Chap – 1 : Nature of Auditing

INTRODUCTION
— Professional judgment: He should apply relevant training, knowledge &
•‘AUDITING’ → Derived from Latin word → “ Audire” = To hear experience in making decisions.
— Professional skepticism: He should have questioning mind and be alert to
DEFINITION: conditions indicating doubts.
As per General Guidelines on Internal Auditing issued by ICAI, ► He should have a good knowledge of:
Auditing is defined as, — The general principles of law (Contracts Act, Partnership Act, etc.)
► a systematic and independent examination of data, statements, — The Nature of clients business
records, operations and performances (financial or otherwise) of an enterprise — General economic trends and scenario
► for a stated purpose. — Specific regulations & provisions (Companies Act, Trust Act, etc.)
► In any auditing situation, the auditor — Accounting & auditing concepts (AS, SAs, Principles, etc.)
-perceives and recognizes the propositions before — Data Processing i.e. computers
him for examination, ► He should continuously update his knowledge.
-collects evidence, ► He should have adequate practical experience under proper
-evaluates the same and supervision.
-on this basis formulates his judgment which is
communicated through his audit report. OBJECTIVES OF AUDIT:
Aspects of audit
1. Information conveyed by the statements is CLEAR and UNAMBIGUOUS. PRIMARY OBJECTIVE - EXPRESSION OF OPINION
2. Financial statements (hereafter referred as FS) are in CONFORMITY with (1) The objective of an audit of financial statements is to enable an auditor to
AS. express an opinion on such financial statements. His opinion helps
3. FS present TRUE and FAIR view of operational results. determination of true and fair view of the financial position and operating
4. None of the entries in books of entries are omitted. results of an enterprise.
5. The entries in books are adequately supported by evidence. (2) He should obtain reasonable assurance about whether financial
6. The Accounts have been drawn up with reference to entries in the books. statements as a whole are free from material misstatement. Auditor’s opinion is
not an absolute assurance due to inherent limitations of audit.
CUTE – CLEAR+ CONFORMITY+ TRUE and FAIR+ Evidence. (3) The auditor should review and assess the conclusions drawn from audit
evidences and on this basis form an overall conclusion as to whether:
(a) the financial information has been prepared using acceptable
THE AUDITOR accounting policies, which have been consistently applied;
(b) the financial information complies with relevant regulations and
1. The person conducting audit is known as the auditor; statutory requirements;
2. he makes a report to the person appointing him (c) there is adequate disclosure of all material matters relevant to the
3. in the form of an opinion on financial statements proper presentation of the financial information, subject to statutory
4. after due examination of accounting records and statements. requirements, where applicable.
5. Audit has to be conducted by a person having good knowledge of auditing (4) The audit report should contain a clear written expression of opinion on
& accounting concepts. the financial information.
6. In India, as per Companies Act, 2013 only Chartered Accountants can SECONDARY OBJECTIVE - DETECTION OF FRAUD &
conduct audit of companies. ERRORS
FUNCTIONAL CLASSIFICATION OF AUDITOR: (1) The auditor has to see that what the statements of account convey is true
S.NO INTERNAL AUDITOR EXTERNAL AUDITOR and not misleading and such errors & frauds do not exist as to distort what
the accounts really should convey.
(2) If an auditor has a suspicion of existence of any fraud then he must extend
1 They are company employees. They work for an outside audit firm.
his audit procedures to clear the doubts. His duty is to detect a fraud not to Procedural Errors.
1.An accounting system includes both records and procedures.
prevent it.
2 They will examine issues related They examine the financial records 2. Any breakdown in the laid down procedures may result in an error.
(3) An auditor is not bound to be a detective or to approach his work with 3.Errors which occur in the implementation of the procedures may be termed as procedural
to company business and issue an opinion regarding the
practices and risks. financial statements of the company suspicion. He is a watch dog, but not a bloodhound. Any undetected fraud errors.
in accounts, which can’t be observed in normal course of examination of 4.This type of error cannot be located by any rigorous examination of the books of account.
3 Scope of work – Is determined .Scope of work – Is determined by
accounts, will not be construed as failure of audit, provided the auditor was not Eg:It is the normal procedure that goods when received should be inspected for quality by the
by MANAGEMENT the STATUTE.
negligent in the carrying out his normal work. Re-Kingston Cotton Mills Co. inspection department staff. If the storekeeper carried out this function it is indeed risky.
4 NOT INDEPENDENT with INDEPENDENT of the management Similarly, if the procedure requires that the timber godown should have been given periodical
regard to management of the of the organization.
(4) The ultimate responsibility for control over Frauds & errors is of the
insecticide treatment and management has ignored that, a great loss may be caused to the
organization. management. So, management should install controls to ensure compilation of timber by white ants.
reliable statements of account.
5 They may or may not be Only qualified professionals are ERRORS Frauds
qualified professionals. eligible to conduct External Audit.
As per SA 240 “The Auditor’s Responsibility to Consider Fraud and Error in an Audit of Financial
Statements”, Fraud is:
6 Appointed by – MANAGEMENT. Appointed by – OWNERS (SHARE
 an intentional act by one or more individuals among management, those charged with
HOLDERS).
governance, employees or third parties,
7 They provide advice and other They are constrained from  involving the use of deception
consulting assistance to supporting an audit client too  to obtain an unjust or illegal advantage.
employees. closely Fraud involving one or more members of management or those charged with governance is
referred to as ‘management fraud’; fraud involving only employees of the entity is referred to as
QUALITIES OF AN AUDITOR: ‘employee fraud’. Risk of management fraud being undetected is higher than risk of employee
fraud being undetected.
► As per SA 200: As per SA 240, frauds can occur in two types:
— Integrity : Auditor should be straight forward, honest & sincere in (1) Fraudulent Financial Reporting
performing his duties. It involves intentional misstatements in financial statements with an intention to deceive
— Objectivity : He should be fair & unbiased in his approach. and conceal truth, by way of alteration of accounting records or documents, omission of
transactions or information or misapplication of accounting principles
— Independence: He should maintain an impartial attitude and be free of any
(2) Misappropriation of Assets
interest. His judgment should not be affected by the wishes or It involves theft of an entity’s assets accompanied by falsification of records to conceal the fact.
directions of another person.

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