CHAPTER 1: INTRODUCTION TO AUDITING

College of Economics and Business Administration

Course : Principles of Auditing
Course Code : BSAC2104
Specialization: Accounting and Finance
 Learning Outcomes

1. Explain the purpose and scope of an audit, its types, and the meaning
of a true and fair view.

2. Describe the difference between auditing and accounting, and the

duties, power and responsibility of auditors.
CONTENTS

1. Introduction to Audit
2. Meaning of Audit
3. Definition of Auditing
4. Purpose of Audit
5. Scope of Audit
6. Types of audit
7. Meaning of true and Fair View
8. Difference between Accounting and Auditing
9. Duties, Power and Responsibilities of Auditors
 Introduction to Audit

Historically, the term Auditor was used to refer to the one to “Whom the Receipts and
Payments of an Organization were Read”.
• The word audit is derived from the Latin word “Audire” which means “To Hear”.
• In olden times whenever the owners of a business suspected fraud they appointed certain

persons to check the accounts.

• Such persons sent the documents to the accountants and “Heard” whatever they had to

say in connection with the accounts.

The original objective of audit was to check, whether the accounting party has properly
accounted the receipts and payments of cash.
Meaning of Audit

☻ Audit is a systematic examination of books and records of any organization to verify the
financial operations and transactions of a company.
☻ Auditor verifies the entry passed by an accountant and the accounts prepared by him.
So, when accounting ends and auditing starts.
☻ Auditing is to check whether Profit & Loss Account gives a true and fair view of the
Profit & Loss for the Financial Period. Accountant has to provide the best information
and explanation as per the Auditor’s request.
☻ Accounts, Books and Vouchers are checked in Auditing, which enables the Auditors to
satisfy themselves that the Balance sheet has been properly drawn up, so as to give a
true and fair view of the business concern at the current stage.
 Meaning of Audit

Auditing is done by a person having the required qualification of being an auditor.

Auditor has to determine whether the Generally Accepted Accounting Principles (GAAP) have been
followed.
Auditing is done with the help of vouchers, documents, information and explanations given by the
clients (Auditee) to the auditor.
The auditor reports that:
Balance Sheet shows a true and fair view of the state of affairs of the business.
Profit and Loss Account shows a true and fair view of the profit or loss for the financial period.
Books are properly maintained and accounts have been prepared as per the law of the land.
 Definition of Auditing
“Auditing is a systematic examination of the books and records of a business or the

organization in order to ascertain or verify and to report upon the facts regarding the financial

operation and the result thereof.”

- Montgomery (Leading American Accountant)

Generally Accepted Auditing Standards (GAAS)

 The auditor does auditing on the basis of certain laws, standards, principles, guide notes etc.

 Standards and principles on the basis of which the auditor conducts the audit work and gives report are called GAAS

 GAAS: The auditor is supposed and required to follow the following standards (GAAS) while conducting the audit work

and reporting the valuable findings:

 Definition of Auditing
1. General Standards:

 Independence: The auditor must be totally independent of the organization of which the auditing work is done.

 Due Care: The auditor should exercise due care while performing his/her duty as auditor.

2. Field Work Standards:

 Planning & Supervision: Auditor must plan the audit work properly & supervise during the conduct of audit

work.
 Internal Control: The nature, scope and depth of audit work depends upon the efficiency and efficacy of

internal control of the organization. The auditor must evaluate the internal control system properly.
 Evidences: Evidences are the grounds on which the audit stands. The auditor should collect, examine and

evaluate the audit evidences properly

Definition of Auditing
3. Reporting Standards:
 Financial Statements: Auditor has to certify whether the financial statement has been prepared using GAAP. If not, he

should state, what the deviations are and the reasons leading to such deviations.

 Consistency: Auditor has to certify that the financial statement has been consistent as per GAAP up to the current year.

 Disclosure: In case the auditor does not make any adverse comment, the financial statements are assumed to be

reasonably correct.

 Obligation: The auditor is required to give his report with his opinion after concluding the audit. In case, he is not able

to form an opinion, proper reasons must be furnished along with the report.
 Purpose of Audit
The Purpose of Auditing can be classified into three divisions as follows:
1. Main Purpose
2. Secondary Purpose
3. Specific Purpose

1. Main Purpose :
• To verify that the accounts are prepared within the framework of recognized accounting policies and practices.
• Auditing signifies whether the facts are presented in the Balance Sheet and Profit and Loss Account are true.

