PG & RESEARCH DEPARTMENT OF COMMERCE

ST.JOSEPH’S COLLEGE OF ARTS & SCIENCE (AUTONOMOUS)

PRACTICAL AUDITING (CM618)

STUDY MATERIAL FOR

III - B.Com
SYLLABUS
UNIT – I

Auditing – Meaning – Definition – Objectives – Scope – Advantages And Limitations – Difference between
auditing and Accounting – Difference Between Auditing and Investigation – Materiality in Auditing – Audit
evidence – Audit Techniques – Classification as to Methods of Approach to work – Types and Conduct of
Audit.
UNIT -II

Audit Planning – Audit Engagement Letter – Factors considered before commencing a new audit -, Audit
Programme – Audit Files – Audit Note Book – Working Papers – Vouching of Cash and trading
Transactions – Internal Check – Internal Control – Internal Audit.
UNIT – III

Verification and Valuation of Assets and Liabilities – Meaning – Objectives of Verification and Valuation –
Difference Between Verification and valuation - Classification of Assets – Importance of Valuation –
Verification and Valuation of Liabilities.
UNIT – IV

Audit of Limited Companies – Necessity of Company Audit – Qualification and Disqualification of

Auditors – Appointment of Auditors – Ceiling of umber of Auditors – Remuneration of Auditors – Removal
of Auditors – Special Audit u/s 233A – Power of Central Government - Powers and Duties of Company
Auditor – Powers and Duties of Special Auditor – Contents of Special Audit Report.
UNIT - V

Investigation – Scope – Objectives – Procedure followed in Investigation – Investigation under Companies

Act – Powers of Inspectors – Electronic Data Programming System – Characteristics – Comparision of
Manual and EDP System - Features of Computer Assisted Auditing Techniques [CAAT] – uses of
Computer Assisted Auditing Techniques [CAAT].

Textbooks:

1. B. Tandon – Practical Auditing.

2. S.N. Mageshwari – Practical Auditing.
3. Dr. N. Premavathy – Practical Auditing.
 Unit – I
Introduction
MEANING AND DEFINITION:
Auditing means the scrutiny of accounts books and the relative documentary evidence by an
independent qualified person in order to ascertain the accuracy of the figures appearing therein.
Montgomery, a leading American Accountant and Author, had defined auditing as “a systematic
examination of the books and records of a business or other organizations in order to ascertain or verify and
to report upon the facts regarding the financial operations and the results thereof.”

PRINCIPLES GOVERNING AN AUDIT:

