auditing - india.oup.com

PrincipalJogesh Chandra Chaudhuri College

Kolkata

For B Com Honours Degree Course of University of Calcutta

Pankaj Kumar Roy

Auditing

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Features of

Learning Objectives Provide a broad overview of a chapter.

Ch

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r1Introduction to Auditing

IntroductIon

Book-keeping is the primary stage of accounting. Auditing begins where accounting ends. Irrespective of whether accounting is carried out as per the Generally Accepted Accounting Principles (GAAP), Generally Accepted Auditing Standards (GAAS), Accounting Standards (AS), Standards on Auditing (SA), Companies Act 2013, Income Tax Act 1961, International Financial Reporting Standards (IFRS) or not, it reveals the true and fair view of the financial outcome and financial position of the organization.

EvolutIon of AudItIng

Similar to other social sciences, auditing also has a long history. In the 100 Sarga of Ramayana Rama asks Bharata, ‘Is your income more than your expenditure or your expenditure less than your income.’ This very statement reveals the sense of auditing in the kingdom of Ayodhya. In the Mahabharata Nakul is the account-ant of Yudhisthir, who maintains the accounts of the stable, and at the same time Yudhisthir gives Nakul and Sahadeb the direction to maintain the accounts of the Kurukshetra War. In the Maurya period, the Arthashastra of Kautilya categorically states that all government transactions must pass through the treasury, and government accounts and an audit must be maintained. In 1494, Luca Pacioli, in his famous book Summa de Arithmetica Geometrica Proportioni et Proportionalita, incorporates one chapter in the name of double-entry book-keeping and elaborates on the task of an auditor.

From the Industrial Revolution (1750–1850), the centre of trade was shifted from Venice to London (small traders’ city) and with the introduction of the British Companies Act, 1862 for ascertaining the actual financial condition and earning of an enterprise, the Indian Companies Act, 1857 introduced optional annual audit. Until 1850, the task of auditing was confined to the detection of fraud. From 1850 to 1905, the objec-tive was extended to the detection of fraud and clerical errors.

1905–1940 witnessed the scope of detection of frauds and errors expand to determination of fairness of reports, with independent progress in the UK and USA. 1940 onwards, the objective has extended to the determination of the fairness of the reported financial position with the implementation of test checking as a principle on the basis of statistical sampling. In the post, the Second World War was declared independent. In the post-independence period of India, with the enactment of Chartered Accountants Act 1949, auditing became a profession on the recommendation of the Bhabha Committee which submitted its report in March,

Learning Objectives

Module I

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Not assisting investigating inspector—liability for negligence of assistants

Civil liabilities are due to civil wrongdoing of the auditor. Losses or damages may occur and remedy may be got from a civil court against the civil wrongdoing made by the auditor. In case of civil liability punishment will be made only in monetary terms.

Liability for negligence Here, negligence means harm caused due to careless activities but not intentional. The auditor is appointed by the Board, shareholders, or CAG to judge the accounts of the company and to give a report on the accounts that the true and fair view has been reflected. If an auditor is unable to perform his/her duties with reasonable skill and care, negligence arises.

Judgement on civil liability for negligence

1. Case: Irish Woollen Co. Ltd. vs Tyson and OthersYear of judgement: 1900Content of the case: The auditor had failed to discover a company’s liability due to suppression of the creditor’s invoices. The auditor could have discovered this either by checking the ledger balance or by scrutinizing the daily balances, which he never did.Judgement of the case: The auditor merely goes for checking arithmetical accuracy. He could have exercised sufficient skill and care for validity of the entries. He was held liable for negligence.

2. Case: Armitage vs Brewer and KnottYear of judgement: 1932Content of the case: The accountant had embezzled a huge amount of money by manipulating the wage sheet. The auditors have not taken reasonable skill and care and were unable to detect the embezzlement. They were held liable.

Decision of the case: The auditors were held liable for negligence and he had to give compensation to the plaintiff. The Learned Judge observed that, ‘it was the duty of auditors to be suspicious: that was what they were there for. If everybody was honest and careful, there would be no need for auditors.’

3. Case: Superintendent and Remembrancer of Legal Affairs, Bengal vs Akhil Bandhu Guha and OthersJudgement of the case: 1936Content of the case: Liability of auditor for negligenceDecision of the case: Without the proper explanation of the balance sheet items of assets and liabili-ties, if the auditor certifies the balance sheet, he will be liable for negligence.

4. Case: Government of India vs G.M. OkhaJudgement of the case: 1952Content of the case: Liability of auditor for negligenceDecision of the case: Not verifying the existence of an investment will make the auditor liable for negligence.

Liability for misfeasance The term misfeasance means breach of trust or duty has to be performed in case of a loss. Misfeasance refers to wilful inappropriate action or any incorrect action made by the auditor. After the liquidation of the company, misfeasance proceedings may be initiated against the auditor by the liquidator, the creditor, or by a contributory of the company.

Judgement on civil liability for misfeasance

1. Case: London and General Bank Ltd.Year of judgement: 1895Content of the case: The auditor who does not report to the shareholders regarding the real status of the balance sheet is guilty for misfeasance.

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Auditing34

Information system audit

In the words of Rob Weber, ‘Information system audit is the process of collecting and evaluating evidence to determine whether computer system safeguards assets, maintains data integrity, achieves organizational goals effectively, and consumes resources efficiently.’

Table 2.4 shows the differences between internal and statutory audits, and Table 2.5 depicts the differ-ences between statutory and non-statutory audits.

table 2.4 difference between internal audit and statutory audit

points of difference Internal audit statutory audit

Stage Internal audit is a mid-term audit to face the final or statutory audit.

Statutory audit is a final audit done to submit the audit report.

Scope The scope of internal audit is determined by the management.

The scope of statutory audit is vast and in no circumstances can it be limited.

Appointment and remuneration

Appointment along with the remuneration of the internal auditor is fixed by the management.

Appointment of statutory auditor is either made by the shareholders in the Annual General Meeting, or by the Board of Directors, or by the CAG as the case may be. Remuneration is also fixed by the respective appointing authority.

Qualification Internal auditor may or may not be a Chartered Accountant.

Statutory auditor must be a Chartered Accountant.

Rights and duties The management pre-determines the rights of the internal auditor. The internal auditor performs his/her duties accordingly.

The rights of the statutory auditor cannot be curtailed and it is just to perform his/her duties. The ultimate task of the statutory auditor is to submit an audit report to the appointing authority.

table 2.5 difference between statutory and non-statutory audit

points of difference statutory audit non-statutory audit

Definition Statutory audit is mandatory or compulsory as per statute or respective law.

Non-statutory audit is not mandatory or compulsory as respective statute or law but it is done to derive the benefit of audit.

Organization covered Joint stock companies, banking companies, and insurance companies along with others.

Sole proprietorship firms, partnership firms, etc.

Qualification of the auditor Auditor must possess the requisite qualification as per the statute: Chartered Accountant with completion of Articleship.

Auditor qualification is not mandatory as per the statute but should preferably be a Chartered Accountant with completion of Articleship.

Appointment In case of a joint stock company, appointment is made by the shareholders in the Annual General Meeting and in some cases by the Board of Directors or by the Central Government.

In case of sole proprietorship firms, appointment is made by the owner and in case of the partnership firms, appointment is made by the firm.

Remuneration Remuneration is fixed by the appointing authority.

Remuneration is fixed as an agreement between the auditor and appointing authority.

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Tables Numerous tables are provided to support the text.

Case Studies Provide numerous legal cases to highlight associated laws.


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the Book

Exercises (MCQs & Sections A, B & C) Exercises consist of multiple choice questions and

review questions that follow the CU exam pattern to acclimatize

students to the prevailing structure.

Question Bank Provides numerous solved questions to help students prepare for examinations.

Question Bank

Group A

Q1. From which Latin word is the term audit derived?

Ans: The term audit is derived from the Latin word audire, which means ‘to hear’.

Q2. Define the term auditing. State the two objectives of auditing.

Ans: The Institute of Chartered Accountants of India (ICAI) describes audit as ‘the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such examination is conducted with a view to express an opinion thereon’. Spicer and Pegler opined, ‘An audit may be said to be such an examination of books, accounts and vouchers of a business, as will enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair view of the state of affairs of business and whether the profit and loss account gives a true and fair view of the profit or loss for the financial period, according to the best of the informa-tion and explanation given to him and as shown by the books; and if not, to report in what respects he is not satisfied.’ The Auditing Practices Committee in its Standard Auditing Practices 1 (SAP 1) stated that ‘An audit is the independent examination of financial information (encompasses financial statement) of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.’ The scope of auditing has now shifted from verification to independent examination.

Auditing begins where accounting ends. The task of the auditor is to ensure that accounting is carried out as per norms and forms. Based on this, the basic objectives of auditing are to ensure the following:

1. The accounts must be free from frauds.2. The accounts must be free from errors.3. The accounts must exhibit the true and fair view and prepared as per accounting standards.4. The accounts must inculcate financial culture of the organization in particular and the society at large.

Q3. Auditing may be defined as ‘accounting control’ or auditing may be considered as Accounting Control. Discuss this statement.

Ans: Auditing is quite different from book-keeping and accounting. It has nothing to do with the writing of the books of accounts or the preparation of final accounts. In the words of Robert E. Schlosser, ‘Auditing is a systematic examination of financial statements, records and related operations to determine adherence to stated requirements.’ Auditing is a careful and critical examination of the books of accounts to find accuracy and to see whether the profit and loss accounts reflect the actual financial result or not, and the balance sheet exhibits a snapshot of the financial position at a particu-lar point of time. In short, it checks for the true and fair view of the financial position and it has to be prepared as per Accounting Standards. ‘Auditing has its principal roots not in accounting which it reviews, but logic on which it leans heavily for ideas and methods.’ ‘Accounting is necessary but auditing is luxury.’ ‘Auditing may be defined as accounting control’ or it may be said ‘where accounting ends, auditing begins’.

Q4. ‘The auditor is not an accountant.’ Explain.

Ans: Accounting involves the preparation of final accounts to show the financial outcome of the business at the end of the financial period. In the words of American Accounting Association, ‘Accounting refers to the process of indentifying, measuring and communicating economic information to permit informed judgement and decision by the user of the information.’ The man entrusted with this work is called the accountant. This work not only involves supervising book-keeping but also to analyse, review, and draw a conclusion in the form of final accounts (income statement and balance sheet). This work is of a specialized nature and must be well within the framework of accounting.