2. Secondary Purpose :
In this case, the auditing work is divided into two types
(a) Detection and Prevention of Errors and
(b) Detection and Prevention of Fraud.
 Purpose of Audit
(a) Detection and Prevention of Errors: The secondary objective is to detect and prevent the errors at
first sight, as innocent errors are ultimately found to be due to fraudulent manipulations. Therefore,
an auditor must pay particular attention to every error, however innocent it may appear to be at
first sight.
The following are the various types of errors:
A. Errors of Omission
B. Errors of Commission
C. Compensating Errors
D. Errors of Principle
E. Clerical Errors
F. Errors of Duplication
Purpose of Audit
A. Errors of Omission: If an accountant Forgets to pass the Journal Entry of any transaction partially or fully, then

these mistakes are called errors of omission. Accountant may also forget to post any journal entry in ledger

accounts.

B. Errors of Commission (EOC): In case an accountant passes Incorrect Entries in the Books of Accounts either

wholly or partially.

Ex: Wrong Entries or Wrong Posting or Wrong Carry Forward. Such errors can be verified be preparing a Trial

Balance but in some cases they may not be identified.

C. Compensating Errors (CE): These errors arise due to Two/More Mistakes Committed during counter balancing of

Accounts. Such an error is known as Compensating Error.

Ex: If the amount is wrongly debited by OMR 100 less and Wrongly Credited by OMR 100 such a mistake is

known as CE.
Purpose of Audit
D. Errors of Principle: The Errors committed by following Improper Accounting Principles, which
is mainly due to lack of knowledge of accounting.
Ex: Revenue Expenditure may be treated as Capital Expenditure.
E. Clerical Errors: The errors which are committed by accounting clerks on account of Ignorance
or Carelessness or Negligence are known as Clerical Errors.
Ex: The accountant, by mistake, enters an incorrect figure in accounts.
F. Errors of Duplication: The Errors arises due to double recording. It happens when Journal
entry is made twice in the Journal and posted twice in the Ledger book.
Ex: Salary expense was debited twice for the same amount.
Purpose of Audit
(b) Detection and Prevention of Frauds: This is one of the most important works in auditing. Fraud means false

representation or entry made intentionally or without belief in its truth with a view to defraud somebody. The
following are the main ways to commit fraudulent works:
1. Misappropriation of Cash
2. Misappropriation of Goods
3. Fraudulent Manipulation of Accounts

1) Misappropriation of Cash: Cash may be misappropriated purely based on the following issues
• Omitting to enter cash which has been received.
• Entering less amount than what has been actually received.
• Making fictitious entry in the payment side of cash book.
• Entering more amount on payment side than actual amount.
 Purpose of Audit
2) Misappropriation of Goods: The other misappropriation is related to goods. This type of fraud is very difficult to trace

especially when the goods are of high value but not bulky.

3) Fraudulent Manipulation of Accounts: This refers to forgery of accounts to show a different picture about the profits

or financial strength of the business. It is also known as “Window Dressing”. his type of fraud is difficult to discover

as it is done by the top officials of the firms.

• Ex: Showing more profit than the actual so that the commission earned on profits will be higher or to obtain

further credit by showing the financial position of the business better than the actual.
• In some cases, less profit than the actual will be shown to avoid the payment of taxes.
• Some times, the manipulation may also involve Under or Over Valuation of Assets and Liabilities; by

establishing a secret reserve or transferring revenue expenditure to capital account or by showing fictitious sales

or purchases.
 Purpose of Audit
3. Specific Purpose:
• Auditing not only includes the Financial Audit, it may also include other areas like
review of Operations, Performance Management Policy, Cost Records and so on.
• Accordingly, there will be specific objective in respect of each type of specific audits.
 Ex: In operation audit, the aim of audit is to evaluate the existing operation of
the firm in order to give expert advice to improve their efficiency.
 In cost audit, cost records are checked to report on the proper ascertainment of
the cost of production of goods or services.
 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.
 The scope of auditing objective should be long range and serve as a guide to the management in
future decisions.
 Today, most of the economic activities are largely conducted through public finance. The auditor has
to verify if these large funds are properly used (i.e., Public Money is handled properly & carefully).
 The scope of audit includes verification of accounts with an intention of giving opinion on its
reliability.
 The scope of audit should include understanding the increasing complexities of the business.
 Hence, it covers Cost Audit, Management Audit, Social Audit, Environmental Audit etc.
 Scope of Audit

The scope of an audit involves:

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 has to determine the scope of an audit of financial statements in accordance with the

requirements of legislation, regulations or relevant professional bodies.