The council of the institute of Chartered Accountants of India has issued a statement of Standard Accounting
Practices (SAP1) on the basic principles which govern an audit. The statement lays down the following
basic principles.
1. Integrity, Objective and Independence: The auditor should be straightforward, honest and sincere in
his approach to his professional work. He must be fair and must not allow prejudice or bias to override
his objective.
2. Confidentiality: The auditor should respect the confidentiality of information acquired in the course
of his work and should not disclose any such information to a third party without specific authority.
3. Skills and competence: The audit should be performed and the report prepared with due professional
care by persons who have adequate skills, training, experience and competence in auditing.
4. Work performed by others: When the auditor delegates work o assistants or uses work performed by
other auditors and experts, he will continue to be responsible for forming and expressing his opinion
on the financial information.
5. Documentation: The auditor should document matters which are important in providing evidence that
the audit was carried out in accordance with the basic principles.
6. Planning: The auditor should plan his work to enable him to conduct an effective audit in an efficient
and timely manner. Plan should be based on the knowledge of the client’s business.
7. Audit evidence: The auditor should obtain sufficient appropriate audit evidence through the
performance of compliance and substantive procedures to enable him to draw reasonable conclusions
there from on which to base his opinion on the financial information.
8. Accounting system and internal control: The auditor should gain an understanding of the accounting
system and related internal controls and should study and evaluate the operation of those internal
controls upon which he wishes to rely in determining the nature, timing and extent of other audit
procedures.
9. Audit conclusions and reporting: The auditor should review and assess the conclusions drawn from
the audit evidence obtained and from his knowledge of the business of the entity as the basis for the
expression of his opinion on the financial information.
PERSONAL QUALITIES: The various qualities of him are as follows:
PROFESSIONAL EXPERTISE:
1. Knowledge of accounting system: He should know various systems of accounting and its functions.
He should also keep himself abreast of the changes and developments in the field of accounting.
2. Knowledge of principles of accounting: He should be familiar with the accounting principles
followed in a business. He is also required to be fully conversant with the Accounting Standards (AS)
issued by the institute of Chartered Accountants of India.
3. Knowledge of cost accounting: He should be fairly acquainted with the concepts of cost accounting
and its importance in decision making.
4. Knowledge of business systems & techniques: He should be adequately familiar with the system and
techniques of accounting in the business under audit.
5. Knowledge of business laws: He is required to possess and extensive knowledge of the laws governing
different types of business. He should understand the relationship between central state laws and
between the statutory and the common law.
6. Knowledge of production system: He should possess adequate knowledge about the nature of
production relating to the business under audit.
7. Knowledge of economics: He should be familiar with the economic factors which affect a business
unit.
8. Knowledge of mathematics and statistics: He should have a fair knowledge of mathematical and
statistical methods of solving business problems by quantification techniques.
9. Knowledge of general management: He should have proper understanding of the general principles
and functions of management.
10. Knowledge of financial management: He should know the concepts and methods used in financial
analysis to evaluate the capital needs of the business.
11. Knowledge of marketing management: He should have proper knowledge of methods of pricing,
various channels of distribution, and how accounting can be used to solve a marketing problem.
GENERAL:
1. He should be honest and steadfast in his ethical behavior.
2. He must be tactful to put intelligent questions to extract full information.
3. He must be vigilant, cautious, methodicial and accurate.
4. He must constantly make judgements as regards evidence, audit programme and procedure.
5. He must display a great sense of responsibilities to gain public confidence.
6. He must work diligently and methodically to accomplish his task to set an example to his
subordinates.
7. He must be able to communicate effectively both orally and in writing.
8. He must not be influenced directly or indirectly by others in the discharge of duties.
9. He should not disclose the secrets of his clients.
10. He must not adopt an attitude of suspicion.
11. He must be prepared to hear arguments and must be reasonable.
12. Above all he must have common sense.

OBJECTIVES OF AUDITING:
The main objective of the audit is to find out whether the accounts of a particular concern show a
true and fair view of the earning and financial state of affairs.
According to R. Robert Coomber, “The main purpose of audit today is the verification of financial
statements, usually a Balance Sheet and Profit and Loss Account in the light of certain accounting principles
to establish whether or not it is a true statement and correctly drawn up.”

