CHAPTER 1

INTRODUCTIONS ABOUT AUDITING

INTRODUCTION

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, roll forward prior year working
papers, 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. In recent years auditing has
expanded to encompass many areas of public and corporate life. Professor Michael
Power refers to this extension of auditing practices as the "Audit Society".

The development of modern accountancy and the growth of Auditing profession in

India, and indeed in the world as a whole must be seen in the context of the enormous
expansion of industry and commerce, which has taken place since the Industrial revolution.
While business enterprises where comparatively small, and where managed by their
proprietor, there was a little need for the development of complex accounting procedures.
When the scale of operation increased and capital was invested in joint stock companies by
shareholder’s who took no part in management of such companies, it become necessary for
the managers to present accounts to the shareholders at regular interval by mean of annual
accounts.
ORIGIN AND EVOLUTION

The term audit is derived from the Latin term ‘audire,’ which means to hear. In early
days an auditor used to listen to the accounts read over by an accountant in order to check
them. It was in use in all ancient countries such as Mesopotamia, Greece, Egypt. Rome, U.K.
and India. Arthasashthra by Kautilya detailed rules for accounting and auditing of public
finances. The history of auditing can be traced back to ancient civilizations such as
Mesopotamia, Greece, Egypt, Rome, UK, and India. The purpose of audits was to gain
information about the financial system and records of the business. However, recently
auditing has begun to include non-financial subject areas such as safety, security, information
system performance and environmental concerns . The auditing origin can be traced back to
the 18th century, when the practice of large-scale production developed as a result of the
Industrial Revolution. Systems of checks and counter checks were implemented to maintain
public accounts as early as the days of ancient Egyptians, Greeks and Romans. The last
decade of the 15th century was a crucial period during which a great impetus was given to
trade and commerce by Renaissance in Italy, and the principles of double entry bookkeeping
were evolved and published in 1494 at Venice in Italy by Luca Paciolo

MEANING OF AUDITING

Auditing is an examination of the books of accounts of a business or organization to

ascertain their authenticity and accuracy . The primary purpose of the audit is to confirm the
authenticity of books of accounts prepared by an accountant. In other words, auditing is done
to determine the true and fair picture of such accounts 1. The audit is an intelligent and critical
examination of the books of accounts of the business. It is done by an independent person or
body of persons qualified for the job with the help of statements, papers, information and
comments received from the authorities so that the examiner can confirm the authenticity of
financial accounts prepared for a fixed term and report that: The balance sheet exhibits an
accurate and fair view of the state of affairs of concern; The profit and loss accounts reveal
the right and balanced view of the profit and loss for the financial period; The accounts have
been prepared in conformity with the law.
SCOPE OF AUDITING

 Legal Requirements

The auditor can determine the scope of an audit of financial statements following the
requirements of legislation, regulations, or relevant professional bodies. The state can frame
rules for determining the scope of audit work. In the same way, professional bodies can make
rules to conduct the audit.

 Entity Aspects

The audit should be organized to cover all aspects of the entity as far as they are
relevant to the financial statements being audited. A business entity has many areas of
work. A small entity may have few functions, while a large concern has many. The
auditor has to go through all the functions of the business. The audit report should cover
all functions, so the reader may know about all the workings of a concern.

 Reliable Information

The auditor should obtain reasonable assurance as to whether the information

contained in the underlying accounting records and other source data is reliable and sufficient
as the basis for preparing the financial statements. The auditor can use various techniques to
test the validity of data. All auditors usually apply compliance and substance tests while
doing the audit work. The auditor can show such information in the report.

 Proper Communication

The auditor should decide whether the relevant information is properly

communicated in the financial statements. Accounting is an information system, so facts and
figures must be presented so that the reader can get information about the business entity. The
auditor can mention this fact in his report. The accounting principles can be applied to decide
the disclosure of financial information in the statements.

