Auditing Notes

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Affiliated with Northern University, Nowshera

Audit:
An audit is a systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree of
correspondence between these assertions and established criteria and communicating the
results to interested users.
By the audit process, the auditor enhances the usefulness and value of the financial
statements, and also increases the credibility of other non-audited information released by
management.
Brief history of auditing
The attitude of profit maximization from end middle ages - merchant houses in Italy.
Double-entry bookkeeping was first described in Italy (Pacioli 1494).
Industrial Revolution Great-Britain
1780 lead to the emergence of large industrial
companies.
1853 the Society of Accountants in Edinburgh was founded.
FEATURES OF AUDITING
a. Audit is a systematic and scientific examination of the books of
accounts of a business;
b. Audit is undertaken by an independent person or body of persons
who are duly qualified for the job.
c Audit is a verification of the results shown by the profit and loss
account and the state of affairs as shown by the balance sheet.
d. Audit is a critical review of the system of accounting and internal
control.
e. Audit is done with the help of vouchers, documents, information and
explanations received from the authorities.
OBJECTIVES OF AUDITING
There are two main objectives of auditing. The primary objective
and the secondary or incidental objective.
a. Primary objective as per Section 227 of the Companies Act
1956, the primary duty (objective) of the auditor is to report to
the owners whether the balance sheet gives a true and fair view
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of the Companys state of affairs and the profit and loss A/c
gives a correct figure of profit of loss for the financial year.
b. 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 are:
i. Detection and prevention of Frauds, and
ii. Detection and prevention of Errors.
THE AUDITOR SHOULD PERFORM THE FOLLOWING DUTIES
IN RESPECT OF FRAUD.
1. Examine all aspects of the finance.
2. Vouch all the receipts from the counterfoils or carbon copies or cash
memos, sales mart reports etc.
3. Check thoroughly the salary and wages register.
4. Verify the methods of valuation of stocks.
5. Check up stock register, goods inwards notes, goods out wards
books and delivery challans etc
6. Calculate various ratios in order to detect fraudulent manipulation of
accounts
7. Go through the details of unusual items.
8. Probe into the details of the problems when there is a suspicion.
9. Exercise reasonable skill and care while performing the duty.
10. Make surprise visit to check the accounts.
TYPES OF AUDIT
Audit of financial statements
Examine financial statements, determine if they give a true and fair view or fairly present
the financial statements.
Operational Audit
A study of a specific unit of an organization for the purpose of measuring its
performance.
Compliance Audit
A review of an organizations procedures and financial records performed to determine
whether the organization is following specific procedures, rules, or regulations set out by
some higher authority.
Types of Auditors
Internal auditors are employed by individual companies to investigate and appraise
the effectiveness of company operations for management.
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Independent auditors/External auditor are typically certified either by a

