CHAPTER I

INTRODUCTION
Origin of Audit. —
The origin of audit may be traced to middle ages but the
audit in the present sense can be traced after the introduction of
large-scale production in consequence of Industrial Revolution during
the 18th century. Before this era, goods were produced by indivi-
duals on small scale. There was not much capital, The individual
who invested the capital, usually himself maintained the accounts
and therefore there was no necessity of checking them.
Again stabilised governments, expansion of banking facilities
and new means of communication have widened the scope of
investment and business. The investor would naturally like to
see that his investment is safe. For this purpose the accounts
must be checked and audited especially in case of joint-stack compa-
nies, where the shareholders are drawn from far-off places, and who
have no hand in the actual running of the business. It is hut
essential to get the accounts audited in order to assure them that
their investment is safe and that the Directors and the Managing
Agents etce., who handled the capital and accounts, presented true
and correct accounts. Itis not possible for the shareholders to
check the accounts of the company. The shareholders appoint a
person who would audit the accounts on their behalf. Formerly
such a person used to be one of the shareholders who might not have
technical knowledge of accountancy. To havean effective check,
the custom to apoint professional auditors began to develop.
Definition of Audit, -——-
The word ‘‘audit” is derived from the Latin word “audire”
which means to hear. In olden times, whenever the owners of
a business suspected fraud, they appointed certain persons to
check the accounts. Such persons sent for the accountants and
“heard” whatever they had to say in connection with the
accounts. It wasan Italian, Luca Pacialo, who first published his
treatise on double entry system of book-keeping for the first time in
1494. He mentioned and described the duties and responsibilities
ofan auditor. Since then there have been lot of changes in the
scope and definition of audit and the duties and responsibilities of an
auditor,
 )
A HANDBOOK OF PRACTICAL AUDITING
2

As has been indicated above, the original object of an aut

was principally to sce whether the accounting party had propery
accounted for the receipts and payments of cash. Thus it was
only a Cash Audit, but as will be seen later on, the principal olyject
s a true
of modern audit is to sce whether the Balance Sheet exhibit
and fair view of the state of affairs of a company, Since the Balance
Sheet incorporates all personal and impersonal accounts and the
balance of Profit and Loss Account, which in its turn incorporates
fictitious transactions, we may safcly say that the Balance Sheet for
a particular period incorporates all the transcations which took place
during the period for which the Balance Sheet is prepared.
Spicer and Pegler have defined an Audit as “such an examina-
tion of the books, accounts and vouchers of a business, a5 shall
enable the auditor to satisfy himself whether or not the balance
sheet is properly drawn up, so as to exhibit a true and correct
view of the state of the affairs of the business, according to the best
of his information and explanation given to him and as shown by the
books ; and if not, in what respect it is untrue or incorrect.”
Another writer has given the definition : “Auditing may be
defined as careful searching of the books of accounts by comparing
them with the documents and papers from which thcy have beer
‘written up; and thus trying to find out whether the profit or loss for
@ particular period and the financial position, as shown by the Final
Account are correct and true.”
Yet another writer says : ‘Official examination and verification
of accounts or claims; especially an examination of account:
by proper officers, or persons appointed for that purpose, whe
compare the charges with the vouchers, cxamine witnesses, and state
the result.”
From the above definitions, it would be seen, that an auditor
has not only to sce the arithmetical accuracy of the books of accounts
but has to go further and find out whether the transactions
entered ir
tthe books of original entry are correct or not. How
is he to find it
“+ ? The answer is by inspecting, comparing,
checking. reviewing,
:atinising the vouchers supporting the
transactions in the books of
sunts andthe correspondence, minutes books of the
sharcholders
and directors, memorandum of association and
articles of association et
Difference between Accountan
cy and Auditin _
Before we proceed further. it j . Bs
should und erstand the diff > #48 considered necessary that one
paar erence between Accountancy and
 INTRODUCTION 3

