CHAPTER-1

INTRODUCTION

EVOLUTION OF AUDITING

The term audit is derived from the Latin term “audire,” which means to hear. In early days a person
used to listen to the accounts read over by an accountant in order to check them. He was known as
auditor. Auditing is as old as accounting and there are signs of its existence in all ancient cultures
such as Mesopotamia, Greece, Egypt. Rome, U.K. and India. Arthshastra by Kautilya detailed
rules for accounting and auditing of public finances.

Audit is performed to ascertain the validity and reliability of information. Examination of books
of accounts with supporting vouchers and documents in order to detect and prevent error and fraud
is the main function of auditing. The goal of an audit is to express an opinion on the financial or
non-financial areas. Audit safeguards the financial interest of persons not associated with the
management like partners or shareholders, acts as a moral check on the employees and prevents
from committing fraud. However, due to constraints, an audit seeks to provide only reasonable
assurance that the statements are free from material error. In case of financial audit, a set of
financial statements are said to be true and fair when they are free of material misstatements. But
recently, argument that auditing should go beyond just true and fair is gaining momentum in view
of recent frauds by high profile organizations in connivance with the reputed audit firms.

Traditionally, audits were mainly associated with gaining information about financial systems and
the financial records of a company or a business. However, recently auditing has begun to include
non-financial subject areas, such as safety, security, information systems performance, and
environmental concerns. With non-profit organizations and government agencies, there has been
an increasing need for performance audit, examining their success in satisfying mission objectives
of business.
In India the Companies Act, 2013 made audit of company accounts compulsory. With the increase
in the size of the companies and the volume of transactions the main objective of audit shifted to
ascertaining whether the accounts were true and fair rather than true and correct. Hence the
emphasis was not on arithmetical accuracy but on a fair representation of the financial efforts. The
Companies Act, 2013 also prescribed for the first time the qualification of auditors. After the
independence in year 1956, Company Act, 1956 was implemented and detailed provisions were
made in Act regarding Audit and auditors. Recently Companies Act, 2013 has been implemented
w.e.f. 1 April, 2014 and this contains detailed provisions about statutory audit, Cost Audit, Internal
Audit and Secretarial Audit.

AUDITING
An audit is an “independent examination of financial information of any entity, whether profit
oriented or not, irrespective of its size or legal form when such an examination is conducted with
a view to express an opinion thereon.” Auditing also attempts to ensure that the books of accounts
are properly maintained by the concern as required by law. Auditors consider the propositions
before them, obtain evidence, and evaluate the propositions in their auditing report. Audits provide
third-party assurance to various stakeholders that the subject matter is free from material
misstatement. The term is most frequently applied to audits of the financial information relating to
a legal person. Other commonly audited areas include: secretarial and compliance, internal
controls, quality management, project management, water management, and energy conservation.
As a result of an audit, stakeholders may evaluate and improve the effectiveness of risk
management, control, and governance over the subject matter.

IMPORTANCE OF AUDITING
Audit is an important term used in accounting that describes the examination and verification of a
company’s financial records. It is to ensure that financial information is represented fairly and
accurately. Also, audits are performed to ensure that financial statements are prepared in
accordance with the relevant accounting standards. The three primary financial statements are:
• Income statement
• Balance sheet
• Cash flow statement
Financial statements are prepared internally by management utilizing relevant accounting
standards, such as International Financial Reporting Standards (IFRS) or Generally Accepted
Accounting Principles (GAAP).
They are developed to provide useful information to the following users:
• Shareholders
• Creditors
• Government entities
• Customers
• Suppliers
• Partners
Financial statements capture the operating, investing, and financing activities of a company
through various recorded transactions. Because the financial statements are developed internally.
There is a high risk of fraudulent behaviour by the preparers of the statements. Without proper
regulations and standards, preparers can easily misrepresent their financial positioning to make the
company appear more profitable or successful than they actually are. Auditing is crucial to ensure
that companies represent their financial positioning fairly and accurately and in accordance with
accounting standards.