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 I. MAIN OBJECTIVES:
The main or principal objectives of auditing may be stated as follows:
1. Examination of the books of accounts and records with a view to test the arithmetical accuracy and
correctness in recording of transactions and their reliability.
2. Verify that the Balance Sheet and Profit and Loss Account are drawn in conformity with the books
of accounts and records.
3. Ascertain that proper accounting principles and procedures and management policies are followed.
4. Ensure that books of accounts and records as required by law are kept.
5. Report on Balance Sheet as to whether it reflects the true and fair state of affairs of the business and
that the Profit and Loss account shows the correct profit and loss of business.
6. Inspect all the documents, records and books of accounts of the business and express opinion on
matters required by the statutes.
Thus the main object of auditing is to form an independent judgment and opinion about the reliability
of accounting records and true and fair view of financial state of affairs and working results.
II. SUBSIDIARY OBJECTIVES:
The subsidiary objects of audit are:
A. Detection and Prevention of Errors; and
B. Detection and Prevention of Frauds.
In the case of proprietary or a partnership concern, however, detection of errors and frauds may be
the principal object of audit.
A. DETECTION AND PREVENTION OF ERRORS:
Errors are generally innocent but sometimes the errors which might appear, at first sight, as
innocent are ultimately found to be due to fraudulent manipulation and therefore an auditor must pay
particular attention to every error, however, innocent it may appear to be at first sight. The following are the
various types of error:
1. Clerical Errors: These errors are committed in posting, totaling and balancing. Such errors may again be
subdivided into: Errors of Omission and Errors of Commission.
a) Errors of Omission: As the name itself indicates, the error of omission is one where a transaction has
not been recorded in the books of account either wholly or partially. In the former case it will not be east\y
to detect the error and it will not affect the trial balance. But sometimes it is apparent from the balance of
an account that an entry has been omitted, e.g., the rent account may show that the debt has been paid for
11 months only and that the rent for the 12th month has not been paid. This type of error can be detected by
careful observation. But if one aspect of the purchases or sales has been entered in the books, it will affect
the trial balance and the omission will be easily detected.
b) Errors of Commission: When the 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., a
purchase invoice for Rs. 4215 was entered in the purchase book as Rs.4512. such an error may be
intentional or unintentional. The underlying idea may be to misappropriate cash in league with the seller of
the goods. Therefore vouching should be done very carefully in order to detect such an error or fraud.
Other errors of commission are wrong castings, calculations, postings, extensions, carry forwards, etc.
Some of such errors will be detected by the non-agreement of trial balance.
2. Errors of Principle: Such entries arise when the entries are not recorded according to the fundamental
principles of accountancy, e.g., wrong allocation of expenditure between capital and revenue, ignoring
the outstanding assets and liabilities, valuation of assets against the principles of book keeping.
Such errors may be committed either intentionally or unintentionally. If they are committed
intentionally, the object is to falsify and manipulate the accounts either to show more profit or less
profits that they actually are. Such errors ultimately affect the profit and loss account the Balance Sheet.
Therefore, it is very important for an auditor to pay particular attention towards this type of error. Such
an error is not disclosed by the trial balance or by routine checking. It can detected only by searching
enquiry and independent checking.
3. Compensating Errors or Setting off Errors: A compensating error or setting off error is one in which
is counter balanced by any other error or errors, e.g., if A’s account was to be debited for Rs.100 but was
debited for Rs.10 while B’s account which was to be debited for Rs.10 was debited for Rs.100. thus both
the accounts have been debited for a total sum of Rs.110 which amount ought to have been debited or a
sale of Rs.10 to A is posted to the debit of B as Rs.5, and the purchase book is over cast by Rs.5. again
 an overcasting of an account may be counter balanced by the under casting of another account to the
same extent. These errors are most dangerous and are difficult to guard against. This type of error will
not be detected by the trial balance. Such an error will not affect the trial balance and will not be
detected easily. This error may or may not effect the profit and loss account.
4. Errors of Duplication: Such error arises when an entry in a book of original entry has been made twice
and also has been posted twice, e.g., rent paid Rs.100 has been entered twice in cash book and posted in
rent a/c twice.
Location of Errors: The question is how to locate an error if the trial balance does not agree and the auditor
is called upon to locate the error although it is not his duty to do so. If the following steps are taken 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 accounts might not have been transferred to the
trial balance especially in the case of the balance of cash book, purchases and sales book, bill books,
etc.
3. Total the lists of debtors and creditors and compare them with the trial balance.
4. If the books are maintained on the self-balancing system; see that the total of different accounts agrees
with the total of these accounts with the balance of the accounts as recorded in the trial balance.
5. Compare the items of trial balance with the items of the trial balance of the previous year to see if any
item has been omitted.
6. Whatever the difference is in the trial balance, half it and see if there is any item of this value. This is
done to avoid the putting of the debit balance on the credit side of the trial balance or vice versa.
7. It is possible that the totals of some subsidiary books, e.g., cash book, purchase book, sales book, etc.,
might not have been transferred to the trial balance. Re-check the totals of these books.
If in spite of the above steps the error cannot be located the error may be due to the following causes:
1. An error say of Rs.1 or 10 or 100, etc., i.e., a round sum may be due to wrong totaling. If the
difference is in rupees and paise, it may be due to wrong posting or extracting of wrong balance.
2. An error which is divisible by 9 may be due to misplacement or transposition of figures, e.g., 32 for
23, 52 for 25. Or 54 for 45 and so on.
It may be remembered that in spite of the fact that the trial balance has agreed, it does not mean that
there are no errors.

