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Com 3rd Year (2015-16)

Subject: Auditing
UNIT - 1
The word, audit is derived from the Latin term audire which means to hear. In early days an
Auditor used to listen to the accounts read out by the accountant in order to check them.
However, the post ancient period auditing has gone through dramatic changes. The change in the
technology, expansion of business organization, diversification of activities has influence and
altered the scope and techniques. As the concept of original auditing was to detect and prevent
errors and frauds and its concepts goy evolved with rapid growth after the industrial revolution in
18th century and further with growth of joint stock companies which saw a divorce of ownership
from management. The shareholders who are owners needed a report from an independent expert
on accounts of the company managed by board of directors who are the employees of the
company and hence the objective of audit shifted and it was expected to ascertain whether the
accounts were true and fair rather than detection of fraud and errors. Further the fast developing
communication technology has shrunk the earth into global village where transactions are made
through internet across the world. In these circumstances, it is impossible to apply the traditional
methods of auditing. With this the definition of audit which was to hear has also changed.
Institute of chartered accountant of India, defines auditing as a systematic independent
examination of financial statement, irrespective of its legal form, whether for profit oriented or
not, when such examination is conducted with the view to express an opinion, whether financial
statement gives true and fair view.
According to R.R. Mautz Auditing is concerned with the verification of accounting data, with
determining the accuracy and reliability of accounting statements and reports.
Spicer and Pegler: "Auditing is such an examination of books of accounts and vouchers of
business, as will enable the auditors 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 that the profit and
loss account gives true and fair view of the profit/loss for the financial period, according to the
best of information and explanation given to him and as shown by the books; and if not, in what
respect he is not satisfied."
The book "an introduction to Indian Government accounts and audit" issued by the
Comptroller and Auditor General of India, defines audit an instrument of financial control. It
acts as a safeguard on behalf of the proprietor (whether an individual or group of persons)
against extravagance, carelessness or fraud on the part of the proprietor's agents or servants in the
realization and utilization of the money or other assets and it ensures on the proprietor's behalf
that the accounts maintained truly represent facts and that the expenditure has been incurred with
due regularity and propriety. The agency employed for this purpose is called an auditor."
Hence, auditing can be said as a systematic examination of accounting records prepared by
business enterprise or other economic unit, ascertaining that they correctly reflect the
transactions to satisfy a qualified auditor, who has to report honestly, giving his opinion on
fairness and accuracy of financial statement.

Features of Auditing:
1. 1. It is the systematic, scientific and critical examination of the accounts of a business.
2. It is done by an independent person or body of persons qualified for the job.
3. It is a verification of result shown by profit and Loss Account and the state of affairs
shown by Balance Sheet.
4. It is a critical review of the system of accounting and internal control.
5. It is done with the help of vouchers, documents, information and explanations received
from the authorities.
6. The auditor has to satisfy himself with the authenticity of the financial statements and
report that they exhibit a true and fair view of the state of affairs of the concern.
7. Audit of a accounts in business made thought the year or periodically
8. Auditing always provides true and fair report of financial statement.

The scope of audit is not only limited to the business concern but also extended non
business concerns such as educational institutions. Health department, charitable trust etc.


1. Industrial revolution.
2. Divorce of ownership from management.
3. Regulations.
4. Pronouncement by the court of law.
5. Growing use of computer in accounting.
6. Regulation by professionals.
7. Establishment of International Accounting Standards.
8. Social responsibility.
9. Compulsory Audit.
The main objective of auditing is to verify the accounts and reports whether the balance sheet
and profit and loss account are prepared as per the companies act, GAAP, Accounting Standards
and whether they exhibit true and fair view of affair of the concern.
Sec 143 of companies act, requires an auditor to give a true and fair view in case of balance
sheet its affairs at the end of a period & in case of profit and loss accounts its operating profit and
loss for the year, to form an independent judgment and opinion about regularity and reliability of
accounting records.
The objectives of an audit may broadly be classified as:
1. Primary Objectives.
2. Secondary objectives.

Primary objectives:
a. Conformity with law.
b. True and fair view of the state of affairs of the business concern.
Secondary objective: It is also called the incidental objective
as it is incidental to the satisfaction of the main objective. The incidental objective of auditing
a. Detection of Frauds
b. Detection of Errors.
c. Prevention of frauds and errors.
a. Detection of frauds: Fraud refers to intentional misrepresentation of financial information
with the intention to deceive. Frauds can take place in the form of manipulation of accounts,
misappropriation of cash and misappropriation of goods.
It can be for:
a. Benefit of the organization
b. Personal benefit at the expense of the organization.
Embezzlement of cashIt is also known as misappropriation of cash where cash is
misappropriated by theft or cash receipt, cheques and showing fictitious payments to workers,
creditors, purchasers etc. It is an easy affair and can be done with little efforts especially in large
business house where there is not much direct contact between the owners of the business and
the persons handling the cash. This method is called by the name of teaming and lading or
lapping. It is a method of committing fraud by an employee or cahier of the business concern.
Teeming means misappropriation or misuse of cash.
Lading means shortage of cash by the cashier. Totally it is a method of cheating to the business
owner by the way of continuous cash shortage.
Omitting to enter cash receipt.
Entering fewer amounts than what has been actually received.
Omitting to records sales and taking the money received from customers for such sales.
Making fictitious entries for the items like discounts, returns, bad debts, etc , in the
accounts of customers.
Misappropriating money recorded as wages in the wages sheet by entering dummy names
of workers there in.
Misappropriation of goods- It refers to fraudulent application of goods by those who handle
them. It can be done by recording sales of larger quantities and misappropriating the balance or
by recording purchase of large quantities receiving less quantity and then receiving the balance
amount privately. Only the efficient system of store record keeping, periodical physical checking,
internal check, and adequate security arrangement will help in avoiding misappropriation of
goods. Auditor has to check thoroughly the inwards and outwards register, invoices, sales
memos, audit notes, etc.,

Manipulation of accounts- It implies presentation of accounts more favorably than what they
actually are. Window dressing means showing a wrong picture. The fraud through manipulation
of accounts is also known as window dressing because accounts are manipulated to show a
wrong picture of the profit or loss of the business and its financial state of affairs. Generally this
type of fraud is committed by the people at the top management level. This does not involve any
misappropriation of cash or goods but it is either over statement of profit or understatement of
the same. Such fraud is committed with certain objective and is relatively difficult to detect.
There are two types of motives behind such manipulations:
1. Inflating the profit
2. Deflating the profit.