1. Accountancy means keeping the books of accounts in such

away that one is in a position to know the state of affairs
of the business, while auditing means the checking of such
accounts to find out their accuracy.
2. The spade work is done by the accountant while the
finishing touch is given by the auditor or, as has been said,
that where the work cfan accountant ends, the work of
an auditor begins.
3. Sometimes an auditor is asked to prepare from a set of
books the trial balance, profit and loss account and
balance sheet in which case he would be acting as an
accountant and he would not be required to give his
-certificates at the foot of the BS. He has simply to put
his signature in token of his having prepared such a
profit and loss account and balance sheet that the balance
sheet exhibits a true and correct state of affairs. On the
‘ other hand, an auditor has not to prepare the Trial
Balance, P & L Account and Balance Sheet. He is to
certify that the balance sheet as has been prepared by an
accountant exhibits a true and correct state of affairs of
the concern.
4. An accountant has to,record the transactions in the books
of accounts while gfauditor has to check and verify such
transactions ang” accounts prepared by an accountant.
Investigation.
Sometimes students get an impression that auditing and
investigation mean the same thing. However, there is a lot of
difference between the two. Investigating means a searching enquiry
into the profit-earning capacity or the financial position of a con-
cern or to find out the extent of the fraud ifthere is any suspicion
about it.
1. Audit is carried out to find out whether the B.S, is properly
drawn up and exhibits a true and correct state of affairs,
while investigation is carried out with a certain end in
view, e.g., the profit-carning capacity, or the financial
Position of a concern or to find ont a fraud and the extent
thereof.
2. Investigation covers several years, say 3, 5, or 7 years to
find out the average earning capacity, financial position
etc., while audit relates to one year only.
 A HAKDHGOK OY PRACTICAL ADITTING

%~. Invesdgation imey he carried outon hefialf of eile

while audit is conducted on behalfof dre prnprictors arn
However, investigation is carried eat by propneion x
in some cases where fread or defaleation is ayapected,
Qualities of an Auditor,
Acis very jimpartint i
for an auditar ta he well) ver seq in
. ‘ var)
1.

the findamental principles and theory ofall Tranche

accounting, e.g., general accounting, cost account Fa
income tax, ete. tis not possible far a perssn 1 AUC
. . ate
the acenunts unless he himself knows how fo pep
them.
. te it is
Vie should not pass a transaction unless he knows thaw! .
correct. This is posible only when one knows thoroughly
well the principles of accounting,
Bet mm . »
He should be able to grasp quickly technical details of
. nance ee ae age ft ogsibie.
the business whose accounts he is auditing. If pos ’
he should pay a visit to the works before he undertakes
4%
the work of audit. ttidecnelicn ¢
He should be prepared to seck clucidation on technical
questions rather than show afalse pride or fear of dis-
playing his own ignorance.
3. He should be quite familiar with the Company Law and
must be complete master of the principles of auditing.
&. He must be tactful and honest, as Lord Justice Lindley
has said: “An auditor must be honest, ic. he must not
certify what he docs not believe to be truce, and he must
take reasonable care and skill before he beHeves what he
certifies is true.” (In re London and General Bank, 1895).
7. He must not be influenced directly ar indircetly by others
in the discharge of his duties.
8. Sometimes he is put ina very awkward position when his
duties to his client is opposed to his own interests
in
which case he must have the courage to carry out his
duties faithfully and honestly even if such
a step harms
him. In the long run this policy w ill be of immense
to him.
value
He willacquire a repu tatio
n for his honesty
which will bring more business
to him.
Me must be Tre ea
ese rather than Signa
. balance
not exhibit es i
view of the state of affairs and
thus give
i a file
false report.
eo
 INTRODUCTION 5

10. He should not disclose the secrets of his clients.

li. We must have the tact to put intelligent questions to
extract full information.
12. He must not adopt an attitude of suspicion. Lord Justice
Lope has said : “An Auditor is not bound to be a detective
or as was said, ‘approach his work with suspicion’, or with
foregone conclusion that there is something wrong. He
should behave like a ‘watch dog’ but should not adopt
; the attitude and outlook of a ‘blood hound’.”
13. He must be prepared to hear argument and must be
reasonable.
14. He must be vigilant, cautious, methodical and accurate.
15. He should have the ability to write clearly, forcibly,
concisely and correctly. ;
16. He should have an understanding of the general principles
of economics.
17. He should have thorough training in business organisation,
management and finance.
18. Heshould be able to write the report clearly, forcibily
concisely, and correctly. x
19. Last but not the least, he should have ‘Common Sense’,
Objects of an Audit. yo
The next point to be considered is the object and extent ofan
audit. The objects of an audit may be said to be :—
I. Detection and prevention of errors ; and
IJ. Detection and prevention of fraud.
I. Detection ef Errors. “S .
Errors are generally innocent but sometimes errors which might
appear at first sight as innocent are ultimately found to be due to
fraudulent manipulation and therefore an auditor must pay parti-
cular attention to any error, howsoever innocent it may appear to be
at first sight.
Errors are of three kinds, viz.
1. Clerical crrors which can be sub-divided into
(a) Errors of Omission ; and
(6) Errors of Commission.
2. Errors of Principles.
3, Compensating Errors.
Let us explain these separately in detail.
6 A HANDBOOK OF PRACTICAL AUDITING

(a) Errors ef Cmission.

rr a
As the name indicates, the error of omission 1s one W wher
. * end .

