Auditing Notes_221103_182330_240716_121548.pdf

AUDITING Chap – 1 Introduction to Auditing 1) The word “Audit” is derived from Latin word “AUDIRE” which means to “hear”. In old days, whenever a businessman is suspected of any fraud/irregularity in the A/c, he used to appoint some expert wh...

AUDITING Chap – 1 Introduction to Auditing 1) The word “Audit” is derived from Latin word “AUDIRE” which means to “hear”. In old days, whenever a businessman is suspected of any fraud/irregularity in the A/c, he used to appoint some expert whose duty was to hear the Accounting statements read by the Accountant and make necessary comments thereon. In India origin of audit may be traced to Vedic period as Atharva Veda contains references to Accounting & Auditing. In year 1494, Luca pacioli, an Italian published his treatise on “Double entry system of Book keeping”, for the first time & mentioned & described the duties & responsibilities of Auditor usually in those days majority of the business organizations were proprietary concern & the Business were carried on small scale & usually proprietor himself used to maintain A/c’s and hence there was no necessity of checking them. However after the industrial revolution, production started on a very large scale with Joint stock company form of organization ownership & management was in separate hands. This increased need and scope of auditing. The original object was to detect & prevent errors and frauds and to ascertain whether the Accounts were “True and correct”. This emphasis on Auditing was on Arithmetical accuracy. However, now-a-days the object of the auditing is to ascertain whether the financial statements reflect a “True & fair view” of the financial affairs or not. -write short note on origin of Audit? 2) Meaning and definition of term Audit:- According to Spicer & peggler – “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 to give a true and fair view of the state of affairs of the business, and whether the profit & Loss A/c gives a true and fair view of the profit or loss for the financial period, according to the best of his information and the explanations given to him and as shown by the books, and if not, in what respect he is not satisfied. * According to the Institute of chartered accountants of India 1  AAS-1 “Auditing is an independent examination of finding information of any entity, whether profit oriented or not, and irrespective view to expressing an opinion thereon”. In simple words, auditing means checking the books of account As per the definition, it means an examination of the books of account in a critical and through manner with the supporting documentary evidences as will enable the auditor to report whether the Balance-sheet gives a true and fair view of the state of affairs of the business and whether the Profit & Loss A/c gives a true and fair view of the profit/loss during the period under audit. Thus person carrying out such an examination of the books of account is called an “Auditor”. Define and explain the term Auditing? * Financial Statements: I Items included in financial statement It includes, 1) Balance-sheet, 2) A statement of Profit & Loss, 3) A cash flow statement (wherever Applicable), 4) Statements & Explaining Notes. 5) Supplementary schedule & information II Items not included in financial statement:- 1) Reports of director 2) Statement of chairman. 3) Discussion and analysis by management; etc…. III The Balance-sheet gives a position of asset and liabilities of an entity as on a particular date and the statement of profit & loss reflects the financial performance of the entity for a particular period of time. IV These statements are prepared in accordance with the various guidelines and accounting standards issued by the ICAI. V It satisfies the information requirement of different users. 2 VI It is responsibility of the management to prepare the financial statement and not that of auditor. * What are the financial statement? * Users of financial statement: (SLC ISICE) 1. Shareholders: - shareholders are the owners of the company. They are spread all over the world and management of the company is in different hands only through the study of these financial statements, shareholders come to know whether the company is making profit/losses, whether it is financially stable and sound or in deep financial crisis & trouble, etc. 2. Lenders: - financial institution and others who have given loan to the company are interested in studying the financial statements of the company to whom they have given loan. This enables them to find out whether company’s liquidity & profitability position is strong or weak, whether they can recover interest and principal amount on time. 3. Customer/Debtor: - customers/debtors are interested in studying the financial statements of the company before buying or placing an order for goods to the company. If company is not financially sound or not having sufficient stock then there might be ex-ordinary delay in getting orders delayed, which may result in heavy losses. 4. Investors: - Those who want to buy share of a company have to study financial statement of that company. They have to study profitability, return on investment, Dividend payout ratio, EPS, etc…… before taking a decision whether to buy shares & invest money in company or not. 5. Suppliers/creditors:- creditors for goods and creditors for expenses are interested in studying the financial statements of the company before taking a decision whether to supply goods or services on credit basis to the company or not. If goods or services are given to the company on credit basis without studying its financial statement of the company then there might be tremendous loss due to Bad debt. 6. Interested parties:- if a person is joining a partnership as a new partner he will study the financial statements of the firm he is joining. If a company is taking over another company or merging with another company it will study the financial statement helps in determining value of goodwill, value of share, etc. 3 7. Competitors: - The financial statements of a company are public documents. Generally these statements of a company are keenly studied by the competitors of that company. It makes them aware about where they stand in comparison to that company in profitability, Liquidity & efficiency, etc. 8. Employees:- Many times employees and Labour unions demand increase in pay scale, higher bonus, and other allowances, etc. management is generally not willing to accept these demands saying that company is not making unions from the financial statement of the company. *“Who are the users of financial information?” Objectives of Auditing:- Auditing refers to examination of accounting and financial records to ascertain and give opinion whether such records show true and fair view or not. Objectives Primary Secondary 1. Primary objective: - The primary objective of audit is to enable the auditor to express opinion whether a) Balance-sheet gives true and fair view of the financial position of the entity and b) Profit & Loss statement gives true and fair view of the financial result of the entity. c) All material items are disclosed d) Final A/c comply with requirement of Law. 2. Secondary objectives:- Secondary object of an audit is detection and prevention of errors and frauds. The auditor has to check books of accounts, document, vouchers, etc. to ensure that the A/c are free from errors and frauds, so as to give true & fair picture. * What are the objectives of auditing? 4 Inherent Limitations of Auditing:- 1) Difficult to detect errors and frauds: - if accounts are prepared with malafied intentions and for that manipulations are committed, the auditor may not be able to detect such well-planned frauds. Similarly, auditor cannot check each & every transaction and hence some errors may remain un-detected. 2) Dependence on explanation: - Auditor has to depend on the information and explanation given to him by the management. If such information is wrong, Audit report will also be adversely affected and report shall be far away from Actual fact. Thus he cannot certify true & fair view. 3) Dependence on other experts: - Auditor has to rely on opinion given by different expert such as engineers, architect, Lawyers, Solicitors, etc. If these expert give wrong opinion, audit report will be adversely affected. 4) No assurance: - Audit cannot assure the user of A/c’s about the future, profitability & prospects of the company. Audit is just a post-mortem of past events or transactions. It does not give any guarantee/assurance about the future 5) Management influence: - The management may use corrupt practices to influence the auditor and he may not report to the owner (shareholder) their wrong doings. Sometimes auditor is appointed by the management and management itself is involved in some fraud and hence they try to influence the auditor & makes an attempt to get a clean certificate from the auditor. 6) Matter of judgement:- many items in financial statements are based on personal judgement e.g. provision for doubtful debt, method of depreciation, method of stock valuation, reserved for discount on debtors and creditors, etc. These provision prove to be correct or wrong in future as these provisions made on the basis of personal judgement & future is uncertain. 7) Inherent Limitations of Financial Statements:- Financial Statements are based on historical cost & hence they may not reflect true picture, even after audit due to inflationary trends. Similarly some aspect such as quality, pollution, HR development, etc. cannot be measured in A/c’s, hence Auditor cannot completely cover all the aspects of Business. * What are Limitation/inherent Limitation of Audit? 5 Distinguish between Accounting and Auditing. (Apr.98, Oct.01) Accounting Auditing 1. Meaning:- Accounting is maintenance of books of Auditing is an examination of books of account and preparation of final account and vouchers to report whether accounts. the final accounts exhibit a true and fair view of the business or not. 2. Nature:- It is connected with the preparation of It is connected with establishing the Balance Sheet and Profit & Loss reliability and authenticity of the Account. financial statements. 3. Commencement and End:- It starts when book-keeping ends. It It starts when accounting ends. It ends ends with the preparation of final with the submission of audit report. accounts. 4. Objects:- To find out the trading results and To certify the correctness of financial prepare financial statements & also to statements and to certify whether they find out the Net Profit for financial show a true and fair view of the period. business. The secondary object is to detect & prevent errors and frauds. 5. Qualifications:- Legally an accountant does not require Auditor must be a practicing chartered any qualifications. accountant. He needs prescribed qualifications. 6. Reporting:- An accountant is not required to submit An auditor has to submit report in the any report. prescribed form. 7. Status:- An accountant is an employee of the An auditor is an independent organization. professional person. 8. Scope:- It involves maintenance of books of It depends upon agreement or account. It does not go beyond the provisions of law. It may go beyond books of account. books of account. 