SCOPE OF AUDIT
• Within the audit mandate, the Comptroller and Auditor General is the sole authority to
decide the scope and extent of audit to be conducted by him or on his behalf. Such authority
is not limited by any considerations other than ensuring that the objectives of audit are
achieved.
• In the exercise of the mandate, the Comptroller and Auditor General undertakes audits
which are broadly categorized as financial audit, compliance audit and performance audit.
• The scope of audit includes the assessment of internal controls in the auditable entities.
Such an assessment may be undertaken either as an integral component of an audit or as a
distinct audit assignment.
• The Comptroller and Auditor General may, in addition, decide to undertake any other audit
of a transaction, programme or organisation in order to fulfill the mandate and to achieve
the objectives of audit.
LIMITATIONS OF AUDITING
Besides having various benefits, there are some inherent limitations of auditing. These are as
follows:
i. Higher Cost Burden: Due to Higher Cost Burden, the auditor limits his scope of work to
selective testing or sampling thus in depth checking of books of accounts is not possible.
ii. Based on test checks: Generally an auditing exercise is based on test checking. Inferring a
result on the basis of test check always need not to be true.
iii. Insufficient Time: Generally an auditor needs to release the report up to a specified
timeline. Sometime this timeline become a constraint for an auditor in carrying out the
auditing exercise effectively. This time constraint may affect the amount of evidence that
can be obtained concerning events and transactions after the balance sheet date that may
have an effect on the financial statements. Moreover, there is a relatively short time period
available for resolving uncertainties existing at the financial statement date
iv. Inconclusiveness of Evidences: The evidences obtained by an auditor are persuasive rather
than conclusive. For example, an architect’s certificate of valuation for a newly constructed
building of a client may not be conclusive evidence of the correct value of building.
v. Based on Estimates: Estimates are an inherent part of the accounting process, and no one,
including auditors, can foresee the outcome of uncertainties. Estimate range from the
allowance for doubtful accounts and an inventory obsolescence reserve to impairment tests
of fixed assets and goodwill. An audit cannot add exactness and certainty to financial
statements when these factors do not exist.
vi. Based on the Information provided by the Management: The audit opinion is based on the
information provided by the management. Hence, outsiders cannot fully rely on the
auditor’s report.

AUDITOR
An auditor is a person or a firm appointed by a company to execute an audit.[1] To act as an
auditor, a person should be certified by the regulatory authority of accounting and auditing or
possess certain specified qualifications. Generally, to act as an external auditor of the company, a
person should have a certificate of practice from the regulatory authority.
QUALITIES OF AN AUDITOR
1. An auditor needs to be well versed in the fundamental principles and theory of all branches
of accounting, e.g., general accounting, cost accounts, income tax, etc. A person can’t audit
the accounts unless he knows how to prepare them. He should be aware of the latest
development in accounting techniques so that he may modify his work procedure.
2. He should not pass a transaction unless he knows that it is correct. This is possible only
when one knows thoroughly well the principles of accounting.
3. He should be able to grasp quickly the technical details of the business whose accounts he
is auditing. If possible, he should pay a visit to the works of his client before he commences
his work.
4. He should be prepared to seek elucidation on technical questions rather than show a false
pride or fear of displaying his ignorance.
5. He should be quite familiar with the company and mercantile laws and be a complete
master of the principles of auditing.
6. He must be tactful and scrupulously honest. He must not certify what he does not believe
to be true and take reasonable care and skill before he believes what he certifies is true.
7. Sometimes he is put in a very awkward position when his duty to his client is opposed to
his interests, in which case he must have the courage to carry out his duty faithfully and
honestly, even if such a step harms him. In the long run, this policy will greatly value him.
He will acquire a reputation for his honesty, bringing him more business.

TYPES OF AUDITOR

1.EXTERNAL AUDITOR
The most common type of auditor is the external auditor. He is asked to come to an institution or
company and conduct an audit according to regulatory norms. An external auditor is expected to
conduct an unbiased opinion and present an independent report. He conducts the audit once a year
and he has no affiliation with the company. The work of external auditors is crucial and he is
answerable to the investors and government bodies. An external auditor may have to communicate
with the internal auditors but they are not influenced by the internal auditors. An External auditor
may also have to coordinate with other departments such as technology or operations if he is doing
a department focused audit.