professional organization or government agency.
Audit Process Model

1. Phase I - Client Acceptance
2. Phase II - Planning
3. Phase III - Testing and Evidence
4. Phase IV - Evaluation and Judgment
Phase I Client Acceptance
Objective: The client acceptance phase of the audit plan, Phase I, involves deciding
whether to accept a new client or continue with an existing one.
Procedures: (1) Evaluate the client's background and reasons for the audit. (2) Determine
whether the auditor is able to meet the ethical requirements regarding the client. (3)
Determine need for other professionals. (4) Communicate with predecessor auditor; (5)
Prepare client proposal. (6) Select staff to perform the audit, and (7) Obtain an
engagement letter.
Phase II Planning the audit
Objective: Determine the amount and type of evidence and review required to give the
auditor assurance that there is no material misstatement of the financial statements.
Procedures (1) Perform audit procedures to understand the entity and its environment,
including the entitys internal control; (2) Assess the risks of material misstatements of
the financial statements. (3) Determine materiality; and (4) Prepare the planning
memorandum and audit program, containing the auditors response to the identified risks.
Phase III Testing and Evidence
Objective Test for evidence supporting internal controls and the fairness of the
financial statements.
Procedures: (1) Tests of controls; (2) Substantive tests of transactions; (3)
Analytical procedures; (4) Tests of details of balances. (5) Search for unrecorded
liabilities.
Phase IV, Evaluation and Reporting
Objective: Complete the audit procedures and issue an opinion.
Procedures: (1) Evaluate governance evidence; (2) Perform procedures to identify
subsequent events; (3) Review financial statements and other report material; (4) Perform
wrap-up procedures; (5) Prepare Matters of Attention for Partners; (6) Report to the board
of directors; and (7) Prepare Audit report.
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Vouching
Introduction
It means to test the truth of items appearing in the books of original entry. It is an
important part of an auditor's duty to certify as correct the transactions recorded in the
looks of accounts. The Accountant of a business is responsible for passing entries in the
books of prime entry. The question arises how and on what basis such entries have been
passed. The auditor's primary duty is to check these entries and only then certify the
accounts as correct and free from any error or fraud.
Definition
A careful examination of all original evidence such as invoice receipt of correspondence
minutes, contracts etc.
Vouching is very useful in proving the accuracy of the entries in the books of accounts. It
also indicates about that transaction, which is omitted from the books of account.
Importance
Vouching is called the essence of auditing. So audit is not possible without vouching. The
object of vouching is to find out the accuracy of the entries appearing in the books of
accounts and detect that no entry has been omitted from the books of account.
Principles of Vouching
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1. Arranged Voucher
In the books of accounts the vouchers are based an entry. A voucher is helpful to support
any transaction, which may be cash memo fill, voucher, ticket or others.
2. Checking of Date
The voucher date can also be checked; it must be related to the current year. The date of
the last or future year must not be adopted.
3. Checking of Authority
The vouchers are considers correct only when the proper authority signs on them. For the
approval of the dealing the owner or the management must put the signatures for the
approval of dealing if the vouchers are without the signatures of the proper authority.
They are not considers the true.
4. Cutting or Change
There should be no changes in the vouchers. Any person for making the fraud can change
the time, date, amount and name of concern. So, these changes cannot be acceptable till
the approval authority has made the signature.
5. Compare the Words and Figures
The auditor should satisfy himself amount written on the vouchers, it figures and words
are same or not.
6. Transaction Must Relate to Business
For the correctness of the vouchers it is necessary that it relate with the business.
Concern, the vouchers must be in the name of the business and also the manager. If it
does not the vouchers are not acceptable and doubtful.
7. Case of Personal Vouchers
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The auditor should not accept the voucher in personal name. There is a chance than an
officer of the company has purchased any item in his personal capacity.
8. Checking of Account Head
Auditor must be satisfied about the head of account in which cash is deposited and
drawn. He should examine the documentary evidence in these regards.
9. Revenue Stamps
For the stamps, the stamps act 1899 is applicable while fixing the revenue stamps. The