Auditing is quite different from book-keeping and accounting. It has nothing to do with the writing of the books of accounts or the preparation of final accounts. In the words of Robert E. Schlosser, ‘Auditing is a systematic examination of financial statements, records and related operations to determine adherence to stated requirements.’ Auditing is a

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Solved CU Question Papers

CalCutta university

Auditing (Honours) 2012

(Full Marks: 100)

Group-a 1. State the status of a company auditor. 5 Ans: [Q 11, p 275–276] 2. What is long form audit report (LFAR)? 5

Ans: [Q 4, p 261]3. ‘Vouching is the essence of audit.’ Discuss. 5

Ans: [Q 38, p 252–253]4. What is cost audit? What are its advantages? 5

Ans: [Q 48, p 256–257]5. What is internal audit? Is it compulsory for every limited company? Comment. 5

Ans: [Q 39, p 253] 6. Can dividend be paid out of capital? Give reasons for your answer. 5

Ans: [Q 51, p 257] 7. What are the considerations to keep in mind by an auditor before commencement of new audit? 5

Ans: [p 45–46] 8. Explain the types of opinion made by an auditor in relation to an audit. 5

Ans: [Q 17, p 267–268]9. What is environment audit? What are its objectives? 5

Ans: [Q 22, p 247] 10. What is fraud? State the role of an auditor to prevent fraud. 5

Ans: [Q 11, p 242]11. Mention the important points relevant for audit of insurance companies. 5

Ans: [Q 16, p 267] 12. Write a short note on tax audit. 5

Ans: [p 217]

Group-B 13. (a) What do you mean by ‘internal control system’? What are its objectives?

Ans: [p 54–55] (b) Write in detail the internal control system in relation to payment of wages in a large manufacturing

concern. 5 +10 = 15Ans: [p 56–57]

14. (a) Can dividend be paid under the following circumstances?(i) Out of current profits without making good the past loss.

Ans: [Q 4, p 271] (ii) Out of current profits without writing depreciation on fixed assets.

Ans: [p 146–147]

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Model Question Papers

Set 1

Auditing (Honours)

(Full Marks 100)

Group-A 1. State the status of a company auditor. 4

Or Explain the concept of ‘auditor’s independence’. 4 2. What is long form audit report (LFAR)? 4

OrWhat is meant by ‘limited review’? 4

3. ‘Vouching is the essence of audit.’ Discuss. 4 Or

What is internal audit? Is it compulsory for every limited company? Give your comment. 4 4. Discuss the qualifications of a company auditor. 4

Or‘Auditing may be defined as accounting control.’ Discuss. 4

5. Can dividend be paid out of capital? Give reasons for your answer. 4 Or

What is meant by unclaimed dividend? How is it shown in accounts? 3 + 1

Group-B6. What is environment audit? What are its objectives? 6

OrWhat is management audit? Discuss its advantages. 2 + 4

OrWhat is meant by analytical procedure of an audit? State the circumstances when an auditor can rely on it. 2 + 4

OrWhat is test checking? Give two examples of cut-off checking procedure. 4 + 2

7. What are the auditor’s duties relating to errors and frauds? 6 Or

State six important aspects that are usually included in audit engagement letters. 6 Or

Discuss six important features of auditing in CIS environment. 68. State the salient features of investigation. Mention the types of investigation with example for each. 4 + 2

OrMake a brief outline of investigation about business combination. 6

9. State four important matters included in a company’s annual report. 6 Or

Mention the important points relevant for audit of insurance companies. 6 Or

Narrate the steps to be taken before commencement of new audit of a joint stock company. 6

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Solved CU QPs and Model QPs Provide last five years’

solved question papers as well as two model question papers to help students prepare for examinations.

161Depreciation

transfer, annual provision for depreciation, written down value of the asset, cost of repairs and maintenance, number of working hours, number of idle working hours of the fixed assets, abnormal loss of the assets due to floods, fires, etc.

advantages

1. Existence of the assets can be verified.

2. Details of rate and method of each and every asset has to be scrutinized.

3. Reflection of the value of asset for each category has to be made in the balance sheet.

4. Comparing the written down value along with sale value will determine the profit or loss on sale of assets.

5. Replacement of asset has to be on track.

exercises

Multiple-choice Questions 1. Concept of depreciation is based on (a) use (b) effluxion (c) obsolescence (d) All of these 2. Depletion method is useful in case of (a) tangible assets (b) intangible assets (c) washing assets (d) None of these 3. Under which method does the depreciated value of the

asset never come to zero? (a) Straight line method(b) Diminishing balance method(c) Annuity method(d) None of these

4. Rate of depreciation to be employed by the company in respect of fixed assets is stated in which Schedule of the Companies Act, 2013? (a) Schedule I (b) Schedule II(c) Schedule III (d) None of these

5. Which of these is not considered as internal cause of depreciation? (a) Wear and tear (b) Exhaustion(c) Effluxion of time (d) None of these

6. Which one of these is not to be considered as an external cause of depreciation? (a) Depletion(b) Obsolescence or technological change(c) Accident and weather(d) None of these

7. Provision of depreciation is stated in which Section of the Companies Act, 2013? (a) Section 121(2) (b) Section 123(2)(c) Section 125(2) (d) None of these

8. Depreciation policy of the organization is determined by the

(a) accountant (b) auditor (c) board of directors (d) None of these

9. Before declaration of dividend, declaration of depreciation policy is

(a) compulsory (b) obligatory(c) not compulsory (d) None of these

10. Useful life of depreciable assets is (a) short (b) long

(c) limited (d) None of these11. Which one of these does not indicate depreciation?

(a) Gradual fall (b) Gradual rise(c) Permanent fall (c) Continuous fall

12. Asset register can be made for (a) tangible assets (b) intangible assets(c) current assets (d) None of these

13. Which method is the extension of sinking fund method or depreciation fund method?(a) Revaluation method(b) Insurance policy method(c) Depletion method(d) None of these

14. Which method is an approximation of diminishing balance method? (a) Sinking fund method(b) Depletion method(c) Insurance policy method(d) None of these

15. Which method is more useful in case of machines with high value but low useful life?(a) Machine–Hour Rate method(b) Depletion method

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(c) Diminishing Balance method(d) None of these

16. AS 6 on depreciation has conformity with which account-ing principle? (a) Conservatism principle (b) Disclosure principle(c) Material principle (d) None of these

17. Depreciation is stated in which Accounting Standard? (a) AS 1 (b) AS 2(c) AS 6 (d) None of these

18. For calculating Sum-of-the-years’-digits method, which mathematical progression series is applicable? (a) AP (b) GP(c) HP (d) None of these

19. As per AS 6, depreciation should be calculated in accord-ance with the new method from (a) date of change of method(b) date as decided by the board of directors(c) date of the asset coming to use(d) None of these

20. The straight line method or diminishing balance method is useful in case of which of these?(a) Tangible assets (b) Intangible assets(c) Washing assets (d) None of these

group a1. Distinguish between depreciation and amortization.

[CU B Com (Hons) 2002]2. What is the objective of charging depreciation on washing

assets? [CU B Com (Hons) 2008]3. Write the difference between depreciation and fluctua-

tion? [NBU B Com (Hons) 2006, 2010]4. Write the difference between depreciation and

obsolescence. [BU B Com (Hons) 2002, 2010]

5. What are the provisions of the Companies Act regarding arrear depreciation?

[CU B Com (Hons) 1998, 2001, 2004]

group B

As an auditor how would you deal with the following situations? (a) Fixed assets costing less than `5000 and therefore writ-

ten off in the year of acquisition is not entered in the fixed assets register.

(b) On the basis of a report of values showing that the book value of the net assets of the enterprise is much lower than their market value, the difference has been accumu-lated for as goodwill.

(c) Depreciation has been provided by including the cost of land in value of the building.

[CU B Com (Hons) 2002]

group c

1. Discuss the legal provisions of an auditor relating to the provisions for depreciation on fixed assets of a company.

2. What are the legal provisions to charge depreciation on fixed assets? [KU B Com (Hons) 1992]

3. What are the duties of an auditor regarding depreciation?[NBU B Com (Hons) 2012]

4. (a) Discuss the necessities of depreciation.[KU B Com (Hons) 1993, 1996, 1998]

(b) Discuss the duties of an auditor regarding deprecia-tion. [BU B Com (Hons) 2006, 2010]

5. Give an outline regarding the provisions of depreciation and duties performed by the auditor in this regard.

answers to Multiple-choice Questions 1. (d) 2. (c) 3. (b) 4. (b) 5. (c) 6. (a) 7. (b) 8. (c) 9. (a) 10. (c)

11. (b) 12. (a) 13. (b) 14. (b) 15. (a) 16. (b) 17. (c) 18. (a) 19. (c) 20. (a)

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Preface

Auditing is the outcome of the work carried out by a professional auditor which he does on the basis of pre-vailing Accounting Standards (AS), Standards of Auditing (SA), Generally Accepted Accounting Principles (GAAP), and the Companies Act, 2013 to find the true and fair view of the financial statements of an organi-zation. It is not only incorporated in the University of Calcutta syllabus as a subject, but also lays down the foundation of financial transparency in the corporate sector in particular and society at large.

About the Book

The basic objective of the book is to motivate the students to read the textbook, to assimilate the technical subject in an easy way, and to secure good marks and grades in university examinations. Students will be empowered to write answers with an accounting flavour. All relevant Sections are mentioned; and different case laws with facts and judgements are also given in the book. Realistic illustrations give the book a different magnitude. The book will be accepted by the students and teachers for its lucid presentation covering the wide spectrum of course contents. It is written as a textbook for university students and on the line of profes-sional approach to cater to students pursuing professional courses like ICAI (both Chartered and Cost), CS as well as law, management, and engineering students. The book is completely updated with the Companies Act, 2013 with up-to-date amendment, Standard on Auditing, Accounting Standard CARO, 2015.

Salient Features

Appropriate figures are used wherever necessary for clear understanding of the concepts. Five sets of university question papers are provided with full solutions. Two sets of model questions are

also provided for practice. Exercises are provided at the end of every chapter. They are divided into three groups (A, B, and C) in

keeping with the university examination pattern. Case studies along with fact of the case and decision of the case are given in sufficient numbers to enrich

the book. Several illustrative examples are provided throughout the book to make learning of difficult laws more

easy and understandable. A Question Bank containing numerous questions and answers is provided at the end of the book to help

students prepare for examinations

Online Resources

To aid the faculty and students using this book, additional resources are available at www.india.oup.com/orcs/9780199476503.

For Faculty and Students: Solutions to Chapter-end Exercises Solutions to Model Question Papers

Structure and Content of the Book

The book is broadly divided into two parts: Module I and Module II.


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viiPreface

The entire content is spread over fifteen chapters.

Chapter 1 introduces the subject of auditing. It covers the basic principles of auditing, relation between account-ing and auditing, and discusses the concepts of error and fraud in auditing.

Chapter 2 provides a detailed classification of audit. Auditing is classified according to objective, technique, coverage, organization structure, specific matter, etc.

Chapter 3 covers auditing procedures and techniques. The content includes auditing engagement, planning, and programme. It also covers documentation, audit evidence, and preparation before commencement of a new audit.