: F . ne
transaction has not been recorded in the books of accounts ‘. ect
wholly or partially.4 In the former case it will not be easy to ae
. But }
sometimes }it
the error and it will not affect the Trial Balance.
. n
is apparent from the balance of an account that an entry has bee
omitted, e.g. the rent account may show that the rent has been paid
for only 11 months and that the rent for the 12th month has not been
paid. But there are many other cases where it may not be possible
to detect the omission, c.g. purchases or sales have entirely been
omitted to be entered which error will not affect the Trial Balance
and the omission will not be apparent even.
But if one aspect of the purchase or sales has been entered in
the books, it will affect the Trial Balance and the omission will be
easily detectable. It may be due to the fact that the item has not
been posted although entry has been made in the books of original
entry. Ifa transaction has been omitted to be entered in the books
of accounts intentionally, it will affect results shown by the accounts
and affect the ultimate profit or loss.
(b) Errors of Commission.
When a transaction has been recorded but has been wrongly
entered in the books of original entry or posted in the ledger, error of
commission is said to have been made, e. g. incorrect entries in the
original records, wrong castings, calculations, postings, extensions and
carry forwards. Some of such crrors will be detected by the non-
agreement of the Trial Balance. On the other hand, if a mistake has
been committed in the invoice for the sale of goods, the error will
not be detected as the mistake will appear both in the original books
as well as in the ledger.
2. Errors of Principle
Such errors arise when the entries are not passed according to
the fundaniental principles of accountancy, ag. wrong allocation
* . oS
of expenditure between capital and revenue, !gnoring the outstanding
. sye,e . 3 oy
ins the
assets; and . liabilities, ’ valuation of assets against 1s y
principles of
book-keeping.
. Such errors may be committed either intentionall
tionall
y. Ifthey are committed intentionally the obieny or uninte int n-
and manipulate the accounts either to show more profite nd te falsity
Sheen actually are, Sach errors ultimately affect the Blanc
x a

* Slerciore, it is very important for an audito

r to pay particular
 INTRODUCTION ~ 7

attention towards this type of error. Suchan error is not disclosed

by the Trial Balance or by routine checking. It can be detected only
by a searching enquiry and independent checking.
3. Compensating Errors.
A compensating error is one which is counter-balanced by any
other error or errors, e,g., if A’s AJC was to be debited for Rs. 100 but
was debited for Rs, 10 while B’s A/G which was to be debited for
Rs. 10 was debited for Rs. 100. Thus both the accounts have been
debited for Rs. 110 which amounts ought to have been debited.
This type of crror will not affect the Trial Balance and will not be
detected easily. Such errors may affect the Profit & Loss Account
or not.
An over-casting of an account may be counter-balanced by the
under-casting of another account to the same extent. This type of
crror will not be detected by the Trial Balance. ,
Location of Differences.
The question is how to locate an error if it is found that there
has been an error. If the following methods are adopted, there will
be no difficulty in finding out an error :—
1. Check the totals of the Trial Balance.
2. Compare the names of the accounts in the Ledger with the
names of the accounts as have been recorded in the Trial
Balance. It is possible that balance of some account might
not have been transferred to the Trial Balance especially
in the case of the balance of Cash Book or some other
subsidiary book.
3. Total] the lists of debtors and creditors and compare them
with the Trial Balance.
4. Ifthe books are maintained on the self-balancing system,
see that the total of different accounts agree with the total
of these accounts with the balance of account as recorded
in the Trial Balance.
5. Whatever the difference is in the Trial Balance, halve it and —
see if there is any item ofthis value. This is done to
avoid the putting of the debit balance on the credit side
of the Tria] Balance or vice versa.
If in spite of the above methods, the error cannot be Jocated,
the error may be due to the following causes -—
1. An error of say Re. 1 or 10 or 100 etc., ie, a round sum,
may be due to wrong totalling. Ifthe difference is rupees, and
“ v
 A HANDBOOK OF PRACTICAL AUDITING