B. DETECTION AND PREVENTION OF FRAUD:

Having dealt with the detection and prevention of errors, let us now proceed to discuss the detection
and prevention of fraud.
FRAUD means false representation or entry made intentionally or without belief in its truth with a
view to defraud somebody. Detection of fraud is considered to be one of the important duties of an auditor.
As a manner of fact, originally audit was conducted mainly with a view to detect fraud whenever it was
suspected. The system of internal check aims at the prevention of fraud. If the auditor finds that the internal
check system is defective and will not prevent the commission of frauds, he should suggest a better system.
The following are the chief ways in which fraud may be perpetrated:
1. Embezzlement of Cash
2. Misappropriation of Goods
3. Fraudulent Manipulation of account
1. Embezzlement of cash:
There is a greater possibility of deflation of money in a big business house than in case of a small
proprietary business where the proprietor has a direct control over the receipts and payments of cash. In a
big business house, the system of receipt and payment of cash should be such that the work of one clerk is
automatically checked by another clerk. Such system is known as “Internal Check” system. It is easier to
misappropriate cash and, therefore, the auditor will do well to pay particular attention towards cash
transaction.
Cash may be misappropriated by
a) Omitting to enter any cash which has been actually received; or
b) Entering less amount than what has been actually received; or
c) Making fictitious entries on the payment side of the cash book; or
 d) Entering more amounts on the payment side of the cash book than what has been actually paid.
In order to discover fraud under (a) and (b) above, the auditor should check the debit side of the
cash book with rough cash book, salesmen’s report, counterfoils of the receipt books, agents’ returns and
other original records while the fraud under (c) and (d) can be discovered by reference to the vouchers, wage
sheet, salary book, invoices, etc.
2. Misappropriation of goods:
Again, fraud may be in respect of goods, i.e., misappropriation of goods. This type of fraud is very
difficult to detect especially when the goods are less bulky and are of higher value. Proper methods of
keeping accounts in regard to purchases and sales, stock taking, periodical checking of stocks, comparing
the percentage of gross profit to sales of two periods, necessity for collusion will help to avoid
misappropriation of goods.
3. Fraudulent manipulation of accounts:
This type of fraud is more difficult to discover as it is usually committed by directors or managers
or other responsible officials with the objects of
a) Showing more profits than what actually they are:
i So that if they get commission on profits, they may get more commission; or
ii Their service may be retained by showing to shareholders that because of their efficiency they have
shown more profits and thus maintain the confidence of the shareholders; or
iii If they hold shares, they may sell them at high price by declaring higher dividends; or
iv To obtain further credit by showing the financial position of the business better than what actually it
is; or
v To attract more subscribers for the sale of the shares of the company, etc.; or
b) Showing less profit than what actually they are
i In order to purchase shares in the market at lower price; or
ii To reduce or avoid the payment of income tax; or
iii To give a wrong 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; or
b) By under valuation or over valuation of assets and liabilities; or
c) By showing fictitious sales or purchases or returns in order to show more profits or less profits
whatever the case may be; or
d) By utilization of secret reserves during a period when the concern has made less or no profit, without
disclosing that fact to the shareholders; or
e) By sharing revenue expenditure to capital account, or vice versa;
f) By crediting the revenue account with the income which will be received next year or not crediting the
profit and loss account with the income which has accrued but which has not been received.
Such frauds are difficult to detect as they are committed by the people at the helm of the affairs who
are presumed to be trustworthy, honest and responsible and, therefore, no suspicion falls on them. They are
very cleverly made and, as such, the auditor should be very careful in detecting such frauds. He should carry
on the routine checking and vouching most carefully and make searching, tactful and intelligent enquiries.