9. Errors and frauds:- Accountant may commit errors and Auditor cannot and should not commit frauds in maintenance of accounts. errors and frauds. He has to detect 6  errors and frauds in the books of account. Distinction between Auditing & Investigation Auditing Investigation 1. Object:- To find out whether the Balance To know the essential facts about a Sheet and the Profit & Loss Account matter under enquiry. It is done with exhibit a true and fair view of some special purpose. business. 2. Period:- It usually covers one accounting year. It may cover more than one accounting year. 3.Conduct:- It is conducted for the owners of the It may be carried out for the owners business. or for any party interested in the matter. 4. Scope:- It is restricted to the Balance Sheet It may extend beyond the Balance and Profit & Loss Account. Sheet and Profit & Loss Account. 5. Compulsion:- It is legally compulsory for all the It is voluntary. It is required under companies whether private limited of certain circumstances. public limited. 6. Appointment:- Owners or the management appoint Even third parties can appoint auditors. investigators. 7. Report:- Form of audit report is generally Form of report is not prescribed. prescribed by the relevant act. 8. Qualification:- The Auditor must possess the The investigator qualification need professional qualification. not possess any professional qualification. 9. Re-work:- Re-Audit is not undertaken Re-investigation may occur. 7  what are the different types of errors? Errors Error of principle Clerical error Error of Compensating Error of Error of Omission Error Duplication Commission * Complete partial Casting Posting Recording Error Error Error Error of principle:- The principles of error generally occurs, when generally accepted accounting principles i.e. rules and regulations of Accounts are not followed properly. E.g.:- 1) Treatment of Capital Expenditure as revenue Expenditure and vice Versa. 2) Overvaluation or undervaluation of stock. 3) No charging of depreciating/charging excess depreciation. 4) Ignoring prepaid, outstanding income/exp. 5) Treating Dr. Expense on Cr. Side & vice versa. Write short note on error of principle? *Write short note on clerical Errors? Clerical errors are human errors, which are committed by clerks while process of recording financial transaction. Clerical errors a) Error of b) Compensating c) Error of d) Error of Omission Error Duplication Commission 8 1) Errors of omission:- The Errors committed by not recording transaction in the books of accounts is caller Error of Omission. Errors of omission Complete omission Partial omission *Complete omission – When a transaction is not recorded at all in the books of accounts then it is a case of complete omission. Such omission does not affect trial balance. Example: - Sales transaction not recorded at all. *Partial omission: - When a transaction is recorded only partially, then it is a partial omission such errors affect the Trial Balance. Example: - Goods sold to customers recorded only in sales Book and omitted to be recorded in parties Ledger. 2. Error of commission: - Errors committed while posting a transaction are called Error of commission. Casting error posting error Recording error 1) Casting error: - casting errors are committed while taking the totals or carrying forward Balances in day Book or ledger A/c. E.g.:- Total of sales book calculated as Rs.1,000/- instead of Rs.900/- Such errors affect the trial balance. 2) Posting error: - Posting errors may occur by way of a. Posting wrong amount E.g.:- posting Rs.1,000/- instead of Rs.100 b. Posting to the wrong side of the amount E.g.:- posting on the Dr. Side instead of Cr. Side. 9 c. Posting to the wrong amount E.g.:- posting to Mr. A’s account instead of Mr. B’s A/c. a. case. Will affect trial Balance. b. case. Will affect trial Balance. c. case. Will not be affecting the trial Bal. 3) Recording Errors: - Recording errors are errors which are neither casting error nor posting errors. They are basic errors in passing accounting entries. E.g.:- recording sale transaction as a purchase transaction. -such errors do not affect the Trial Balance. 3. Compensating errors:- When 2 or more errors are committed in such a way that the effect of one error is cancelled or Nullified by the other, then such errors are called compensating errors. In short, one error cancels the effect of another error. They do not affect the trial Balance. Example:- a) If one sales bill of Rs.50,00,000/- is recorded and simultaneously one purchase bill of Rs.50,000/- is also recorded against each other then they are called as compensatory error. It does not have any impact on the trial Balance as the omission of sales bill has been compensated by the omission of purchase bill. 4. Errors of Duplication: - Such errors arise when an entry is recorded twice in the books of Accounts such errors do not affect the trial Balance because both debit & credit effect are passed correctly. Example:- a) Reimbursement of expenses of the company driver, Mr. Ramu – Rs.626/- booked twice. 10  * What is a fraud? What are the types of frauds? Ans) Fraud means international or deliberately misrepresentation of financial information by management or any employee or any third party with an objective to cheat others or make illegal gains. Frauds Manipulation or alternation Misappropriation Deliberate Recording of Window Cash & Goods Teeming Lading Omission Bogus transaction Dressing 1) Manipulation or alteration of Accounts :- a) Deliberate omission A transaction may not be recorded at all in the books of Accounts Example: A cash sale of Rs.20,000/- made by a salesman , but not recorded by him / informed by him superior. b) Recording of bogus transaction:- Dummy or bogus transaction may be recorded in order to manipulate the financial position & profit & loss of the company. Example: Management / Owners may show dummy expenses to pay less tax & lower the profit. c) Window Dressing:- Window dressing refers to presenting financial statement in such a way that it will show a rosy picture than the actual position of the company 2) Misappropriation: - a) Following are the ways of misappropriation of cash:- Not recording cash received Enter less amount in the books Recording dummy cash payment 11 b) Misappropriation of goods:- Not recording goods received Recording only part of goods received By recording dummy sale Actual theft of goods c) Teaming & Landing :- Cash received from a customer Mr.Rupesh may be used by an employee for his own personal purpose. To hide the same he may record cash received later on from Mr.Rahul as cash received from Mr.Rupesh & Record cash received from Mr.Rahul & So on. This fraud done is called teaming & Lading 9) What are the circumstances that indicate errors and Frauds ? Ans: Errors is an un intentional mistake which results in misstatement of books of accounts. Frauds means intentional or deliberate misrepresentation of financial information by management or any employee or third party , with an objective to cheat others or make illegal gains. The following circumstances indicate errors and frauds :- 1. High level of suspense in accounts department 2. Sudden exits / registration from high level management 3. No proper documentation of transaction 4. Lack of paper proofs 5. No Proper / satisfactory explanation from management / Accountant for any entry / transaction 6. Many transaction in name of same parties (Corruption) 7. Changes / Big changes in Accounting ratios as compared to previous year 8. Payments / Receipts made / Received from unknown parties. Q10) What is the responsibility of the auditor with respect to errors and frauds ? Ans) Error is an unintentional mistake which results in misstatement in books of accounts. Frauds means intentional or deliberate misrepresentation of financial information by management or any employee or third party with an objective to cheat other or make illegal gains. 12 Shortcut: PACCA 1) Primary Responsibility of management The management is primarily responsible for prevention and direction of errors and frauds by implementing a good internal control system. 2) Auditors responsibility Detection of errors and frauds is a secondary objective of an audit. However the auditor should take steps to detect errors & Frauds 3) CARO (2016) Under CARO (Companies auditor report order 2016) the auditor is required to report whether any fraud is noticed and if so then the auditor has to report i) Nature of fraud ii) The amount involved 4) Confirmation of error and fraud When any error is confirmed, auditor should ensure that management has rectified the same. Further , when fraud is confirmed , auditor should report the same to an appropriation 5) Auditor not responsible The auditor cannot be held responsible for undetected errors and frauds if he had taken reasonable steps to detect them * Write a short note on secret reserves? Reserves means the part of profits reserved for future use. Secret reserves means part of profits secretly reserved for future use. Such reserves are not shown in the balance sheet. Secret reserves are exactly opposite of the term “Window dressing”. Window dressing means showing the balance sheet in for better position, than actually it is i.e. in simple layman’s language it means showing the bad financial condition of company. As good by manipulating it. * Why secret reserves are created ? (M H T BIKE) SHORTCUT 1. Mislead competitions: A concern like to mislead its competitors by hiding its real earnings. 13 2. Hide abnormal profit: Sometimes organisations / concerns may earn extra – ordinary or abnormal profit and company. May hide such profit for some future projects of the company 3. Tax evasions: Sometimes it may happen that owners in order to save amount / increase profit may show less reserves to evade tax. 4. Bank: Bank normally has to maintain legal reserves also bank are not allowed to disclose such amount of reserves to public to maintain confidence. *How Secret Reserves Are Created Secret Reserves Understanding of assets Overstatement of assets Understatement of assets 1) Record new fixed asset at lower cost 2) Omitted to record new fixed asset in books 3) Provide excess depreciation 4) Undervaluation of closing stock 5) W/O intangible asset like patent / goodwill 6) Ignoring prepaid expenses 7) Making excess provision for bad debts , doubtful debt , discount etc. Overstatement of liabilities 1) Record liabilities at higher at higher amount 2) Record fictitious liabilities in the books 3) Treating income as liability 4) Record contingent liabilities as actual liabilities 5) Record outstanding expenses at higher amount 6) Showing reserve as current liability *Objections against secret reserves (SHORTCUT – MANNNUS) 1) M – Management fraud – sometimes the management may commit fraud thus representing such amount as secret reserves 14 2) A – Against Companies Act, 2013 – Creation of any secret reserves is against the companies Act, 2013. Even if such reserves are maintained it must be disclosed as per the law 3) N – No true and fair view – If an organisation tries to maintain secret reserves , then it shall not be able to disclosed all the amounts in financial statement. Thus the company will not be able to disclose true picture 4) N – No check on asset – If an organisation does not keep watch on the asset , then there is chance that employees may misuse such assets. And also there small be on evidence for such transactions. 