Auditing Origin
The word ‘audit’ is derived from the Latin word Audire which means ‘To Hear’. Earlier it was customary for a person responsible for maintenance of accounts to go to some impartial and experienced person who used to hear these accounts and express their opinion about their correctness or otherwise. Such person was known as Auditor. Thus, the term auditor means Hearer (One who hears). Necessitated because of complexity and volume of the transactions. Objective to detect and prevent frauds. Auditing is as old as accounting. It was in use in all ancient countries such as Mesopotamia, Greece, Egypt. Rome, U.K. and India.
Auditing evolved and grew rapidly after the industrial revolution in the 18th century. Shaped into present day’s discipline owing to rules, regulations and guidelines laid down by authorities like Governments, legal bodies and institutions. The main objective of audit shifted to ascertaining whether the accounts were true and fair rather than true and correct.
International Standards on Auditing (ISA) are professional standards for the auditing of financial information and are issued by the International Federation of Accountants (IFAC) through the International Auditing and Assurance Standards Board (IAASB).
Note - In simple words, Auditing is the verification of financial position as disclosed by the financial statements.
Auditing in India
The history of auditing in India dates back to April 1914 when the Indian company Act,1913 came into force. Because of this act there was growth in accountancy profession in India which made it obligatory on the part of every company registered under it to have the accounts auditor at least once every year. The act for first time prescribed the qualification for an auditor. The Chartered Accountant Act was passed in 1949 ICAI was set up and on the passing of this act the autonomy was granted to the accountancy profession.
Meaning and Definition of Auditing
The book "an introduction to Indian Government accounts and audit" "issued by the Comptroller and Auditor General of India, defines audit “an instrument of financial control. It acts as a safeguard on behalf of the proprietor (whether an individual or group of persons) against extravagance, carelessness or fraud on the part of the proprietor's agents or servants in the realization and utilisation of the money or other assets and it ensures on the proprietor's behalf that the accounts maintained truly represent facts and that the expenditure has been incurred with due regularity and propriety. The agency employed for this purpose is called an auditor."
In simple terms, Auditing is an examination of accounts to ascertain whether the financial statements give a true and fair view financial position and profit or loss of the business. Auditing is the intelligent and critical test of accuracy, adequacy and dependability of accounting data and accounting statements.
Definition of auditing by experts
- According to Taylor & Perry - An audit is an investigation by an auditor into the evidence from which the final revenue accounts and balance sheet or other statements of an organisation have been prepared, in order to ascertain that they present a true and fair view of the summarized transaction for the period under review and of the financial state of the organisation at the end date, so enabling the auditor to report thereon.
- According to R. B. Bose – Audit is the verification of the accuracy and correctness of the books of accounts by an independent person qualified for the job and not in any way connected with preparation of such accounts.
- According to L.R. Dicksee - Auditing is an examination of accounting records undertaken with a view to establishment whether they correctly and completely reflect the transactions to which they purport to relate.
According to above definition we can simplify the word audit with this question given below.
- What is Audit?
- An intelligent and critical examination of the books of account of a business.
- Audit is Done by Whom?
- Done by Independent person or body of persons qualified for the job.
- How to Audit to be done?
- With the help of vouchers, documents, information and explanation received from the authority.
- End auditor prepared report
- Auditor may satisfy himself with the authenticity of financial accounts prepared for fixed term and ultimately reports that balance sheet and profit & loss account exhibits a true and fair view of the state of affair of the concern.
Auditing Scope
Audit scope is defined as the amount of time and documents which are involved in an audit, is an important factor in all auditing. Audit scope, ultimately, establishes how deeply an audit is performed. It can range from simple to complete, including all companies’ documents.
In simple terms, to determine the fairness and authenticity of reported financial position together with the detection and prevention of errors and fraud. Financial statements meet with exhaustive rule and regulation which are being framed in particular country.