Chapter 4 deals with internal control and internal audit. The chapter covers the definition and objectives of internal check and internal control, as well as internal audit and audit risk.

Chapter 5 covers audit sampling and analytical procedure. Topics covered include types of sampling, test checking, and tools and techniques of analytical procedure.

Chapter 6 deals with vouching of different items, while Chapter 7 covers verification and valuation of audit of share capital, loans, fixed assets, creditors, etc.

Chapters 8–10 deal with company audit. They include qualification, disqualification, appointment, removal, and remuneration of company auditors. They also cover audit ceiling, branch audit, maintenance of book of accounts, dividend and divisible profits, and depreciation.

Chapter 11 covers audit report and certificate. It defines the two terms and shows the differences between them. Other topics covered include relevance of opinion, contents of annual report and auditor’s report, window-dressing of balance sheets, materiality, certificate on corporate governance, etc.

Chapter 12 discusses audit of different institutions such as banks, insurance companies, educational institutions, and hospitals. It also covers the audit of government bodies, NGOs, and NPOs.

Chapter 13 deals with investigation. Topics covered include types of investigations, assessing a business, inves-tigations to detect fraud, misappropriations, and defalcations.

Chapter 14 explains different thrust areas of auditing which include cost audit, management audit, tax audit, systems audit, social audit, environmental audit, energy audit, and forensic audit.

Chapter 15 discusses auditing ethics. Topics covered include professional misconduct, auditor’s independence, and auditing in a CIS environment. It also gives an overview of standards of auditing.

Acknowledgements

Special thanks go to Sweta Roy for her illustrative support. Thanks also go to Swapnil Roy for his silent sup-port. I owe my special thanks to Dr Tarashankar Roy, Prof. Ashim Brahma, Prof. Prabir Saha, and Prof. Sukumar De who acted as fountains of inspiration for doing this work. I would also like to thank

Dr Malayendu Saha, Vice Chancellor – Former University of Kalyani Dr Sagata Sen, Pro VC (Academic ) – University of Calcutta Dr Sujit Kumar Das, Former Principal – New Alipore College Dr Ashok Mukhopadhyay, Principal – Seth Anandaram Jaipuria College Dr Sukomol Dutta, Principal – Naba Ballygunge Mahavidyalaya Prof. Soumendu Sengupta, Former Principal – Maheshtala College Dr Manturam Samanta, Principal – Maharaja Manindra Chandra College Dr Asit Kumar Sarkar, Principal – Acharya Girish Chandra Bose College Dr Dipak Kar, Principal – Asutosh College Dr Sandip Kumar Paul, Principal – City College of Commerce and Business Administration


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Prefaceviii

Dr Subir Kumar Dutta, Principal – Khudiram Bose Central College Dr Indrani Saha, Sri Shikahayatan College, Subiresh Bhattacharya Dr Ashis Sana, Department of Commerce, University of Calcutta Prof. Radhanath Payne and Prof. Anil Saha, Seth Anandaram Jaipuria College Dr Biswajit Bhadra, Netaji Nagar College Dr Bhaskar Purakayastha, Principal – Shibpur Dinabandhu Institution Prof. Samir Kumar Sinha, Prof. Jayanta Nath Kundu, and Prof. Durgadas Bhattacharyya of Jogesh

Chandra Chaudhari College Prof. Mukul Saha and Prof. Shrutinath Praharaj, Raja Peary Mohan College Prof. Sanjib Roy, Sammilani Mahavidyalaya Dr Pinaki Roy, Former Principal – Netaji Nagar College Dr Keya Ghosh, Amity University, Kolkata

I would like to thank the editorial team of Oxford University Press India for their relentless support. Feedback and suggestions from knowledgeable quarters for improving the future editions are always welcome and can be sent at [email protected].

Pankaj Kumar Roy


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Brief Contents

Features of the Book ivPreface viDetailed Contents xRoad Map to Auditing xv

MOdULE I

1. Introduction to Auditing 1

2. Classification of Audits 15

3. Audit Procedures and Techniques 37

4. Internal Control and Internal Audit 50

5. Audit Sampling and Analytical Procedure 66

6. Vouching of different Items 79

7. Verification of different Items 93

MOdULE II

8. Company Audit 108

9. divisible Profit and dividend 137

10. depreciation 150

11. Audit Report and Certificate 163

12. Audit of different Institutions 177

13. Investigation 203

14. Other Thrust Areas in Auditing 212

15. Professional Ethics and Misconduct 224

Question Bank 241Solved CU Question Papers 286Model Question Papers 297Index 301About the Author 304


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Detailed Contents

1. Introduction to Auditing 1Introduction 1Evolution of Auditing 1Auditing Standards 2Meaning and Definition of Audit 2

Scope of Auditing 3Objectives of Auditing 3Advantages of Audit 5Limitations of Audit 5

Basic Principles of Auditing 6Auditing—A Dynamic Social Science 6

Accounting and Auditing 7Accounting 7Auditing 7Accounting is Necessary but Auditing is a Luxury 7

Errors 8Errors in Accounting 9Detection and Prevention of Errors 9

Responsibilities of Auditors 10Fraud 10

Purpose of Fraud 10Types of Frauds and Role of Auditors 10Role of Auditor in Case of Teeming and Lading 11Factors Leading to Increase in Risk of Errors and Frauds 12Auditor’s Duties Regarding Errors and Frauds 12

2. Classification of Audits 15Introduction 15Internal Audit 15

Objective 16Advantages 16

Independent Financial Audit or External Audit 16Objectives 17

Independence of Auditor 17Periodicity-wise Classification of Audit 18

Periodical Audit 18Continuous Audit 19Interim Audit 20Final Audit 21

Limited Review 21Technique-wise Classification of Audit 22

Balance Sheet Audit 22Standard Audit 23System Audit 23Electronic Data Processing Audit 23

Coverage-wise Classification of Audit 24Complete Audit or Detailed Audit 24Partial Audit 24

Organization Structure-wise Audit 25Statutory Audit 25Non-statutory Audit 26Government Audit 26

Specific Matter-wise Audit 27Cost Audit 27Management Audit 28Tax Audit 28Environmental Audit 29Human Resource Audit 29Social Audit 29Operational Audit 30Propriety Audit 30Stock Audit 31Public Deposit Audit 31Corporate Governance 32Cash Flow 32Compliance Audit 33Performance Audit or Efficiency Audit 33Information System Audit 34

3. Audit Procedures andTechniques 37

Introduction 37Auditing Engagement 37

Objectives 37Contents 37

Audit Planning 38Objectives 38Advantages 38

Features of the Book ivPreface viBrief Contents ixRoad Map to Auditing xv

MOdULE I


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xiDetailed Contents

Audit Programme 38Objectives 39Steps 39Matters to be Considered 39Advantages 39Disadvantages 39

Audit Documentation 40Audit Working Papers 40

Objectives 40Features 40Preservation, Ownership, and Custody 41

Audit File 41Classification 41

Audit Note Book 42Contents 42Advantages 43

Audit Memorandum 43Contents 43

Audit Evidence 43Concept 44Need 44Procedure 44Source 44Reliability 44Methodology 45

Preparation before Commencement of New Audits 45

Routine Checking 46Features 46Advantages 46Disadvantages 46Auditor’s Duty 47

4. Internal Control andInternal Audit 50

Introduction 50Internal Check 50

Objectives 50Process 51

Preparation of Check List 54Internal Control 54

Objectives 54Evaluation 55Internal Control in Computerized Environment 55

ICQ and Its Presentation 56Internal Control Questionnaire 56

Internal Audit 59Objectives 60Reliance by Statutory Auditor on Internal’s Audit Work 61Internal Audit Not Substitute of Statutory Audit 61

Audit Risk 62Objective 63Types 63Assessment Procedure of Audit Risk 63

Relationship between Materiality and Audit Risk 63

5. Audit Sampling andAnalytical Procedure 66

Introduction 66Audit Sampling 66

Necessity 66Advantages 66Methods of Sampling 67Stages 68Techniques of Sampling 69

Sampling Risk or Risk Factor in Auditing 69Test Checking 69

Presumption 70Advantages 70Limitations 70Role of Auditor 70

Cut-off Checking 71Objectives 71Auditor’s Duty 71

Surprise Checking 71Recommendations 72Advantages 72

Auditing-in-depth 72Advantages 72Limitations 72Auditor’s Duty 73

Analytical Procedure 73Nature 73Applications 73Tools and Techniques of Analytical Procedure 74Applications of Tools and Techniques 74Reliance on Analytical Procedure 75Circumstances When Auditor Relies on Analytical

Procedure 75Use for Substantive Testing 75

Related Party Transactions 76Substantive Testing in Audit Sampling 77

6. Vouching of different Items 79Vouching 79

Objectives 79Features 80Importance 80Duties of Auditors 80

Voucher 81Important Factors to be Considered 81

Teeming and Lading—Challenge of Vouching 82Duties of Auditors 82


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Vouching of Different Items—Receipts and

Payments-related 83

Duties of Auditors Regarding Missing Vouchers 90

Vouching-in-depth or Auditing-in-depth 91

7. Verification of different Items 93

Verification 93

Objectives 93

Advantages 94

Auditor’s Duty 94

Is Verification Indispensable? 95

Verification Includes Valuation 95

Valuation of Assets and Liabilities 96

Valuation 96Meaning 96Objectives 96Importance 96Auditor’s Duty 97

Verification of Non-current Assets 98Tangible Assets 98Intangible Assets 99

Verification of Semi-current Assets 100Investment 100Verification of Current Assets 100Verification of Other Assets 102Verification of Shareholders Fund 102Verification of Non-current Liabilities 103Verification of Current Liabilities 103Some Important Items to be Verified 104Verification of Contingent Liabilities and Commitments 105

MOdULE II

8. Company Audit 108Qualification of Company Auditors

[Section 141(1) and Section 141(2)] 108Disqualification of Company Auditors

[Section 141(3) and Section 141(4)] 108Appointment of Company Auditors [Section 139] 109

Specimen of Willingness Given by the Auditor 110Removal of Company Auditor [Section 140] 111Resignation of Company Auditor [Section 140] 111Remuneration of Auditor [Section 142] 111Audit Ceiling [Section 141(3)(g)] 111

Status of a Company Auditor 112Position of Company Auditor 112Rights and Power of Company Auditor

[Section 143] 113Decision of the Cases 113

Duties of Company Auditor [Section 143] 114Liabilities of Company Auditor 114Liabilities as Per Companies Act, 2013—Sections 35(1),

143(15), 342, 450, and 452 117Criminal Liabilities as per Companies Act, 2013—

[Sections 34, 36, 147, 282(3), 448, 449, 451, and 452(2)] 118

Liabilities as per Indian Penal Code [Section 197] 119Special Court [Sections 435 and 436] 121