5) N – No insurance claim – In case of loss by fire , where such hidden are destroyed , the company will not get full compensation 6) U – Undue benefit to management – Maintaining secret reserve helps the management to go for any activity , which can benefit to any person personality , because such transaction have no proof or evidence 7) S – Suffering of owner / shareholder – If any share of profits are kept as secret reserves , then it would be loss for shareholders as such share of profit would had been distributed as dividend if they were not kept as secret reserve. AUDITNG * Write short note on “Materiality Concept” ? Ans) In Accountancy , materiality concept means it is assumed that all material items of expenses and incomes , assets and liabilities are shown separately in the final accounts & not hidden According to AAS – 13 (Auditing and assurance standard - 13) issued by institute of chartered accountant of India. The Auditor must confirm materiality Any information if its misstatement (. i.e. Omission or wrong statement) could influence the economic decisions of users. Materiality depends on the size and nature of item. Creditor should consider materiality at both the levels “Overall financial information” and “Individuals account balance 15 If auditor comes across any such misstatements then , he should request the management to rectify those misstatement and adjust financial information Whether a particulars item is material or not is a matter of professional judgement *Write a short note on “Going concern concept” Ans) According to AAS – 16 (Auditing & Assurance standard 16) “Going concern concept” in accounting means it is assumed that the organisation will be continued as a going concern for long time and that there is no intention to close it down in the near future. *Indicators of Absence of Going concern assumption 1) Financial Indicators: Negative net worth , negative working capital , Adverse key financial ratio’s recurring operating and net loss , negative cash flow position , increasing unsaleable. 2) Operating indicators: Loss of key perisomal , Labour problem , Loss of major customer / Supplier loss of infrastructure facilities like power , water , roads etc. 3) Other indicators : New legislation , chance in government policy , pending legal case , ban on products , change in technology etc. 4) Management Intention: Auditor after considering management plans and other factors, etc. The auditor should decide whether the come is going or not. 16  Chapter 2. Types of Audit 1) Write short note on balance sheet audit? 1. Balance sheet Audit : Balance sheet Audit is an “American Concept” in this type Audit , Auditor makes an detailed scrutiny of balance sheet. Verification and valuation of all the assets and liabilities is made thoroughly P&L A/c is not given much importance. Such type of Audit should be applied only if internal control system of company is very strong. Advantages of balance sheet Audit (SILLNO) a) Speedy completion: In balance sheet audit , only balance sheet items are checked thoroughly and internal control is checked thus such Audit can be completed fast. b) Improve internal control: The Auditor checks internal control system thoroughly , so he can give valuable suggestions to improve internal control. c) Less Expense: As Audit is completed in less time hence , it is less expensive d) Less Error & Frauds: As it is done at a stretch without interval there is no scope for error / Fraud e) No disruption of A/c work : As Audit is started after the final A/c are prepared there is no disruption of A/c work. Disadvantages of balance sheet Audit : (ENDNP) 1)Errors and frauds remain undetected – Auditor Examine only balance sheet hence error and frauds may remain in P&L & other A/c’s 2) Not suitable – If internal control is weak , then such audit cannot be applied 3) Delay in Final A/c & Audit – If final a/c preparation is delayed , the audit work will also be delayed because Audit starts , when accounts end. 17 4) No moral check – As audit begins after preparation of balance sheet there is no moral check on employees of client during the year. 5) Pressure of work – As on audit is done during the year but audit begins after the year is over and final A/c is prepared. Therefore this audit is not done during the year but after & final account is completed thus this increasable work load of audit staff , which may result in mistake in audit work. *Interim Audit It is conducted between two annual completed audits. The purpose of this audit to find out the interim profit or loss and to know the financial position at the end of a part of accounting year. It is necessary when quarterly results are to be declared , interim dividend is to be declared on sale of a running business or when there is admission , retirement or death of a partner. ADVANTAGES OF INTERIM AUDIT 1) Quarterly results – All public limited companies which are listed on the store exchange are required to publish their quarterly results. Interim audit helps comply with this legal requirement as audited results are reliable. 2) Interim dividend - When a company wants to declare interim dividend, it can sure that company is really making good profits to declare interim dividend on when its accounts are audited by interim audit. 3) Sale of business – When a running business is to be during the year , interim audit helps in fixing the purchase consideration. 4) Changes in Firm – When there is admission, retirement or death of a partner dissolution of a firm during the year , interim audit helps in valuation of goodwill earned. 5) Detection and prevention of errors and frauds – Interim audit helps in detection error and frauds at an early stage and it also helps in prevention of error and fraud 6) Moral Check – As audit begins along with the accounts to certify quarterly or has yearly results , there is a constant moral check on the employees of the client. 18 7) Quick finalisation – Interim audit helps in quick finalisation of accounts. There is a pressure at the end of the year as interim audit takes care of much of the audit during the year. 8) Utilisation of audit staff – As audit is done during the year , audit staff is utilisation throughout the year in a better manner. Interim audit can be taken up when audit staff is relatively free. *DISADVANTAGES OF INTERIM AUDIT 1) Expensive – As audit is conducted during the year more or less continuously, it is expensive as compared to balance sheet audit which is done after the balance sheet is prepared. 2) Disruption of accounts work – As audit is conducted during the year in different intervals , there is disruption and dislocation of accounts work. Accounts staff have to leave their routine work and attend auditors. This disrupts their work and creates backlog. 3) Possibility of alternation of figures – As there are intervals in the visit of audit – staff and auditor , there is a possibility that the accounts people may change the figures which are already audited. To overcome this, Auditor can keep a note of important figure in his audit notebook or create such system is computerised accounts that without his permission and information alternation in figures is not possible. 4) Possibility of alternation of figures – As auditor is not coming continuously but in intervals a query remaining unanswered may be missed by the auditor in his next visit. To overcome this , auditor should note down all his queries in his audit notebook and make sure that all his queries aree properly answered and solved. *Write a note on interim audit * What are the advantages and disadvantages of interim audit ? Continuous audit In this type of audit , auditor and his staff conduct the audit throughout the year continuously at regular or irregular intervals. This audit is suitable where the number of transaction is too large. In case of bug companies having turnover in crores and having numerous transaction , continuous audit is required to be adopted for completing audit quickly and in time. It is also required where there 19 is no internal control or weak internal check system or inefficient and suspicious accounts staff of the client. This type of audit becomes necessity where quarterly or half-yearly results are to be declared or where interim dividend is to be declared. ADVANTAGES OF CONTINOUS AUDIT 1) Speedy completion – As auditor is coming continuously at regular or irregular intervals, major part of checking is done during the year itself. At the end of the year audit can be completed fast and in time. 2) Quick detection of error and frauds – Continuous audit helps in detection of error and frauds at an early stage. It avoids consequential losses of the company. Similarly as auditor is visiting throughout the year , there is prevention of error and frauds as nobody dares to commit errors or frauds. 3) Quick finalisation – A auditor is coming continuously during the year at the end of the year finalisation of accounts becomes easily and fast. Final accounts of the company can be prepared in time so that its analysis is useful for the management to take decision for the future. 4) Moral check – As auditor gives surprise visits during the year , accounts department of the client is under constant moral check. Auditor gives surprise visits and checks bank reconciliation statements , stock – register , cash in cash box , journal register , minutes book and does ledger scrutiny. Accounts have to be kept up to date and perfect. There is no chance pending work error or frauds. 5) Knowledge of client’s business – As auditor visits regularly he , know clients business very well. He can visit production department , purchase department , sales department , department , research department , purchase department , sales department , account department , quality control department, human resource and administration department etc. and have more discussions with the directors , partners or manager and technical person and have better knowledge of client’s business which helps improving the quality of audit. 6) Better quality – As auditor is doing audit along with the accounts throughout the year auditor can check important item in detail and the quality of audit improves. He can do verification and vouching and ask for confirmation of accounts from different parties, be present at the time of stocktaking, use 20 ratio analysis and comparative statements for audit etc. This makes audit more reliable. 7) Audit staff utilisation – in continuous audit , auditor can make better of his audit staff. He can keep them busy throughout the year and there is no unnecessary pressure of work after the year is over. 8) Better advice – As auditor visits regularly he knows the business of the client in a better way. He can give valuable suggestions about improving internal control and internal check system. This can minimise and prevent errors and frauds. Auditor can also give suggestions to improve the probability , efficiency and liquidity of the company in a better way if he is doing continuous audit. DISADVANTAGES OF CONTINOUS AUDIT 1) Expensive – As audit is conducted during the year continuously it is more expensive or costly as compared to balance sheet audit or final audit which is conducted after the year is over and after the balance sheet is prepared. 2) Disruption of accounts work – As auditor gives frequent visits during the year , there is disruption and dislocation of accounts work. Accounts people have to attend to auditors and their routine work suffers. 