Scope and duties of an auditor have increased reason
- Expansion of Business - Earlier, the scale of business was small because there wasn't enough money at that time, so sole proprietor majorly in business, due to industrial development partnership firm are formed in this era company is registered swiftly due to expansion of business. In companies’ stakeholder and investor invested money so they need fair financial statements, know financial position of the company.
- Statutory Control – Introduction of Company act 2013, audited the book in a every year, compliance such as assets depreciation of company act 2013 varies with income tax act soon.
- Standard set by professional institute – Auditor must follow the Standard Auditing Practice prescribed by professional institute for the country. It varies country to country here in India ICAI is regulating.
Note - Scope and objectives are truly dependent on the circumstances of each audit case.
Objectives of Auditing
To verify the books of accounts and to report whether the balance sheet and the PL account have been drawn properly according to company act and whether they exhibit a true and fair position of company.
- To detect the errors and frauds
- To prevent the recurrence of those errors and of fraud
The objectives of the auditing have been classified under two heads:
- Main / primary objective
- Subsidiary/ secondary objectives
Main Objective: The main objective of the auditing is
- To find reliability of financial position and profit and loss statements.
- To ensure that the accounts reveal a true and fair view of the business and its transactions.
- To verify and establish that at a given date balance sheet presents true and fair view of financial position of the business and the profit and loss account gives the true and fair view of profit or loss for the accounting period.
- To be established that accounting statements satisfy certain degree of reliability.
- To form an independent judgement and opinion about the reliability of accounts and truth and fairness of financial state of affairs and working results.
Subsidiary objectives:
- Detection and prevention of fraud: the one of the important subsidiary objectives of auditing is the detection and prevention of fraud. Fraud refers to intentional misrepresentation of financial information.
- Fraud may involve:
- Manipulation, falsification or alteration of records or documents
- Misappropriation of assets.
- Suppression of effect of transactions from records or documents.
- Recording of transactions without substance.
- Misapplication of accounting policies
- Detection and prevention of errors: is another important objective of auditing. Auditing ensures that there is no mis-statement in the financial statements. Errors can be detected through checking and vouching thoroughly books of accounts, ledger accounts, vouchers and other relevant information.
Features of Auditing
- Audit is a systematic and scientific examination of the books of accounts of a business;
- Audit is undertaken by an independent person or body of persons who are duly qualified for the job.
- Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown by the balance sheet.
- Audit is a critical review of the system of accounting and internal control.
- Audit is done with the help of vouchers, documents, information and explanations received from the authorities.
- The auditor has to satisfy himself with the authenticity of the financial statements and report that they exhibit a true and fair view of the state of affairs of the concern.
- The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions and examine correspondence, minute books of shareholders, directors, Memorandum of Association and Articles of association etc., in order to establish correctness of the books of accounts.
Importance of Auditing
Importance of auditing can be judged from the fact that even those organizations which are not covered by companies Act get their financial statements audited. It has become a necessity for every commercial and even non- commercial organization. The importance of auditing can be summed in following points:
- Audited accounts help a sole trader in knowing the value of the business for the purpose of sale.
- Dispute over correctness of profits can be avoided.
- Shareholders, who do not know about day-to-day administration of the company, can judge the performance of management from audited accounts.
- It helps management in detecting and preventing errors and frauds.
- Management gets advice on financial affairs from the auditors.
- Long- and short-term creditors depend on audited financial statements while taking decision to grant credit to business houses.
- Taxation authorities depend on audited statements in assessing the income tax, sales tax and wealth tax liability of the business.
- Audited accounts are useful for the government while granting subsidies etc.
- It can be used by insurance companies to settle the claims arising on account of loss by fire.
- Audited accounts serve as a basis for calculating purchase consideration in case of amalgamation and absorption.
- It safe guards the interests of the workers because audited accounts are useful for settling trade disputes for higher wages or bonus.
Difference between Audit vs. Investigation?