pice, it may be due to wrong posting or extracting a wrong

balance.
2. Anerror which is divisible by 9 may be duc to misplace-
ment or transposition of figures, c.g., 32 for 23, 52 for 25
or 54 for 45 and so on,
Il. Detection and Prevention of Fraud,
Having dealt with the first object of audit, viz., detection and
prevention of errors, let us proceed further and discuss the second
object namely :
Detection and Prevention of Fraud.
Detection of fraud is considered to be the mast important duty
ofan auditor. Asa matter of fact, originally audit was conducted,
mainly with a view to detect frauds whenever it was so suspected.
Fraud means false representation or entry made intentionally or
without belief in its truth with a view to defraud the proprietors of
the business. Fraud is of two kinds :
j. Defaication of money or goods ; and
2. Fraudulent manipulation of accounts not involving the
misappropriation of money or goods,
1, Defalcation of money or goods.
There is a greater possibility of defalcation of money or goods in
a big business house than in the case ofa small proprietary business
where the proprietor has a direct control over the receipts and pay-
ment of cash and purchase and sale of goods. Ina big business
house, the reccipt and payment of cash and the purchases and
sale of goods should be so organised that the work of one clerk may
be automatically checked by another clerk which system is known
in auditing as “Internal check” system and which will be dealt
with in detail later on. As between the two, namely misappro-
priation of cash and goods, it is casier to misappropriate cash, and
therefore the auditor will do well to pay particular attention
towards cash transactions.
Cash may be misappropriated by
{a) omitting to enter any cash received ; or

SSR se amonme
han wha i actly recrved ;o
book ; or € payment side of the cash
- (d) entering more amount on the
payment si
book than what has actually bees maid, side of the cash
 INTRODUCTION 9:

In order to discover fraud under (a) and (6) above, the auditor
should check the debit side of the cash book with rough cash book,
salesmen’s reports, counterfoils of the receipt books and other original
records while the fraud under (c) and (d) can be discovered by ref.
erence to the vouchers, wage sheets, salary book, invoices etc.
Again fraud may be in respect of goods, i.e, defalcation and
misappropriation of goods. This type of fraud is very difficult to
detect. Proper methods of keeping accounts in regard to purchases
and sales, stock taking, periodical checking of stocks, the necessity for
collusion, will help to avoid misappropriation of goods.
2. Fraudulent manipulation of accounts, not involving any
misappropriation of money or goods.
This type of fraud is more difficult to discover as itis usually
committed by directors or managers with the object of
(a) showing more profits, than actually they are (7) so that iff
they get commission on profits, they may get more commis-
sion; or (i) their service may be retained by showing to the
shareholders that because of their efficiency they have-
shown more profits and thus maintain the confidence of the:
shareholders and the public ; or (iii) if they hold shares,
they may sell them at high price by declaring higher divi-
dends ; or (ip) to obtain further credit by showing that the-
position of the business is better than what actually it is;
or (vy) to attract more subscribers for the shares of the
company etc.
(b) Showing less profit than actually they are (7) in order to-
purchase shares in the market at a lower price ; or (ii) to-
reduce or avoid the payment of income tax ; or (ii) to give
awrong impression about the success of the business to.
competitors etc. :
Falsification of accounts may be resorted {to :
(a) By not providing any depreciation or providing less.
depreciation or providing more depreciation ; of
(b) By under-valuation or over-valuation of assets and
liabilities ; or
(c) By including fictitious sales or purchases or returns in
order to show more profits or less profits.
Such frauds are difficult to detect as they are committed by the
people at the helm of affairs, who are presumed to be trustworthy,.
honest and responsible, and therefore, no suspicion falls on them.
10 A HANDBOOK OF PRACTICAL AUDITING