3) possibility of alteration of figures - As there are intervals in the visits of audit – staff and auditor there is a possibility that the accounts people may change the figures which are already audited. To overcome this auditor can keep a note of important figures in his audit notebook or create such system in computerised accounts that without his permission and information alternation in figures is not possible. 4) Possibility of missing a query – As auditor is not coming continuously but in intervals a query remaining unanswered may be missed by the auditor in his next visit. To overcome this auditor should not down all his queries his audit notebook and make sure that all his queries are properly answered and solved. 5) Dependence on auditors – As audit staff is continuously doing audit during the year with regular intervals , A/c people of client become more dependent on audit staff for their work. 21 6) Collusion between audit and accounts staff – Constant visits by audit staff may create friendship between them & accounts staff of client. This may lead to covering up errors and frauds without reporting to higher authority. Concurrent Audit: - The word “concurrent” means consistent. This audit is carried out on a day to day basis each and every transaction are checked on that day itself. Frauds and mistakes in such a audit are detected fast and timely action can be taken to rectify such frauds and mistakes. Generally such type of audit is adopted in Banks, normally such type of audit is carried by highly qualified professional like CA’s (Chartered Accountant) Advantages of concurrent audit: (S2QM) 1) Speedy Completion – As this type of audit is done consistency thus this audit helps to complete other types of audit on time. 2) Quick detection of errors & Frauds – The Audit is done consistently and each and every transaction is checked and scrutinised in detail thus there is no gap for error and frauds. 3) Quick Finalisation – As auditor is coming continuously during the year , the finalisation of Accounts becomes fast and easy. 4) Moral Check – As auditor checks transaction and accounts everyday so the staff of the client is under constant moral check. DISADVANTAGES OF CONCURRENT AUDIT (DEC) 1) Dependence on auditor – As audit staff is continuously doing dependent during the year , the account staff become more dependent on auditor / Audit staff. 2) Expensive – As audit is conducted during the year continuously it is very expensive. 3) Collusion between audit and accounts staff – Constant visit of audit staff may create friendship , with accounts staff and this may result in errors and frauds 22 *Annual Audit – According to Spicer & peggler , annual audit means / defined as “An audit which is not commenced until after the end of financial year and then carried on until completed” It is same like balance sheet audit but only difference between balance sheet and annual audit is that , in balance sheet audit only scrutinizes balance sheet items i.e. Asset & Liabilities , but in case of annual audit the whole of the A/c’s. (Includes all ledger , trail balance , Final A/c) were to be scrutinized. ADVANTAGES OF ANNUAL AUDIT (LN3) 1) Less expensive – Audit is completed in less time it is less expensive as compared to continuous Audit. 2) No disruption of A/c work – Audit is started after final A/c is prepared & hence there is no disruption of A/c’s work. 3) No Alteration of figure – As audit is done at a stretch without any interval , then there is no scope for changing the figure. 4) No possibility of missing a query – As auditor is coming continuously without any break , there is no possibility of missing a query. DISADVANTAGES OF ANNUAL AUDIT (D3NET) 1) Delay in final accounts and audit – As audit will begin only when accounts are completed , so if accounts are delayed the audit will be automatically delayed. 2) No moral check – There is no examination or checking of accounts during the year and hence there is no moral check on the employees of the client. Thus which may ultimately result into error & Frauds. 3) Not suitable – If there are no strong internal control then such type of audit is not suitable in large MNC’s this audit is not suitable 4)No proper understanding of clients business – This audit has to be completed in time the problem with such audit is that the auditor has to 23 complete the audit in a very short span of time , where the Auditor has no time to understand the client business properly. 5) Errors and frauds remain undetected – The Audit is done only upto 31 st March hence if there is any fraud / error after 31st March they remain undetected. Also it is not possible for the auditor to check each and every transaction, hence auditor may go to check only a sample out of full A/c’s. Where. 6) Test – checking – Auditor has to apply test checking on sample transaction because auditor has less time for examining A/c’s hence there is chance that auditor may miss some item. * Statutory Audit – It is the audit which is compulsory under a statue or law. It is governed by respective statutory audit Eg: Companies Act, 2013 ; Banking regulation Act , 1949 ; income tax Act 1961 etc. Advantages 1) Exact Government revenue – The Audit helps in calculating & Examining exact data , thus the tax on such audit will be accurate. 2) Helps other forms of Audit – The statutory audit has to completed & submitted to respect government authorities. Thus this audit could help in completed & submitted to respect t government authorities thus this audit could help in competition of another type of audit. 3) Loan Facility – The banks can grants loans to such type of organisation who go for statutory audit. Because it is most reliable from of audit. DISADVANTAGES 1) Misleading – The statutory audit if wrong then it can mislead many stakeholders. Including government authorities. 2) Audit by specified professional only – Such type of audit can only be conducted by chartered accountants only. 24 AUDIT PLANNING , PROCEDURES AND DOCUMENTATION * Audit Planning - Q1) What is audit planning? and its advantages? Ans) The auditor should plan audit, so that the auditor may complete the audit work on time and in an efficient way. Normally the audit plan is always different for different types of audit & it must be on nature of business of client. * ADVANTAGES – (AUDITS) 1) Attention – Proper attention can be devoted on necessary areas , due to planning 2) Under control – Due to proper planning, the work of audit will be under the control of auditor. 3) Duly – Coordinated – Due to planning, auditor can easily coordinate with his staff , other auditor , and experts. 4) It is properly allocated – Due to planning the audit work can be properly allocated among the audit. 5) Selection of staff – The auditor can select the proper staff for the audit work , depending upon the skills and expertise. 6) Timely Completion – Due to planning the audit can be completed on time Q2) What are the various factors to be considered for planning the audit ? Ans) The factors for planning the audit are as follows (CA , CPT KE) Do level. 1) Consider time availability – The auditor can easily come to know about time available , so auditor can plan accordingly to complete the audit on time 2) Availability of audit staff – The Auditor has to consider that , how many audit staff are available and as such the audit must be planned 3) Complexity of the audit – Before planning the audit , the auditor must also consider the complexity of audit & then plan for the same. 25 4) Past experience with the client – Auditor must consider the previous experience with the clients for planning , as it also depends on the level of cooperation from the side of client. 5) Types of audit – Before planning , the auditor must see the type of audit ; then set time for audit and plan accordingly. 6) Knowledge of client business – The auditor before planning must have the complete knowledge of client business. 7) Discussion with client – Before planning , auditor must discuss with client the No. of staff available for audit 8) Level of readiness of staff – Before planning the auditor must check the No. of staff available for audit 9) Volume of transactions – Before planning the volume of transaction must be seen so as to plan , the audit properly. Q3) What are the various sources for obtaining knowledge about the business ? Ans) The following are the various sources for obtaining knowledge about the business of the client. a) Audit file of the P.Y , which includes auditing working papers of the audit staff b) From the financial statements c) Internal reports prepared by the client and which are shared by the auditor d) Minutes book , from where the minutes of meeting of shareholders , board of directors & other committee e) Policy manuals or hand book published by the client f) Industry publication , trade journals & magazines etc. g) Internal audit report etc. h) Visit office & factories of the client j) discussion with clients k) Changes in accounting system , procedure , policies & internal control system l) Any government & regulation which may affect development of the business. Q4) What is an audit programme ? What are the factors to be considered while developing an audit programme ? 26 Ans) An audit programme mean a “detailed plan of audit work to be performed , specifying the procedures to be followed. The following are the points to be considered (SCRAP-C1) 1) Support from client – While developing the audit programme the auditor should consider coordination and support from the client. 2) Clients nature of business – The Audit programme will also depend on the clients nature of business. It is because the audit programme will change on form industry to industry. 3) Reliance on internaicontrols – The auditor should consider the extent of reliance on internal control the scrutiny of account must be very strict. 4) Availability of Audit staff – The auditor must also check about the available staff for audit , and then go for audit programming as according to availability of staff the work can be allotted. 5) Previous year audit programme – The Auditor must also consider the previous year audit work to understand the areas where the auditor has to focus upon. It also becomes very helpful when audit staff is new. 6) Cost benefit analysis – The auditor must consider the cost of performing audit procedures and benefits i.e cost must not be higher. 7) Involvement of other auditor & experts – The involvement of other auditor i.e. internal auditor, etc must also be taken in accounts. i.e the auditor may not go for detailed scrutiny where the other auditors have worked open. State what are the types of audit programme? Audit Programme Fixed Flexible 1) Fixed audit programme is fixed once to the audit it and then this programme has to be follow strictly throughout the audit. 2) Flexible Audit programme is reviewed at regular intervals during the audit is modified considering actual circumstances. 27 * What are the contents of the audit programme ? The contents of audit programme differs from client also depending on type / nature of business. The following are the contents in audit programme. 