Liability of the Honorary Auditor 121Branch Audit [Section 143] 122

Joint Audit [SA 299] 123Liability of Joint Auditors 123Special Audit 123Maintenance of Books of Accounts [Section 128] 124List of Statutory Registers and Books 124Related Party Disclosures [AS 18] 125

Auditor’s Duty Regarding Related Party Disclosure 126Segment Reporting [AS 17] 126Advantages of Segment Reporting 127Disadvantages of Segment Reporting 127Auditor’s Duty Regarding Segment Reporting 127

Audit of Financial Statement [Sections 136 and 137] 127

Cash Flow Statement 130Authentication of Financial Statements

[Section 134] 133Annual Report 133

Audit Committee [Section 177] 134Function of Audit Committee 134

9. divisible Profit and dividend 137Profit 137Capital Profit 138

Revenue Profit 138Divisible Profit 138

Factors Affecting Determination of Profit 138Provision of the Companies Act Regarding Divisible

Profit [Section 123(1)] 139Auditor’s Duty Regarding Divisible Profit 139

Dividend 140Interest 140Provision of the Companies Act, 2013 for Payment of

Dividends [Section 123 and 124] 141Auditor’s Duty Regarding Payment of Dividend 142

Interim Dividend 142Objectives 142Provision of the Companies Act Regarding Interim

Dividend [Section 123(3)] 143Auditor’s Duty 143


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Provisions of the Companies Act Regarding Unpaid Dividend and Unclaimed Dividend [Section 123(1) and 124] 144

Auditor’s Duty 144Declaration of Dividend and Problem Regarding

Depreciation [Section 123(1)] 144Problem Regarding Writing-off Past Losses 145Problem Regarding Payment of Dividend from Reserve

[Section 123(1)] 146Problem Regarding Payment of Dividend from Capital

Profit [Section 123(1)] 146Problem Regarding Payment of Dividend from

Revaluation Profit [Section 123(1)] 146Problem Regarding Writing-off Capital Loss 147Right to Dividend, Rights Shares and Bonus Shares to

be Held in Abeyance Pending Registration of Transfer of Shares [Section 126] 147

Punishment for Failure to Distribute Dividend [Section 127] 148

10. depreciation 150Depreciation 150

Essential Features 150Causes 151Objectives 151Necessity 151Difference between Depreciation and Amortization 151Factors Affecting Determination of Depreciation 152Methods of Depreciation 153

Revaluation of Assets and Depreciation 158Change of Rate and Method of Depreciation 158Provision for Depreciation under Companies Act, 2013 159

Auditor’s Duty Regarding Depreciation 159Legal Decisions 160Fixed Asset Register 160

Advantages 161

11. Audit Report and Certificate 163Audit Report 163

Objectives 163Need and Importance 163Responsibility of an Auditor [Section 143] 164Requirement of a Good Audit Report 164Particulars to be Furnished in Audit Reports 165

Signature on Audit Report [Section 145] 165Audit Certificate 165Relevance of Opinion 166

Types of Audit Reports 166Contents of Annual Report 167Contents of Audit report (As per Companies Act and

Standards on Auditing) 168Specimen of Independent Auditor’s Report 168

True and Fair View 170Window-dressing of Balance Sheet 171Materiality Concept 171

Importance of Materiality to Auditors 171Limited Review 172Disclosures 172Certificate on Corporate Governance 172

Specimen of Auditor’s Certificate on Compliance of Conditions of Corporate Governance 173

Cash Flow Statement Reporting 174Companies Auditor’s Report Order (CARO), 2015 174Matters Included in Auditor’s Report 174

12. Audit of different Institutions 177Audit of Banks 177

Legislations Relevant to Audit of Banks 178Accounting Provisions 178Bank Auditor 179

Qualification 179Appointment 179Remuneration 179Rights and Liabilities 179

Features of Bank Audit 180Stages of Bank Audit 180Audit Procedure of Bank Audit 181

Specimen of Auditor’s Report of a Bank 182 Internal Control of Bank 184Evaluation of Bank Audit 184

Concept of Non-performing Assets 184Evaluation of Non-performing Assets 185

Long Form Audit Report (LFAR) 185Insurance Company 185

Audit 185Audit of Accounts of Life Insurance Corporation 186Audit of Accounts of General Insurance Corporation 187Review of Internal Control of Insurance Company 187Contents of Audit Report of an Insurance Company as per

IRDA—Specimen of Auditor’s Report of an Insurance Company 187

Specimen of Independent Auditor’s Report 187Audit of PSU 190Features and Basic Principles of Government

Audit 190Educational Institutions 190Hospital 191Social Audit 192Propriety Audit 192

Objectives of Propriety Audit 192Advantages of Propriety Audit 193

Audit of PSU 193Audit of PSU [Article 149] 193Objectives of Propriety Audit of PSU 193Audit of Departmental Undertakings 194 Audit of Statutory Corporation 194Audit of Government Company 195

The Comptroller and Auditor General of India (CAG) [Articles 148 to 151 of the Constitution of India] 196

Appointment of CAG [Section 148] 196


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Tenure of Service of CAG 196Duties and Power of CAG [Article 149] 196Forms of Accounts of the Union and of the States

[Article 150] 197Annual Budget [Articles 112 to 116] 197Fund [Article 265 and Article 266] 197Audit Report by CAG [Article 151] 197

Functions of CAG 197Definition of Government Company [Section 2(45)] 197Audit of Government Company 197Appointment of Auditor of Government Company

[Section 139(5) and Section 139(7)] 198Remuneration of Government Auditor 198Audit Procedure [Section 143(5)] 198Audit Report and Function 198Preparatory Steps before Commencement of Audit of a

Company [Section 139(1)] 198Audit of Local Bodies 199

Salient Features of Financial Administration of Local Bodies 199

Definition of NGOs 200Audit Procedure Followed by NGOs 200

13. Investigation 203Investigation 203

Purpose 203Provisions of Companies Act, 2013

Regarding Investigation 204Rights and Duties of Auditors

Regarding Investigation as per Companies Act, 2013 204

Approach of Investigation 205Types 205

Due Diligence Review of Business 205Valuation 205

Role of Investigator 206Investigation to Suspected/Detect Fraud 206Investigation of Misappropriations of Goods 207Defalcation of Cash by Employees 207Investigation with Respect to Business Combinations 208

Investigation into Financial Position of Running Businesses 209

Investigation Regarding Sickness 209Investigation More Effective than Audit 209

14. Other Thrust Areas in Auditing 212Cost Audit 212

Definition 212Objectives 212Advantages 213

Relevant Provisions of Companies Act Regarding Cost Audit 213

Management Audit 214Objectives 215Importance 215

Tax Audit 217Appointment of Tax Auditor 217Ceiling of Tax Auditor 217Application of Tax Audit 217

Systems Audit 217Social Audit 217

Objectives 218Environment Audit 218

Legal Framework of Environment Audit 218Environment (Protection) Act, 1986 218Objectives 218

Energy Audit 219Objectives 219Key Factors 219

Forensic Audit 219Objectives 219

Performance Audit 220Peer Review 221

Objectives 221Regulatory Requirements 222Peer Review Board 222

15. Professional Ethics andMisconduct 224

Ethics in Auditing 224Professional Ethics 224

Fundamental Principle 225Legal Requirements Regarding Auditor’s Independence 229

Auditor’s Independence 229Definition 229Need 230Concept 230

Auditing in CIS Environment 230Features 231Approach to Auditing 231Problems Faced by Auditors in Computerized

Environments 232Accounting Standard 232Evolution of Standards on Auditing 234Definition of Standards on Auditing (SA) 234

Purpose of SA 234Importance of SA 234

Present Position as to Number and Title (as Issued by ICAI) 234

Question Bank 241Solved CU Question Papers 286Model Question Papers 297Index 301About the Author 304


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Road Map to Auditing

Module I

Unit Topic description Chapter

Unit 1 Introduction Definition - Nature - Scope and Objectives of Independent Financial Audit - Limitation Basic Principles Governing an Audit - Relation between Accounting and Auditing Errors and Frauds - Concepts, Means of Doing Fraud, Purpose - Conditions which Increase the Risk of Fraud and Error - Auditor’s Responsibility towards Detection and Reporting Classification - Objective-wise (Internal and Independent Financial Audit), Periodicity-wise (Periodical, Continuous, Interim, Final, Limited Review), Technique-wise (Balance Sheet, Standard, System, EDP), Coverage-wise (Complete, Partial, EDP), Organisation Structure-wise (Statutory, Non-statutory)

1

2

Unit 2 Auditing Procedures and Techniques

Auditing Engagement - Audit Planning - Audit Programme Documentation - Audit Working Papers, Ownership and Custody of Working Papers - Audit File (Permanent, Current) - Audit Note Book - Audit Memorandum - Audit Evidence - Concept, Need, Procedure to Obtain Audit Evidence, Source and Reliability, Methods Preparation before Commencement of a New Audit

3

Unit 3 Internal Control and Internal Audit

Internal Check - Definition, Objective, Preparation of Check Lists Internal Control - Definition, Objectives, Evaluation, Internal Control in Computerized Environment, ICQ and its Preparation, Comparison with Internal Check Internal Audit - Definition, Objectives, Regulatory Requirements (Companies Act), Reliance by Statutory Auditor on Internal Auditor’s Work Audit Risk - Concept, Types and their Assessment Procedure

4

Unit 4 Audit Sampling and Analytical Procedure

Concept, Need and Types of Sampling - Sampling Risk - Stages in Audit Sampling Test Checking - Auditing in Depth and Cut-off Checking Analytical Procedure - Nature and Application of Analytical Procedure - Tools and Techniques of Analytical Procedure - Extent of Reliance on Analytical Procedure - Use of Analytical Procedure for Substantive Testing

5

Unit 5 Audit (Vouching and Verification) of Different Items

Vouching - Meaning, Objectives - Vouching of Different Items (Receipts and Payments Related) Verification - Concepts, Objectives - Audit of Share Capital, Loans (Secured and Unsecured), Fixed Assets (Building, Plant and Machinery, Loans and Advances, Investment, Goodwill, Copy Right, Patent Right Inventories, Debtors), Creditors, Subsequent Events, Preliminary Expenditures, Directors’ Remuneration, etc.

