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Sunday, May 11, 2014

Auditing: Features and Objectives

Introduction
The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially auditor was a person appointed by the owners to check account whenever the suspected fraud, he was to hear explanation given by the person responsible for financial transactions. Emergence of joint stock companies changed the approach of auditing as ownership was pestered from management. The emphasis now is clearly on the verification of accounting date with a view on the reliability of accounting statement.

In the words of Spicier and Pegler ,“An audit is such an examination of the books, accounts and vouchers of a business as it enable the auditor to satisfy that the Balance Sheets is properly drawn up, so as to give a true and fair view of the state of the affairs of the business and whether the profit and loss accounts gives a true and fair view of the profit or loss for the financial period according to the best of his information and explanations given to him and as shown by the books, and if not, in what respects he is not satisfied”. 

In the words of Montgomery,”Auditing is a systematic examination of the books and records of a business or other organization, in order to ascertain or verify and report upon the facts regarding its financial operation and the result thereof”. 

In the words A.W. Hanson,”An audit is an examination of such records to establish their reliability and the reliability of statement drawn from them”. 

From the above definitions it is clear that Auditing is an examination of the books of accounts and vouchers of a business to enable the auditor to satisfy him/her self that the Balance sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and whether the profit and loss a/c gives a true and fair view of the profit and loss for the financial period according to the best of information and explanation given to him/her and as shown by the books of accounts.

Features of Auditing
a.       Audit is a systematic and scientific examination of the books of accounts of a business;

b.      Audit is undertaken by an independent person or body of persons who are duly qualified for the job.

c.        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.

d.      Audit is a critical review of the system of accounting and internal control.

e.      Audit is done with the help of vouchers, documents, information and explanations received from the authorities.

f.        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.

g.       The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions and examine correspondence, minute books of share holders, directors, Memorandum of Association and Articles of association etc., in order to establish correctness of the books of accounts.

Objectives of Auditing.
Auditors are basically concerned with verifying whether the account exhibit true and fair view of the business. The objectives of auditing depend upon the purpose of his appointment. There are two main objectives of auditing.
1.       Primary objective and
2.       Secondary or incidental objective.

Primary Objective.
The primary objective of an auditor is to respect to the owners of his business expressing his opinion whether account exhibits true and fair view of the state of affairs of the business. It should be remembered that in case of a company, he reports to the shareholders who are the owners of the company and not tot the director. The auditor is also concerned with verifying how far the accounting system is successful in correctly recording transactions. He had to see whether accounts are prepared in accordance with recognized accounting policies and practices and as per statutory requirements.

Secondary Objective:
The following objectives are incidental to the main objective of auditing:
A) Detection and prevention of errors: errors are mistakes committed unintentionally because of ignorance, carelessness. Errors are of many types:
a.       Errors of Omission: These are the errors which arise on account of transaction into being recorded in the books of accounts either wholly partially. If a transaction has been totally omitted it will not affect trial balance and hence it is more difficult to detect. On the other hand if a transaction is partially recorded, the trial balance will not agree and hence it can be easily detected.

b.      Errors of Commission: When incorrect entries are made in the books of accounts either wholly, partially such errors are known as errors of commission. E.g.: wrong entries, wrong Calculations, postings, carry forwards etc such errors can be located while verifying.
c.       Compensating Errors: when two/more mistakes are committed which counter balances each other. Such an error is known as Compensating Error. E.g.: if the amount is wrongly debited by Rs 100 less and Wrongly Credited by Rs 100 such a mistake is known as compensating error.

d.      Error of Principle: These are the errors committed by not properly following the accounting principles. These arise mainly due to the lack of knowledge of accounting. E.g.: Revenue expenditure may be treated as Capital Expenditure.

e.      Clerical Errors; A clerical error is one which arises on account of ignorance, carelessness, negligence etc.

f.        Location of Errors: It is not the duty of the auditor to identify the errors but in the process of verifying accounts, he may discover the errors in the accounts. The auditor should follow the following procedure in this regard:
                                 i.      Check the trial balance.
                               ii.      Compare list of debtors and creditors with the trial balance.
                              iii.      Compare the names of account appearing in the ledger with the names of accounting in the trial balance.
                             iv.      Check the totals and balances of all accounts and see that they have been properly shown in the trial balance.
                               v.      Check the posting of entries from various books into ledger.

B) Deduction and Prevention of Fraud: A fraud is an Error committed intentionally to deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.

a.       Misappropriation of Cash: This is one of the majored frauds in any organisation it normally occurs in the cash department. This kind of fraud is either by showing more payments/ less receipt. The cashier may show more expenses than what is actually incurred and misuse the extra cash. E.g.: showing wages to dummy workers. Cash can also be misappropriated by showing less receipts E.g.: not recording cash sales. Not allowing discounts to customers. The cashier may also misappropriate the cash when it is received. Cash received from 1st customer is misused when the 2nd customer pays it is transferred to the 1st customer’s account. When the 3rd customer pays it goes forever. Such a fraud is known as “Teaming and Lading”. To prevent such frauds the auditor must check in detail all books and documents, vouchers, invoices etc.

b.      Misappropriation of Goods: Here records may be made for the goods not purchase not issued to production department, goods may be used for personal purpose. Such a fraud can be deducted by checking stock records and physical verification of goods.

c.       Manipulation of Accounts: this is finalizing accounts with the intention of misleading others. This is also known as “WINDOWS DRESSING”. It is very difficult to locate because it is usually committed by higher level management such as directors. The objective of WD may be to evade tax, to borrow money from bank, to increase the share price etc.


To conclude it can be said that, it is not the main objective of the auditor to discover frauds and irregularities. He is not an insurance against frauds and errors. But if he finds anything of a suspicious nature, he should probe it to the full.