1) Name of the clients & Accounting year 2) Date of commencement of Audit and date of completion of audit 3) Evaluation of internal control system 4) Vouching and verification 5) Ledger scrutiny of A/c 6) Analytical review 7) Checking disclosure in final accounts 8) Preparation of report 9) Allocation of work to the audit it staff 10) Time schedule *What are the advantages and disadvantages of making Audit programme? Ans) Advantages (FIRM SAGE) 1) Fixed responsibility – Responsibility for any mistake or negligence on the part of the clerk can be laid down. 2) Instruction to audit staff – It provides clear out instruction to the audit staff in carrying out work. 3) Review of work – The audit staff in carrying analyse the progress of audit work. 4) More clients – Due to systematic working the auditor may get more clients 5) Systematic – It facilities systematic auditing 6) Audit control – The chief auditor can control the work effectively 7) Guidance – It can serve as an important evidence in court 8) Evidence – It can serve as an important evidence in court DISADVANTAGES – (NIRMI) 28 1) No Adequate reward – The effort involved in the preparation of audit programme may not cover all the aspects of organisation 2) Incomplete – The programme may not cover all the aspects or organisation 3) Rigid – The work becomes rigid. Which may create monotonous work environment. 4) Mechanical – The work becomes mechanical which curbes the initiative & creativity of staff. 5) Insufficient evidence – Audit programme cannot revel quality of evidence. It shows only quantity of work. STATE WHAT ARE REMEDIES TO OVERCOME DISADVANTAGES Ans) Shortcut (SARCC) 1. Suggestion of the assistances:- The audit assistances should be encouraged to make suggestions for revising the programme. 2) Additional tests:- The Assistants must be made to be understood, that test conducted are only base to check the Areas in A/c’s. 3) Revisions:- The Audit programme must not be rigid, but it should be made as such, that it can be changed from time to time OR depending upon the situation. 4) Change in controls:- The internal control should be reviewed, so that the auditor becomes aware of the change in the control, systems & procedure. 5) Changes in operation & practices:- The auditor should obtain information about the New lines of business or new systems to carry the old business. * What are the methods of work that should be followed by the Auditors? Shortcut:-2RA2CU: 1. Regularity:- Auditor must Ensure that audit is carried out regularly and all the records must be maintained properly. 2. Reporting:- The Audit staff must report about the constant progress of the work to the chief Auditor. 3. Adequate Documentation:- All the Documents related to audit must be properly preserve at all the levels. 29 4. Cancellation of vouchers examined:- After examination, the vouchers must be immediately cancelled with an Audit stamp. 5. Confidentiality:- Audit staff must maintain confidentially about the clients information. 6. Use of Different coloured pens:- The Auditor must use different coloured pens for different types of process but it must not be revealed to the client. * What are the various steps to be taken by the auditors before commencement of an Audit? Ans) PKTAT: 1) Preparation by the client:- The Auditor must give the list of things that needs to be kept ready by client. Which includes: a) Vouchers b) Bank reconciliation statement & cash book c) Salary d) Balance from major debtor and creditor e) Register of Fixed Assets, etc. 2) Knowledge of clients business:- The Auditor should obtain sufficient knowledge about clients business from various documents like Articles of Association, memorandum of Associations, List of registers, A/c’s Book, etc.. 3) Type of Audit:- The auditor should find the type of audit such as financial audit/ interim audit/ tax audit/ statutory audit, etc. This helps the auditor in defining the time to complete audit on time. 4) Appointment of Auditor:- The Auditor must get the Appointment letter from the client before commencing his audit work; the letter is obtained from AGM/Board meeting as the case may be. 5) Types of document from client:- The Auditor must obtain various documents from client before commencing such audit a) Letter of Appointment b) Memorandum of Association c) Articles of Association d) Organizational chart e) List of related parties. f) Previous year/ financial year, etc. 30 * Write short note on “Audit working papers”? Audit working papers are written records kept by the auditor as regards evidence accumulated during the course of audit, methods, procedure followed, etc. Audit working paper includes:- 1) Trial Balance 2) BRS 3) Adjustment entries 4) Dep on Fixed Assets 5) Audit plan/ Audit programme 6) Certificate from management 7) Ledger Books 8) Final A/c – Trading & P&L A/c & Balance sheet 9) Details of closing stock. * Write short note on importance of working papers? Working papers are important due to the following: 1. The auditor can understand the sincerity of his assistants. 2. These papers help the auditor in finalisation of audit report without any delay. 3. It provides training to audit staff. 4. It provides a means to control the audit work. 5. Working paper are property of auditor. 6. Internal control could be easily understood. 7. Helpful for new staff. * What are the contents of the audit working papers? Working papers are written records which are prepared or obtained by the auditor during the course of Audit. Working papers Permanent file Current fi le *Permanent file:- - Permanent file contains paper of continuing importance. It gives information about the constitution of the organization, internal control system, etc. a) 1) certified copies of memorandum of Association 2) certified copies of Articles of Association 31  3) Trust deed. 4) partnership deed, etc. b) Nature of business. c) Laws, rules and regulations. d) Communication with the previous auditor & his reply. e) List of directors/ partners. f) List of related parties. g) List of officers with the Nature of work done by them. h) Details of holding and subsidiary company’s. i) Copy of audited a/c’s of earlier years. * Current file:- A current file contains papers which are relevant for the audit of current year only. 1) Letter of appointment 2) Copy of financial statement 3) Audit paper 4) Audit programme 5) Extract of minutes book 6) All working/ calculation/ discussion, etc. 7) Queries raised during audit and details of response. * Auditor’s right of lien:- - A lien is the right of 1 person to satisfy a claim against another by holding the others property as security. A person has a right to retain such property for non- payment of his dues for the work done. 1) Lien on working papers: The question of lien does not arise in case of working papers since they belong to the auditor. 2) Lien on clients books of Accounts: The question of lien can arise of clients books of Accounts if the client has not paid the audit fees of the auditor. NO Lien on Books of company:- 1) Provision of companies act:- E.g.:- The books also have to be open to inspection by directors, shareholders, officers of Govt, etc. 2) Legal cases. 3) The institute of chartered accountants of England and wales has stated that an auditor cannot have a lien on accounting records. 32 Audit Notebook:- * Meaning:- It is generally a bound book which records large variety of matters observed during audit. It is a notebook maintained by the auditor for recording a large variety of matter observed during the course of audit. It contains errors difficulties, doubtful queries of various accounting records. It is a part of the current audit file. Contents of audit notebook:- Audit note book contains information about the following:- 1) Name of the client and the audit year. 2) List of accounts books in use. 3) Organization chart containing important officers, their duties and responsibilities. 4) System of A/c’s and Internal check in operation. 5) Routine queries like missing vouchers receipts, etc. 6) Mistakes & errors noticed during the course of audit. 7) Audit matters communicated with clients. 8) Extract from minutes and contracts. 9) The Audit programme. 10) Analysis of transactions & balances. * Importance of audit Note book:- The following is the importance of an audit note book. 1. Helps in finalization of audit reports: - The Audit notebook helps the auditor in finalization of audit report. It also contains detains regarding various items in the financial statement. 2. Helpful for next year’s audit:- - With help of audit note book, auditor staff can plan for next year audit work. 3. Evidence in court of Law:- - Audit notebook is a proof that the auditor used for future reference. 4. Audit evidence:- - Audit Notebook constitutes important evidence of matters considered by the auditor during the course of the audit. 5. Recording queries:-Audit notebook can be used for recording the various queries raised in the course of audit & their disposal. 33  Module 3 – AUDITING TECHNIQUES *what is test check? “Test checking means to select and examine a representative sample from a large No. of similar items.” According to the International Auditing Guideline test checking or audit sampling means checking less than 100% of items within an Account, balance or class of transaction. Big Business houses/multinational Co.’s have a lot of transaction. So it is very difficult to check all the transaction in detail. An Auditor needs to prepare and present report in short period of time. So an auditor checks the sample transactions and prepares and present report to the concerned authority which is known as test checking. Example of test checking:- The following example how the test check should be used: 1) Checking only 1st quarter out of total 4 quarters. 2) Checking the Bills & vouchers only of amt of Rs.1,00,000 and above. 3) Or; check every 10 th Entry. Features of test checking: - JIM’s SSC 1) Judgement: - The test checking; is purely based on personal judgement of the Auditor. The Auditor’s judgement depends on the previous experience of the auditor. 2) Item selected on random basis:- In test checking any entry or transaction selected is purely on random basis. 3) Material item:- Under the test checking, the material amount is checked on mandatory basis. 4) Selective verification:- In test checking, only a few of transaction is selected and scrutinized on the basis that if the selected sample is correct, then it shall be assumed that all the Entries are correct. 5) Surprise check:- In test checking, the Auditee of the company must not be able to anticipate/estimate the pattern of test checking, otherwise they will be able to predict the areas and periods to be covered in any one year. The Auditor must be very careful. 6) Complete coverage:- Test check is generally planned in such a way that in the audit programs if out of 12 months April, December and March is checked, 34 and based upon this it shall be assumed that, full year is covered. This type of sampling may be used in firms & MNC’s which have Large No. of transaction. State what are the factors in deciding the size of sample? Ans) Shortcut-(RIT NAAP) 1) Risk tolerate level:- If there is a heavy risk involved in not checking the items, the auditor may check the items in detail so in such case the sample size needs to be increased the risk of tolerance level is more if sample size is small. 2) Internal control system: - If the internal control system is efficient, the auditor can restrict the size of sample to minimum. 3) Time: - The auditor may select the size of sample depending on the schedule of Audit. 4) Nature of Business: - If the Nature of Business is repetitive in Nature, the auditor can select small size of sample. 