1. When vouchers, invoices, cheques, contracts are missing etc.

2. When control account does not agree with subsidiary books.
3. When the difference in trial balance is difficult to locate.
4. When there are greater fluctuation in G.P. and N.P. ratios.
5. When there is difference between the balance and the confirmation of the balance by the
6. When there is difference between the stock as per records and the stock physically counted.
7. When the explanation given by the client is not satisfactory.
8. When there is a overwriting of some figures.
9. When there is a contradiction in the explanation given by different
b.Detection of errors : Errors refer to unintentional mistake in the financial information arising
on account of ignorance of accounting principles i.e. principle errors, or error arising out of
negligence of accounting staff i.e. Clerical errors but sometimes they can be the outcome of
deliberate action of dishonest employee.
It can be further divided into:
Technical or clerical errors.
Errors of principle.
Technical errors:
a. Error of omission- When any transaction is not recorded in the books of accounts, it is called
an error of omission. So transaction is absolutely omitted from the record.
Effect on Trial Balance: - Now this error will not be detected by the trial balance. The trial
balance will agree even this error is committed. So the error willing to be disclosed by the trial
balance. It will be very difficult to locate the error.
Example: - Suppose some purchase was not recorded in the books. The total purchase recorded
in the books will be less than actual purchase. This error will not be disclosed by the trial

Detection: - An auditor may detect the error by comparing the data of previous with this item.
We may say that critical analysis of the auditor locate such type of errors.
b.Error of commission- When the transaction is recorded but incorrectly we say that
error of commission is committed.
(i). Wrong posting from original books to ledger.
(ii). Incorrect entries in the original records.
Effect on Trial Balance:(A). in the invoice if transaction is recorded incorrectly, the effect on the trial balance will be
(B). If a part of transaction is recorded incorrectly then the trial balance will be not balanced.
Detection of Errors: - Such errors can be detected by checking the arithmetical accuracy of the
original books. It can also be discovered when somebody challenges the transaction.
c. Error of duplication- This errors occurs if the same transaction has been recorded twice in
the books of original entry and also posted twice in the ledger a/c . It is very difficult to trace.
d. Compensating error- When two or more errors are committed in such a way that the result
of these errors on the debits and credits is nil, they are referred to as a compensating errors.
For example- Anils account which was to be debited for Rs. 500 was credited for Rs. 500
and similarly, Sunil's account which was to be credited for Rs. 500 was debited for Rs.500.
These two mistakes will nullify the effect of each other. Both the sides of the trial balance
are equally affected. As such, these errors are difficult to locate unless detailed investigation
is undertaken.
Such errors are committed when some fundamental principle of accounting is not properly
observed in recording transaction. For example, if there is incorrect allocation of expenditure or
receipt between capital and revenue or when closing stock is over-valued. Though trial balance
will not disagree, the Profit and Loss Account may be very much affected. Sometimes, such
errors are committed deliberately to falsify the accounts or unintentionally due to lack of
knowledge or sound principles of accounting. Thus, a thorough examination is to be done to
locate such errors.
C.Prevention of frauds and errors:
1. Verification of Books and Statement: - The main object of audit is the verification of the
books and the financial statements of the company concerned.
2. Discover and Prevention of Error: - While examining the books, auditors detect some
errors. These are various kinds of errors. So audit is very useful in preventing and detecting the
3. Discovery and Prevention of Fraud: - Fraud means false representation made intentionally
with a view to defraud somebody. It is the duty of the auditor that he should detect the fraud. So
audit main object and advantage is that fraud may be detected and prevented. Auditor may also
suggest various methods of internal check which will prevent fraud.

4. Moral Check: - When each staff of the company knows that this financial transactions will be
examined by the auditor then he fears to do that fraud. The fear of their detection acts as a moral
check on the staff of the company.
5. Independent Opinion: - Auditing is very useful to obtain the independent opinion of the
auditor about the business condition. If the accounts are audited by the independent auditor, the
report, of the auditor will be a true picture and it will be very important for the management.
Keeping in view the report, owner of the business will be able to prevent frauds and errors in
6. Protects the Interest of Share Holder: -Audit protects the interest of shareholders in the case
of Joint Stock Company. Through audit shareholders are assured that the accounts of the
company are maintained properly and their interest will not suffer.
7. Check on Directors: - Audit acts a check upon the directors and precaution against fraud on
the part of the management.
8. Expert Advice: - The auditor has expert knowledge about the accounts and finance problems,
so he may be consulted about these problems.
9. Disputes Settlement: - In case of partnership, audit is very useful in settling the disputes
among the partners. If any partner dies, or retires, the audited balance sheet will be very useful in
estimating the value of goodwill.
10. Easy negotiation with banks and other financial institutions: - If accounts are audited,
then true picture will be known to the financial institutions and they will never hesitate to lend
the money.
11. Insurance Claim:- In case of fire insurance and participation of fraud claims can be settled
on the basis of audited accounts of the previous years.
12. Advantage for General Public:Audited financial statements present the real position of the company before the general public.
Keeping in view the position of a company one can do the investment.
13. Useful For Tax Department:Assessment of tax becomes very easy job for the tax department. Keeping in view the audited
accounts they impose the taxes.
Disadvantages of auditing:
It is true that auditing as many advantages, but it has some limitations as such
1. Non-detection of errors/frauds: - Auditor may not be able to detect certain frauds which are
committed with malafide intentions.
2. Dependence on explanation by others: - Auditor has to depend on the explanation and
information given by the responsible officers of the company. Audit report is affected adversely
if the explanation and information prove to be false.
3. Dependence on opinions of others: - Auditor has to rely on the views or opinions given by
different experts viz Lawyers, Solicitors, Engineers, and Architects etc. he cannot be an expert in
all the fields
4. Conflict with others: - Auditor may have differences of opinion with the accountants,
management, engineers etc. In such a case personal judgment plays an important role. It differs
from person to person.
5. Corrupt practices to influence the auditors: - The management may use corrupt practices to
influence the auditors and get a favorable report about the state of affairs of the organization.