be very
They are very cleverly made and as such, the auditor should
careful in detecting such frauds. He should carry out the routine
checking and vouching most carefully and make searchin g enquirie s
intelligently.
Advantages of an Audit.
On account of the following advantages people get their accounts
.audited especially in cases where audit is not compulsory :
1. Errors and fraud are located at an early date and in future
no attempt is made to commit such frauds or one is rather
careful not to commit a mistake as the accounts are
audited at regular intervals.
The auditing of accounts keeps the accounts clerks regular
and vigilant as they know that the auditors would comp-
lain against them if the accounts are not prepared up to
date or there is any irregularity.
Audit of accounts by an independent auditor minimises the
chances of dispute amongst the partners.
In the case of joint-stock companies, the sharcholders, who
have no hand in the actual running of the business, are
assured that the accounts have been properly maintained
and that the directors have not taken any undue advantage
of their position and thus inisappropriated money.
in case of fire, the insurance company may settle the clair
on the basis of the audited accounts of the previou
years.
Money can be borrowed easily on the basis of the pre
vious audited balance sheet.
If the business is to be sold, price can be fixed on th
basis of the previous audited balance sheet.
Income tax authorities generally accept the profit and
loss account which has besn prepared by a qualified
auditor and they do not go into details of the accounts.
Ifa new partner is to be taken in or one of the partners
retires or dies, the audited balance sheet will be a good
basis to estimate the value of the capital of such a partner
or partners.
Different Classes of Audit and their Adva
miages,
A. The audit of the ac counts of priv
le) proprietor and the ad vantages deri ate individu als or a
ved from it.
 INTRODUCTION 11

When an auditor is asked to audit the accounts of a private

“individual or a sole trader, he must get clear instructions from his
F -client in writing as to what he is expected to do. As he is appointed
by an individual or a sole trader under an agreement, therefore, his
dutics and the nature of the work will depend upon such an agree-
ment.It is very important because if later on any charge of negligence
is levied, he can produce the agreement asto what he was asked
todo. Tn the case of an auditor to audit the accounts of joint-stock
‘companies, this question does not arise as his duties are defined by
the Companies Act itself, Sometimes an auditor is appointedby an
individuay to prepare the accounts ors ometimes he is asked to prepare
the accounts for the purpose of presenting them to the income tax
authorities. Therefore. it is very essential that he must know his
-duties and the nature of the work he is calied upon to perform.
Tf he is called upon to perform the full audit, he must sce
that the accounts are properly prepared and that the balance
sheet is correct. It is possible that his client might propose to take
a joan on the basis of the balance sheet signed by him, In such a
case if the lender later on finds that the balance sheet does not
represent the true and correct financial position of the individual,
‘the auditor might be held responsible to the banker to make good
the loss. In short he rnust act strictly according to the instructions
ofhis employer.
Advantages.
1, The individual is ussured that his accounts are properly
maintained and that he is not being defrauded by the
accountant and his agents. This is specially important
when the proprietor is a landlord and has a large estab-
lishment and consequently cannet have proper contro]
over it,
2. The accounts which have be2n audited by a qualified
auditor are generally taken as correct by the income tax
authorities and hence an individual does not feel any
difficulty in regard to income tax.
3. The audited books of a deceased are very helpful to the
executors and administrators as such accounts will form
the basis for the preparation of the death duty accounts.
4 Ifthe accounts have been prepared on a uniform basis,
accounts of one year can be compared with other years
and if there isan increase in expenditure, cause may
12 A HANDBOOK OF PRACTICAL AUDITING

be enquired into as to why the expenditure has increased

and efforts may be made to reduce the expenditure,
5. Where agents are appointed, it is difficult to keep a check
on their accounts and if the auditors are appointed, ; the
agents will keep proper accounts. If they have committed
any defalcation etc., these can be easily discovered by the
auditors.
B. The Audit of the Accounts of a Firm.
The auditor ofa firm is not appointed under any statute. He
is appointed by the partners and hence his scope of work will ex
tend according to the terms of appointment and instructions issued
to him. He should strictly adhere to the instructions, Some-
times he is appointed by a firm to prepare the accounts, in which
case he will act more or less like an accountant.
Sometimes an auditor is called for an interview and after
having discussed the work to be done by him and the terms of
appointment, he is verbally asked to begin his work. In sucha
case, it will be in the interest of the auditor to get in writing the
nature of his work, to avoid any difficulty later on. Inthe case of
Apfel vs. Annan Dexter & Co., it was held by the court that according
to the instructions issued to the auditors, it was clear that they were
to prepare the accounts for the purpose of income tax and hence
they were not to audit the accounts.
The responsibility of any
fraud will not lie on their head. it is very important
Therefore
that an auditor should get clear instructions from his clients. In
the above-mentioned casc, fortunately, the auditors had instructions
in writing and hence they were freed from any responsibility fo: any
fraud.
This point has clearly been decided in several cases, viz.,
Leech vs. Stokes, the Scarborough Harbour Commissioners vs, Robinson,
Coulson Kirkbep & Co., ctc., where their lordships said that if the
auditors had acted to the clear instructions of their clients, the
auditors would not be responsible.
‘The advantages derived by getting the accounts of a
firm audited.
1. The partners are satisfied with accou
nts which have been
maintained by one of the
partners This will avoid
any dispute amongst the
partners. This is why usua
provisions regarding audit of l
the firm > 8 account
: the Partnership: Deeds of most ie
in of t is are made
he firms,
 INTRODUCTION 13