III. SPECIFIC OBJECTIVES:

 Audit includes such other areas like Review of operation, Performance management policy, Cost
records and so on.
 Accordingly, there will be specific objectives in respect of each type of such specific audits.
For example,
Operational audit: to evaluate the existing operation of the existing in order to give expert advice to
improve their efficiency.
Cost audit: to check the cost records of the entity in order to make proper ascertainment of cost of
production of goods and services. Management audit, HR audit, etc.

SCOPE OF AUDITING:
The increased complexity of modern trade and trade has greatly widened the scope of the auditors
operations and calls for a high degree of skill and experience. In this connection, the following major
auditing developments of the 20th century are worth nothing:
 1. The change of objectives from the detection of frauds to determination of fairness of financial
statements.
2. The responsibility of auditor for the income statement as well as Balance Sheet.
3. Increased responsibility of the auditor to ‘third parties’ such as Government Agencies, Stock Exchange,
and investing public numbering lakhs of people.
4. The change of auditing methods from detailed examination of individual transactions to use of
sampling techniques.
5. Recognition of the need to evaluate the system of internal control as a guide to the direction and amount
of testing and sampling to be performed.
6. The development of new auditing procedure applicable to electronic data processing system and use
of computers as an audit tool.
Thus, it would be observed that the scope of the audit has undergone a radical change. The extent to
which the auditor should carry out his examination would vary from firm to firm and industry to industry
and will, to a very large extent, depend upon the individual facts and circumstances of each case.

ADVANTAGES OF AUDITING:
The main advantages of audit are as follows:
1. For the enterprise:
i. Employees in charge of maintenance of books of account and other records are regular, careful and
systematic in their work.
ii. Errors and frauds, if any, committed by employees of the business are promptly detected. In any case,
knowledge of an impending audit exercises moral checks on the employees who might otherwise be
tempted to commit defalcation and embezzlement.
iii. Loans and credit can easily be obtained on the basis of audited accounts which are widely regarded as
a reliable index to the state of affairs of the enterprise.
iv. Liability of the enterprise as to income tax, wealth tax, sales tax, etc., can easily be determined on the
basis of audited accounts as these are readily believed by the tax authorities. The income tax act also
contains a provision for holding tax audit.
v. In case of a running business is proposed to be sold, purchase consideration can easily be determined
on the basis of audited accounts.
vi. Audited statements or accounts provide a mutually satisfactory basis for the resolution of disputes as to
higher wages and bonus payments to workers.
vii. In case of loss or damage to business property, audited accounts facilitate the determination of claims
against the insurer.
viii. Weaknesses of the existing system of internal check and internal control may be detected such that
remedial steps can soon be initiated.
ix. Audit is an easy means to ascertain whether the undertaking is in fact maintaining the register and
books of account as required under the law.
x. The enterprise can benefit from the professional competence and experience of the auditor who is
always at hand to appraise the efficiency of various control measures, and to suggest improvements
therein.
2. For the owners of the enterprise:
i. In a sole proprietary business, in case of which audit is not compulsory, audited statements of accounts
provide a proof that all business transaction have been duly accounted for, and there is no error or fraud.
ii. In a partnership firm, audited accounts serve as an evidence of proper management of the affairs of
business by the Active partners and employees of the firm. Such accounts are also of great help in
settlement of accounts in case of admission, retirement or death of a partner.
iii. In a joint stock company, shareholders rely on the audited statements of accounts to satisfy themselves
that the affairs of the company are being smoothly run and their investment is safe.
iv. In case of trust, co-operative societies, etc., auditing serves as an evidence for the
beneficiaries/members, etc., that their interest are being properly and efficiently looked after.
3. For others:
Audited statements of accounts are also relied upon by outsiders for various purposes. In case of
banks, for example, audited statements of a business serve as a reliable guide to make decision as to loan to
the business. Insurers also rely on audited statements to settle claims in respect of damage to, or loss of
business assets. For determination of liability under income tax, sales tax, wealth tax, etc., tax authorities
unquestioningly accept the audited statements.