2.GOVERNMENT AUDITOR
Government Auditors are those who audit the financial position of Government agencies and
private businesses involved in activities pertaining to government regulations, taxation, foreign
exchange, etc. Most of the Government Auditors are associated with audit firms which cater only
to the public sector. The main role of the Government Auditors is to ensure that the finances are
spent and earned according to the stipulated laws and rules. They conduct a high-quality audit that
holds their clients accountable for the use of public resources in compliance with laws and
regulations. Some of the functions performed by the Government Auditors are:
• Readiness for Audit
• Examination of the report
• Financial statement audits
• Compliance audits
• Performance audits
• Internal control testing

3.INTERNAL AUDITOR
Internal auditor is someone who acts independently to assess the efficiency of a company’s internal
control structure. Internal Auditors report to a company’s board or executives. They don’t just look
at the financial statements but the overall risk management process to see which area needs
improvement and redesigning.
The roles and responsibilities of an internal auditor are to collect, analyze and scrutinize all the
company records to check if they are complying with all the regulations and managing the risk
accordingly. They also perform an audit on all the systems, processes and internal controls. They
may also do some value-additions to reduce the management costs, optimize resources and
mitigate overall risk.

4.FORENSIC AUDITOR
They are one of the most specialized kinds of auditors. Forensic Auditors are akin to external
auditors in their functions but the purpose of their audit is very specific. This audit is performed
as a part of certain legal proceedings. The audit report is a part of the report that needs to be
submitted as evidence. The Forensic auditor may conduct the audit to impeach a party against
crimes such as embezzlement, fraud or any other criminal activity. The key objectives for a
Forensic Auditor are:
• Identifying if any fraud is being carried out
• Determining the period of fraud
• Investigating how the fraud was conducted in secrecy.
• Estimating the amount of loss that may have occurred.
• Gathering accurate evidence to be produced in court
• Recommending measures to prevent these frauds

DUTIES OF THE AUDITOR

The duties of an auditor have been laid down by the Companies Act, 2013, provided in Section
143. The Act explains the duties in a simplified manner, although the list given is not exhaustive.

PREPARATION OF AN AUDIT REPORT

• An audit report, in simple terms, is an appraisal of a business’s financial position. The
auditor is responsible for preparing an audit report based on the financial statements of the
a company. The books of accounts so examined by him should be maintained in accordance
with the relevant laws.
• He must ensure that the financial statements comply with the relevant provisions of the
Companies Act 2013, relevant Accounting Standards etc.
• In addition to this, it is imperative that he ensures that the entity’s financial statements
depict a true and fair view of the company’s financial position.

FORM A NEGATIVE OPINION WHERE NECESSARY

The auditor’s report has a high degree of assurance and reliability because it contains the auditor’s
opinion on the financial statements. Where the auditor feels that the statements do not depict a true
and fair view of the financial position of the business, he is also entitled to form an adverse opinion
on the same. Additionally, where he finds that he is dissatisfied with the information provided and
finds that he cannot express a proper opinion on the statements, he will issue a disclaimer of
opinion. A disclaimer of opinion basically indicates that due to the lack of information available,
the financial status of the entity cannot be determined. However, it is to be noted that the reasons
for such negative opinion is also to be specified in the report.

MAKE INQUIRIES
One of the auditor’s important duties is to make inquiries, as and when he finds it necessary. A
few of the inquiries include:-
• Whether loans and advances made on the basis of security are properly secured and the
terms relating to the same are fair
• Whether any personal expenses (expenses not associated with the business) are charged to
the Revenue Account
• Where loans and advances are made, they are shown as deposits. D. Whether the financial
statements comply with the relevant accounting standards

LEND ASSISTANCE IN CASE OF A BRANCH AUDIT

Where the auditor is the branch auditor and not the auditor of the company, he will lend assistance
in the completion of the branch audit. He shall prepare a report based on the accounts of the branch
as examined by him and then send it across to the company auditor. The company auditor will then
incorporate this report into the main audit report of the company. In addition to this, on request, if
he wishes to, he may provide excerpts of his working papers to the company auditor to aid in the
audit.

COMPLY WITH AUDITING STANDARDS

The Auditing Standards are issued by the Central Government in consultation with the National
Financial Reporting Authority. These standards aid the auditor in performing his audit duties with
relevant ease and accuracy. It is the duty of the auditor to comply with the standards while
performing his duties as this increases his efficiency comparatively.

REPORTING OF FRAUD
Generally, in the course of performing his duties, the auditor may have certain suspicions with
regard to fraud that’s taking place within the company, certain situations where the financial
statements and the figures contained therein don’t quite add up. When he finds himself to be in
such situations, he will have to report the matter to the Central Government immediately and in
the manner prescribed by the Act.