2. Although there is no provision regarding the sleeping

partner under the Indian Partnership Act of 1930, all
the partners do not take active part in the business.. If
the accounts are audited by an auditor such a partner
who did not take active part in the business, will be quite
satisfied that there has been no fraud.
3. Incase of the death or retirement of a partner or when
a new partner comes in, the valuation of goodwill or the
settlement of accounts will become very easy.
4, Negotiation for loans from a bank or an individual will be
much facilitated if the audited accounts are presented.
The bank in such a case can casily forma correct opinion
about the financial position of the firm,
5. The Income Tax authorities generally take such audited
accounts as correct for the purpose of assessment of income
tax,
6. The auditor can sometimes suggest better methods of keep-
ing the accounts.
7, Ifthe business is sold asa going concern, there will not
be much difficulty regarding the valuation of the business
if the accounts had already been audited.
In addition to the above-mentioned particular advantages, a
firm derives all the advantages which are usually derived in getting
the accounts audited.
C. The advantages derived bya Joint-Stock Company in getting
the accounts audited.
1. The shareholders of a company have no access to the
books of accounts and therefore if the accounts which
have been maintained by the directors are audited
by an auditor who is a professional accountant, they are
assured that they have not been defrauded.
2. The audit keeps a check on dishonest employees.
3. The auditor of a company may give sound financial
advice though it is not his duty.
In addition to the above-mentioned particular advantages, a
‘Company derives all the advantages which are usually derived in
getting the accounts audited.
Distinction between the audit of a Joint-Stock Company and
a Partnership or firm.
i. The audit of joint-stock companies is compulsory under
14 A HANDBOOK OF PRACTICAL AUDITING

the Companies Act of 1956 while that of a partnership

is not.
2. The duties, powers, rights ctc., of an auditor of a joint
stock company are defined by the Companies Act, 1956,
while in the case of a partnership they depend upon the
agreement between the auditor and the firm.
33. Inthe case of a joint-stock company, its auditor must
bea qualified auditor as is laid down under 5. 226 of
the Companies Act, 1956, while in the case of a partner:
ship, its auditor need not hald those qualifications.
D. The Andit of Trust Accounts.
Trusts are created for the benefit of some institutions, widows,
minors ete. The trustees look afler the propety left over by the testator-
They collect the rents of the property, dividends on the shares
ete. and distribute the income to the beneficiaries according to the
terms of the Trust Deed. As the widows, minors etc. for the
benefit of whom these trusts are created, are not in a position to
have access to the boohs of accounts and criticise them, they are
often defrauded by the trustees, There have been cases where the
trustees have misappropriated large sums of trust money without
the knowledge of the beneficiaries. Sometimes the trustees them-
szlves do not know how to keep accounts or sometimes they do not
do so at all, not because they are dishonest but because they are
ignorant of the trust Jaws and the fundamentals of book keeping
To avoid such a thing, somctimes a provision is made in the Trus!
Deed for the appointment of auditors to check the accounts of the
irust.. This step will avoid the misappropriation of money by the
trustees. Ifthe accounts are audited by a qualified auditor, it wil
help both the trustees and beneficiaries. Trustees will he benefites
because there will be no unnecessary criticism against them, Th
beneficiaries will also be benefited because they will be assure
that the accounts have been properly maintained and that ther
has been no misappropriation of trust money or fraud.
Cenduct ef Audit.
Audit may be
Pa Continuous, or II, Periodical,