6. No assurance: - Auditor cannot give any assurance about future profitability and prospects of
the company.
7. Inherent limitations of the financial statements: - Financial statements do not reflect current
values of the assets and liabilities. Many items are based on personal judgment of the owners.
Certain non-monetary facts cannot be measured. Audited statements due to these limitations
cannot exhibit true position.
8. Auditing is a postmortem examination: auditing work begins where accounting ends then
the auditor is fully depends upon the accounting transaction provided by the accountant in the
throughout the year. So auditing work is not suitable for the current position of the business. But
it is useful to the future business situation.
9. Auditor cannot check each and every transaction. He may be required to do test checking.
Auditing can be classified into different types such as:
a. On the basis of organizational structure.
b. On the basis of scope or coverage.
c. On the basis of time.
d. On the basis of degree of independence.
e. On the basis of objective.
f. On the basis of recent trends.
On the basis of organizational structureGovernment Audit- Such audit is applicable to all government departments. Government audit
is a control measure for public accounting of government funds. It covers the audit of all
expenditure and receipts done by the executive and audit of commercial accounts maintained by
public enterprises. Public enterprises are classified under three categories department
undertaking, statutory corporations financed by government and government companies set up
under the Companies Act.
It is undertaken by a separate department accounts and audit department which is headed by
CAG (Comptroller and auditor general of India).
Private Audit- When the audit is not a statutory requirement, but is conducted at the desire of
owners, such an audit is private audit. The audit is conducted primarily for their own interest. At
times the private audit may become a requirement under tax laws, if the turnover exceeds a
specified limit i.e. if the turnover or gross receipt exceeds Rs. 40 lakhs.
Sole trading concern: There is no legal compulsion to audit their accounts. But nowadays
it has become customary to have their accounts audited, especially those traders whose
area of operations and the volume of business are very large. Here audit work, scope and
nature depends upon agreement between client and auditor.
Partnership firm:In case of partnership also is audit is not compulsory but as there are
many advantages of getting the accounts audited, now firms are making their own efforts

to make provision for audit in partnership deed. The scope of duties responsibilities of
auditors are wholly determined on the basis of the agreement between the firm and the
auditor. In the report the auditor must mention as to the capacity in which he has acted,
whether the records appear to be reliable and adequate as to the nature of the business and
whether the client imposes any limitation on his conduct of the audit.
Individuals: Who derive large income and incur heavy expenditure to earn such incomes,
appoints accountants to prepare and maintain accounts. They may also appoint auditors to
audit their accounts and to verify their accuracy. His scope of work and responsibilities
will depend upon the agreement entered into with his client.
Audit of other institutions: Institutions which are not meant for earning profit such as
clubs, hospital, libraries, colleges, schools, etc. The primary objective of such audit is to
detect error of frauds committed by the staff. At times, these institutes avails grants from
the government, international agencies, etc. In such cases, audit of utilization of such
grants become essential.
On the basis of scope/coverage
I. Complete Audit: In this type of audit, the auditor is required to check each and every
transaction recorded in the books of accounts. He has to examine each and every voucher,
document or correspondence relating to the transaction. This type of audit is not possible for
large sized organizations.
II. Partial Audit:In Partial audit, the auditor is not required to examine all the books of
accounts. Only a part of the accounts or some transactions as desired by the clients may be
scrutinized. Auditor has to state the area covered by the audit. This type of audit cannot be
followed in the case of statutory audit. It may be followed in the case of statutory audit. This
audit is not convenient when the audit is legally required.
III.Detailed Audit: Under detailed audit, few business transactions are examined in detail by the
auditor. Spicer and Pegler have defined it as, An audit which starts with books of prime
entry and ends with the balance sheet. The checking sequence is arranged in order of
recording the transactions in the primary book. Thus, for the purpose of detailed audit
certain transactions are traced through various stages from beginning to their end with the
help of available evidence. This technique of examination is also called audit-in-depth. To
take an example, detailed audit of purchase of goods for inventory would consist of tracing
the transaction though all the points of transaction cycle viz., requisitioning the goods,
ordering the goods requisitioned, receiving the goods ordered and preparing the payment
On the basis of time:
Continuos Audit:Continuous audit is defined by R.C. Williams as one where the auditor
is constantly or at (regular or irregular) intervals engaged in checking the accounts

during the period. Continuous Audit means an audit at regular intervals throughout the
accounting year. Generally, the audit work begins after the accounting year is over. But
in case of Continuous Audit, the work begins the accounting year itself.
For example, if the accounting year begins on 1st April 2002 and ends on 31st March,
2003 normally, audit work would begin in April 2003 and continue thereafter. But in
case of Continuous Audit the work would begin in April 2002 itself and continue at
regular intervals till it is complete. Thus in Continuous Audit, accounting and auditing
work is done almost side by side. Continuous Audit, however, does not mean the audit
work goes on for 365 days of the year. The auditor may make periodical visits, say, every
two or three months during the year and at the end of year we would verify the final
statement of account.

Continuous Audit is necessary in the following casesa. Where the volume of transaction is very large and complex.
b. Where the management requires monthly or quarterly audited statements of accounts
or the statements of accounts are required immediately after the accounting year.
c. Where the system of internal control or internal check is weak.
d. Sometimes continuous audit becomes necessary for self-survival against cut-throat
business competition.
e. When interim dividend is to be declared.
Advantages of Continuous Audit:
a. Quick Preparation of Final accounts: Since, the routine audit is done continuously;
the Final Accounts can be prepared immediately after the year end.
b. Early Dividends to Shareholders: The shareholders would be happy as they receive
dividends soon after the end of the financial year. The Company can prepare interim
accounts and pay even interim dividends to the shareholders.
c. Up-to-date Accounts for Banks/Investors: The up-to-date final accounts are useful to
banks and investors for taking decisions regarding loans and investment.
d. Check on Employees: Since the auditors visit regularly throughout the year, it acts as
check on the employees to keep the accounts ready and up-to-date.
e. Prevents Errors and Frauds: Constant checking by the auditors helps to detect and
even prevent errors and frauds.
f. Familiarity with Clients Business: Since the auditor spends more time at the clients
place, he becomes familiar with all the aspects of clients business.
g. Thorough Audit: The auditor has more time at his disposal to do a thorough checking
of all transactions. This reduces the risk of missing any material items.
h. Utilization of Audit Staff: Audit Staff can be kept busy throughout the year. Audit
work can be evenly distributed to avoid overwork after year end.
Disadvantages of Continuous Audit:
a. Expensive: Since the auditor spends more time on the audit work, the audit fees are
much more. Continuous Audit is thus expensive. However, only a large organization
should opt for a Continuous Audit.