stamps are required according to the valuation of the amount or cash memo. There is no
need of vouchers if amount is less than twenty rupees.
10. Case of Cancelled Voucher
The auditor should not accept the cancelled vouchers because it has already served the
purpose of payment. There will be a danger of double payments, if it is accepted.
11. Important Notes
For finding the correct decision, the auditor can also take help from the working papers of
the previous year and others paper or note related to business and available with the
management.
12. Minutes Book
When the meeting of shareholders is held. All the resolutions and decisions of the
directors and shareholders are recorded in the minute's book. This minutes book must be
examine by the auditor. He has to check that these decisions have been implemented in
the books of accounts or not.
13. By Laws
In case of company the article of association and memorandum are basically the rules and
regulations. But on the other hand in the societies and clubs the by laws are used to
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determine the powers of management. The auditor goes through these rules and
regulations to find the true and fair view.
14. Agreements
The auditor must examine all the related papers of the business such as the agreement,
correspondence and others. The basic information can be received to the auditor by such
papers.
15. Deed of Mortgage
Some times, you are the sale or purchase of any assets, the management can enter into the
agreement is prepare in this case. If the agreement is prepare in this case. If the agreement
is made for a loan against the immovable property then the mortgage deed is signed. It is
compulsory for the auditor to study the content of the deed.
Procedures of Vouching
1. Reading Out
The vouching is a task of the auditor. The junior audit can read out the contents of the
vouchers. He can inform the senior auditor about the data name of organization, number
of voucher and amount of vouchers.
2. Comparison
The senior can head the contents called out by junior auditor. He tally each and every
item stated in the voucher with entries in the books of accounts. Thus comparison is a
part of vouching procedure.
3. Ticking
The senior auditor can use various ticks or symbols to clear the items checked. The ticks
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may be an abbreviation of words. Such ticks or symbols may differ from auditor to
auditor because these are code words.
4. Stamping
The senior auditor instead of signature or initials he can use stamps for checking the
vouchers can use the rubber stamps. The rubber stamp may have the wording checking
and cancelled on it.
5. Signatures
The senior auditor can vouch the entries with the help of vouchers. He can put his
signature or initials on every voucher for safety measures. The signed vouchers cannot be
presented again for another entry.
6. Query
The voucher may be missing. The entries may be doubtful due to over writing and
erasing. The audit staff can make the word "Q" against such entry. This entry is recorded
in working papers.
7. Management
The audit staff can be giving sometime to the management for clearing the objections.
The doubtful entries are handed over in written form. The management can examine the
record in detail.
8. Reply
The management may reply after one or two days about the doubtful entries. The auditor
can examine the reply of the managers. The auditor can judge whether the reply is right
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or wrong.
9. Clearance
The audit staff can clear the query for which proper answer is made available. The auditor
may not be satisfied with the answer of objections. He can inform the management about
this query.
10. No Satisfactory
The auditor may reject the unsatisfactory reply. He has skill, training and experience. He
can use all available means to test the truth. He can note down poor clarification in
working papers.
11. Objections
The objection stated in the working papers can be discussed with the management at the
end of audit. He can form an opinion on the basis of such objections. He can submit his
report either clear or qualified
Objectives of Vouching
1. Proper Evidence
The purpose vouching is to note that proper evidence is available for every entry. The
signatures, initials and rubber stamp are evidence that document has been authorized and
checked.
2. Proper Authority
The purpose of vouching is to note that there is proper authority behind every transaction.
In the absence of any signature of manager the transaction are not acceptable at all.
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3. Right Period
The purpose of vouching is to check that date of the vouchers relate to accounting period.
The adjustments in books are made on the basis of current year record of transactions.
4. Correct Amount
The purpose of vouching is to check that correct amounts have been recorded in the entry.
The vouching is useful to record only correct amounts in the books of accounts.
5. Capitals and Revenue Analysis