LIMITATIONS OF AUDITING:
Auditing also suffers from the following limitations:
1. Conceptual restrictions: Auditing has traditionally been regarded as a practical subject dealing
mainly with procedures and techniques of checking, ticking, totaling, vouching, etc., As a result, several
vital aspects such as finances, managerial efficiency and effectiveness, business ethics, etc., are wholly
ignored as being outside its scope. In the circumstance, it can hardly be expected to do justice to its objects.
2. Postmortem on prepared accounts: Auditing begins where accountancy ends. The auditor may be
nowhere around when the accounts are being finalized. Therefore, it may not be possible for him to discover
clever manipulations in the books and accounts at the preparatory stages. Thus, many questionable facts may
remain undiscovered even after the accounts have been audited.
3. Dependence on inside information: Books of account of business, however complete they may be in
every respect, do not tell the complete story as to transactions recorded there in. as such, an auditor has of
necessity to seek additional information, clarifications and explanations from various personnel of the
enterprise. Authenticity of such information, etc., is always open to question, particularly so if the personnel
providing it have themselves been a party to the manipulation to the books of accounts. As a result, even the
audited statements or accounts may not reveal the correct or complete picture.
4. Inadequate or faulty external evidence: Though an auditor will be well within his right to tap
external sources for evidence for support the propositions made in the accounting statements, such evidence
may not always be wholly reliable. A debtor of the business might, for example, providing wrong
information about the debt owed by him. The company lawyer may twist facts to say that there are no claims
against the company. The valuer might go wrong in valuing a asset. In the circumstance, even audited
accounts may lack authenticity.
5. Application of faulty techniques: Collection of adequate evidence in support of any proposition
made in the books of account depends on the types of audit techniques employed for the purpose. Where an
audit technique is not consistent with the nature or type of the business enterprise, or with the method of
record keeping followed by it, it will not provide the right kind of evidence, and even audited accounts may
not tell the entire story. Such a possibility is more likely in the case of an auditor who is simultaneously
engaged in audits of number of organizations, large and small, complex and simple, with different methods
of record keeping.
6. Formation of faulty judgements: The auditor’s judgement as to correctness and fairness of the
propositions in the books of account is based on an objective evaluation and critical review of the evidence
collected by him through appropriate audit techniques. However, at times personal opinion of the auditor
might cloud his sense of judgement so that his report might contain an assessment which is unsupported by
relevant material evidence. In the event, the audited statements will not mirror the correct position of the
business.

DIFFERENCE BETWEEN ACCOUNTANCT AND AUDITING:

SL.No. Accountancy Auditing

1. Accountancy refers to the preparation of Auditing refers to examination checking of
final accounts and its interpretations. these accounting records.
2. Accountancy is primarily constructive and Auditing is analytical in nature.
concerned with current recording of
business facts.
3. The main objective of accountancy is to The objective of auditing is to certify the
ascertain the trading result of a business correctness and justification of the financial
concern during a financial year. statements prepared by the accountant.
4. An accountant need not be chartered An auditor must be a chartered accountant.
accountant.
5. When book-keeping records are completed, The work of auditing starts, only when the
they become available for the beginning of work of accountancy has been completed.
works of accountancy. In other words, In other words, where accountancy ends
 accountancy starts where book-keeping auditing starts.
ends.
6. An accountant need not be expert in the An auditor must have through knowledge
work of auditing. of the principles of accountancy otherwise
he cannot perform his job satisfactorily.
7. Accounting work is undertaken throughout Auditing is generally done at the end of the
the year. financial year.
8. An accountant is a permanent employee of An auditor is not a permanent employee of
the business concern. the concern. He may be changed from year
to year.
9. An accountant is not required to submit a An auditor is required to submit a report to
report to the proprietor of the concern when the proprietor after the completion of the
the accounting works is over. audit works.