Audit in Installments: Since the audit work is done at intervals and not
at one go, audit may be inefficient. The queries during the last visit may remain
unsolved. It is difficult at each visit to take up the work precisely at the stage of last
visit. To overcome this disadvantage, audit should be well-planned. All queries should
be noted in the Audit Note Book and cleared before taking up fresh work. The work
done up to end of each visit, relevant voucher numbers, totals etc. should be carefully
noted in the Audit Note Book.
Dislocation of clients work: If a proper audit programme is not adopted, continuous
audit may disrupt the routine accounting work of the client. Either the audit staff may
have to sit idle or the accounts staff of the client may waste time for want of books of
accounts. Employees have to attend the auditor for explanation. They have to keep
aside their usual work to attend the auditors for explanation.
Errors and Frauds in Books Already Checked: If an employee changes some figures
in the books already checked by the auditor during his earlier visits, it would be
difficult to detect such errors and frauds subsequently.
Monotonous- tiresome-tedious: Continuous visits to the clients place may make the
work tedious and the audit staff loses interest from work consequently. The quality of
audit suffers.
Absence of link: In the absence of well-planned audit work, an auditor may miss the
thread of audit work. Further, some important queries may be overlooked if no proper
audit notes and queries are recorded by the audit staff during the course of the audit.
Conflict between audit and accounts staff: The members of audit and accounts staff
come in close contact and sometimes it may result in spoiling the healthy relations
between them and thereby the quality of audit may suffer.
Dependence of the accounts staff on the auditor: The accounts staff may depend on
the audit staff. They may require the help of auditor for even small errors which they
can discover or avoid by taking proper care.

Measures to overcome limitations:

Strict instructions: Strict instructions should be given to clients staff not to alter
the audited figures. Mistakes, if any, should be rectified by passing rectification journal
entries and not by alteration of figures.
Audit programme: Proper audit programme should be prepared by the auditor,
so that the time of accounts and audit staff is not wasted.
Special ticks: Special ticks should be used for unaudited altered figures. Auditor
should write in the margin the actual figures audited with his audit pencil.
Audit notes: the auditor should keep exhaustive audit notes. The queries and their
explanation by the client should be properly recorded.
Checking the ledger: Checking the impersonal ledger should be done only after
the close of the accounting year.

Surprise visits: Surprise visits should be made in addition to the regular visits.
Rotation: There should be reasonable rotation of audit staff and their duties so that
they may not lose interest in their work.


Better control and supervision: There should be better control and supervision over
the audit staff. All the important figures in the balance sheet should be noted in the
audit diary and they should be rechecked at the time of subsequent visits.
Rectification entry: Any alteration should be done by means of a rectification entry in
the journal.
Secret tick: The auditor should put a secret tick against any figure
already altered.
Final Audit: It is also known as periodical audit. It is generally start after the completion
aspect more than the depth aspect of audit. The danger of alteration of figures or
manipulation of accounts is totally absent. Generally, it starts after the close of the
financial period. There is very little impact on prevention of errors and frauds by way of
moral checks. It is best suited for small and medium sized business. It saves in terms of
time, energy and money.

Final Audits have the following advantages

a. Inexpensive: Since the audit spends normal time on the audit work, the audit fees are
also normal. Final Audit is thus inexpensive. Even a small organization (a sole trader or a
firm) can opt for a Final Audit to obtain the advantages of an independent financial audit.
b. Audit at a Stretch: Since the audit work is done at a stretch, without any gaps, audit is
carried out efficiently. All queries are solved immediately. The work is done continuously
and not in installments. The audit planning and programme are simple
c. Less errors and Frauds: Since the books are checked at a stretch, no employee can
change any figures in the audited books.
d. Do not Disrupt Accounts Work: The accounts staff is not disturbed anytime during the
accounting year. There is no need for the accountants to attend to audit work every now
and then.
Final Audit has the following disadvantages
Delay in final Accounts: Since the routine audit is done after a year end,
the Final accounts may be delayed and ready long after the year end.
b. Late Dividends to Shareholders: The shareholders would be unhappy as they receive
dividends long after the end of the financial year. It would be difficult for a Company to
prepare interim accounts and pay interim dividends to the shareholders during the
financial year.
c. Stale Accounts for Banks/Investors: The final accounts are available long after the end
of the accounting year. Such stale accounts are not useful to banks and investors from
taking decisions regarding loans and investment.
d. No Moral check on Employees: Since the auditors visit only at the end of the year,
dishonest employee have a chance to commit frauds during the year and clean up the
accounts just before the auditors arrive, e.g. teeming and lading.
e. No Familiarity with Clients Business: Since the audit spends little time at the clients
place, he cannot become familiar with all the aspects of clients business. They may
affect the quality of audit.
f. Sample Check: Since the auditor has to complete the audit in a short time, he has to
resort to sample checking. The increases the risk of missing material items.

Interim Audit:Interim Audit is an audit conducted in between the annual audits. It is conducted
to find out the interim profit and know the financial position at the end of a part of the
accounting year. For example, an audit of accounts prepared for the period of six months
from 1st April to 30th September, would be Interim Audit.
When Conducted: Interim Audit is conducted in the following cases
a. Quarterly Results: Public Limited Companies listed on the stock exchange has to
declare their quarterly results. It is preferable, though not compulsory, to declare such
results on the basis of interim audit.
b. Interim Dividends: Interim audit is also advisable when a company intends to pay
interim dividends. Interim audit would ensure that there are enough profits to justify
payment of interim dividends.
c. Change in firms: In case of a sole partnership firm, interim audit becomes necessary on
admission, retirement or death of a partner, dissolution of partnership, sale of a firm to a
company, valuation of goodwill etc.
d. Sale of business: In case of a proprietor, interim audit may be conducted when the
business is proposed to be sold, to fix the purchase consideration.
Advantages - Interim audit is similar to Continuous Audit and enjoys similar
Quarterly Results: A public limited company listed on the stock exchange
can comply with the statutory provision of declaring quarterly results.
Interim Dividends to Shareholders: The shareholders would be happy as the
Company can pay interim dividends to the shareholders.
Quick Preparation of Final Accounts: Since the interim audit is already
done, the Final Accounts can be prepared immediately after the year end.
Up-to-date Accounts for Banks/Investors: The up-to-date interim accounts
are useful to banks and investors for taking decisions regarding loans and investment.
Check on employees: Interim audit acts as check on the employees to keep
the accounts ready and up-to-date.
Prevents errors and frauds: Checking by the auditors for the purpose of
interim audit helps to detect and even prevent errors and frauds.
Thorough Final audit: The auditor has more time at his disposal at the time
of final audit, which reduces the risk of missing any material items.
Utilization of Audit staff: audit staff can be utilized in a better manner.
Interim audit is done when the audit staff is relatively free.
Disadvantages and Precautions:
a. Expensive: Since the auditor does two audits in one year, the audit fees are more to that
extent. Interim Audit is thus expensive.
b. Audit in Installments: since the audit work is done at two stages (interim and final) and not
at one go, audit may be inefficient. It is difficult at the time of final audit to take up the
work precisely at the stage where it was left at the time of interim audit. To overcome this,
audit should be well-planned. The work done up to end of the interim audit, relevant
voucher numbers, totals, etc. should be carefully noted in the Audit Note book.

