Fraud which takes places in respect of goods is Misappropriation of Goods. Such a
type of fraud is difficult to detect and usually takes place where the goods are less
bulky and are of high value.
 By showing less amount of purchase than actual purchase in the books of accounts.
 By showing issue of material more than actual issue made.
 By showing good materials as obsolete or poor line of goods.
 By showing fictitious entries in the books of accounts.
Detection of Misappropriation of goods is a difficult task for an Auditor. Only
through efficient system of inventory control, periodical stock verification, internal
check system and adequate security arrangement the scope for such frauds can be
eliminated or minimized. Auditor has to thoroughly scrutinize the inward and outward
registers, invoices, sales memos, audit notes, etc., to detect the goods-related frauds.
3. MANIPULATION OF ACCOUNTS
There is a very common practice almost in every organization, some dishonest
employees have intention to commit this type of fraud. Manipulation of accounts is
the procedure to alter books of accounts in such a way that there will be an increase
or decrease in the amount of profit to achieve some personal objectives of the high
officials. It is very difficult for the auditors to identify such frauds which may be due to
manipulation of accounts.

Basic Principles of Governing An Audit (AAS-1):

This Auditing and Assurance Standard was the first standard on auditing issued by the
Institute. This Standard describes the basic principles which govern the auditor’s
professional responsibilities and which should be complied with whenever an audit is
carried out.
1. Integrity, Objectivity and Independence:
The auditor should be straightforward, honest and sincere in his approach to his
professional work. He must be fair and must not allow prejudice or bias to override his
objectivity. He should maintain an impartial attitude and both be and appear to be
free of any interest which might be regarded, whatever its actual effect, as being
incompatible with integrity and objectivity.
2. Confidentiality:
The auditor should respect the confidentiality of information acquired in the course of
his work and should not disclose any such information to a third party without specific
authority or unless there is a legal or professional duty to disclose.
3. Skills and Competence:
The audit should be performed and the report should be prepared with due
professional care by persons who have adequate training, experience and
competence in auditing. The auditor requires specialized skills and competence which
are acquired through a combination of general education, technical knowledge
obtained through study and formal courses

4. Documentation:
The auditor should document matters which are important in providing evidence that
the audit was carried out in accordance with the basic principles.
5. Planning:
The auditor should plan his work to enable him to conduct an effective audit in an
efficient and timely manner. Plans should be based on a knowledge of the client’s
business.
Types of Audit
Once we complete preparing the final statements and accounts for the year the
accounting process is over. However, we still cannot be completely certain of the
accuracy of these accounts. This is when the concept of auditing comes in. Let us see
the different types of Audit.
1. Statutory Audit
One of the main types of audits is a statutory audit. It is a legal requirement as per
the state or national laws prevalent in the region. In India, the laws regarding a
statutory audit are in the Companies Act, 2013. A statutory is another name of a
financial audit. It is essentially an audit of the final statements of a company, i.e. the
profit and loss and the balance sheet. The purpose of a statutory audit is to ensure
that these accounts of the company represent a fair and accurate picture of the
company’s current financial position on the date of the balance sheet.
2. Internal Audit
The management of an organization may want the safety of having an independent
audit team within the organization, that keeps a constant check on the accounting
and finance practices. So they usually set up an internal audit. This is quite different
from a statutory audit. As per the name, an internal audit occurs within an
organization. So an independent auditor or team of auditors, who are actually
employees of the organization, will review the financing, accounting and operating
activities of the organization. It is actually a part of the internal control system of the
company.
3. Cost Audit
The Cost and Works Accountants of India (ICWA) actually defines a cost audit as a
system that reviews and examines cost accounting records. This means it examines
the accuracy of the costing records and that all cost accounting principles were
adhered to. It helps to determine whether the cost accounts reflect a true picture of
the organizations financial status.
4. Tax Audit
In India, all businesses have to pay a direct tax to the central authorities if they fall in
the tax slab. The rules regarding tax and tax payments are in the Income Tax Act,
1961. Section 44AB of this Act provides for a compulsory tax audit of certain assesses.
This is done to ensure to the tax authorities that the financial records submitted are
reliable and the tax liability is calculated correctly. The authorities also rely on a tax
audit to ensure that the deductions are taken, exemptions prevailed etc. are also
lawful.

5. Propriety Audit
Generally, in companies and other big organizations, ownership and management are
separate. This means the real owners of the business have to rely on executives to
make the correct decisions and take the due course of action as per the law. This is
where the concept of propriety audit is born.
6. Bank Audit
Banks are the cornerstone of our economy. They handle huge amounts of public
deposits and savings, so they have to be closely monitored and reviewed. A bank
audit is one important process of this monitoring.