 Evaluation

The auditor assesses the reliability and sufficiency of the information in the
underlying accounting records and other source data by studying and evaluating
accounting systems and internal controls to determine the nature, extent, and timing of
other auditing procedures.
IMPORTANCE OF AUDITING

When it comes to the importance of auditing, the main factor to note is that it allows
organisations to represent their financial situations accurately and fairly. Here are some specific
benefits that auditing offers to companies and related parties:

 It lets business leaders know that the operations of the business and its various
departments are performing optimally.
 It helps prevent and detect fraudulent reporting and honest errors.
 It helps the business maintain accurate records and verifies the accuracy of various
accounts.
 It allows a qualified professional to offer an independent opinion to a company's
management team.
 It increases responsibility and accountability amongst a company's staff members so
that they know to report financial information carefully.
 It reassures shareholders that the appropriate personnel are protecting their interests
and managing their accounts properly.
 It stimulates confidence in potential creditors and other interested parties, making it
easier for companies to secure loans and grow their businesses.
 It helps companies increase the effectiveness of their internal control measures.
 It helps companies remain within legal compliance.
FEATURES

 An audit is the verification of the results shown by profit and loss accounts and the
state of affairs confirmed by the balance sheet.
 The audit is a critical review of the system of accounting and internal control.
 The audit is done with the help of the vouchers, documents, information, and
explanations received from the authorities.
 The critical responsibility of Auditor is to ensure that the financial statements and
reports are authentic and show a fair view of the state of affairs.
 An auditor investigates, analyzes, reviews examine the documents supporting the
transactions.
 He examines the minute books of Directors, shareholders, memorandum of
associations to ascertain the correctness of the books of accounts.
 Various methods and procedures are used for performing the audit.
 The audit is not only limited to an examination of financial records, but it also
includes other areas like operational audit, process audit, tax audit, secretarial audit,
efficiency audit, social audit and more.
 It involved reporting by the auditor on the accounts examined by him and prepared as
per GAAP (Generally Accepted Accounting Principles) principle and present accurate
and fair view.
DEFINITION
MERITS OF AUDITING

 Ensures Account Correctness: Auditing involves a meticulous examination of

an organization’s accounting books. It verifies the accuracy of financial records and
ensures compliance with statutory requirements 1. This process helps maintain reliable
financial information.
 Detects and Prevents Errors: Auditing identifies errors and irregularities in
financial transactions. By evaluating each transaction, auditors reduce the risk of
mistakes and fraud. This vigilance contributes to the overall accuracy of financial
reporting.
 Maintains Accounts Regularly: Regular auditing ensures that accounts are
consistently maintained. If any irregularities arise, auditors raise questions and prompt
corrective actions. This discipline helps organizations stay on track.
 Assists in Decision Making: Auditing provides valuable information to
managers, aiding them in making informed decisions. Expert auditors offer advice
and help resolve financial issues.

DEMERITS OF AUDITING

 Costly: Auditing process puts a financial burden on organizations as it requires the

huge cost to conduct an examination of all financial accounts. Business needs to pay
large fees to auditing experts for their services.
 Rely on experts: Auditor is dependent on experts of various fields for conducting
auditing process. For acquiring true information regarding the valuation of fixed
assets and contingent liabilities, he needs to approach valuers, engineers and lawyers.
 Impossibility of checking all transactions: Another major drawback of
auditing is that it is not always possible to check each financial transaction of
organizations. Some organizations are too big and have a large number of transaction,
where evaluating all of them become quite an impossible task.
Objectives of Auditing

The objectives of auditing keep changing according to the advancements in the business
techniques. These objectives can be classified into:

1. Main objective
2. Subsidiary objectives

MAIN OBJECTIVE

main objective of auditing is to find reliability of financial position and profit and
loss statements. The aim is to ensure that the accounts reveal a true and fair face of the
business and all of its transactions.

The objective is also to verify and establish that at a given date, both the profit and loss
account and the balance sheet presents an accurate and reliable financial position of the
business.

Hence, the main objective of auditing is to form an independent judgment and opinion about
the reliability of accounts and truth and fairness of financial state of affairs and working
results.

Subsidiary objectives

1. Detection and prevention of fraud: It is one of the foremost subsidiary

objectives of auditing. As, fraud refers to the intentional misrepresentation of
financial information. Fraud can involve:
1. Manipulation, falsification, or alteration of financial records
2. Misappropriation of assets
3. Misapplication of accounting policies
4. Recording transactions without proofs
5. Suppression of effect of transactions from records|
2. Detection and prevention of errors: It is another important objective of auditing.
The act of auditing ensures that there is no misrepresentation of the financial
statements. Such errors can be ascertained by checking and vouching thoroughly the
books of accounts, vouchers, ledger accounts, etc.