:imes @called,
A Contincous Audit or a detailed audit, as it is some
is an audit which involves a detailed cxaminats
he books of accounts at a regula r interval of, xamination ¢
‘ enh s. The auditor
i set s his+ clie
visit as » sa Say one month or thre
a
nts at regular intervals durin
 INTRODUCTION Ww

the financial year and checks cach and every transaction. At the:
end of the year he checks the profit and loss account and the
balance sheet.
Advantages of Continuons Audit.
ea 1. Mistakes and frauds are discovered easily and quickly as
the auditor checks the accounts at regular intervals and
in detail. If he were to check the accounts after one-
year, it would be difficult to locate an error. As the
auditor visits his clients, say after a fortnight or,a month
or so, the number of transactions will be small and hence
the error will be detected casily and quickly.
2. Since the auditor remains more in touch with the
business, he is in a position to know the technical details.
ofitand hence can beof great help to his clients by
making valuable suggestions.
3. Most of the checking work having been already performed’
during the course of the year, the final audited accounts
can be presented to the shareholders soon after the closing
of the financial year at the annual general meeting.
4. Asthe auditor visits the clients at regular intervals, the
clerks will be very regular in keeping the accounts up to
date and they will see that there is no inaccuracy or fraud
as it would be detected by the auditor at his next visit,
and lest the clerk might be taken to task.
5. Ifthe auditor pays surprise visits, it will have a consider-
able moral check on the clerks preparing the accounts as
they do not know when the auditor may come and check.
the accounts?
6. The auditor, having more time at his disposal, can check.
; the accounts with greater attention and detail.
- Disadvantages of Continuous Audit.
In spite of the above-mentioned advantages of a continuous
audit, there are certain drawbacks of such an audit which are as.
under :
1. Figures in the books of accounts which have already been
checked by the auditor at his previous visit, may be altered
by a dishonest clerk and the frauds may thus be
perpetuated,
2. The frequent visits by the auditor may disturb his client.
3. It is an expensive system of audit.
16 A HANDBOOK OF PRACTICAL AUDITING

4. The audit clerk may loose the thread of his work and
the queries which he wanted to make may remain out-
standing.
These disadvantages and dangers may be avoided by taking
some precautions, e.g.,
1. No alteration should be allowed to be made after the
transactions have been checked by the auditor, without
his permission.
2. Ifany alteration has to be made, it should be done by
means of a rectifying entry.
3. Checking of a book should be complete as far as possible
at one visit. However, if this is not possible, the auditor
should check the transactions up to a particular date and
make a note of it in his diary and, if possible, he should
make a note of the totals up to that date in his diary or
note-book.
4, Well drawn-up programme by the auditor will prevent
any loose ends.
TL. Periodical Audit or Final Audit or Balance Sheet Audit or
Complete Audit.
Periodical audit is one which is taken up at the close of the
financial or trading period when all the accounts have been balanced
and a Trading and Profit and Loss Account and the Balance Shect
have been prepared. At this juncture, the auditor gets hold of the
books and checks the accounts. He is in possession of the full facts
relating to accounts for the year under review. In the case of such an
audit, the auditor visits his client only once a year and goes on
checking the accounts until the work for the whole of the period is
completed.
This type of audit is verysatisfactory especially in the case of
small concerns. This class of audit is usually adopted by almost all
concerns. But in the case of large concerns, it takes more time to
complete the audit and hence presentation of accounts to the
shareholders is delayed. The share- holders are usually very anxious
for the dividends which cannot be declared until the final accounts
jhave been prepared and audited,
The question often put is, what type of audit is satisfactory
which may be adopted, as both the continuous and periodical audit
ve Advantages as well as drawbacks.
A It is suggested that an interim audit followed by the final
‘tis the most satisfactory type of audit although it is very
>
 INTRODUCTION 17

expensive. The type of audit to be adopted depends upon the

magnitude of the business.
Procedure.
How to proceed with the work will depend upon the circum-
stances of each case. The method of work varies with the training,
experience, and knowledge of the auditor. Some general points are
given below ;
Distinctive ticks of different colours for, say additions, Postings,
ledger balances, carry forwards etc, should be adopted. The
significance of these ticks should not be made known to the clerks
ofthe client. The same kind of ‘tick’ should not be used for every
firm and for the same kind of transactions or for all the visits. As
far as possible the work of checking of one book should be completed
at one sitting forif it is not donc, some fraudulent alterations may
‘be made by the clerks after the audit clerk has left the office for the
day, Onthe next visit, the audit clerk should see that :there has
been no alteration by rubber or by scratching of the work he had
already checked on the previous visit. If it has been done, he should
get an explanation and check the whole of the work again. If any
adjustment is found to be necessary, it should be made by a journal
entry and no alteration ofa figure should be allowed. Special ticks
should be used for figures which had_already been erased. Pencil
figures should not be accepted. It sometimes so happens that the
clients put the total figures with pencil. The auditor should refuse
to commence his work until these figures are inked. The audit
clerk should not balance the books, [tis not his work. Sometimes
he is asked to balance the books, in which case, he will be acting in
the capacity ofan accountant rather than an auditor. Frequently,
the auditor is asked to begin the audit work even before the
balancing of books, so that the audit may be completed sooner.
However, this procedure should be discouraged as there is a danger
ofthe errors being overlooked because there has been no clerical
test like the preparation of the Trial Balance. No transaction should
‘be passed unless he understands it, for an auditor must not certify
what he does not believe to be true.
The auditor should not discuss anything in regard to the
ameaning of different ‘ticks’ etc., lest the client’s staff may know about
the secret meaning and defraud the auditor. Vouching should be
carricd out by two clerks, the senior examining the voucher and
calling out the amount and the junior agreeing the amount and
placing a special tick against the item inthe Cash Book, When
18 A HANDBOOK OF PRACTICAL AUDITING