c. Disrupts Accounts Work: Interim audit disrupts the work of accounts staff. To avoid this
advantage, the audit programme should be coordinated with the client to avoid disruption
in routine accounts work. The client should appoint an employee especially to co-ordinate
with and attend to the auditors.
IV. Balance Sheet Audit: Balance Sheet Audit is an American terms which means verification of
the items appearing in the balance sheet. It includes verification and valuation of assets and
liabilities appearing in Balance Sheet.
Profit and loss account is not given much importance in this type of audit. In balance sheet
audit, the auditors assume that there is a reliable system of internal check and internal audit.
Balance sheet is also referred as Limited Audit. Such a type of audit is used where the size
of the type of audit is used where the size of the company is very large. Under balance sheet
audit accounts are verified and tests are imposed only on those items in Profit and Loss A/c
which are directly related to assets such as depreciation, repairs, bad debts etc.
Applicability: Balance sheet Audits are not conducted in all cases. Such Audits are
conducted in case of very large organization banks, etc. in the following circumstances
a. The Internal Control System is very strong. The controls have been developed
and tested over the years. The controls are capable of detecting and preventing
errors and frauds.
b. The volume of transaction is so large that an in-dept checking is impossible. A
detailed vouch-and-post audit is not possible if the final accounts arte to be ready
in time.
c. The concern has its own internal audit department. The statutory auditor,
therefore, need no duplicate this work.
d. The accounts staff is highly qualified, the management is professional and
accounts are computerized.
Method: Balance Sheet Audit is conducted in the following manner
1. Review of Internal Controls: The auditor must evaluate the system of internal
controls in the following respects:
a. Whether the internal controls are effective: If the internal controls are effective,
auditor can concentrate on material items instead of checking arithmetical accuracy of
each and every transaction.
Whether the internal controls are in operation: He should carry out tests to
ascertain that the controls are actually in operation. Based on his evaluation of the
internal controls, the auditor should plan his audit programme.

Verification of Items in the Final Accounts: He should verify the major items of assets
and liabilities and income and expenditure appearing in the Final Accounts (Balance
Sheet and Profit and Loss) in the following manner :
a. Verification: He should carry out physical verification of major items of assets and
liabilities on sample basis.


Inspection: He should inspect documents of title etc. in respect of major items on

sample basis to verify whether such transactions actually occurred, and whether such
transactions are recorded in the books for the right amount.


Vouching: He should vouch only the major transactions on sample basis to

ascertain whether such transactions are actually occurred by the concern; and whether
such transactions are recorded in the books for the right amount.

d. Valuation: He should satisfy himself that the assets and liabilities are properly
e. Presentations and Disclosure: He should check whether the assets, liabilities,
income and expenses are presented and disclosed in the Final Accounts properly,
according to the recognized accounting policies and the requirements of law.
3. Specific Items: The auditor should pay special attention to the following specific
items in the Final Accounts
a. Verify fixed assets, investment physically;
b. Check the addition to and deduction from fixed assets and investments;
c. Check the amount of depreciation charged;
d. Check the accounts of major debtors and creditors and obtain confirmations and
statement of accounts;
e. Verify cash and stocks physically;
f. Check valuation of stocks;
g. Ascertain amount of bad or doubtful debts;
h. Check estimates of contingent liabilities.
4. Overall Checking of Final Accounts (Analytical Review):
a. Compare the amount of each item for the previous year with that of the
current year. Investigate the reasons for abnormal variations.
b. Check major rates e.g. Current Ratio, Debt Equity Ratio, Gross Profit Ratio,
Operating Ratio, Expenses Ratio, Stock Turnover, Net Profit Ratio, Return on
Capital Employed and Debtors Turnover etc.
c. Check quantitative ratios (input-output ratios), Material Consumption ratio
and quantity reconciliations.
d. Check all unusual or non-recurring transactions.
e. Check statement of Sources and application of Funds and Cash Flow
f. Check the Minute Books.
On the basis of degree of independence:
Statutory Auditor- Statutory Audit is compulsory audit prescribed under statute i.e.
law. Appointments of auditors, removal, remuneration, rights, duties, liabilities are governed as
per the Provisions of the respective law applicable to the organization. Scope of the audit work
and all others terms are as laid down by the law. It can be conducted only by a qualified
Chartered Accountant.

Statutory audit is conducted after preparation of final accounts. Statutory auditor has to report
whether the balance sheet and profit and loss A/c are drawn upon conformity with law and
whether they show true and fair view. Statutory auditor has to submit report to the shareholder.
His remuneration is fixed by shareholder. The concerns and the corresponding Acts are as shown
in the following Exhibit:

Financial audit
Special audit
Cost audit
Insurance Companies

Companies Act, 1956
Banking Companies Regulation Act,1949
Insurance Act,1938

Co-operative Societies
Public charitable trust
Statutory corporations

Respective State Co-operative Act

Indian Trust Act etc
Special Act of Parliament e.g. Life Insurance
Electricity Supply Act, 1948

Electricity Companies

Internal Audit- Prof. Meigs: Internal Auditing is a continuous, critical review of financial and
other operating activities by a staff of auditors, functioning as full time salaried employees.
Internal Audit is an independent appraisal activity within an enterprise for the review of
accounting, financial and other operation and controls as a basis for service to management. It
involves a specialized application of the techniques of auditing. Thus
A .Internal Auditing is normally done by the employees of the concern.
b. It is part of the system of internal controls.
c. It is a critical review of other internal controls i.e. of (i) accounting controls and (ii)
operational controls.
d. The review is done by normal auditing techniques such as vouching, verification etc.
Scope and Objectives:
1. Review of Accounting System and Internal Controls: Management is responsible for
establishing a reliable accounting system and internal controls. Management in turn
expects the Internal Auditor to review the accounting system and Internal Controls, check
that they are effective and suggest improvements.
2. Examination of Accounting Controls: Internal Auditor has to review the operation of
Accounting Controls to see that
a. All transactions are duly authorized.
b. All transactions are properly recorded.
c. All transactions are recorded promptly as soon as they occur.
d. The accounting policies adopted by the management are implemented.


The assets of the concern are safeguarded.

Errors and frauds are prevented and detected.
G .The books of accounts are complete and accurate.
The final accounts are reliable and ready in time.