Audit Procedure and Audit Report

Vouching: Concept and Definitions
Vouching is the core aspect of auditing. It is an act of establishing the accuracy and
authenticity of the entries made in the books of accounts by examination of the
documentary evidences in support of the transaction. It consists of comparing the
actual entries in the books of accounts with the supporting documents in order to
ensure that the actual transaction has taken place as per the entries made in the
books of accounts. It helps auditor to find out errors and frauds in the business.
Vouching gives basis to form an opinion on the financial matters of the business. It
gives
confidence by providing concrete information about the financial records so that the
auditor can express his opinion on the financial records maintained by the company.
Vouching starts which the examination of vouchers. So let’s now understand the
concept of voucher.
Voucher:
A voucher is a documentary evidence on the basis of which an accounting entry is
passed. The documentary evidence may be purchase receipt, counterfoils of a receipt
book, invoice, fixed deposit receipt, an agreement, correspondence, gate keeper’s
book, wage book etc. There are two types of vouchers i.e. Primary Voucher and
Collateral Voucher. A written original evidence is said to be primary voucher while in
case original voucher is not available then the copies there of are produced in
support, such voucher is known as collateral voucher.
“Vouching may be defined as detailed examination of evidences offered in
substantiation of entries in the books, including in such examination the proof, so far
as possible that no entries have been omitted from the books.”
Objectives of Vouching
The following are the objectives of vouching.
1. To see all the transactions are recorded in the books of accounts.
2. To see the recorded transactions are actually taken place.
3. To ensure that all the entries recorded in the books of accounts are supported by
the documentary evidences.
4. To verify authenticity of the vouchers and documentary evidences.
5. To verify the correctness of transactions.
6. To ensure that there is no fraudulent entries in the books of accounts.
Importance of Vouching
Vouching the most important step in auditing. It is process of a comparing entries in
the books of accounts with the documentary evidences in support thereof so as to
ensure that transactions are in order, have been properly authorizes and correctly
recorded in the books. The importance of vouching can be explained as under
1. Foundation of Audit: Vouching is a first and prime step in audit process. It gives
confidence and the valuable basis to the auditor to form an opinions on the true and
faire view of state of affairs of the concern.
2. Errors and Frauds: Vouching helps auditor to find errors and frauds in the books of
accounts. Careful inspection of the tractions with their documentary evidences can
easily reveals errors and frauds if any.
3. Actual Occurrence of Transaction: Vouching helps auditor to ascertain whether the
transaction actually occurred. It reveals the truth of the entries in the
books of accounts.
4. Check on Employee: Vouching is also important from the company point of view. It
acts as a moral check on employee. If employees are well aware that all entries are
going to be examined with their vouchers, they may not go for recording fraudulent
entries in the books of accounts.
5. Relevant Entries: Vouching helps the auditor to ascertain whether the entries
recorded in the books are relevant i.e. they relate to the concern and to the current
accounting year.
6. As per Standards: Vouching enables auditor to verify whether an item is accounted
as per the recognised accounting standards, policies and practices.
7. Compliance with Law: Vouching ensures that the trasaction complies with the
provisions of Law e.g. the Companies Act, Income-Tax Act. etc.
8. Capital and Revenue Expenditure: Vouching assist auditor to ensures the proper
allocation of expenditure into capital and revenue.
Receipt of Loan:
Cash received on account of loan is recorded on the debit side of the cash book. In
such case auditor look into following things:
i. The auditor should enquire the loan agreement to know rate of interest and
repayment schedule and other the term and conditions.
ii. The auditor should see that whether client is entitles to raise loan.
iii. He should see whether the security offered is indicated in the balance sheet
iv. He should check whether interest payable but not paid is adjusted in the accounts
at the end.

Sale of Fixed Assets:

i. The auditor should verify the sale of fixed assets with the board resolution, broker’s
statement, auctioneer’s note, tender of sales price etc.
ii. The auditor should ensure that the sale of fixed assets has been properly
sanctioned.
iii. The auditor should see that the proper asset account has been credited with the
amount. If there is any profit on the sale of fixed assets, that should credited to capital
reserve account which is not available for distribution to the shareholders.