calling back the figures, the audit clerk must be very clear in
speaking out the figures otherwise mistakes may crop in ¢.g., when
one clerk calls out the figure as Rs. 60, nP. 9, he might be understood.
as Rs. 69. Therefore the clerk should make a pause between 60 and
9, Similarly there might be confusion between ninety and nincicen,
eighty and cighteen. It would ,be advisable to pronounce ninety as
ninetic and so on.
As already mentioned, work done by cach clerk should be
recorded in the Audit Note Book which js known by different names
such as Working Papers, Audit Notes, Memoranda ete. In addi-
tion to the programme mentioned above, it contains full record of
all important notes and queries, which were not satisfactorily ex-
plained, missing vouchers and invoices, all important matters which.
may be useful for future audit, points which have to be mentioned
in the report, answers to queries, together with the names of the
officers who gave such answers. Unimportant and minor matters
should not finda place inthe Audit Note Book. They may be
settled atthe spot. These Note Books should never be destroyed
for they may be used for future reference and especially when a
question of the liability of the auditor arises. Such a question may
arise after many years when the clerk responsible for the work might
have resigned or the auditor might have altogether forgotten about
the particular events. The Audit Note Book will be the best evi-
dence in favour of the auditor.
QUESTIONS
1. What is an Audit ? What are its advantages ?
2. Briefly explain the difference between Book-Keeping, Ac~
countancy and Auditing. (Allah. B. Com. 1945)
3. Explain the difference between Auditing and Investigation.
4. State the qualities that are required of an anditor. .
5. What are the main classes into which errors in the books
of accounts are divided? Briefly explain and illustrate such errors.
6. What are the principal objects of an audit ?
(G. U. Gom. 7939)
7. Explain and iMustrate “manipulation or falsification of
accounts,”
8. How is money or goods misappropriated ? Suggest methods
to prevent such a fraud.
9. Mention some of the types of frauds on the part
of the
ors which the auditor must be on the look-out
for and the
 INTRODUCTION 19
precautions he should take so as not to be liable for such frauds.
(C. A. Final, Nov. 1951)
10. What do you mean by “routine checking’ ?
11. Describe the value of an audit for trading and non-trading
concerns.
12. State briefly the difference in principle between the audit
of accounts of a firm or a sole trader or a trust and that of a joint-
stock company.
13. “The auditor ofan individual or a firm has no statutory
obligation to comply with.” Discuss briefly the implications and
limitations of this statement.
14. What is a Continuous Audit ? What are its advantages
and disadvantages ?
15. Distinguish between
(a) Complete and Partial Audit.
(b) Continuous or Running and Final or Balance Sheet
Audit.
16, What is your opinion as to the value of an Audit Note
Book ?
17. Write a short note on the “Method of work” and “Check
Marks or Ticks” generally adopted during audit.
18. Isita part ofan auditor’s duty to trace and locate a dif-
ference in the books he is auditing? What steps should be taken
when asked to sign the Balance Sheet if the Trial Balance shows a
difference ?
19. The Trial Balance of a company does ‘not agree. What
steps would you take to locate the error if you are asked to discover
the error or errors?
20. What is an auditor’s duty in relation toa difference in
books undiscovered at the time of commencing the audit ?
21. Differentiate between
(a) the fundamental principles of auditing, and
(b) the technique of auditing,
Explain why the latter must be subject to change though
the former may remain constant.
(C. A. Final, 1951)
22. Give examples of errors which might still exist in a set of
books after the Trial Balance had been agreed, and state th aia
auditor would take to detect them. f