3. Examination of Operational Controls: Internal Auditor must review the working of the
Operational Controls to see that the management policies in respect of the operation and
administration of the concern are implemented. This ensures that the business is
conducted in an orderly and efficient manner. Thus Internal Auditor should review
Quality Control, Budgetary Controls, and Internal Check etc.
4. Physical Verification: Internal Auditor should physically verify the assets of the concern
such as fixed assets, cash, inventory etc.
On the basis of objective:
1. Cash Audit
2. Special Audit-Central Government has power to order a special audit of the accounts of a
company for a specific period. This is under Section 233A of the companies Act, 1956. Special
audit is ordered without providing an opportunity to the company, where the central government
is of the opinion:
When affairs of any company are not managed as per the sound business principles.
When company is being managed in a manner which is likely to cause serious injury or
damage to the interest of trade or industry.
When financial position of a company is such as to endanger its solvency.
Special audit can be entrusted by the central government to the companys auditor himself or to
any other chartered accountant. Auditors remuneration will be fixed by the Central Government
and pad by the company Auditor submits his report to the central government. On the basis of his
report the Central Government may take adequate actions. Such auditor has the same rights,
duties, powers and liabilities as the statutory auditor of the company.
The special auditor will have the same powers and duties as provided U/s 227. The report will
include all matters required to be included in an auditors report. The report will also include
statements on any other matter as may be directed by the Central Government.
3.Cost Audit- It is a type of audit which involves verification of cost records maintained by the
organization. U/s 233(B) of the Companies Act 1956 the Central Government may direct an audit
of cost records by a person who is qualified. Appointment of auditor is done by the board of
directors subject to the approval of the Central Government.
The auditor reports to the government, the copy of the report sent to the company. Cost audit is
prescribed for certain types of industries with a view to achieve the following objects:

to grant the price concession of the company;

to fix up selling price;
to safeguard interest of customers;


to consider the question of protection to be granted to the company;

To ascertain the causes of loss suffered by the company.

Scope: Cost audit refers to audit of records relating to utilization of materials, labor and other
items of cost as may be prescribed by the Central Government. Cost audit shall be in addition to
financial auditing conducted U/s 224. The procedure is similar to that of financial audit.
Qualifications: The cost auditor shall be either a cost accountant within the meaning of the cost
and works accountant Act, 1959 or any Chartered Accountant within the meaning of the
Chartered Accountants Act, 1949 or other person possessing prescribed qualifications. A person
not qualified to be appointed as auditor of a company under section 226 cannot act as its cost
Appointment: A cost auditor is to be appointed by the Board of Directors with prior approval of
the Central Government.
4. Management Audit - Management audit involves examines of the plans, policies, procedure,
method and strategies and evaluates the performance of management with a view to improve
organizational effectiveness. It does not look into the past, present but also in the
future.According to Leslie R. Howard, Management Audit is an investigation of a business from
the highest level downward in order to ascertain whether sound management prevails throughout
thus facilitating the most effective relationship with the outside world and the most efficient
organization and smooth running of internal organization.
Scope: The scope of management audit is quite comprehensive. It involves critical review of all
aspects and processes of management. It also includes the objectives, the plans, the organization
structure control and any other specific function assigned by management from time to time. It
includes the appraisal of the decisions taken by the top management in achievement of
organizational objectives.
It revolves around the following factors/ steps:
Identify the objectives of the organization.
Break the overall objective into targets and plans.
Review the organizational structure.
Examine the performance of each functional area.
Check that delegated authorities are not exceeded.
Audit the integrity of the information system.
Assess the efficiency with the resources are utilized.
Suggest a realistic course of action on the basis of the examination.

Management audit helps to establish a system of incentives and rewards for the managers
on the basis of performance.
It helps in taking decisions regarding takeover of a sick unit. It can indicate whether the
management was responsible for the sickness.
It can help an investor or lender to decide about investing in a company or advancing a
loan to a company.
It helps the foreign collaborators in studying the performance of the local management.

It is regarded as a vague concept and serves no major purpose.

It is easy to review and criticize past actions, when all the information is available. The
manger has to take quick decisions on the basis of whatever information is available.
Management audit, critics say, is nothing but post-mortem which may discourage managers.
On the basis of recent trends:
Social Audit
Environmental Audit
Quality Audit
Audit Planning & Procedures
The audit of a concern involves sound planning, conduct and judgment. So auditor must
devote his time to think before acting because he has to face several problems while
conducting the audit. He must determine the future course of action-framing policy and
laying down a programme and procedure and finally dividing the whole work carefully
among the audit staffs.
An effective audit is an outcome of systematic audit procedure applied on examination
of audit evidence with the help of audit technique
Audit techniquesMoyer It is referred as a device or method available to auditor for obtaining competent
evidential matter. So they are the tool used to get reliable evidence while conducting
Prof.Mautz, there are ten techniques available:
1. Physical examination.
2. Confirmation.
3. Comparing documents with records.
4. Computing.
5. Retracing book keeping.
6. Scanning.
7. Inquiry
8. Examine subsidiary records.
9. Correlation with the related information.
10. Observation of pertinent activities.
Audit Process- it is the way in which audit is conducted and it involves four steps:
1. Planning.
2. Gathering evidences
3. Evaluating evidences
4. Issuing reports.
A hypothesis is formulated as the first step of audit process which is an assumption that
says financial reports are accurate or inaccurate. Then audit evidences are collected
which acts as a proof obtained to support the hypothesis. It becomes his duty to collect all

the necessary support to his audit work. This gathering of information involvesobservation, confirmation, calculation, analysis, inspection & comparison.
Then the initially formulated hypothesis is evaluated on the basis of evidence and then he
can accept or reject the hypothesis and finally on the basis of all this he prepares a report
and gives his opinion on it.
Audit PlanningAn auditor should plan his work so that it enables him to conduct an effective audit in an
efficient and timely manner. Any planning must be made on the basis of knowledge of
clients business and it should cover
a) Acquiring knowledge of clients accounting system, policies and internal control
b) Establishing the expected degree of reliance to be placed on internal control.
c) Determining and programming the nature, timing of audit procedure to be performed.
d) Co-ordination the work to be performed.
Planning is also subject to revision of overall plan due to change in conditions and
unexpected audit results.
Benefits/ Need for planninga) Ensures that appropriate attention is given to important area of audit.
b) Full utilization of audit staffs.
c) Co-ordination of work done.
d) Time bound progress and completion.
Points to kept under consideration while planning:
Complexity of the audit.
Term of engagement.
Environment in which the entity operates.
Nature of internal control.
Previous experience with client.
Knowledge of clients business.
Nature of reporting required.
Anticipation of future problem.
Audit ProgrammesImplementation of any plan depends on a good programme.
So, an auditor should chalk out a programme according to the requirement of each case as
to what work is to be done by senior and junior staff and time by which the work should
be finished.
So, Audit Programme can be defined as a detailed plan of audit work to be performed,
specifying the procedure to be followed in verification of each item in financial statement
and giving the estimated time required.