The purpose of vouching is to examine the analysis of transaction into capital and
revenue. The expense relating to one year is treated as revenue other wise it is called
capital.
6. Purchase for Business

The purpose of vouching is to check that purchase relate to the nature of business. The
private purchase cannot be recorded as business due to vouching.
7. Arithmetical Accuracy
The purpose of vouching is to see the arithmetical accuracy of books of accounts. The
auditor to confirm that books are accurate can check the total subtotals, casting and
posting.
8. Postings
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The postings of total from journal to the ledger can be voucher by the auditor. He can see
through vouchers that posting are complete and correct.
9. No Error
The purpose of total vouching is to check that there are no errors in the books of
accounts. The errors are the result of carelessness or over work. But audit staff is not over
loaded so they can locate error.
10. No Fraud
The purpose of vouching is to examine that no fraudulent payments are made. The fraud
can be committed due to matching of minds of employees and customer. The auditor can
vouch the entries top disclosed such frauds.
11. Castings
The purpose of vouching is to check castings or loads. The auditor can calculate all total
by himself. He can compare the totals with books to maintain accuracy.
12. Cast at Bank

The purpose of vouching is to determine true cash at bank. He can vouch receipt and
payments. The result is that he can check whether cashbook is correct or not.
13. Cash Balance

The purpose of vouching is to check that cash in hand figures are facts. The cash can be
counted. He can compare it with cashbook. He can apply test checking to determine
accuracy.
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14. Reporting
The purpose of vouching is to form an opinion for the purpose of reporting. In case of
true and fair view there is good report. In the absence of such result there may be
qualified report.
Techniques of Vouching
1. Correct Accounts
The auditor can check the accounts debited and credited are correct in all respects. The
rules of debit and credit can be followed for dividing the transactions into accounts.
2. Agreements
The auditor must examine the agreements, correspondence and other papers relating to
business activities. Such agreement provides basic information to the auditor. He can
vouch the transactions based on such agreements.
3. By-Laws
The memorandum and articles of association are rules and regulations in case to
company. The by-laws of societies and clubs and used to determine management power.
The auditor has the right to go through these rules and regulation.
4. Mortgage Deeds
The management may enter into agreement with any party for the purpose and sale of
assets. The deed or agreement is prepared. In case of loan against immoavable property
mortgage deed is signed. The content of deed must be situated.
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5. Minutes Book
The auditor should examine the minute's book. The resolution and decision of directors
and shareholder are recorded there. He can see that such decision have been implemented
in the books of accounts.
VERIFICATION :It means confirmation or proving the truth about the assets and liabilities appearing in the
balance sheet. Auditor has not only to check the arithmetical accuracy of the account by
vouching only.
H has also to verify the assets and liabilities appearing in the balance sheet to satisfy
himself that these are correct. Auditor will also check that the existence of actual items
and their actual possession held by the company concern.
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OBJECTS OF VERIFICATION :The object of verification of asset is the satisfaction by the auditor as to its existence,
proper disclosure, proper valuation, correct ownership on the balance sheet.
TECHNIQUES OF VERIFICATION :In the process of verification following techniques are used :
1. Existence Of Assets :The auditor should satisfy himself that such assets and liabilities which are shown on the
balance sheet really exist on that date or not.
2. Proper Disclosure :The auditor should also satisfy himself that each item of assets and liability is being
properly disclosed as required by the law.
3. Ownership Of Assets :This technique is used for establishing the ownership of assets and liabilities. Those
assets which are shown on the balance sheet must be properly of the client.
4. Assets In Possession :The auditor should satisfy himself that such assets which are shown on the balance sheet
were in the possession of the client at the date of the balance sheet.
5. Valuation Of Assets :Auditor should also satisfy himself that all those assets which are shown in the balance
sheet are properly valued. There are different factors which determine the basic of
valuation like, nature of business, object for which the assets are held and the nature of
assets.
6. Valuation Of Liabilities :Auditor should also satisfy himself about the liabilities that these are properly valued
which are shown on the balance sheet. Overstated or understand liabilities do not give a
true picture about the financial position.
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Auditor should pay special attention to this point. Because profit and loss account also
depends upon the accuracy of valuation of assets and liabilities. Valuation upto object is
that balance sheet should show a true and correct view about the financial position of a
client firm.
8. Purchase By Proper Authority :The auditor should also satisfy himself that the purchase of any particular asset was made
by the orders of empowered person. In this respect, auditor may check the legal document
or resolutions of the directors and shareholders.
9. Business Motive :Auditor should also satisfy himself that all the assets were obtained for the business
motive of the firm.
10. Checking Of Charges :Auditor should also examine that assets of the firm are free from mortgage and pledge.
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INTERNAL CONTROL, INTERNAL CHECK AND INTERNAL AUDIT