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Module II

Unit Topic description Chapter

Unit 1 Company Audit Qualification, Disqualification, Appointment, Removal, Remuneration of Auditors Audit Ceiling - Status, Power, Duties and Liabilities of Auditors Branch Audit - Joint Audit - Special Audit Maintenance of Books of Account - Related Party Disclosures - Segment Reporting Divisible Profit, Dividend Depreciation (Companies Act, Standards on Accounting, Legal Decisions and Auditor’s Responsibility) Representation by Management - Contents of Audit Report (A Brief Idea)

8

910

Unit 2 Audit Report and Certificate

Definition - Distinction between Report and Certificate - Types of Reports/Opinion (Clean, Qualified, Disclaimer, Negative and Piecemeal) Contents of Audit Report (As per Companies Act and Standard of Auditing) True and Fair View (Concept and Guiding Factors) - Materiality (Concepts and Relevance) - Limited Review - Disclosures Certificate on Corporate Governance - Cash Flow Statement Reporting

11

Unit 3 Audit of Different Institutions

Banks - Legislation Relevant to Audit of Banks, Approach of Bank Audit, Internal Control - Evaluation, Non-performance Assets (Concept, Provisions), Long Form Audit Report Insurance Companies - Legislation Relevant to Audit of Insurance Companies (Life and General Insurance), Review of Internal Control, Audit Report (Matters as per IRDA) Educational Institutions and Hospital - Features and Basic Principles of Government Audit - Local Bodies and Non-profit Seeking Organization (Including NGOs) Comptroller and Auditor General and its Constitutional, Role

12

Unit 4 Investigation Meaning, Purpose - Distinction between Investigation and Auditing, Approach to Investigation - Types of InvestigationsAssessing a Business (Due Diligence Review, Valuation) Investigation to Direct Fraud, Misappropriations and Defalcations - Investigation with Respect to Business Combinations

13

Unit 5 Other Thrust Areas

Cost Audit - Concepts, Objectives, Advantages, Relevant Provisions of Companies Act Management Audit - Tax Audit - Systems Audit - Social Audit - Environment Audit Energy Audit - Forensic Audit - Peer Review (Concepts, Objectives and Regulatory Requirements) Ethics in Auditing - Auditor’s Independence Auditing in CIS Environment Standards on Auditing (Concepts, Purpose and Present Position as to Number and Title as Issued by ICAI)

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r2Classification of Audits

IntroductIon

Auditing has evolved as a dynamic social science. On the basis of structure, there are two types of audit, namely statutory and non-statutory. Statutory organizations come under the purview of the law, for example, a company and a co-operative society. In the case of non-statutory organizations, auditing is not mandatory although they may take the benefit of auditing, such as sole proprietorship and partnership. Large concerns are not only going in for statutory audit but also implementing cost audit, tax audit, social audit, and environ-mental audit as per the law or social commitment.

Audit

External audit or independent audit Internal audit

Not by the staff of the concern By the staff of the concern

Internal audIt

Internal auditing is an independent appraisal function established within an organization to examine and evaluate the accounting and financing activities as service to the organization. The objective of internal audit-ing is to assist the members of the organization in the effective discharge of their responsibilities. The scope of internal audit is determined by the management. In any case, internal audit is nothing but a post-transaction review to evaluate the records, controls, and operations in an organization.

Learning Objectives

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Section 138 of the Companies Act, 2013 stated that such class or classes of companies as may be pre-scribed shall be required to appoint an internal auditor, who shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Board to conduct internal audit of the func-tions and activities of the company.

After the introduction of Companies Act, 2013, internal audit got legal recognition and the scope of pro-fessionals such as Chartered Accountants and Cost Accountants, along with other professionals has widened. As per Rule 14 of the Companies (Accounts) Rules, 2014, appointment of an internal auditor is statutory in the following cases:

1. Every listed company

2. Every unlisted company having paid up capital of `50 crore or more during the preceding financialyear or having a turnover of `200 crore or more during the preceding financial year, having outstand-ing loans, or if borrowings from banks or financial institutions exceed `100 crore or more at any pointof time or if there are outstanding deposits of `25 crore or more at any point of time

3. Every private company having a turnover of `200 crore or more during the preceding financial year,outstanding loans, or if borrowings exceeds `100 crore or more at any point of time during the preced-ing financial year

objective

The Standard on Internal Audit (SIA) 1 to 17 has categorically mentioned the responsibilities of the internal auditor regarding compliance of laws and regulations on the one hand and review the significant impact on the functioning of the concern. The revised standard on internal audit reminds us, ‘The internal audit in itself has, for one, been a niche area for the members of the institute, and second the Indian economy today needs the value addition made by the modern-day internal audit to help its corporates face the acerbic competition, both on the domestic and international frontiers.’ ‘The Institute of Chartered Accounts of India through Internal Audit Standards Board (IASB) has made keen attention on the functioning of internal audit done by the practicing members to be considered as a best practice in the field.’

advantages

1. Supplements the external audit

2. Complies with the Companies Act, 2013 and the Standard on Internal Audit guide lines made by theICAI

3. Helps to prepare the financial statements in conformity with Accounting Standards as laid down in theAct

4. Improves the trustworthiness among investors, banks and financial institutions, governments, and thesociety

5. Improves the degree of internal control to strengthen financial discipline

Example: Satyam is a `700 crore lie; this is because internal audit has failed. On the other side of the coin, Infosys has completed financial auditing of the preceding financial year within 15 April of the succeeding financial year.

Independent FInancIal audIt or external audIt

The term ‘audit’ comes from the Latin word audire which means ‘to hear’. Earlier, accounts were getting checked by others. Nowadays, every organization checks the accounts with the help of an external agency

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17

for independent judgement. For the purpose of statutory audit, a qualified Chartered Accountant with com-pletion of Articleship is essential to conduct the audit. In the case of non-statutory audits as well, qualified Chartered Accountants are being appointed to derive the best benefits from the audit. Auditing has now become the culture of an organization in particular and the society at large. The Indian Companies Act, 2013 lays down the guidelines for an audit. Chartered Accountants Act, 1949 also mentions the code of conduct of the auditor for smooth functioning of the audit.

The principal objective of a financial audit is to report the financial position of the organization consid-ering the financial statements, both the income statement and the balance sheet, along with the cash flow statement. Financial statement must be free from errors and frauds inter alia; the true and fair view must be exhibited in view of the Accounting and Auditing Standards being followed—International Financial Reporting Standards (IFRS) and Standards on Auditing (SA).

objectives

1. Transparency of accounting

2. Universal acceptability of accounts

3. Reduction in the coherence between the internal user and external user of the accounts

4. Exhibition of error-free and fraud-free accounts

5. Demonstration of the true and fair view, as per the accounting standards

Independence oF audItor

The very concept of ‘independence of auditor’ reflects the underlying concept that auditing is not influ-enced by the appointing authority. Independent opinions passed by the appointed auditor makes the process transparent and widely accepted in all parts of the society. An audited financial statement is accepted by the Income Tax department, banks or financial institutions, local authorities (corporation, municipality, or a notified area authority) or any other purpose deemed to be fit for the purpose of clarification, explanation, and support.

In the case of London and General Bank, Lord Justice Lindley has opined, ‘An auditor must be honest, that is, he must not certify what he does not believe to be true and he must take reasonable care and skill before he believes what he certifies is true.’

Section 144 of the Companies Act, 2013 also upholds the independent character of the auditor. He/She must not render the following services directly or indirectly to the company, its holding company, or a sub-sidiary company:

(a) Accounting and book-keeping

(b) Internal audit

(c) Design and implementation of any financial information system

(d) Actuarial services

(e) Investment advisory services

(f) Investment banking services

(g) Rendering of outsourced financial services

(h) Management services

(i) Any other kind of services as may be prescribed

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It is clear that the auditor must not render any sort of services that will hamper his/her honesty, integrity, and independence. He/She will perform his/her statutory obligation and no way deviate from the ethical code of conduct, as laid down in the Chartered Accountants Act, 1949.

perIodIcIty-wIse classIFIcatIon oF audIt

Classification on the basis of periodicity

Continuous audit Periodical audit Interim audit Final audit Limited review

periodical audit

Completed, final, or periodical audit is done at the end of an accounting period for the purpose of final or end-term audit. In the words of Spicer and Pegler, ‘Periodical is commonly understood to be an audit which is not commenced until after the end of the financial period and is then carried on until completed.’

Objectives

1. Time span: Work will be carried out till the completion of the audit work task, stipulated time will beprovided for that.

2. Work plan: Considering the volume of the audit, a plan will be laid down so that the task of auditingwould become easier.

3. Less monotony: As audit work is done at the end of the financial year, repetition of work is not possibleand chance of monotony will be minimized.

4. Continuity restraint: Periodical audit restrains the continuity of work.

5. Cost effective: As continuous audit is cost effective, it will be equally applicable to all concerns, irrespectiveof size.

Advantages

1. Economics: The cost of periodical audit is comparatively cheaper than that of continuous audit; henceany type of concern can adopt this irrespective of size.

2. Comfortable: As the audit starts at the end of the financial year, concerns are not affected in any way andit is a comfortable time to conduct the audit.

3. Hassle-free: As periodical audit is done at the end period, it will be hassle-free and regular work wouldnot be affected.

4. Time bound: Periodical audit is a time-bound game and plans can be introduced smoothly.

5. Continuity of work: As the audit is completed in a single session, the loss of link is not possible.

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continuous audit

A continuous audit or a detailed audit is an audit which involves a detailed examination of the books of accounts at regular intervals, every month or every three months. In the words of R.C. Williams, ‘A continu-ous audit is one where the auditor or his staff is constantly engaged in checking the accounts during the whole period or where the auditor or his staff attends at regular or irregular intervals during the period.’

The auditor visits his/her clients at regular or irregular intervals during the financial year and checks each and every transaction meticulously. Continuous audit is not of much use to a small concern as its accounts can be audited at the end of the financial year without much loss of time.

Objectives

This type of audit is especially applicable to the following businesses:

1. When the business is very large and the entire process of auditing cannot be completed in a short periodof time

2. Where a good and efficient system of internal audit does not prevail

3. Where the volume of transaction is very large

4. Where the monthly results are required to ascertain the trend of the business

5. Where it is desired to prepare the final accounts just after the closing of the financial year

Advantages

1. Easy and quick discovery of errors and frauds: Errors and frauds can be discovered easily and quickly as theauditor checks the accounts at regular intervals and in detail. If the auditor checks the accounts afterone year it would be difficult to locate an error and fraud. The auditor visits the organization everymonth or every two or three months. The number of transactions tends to be few, and errors and fraudscan easily be detected.

2. Quick presentation of accounts: Since most of the checking has already been carried out during the financialyear, the final audited accounts can be presented soon after the end of the financial year at the annualgeneral meeting.

3. Knowledge of technical details: Since the auditor remains more in touch with the business, he/she is in aposition to know the technical details and accordingly make suggestions.

4. Ethical upgradation of staff: Since the auditor visits the client at regular intervals, there is ethical pressureon the accounting staff to keep the accounts up-to-date on a true and fair basis. It is more than that forinternal auditing.

5. Efficient audit: As the auditor has more time at his/her disposal, he/she can check the accounts withgreater attention and work with considerably more efficiency.

6. Preparation of interim audit: When the director of a company has desire to declare an interim dividend,continuous audit will help to prepare the interim accounts without much delay.

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Table 2.1 depicts the differences between continuous audit and periodical audit.

table 2.1 difference between continuous audit and periodical audit

points of difference continuous audit periodical audit

Definition Financial position of the organization can be assessed on a monthly, quarterly, or half-yearly basis.

