Auditing: Principles and Practices CBCAT6T11B

Syllabus topics (RTMNU)

• Meaning, definition, objectives
• Importance and advantages of auditing
• Principles
• Scope of auditing
• Limitations of auditing
• Types of auditing
• Difference between accounting and auditing
• Meaning, Qualities and qualifications of an auditor
• Rights and duties of an auditor
• Appointment, Removal, Remuneration of an auditor

Meaning and Definition of Auditing

Auditing is the systematic and independent examination of books of accounts, vouchers and records of an organisation, to find out how far the financial statements show a true and fair view, and to express an opinion on them.

Objectives of Auditing

Main objective: to express an independent opinion on whether the financial statements give a true and fair view. Subsidiary objectives: detection and prevention of errors (errors of omission, commission, principle, compensating errors) and frauds (misappropriation of cash or goods, manipulation of accounts/window dressing).

Importance and Advantages of Auditing

1. Gives credibility to financial statements for shareholders and investors.
2. Detects and prevents errors and frauds; moral check on staff.
3. Accepted by banks for loans and by tax authorities (Income Tax, GST).
4. Helps in valuation during admission/retirement of partners, mergers.
5. Protects interests of absentee owners (shareholders).
6. Gives useful suggestions to management for better systems.
7. Helps settle insurance claims and disputes.

Principles of Auditing

Integrity, objectivity and independence; confidentiality; professional skill and competence; work performed by others (reliance with care); documentation; planning; audit evidence; accounting system and internal control; audit conclusions and reporting (as stated in SA 200 and ICAI's basic principles).

Scope of Auditing

The scope is decided by law (Companies Act, Income-tax Act), the terms of engagement and Standards on Auditing. It covers examination of books, vouchers, internal control, verification of assets and liabilities, compliance with accounting standards and laws, and reporting. Today the scope extends to cost audit, tax audit, GST audit, internal audit, management audit, social and environmental audit.

Limitations of Auditing

• Auditor relies on test checking, so some errors may remain.
• Depends on explanations by management.
• Accounts involve estimates and judgement (depreciation, provisions).
• Collusive frauds are hard to detect.
• Audit is done after the event; it is historical.
• Time and cost constraints.
• Audit gives reasonable assurance, not absolute assurance.

Types of Audit

Difference between Accounting and Auditing

Auditor: Qualities and Qualifications

Qualities: honesty and integrity, independence, tact, knowledge of accounting, law and taxation, alertness ("watch-dog, not a blood-hound" — Kingston Cotton Mills case, 1896), patience, communication skill, confidentiality.

Qualifications (Section 141): only a Chartered Accountant holding a certificate of practice (or a firm of CAs/LLP where majority partners are CAs) can be a company auditor. Disqualified: a body corporate (other than an LLP), an officer or employee of the company, a partner or employee of such an officer, a person holding securities of the company (a relative may hold only up to the small prescribed limit), a person indebted to the company beyond the prescribed limit, a person in business relationship with the company, a relative of a director or KMP, a person convicted of fraud within 10 years, a person who is auditor of more than 20 companies.

Appointment, Removal and Remuneration

• First auditor (Section 139(6)): appointed by the Board within 30 days of registration; if not, by members at an EGM within 90 days.
• Subsequent auditor (Section 139(1)): appointed by members at the AGM for a term of 5 years (from the end of that AGM to the 6th AGM).
• Rotation (Section 139(2)): listed and certain companies — an individual auditor for one term of 5 years, an audit firm for two terms of 5 years, followed by a 5-year cooling-off.
• Casual vacancy: filled by the Board within 30 days; if due to resignation, approved by members within 3 months.
• Removal before term (Section 140(1)): by special resolution after obtaining prior approval of the Central Government; the auditor must be given a reasonable opportunity of being heard.
• Resignation: file Form ADT-3 within 30 days stating reasons.
• Remuneration (Section 142): fixed by members in general meeting (or as they decide); for the first auditor, by the Board.

Rights and Duties of an Auditor

Rights: access at all times to books, accounts and vouchers; to obtain information and explanations from officers; to receive notice of and attend general meetings and be heard; to visit branches; to be paid remuneration; to sign the audit report.

Duties (Section 143): enquire into loans and advances, book entries, sale of investments, personal expenses charged to revenue; make a report to members on the accounts; comply with Standards on Auditing; report on CARO 2020 matters; report frauds to the Central Government (above the prescribed amount); report on adequacy of internal financial controls.

Likely exam questions

1. (Long, 8/16 marks) Define auditing. Explain its objectives, advantages and limitations.
2. (Long, 8/16 marks) Explain the provisions of the Companies Act 2013 regarding appointment, removal and remuneration of a company auditor.
3. (Short, 4 marks) Distinguish between accounting and auditing.
4. (Short, 4 marks) State the qualifications and disqualifications of a company auditor.
5. (Short, 4 marks) State any four rights of a company auditor.