5) Audit objectives: - If the object of audit is to verify correctness of data, Entire transactions are to be checked. 6) Analytical reviews: - By conducting the critical examination, of financial statements, by Analytical reviews like using ratio’s and other formulas, the auditor can find the errors and frauds. 7) Previous history: - The Audit history of the organization in the past also helps to decide the size of sample. The audit depends on previous history. State what are the Advantages and Disadvantages of test checking? Ans) Advantage:-(Shortcut: SMS AT MT). 1) Special Attenetion:- The auditor can pay special attention to important matters. Test checking reduces the labour work on the part of audit staff. There is sufficient time period to settle important matters. 2) Many Audits:- Test checking is useful to complete many audits in one year. It saves sufficient time, which can be used to check the books of new clients. The Auditor is able to raise more income. 3) Suitable for large organisation:- Big Business houses have a lot of transaction, so it is very difficult to check all the transactions in detail so test check is suitable for large size organisation. 4) Assurance:- Test check gives assurance of accuracy & reliability of transaction to some extent. The test checking is a step in the right direction to prove accuracy. 5) Time saving:- Test checking helps an auditor to complete work on time because test of few transaction can be made. 35 6) Moral check:- Test checking creates a moral check on the employees of the client since they are unaware as to which transaction will be checked by the auditor. So Employee has to be alert all the time. 7) Timely completion of work:- An auditor can complete the work of audit of various organisations within given time because each & evry transaction is not to checked. Disadvantages:-(Shortcut:-FER NSDS) 1) Frauds:- The demerit of test checking is that planned frauds may not be disclosed. The fraud discovery is the responsibility of management. The audited Accounts cannot show true & fair view when fraud exists in books. 2) Errors:- The demerit of test checking is that errors are not disclosed by it. In the presence of error true & fair view is not possible. No doubt the location of errors is the duty of management but it affects the audit work. 3) Repots:- The auditors report may fail to disclose true & fair view of business matters. After test the auditor signs checking the auditor report. The auditor is responsible for audit report based on test checking. 4) Not suitable for small organisation:- Test check is not suitable method for the audit of small organisation. Because there are very few transactions on the small organisation. 5) Smaller sample:- To reduce the work the audit assistants may take smaller samples due to which a lot of transaction may remain unchecked. 6) Detail checking is not done:- All the transactions are not covered in test checking hence it is not an auditing in full, only a few areas may be checked in the audit. 7) Selection of sample on random basis:- The transactions to be checked & the Extend of checking are selected on a random basis. The selection depends upon the personal judgement of auditor. State what are the precautions to be taken while test checking? Shortcut:- DAN N TDS:- 1) Decide No. of transaction:- The transaction must be properly classified under suitable heads. Then sample should be selected from each head to cover all the areas of audit. 2) Avoid unsuitable Ares:- Test check may not be suitable on:- a) Opening and closing entries. b) Bank reconciliation statement. c) Very important or material transaction. d) Vouching cash book. e) Seasonal, non-recurring or exceptional transaction 36  f) Items requiring calculations/Estimation. 3) No Bias in selection:- The samples should be selected on a random basis and there should not be any bias in their selection. 4) Not disclosed to clients:- Clients staff should not come to know of the entries selected for test checking. Auditor should not disclose to client staff, so there will be effective audit. 5) Test check plan:- A properly thought out test check plan should be prepared. The objective of each check should be clearly understood by Auditing staff. 6) Decide significance of errors:- The errors may be divided into 2 parts 1) Tolerable error 2) Non tolerable error Tolerable error means a error, which does not affect financial statement & is of not more relevance. Expected error means the error which not affects the financial statement & it is not greater than tolerable error. 7) Selection of sample:- The sample must be selected on proper basis, without any unbiasedness and whole sample selected must represent all the transactions. What do you mean by internal control? Meaning:- Internal control refers to all the policies and procedures that are adopted by the management to ensure:- 1. Smooth and efficient operations of the business. 2. Optimum utilization of resources. 3. Prevention of errors & frauds. Internal control is wider concept, it covers internal check, internal audit and other forms of control. What are the features of Good internal control system:-? Following are the characteristics of a good internal control system 1. A plan of organisation which provides proper division of responsibility. 2. A proper system of authorisation and record procedures in order to ensure reasonable control over assets, liabilities, revenues and expenses. 3. Sound practices to be followed by each department. 4. Competent people. 5. Effective managerial supervision and review. 37 *State the purpose and Advantages/objectives of internal control:-? Accounting controls:- 1. All transaction are duty authorised. 2. All transaction are properly recorded. 3. All transaction are recorded promptly as soon as they occur. 4. All accounting policies adopted by the management. 5. The assets are safeguarded. 6. Errors and frauds are prevented & detected. 7. The books of A/c’s are complete & accurate. 8. The final A/c’s are reliable & ready in time. *State what are the Auditor’s duties towards internal control? 1. Responsibility of management:- The management is responsible for establishing & operating the internal control system. 2. Auditor’s Duty:- The Auditors duty is to study the system, check whether the system was actually in operation during the year and evaluate the system to ascertain how much he can rely upon it. 3) Need for evaluation:- An auditor needs to evaluate the internal control system for the following reasons: a. Establish reliable internal control:- An auditor has to Ascertain whether he can rely upon the internal control, so that he can be sure that all transactions are authorised, recorded properly, accounting policies are properly followed. b. How much to check:- It is not possible to do a detailed vouch & post audit when the Number of transaction is large. A detailed audit is also not necessary when the accounts are computerized. If the internal control are reliable, he can use test checks and concentrate on only the important areas of Audit. State what are the steps to be followed as remedies/steps? The auditor should take the following steps:- a) Understand the system:- In the first step, the auditor should understand the system of internal control with help manual, discussion with managers,etc. b) Test application:- He should check whether the controls were actually applied in practice. He can check some transaction in depth. 38 c) Evaluate the system:- He should judge on the basis of above tests whether he can rely on the system and if so to what extent. d) Communicate weakness to management:- The material weakness in internal control should be communicated to the management by the auditor, such communication should be in writing. e) Report under CARO, 2016:- Auditors had to report, about internal control over purchase of inventory, fixed assets and the sale of goods, whether, a) Internal control is commensurate with the size & nature of the company and its Business. b) There is a continuing failure to correct major weakness in Internal controls. State the Inherent Limitations of internal control? (Shortcut: - HH 3MNC). 1) High cost:- cost of implementing a control procedure may be much more than its benefits. 2) Human error:- A control procedure may not prove effective due to human errors. E.g.:- carelessness of Employee, wrong judgement, etc. 3) Misuse of employee:- An employee responsible for a particular function may misuse his authority. 4) Manipulation by management:- manipulation & misappropriation by top management will defect the very purpose of internal control. 5) Misunderstanding of internal control:- Internal control is designed by management. It is necessary that employee should understand implementation of internal control in detail manner. 6) No Strict Action:- If internal control is weak, strict action are required, if any weakness arises management not taking any strict action against weak internal control. 7) Collusion:- Even if duties are divided among different employee, they may work together fraudulently. 39 *Write short note on internal control for sales/purchases/salaries/wages: 1) Division of works:- There should be proper division of work responsibility of members of the staff works relating to it should be divided among different department. 2) Cross check: - The work should be divided in such a way that it are prepared by different person and are automatically checked by another employee. 3) Change in duties:- The duties of concerned employee should not do the same work for long time. 4) Access to books: - The other department staff should not have access to the books of Accounts. 5) Proper recording: - All items should be properly recorded recording should tally with documents. 6) Separation of Account & control:- No person should be able to establish accountability over his own operation. 7) Safeguarding:- Safeguards should be prescribed to keep unused receipt, cheque book, field, bill, etc. to avoid their misuse. 8) Confirmation:- Confirmation of balance should be obtained from them at least once during the years. *Internal control for debtors:- 1. Credit Limit:- The Credit Limits for debtor should be. a) Fixed on a basis, which is clearly laid down. b) Approval by an officer interdependent of sales dept. c) Checked before accepting orders from customer. d) Reviewed from time to time. 2. Prompt recording:- The procedure should ensure prompt recording of amount due from debtors. 3. Prompt Adjustment:- Auditor should ensure that any amount paid against bill then properly adjusted in A/c if any unadjusted amount must be reconciled. 4. Time/period:- There should be a procedure for preparing time wise schedule (E.g.:- 1 month, 2 months, 90 days, 120 days, 15 days) 5. Statement of Account:- Auditor must ensure that statement of A/c’s are properly prepared. The debtor should be requested to check the statement with their own records. Debtors should be requested to confirm the balance or point out differences. 6. Reconcile control account:- 40 There should be a system of periodic reconciliation with the related control A/c’s. 7. Confirmation:- The Account balance department should ask for balance confirmations from party on regular basis to ensure that transactions have been recorded properly. 