Financial position can be assessed at the end of the financial year.

Detection of errors and frauds Errors and frauds can be detected early. Errors and frauds remain unidentified till the completion of the periodical audit.

Cost The system is very expensive and only medium and large concerns can bear the costs. Small concerns cannot afford that.

The system is mandatory and to derive the benefit of auditing, small, medium, and large concerns adopt this.

Dependence Much dependence on the auditor make the staff inefficient.

Less dependence on the auditor make them keep the accounts ready at all times.

Monotony An auditor’s mechanical and monotonous attitude might make the whole process seem fishy.

Auditor takes a fresh look at the audit, and the values portrayed will be more realistic.

Frequent visit Frequent visits by the auditor lay pressure on the accounts office of the concern.

As there are no frequent visits, accounts office will be less concerned.

System An appropriate system has to be developed to make the auditing perfect.

An appropriate system forms a bridge between continuous audit and periodic audit.

Interim audit

Interim audit is done in between two financial audits. In the words of B.N. Tandon, ‘An audit which is con-ducted in between the two annual audits with a view to find out interim profits to enable the company to declare an interim dividend should be called Interim Audit.’

Objectives

1. For the purpose of declaration of interim dividend

2. For the purpose of transfer of ownership

3. For the purpose of takeover of the company

4. For the purpose of calculation of goodwill

5. For the purpose of investigation

Advantages

1. Preparation of interim financial result

2. Declaration of interim dividend

3. Taking mid-term preventive measures regarding errors and frauds

4. Urgent need for borrowing from banks/FIs

5. Urgent need for ownership change, merger or acquisition

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Final audit

Standard audit may be defined as ‘complete check and analysis of certain items and contingent upon effec-tive internal check, appropriate test checks on remaining items, the whole of work being in accordance with general auditing standards.’

Standard is a comprehensive audit based on test checking provided that internal control exists. Standard audit is based on the guidelines of New Standards on Quality Control (SQCs); earlier it was based on Auditing and Assurance Standards (AAS) and International Financial Reporting Standards (IFRS), along with the Accounting Standards, New Companies Act, 2013, and the judgement from cases. Standard audit or final audit is very popular in India, along with most other countries in the world.

Objectives

1. To protect the interest of the owner

2. To protect the interest of the stakeholders

3. To revive the true and fair view of the organization as per Accounting Standards

4. To generate independent view regarding the organization

5. To make report as per compliance of law

Advantages

1. Full-year audit has to be done based on the financial year’s data, information, and fact.

2. Chance of manipulation is less as it is done at the end of the financial year.

3. Both statutory and non-statutory audit can be done.

4. Satisfies the stakeholders in all respects.

5. Mitigates statutory obligation.

limited review

Under Limited Review the auditor has to submit a quick review report in an interim period. This type of review is not at all a full-fledged audit report and not based on the Generally Accepted Auditing Standards (GAAS). It may be called a narrow-ranged audit.

Objectives

1. The scope of limited review is narrower in comparison to general audit.

2. Examination of books of accounts is made on a basic understanding.

3. It is assumed that accounts are free from errors and frauds.

4. Limited review is done in the limited speared.

Advantages

1. In-depth study is possible.

2. Quick report is generated.

3. Interim report is prepared as per the requirement.

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technIque-wIse classIFIcatIon oF audIt

On the basis of technique, audits can be classified as follows:

Classification on the basis of technique

Balance sheet audit Final audit Standard audit System audit EDP audit

Balance sheet audit

A balance sheet audit is an evaluation of the accuracy of information derived from a company’s balance sheet. In the words of B.N. Tandon, ‘The term balance sheet audit means verification of the value of assets, liabili-ties, the balances of reserves and provisions and the amount of profit earned, or loss suffered by a firm during the year.’ Balance sheet audit involves transactions related to balance sheets and especially, items related to assets and liabilities. By way of balance sheet audit, the weakness in the accounting system is identified and appropriate action is taken. Balance sheet audit is a very recent origin and popular in the USA.

Role of auditor1. A good and effective internal control system has to be developed to derive the best benefit of the balance

sheet audit.

2. Balance sheet audit is closely associated with balance sheet items and associated items of Profit and LossAccount cross-related with the balance sheet.

3. The accounts and finance department has to be professionally managed to derive the best benefits of abalance sheet audit.

Advantages 1. Balance sheet audit strengthens internal control systems.

2. EDP audit will be realistic if balance sheet audits prevail.

3. A qualified accountant and auditor can make and derive the best benefit of the balance sheet audit.

4. In case of too many transactions, the balance sheet audit will be more effective.

5. A comparative and comprehensive study will be more realistic.

Table 2.2 depicts the differences between balance sheet audit and final audit.

table 2.2 difference between balance sheet audit and final audit

points of difference Balance sheet audit Final audit

Definition It is only based on the balance sheet. It is based on complete books of accounts.

Scope Scope of balance sheet audit is limited. Scope of final audit is wide.

Statutory Balance sheet audit is not statutory. Final audit is statutory.

Acceptability Balance sheet audit is very popular in USA. Final audit is well accepted throughout the globe.

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standard audit

Standard audit refers to audit based on test checking. In this type of audit, detailed checking of certain items is made. Sampling and statistical sampling methods are widely used in this regard. The entire task is based on auditing standards to prepare an unqualified audit report.

system audit

System audit judges if the various systems of accounting and control mechanisms are efficiently followed in the organization or not. Financial statements are the outcome of the prevailing system. The auditor has to judge if the systems are being properly followed or not.

Objectives

1. There is no stress to judge transactions.

2. More emphasis is laid on internal control and internal check.

3. In the prevailing internal control system, the auditor has to judge whether financial statements are freefrom errors and frauds.

Advantages

1. The outcome of the system audit is more transparent.

2. System audit expedites the audit functioning.

3. It justifies the accounting system.

4. Internal control will be imposed strongly.

electronic data processing audit

Electronic Data Processing Audit (EDP Audit) is a type of audit carried out in a computerized environment. Despite change in the environment, the dimension of audit has not yet changed. In EDP audit, the methods of evidence collection and evaluation have changed substantially. The auditor has to keep pace with the cur-rent changes in technology and audit software has to be installed in this regard.

Objectives

1. Introduction of technology to safeguard data.

2. Achievement of organizational goal efficiently.

3. Maintenance of resource efficiency.

4. Whether overall objective of audit has been violated or not.

Advantages

1. Fast auditing can be done.

2. On-time audit is possible.

3. Outcome of modernization.

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Disadvantages

1. End users can make unintentional errors.

2. There may be a mismatch between management information system (MIS) and decision supportsystem (DSS).

3. Due to lack of overall modernization, the entire system could be jeopardized.

coverage-wIse classIFIcatIon oF audIt

On the basis of coverage, audits are classified as follows:

Classification on the basis of coverage

Complete audit Partial audit

complete audit or detailed audit

In case of complete audit, the auditor has to check all the transactions irrespective of nature and importance. In such a case, the auditor has to operate without any restriction on the scope of the audit. Nothing is untouched or unchecked. All records, vouchers, and supporting documents have to be scrutinized in the interest of the concern.

Objectives

1. Audit starts after the completion of the accounting work.

2. Auditors take up the process of auditing and hand over the accounts back to the organization aftercompletion.

3. Uninterrupted auditing can be carried out.

4. Irrespective of the size of the organization, the auditing has to be carried out completely.

Advantages

1. Smooth functioning of work is possible.

2. It is efficient and economic for small organizations.

3. A comprehensive report of the organization’s accounts can be prepared.

4. There is less chance of errors or frauds.

5. There is no hurry to complete the audit work and there is lesser chance of mistakes.

partial audit

When the audit is conducted on partial records of the books of accounts or over a partial period of the whole year, it is called partial audit. The scope of partial audit is very limited. In the case of partial audit, the auditor must specify the scope of audit to avoid future liability.

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Objectives

1. The scope of the partial audit is limited.

2. The scope has to be mentioned to avoid liability of errors or frauds.

3. It involves lesser time and cost.

Advantages

1. In-depth study is possible.

2. It takes lesser time.

3. It involves lesser cost.

4. It is generally undertaken by sole proprietorship or partnership organizations.

organIzatIon structure-wIse audIt

On the basis of organizational structure, audits are classified as follows:

Audit

Statutory audit Non-statutory audit

Sole proprietorship audit,partnership audit

Government company audit,statutory corporation, andgovernment department

Government audit

statutory audit

When audit is done as per the statute or when it is mandatory, it is called statutory audit. Audit of the joint stock companies, banking companies, insurance companies, electric supply companies, and registered socie-ties are mandatory or statutory as per their respective statutes. Companies Act, 2013, Banking Regulation Act, 1949, Life Insurance Corporation of India Act, 1956, Societies Registration Act, 1960, and Income Tax Act, 1961 have prescribed statutory audits.

Objectives

1. Scope of independent audit can be explored and that can’t be limited or restricted.

2. Statutory audit can be done by an independent auditor.

3. The qualification, disqualification, remuneration, rights, duties, and liabilities of an independent audi-tor are to be governed by law.

4. The report prepared by the independent auditor is for stakeholders.

5. It will uphold the financial culture of the organization and acceptability of the organization to the soci-ety at large.

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Advantages

1. Statutory audit serves the statutory obligation.

2. Stakeholders will be more satisfied.

3. It safeguards the interest of the creditors, banks, financial institutions, government, and the societyat large.

4. The trustees will be more satisfied with the financial operations of the organization.

5. The management can prove its efficiency and honesty.

non-statutory audit

When auditing is not mandatory or statutory as per the respective statute but is done to derive the benefit of audit, it is called non-statutory audit. The auditing of sole proprietorship firms, partnership firms and clubs are the brightest examples of non-statutory audit.

Objectives

1. To derive the benefit of audit.

2. To maintain a healthy relationship among the persons involved in the organization.

3. To ensure financial transparency among the stakeholders.

4. To increase social acceptance of the organization.

5. Sole proprietorship organizations, partnership firms, and individuals can derive benefits from non-statutory audits.

government audit

The audit of government companies, public sector undertakings (PSUs), and both central and state gov-ernment departments has to be conducted by the Comptroller and Auditor General of India (CAG). The appointment, remuneration, duties, and powers of the CAG have to be stated in Articles 148 to 151 of the Constitution of India.

The objectives of the government audit are as follows:

1. To ensure that the financial transactions of government companies, public sector undertakings, andgovernment departments are made in conformity with financial rules.

2. To ensure that expenses are made within the purview of the budget.

3. To ensure that all the activities of the government companies, government undertakings, and govern-ment departments are made for public interest.