Syllabus topics (RTMNU)

• Meaning, definition, objective of Audit planning
• Meaning, definition, objective of Audit programme
• Meaning, definition, objective of Audit working papers
• Meaning, definition, objective of Audit notebook
• Meaning, objective of routine checking
• Meaning, objective of Test checking
• Meaning, objective of Internal control system
• Internal check
• Auditor’s role in internal control

Audit Planning

Audit planning means developing an overall strategy and a detailed approach for the expected nature, timing and extent of the audit (SA 300).

Objectives: give proper attention to important areas; identify potential problems in time; complete the audit efficiently and on time; assign work to suitable staff; coordinate work of experts and other auditors.

Steps: understand the client's business and industry; study the accounting system and internal controls; assess risks and materiality; decide audit approach; prepare the audit programme; plan time and staff; communicate with management.

Audit Programme

An audit programme is a detailed written plan of the audit work, listing the procedures to be performed, the extent of checking, the staff responsible and the time allotted.

Objectives: clear instructions to assistants; ensures no important work is left out; fixes responsibility; record of work done; helps control progress; evidence in case of negligence claims.

Advantages: uniformity, easy supervision, division of work. Disadvantages: mechanical, kills initiative, may become rigid and outdated — so it should be reviewed regularly.

Audit Working Papers

Working papers are the documents prepared or obtained by the auditor during the audit and kept as evidence of the work done (SA 230 — Audit Documentation). They include the audit programme, copies of important documents, notes of discussions, schedules of assets, confirmations, management representations and the draft report.

Objectives: evidence that audit was done as per SAs; helps in planning and supervising; basis for audit report; reference for next year's audit; defence in legal cases. Types: permanent audit file (data of continuing importance — memorandum, articles, agreements) and current audit file (for this year's audit). Working papers are the property of the auditor.

Audit Notebook

An audit notebook is a register kept by the audit staff to record day-to-day matters noticed during the audit — queries, errors, missing vouchers, explanations needed, points for the senior's attention, and work done each day.

Objectives/uses: record of queries to be cleared; helps in writing the report; evidence of work done; useful for next year; helps fix responsibility of staff.

Routine Checking

Routine checking means checking the arithmetical accuracy and posting of entries in books — casting (totals), carry-forwards, postings to ledger, balancing and extraction to trial balance.

Objectives: detect clerical errors and simple frauds. Limitation: cannot detect errors of principle or well-planned frauds; it is mechanical. Ticks and marks of different colours are used.

Test Checking

Test checking means checking a selected sample of transactions instead of all, and drawing conclusions about the whole (SA 530 — Audit Sampling).

Objectives: save time and cost in big organisations; focus on important areas. Conditions: a strong internal control system; random or statistical selection; larger samples for weak areas; checking 100% for important items (cash, large amounts); samples not disclosed in advance. Merits: economical, practical for large firms. Demerits: errors outside the sample may be missed.

Internal Control System

Internal control is the whole system of controls — financial and otherwise — established by management to run the business in an orderly and efficient manner, safeguard assets, prevent and detect fraud and error, ensure accuracy and completeness of records, and prepare reliable financial information on time.

Elements: control environment; risk assessment; control activities (authorisation, segregation of duties, physical controls, reconciliations); information and communication; monitoring.

Internal Check

Internal check is an arrangement of staff duties so that the work of one person is automatically checked by another, and no single person has complete control over any transaction from beginning to end.

Principles: division of work; rotation of duties; compulsory leave; physical control of cash and stock; use of mechanical devices (cash registers, computerised controls); authorisation limits.

Auditor's Role in Internal Control

1. Study and evaluate the internal control system (through questionnaires, flow charts, walk-through tests).
2. Test whether controls actually operate (tests of control).
3. Decide the extent of test checking — strong controls mean less detailed checking.
4. Report weaknesses to management (SA 265) and suggest improvements.
5. Under Section 143(3)(i) of the Companies Act 2013, report on the adequacy and operating effectiveness of internal financial controls (for applicable companies).

Likely exam questions

1. (Long, 8/16 marks) What is an audit programme? Explain its objectives, advantages and disadvantages, and how it differs from audit planning.
2. (Long, 8/16 marks) What is internal control? Explain internal check and the auditor's role in internal control.
3. (Short, 4 marks) What are audit working papers? State their objectives.
4. (Short, 4 marks) Distinguish between routine checking and test checking.
5. (Short, 4 marks) What is an audit notebook?