8. Payment:- The Accounts manager should ensure that payment is made to the party as per credit terms mentioned in invoice. Internal control for creditor:- 1) Prompt recording:- The procedure should ensure prompt recording of amount. Auditor should check whether amount is properly recorded or not. 2) Prompt Adjustment:- Auditor should ensure that any amount paid against bill then properly adjusted in account if any unadjusted amount should be reconciled. 3) Time/period:- There should be a procedure for preparing age wise schedule of creditor E.g.:- Amount outstanding for month outstanding for 2 months, etc. 4) Statement of A/c:- Auditor should ensure that statement of accounts are properly prepared. The creditor should be requested to check the statements with their own records. 5) Reconcile control A/c’s:- There should be a system of periodic reconciliation with the related control A/c. 6) Payment:- The accounts manager should ensure that the payment is made to the party as per the credit terms mentioned in the invoice. 7) Discount & write back:- All material Adjustment in the creditors A/c’s such as discount received, should be approved by manager. What is Audit sampling? State the purpose of audit sampling? Methods of selecting sample items:-? Meaning:- 1) “Audit sampling” means the application of audit procedures to less than 100% of the items selected, in order to form or assist in forming a concerning the population. 2) The Audit sample selected from a population is evaluated to form a conclusion about the whole population. The purpose of sampling:- a) To enable auditor to design, select an audit sample. b) To evaluate sample results. c) To obtain appropriate audit evidence. 41  * Methods of selecting sample:- 1) Random Selection 2) Systematic Selection 3)HaphazardSelection 1. Random Selection:- Random selection sample ensures that an items in the population have an equal chance of selection, The random sampling can be further classified in 2 types Simple random sampling Stratified sampling E.g.:- Out of 1000 transactions recorded auditor will choose any 300 number transactions from any quarter of a year. 2. Systematic Selection:- This method of sample selection is also known as interval sampling. It involves selecting items using a constant interval between selections, the first interval having a random start. E.g.:- every 20th voucher must be checked. 3. Haphazard Selection:- Under this method, auditor selects the samples on a haphazard manner. There is no particular pattern that is followed. However, care should be taken to avoid any kind of Biasedness. *State what are the factors in determining sample size? When determining the sampling size, the auditor should be consider sampling risk, the tolerable error & expected error. 1. Tolerable error:- Tolerable error is the maximum error in population that auditor would be willing to accept & still concludes that result from sample has achieved the audit objective. Tolerable error is considered during the planning stage & substantive procedures, is related to the auditors judgement about materiality. The smaller the tolerate error, the greater the sample size will need to be. In tests of control, the tolerate error is the maximum rate of deviation from a prescribed procedure. In procedures, the tolerable error is maximum monetary error in an Account that the auditor would be willing to accept so that when the 42  result of all audit procedure are considered, the auditor is able to conclude. 2. Expected Error:- If the auditor expects errors to be present in the population, then the sample size would need to be larger to prove that the Actual error is not greater than the tolerable error. The auditor needs to consider the following for determining the expected error in expected error in the population: a. Error levels identified in previous audits. b. Change in the entity’s from other procedures. *State the factors in determining sampling risk? Sampling risk is basically the probability that the auditor may approve at a different conclusion, the sample size and sample risk have an inverse relation. Lower the risk the auditor is willing to accept, the greater will be sample size. The auditor is faced with sampling risk in both test of control and substantive procedure is as follows:- A) Test of control; B) substantive procedure C) Effect of sampling risk on audit. A) Test of control:- a) Risk of under reliance. The risk, although the sample result does not support the auditor’s assessment of control risk, the actual compliance rate would support such an assessment. b) Risk of over reliance:- The risk that, although the sample result supports the auditor’s assessment of control risk, the actual compliance rate would not support such an assessment. B) Substantive procedures:- a) Risk of incorrect rejection:- The risk that, although the sample results the supports the conclusion that a recorded account balance or class or transaction is not materially misstated, in fact it is not materially misstated. b) Risk of incorrect acceptance:- The risk that, although the sample result support the conclusion that a recorded A/c Balance or class or transactions is not materially misstated. C) Effect of sampling risk on Audit:- a) The risk of under reliance and the risk of incorrect rejection affect audit efficiency as they would ordinarily lead to additional work being performed by the Auditor and Vice versa situation. 43 Module 4 – VOUCHING &VERIFICATION Q1) Write a short note on Vouching? Ans) Meaning:- 1) Vouching is an important procedure for obtaining audit evidence. 2) Vouching means examination of documents & evidence in support of entries. 3) It includes ensuring that entries & transaction have been properly entered in the Book of Accounts & other Accounts. *Objectives of vouching:- 1) All transactions are recorded properly in books of accounts. 2) All entries are supported by proper evidence. 3) No fraudulent transactions are recorded in books of Accounts. 4) Transactions are properly authenticated by a responsible person. Q2) what are the points to be considered before vouching? Ans) Point to be considered in vouching is as follows:- 1) Name of party:- Voucher should contain the name of party, whose accounts are being audited. Name of the party on top of the document is a proof that transaction pertains/relates to the client. 2) Date:- It is important to verify that the transaction pertains to current year & not to Earlier OR next year. 3) Amount:- The amount written in word helps to prevent alteration of amount in figures. The amount should tally with the amount as per the documents. 4) Serial No:- Voucher should be serially Numbered No Entry’s OR voucher No’s must be missed out. Or Sr. No’s must always be in chronological order only. 5) Supporting documents:- Auditor must carefully verify documents such as cash book, vouchers, bills, etc. 6) Signature:- On every voucher proper authorized signature must exist. This proves that transaction & entry is valid. 7) Errors:- Auditor should ensure that there is no error of commission or omission. He should pay attention to the transaction at close year end. 8) Disclosure in schedule III:- 44 Amount & quantity both should be disclosed separately as per the requirements of schedule III. 9) TDS:- Auditor should also verify the provision of income tax i.e. whether co. has properly deducted TDS on eligible transaction. Q3) Write short note on the vouching of credit sale/cash sale? Ans) The auditor should check following points while vouching the sales:- 1) Name: - Auditor should check the Name of the concern on sales bill & on the sales register & in supporting documents. 2) Date:- Auditor should examine date on the sales bill in the sales register & in the supporting document whether current year or not. 3) Amount:- Auditor should examine that amount in figures & words on the sales register & the supporting documents. 4) Serial No:- Serial No. on the sales bill should be continuous & tally with those in the sales register. 5) Error & Fraud:- Auditor must ensure that there is no error and fraud, the Auditor must check especially during the year end transaction & i.e. cut off date. 6) Signature on bills(authorization):- Auditor should check whether entry is (sales entry), properly signed & authorized by senior personnel’s. This ensures strong internal control. 7) Proper accounting:- Auditor should check, whether entry is correct according to basic’s/rules of Accounting & Accounting standards. 8) Disclosure in schedule III:- The sale must be properly disclosed in final A/c’s, under profit & loss A/c statement under sales.(Income from operations). 9) Supporting documents: The sale transaction should be supported by sales bill and with other supporting documents like challan/octroi receipts, etc. Q4) Write short note on Vouching of Rental income? (Any 9 Points) Ans) Auditor should check following point:- 1) Name:- Auditor should check name of the concern in the rent receipt, in the rent agreement, on bank book, and pay-in-slip should be of the clients. 2) Date:- Auditor should examine date on the rent receipt, in the bank book, pay-in-slip and in the supporting document whether current year or not. 3) Amount:- Auditor should examine that amount in figures and words on the rental receipt must be same & tally with the amount in the supporting documents. 45 4) Serial No:- Serial No. on the rent receipt voucher should be continuous & tally with those in the Accounts. 5) Error and Fraud:- Auditor should ensure that there is no error of commission or omission. 6) Signature on bills:- Auditor should check that the Rental Agreement & other related documents must be signed by authorized official only. 7) Proper accounting:- Auditor should see that rent receipts are properly accounted in the books. Auditor should check whether entry is correct according to basic principle of Accounting. Auditor should see that transactions are properly recorded in the books. 8) Disclosure vide schedule III:- Total amount of rent received is properly disclosed in the statement of P&L under the head “other non-operating income”. 9) Supporting documents:- The rent received should be supported by copies of rent receipts, pay-in-slip for deposit in Bank Account, rent agreement. 10) Reconciliation:- The Auditor should reconcile transactions. If there is any difference in reconciliation statement, then auditor must try to find out reasons for differences. Q5) Write short note on Vouching of Dividend income? Ans) 1) Name:- Auditor should check name of the concern on the dividend warrants, in the pay in slips, in Bank book & in other document of the client. 2) Date:- Auditor should examine date on the dividend warrants, & in the supporting document, whether the date relates to current year or not. 3) Amount:- Auditor should examine that amount in figures and words on the pay-in-slip should be same & must tally with the amount in the bank book & supporting documents. 4) Serial Number:- Serial No. on the bank receipt voucher should be continuous and tally with those in the accounts. 5) Error & Fraud:- Auditor should ensure that there is no any kind of Error or fraud. 6) Signature on bills:- Auditor should check whether Dividend warrants should be signed by authorized official. 7) Proper accounting:- 46 Accounting should see those dividends are properly recorded in the books of Accounts. 8) Disclosure in schedule III:- Total amount of dividend income is disclosed in the statement of P&L under the main heading other income. 