INTERNAL CONTROL
Internal Control is best regarded as indicating the whole system of controls, financial
and otherwise, established by the management in the conduct of a business, including
internal check, internal audit and other forms of control.
PURPOSE OF INTERNAL CONTROL
The objectives or purposes of Internal Control system is classified in two types:
FROM CLIENTs POINT OF VIEW
FROM THE AUDITORs POINT OF VIEW
(A) FROM CLIENTs POINTOF VIEW:
Cost Benefit Analysis is applied by the management to assess and select a particular method
of control and its applicability to the business conditions. The benefits which the internal
control system offers are:
a. Providing reliable data: Business decisions require accurate information to run the
business activities efficiently. Examples of significant areas where management requires
reliable information are fixation of
selling prices, production directives depending on requirements etc.
b. Safeguarding assets and records: The physical assets of a company can be stolen,
misused, or
accidently destroyed, if not properly protected by adequate controls. The same is true of
non-physical assets such as accounts receivable, important documents (e.g. confidential
government contracts) and records (e.g. the general ledger and journals). The safeguarding
of certain assets and records has become increasingly important since, the advent of
computer system. Large amounts of information stored on computer media
such as magnetic tape can be destroyed permanently if care is not taken to protect them.
c. To promote operational efficiency: The controls within an organization are meant to
prevent
unnecessary duplication of efforts, protect against waste in all aspects of the business, and
discourage other
types of inefficient use of resources.
d. To encourage adherence to prescribed policies: The system of internal control is meant to
provide reasonable assurance that procedures and rules of the various institutes are followed
by company personnel.
(B) FROM AUDITORS POINT OF VIEW:
The study and evaluation of the clients system of internal control is important to auditors.
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The auditors must have a thorough understanding of the system. A birds eye-view of the
controls fail to meet the standard of due care. There is a difference between the system that
is supposed to be in operation and the one actually being used. Simply by asking certain
questions, reviewing of the organization chart and studying a few procedure manuals to
obtain an understanding of the system is not sufficient. No doubt, these are important
parts of reviewing the system, but to obtain an adequate understanding the system must also
be tested.
There are two ways in which the study and evaluation of the client's of internal control is
used.
To determine whether an audit is possible: if possible, then
To determine the scope of audit.
PRINCIPLES OF INTERNAL CONTROL
Segregation of Duties
Separating duties among different employees reduces the opportunity for any one person
to commit fraud. It also creates double-check procedures to cut down on clerical errors.
The employee who handles record keeping should not have physical custody of the asset.
For example, the person responsible for bank reconciliations should not also receive
payments from customers or prepare the bank deposits.
Access
Physical controls ensure that only authorized employees may access company assets.
Some common controls include lockboxes for petty cash, key cards for warehouses and
unique passcodes for employees using cash registers. These controls may also be digital,
such as requiring a password to access the company's computer system
Authorization
Your company should also develop specific written procedures for financial transactions,
including a list of the people with authority to approve each type of transaction. You can
list standard transactions and acceptable amounts, then require manager approval to
exceed these limits. Approvals should be reviewed to ensure managers are not permitting
fraudulent transactions. Major transactions may require approval from more than one
person. For example, you may permit all employees to execute purchase orders under
$5,000 and require manager approval for any amount over this. The level of seniority
required for approval should rise as the dollar amount increases.
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Record Keeping
All financial statements should be backed up by general ledger reports or additional
schedules. You can also reduce fraud and accidental errors by using standardized forms
for financial transactions whenever possible, such as purchase orders or sales invoices.
These forms should be sequentially numbered so you can identify missing forms in the
sequence or new forms used to backdate a previously undocumented transaction.
Verification
A supervisor should periodically review all key general ledger accounts for accuracy. The
supervisor must be an employee who was not involved in preparing the report. Some
companies also employ internal auditors to verify the supervisor's approval. The
reviewing employee must sign and date the document as proof of his approval.
Supervisors should also look at relevant financial metrics to find areas that may be
experiencing efficiency problems. This may be an indication of fraud or improperly
recorded transactions.
INTERNAL AUDIT
Internal audit is a part of the whole system of internal control. It should operate
independently of the internal check and in no circumstances. It should divert any one of
responsibilities placed on him. It is the examination of accounts of a business concern by its
employees specially appointed for the purpose. It is an independent appraisal of activity
within an organization for the review of accounting, financial and other business practices.
ARTHIMETIC AND ACCOUNTING CONTROLS.
Chart of accounts i.e. balance sheet and income statement is an important control because it
provides the framework for determining the information presented to management and other
financial statement users. Chart of accounts or Financial Statement should be prepared in
accordance with the generally accepted accounting principles.
INTERNAL CHECK
It is an arrangement of duties of members of staff in such a manner than the work performed
by one person is automatically and independently checked by the others.
According to F.R.M.De PAULA, Internal check means practically a continuous internal
audit carried on by the staff it self, by means of which the work of each individual is
independently checked by other members of the staff.
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According to D.R. DAVAR, Internal check is a system or method introduced with defined
instructions given to staff as to their sphere of work with a view to control and verification
of their work and also maintenance of accurate records as the ultimate aim.
OBJECTIVES OF INTERNAL CHECK
1. To exercise moral pressure over staff.
2. To ensure that the accounting system produces reliable and adequate information.
3. To provide protection to the resources of the business against fraud, carelessness and
inefficiency.
4. To distribute the work in such a business transaction is left unrecorded.
5. To allocate duties and responsibilities of each clerk in such a way that he may be held
responsible for
particular fraud or error.
6. To minimize the chances of errors, frauds or irregularities in the business based on the
principle of division
of labour.
7. To detect errors and frauds easily if it is committed, because in an efficient internal check
system, there is
based on the principle of division of labour.
8. To detect errors and frauds easily if it is committed, because in an efficient internal check
system, there is a
provision for independent checking.
PRICIPLES OF A GOOD SYSTEM OF INTERNAL CHECK
1. Responsibility: Responsibility of each individual must be properly defined and fixed. The
work of the business should be allocated amongst various clerks in such a manner that their
duties and responsibilities
are clearly and judiciously divided.
2. Completion: The work should be divided in such a way that no single person is allowed
to complete the work solely by himself from the beginning to the end. However, there
should be no duplication of work.
3. Rotation of employees: A good system of internal check should not allow person having
custody of assets to have access to the books of account. A system of transfer or rotation of
employees from one seat of work to anther must be followed by the business.
4. Automatic check: A good system of internal check must provide for an automatic
checking of the work of one clerk by the other.
5. Reliance: No clerk of the business should be relied upon too much.
6. Safeguards: Safeguards should be prescribed to keep un-used cheque books, files and
securities etc.
7. Supervision: A strict supervision should be exercised to ensure that the prescribed internal
checks and procedures are fully operative.
8. Formal sanction: No deviation should be allowed from the established procedures till it is
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formally sanctioned by the top official.
9. Periodical review: the system of internal check be reviewed from time to time to
introduce improvements.
ADVANTAGES OF INTERNAL CHECK