Issue of Debentures
The company may also issue debentures to raise capital. It is borrowed sources of
capital. The cash received as a result of issue of debentures are recorded in the debit
side of the debentures. While vouching cash book for the entries with respect to the
debentures, the auditor should see following things
i) Firstly auditors should inspect the boards resolutions regarding issue of debentures
to know the amount of capital planned to raise by issue of debentures, issue price of
debentures, types of debentures, collateral securities and other terms and conditions.
ii) The auditor should examine debenture applications and allotment sheet.
iii) The actual amount received is to be verified by comparing bank statement, entries
in the cash book and application and allotment sheet.
iv) If contract is made with debentures holders, then it must be examined.
v) In case of redemption of debentures, the entries in the bank statement and cash
book is to be compared. The auditor must see that debenture certificate is received
back.
vi) If debentures are issued as collateral security for loan, then the loan contract and
resolution for issue of debentures must be examined.
Freehold and Leasehold Property Building
i. The auditor should examine the agreement for purchase of property or the lease
deed, conveyance and title deed.
ii. The auditor should see that a resolution have been passed in the board meeting
regarding purchase of property. Minutes of the board meeting can give all such
details.
iii. If the property has been purchased through a broker, his account should be
examined.
iv. If asset have purchased in auction, auditor should check auctioneer’s statement.
v. The auditor should see that the property has been registered in the name of his
client under section 17(1) of Trust of Property Act. He should see that the title of the
property has been duly verified by the solicitor.
vi. In case of building has been constructed, Architect’s certificate, Builders contract
and his receipt should be examined.
vii. The auditor should see whether all related expenses like architects fees,
brokerage, commission, registration fees, solicitor’s fees etc. are duly capitalized.

Verification of Assets: Concept and Definition

Verification is a process where auditor ensures that the assets actually existed in
the business which are shown in the books of accounts. It also includes to see that
existed assets are owned and valued correctly as shown in the balance sheet.
Verification means the poof of existence of confirmation of assets and liabilities on the
date of balance sheet. Verification usually indicates verification of assets of any
organization by examining value, ownership, existence and possession of any assets.
The liability of the auditor is not limited to checking the arithmetical accuracy only but
he is also liable to verify assets and liabilities otherwise he may be held responsible
for negligence.
“Verification of assets implies an inquiry into the value, ownership and title, existence
and possession and the presence of any charge on the assets.”

Importance of Verification
 Verification is an importance part of audit from point of view of auditor, investors and
the management itself. The importance of verification can be explained as below
i. True and Fair View of Sate of Affaires: The main object of auditing to comment on
whether the financial statements exhibit true and fair view of the state of affairs or
not. By merely examining books of accounts this objective cannot be achieved.
Physical verification of assets and liabilities enable auditor to on true and fair view of
state of affairs of business.
ii. Fraud in Connection with Assets: Any fraud in connection with the purchase or sale
of assets or the fact of asset having been mortgaged comes to the light by verification
only.
iii. Confidence to Shareholders and other Investors: Shareholders and other investors
cannot visit the company to verify the applications of their money. They can only rely
on the data provided by the management. Verification of assets and liability of a
company by an independent auditor will certainly boost the confidence of
shareholders and other investors on the company.
iv. True Information: Creditors and all other stakeholders of the company will get true
information about assets and liabilities of the business. Importance of Verification
Verification is an importance part of audit from point of view of auditor, investors and
the management itself. The importance of verification can be explained as below
i. True and Fair View of Sate of Affaires: The main object of auditing to comment on
whether the financial statements exhibit true and fair view of the state of affairs or
not. By merely examining books of accounts this objective cannot be achieved.
Physical verification of assets and liabilities enable auditor to on true and fair view of
state of affairs of business.
ii. Fraud in Connection with Assets: Any fraud in connection with the purchase or sale
of assets or the fact of asset having been mortgaged comes to the light by verification
only.
iii. Confidence to Shareholders and other Investors: Shareholders and other investors
cannot visit the company to verify the applications of their money. They can only rely
on the data provided by the management. Verification of assets and liability of a
company by an independent auditor will certainly boost the confidence of
shareholders and other investors on the company.
iv. True Information: Creditors and all other stakeholders of the company will get true
information about assets and liabilities of the business.
v. Facilitates Valuation: Verification enables auditor to determine whether the assets
and liabilities are overstated or understated.

Difference Between Verification and Valuation

Verification is a process of ensuring Valuation is a process of ensuring that
that the assets actually existed in the the assets are correctly valued by enquiry
business and enquiry into title of into whether or not valuation in being
ownership, charge. determined on the basis of generally
The main object of verification is to accepted conventions and accounting
check principles
existence, ownership and possession of The purpose of valuation is to see that
assets. the values of assets shown in the balance
Verification is the responsibility of sheet are determined accurately.
auditor. He himself certify regarding Being auditor is not supposed to be
verification of assets and liabilities. the technical person, he most of the
Verification includes vouching. occasions need to depends on the
 The term verification is broader certificate issued by
concept. The scope of verification is the certified valuated.
wider. Valuation does not include vouching.
Verification involves through scrutiny The scope of valuation is limited and
of assets and liabilities which may include narrow as compared with verification
vouching, physical verification and Valuation on the other hand only
valuation. involves checking the correctness of
value.