Auditing Basics

Introduction to Auditing

Auditing is derived from the Latin word 'Audire', which means 'to hear'. In ancient times, auditors used to hear the accounts read out by the accountants.

Definition: "Auditing is the systematic examination of books, accounts, documents, and vouchers of a business ... to ascertain whether the Balance Sheet and Profit & Loss Account are properly drawn up ... and exhibit a true and fair view of the state of affairs of the business." - Spicer and Pegler

Key Objective: To express an opinion on whether financial statements show a "True and Fair View".

Objectives of Auditing

1. Primary Objective

To examine the accuracy of Books of Accounts and express an opinion on Financial Statements.

2. Secondary Objective

Detection of Errors: Clerical errors, Errors of Principle, etc.
Detection of Frauds: Intentional manipulation of accounts (Misappropriation of cash/goods, Falsification of accounts).
Prevention of Errors and Frauds: Through internal checks and controls.

Types of Errors

Error of Omission: Transaction completely or partially omitted.
Error of Commission: Wrong amount, wrong casting/posting.
Error of Principle: Violation of accounting principles (e.g., Capital exp treated as Revenue exp).
Compensating Errors: One error counterbalances another.
Duplication Errors: Same transaction recorded twice.

Classification of Audit

1. Statutory Audit

Compulsory by law. E.g., Company Audit under Companies Act, 2013.

2. Government Audit

Audit of government offices/departments by the CAG (Comptroller and Auditor General of India).

3. Internal Audit

Conducted by staff of the organization (or external firm) to review internal controls. It is a management tool.

4. Interim Audit

Conducted between two annual audits (usually for declaring interim dividend).

5. Continuous Audit

Detailed examination of books practiced throughout the year. Suitable for large organizations like Banks.

Audit Process & Techniques

Vouching

"Vouching is the backbone of auditing." It means examining the documentary evidence (Vouchers) to support the entries in books.

Verification

Proving the truth seeking confirmation. It involves verifying the existence, ownership, and valuation of assets and liabilities.

Vouching implies checking the transaction at inception. Verification implies checking the end result
(Asset/Liability).

Internal Check

Arrangement of duties where work of one person is automatically checked by another.

Rights and Duties of an Auditor

Under Companies Act, 2013:

Right of Access: To books of accounts and vouchers at all times.
Right to Info: To obtain information and explanation from officers.
Duty to Report: Whether financial statements show a true and fair view.
Duty to Inquire: Into specific matters like loans, advances, personal expenses charged to revenue, etc.

Audit Report

Clean Report (Unqualified): No material misstatements found.
Qualified Report: Material misstatements found, but not pervasive. "True and fair view... except for..."
Adverse Report: Misstatements are material AND pervasive. "Do NOT show true and fair view".
Disclaimer of Opinion: Unable to obtain sufficient evidence.

Important Sections (Companies Act 2013)

Section	Provision
Sec 139	Appointment of Auditors.
Sec 140	Removal/Resignation of Auditors.
Sec 141	Eligibility, Qualifications, and Disqualifications.
Sec 143	Powers and Duties of Auditors.

Numericals & PYQs - Auditing Basics

Part A: Practical Scenarios (10 Questions)

Q1. A company capitalized installation charges of ₹50,000 for a new machine. Is this correct?

Yes. Installation charges for a new asset are Capital Expenditure. If treated as Revenue exp, it would be an Error of Principle.

Q2. Auditor found that ₹10,000 cash sales were completely omitted from books. What type of error is this?

Error of Omission. It will NOT affect the Trial Balance agreement.

Q3. Purchase of ₹500 from Ram posted as ₹50 to his account. Impact?

Error of Commission. Trial Balance will not tally. Debit side will be higher by ₹450 (assuming Purchase A/c correct) or credit side lower.

Q4. Closing Stock is overvalued by ₹5,000. Impact on Profit?

Gross Profit will be overstated by ₹5,000. (Closing stock is on Credit side of Trading A/c).

Q5. An auditor noticed Personal Car Repair Expenses of ₹2,000 charged to Repairs Account.

This is a Fraud/Manipulation of Accounts (Personal expense charged to business). It should be treated as Drawings.

Q6. Goods sent on approval basis recorded as credit sales. Correctness?

Incorrect. Revenue should only be recognized when approval is received or time limit expires. Sales should be reversed.

Q7. Company changed depreciation method to show higher profits. Auditor's duty?

Auditor must check if the change is disclosed and justified. If done only to boost profit without justification, he should Qualify the Report.

Q8. Teeming and Lading fraud involves?

Misappropriation of cash receipts. Money received from Debtor A is pocketed, and later Money from Debtor B is credited to Debtor A.

Q9. Verification of Land and Building. What document to check?

Title Deeds. Check if they are in the name of the client.

Q10. Calculate Remuneration as % of Net Profit.

If Net Profit = ₹1,10,000 and Manager Commission is 10% on profit BEFORE charging such commission:
1,10,000 * 10/100 = ₹11,000.

Part B: Previous Year Questions (PYQs) (10 Questions)

Q11. Auditing begins where ________ ends. (JKSSB FAA)

Accountancy.

Q12. The main object of auditing is:

Detection and Prevention of Errors and Frauds. (Verification of accounts is primary).

Q13. Internal Check is a part of:

Internal Control.

Q14. Audit of companies is compulsory under:

Companies Act, 2013.

Q15. Who appoints the first auditor of a company?

Board of Directors (within 30 days of registration).

Q16. Vouching is related to:

Cash and Credit transactions. (Documentary evidence).

Q17. The backbone of auditing is:

Vouching.

Q18. Auditor of a Government Company is appointed by:

C&AG (Comptroller and Auditor General).

Q19. Section 143 of Companies Act deals with:

Powers and Duties of Auditor.

Q20. "Auditor is a watchdog, not a bloodhound." This decision was given in:

Kingston Cotton Mill Case (1896).

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