Some of the widely accepted advantages of an efficient system of internal check are as
follows.
1. FOR THE BUSINESS
a. Proper division of work: Internal check entails a proper and rational distribution of work
among the members of staff of the enterprises keeping in view their individual
qualifications, experience and area of specialization.
b. Detection of errors and frauds: since no individual worker is allowed to handle a job
completely from the beginning to the end, and the work of each clerk is automatically
checked by the other, this heaps in the early detection and discovery of errors and frauds and
the possibilities of the commission of errors and frauds can be minimized.
c. Increased efficiency coupled with economy: A good system of internal check increase the
efficiency of work among the staff and leads to overall economy.
d. Moral check: knowledge of subsequent checking of each employees work by others, acts
as a great check to commission of errors and frauds.
2. FOR THE AUDITOR
a. Quick preparation of final accounts: The Profit & Loss Account and the Balance Sheet are
prepared without any loss of time.
b. Convenience to Auditor: Where an organization is operating system internal check, the
statutory auditor may conveniently avoid detailed checking of the transactions. He may
apply a few tests here and there and can relieve himself from detailed checking.
3. FOR THE OWNER
a. Accuracy of the accounts can be relied upon: if there is a system of internal check the
owner of the concern may rely upon genuineness and accuracy of the accounts.
b. Increase in profits: Overall efficiency and economy in operations result in more profits
thus ensuring larger dividends for the owners or shareholders.
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DISADVANTAGES OF INTERNAL CHECK.
Depending on each other proves fatal in the quick disposal of the work. if one person is
absent, the day-to-day work will be seriously disrupted. Following are some of the
disadvantages of a system of internal check.
1. Costly for small business: A system of Internal check system quite expensive especially
for small business houses.
2. Quality is sacrificed for Promptness: In an internal check system quality of work declines
because the clerks of the business attach greater importance to become quick and do not
care if in the process their work gets substandardised.
3. Carelessness among high officials: The possibility of some of the responsible and high
officials being complacent, increases as they believe, though not always rightly, that under a
sound system of internal check nothing can go wrong.
4. Disorder in the working of a business. In the absence of a proper organized system of
internal check there will be chaos and disorder in the working of business.
5. Risky for an auditor: If the auditor does not apply tests and procedure his own and if he
relies on the output of the system his work cannot be free from irregularities if the system
itself proves to be defective.
Auditors report
Unqualified Opinion
An opinion is said to be unqualified when the Auditor concludes that the Financial
Statements give a true and fair view in accordance with the financial reporting framework
used for the preparation and presentation of the Financial Statements. An Auditor gives a
Clean opinion or Unqualified Opinion when he or she does not have any significant
reservation in respect of matters contained in the Financial Statements. The most frequent
type of report is referred to as the "Unqualified Opinion", and is regarded by many as the
equivalent of a "clean bill of health" to a patient, which has led many to call it the "Clean
Opinion", but in reality it is not a clean bill of health, because the Auditor can only
provide reasonable assurance regarding the Financial Statements, not the health of the
company itself, or the integrity of company records not part of the foundation of the
Financial Statements.[2] This type of report is issued by an auditor when the financial
statements presented are free of material misstatements and are represented fairly in
accordance with the Generally Accepted Accounting Principles (GAAP), which in other
words means that the company's financial condition, position, and operations are fairly
presented in the financial statements. It is the best type of report an auditee may receive
from an external auditor.
An Unqualified Opinion indicates the following
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(1) The Financial Statements have been prepared using the Generally Accepted
Accounting Principles which have been consistently applied;
(2) The Financial Statements comply with relevant statutory requirements and
regulations;
(3) There is adequate disclosure of all material matters relevant to the proper presentation
of the financial information subject to statutory requirements, where applicable;
(4) Any changes in the accounting principles or in the method of their application and the
effects thereof have been properly determined and disclosed in the Financial Statements.
Qualified Opinion report
Qualified report is given by the auditor in either of these two cases:
1. When the financial statements are materially misstated due to misstatement in one
particular account balance, class of transaction or disclosure that does not have
pervasive effect on the financial statements.
2. When the auditor is unable to obtain audit evidence regarding particular account
balance, class of transaction or disclosure that does not have pervasive effect on
the financial statements.
'STATUTORY AUDIT'
A legally required review of the accuracy of a company's or government's financial
records. The purpose of a statutory audit is the same as the purpose of any other audit - to
determine whether an organization is providing a fair and accurate representation of its