Syllabus topics (RTMNU)

• Meaning and importance, objective of vouching
• Vouching of cash receipts
• Vouching of cash payments
• Vouching of purchase book
• Vouching of sales book
• Vouching of wages and salaries
• Meaning of verification and valuation
• Verification of assets and liabilities
• Valuation of assets

Vouching: Meaning, Importance and Objectives

Vouching is the act of examining documentary evidence (vouchers) in support of entries in the books of accounts, to establish that transactions are genuine, authorised and correctly recorded. A voucher is any document that supports a transaction — invoice, receipt, bill, contract, minutes, bank statement, wage sheet.

"Vouching is the essence (backbone) of auditing" — because the whole audit depends on the genuineness of entries.

Objectives: (1) every transaction recorded is genuine and relates to the business; (2) it is properly authorised; (3) it is recorded in the correct account and period; (4) no transaction is omitted; (5) detect errors and frauds.

Points to note on a voucher: date, name of the party (in the client's name), amount in words and figures, authorisation signature, revenue stamp where needed, cancellation after use, and relation to the business.

Vouching of Cash Receipts

• Cash sales: check sales memos/cash memos with the cash book; check carbon copies are serially numbered; examine cash register totals.
• Receipts from debtors: compare counterfoils of receipts issued with the cash book; check discounts allowed are authorised; send confirmation letters to debtors.
• Interest and dividends received: check with interest warrants, dividend counterfoils and bank statements (Form 26AS/AIS for TDS).
• Sale of assets: board authorisation, sale agreement, broker's note.
• Loans and share capital received: loan agreement, board/members' resolution, bank statement.

Vouching of Cash Payments

• Payments to creditors: supplier's receipt, statement of account, invoices.
• Purchase of fixed assets: invoice, board approval, delivery note, capital vs revenue distinction.
• Expenses (rent, salaries, electricity, travel): bills, rent agreement, receipts, approval.
• Petty cash: imprest system, petty cash vouchers signed by the payee and approved.
• Taxes paid: challans (GST, income tax, TDS).
• Payments above the cash limits must be by banking channel (check the Income-tax law restrictions — check latest).

Vouching of the Purchase Book

1. Compare entries with suppliers' invoices: date, name, quantity, rate, amount, GST.
2. Check invoices are addressed to the client and relate to its business.
3. Match with purchase orders and goods received notes (GRN).
4. Check trade discount and GST input credit treatment.
5. Ensure capital goods are not included as purchases.
6. Examine purchases near year-end for cut-off — goods received but invoice not recorded (or vice versa).
7. Check purchase returns with debit notes.

Vouching of the Sales Book

1. Compare with carbon copies of sales invoices and delivery challans/gate passes.
2. Check prices with price lists and authorised discounts.
3. Check GST charged and e-way bills where applicable.
4. Check sales near the year-end for cut-off (goods sent on approval or consignment are not sales).
5. Sales returns with credit notes and goods received inward register.
6. Ensure sale of assets is not recorded as sales.

Vouching of Wages and Salaries

• Wages: check attendance records/job cards, wage rates with agreements, wage sheets prepared and checked by different persons, overtime approval, deductions (PF, ESI, TDS, advances), payment by bank transfer; surprise visit at payment time to check dummy workers.
• Salaries: salary register, appointment letters, increments approved, deductions, bank transfer statements, compliance with Labour Codes (minimum wages, bonus) — check latest.

Verification and Valuation: Meaning

Verification means confirming the existence, ownership (title), possession, valuation and freedom from charge of assets and liabilities on the balance sheet date. Valuation means checking that assets are valued on a proper basis as per accounting standards and law.

Verification of Assets and Liabilities

• Land and buildings: title deeds, registration documents, property tax receipts, mortgage records.
• Plant and machinery: fixed asset register, invoices, physical verification, depreciation.
• Investments: share certificates/demat statements, broker's notes.
• Inventory: physical stock-taking (attend the count), valuation at cost or net realisable value whichever is lower (AS 2).
• Debtors: confirmations, ageing, provision for doubtful debts.
• Cash and bank: surprise cash count, bank statements and bank reconciliation, bank confirmation.
• Liabilities: loan agreements and confirmations, creditors' statements, outstanding expenses, contingent liabilities.

Valuation of Assets

Bases: historical cost, written-down value, market value, net realisable value, replacement cost. Fixed assets — cost less depreciation (AS 10, Schedule II of the Companies Act); inventory — lower of cost or NRV (AS 2); investments — current at lower of cost or fair value, long-term at cost less permanent decline (AS 13); debtors — less provision. The auditor is not a valuer; he relies on experts but checks the basis is reasonable and consistent.