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.

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 preparation of the financial

statements.

4. Proper Communication: The auditor should decide whether the relevant information is properly communicated in the

financial statements.
 Scope of Audit
5. Evaluation: The auditor must evaluate the trustworthiness and satisfactoriness of the information contained in the

underlying accounting records and other source data by making a study and evaluation of accounting system and internal

controls to determine the nature, extent, and timing of other auditing procedures.

6. Test: The auditor should assess the reliability and sufficiency of the information contained in the underlying accounting

records and other source data by carrying out other tests, inquiries and other verification procedures of accounting

transactions and account balances as he considers appropriate in the particular circumstances.

7. Comparison: The auditor has to determine whether the relevant information is properly communicated by comparing the

financial statements with the underlying accounting records and other source data to see whether they properly

summarized the transactions and events recorded therein.

8. Judgments: The auditor should conclude whether the relevant information is properly communicated by considering the

judgment that management has made in preparing the financial statements.

Types of audit
Audits are typically classified into three types:

1. Financial audit

2. Operational audit

3. Compliance audit
 Types of Audit
1. Financial Audit
 Financial audit or Audits of financial statement refers to the examination of
financial statements so as to determine if they give a true and fair view or
fairly present the financial statements in conformity with the specified criteria.
 The criteria may be International Financial Reporting Standards (IFRS) as in
Oman and many other countries, generally accepted accounting principles
(GAAP) as in the USA or national commercial company laws as the case
may be.
 Types of Audit
2. Operational Audit
 An operational audit is a study of a specific unit of an organization for the purpose of measuring its

performance.
 Operational audits review all or part of the organization’s operating procedures to evaluate effectiveness and

efficiency of the operation.

 Effectiveness is a measure of whether an organization achieves its goals and objectives.
 Efficiency shows how well an organization uses its resources to achieve its goals.
 Operational reviews may not be limited to accounting.
 They may include the evaluation of organizational structure, marketing, production methods, computer

operations or whichever area the organization feels evaluation is needed.

 Recommendations are normally made to management for improving operations.
 Types of Audit
3. Compliance Audit
 A compliance audit is a review of an organization’s procedures to determine whether the organization is

following specific procedures, rules or regulations set out by some higher authority.
 A compliance audit measures the compliance of an entity with the established criteria.
 The performance of a compliance audit depends upon the existence of verifiable data and recognized

criteria or standards, such as established laws and regulations, or an organization’s policies and procedures.
 Accounting personnel, for example, may be evaluated to determine if they are following the procedures

prescribed by the company controller.

 Other personnel may be evaluated to determine if they follow policies and procedures established by

management.
 Results of compliance audits are generally reported to management within the organizational unit being
 Types of Audit
Financial Audit Operational Audit Compliance Audit

Examination of financial A study of a specific unit A review of an organization’s

statements to determine of an organization for the procedures and financial records
if they give a true and purpose of measuring its performed to determine whether
fair view of the position, performance the organization is following specific
results and cash flows. procedures, rules or regulation set
out by some higher authority.
Meaning of True and Fair View

 An audit of accounts by an independent expert assures the outside users that the
accounts are proper and reliable. The outsiders can rely on the accounts if the auditor
reports that the accounts are true and fair.
 The accounts are said to be true and fair when:
1. the profit and loss shown in the profit and loss account is true and fair, and
2. the value of assets and liabilities shown in the balance sheet is true and fair.

 What constitutes true and fair is not defined under any law. However the following
general guidelines may be laid down in connection with true and fair:
a) Confirm to accounting principles
b) No window dressing or secret reserves
 Difference between Accounting and Auditing

S. No.
Auditing Accounting
1 Auditing deals with analytical and the critical Whereas accounting is concerned with collection,
examination of financial statements. classification and measurement of financial data.