financial position by examining information such as bank balances, bookkeeping records
and financial transactions.
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1. Errors of Omission:
Errors of omission generally arise due to the mistake of a clerk. If a transaction has been
omitted from being entered in the books of accounts, wholly or partially, it is an example
of error of omission.
There are items like purchases or sales which ought to have been recorded in the books of
accounts but due to oversight or carelessness, they have been wholly omitted from being
recorded.
Apart from these, there are cases where items remain partially recorded, e.g., (i) the rent
or interest may have been paid for 10 or 11 months and the remaining part of it which is
unpaid or outstanding has not been recorded in the journal.
It is, of course, true that such a mistake can be detected by careful audit but this is after
all a case of clear omission, (ii) Secondly, if an item has been recorded in the journal but
has not been posted in the ledger; error of omission may also arise. Really, this is an
example of omission in ledger-posting in which a transaction has been recorded but not
posted to the relevant accounts in the ledger.
The errors which arise due to non-recording of certain items will not affect the Trial
Balance and, the omission can be detected by careful scrutiny. But if one aspect of an
item, e.g., purchases or sales, has been entered in the books, such an omission will affect
the Trial Balance and, hence, will be easily detected. The errors which produce some
effect on the agreement of Trial Balance are easily detectable.
2. Errors of Commission:
Errors of commission usually arise through negligence in the matter of recording some
business transactions in the books of accounts. They are the outcome of a sort of wrong
doing on the part of clerks. If an item is incorrectly recorded in the journal or posted in
the ledger, it is an error of commission.
The following are some examples of errors of commission:
(i) Incorrect Recording-Wholly or Partially:
SIMSIT
When a transaction though recorded in the journal has been wrongly entered in the books
of original entry, error of commission is said to arise, e.g., a sale of Rs. 100 is entered in
the sales book as Rs. 10. Such an error does not affect the Trial Balance.
(ii) Incorrect Posting or Posting an Item to a Wrong Account:
This is another example of error of commission. It is possible that a transaction may be
entered correctly in the journal, but when posted in the ledger, a wrong amount may be
entered, e. g., sale of Rs. 100 may be written as Rs. 10 to the debit of the customers
account, thus debiting Rs. 90 less than the real figures.
The effect of this erroneous posting on the Trial Balance would be that the debit side
would be short by Rs. 90 and it would show a difference.
(iii) Errors in Totaling and Balancing:
Sometimes errors of commission arise in the books through incorrect castings and
calculations. Such cases are also the errors of commission. Such errors will affect the
Trial Balance. The result of such errors would be that the error in the total on the debit
side would lead to the error on debit side of the Trial Balance and so on.
(iv) Errors in Carrying Forward Totals to Trail Balance:
Errors of commission may creep into the books when balances of different accounts are
carried forward to the Trial Balance. The Balance of accounts may be carried forward less
or more than the real figure or double of it and sometimes also to the other side of the
Trial Balance.
For example, the balance of Rs. 125 on the debit side of an account may be carried
forward to the debit column of the Trial Balance as Rs. 115 or Rs. 135 or Rs. 250, and
even Rs. 125 may be written to the credit column of the Trial Balance, thus entering the
correct figure against this account but in the wrong column.
3. Compensating Errors:
Compensating errors arise when an error is counterbalanced or compensated by any other
error or errors so that the adverse effect of one on debit or credit side is neutralised by
that of another on credit or debit side.
SIMSIT
For example, As account, which was to be debited for Rs. 200, was credited for Rs. 200
and similarly, Bs account, which was to be credited for Rs. 200, was debited for Rs. 200.
If Rs. 120 is posted to the debit of the wages account in place of Rs. 100 and similarly to
the credit of rent account Rs. 120 is posted in place of Rs. 100, it is an example of
compensating error.
4. Errors of Principle:
Errors of principle generally arise out of a disregard for the principles of accountancy.
Such errors are sometimes committed intentionally to falsify and manipulate accounts
with an objective of showing more or less profits than their actual figures.
The following are some of the examples of such types of errors:
(i) Incorrect Allocation of Expenditure between Capital and Revenue:
When revenue expenditure is treated as capital expenditure and profits are inflated
thereby, it is a case of error of principle. For example, if repairs to machinery are treated
as an addition to it in the Machinery Account, it would be an error of this nature.
The result would be an increase in the cost of machinery without any charge on the Profit
and Loss Account and, as such, the Balance Sheet would not exhibit true and correct
position of the business.
(ii) Posting Revenue Items to the wrong class of Revenue Account:
When an item of wages is posted to general expenses account and similarly, an amount
on salary account is posted to Advertisement Account, such errors culminate in accounts.
Such errors will not affect the ultimate profit and hence, are said to be minor errors of
principle. But after all, accounts of a concern are falsified and become incorrect.