Likely exam questions

1. (Long, 8/16 marks) What is vouching? Explain its objectives and how you would vouch cash receipts and cash payments.
2. (Long, 8/16 marks) Explain verification and valuation. How would an auditor verify fixed assets, inventory and debtors?
3. (Short, 4 marks) Distinguish between vouching and verification.
4. (Short, 4 marks) How will you vouch the purchase book?
5. (Short, 4 marks) How will you vouch wages?

Syllabus topics (RTMNU)

• Meaning and importance, objective of audit report
• Contents of audit report
• Types of audit report
• Audit certificate
• Difference between audit report and audit certificate
• Meaning of auditor’s liability
• Liability to third parties
• Professional ethics of auditors

Audit Report: Meaning and Importance

An audit report is a written statement by the auditor, addressed to the persons who appointed him (members of the company), expressing his opinion on whether the financial statements give a true and fair view and comply with the applicable financial reporting framework. It is the final product of the audit.

Importance: gives assurance to shareholders, investors, banks and government; basis for decisions; shows compliance with law; fixes the auditor's responsibility; part of the annual report.

Objectives of the Audit Report

1. Express an independent opinion on the financial statements.
2. Inform members about the true and fair view of profit/loss and state of affairs.
3. Report compliance with the Companies Act, accounting standards and CARO.
4. Draw attention to material misstatements, limitations or uncertainties.
5. Report on internal financial controls and frauds (where required).

Contents of the Audit Report (SA 700 and Section 143)

1. Title — "Independent Auditor's Report".
2. Addressee — "To the Members of ABC Ltd".
3. Opinion paragraph — identifies the financial statements and states the opinion.
4. Basis for opinion — audit done as per SAs; independence; sufficient evidence.
5. Key audit matters (for listed companies, SA 701).
6. Other information (director's report etc.).
7. Responsibilities of management for the financial statements.
8. Auditor's responsibilities for the audit.
9. Report on other legal and regulatory requirements — CARO 2020 annexure, matters under Section 143(3) (information received, proper books kept, compliance with AS, director disqualification, internal financial controls).
10. Signature, name, ICAI membership number, firm registration number, UDIN, place and date.

Types of Audit Report

Emphasis of Matter paragraph (SA 706) draws attention to an important matter already disclosed (e.g. a major fire, uncertainty of a lawsuit) without modifying the opinion.

Audit Certificate and Difference from Audit Report

An audit certificate is a written confirmation of the accuracy of specific facts, figures or statements after verification — e.g. a certificate of turnover for a tender, utilisation of a grant, or stock figures for a bank.

Auditor's Liability: Meaning

Auditor's liability means the legal responsibility of the auditor for loss caused by his negligence or misfeasance (breach of duty) or wrongful act in performing his duties.

• Civil liability for negligence: to pay damages to the client for loss due to lack of reasonable care and skill.
• Misfeasance: breach of trust causing loss; the court may order him to compensate the company.
• Criminal liability: under the Companies Act (e.g. Section 147 — fine, and imprisonment where he acted knowingly or wilfully to deceive), and under the Bharatiya Nyaya Sanhita 2023 for false evidence or fraud — check latest amounts.
• Professional (disciplinary) liability: under the Chartered Accountants Act 1949, ICAI can reprimand, remove the name from the register, or fine for professional misconduct.
• Under Section 143(12), failure to report fraud is punishable.

Liability to Third Parties

Third parties (banks, investors, creditors) have no contract with the auditor. Earlier, the auditor was not liable to them. After Hedley Byrne & Co. v. Heller & Partners (1963), a professional can be liable for negligent misstatement if he knew the third party would rely on his report. In Caparo Industries v. Dickman (1990), it was held that the auditor's duty is owed to shareholders as a body, not to individual investors, unless a special relationship exists. The auditor is liable to third parties for fraud and for statements in a prospectus (Companies Act 2013). Under Section 245, depositors/members can file a class action against auditors.

Professional Ethics of Auditors

ICAI's Code of Ethics and the Chartered Accountants Act 1949 require:

1. Integrity — honest and straightforward.
2. Objectivity and independence — no bias or conflict of interest; no audit where he has financial interest.
3. Professional competence and due care.
4. Confidentiality — not disclosing client information without permission or legal duty.
5. Professional behaviour — no advertising or soliciting clients (except as permitted), no sharing of fees with non-members, no accepting audit without communicating with the previous auditor.
6. Non-audit services restrictions — Section 144 bars an auditor from giving services like accounting, internal audit, investment advisory and actuarial services to the audit client company.

Likely exam questions

1. (Long, 8/16 marks) What is an audit report? Explain its contents and types.
2. (Long, 8/16 marks) Explain the civil and criminal liability of an auditor, including liability to third parties.
3. (Short, 4 marks) Distinguish between audit report and audit certificate.
4. (Short, 4 marks) What is a qualified audit report?
5. (Short, 4 marks) State any four professional ethics of auditors.