4. To generate maximum output against minimum input.

5. To ensure that all the activities are made for public interest and funds are not misused.

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specIFIc Matter-wIse audIt

Audits can also be classified as follows:

Specific-matter wise audit

Cost audit Management audit

Environmental audit Information system audit

Operational audit

Compliance audit

Performance audit

Corporate governance

Human resource audit

Tax audit Propriety audit Cash flow Social audit

cost audit

Cost audit may be defined as ‘verification of correctness of cost accounts and of the adherence to the cost accounting plan.’ In the words of Smith and Day it is ‘the detailed checking of the costing system, techniques and accounts to verify their correctness and to ensure adherence to the objective of cost accounting.’

As per Section 148(1) of the Companies Act, 2013, the central government specifies audit of items of cost in respect of such class of companies engaged in the production of such goods or providing such services as may be prescribed, direct that particulars relating to the utilisation of material or labour or to other items of cost as may be prescribed shall also be included in the books of account kept by that class of companies.’ Section 148(3) states that cost audit shall be conducted by the cost accountant in practice appointed by the Board of Directors.

As per the guideline issued by the Ministry of Corporate Affairs (MCA), applicability and maintenance of cost records is mandatory for two sectors, namely regulated sectors and non-regulated sectors laid down in the Companies (Cost Records and Audit) Amendment Rules, 2014.

Objectives

The objective of cost audit falls under two categories, namely general objectives and social objectives.

General objectives 1. Judge the accuracy of cost data and information.

2. Judge whether the recording of cost data is made in accordance with cost accounting standards.

3. Judge whether the determination of cost is made properly.

4. Judge whether the recording is free from errors and frauds as per cost accounting standards.

Social objectives 1. To help the consumers provide goods at least cost.

2. To help in the optimum utilization of resources.

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Advantages

1. Improves productivity: As the cost audit highlights wastage and inefficiency, it will help to increase productivity.

2. Helps in decision-making: As the cost auditor provides extensive data, it will help in decision-making.

3. Early signal for weakness and sickness: Cost audit can give us early signals that the organization is weak.

4. Cost competitiveness: Cost audit helps in cost competitiveness. Better sustainability of the firm is possible.

5. Benefit to the customer and society: The customer and the society will ultimately be benefitted from cost audit.

Management audit

In the words of Leslie R. Howard, ‘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 organizations.’

The American Institute of Management defines it as, ‘Management auditing is a diagnostic appraisal process from analysing goals, plans, policies and activities in every phase of operation to turnover unsus-pected witness and to develop ideas for improvement in areas that have escaped management attention.’ Management audit assesses the performance or efficiency of management.

Objectives

1. It involves comprehensive examination of the organization or part.

2. It is undertaken to check the operation of the management and its effectiveness.

3. It involves analysing goals, plans, policies, and activities in every phase of management operation.

Advantages

1. Evaluates the performance of the management.

2. Reviews the plans and policies taken, and the execution of plans and policies.

3. Suggests necessary steps to mitigate the gap between plan and execution.

4. Guides the management to chart out future policies and plans.

tax audit

According to Section 44AB of the Income Tax Act, 1961 tax audit is compulsory (w.e.f. assessment year 1985–86) in respect of a person carrying on a business or profession where the turnover exceeds `1 crore (w.e.f. assessment year 2013–14) and in the case of profession gross receipts exceeding `25 lakh (w.e.f assess-ment year 2013–14).

The tax auditor may be appointed by the management of the business or profession or by the person duly authorized to do so. The appointment letter should clearly specify that the tax audit is to be conducted as per the requirement of Section 44AB of the Income Tax Act, 1961. As Section 44AB is silent on the rights of the tax auditor, the appointment letter of the tax auditor clearly mentions the domain of the tax auditor.

As per Section 288 of the Income Tax Act, 1961 tax audit shall be conducted by the Chartered Accountant.

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environmental audit

The Confederation of British Industry has defined environmental auditing as the systematic examination of the interactions between any business operation and its surroundings.

Environmental auditing originated in the USA to check whether the company complies with the environ-mental laws of the country or not. In the year 1978, TISCO started an environmental audit.

As per the requirement of Water (Prevention and Control of Pollution) Act, 1974, Air (Prevention and Control of Pollution) Act, 1981, Environment (Protection) Act, 1986, and Wastes (Management and Handing) Rules, 1989, environmental audit report has to be submitted.

Objectives 1. To ensure that the environment is least affected.

2. To judge the risk factor included in the operation of the organization.

3. To judge if the operation of the organization conforms to sustainable economic development.

4. To ensure that environmental laws and regulations are followed.

human resource audit

Human resource audit reviews the policy, procedure, and practices related to human resource.

Advantages 1. Identifies the most important HR programme

2. Implements the most important HR programme

3. Identifies the deviations in HR policy and implementation

4. Measures the deviation from the benchmark HR achievement

5. Promotes innovative ideas with change and creativity

social audit

Social audit assesses the social, economic, and environmental benefits it derives from the society and gives to the society.

In the 1980s, the Union Carbide passed the statutory audit but did not qualify on the social audit param-eter as it was blacklisted because of the Bhopal Gas massacre. In 1980, TISCO worked on the first social audit document. As per Section 135(1) of the Companies Act, 2013 in case of companies having net worth of rupees five hundred crore or more or turnover of rupees thousand crore or more or net profit of rupees five crore or more during any financial year they have to spend 2 per cent of the net profit on account of corporate social responsibility.

Objectives 1. To assess that the company has discharged its social responsibility towards stakeholders.

2. To assess that the company has discharged its social obligation towards shareholders, customers, debt-ors, creditors, and the government.

3. To ensure that the company discharges its statutory obligation.

4. To ensure that the company in no way violates its social obligation.

5. To ensure that economic sustainability is maintained.

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Advantages

1. Fulfils social obligations.

2. Makes the society aware of the functioning of the organization.

3. Assesses the social performance of the organization.

4. Increases the accountability of the organization towards stakeholders.

5. Helps the management judge the organization.

operational audit

All types of activities involved in the operation have to be examined by operational audit. Operational audit judges if the operation is to be made in conformity with the predetermined set of standards or not. Economic efficiency is the key factor in judging operational efficiency. One needs to check if the operational audit is made at an optimum level or not. The auditor has to highlight the causes of deviation and the steps that need to be taken in this regard.

Advantages

1. Reviews the organization’s operating procedures and methods.

2. Improves the performance and efficiency of the organization.

3. Implements the ‘plan, do, check, and act’ (PDCA) model.

4. Implements the profitability objective.

5. Implements the non-profitability objective.

propriety audit

Propriety audit measures the rightness of policy and procedure. It also measures the decisions and actions made in public interest and mitigates the standard code of conduct. Propriety audit involves checking if trans-actions have been made in conformity with the principles, rules, regulations, guidelines, and standards which are in the best interest of the public.

Objectives

1. To ensure operation is being conducted in conformity with rules and regulations.

2. To check that books of accounts are being maintained properly.

3. To see that funds are being utilized in the best interest of the concern.

4. To work towards the desired results of the concern.

Advantages

1. Ensures that public money is not being misused from the point of view of propriety.

2. Ensures that policies and procedure are being followed accordingly.

3. Ensures that public interest is being safeguarded.

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Table 2.3 highlights the differences between traditional audit and propriety audit.

table 2.3 difference between traditional audit and propriety audit

points of difference traditional audit propriety audit

Objective Measures the true and fair view of the financial position

Measures the rightness of financial position

Verification and valuation Based on verification and valuation of financial transaction

Goes beyond verification and valuation to judge greater interest in the company

Concern Not the concern of the auditor whether it is run efficiently or inefficiently

It is the concern of the auditor whether it is run efficiently or inefficiently

Advisory No room left for advisory work Auditor also plays an advisory role

Compliance Compliance with GAAP Revenue expenditure for day-to-day running of the organization, capital expenditure for wealth generation, and ultimately wealth maximization

stock audit

Stock or inventory maintenance is the stickiest issue among current assets. In a stock audit, the auditor indi-cates the quality, quantity, segmentation and value of the stock. Stock audit can be done by way of verification and valuation of stock. Stock audit is an important part of a statutory audit.

Objectives

1. To identify the volume of stock.

2. To ascertain the value of stock.

3. To ascertain the actual profit.

4. To justify the ownership of stock.

5. To verify the status of stock.

Advantages

1. High amount of stock involves blockage of funds, indicates poor cash flow, and high degree of cost andvice versa; stock audit gives caution in this regard.

2. As stock is vulnerable to pilferage, obsolesce, wastage, and damage, stock audit minimizes the situation.

3. Sock audit helps to determine the correct amount of profit and helps to take dividend decisions.

public deposit audit

Banks usually raise public deposit. The audit of public deposit is made as per the Reserve Bank of India 1934, Banking Regulation Act, 1949, The State Bank of India Act, 1955, The State Bank of India (Subsidiary Bank) Act, 1959, The Regional Rural Bank Act,1976, and The Banking Companies (Acquisition and Transfer of Undertaking) Act, 1980. Demand deposit, savings bank deposit, term deposits, deposit of branches in India, and deposits of branches outside India are the types of deposit.

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Objectives 1. Borrowing through deposit is one of the main functions of banks to be monitored.

2. To verify different types of deposits from different registers or ledgers.

3. To ensure that banking regulations are followed properly.

4. To check the interest paid or payable on public deposit regularly.

5. To follow statutory obligations regarding public deposits.

Advantages 1. The public deposit register or ledger is scrutinized to get a real picture of the accounts.

2. Borrowing is carried out as per banking regulations.

3. The interests credited are vividly made.

4. Test checking method of sampling has to be followed carefully to ascertain the interest paid or payable.

5. Internal control mechanisms are followed.

corporate governance

N. Narayana Murty, Chairman, Committee on Corporate Governance of SEBI, has made a remarkable state-ment by saying, ‘Corporate governance is the acceptance by management of the inalienable rights of share-holders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders.’

As per section 135(1) of the Companies Act, 2013, every company having net worth of ̀ 500 crore or more, or turnover of `1000 crore or more or a net profit of `5 crore or more during any financial year shall consti-tute a corporate social responsibility committee of the Board having three or more directors out of which one director shall be the independent director as a part of corporate governance.

Auditor’s duty regarding corporate governance The following points may be noted:

1. The auditor has to collect a board approved financial statement, draft report of the board of directors, and a report on corporate control.

2. The collection of document is as per AS 230.

3. The auditor has to judge if the conformity with guidance is maintained or not.

cash Flow

Cash flow means the inflow and outflow of cash of a business enterprise. It is mandatory to incorporate cash flow statement in the annual report.

Cash flow statement As per the revised guideline, AS 3 issued by ICAI cash flow becomes mandatory w.e.f. 01.04.2004 in the following cases:

1. When turnover of all the commercial, industrial, and business enterprises exceeds `50 crore.

2. For listed companies or companies whose shares and debentures are in the process of being enlisted in a recognized exchange of India.