9) Supporting documents:- The Auditor must also check Dividend warrants & Bank receipt voucher, etc. to confirm the entry recorded in the Books of Accounts. Q6) Write short note on Vouching of interest income? Ans) 1) Interest Receipt:- Auditor should examine the counter foil or carbon copies of the receipts issued. He must also check cash/Bank book to ascertain that entry has been passed for correct amount. 2) Terms:-/ Rental Agreement:- The Auditor should examine the agreement for verifying the amount of interest. 3) Installments:- Auditor should ascertain that installment is also received along with interest, see that only the interest element is credited to the interest account. 4) Rate of interest:- Auditor should see whether loan given to other companies are at a rate of interest not less than bank rate. 5) T.D.S:- Auditor should see that if interest is received net of T.D.S i.e. Rent received is if after deducting T.D.S., then Auditor must also check Form No.16. 6) Reconciliation:- Auditor should check reconciliation of Interest income if there is any difference in income then Auditor must try to find the reason for differences. 7) Disclosures in schedule III:- Interest received is disclosed in the statement of P&L A/c under the head other income. Q7) Write short note on Vouching of Royalty of income? Ans) 1) Agreement:- Check royalty agreement & provisions for calculating the royalty. 2) Correspondence:- Check correspondence with the party, so that amount can be confirmed. 47 3) Calculations:- Auditor must be check calculation of the royalty received, with the Agreement. 4) Provisions:- Auditor must check provisions as regards to royalty income the provision means rules & regulations. 5) Receipt:- Auditor should examine counter foils or carbon copies of the receipts issued, with the cash book. 6) FC earning:- Earning in foreign currency from royalty shall be disclosed as additional information by way of Note. Audit of Expenditure:- Write short note on purchase (cash/credit)? Ans) Auditor should check following points:- 1. Name:- Auditor should check name of the concern on the purchase bills, on the purchase register & in the supporting documents should be of the client. 2. Date:- Auditor should also examine date on the purchase bill, on the purchase register & should tally & must pertain to the current year. 3. Serial No:- Serial No. on the purchase voucher should be continuous and tally with those in the purchase register. 4. Amount:- Auditor should check that amount in figures and words on the purchase voucher should be the same and tally with the amount in the purchase register & supporting documents. 5. Supporting documents:- The purchase should be supported by purchase voucher, cash memo, delivery challan, transporter’s bill, GRN, etc. 6. Signature:- Auditor should also check signature of authorized officer on the bill. 7. Quantity:- The quantity mentioned in the purchase bill should tally with the supporting documents. 8. Error and Fraud:- Auditor should ensure that there is no error of commission or omission. 9. Disclosure in schedule III:- Purchase of stock-in-trade is disclosed separately in the statement of P&L under main head. Write short note on salaries & wages:- Ans) Auditor should check following points:- 1) Name:- Auditor should check name of the concern on the payroll on wages register. 48 2) Date:- Auditor should also examine date on the payroll, on the wage register and should tally and pertain to the current year. 3) Serial No:- Serial No. on the payroll should be continuous and tally with those in the wage register. 4) Amount:- Auditor should check that amount in figures & words on payroll should be the same & tally with the register & supporting documents. 5) Supporting document:- The purchase should be supported by payroll, cash memo, wage-sheet, etc. 6) Signature:- Auditor should also check signature of authorized officer on the bill. 7) Error and Fraud:- Auditor should ensure that there are no Errors of commission or omission. 8) Disclosure in schedule III:- Salary is disclosed separately in statement of P&L under the main head-Employee benefit Exp. Write short Note on Rental Expenses? Common points same as above Write short note on insurance premium? Common point same as above Write short note on telephone expenses? Common points same as above Write short note on Advertising? Common point same as above 49  Verification Meaning:- It means inquiry into the value, ownership & titles Existence and presence of any charge on assets. It means confirmation regarding certain transaction and physical examination of certain assets. Verification include valuation:- The existence of assets or liability on a given date. Ascertain that assets are free from any charge. Assets & Liabilities are properly valued. Scope/objective of verification:- Confirm whether the assets are owned. Confirm whether assets/Liabilities are valued properly. Confirm whether assets are properly authorized. Confirm whether assets are free from any charges. Confirm whether assets are acquired for business purpose. Confirm whether assets actually exist. Techniques of Verification:- 1. Inspection: - It means physical inspection of assets which include Documents of title, Loan agreement, etc. 2. Observation: - It means observing or witnessing the inspection of assets done by others. Thus auditor may not himself take (count) Inventory, but only observe that Inventory is being taken by the staff of the concern in right manner. 3. Confirmation: - It means obtaining written evidence from outside parties regarding existence of assets. E.g.:- Obtaining balance confirmations from debtors. *Valuation:- It means finding out proper value of assets or liabilities for recording in books & disclosure in final Accounts. Verification includes valuation. * Importance of valuation:- 1) Correct Computation. 2) Method of valuation. 3) No change in method. 4) Schedule VI 50 5) Revaluation 6) Recognized Accounting policies. 7) Foreign exchange 8) Event after Balance-sheet date Write short note verification of Debtors? /Bills receivable? Ans) 1) Confirmation: - The auditor should call for balance confirmations from the debtors by writing a separate letter/mail to them & they should be asked to reply directly to the auditor. 2) Nature of Balance: - Auditor should verify the summary of debtors. He should confirm that only those amounts which are receivable on the account of selling of goods appear under this head. 3) Cut-off transactions: - Auditor should verify year end transactions. Transaction pertaining to subsequent year should not be recorded in current year. Similarly current year transaction should not be recorded in subsequent year. 4) Verify Bad Debts: - Auditor should verify the debtor Balance which have been classified as Bad debts by the clients. 5) Verify schedule: - The auditor should call for a schedule of debtors which consists of a list of debtors, their o/s balance & the period for which Balance is outstanding. 6) Ledger scrutiny: - Auditor should scrutinize the ledger A/c and ascertain the major transaction during the year. The opening and closing Balances and transactions should be checked. 7) Events after Balance sheet date: - The auditor should check whether any event has occurred after the Balance sheet date which may affect the value of asset. 8) Verify internal control: - The auditor should understand and review the system of internal control with respect to purchase, use and sale of assets. Write S.N. on Verification of Assets? (Plant & machine/ investment/closing stock) - The auditor should verify the above in following manner: 1) Verify Existence:- The auditor should confirm that the assets shown in the Balance sheet exists and are genuine it may not be possible for the auditor to check existence on the date of Balance sheet. 2) Verify ownership:- 51 The auditor should confirm that the assets are legally owned by the company by inspecting all the deeds, lease agreements invoice, etc. 3) Verify valuation:- The auditor should ensure that the basis of valuation of the assets is proper and recognized. Assets needs to be valued at cost at which it is purchased less depreciation if any for this auditor needs to verify invoice amount, agreement, etc. 4) Verify schedule:- The auditor should ask for a detailed fixed asset schedule which contains details about opening balance, purchases, sales & closing balance of assets. 5) Verify internal control:- The auditor should understand and review the system of internal control with respect to purchase, use & sale of the asset. The purchase and sale should be authorized by senior member of the clients. 6) Verify the records:- Examine records relating to opening balance, additions, physical verification, etc. 7) Schedule III Disclosure:- The auditor should ensure that disclosure of the assets is as per schedule III and compliance with Accounting Standards. 8) Events after Balance sheet date:- The auditor should check whether any event has occurred after the Balance sheet date which may affect value of asset. Verification of Liabilities:- *Write short note on Loans:- 1) Overall check/review of old Balance:- Auditor should compare the detail for the current year with those of previous year. He should investigate the abnormal differences. 2) Review of internal control:- Auditor should study and review system of internal control relating to acceptance of Liabilities. Auditor should verify that whether internal control is effective or not. 3) Proper accounting:- Auditor should ensure that proper accounting has taken place. And there is no error and fraud in any transaction. 4) Audit report under CARO, 2016:- Auditor has to report under CARO, 2016, company has taken any loan then auditor should report under audit report. 52 5) Power to borrow:- Auditor should see that the within the borrowing power specified in MOA & AOA of the co. 6) Confirmation:- Obtaining confirmation from the auditor is the best evidence to verify such A/c. 7) Disclosure in A/c:- The auditor should ensure that Loans have been classified & disclosed as per requirement of schedule III. Write S.N. Creditor/ Bills payable? 1) Overall check:- - Auditor should compare the detail for the current year with those of previous year. He should investigate the abnormal difference. 2) Internal control:- - The auditor should review the internal control with respect to purchase for this purpose, the auditor should discuss with the purchase manager regarding the general process of purchasing, selection of creditors, etc. 3) Confirmation:- - The auditor may also call for balance confirmation from the third party directly to further ensure genuineness of the closing balance. 4) Proper accounting:- - Auditor should ensure that proper Accounting has taken place. And there is no error and fraud in any transaction. 5) Scrutiny of ledger A/c:- Auditor should scrutinize the ledger account and ascertain the major transaction during the year. 6) Schedule III disclosure:- The auditor should ensure that disclosure of the liabilities is as per schedule III & compliance with A/cing standard. 7) Comparison with actual invoice:- Any mismatch should be investigated by the auditor. Auditor should check all the Liabilities are properly recorded. 8) Review old Balances:- The auditor should pay attention to creditors O/S for a long period. He should enquire why the creditor has not been paid & in case amt is no longer payable. 53 54