(iii) Posting an Item of Revenue or Expenditure to a Personal Account:
If rent paid to a landlord is posted to the debit side of his personal account, it is an
example of error of principle. The result of such an error would be that profits would be
inflated and the Balance Sheet would be wrong.
(iv) Valuation of Assets against Fundamental Principles of Accountancy:
SIMSIT
When different types of assets are not valued in accordance with the principles of
accountancy, major errors of principles arise and directly affect the profit and ultimately
the Balance Sheet.
Other Examples of Errors of Principle:
The following are some examples of errors of principle:
(i) Provision for inadequate or excess depreciation;
(ii) Non-provision of depreciation;
(iii) Wrong provision for outstanding expenses and income accrued;
(iv) Wrong adjustment of prepaid expenses;
(v) Wrong provision for bad and doubtful debts; and
(vi) Undervaluation and overvaluation of stock.
Fraud:
Fraud is really a false representation or entry which is made always intentionally with
some mischievous objectives. Fraud may be mainly of two types:
Misappropriation of Manipulation of accounts
Cash Goods
Misappropriation of Cash Usually, Cash is misappropriated by:
(i) The theft of cash receipts and petty cash.
(ii) The theft of cheques and other negotiable instruments.
(iii) Payments made to fictitious creditors or workmen.
Misappropriation or defalcation of cash is a very easy affair.
SIMSIT
Anybody with a little skill on his part can misappropriate money, especially in a big
business-house where the contacts between the proprietor and the persons handling cash
are not as close as in the case of a small proprietary business.
A transaction relating to the receipt of cash may either go totally unrecorded or recorded
at a figure less than the actual one in the Cash Book and, thus, the total or a part of the
cash may be pocketed by the cashier.
Similarly, it is possible to record false payment of money and to enter cash payment at
more than the actual figure. In this way, there may be concealment of money by the
Qualities of Auditor
Assertive
Auditors must be able to quickly establish confidence with the auditee, and during the
audit process must be the one who controls the agenda. They cannot allow the process to
get derailed, and must have the assertiveness to pull it back on track. There will be times
SIMSIT
when the auditor needs to firmly state a position in the face of a hostile reception to bad
news.
Punctual
Because auditing involves a whole team of people who come together for the opening
and closing meetings, its imperative that the process runs in accordance with the audit
plan.
Reliable
Auditees typically invest a lot of time and energy in preparing for an audit and it is
important to harness this energy. Letting people down on the day of an audit may
adversely affect the reputation of the auditor and affect ongoing relationships, which in
turn can affect the ability to get the information required from the audit. Your ideal
auditor is a person who soldiers on in spite of not feeling 100% from time to time.
Reports too must be prepared on time and to the required quality there is nothing worse
than keeping people endlessly waiting for the audit report to be issued.
Determined
Determination is a key attribute for an auditor. They need to have the determination to dig
down to the evidence they need to make a compliance decision - when the auditee is
trying desperately to steer them in another direction. Determination is also required to not
take the easy way out, and to get to the truth. Auditing is not for the faint-hearted.
Articulate
Auditors need to explain a lot of things, and the more clear and succinct they can be, the
better. They need to be able to explain why a regulation or procedure applies in a variety
of circumstances, and the thinking behind their decisions. They also need to be able to
write clear reports and recommendations in a way that people can understand and accept
them without taking offence. Auditors need to be able to communicate well to all levels
within an organisation: one moment they will be discussing requirements with people on
SIMSIT
the shop floor, the next they are explaining results to senior management in a closing
meeting. To say you need to be a diplomat is an understatement!
Independent
Auditors often work alone and have to travel long distances to do their work. The work
itself is lonely too, as they are generally on the other side of the fence from the people
theyre auditing and have to make some tough decisions on their own. Auditors need to
enjoy their own company, be happy to eat meals on their own and otherwise entertain
themselves while away from their home base and family.
Principled
Because of the subjective nature of this role, its important that auditors have high ethical
work standards and boundaries in order to make effective decisions.
You only need to examine the Enron case [http://en.wikipedia.org/wiki/Enron_scandal] to
learn the vital importance of principled thinking and actions on the part of those we trust
to be our compliance eyes and ears and sometimes, brain.

Auditing Notes

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SIMSIT

Affiliated with Northern University, Nowshera

Independent auditors/External auditor are typically certified either by a

Audit Process Model

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5. Capitals and Revenue Analysis

6. Purchase for Business

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12. Cast at Bank

13. Cash Balance

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INTERNAL CONTROL, INTERNAL CHECK AND INTERNAL AUDIT

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ADVANTAGES OF INTERNAL CHECK

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