- Not the same thing
- Audit is carried out to find out whether the balance sheet and P&L a/c of a concern is properly drawn up and it exhibits a true and fair view of a state of affair. Investigation is done with some special purpose.
- Audit is generally conducted at the end of financial year and it is relating to the account of one year only while investigation covers several years to find out average earning capacity etc.
- Audit is always carried conducted for proprietors only while investigation is normally carried out on behalf of those who are outsider who either want to purchase the business the business or to become partners, or to advance loan etc.
- Audit is legally compulsory especially in case of Companies Act but investigation is voluntary and depends upon the necessity of some purpose.
Auditor Qualities
- Firstly, Auditor should be Chartered accountant because only the qualified chartered accountant can be appointed as auditor of a limited company.
- An auditor should have in depth knowledge of the fundamental principle’s theories and practice of all aspect of accounting.
- Auditor should also know all the technical and other details of working of business
- Auditor should also have through knowledge of company and mercantile law; He must have thorough knowledge of audit case laws as per the various cases decide by the courts in and outside India.
- He should honest, impartial and not be influenced directly or indirectly by others in the discharge of his duty; He should not disclose the secrets of his client.
- He should have adequate knowledge of financial management, industrial administration and business organization.
- He must act impartially and not influenced by others, directly or indirectly while discharging his duties.
- He must have capacity to hear arguments of others and should be hard working, systematic and methodical.
- He should have adequate skills and courage to write audit report correctly clearly and concisely.
Errors and Frauds
Error means unintentional mistakes in the preparation or presentation of financial information. Error generally arises out of the innocence or carelessness on the part of those responsible for the preparation of accounts.
Frauds means the unlawful and deliberate misstatement of financial statements. It involves some intention to gain out of manipulating records.
Types of Errors
- Errors of omission
- Compensating Error
- Errors of Commission
- Error of Principles
Error of Omissions
It arises if a transaction has been omitted from being entered in the books of account, wholly or partially. Example there were entries purchase or sales which have to be recorded in the book of accounts but due to oversight or carelessness they have been wholly omitted from being recorded.
Like if an item has been recorded in the journal but has not been posted in the ledger. This error will not affect the trial balance it arises due to non-recording of certain items and as such omission can be detected by careful scrutiny.
Error of Commission
It is a type of clerical error that happens when a mistake is committed by the clerk in recording of transaction in the book of accounts due to negligence. If an item is incorrectly recorded in the journal or posted in the ledger it is an error of commission. For example – incorrect recording wholly or partially a sale of Rs. 100 is entered in the sale book as Rs.10 such an error does not affect the trial balance.
- Incorrect posting or posting an item to a wrong account
- Errors in totalling and balancing
- Errors in carrying forward total to trial balance
Compensation errors
When one error has been compensated or counter balanced or nullify by an offsetting entry that’s also in error, so that the adverse effect of one on debit or credit side is neutralized by that of another on credit or debit side. For example, A’s account which was to be debited for Rs. 200 was credited for Rs. 200 and similarly B’s account which was to be credited for 200 was debited for 200. Compensating error will not affect the trial balance and therefore will not be detected easily.
Errors of principles
It arises when the accountant not consider the principles of accounting while preparing accounts. Such errors are sometime committed intentionally to falsify and manipulate accounts with an objective of showing more or less profit than the actual figure. For example – valuation of assets against principles of accountancy, incorrect allocation of expenditure between capital and revenue, posting an item of revenue or expenditure to a personal account, error of principle does not affect the trial balance.
FAQ’s
What is Auditing?
Auditing is a process in which there is systemic and scientific examination of company accounts by a well-qualified person.
Who conducts an audit?
- Internal audits are conducted by internal employees or a dedicated audit department.
- External audits are conducted by independent auditors or certified public accountants (CPAs).
What is audit evidence?
Audit evidence includes documents, records, and observations that support the auditor's opinion on financial statements
What is an auditor's report?
An auditor’s report is the formal opinion or disclaimer issued by an auditor after examining a company's financial records.