While construction an audit programme, the Auditor should keep the following points in
his mind1. To operate within the scope and limitations of the assignment.
2. To determine the evidence reasonably available and identify the best evidence for
deriving the necessary satisfaction.
3. To apply only those steps and procedures, which are useful in accomplishing the
verification purpose in the specific situation?
4. To consider all possibilities of error.
5. To co-ordinate the procedures to be applied to related items.
Objective of Audit Programme To ensure that no part of checking and verification has been omitted.
To ensure that work is completed in time.
To serve as a guide in future for planning the audit work.
To allocate the whole work among different audit assistants and get the work done
within the time limit.
To fix responsibility of each job among the audit staffs.
i. Assessing progress of Work: - The auditor can judge the efficiency of his audit team
by holding of an audit programme. He is in a position to know the progress of the work.
He can see at any time that what part of the work has been completed and what remains
to be done.
ii. Tool for efficient distribution of Work: - Audit programme is very useful in
distributing the audit work properly among the members of the audit team according to
their talent.
iii. Uniformity of Work: - Audit programme helps in settling all the things in advance, so
the uniformity of work can be achieved.
iv. Legal Evidence against the charge of negligence: - Audit programme is a legal
evidence of work done by every assistant of the audit team. It can be presented in the
court of law if any client is taken against the auditor for negligence.
v. Fixation of Responsibility: - If any error or fraud remains undetected the
responsibility of negligence will fall on the particular assistant who has performed that
vi. Useful for Future as a reference: - On completion of an audit, it serves the purpose of
audit record which may be useful for future reference.


1. Effects the quality of work done:-Auditors may have covered the whole field within
the time specified. So, in order to complete the work on time the quality of work done
may get hampered.
2. Rigidness: - Audit programme loses its flexibility. While each business has separate
problems. So audit programme cannot be laid down for each type of business.
3. Discourages the Initiative of efficient staffs: - It kills the initiative of capable persons
assistant cannot suggest any improvement in the plan.
4. Too Mechanical: - Such audit programme is mechanical that it ignores many other
aspects like internal control.
5. Not Suitable for Small Audit: - It has been proved that audit programme is not
suitable for small audits.
6. New Problems over Looked: - With the passage of time new problems arise which
may be over looked.
Audit working paperThe audit working papers constitute the link between the auditors report and the clients
records. Documentation is one of the basic principles listed in AAS 1(Audit Assurance
Standards). Documentation prepared or obtained by the auditor and retained by him in
connections with performance of his audit refers to working papers. In other words, it is
the competent record of essential information about the material facts under audit. The
objects of an auditors working papers are to record and demonstrate the audit work from
one year to another. Such documents can be form of paper or electronic media.
Working papers are the property of the auditor. The auditor may, at his discretion may, at
his discretion, make portions of or extracts from his working papers available to his
client. Audit working papers are the property of the auditor and he is entitled to retain
Working papers should record the audit plan, nature, timing and extent of auditing
procedures performed, and the conclusions drawn from the evidence obtained. It should
be designed and properly organized to meet the circumstances of each audit and the
auditors needs in respect thereof. The standardization of working papers (for example,
checklists, specimen letters, and standard organization of working papers) improves the
efficiency with which they are prepared and reviewed. It also facilitates the delegation of
work while providing a means to control its quality. Working papers should be
sufficiently complete and detailed for an auditor to obtain an overall understanding of the

The form and content of working papers are affected by:

Nature of the engagement.
Form of the auditors report.
Nature and complexity of the clients business.
Nature and condition of the clients records and degree of reliance on internal controls.
As audit working papers are quite useful they should be prepared properly. They should
have the following essentials:
a. Standard form - they should be prepared in a standard form. The subject matter should
be arranged under various heading and subheadings.
b. Proper layout there should be proper design and layout of the working papers. This
will bring uniformity into the maintenance of working papers.
c. Space for margins there should be enough space for margin after each note for noting
down the auditors remarks and decisions.
d. Proper organization and arrangement the working papers should be properly
organized and arranged. In other words the working papers should be so organized and
arranged that the auditor will be able to locate any particular matter easily.
e. Completeness the audit working papers should be complete in all respects. They
should contain detailed information on all essential facts or points.
f. Clarity and Accuracy the working papers should be quite clear and self-explanatory.
The information contained in the working papers should be accurate.
g. Good quality paper paper of good quality should be used for working papers as they
are subject to frequent handling further the paper used should be of uniform and
convenient size so that they can be easily filed.
Purposes of working papers:
a) Assisting the audit team to plan and perform the audit.
b) Reveals authority &responsibility of audit staffs.
c) Enable the audit team to be accountable for its work.
d) It helps the auditor in finalizing his audit report without much delay.
e) It enables the auditor to find out the weakness of internal check system in operation.
f) It supports auditors in case he is being sued in court by the client for negligence and
acts as an evidence for justice and equity.
g) It serves as a guide for the auditor for audits of the same client in the succeeding years.
Permanent Audit File

A permanent audit file normally includes:

Information concerning the legal and organizational structure of the entity. In
case of a company, this includes the memorandum and Article of association. In
the case of a statutory corporation, this includes the act and regulations under
which the corporation functions.
Extracts or copies of important legal documents, agreements and minute relevant
to the audit.
A record of the study and the evaluation of the internal controls related to the
accounting system.
Copies of audited financial statements for previous years.
Analysis of significant ratios and trends.
Copies of management letters issued by the auditor, if any.
Record of communication with the retiring auditor, if any, before acceptance of
the appointment as auditor.
Notes regarding significant accounting policies.
Significant audit observations of earlier years.
Current Audit File
The current file normally includes:
Correspondence relating to acceptance of annual reappointment.
Extracts of important matters in the minutes of board meetings and general
meetings as relevant to audit.
Evidence of the planning of the audit and audit programme.
Analysis of transactions and balances.
A record of the nature, timing and extent of auditing procedures performed, and
the results of such procedures.
Evidence that the work performed by assistants was supervised and reviewed.
Copies of communication with other auditors, experts and other third parties.
Letters of representation or confirmation received from the client.
Conclusions reached by the auditor concerning significant aspects of the audit,
including the manner in which exceptions and unusual matters, if any, disclosed
by the auditors procedures were resolved or treated.
Copies of the financial information being reported on the related audit reports.
Audit NotebookIt is maintained by audit clerk and also known as remembrance book or memorandum.
While auditing a clerk may come across several difficulties or new points during the
course of audit, which he may want to discuss with his seniors or client, so in order to
remember all the points, he notes down these in a book which is called as Audit
Notebook. It contains a written record of inquiry made, replies received and
correspondence entered etc., which helps auditor in preparing audit report.