3. For banks, financial institutions, and insurance companies including co-operative banks.

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Auditor’s duty regarding cash flow statement

1. The auditor has to see if cash flow statements are to be prepared on the direct method or indirectmethod.

2. In case of listed companies, the cash flow statement is to be prepared on the basis of RevisedAS 3.

3. It is also expected that increase or decrease in cash is made on the basis of operating activities, invest-ment activities, and financial activities.

compliance audit

Compliance refers to the test of control against a specific standard. Compliance audit measures the effective-ness of the internal system in the organization. It also checks whether or not internal audit is carried out in conformity with the prevailing system.

Objectives

1. The medium of transactions is tested with the help of compliance audit.

2. If it is found that compliance is not carried out, there is a need to revise the system.

3. It is used to check if the deviation from conformity is made in isolation or is symptomatic.

Advantages

1. It will help to increase the prevailing standards of audit.

2. The review of the standard of internal audit is the underlying mechanism.

3. It will help in the maintenance of a certain standard.

performance audit or efficiency audit

A performance audit ascertains if the internal activities of the organization are carried out efficiently or not. Performance audit has some sort of symmetry with internal audit. Performance audit studies the competence of achieving goals.

Objectives

1. To strengthen performance control and improve internal audit.

2. To study whether management controls are functioning effectively and efficiently.

3. To appraise and review efficiency.

4. To be obliged towards the attainment of organizational goals.

Advantages

1. Reduces the area of uncertainty in business.

2. Removes bottlenecks in achieving goals.

3. Removes inefficiencies and ineffectiveness.

4. Achieves operational goals smoothly.

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Information system audit

In the words of Rob Weber, ‘Information system audit is the process of collecting and evaluating evidence to determine whether computer system safeguards assets, maintains data integrity, achieves organizational goals effectively, and consumes resources efficiently.’

Table 2.4 shows the differences between internal and statutory audits, and Table 2.5 depicts the differ-ences between statutory and non-statutory audits.

table 2.4 difference between internal audit and statutory audit

points of difference Internal audit statutory audit

Stage Internal audit is a mid-term audit to face the final or statutory audit.

Statutory audit is a final audit done to submit the audit report.

Scope The scope of internal audit is determined by the management.

The scope of statutory audit is vast and in no circumstances can it be limited.

Appointment and remuneration

Appointment along with the remuneration of the internal auditor is fixed by the management.

Appointment of statutory auditor is either made by the shareholders in the Annual General Meeting, or by the Board of Directors, or by the CAG as the case may be. Remuneration is also fixed by the respective appointing authority.

Qualification Internal auditor may or may not be a Chartered Accountant.

Statutory auditor must be a Chartered Accountant.

Rights and duties The management pre-determines the rights of the internal auditor. The internal auditor performs his/her duties accordingly.

The rights of the statutory auditor cannot be curtailed and it is just to perform his/her duties. The ultimate task of the statutory auditor is to submit an audit report to the appointing authority.

table 2.5 difference between statutory and non-statutory audit

points of difference statutory audit non-statutory audit

Definition Statutory audit is mandatory or compulsory as per statute or respective law.

Non-statutory audit is not mandatory or compulsory as respective statute or law but it is done to derive the benefit of audit.

Organization covered Joint stock companies, banking companies, and insurance companies along with others.

Sole proprietorship firms, partnership firms, etc.

Qualification of the auditor Auditor must possess the requisite qualification as per the statute: Chartered Accountant with completion of Articleship.

Auditor qualification is not mandatory as per the statute but should preferably be a Chartered Accountant with completion of Articleship.

Appointment In case of a joint stock company, appointment is made by the shareholders in the Annual General Meeting and in some cases by the Board of Directors or by the Central Government.

In case of sole proprietorship firms, appointment is made by the owner and in case of the partnership firms, appointment is made by the firm.

Remuneration Remuneration is fixed by the appointing authority.

Remuneration is fixed as an agreement between the auditor and appointing authority.

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Covered area The purview of the audit covers the entire organization.

The purview of the audit covers the desired area as deserved by the appointing authority.

Liability Liability of the auditor is fixed by the respective statue and law of the country.

Liability of the auditor is fixed by the law of the country.

Report submission A report has to be submitted to the shareholder in the AGM.

A report has to be submitted to the owner or to the firm.

Scope Scope of the statutory audit is widened. Scope of the non-statutory audit is limited.

exercIses

Multiple-choice questions1. Which one of the following is expensive?

(a) Continuous audit (b) Periodical audit (c) Final audit (d) None of these

2. In 1980, which company started social audit?(a) IOL (b) Infosys (c) TISCO (d) SAIL

3. As per structure audit, which one of the following is theright classification of an audit?(a) Statutory audit (b) Non-statutory audit(c) Government audit (d) All of these

4. The audit of sole proprietorship or a partnership firm is(a) statutory (b) non-statutory(c) compulsory (d) None of these

5. Complete audit, detailed audit, partial audit, and limitedreview is the classification of audit on the basis of(a) coverage (b) technique(c) structure (d) None of these

6. Verification of the correctness of cost accounts and ofadherence to the cost accounting plan is known as(a) cost audit (b) financial audit(c) management audit (d) tax audit

7. Which audit facilitates the most effective relationship withthe outside world and the most efficient organization andthe smooth running of an internal organization?(a) Financial audit (b) Management audit(c) Cost audit (d) None of these

8. Which type of audit ascertains whether internal activitiesof the organization are carried out efficiently or not?(a) Performance audit (b) Operational audit(c) Management audit (d) None of these

9. Which one of these is contained in the Annual Report?(a) Fund flow statement(b) Cash flow statement(c) Both fund flow and cash flow statement(d) None of these

10. Government audit is carried out by the(a) Chartered Accountant(b) Government Officer(c) CAG(d) None of these

11. Public deposit audit is made as per(a) Reserve Bank of India 1934(b) Banking Regulation Act, 1949(c) The State Bank of India Act,1955(d) All of these

12. In 1978, which company started environmental audit?(a) TISCO (b) SAIL(c) BHEL (d) None of these

13. Which audit measures whether transactions have beenmade in conformity with the principles, rules, regulations,guidelines, and standards that would be best in the inter-est of the public?(a) Management audit (b) Propriety audit(c) Performance audit (d) None of these

14. In which type of audit is economic efficiency the key factorfor judging efficiency?(a) Operational audit (b) Performance audit(c) Management audit (d) None of these

15. As per the Companies Act, 2013, every company havingwhich of the following criteria must have to spend 2% ofthe net profit for CSR?(a) Net worth of `500 crore or more(b) Turnover of `1000 crore or more(c) A net profit of `5 crore or more(d) All of these

16. As per Section 148(3) of the Companies Act, 2013, whichaudit must be done by the cost accountant as a practiceappointed by the Board of Directors?(a) Cost audit(b) Tax audit(c) Both cost audit and tax audit(d) None of these

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17. As per Section 138 of the Companies Act, 2013, whostates that such class or classes of companies as may beprescribed shall be required to appoint which type of audi-tor who shall either be a chartered accountant or a costaccountant, or such other professional as may be decidedby the Board to conduct internal audit of the functions andactivities of the company?(a) An external auditor(b) An internal auditor(c) Both external auditor and internal auditor(d) None of these

18. An independent appraisal function established within anorganization to examine and evaluate the accounting andfinancial activities as service to the organization is called_______.(a) statutory audit (b) external audit(c) internal auditing (d) None of these

19. Who can conduct tax audits?(a) A commerce graduate(b) An M.Com graduate(c) A cost accountant(d) A chartered accountant

20. Which audit assesses the performance of themanagement?(a) Management audit (b) Performance audit (c) Efficiency Audit (d) None of these

group a1. What is partial audit?

[CU B Com (Hons) 2014; KU B Com (Hons) 1996]2. What is tax audit? [CU B Com (Hons) 2008, 2014]3. What is management audit? [CU B Com (Hons) 2009]4. What do you mean by interim audit?

[CU B Com (Hons) 2009] 5. What do you mean by EDP audit?

[CU B Com (Hons) 2008]6. Write a short note on:

(a) Social audit [CU B Com (Hons) 2010, 2015](b) Environment audit [CU B Com (Hons) 2012, 2015](c) Proprietary audit [CU B Com (Hons) 2015](d) Performance audit [CU B Com (Hons) 2015](e) Tax audit [CU B Com (Hons) 2008, 2012, 2014](f) System audit [CU B Com (Hons) 2014]

(g) EDP audit [CU B Com (Hons) 2012, 2013](h) Cost audit [CU B Com (Hons) 2011](i) Management audit [CU B Com (Hons) 2005]

(j) Balance sheet audit [CU B Com (Hons) 1995; BU B Com (Hons) 2000; KU B Com (Hons)1997]

group B1. Define performance audit. What are its objects and impor-

tance? [CU B Com (Hons) 1996]2. Define propriety audit. Distinguish between traditional

audit and propriety audit. [CU B Com (Hons) 1992]3. What is meant by balance sheet audit? How is it con-

ducted? Discuss the position of auditor in connection withbalance sheet audit. [CU B Com (Hons) 2014]

4. What is interim audit? What are its advantages and disad-vantages? [CU B Com (Hons) 2007]

5. Internal audit is not a substitute for statutory audit.[CU B Com (Hons) 1996]

6. Explain internal audit, its nature, and scope.[CU B Com (Hons) 2011]

7. Show the points of distinction between independent finan-cial audit or statutory audit and internal audit.

[CU B Com (Hons) 1999, 2014]8. Discuss the auditor’s duty with regard to detection and

prevention of frauds and errors. [CU B Com (Hons) 2010]9. State the advantages and disadvantages of a continuous

audit. [CU B Com (Hons) 2010]

group c1. What is management audit? Discuss its advantages.

[CU B Com (Hons) 2013]2. What is management audit? What are its objectives?

[CU B Com (Hons) 2011]3. What are the objectives of cost audit?

[CU B Com (Hons) 2013]4. What is environment audit? What are its objectives?

[CU B Com (Hons) 2012]5. What is cost audit? What are its advantages?

[CU B Com (Hons) 2010, 2012]6. What do you mean by EDP audit? Mention the problems

associated with such an auditor.[CU B Com (Hons) 2010]

7. Write the difference between statutory audit and non-stat-utory audit. [KU B Com (Hons) 1995, 2010;

NBU B Com (Hons) 2007]8. Write the difference between continuous audit and peri-

odical audit. [BU, B Com (Hons) 1999, 2006, 2009, 2011; KU B Com (Hons) 2004; VU B Com (Hons) 2008]

9. Write the difference between continuous audit and interimaudit. [BU B Com (Hons) 1997; VU B Com (Hons) 2010]

answers to Multiple-choice questions1. (a) 2. (c) 3. (d) 4. (b) 5. (a) 6. (a) 7. (b) 8. (a) 9. (b) 10. (c)

11. (d) 12. (a) 13. (b) 14. (a) 15. (d) 16. (a) 17. (b) 18. (c) 19. (d) 20. (a)

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