2 It examines financial records and statements of It determines the profit or loss of an enterprise and
the business in order to discover errors and communicates financial condition of the business.
fraud.
3 An auditor should be professionally qualified An accountant need not be a professionally qualified
and certified by an authorized institution person
(e.g..: ACCA)
4 Auditor (independent) is not a permanent An Accountant is a permanent employee of the
employee of the organization organization.
 Difference between Accounting and Auditing

S. No.
Auditing Accounting
5 Auditing is done in accordance with the Accounting records are maintained in
Generally Accepted Auditing Standards accordance of Generally Accepted Accounting
(GAAS) Principles (GAAP)
6 An auditor should be familiar with An accountant need not to be familiar with
internal audit procedures, principles and the available system of internal auditing of
methods. the concern.
7 An auditor is generally appointed once Since an accountant is a permanent
in a year after the annual general employee he is working year after year.
meeting. He is appointed between two
annual general meetings.
 Difference between Accounting and Auditing

S. No.
Auditing Accounting
8 An auditor should submit his An accountant is not responsible to submit any
conclusive, clear and unbiased report report to the shareholders.
to the share holders
9 An Auditor is liable for his negligence An accountant is not liable for his negligence
and ignorance while performing his while he is performing his duties to the
duties to the users. management.
10 An auditor is responsible for An accountant is not concerned with any
conducting specialized audits specialized accounting required by the
required by various concerns. companies.
 Duties of an Auditor
 To make an intensive (serious/detailed) check of the system of internal control and
check and advise his audit and testing procedures accordingly.
 To make all verifications personally or through an experienced representative.
 To ensure that the financial statements fully conform to the Generally Accepted
Accounting Principles (GAAP) and relevant legal requirements.
 In case the financial statements disclose a situation even remotely hinting at a
fraud, to pursue the lead to its logical conclusion.
 Powers of an Auditor
 To ascertain the systems of accounting, internal control and management pattern of the
organization.
 To conduct a test check of the system of internal control to find out its soundness.
 To collect all evidences in support of the transaction and find out whether the transactions
entered in the books of accounts reflect the true nature of the transactions.
 To check the arithmetical accuracy of the records.
 To verify the valuation and existence of assets.
 To satisfy that the books of accounts are maintained according to the requirements of the
statute governing the business.
 Powers of an Auditor
 To examine whether the statutory requirements have been complied with.
 To report on the financial status of the business as could be found out from
the financial statements.
 To make recommendations for improvement in internal control and accounting
system.
 To verify the distinction between capital and revenue items.
 To verify the assets and liabilities and ensure that the assets are valued
properly.
 Responsibilities of an Auditor
A. The auditor should adhere to the basic principles of audit, namely, performance
of audit work with requisite skills and competence nature.
B. If an auditor believes that a suspected fraud or error could materially affect the
financial information, he should modify the existing procedure and introduce a
new one keeping in view the type of fraud or error.
C. If auditor’s suspicion of fraud/error is confirmed, he should see that the effect of
fraud is duly reflected in the financial statements, or that the error is corrected.
References
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cjA3qD6AhWwhM4BHRzhDbMQ1QJ6BAhUEAE&biw=1920&bih=969&dpr=1
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• Sources and links
• http://archive.mu.ac.in/myweb_test/study%20TYBCom%20Accountancy%20Auditing-II.pdf
• https://www.audit.pitt.edu/services/audit-services/audit-scope-and-objectives
• https://www.youtube.com/watch?v=XkfYG8mI9fs
• https://archive.mu.ac.in/myweb_test/study%20TYBCom%20Accountancy%20Auditing-II.pdf
• https://www.svtuition.org/2011/12/importance-of-true-and-fair.html
• https://www.auditorgeneral.gov.tt/content/duties-and-powers-auditor-general
• http://kamarajcollege.ac.in/Department/Commerce/II%20Year/e004%20Core%2020%20-
%20Auditing%20-%20VI%20Sem.pdf
CONTACT INFORMATION:

Name of Staff : Ms. Wijdan Saleem

Office:: BS050
Email: [email protected]
Office Number: Office Extension Number: 5218

VERSION HISTORY

Version No Date Approved Changes incorporated

05 Sem. (II) 2023/2024 Update and Revision of PPT

36