It plays an important role in defending the auditor if any legal action is brought against
them. It acts as a permanent record available to the auditor.
Contents of Audit notebook:
All technical terms used in business.
All mistakes or errors discovered.
List of books of accounts maintained by clients.
Fraud and errors found in the books during the course of audit.
Date of commencement and date of completion of audit.
Accounting methods followed in business.
Points that need further explanation.
Points that are to be included in the audit reports.
1. Important matters relating to audit may be easily remembered- All the facts
related to audit are noted down in the audit note book. While preparing the final
reports he can refer to notebook and recall all the essential matters which came
to him while conducting the audit. So, that he or she can save time and cost.
2. Serves as proof against charges of negligence- If any person files the cases
against the auditor charging misfeasance and negligence, an auditor can present
audit note book in the court or concerned authority as it acts as a reliable
evidence and can get clearance against such cases.
3. Ensure continuity of audit work- It ensures that audit programmes have been
strictly followed as per the plans.
4. It helps in measuring efficiency of audit staffs- An auditor gets information
about the performance of individual staff which helps to measure the efficiency
of staffs. An auditor can allocate the job to the staffs on the basis of their
5. It helps in preparation of audit reports.
6. Serves as a guide in framing future audit programmes- Auditor can refer
such noted point in the future which helps to continue the work of audit in
future to the auditor.
1. Dependence of audit staff on clients staff for preparation.
2. In case of any carelessness or negligence while preparation of audit notebook can
be used as an evidence against the auditor.

Routine check
It refers to the check the arithmetic accuracy of journals and ledgers. The purpose such
checking is detection of the error and fraud of simple or clerical nature. The audit staff
can check the balance appearing in journal and ledgers. The sub-total and total are
examined. The differences are calculated. These balances are transferred from one page
to another. The amounts carries forward should be the same. The checking is useful for
determine the accuracy of the books of accounts. The accounting staff cannot chance the
figures after routine checking. The ledger posting is also tested by means of routine
checking. The errors may be locked and frauds may be disclosed by it. The auditor is able
to give his opinion about the fairness of the financial statements. The auditor can fix the
responsibility of the accounting staff for negligence of duty.
Essentials of Routine Checking:
1. Sub-Cast - Sub-Cast is a part of routine checking. Sub-total is possible in accounts
matters. The sub-cast must be correct.
2. Casts- Cast is part of routing checking. Total in journal and ledger accounts should be
examined for accurate results.
3. Carry forward- Carry forward is a part of routing checking. The balance of one page
can be transferred to the next page.
4. Posting - Posting is a part of routing checking. The entries are posted in to the ledger
accounts. Posting must be properly examined.
5. Balancing - Balancing is a part of routing checking. Taking the difference of debit and
credit in the accounts is called balancing.
6. Carry Down - The amounts in an account can be transferred to next page. The carry
down is a part of routing checking.
7. Transfer- Transfer is part of routing checking. The amount is one accounts can be
transferred to another account.
Advantages of Routine Checking1. Maintain Accuracy-The benefit of routine checking is that there is accuracy of
accounting books and records. The sub-total, casts and carry forward posting, balancing
and transfer are stated as correct.
2. Detects Frauds-Routine checking is useful to checking fraud in the books of accounts.
The responsibility lies on the head of management for location of fraud. The management
can use this tool to meet its duty.

3. Positive Verification-Routine checking helps to verify positive made in the ledger.

The correct posting can provide true and fair view of financial statements. The
management can verify posting through it.
4. No Change in Figures-Routine checking is useful to eliminate the alternation of
figures. The management can meet its obligation with the help of routine checking. The
employees cannot alter figures.
5. Final Checking- The benefit of routine checking is that final checking work is
reduced. The final checking become early as major work has already been completed
through routine checking.
Disadvantages of Routine Checking
1. No Care- The work of routine checking is given to junior employee. They do not
consider it as important matter. Therefore the expected result cannot be produced for
audit purpose.
2. Fraud- The demerit of routine checking is that planned frauds are not disclosed. The
responsibility of fraud lies on head of management. The audited accounts may fail to
provide true and fair view.
3. Error-The demerit of routine checking is that errors of principle are not disclosed. The
responsibility or error can be placed on the head of management. The audited accounts
may fail to provide true and fair view.
4. Monotony- The work is routine checking is boring and time consuming. The clerks go
on checking the totals and sub-totals and balances. It does not improve the performance
of employee rather becomes monotonous.
Test checkingExamination in Depth means examination of a few selected transactions from thebeginning to the end through the entire flow of the transaction. It involves studying the
recording of transactions the various stages through which they have passed.
Big business houses have a lot of transactions. So, it is very difficult to check all the
transactions 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 presents report to
the concern authority which is known as 'Test Check'. An auditor checks the books of
accounts of a particular time or area if there is no any doubt, s/he proves the account as
true and fair, otherwise auditor checks in detail where he has doubts. But if any errors or
frauds are left out due to random sampling, auditor will be responsible for such losses.
So, an auditor applies test check if internal check is effective in the organization.
Following points are to be taken into consideration while applying test check:

Size of the organization under audit.

State and efficacy of the internal control.
The sample size of test checking should be increased in case of lower reliability on
evidence produced or on internal control system.
While selecting sample materiality should be considered.
The areas having risk should be given more attention.
The adoption of test check should be mentioned at the time of preparing audit
Auditor must ensure that all the books and statements are produced to him at the time of
selection of sample.
Tolerable error range and degree of the desired confidence.
a) Save time- In test checking instead of checking each and every transaction only those
transactions are checked in details which are selected as sample and hence it saves a lot
of time.
b) Morale of employees- Chances of occurrences of fraud and error at clerical level
reduces due to the fear among them as their transaction may be subject to selection in
c) Economical Since it involves examination of few transactions at one sort the amount
paid to auditor is comparatively less.
d) Early finishing of audit work- Here, instead of examination of each and every
transaction only few transactions are analyzed and hence it saves labour time and ensure
speed audit.
e) Audit of many institutions possible- If auditor examines each and every item
comprehensively, it takes a lot of time and efforts. Hence, time saved by auditor by
resorting to test check technique may be used by him to audit various other concerns and
a. Dependence on internal control- Test check will prove to be inefficient where internal
control check and system is not operating or found inefficient.
b. Not suitable for small business-Since they have a few or less number of transactions.
c. Increase the responsibilities of auditors- Runs the risk that some of the material error
may not be discovered and some of the important areas may go unaudited.
d. Naive and Biased: The extent to which test checking can be resorted to is a matter of
Auditor's personal assessment. It does not ensure selection of representative samples of
adequate size and offers opportunities for bias to enter into selection process.

e. Probability of wrong results- it is bound to show wrong results if samples selected are
not proper representation of population.