DIFFERENCE BETWEEN INVESTIGATION AND AUDITING:

Investigation implies an enquiry into the accounts and records of the business concern. In other
words, investigation is an examination of accounts and records of a business concern with some special
purpose in view. In most of these, the purpose of such inquiry is to ascertain the true financial position of the
business concern or its normal profit earning capacity or the extent of frauds, if any, or to inquire about the
suspected mismanagement, etc. Thus, it is a sort of special audit with a particular object in view. The points
of distinction between an investigation and audit are as follows:
SL.No. Investigation Auditing
1. Investigation is done for some specific The object of audit of account is to ascertain
purpose according to the necessity of the whether the balance sheet of the concern shows
situation. the true and fair view of the state of affairs of the
concern or not.
2. The investigation of books of accounts Audit is compulsory in case of joint stock
records is not legally compulsory. companies.
3. Investigation is a thorough examination of In case of audit, it is usually carried out in the
books of accounts for a particular period. form of test checking.
4. Investigation may be carried out on behalf Audit is carried out on behalf of the proprietor of
of proprietor or on behalf of the third parties the business concern
also.
5. Investigation of the books of records may Audit of books of accounts is for six months or
cover three to seven years. for a full year.
6. Investigation is usually carried on when the It is not so with regard to audit except in case of
books of accounts are already subjected to special audit of joint stock company u/s 233A of
regular audit. the Companies Act, 1956.
7. In investigation, it may become necessary to This is not so required in case of audit.
make certain adjustments in the annual
accounts already prepared.
8. The investigation report is prepared The audit report is prepared according to the act.
according to the necessity of the situation.
9. It is not necessary that an investigator must Auditing can be conducted by a practicing
be a chartered accountant. chartered accountant.
10. The results of investigation are beneficial The reports of auditing are widely used.
only to the client.

MATERIALITY IN AUDITING:
The concept of materiality is fundamental to the purpose of recognition, aggregation, classification
and presentation of financial information. It is also an important consideration for an auditor who has
constantly to judge whether a particular item or transaction is material or not.
Various legal provisions and professional pronouncements contain references to the concept of
materiality. Clauses 5, 6, 8 and 9 of Part I of the second schedule to the Chartered accountants Act, 1949,
refer to material fact, material exceptions and to material departure from the generally accepted procedure of
audit. Again, Part II of Schedule VI of the Companies act, 1956, requires that the profit and loss account
should disclose every material feature. Actually, the disclosure requirements of Schedule VI to the
Companies Act seek to ensure that the financial statement disclose all material information so as to give a
true and fair view of the state of affairs and working results of a company.
Accounting Standard I, Disclosure of Accounting Policies, issued by the Institute of Chartered
Accountants of India, defines material items as “items the knowledge of which might influence the decisions
of the user of the financial statements.”
Whether or not the knowledge of an item would influence the decisions of users of financial
statements would depend on the particular facts and circumstances of each case. It is not possible to lay
down precisely, either in terms of specific items or in terms of amounts, what could be considered as
material circumstances. The auditor has to use his judgement to determine whether a particular item is
material or not in a given situation. However, the following general consideration may be useful to an
auditor in forming this judgement.
Materiality can be judged only in a relative context. In a small business, Rs.1000 may be a material
amount, whereas in a gaint undertaking, even Rs.10000 may not be considered material.
In many cases, percentage comparison may be useful in determining the materiality of an item. For
example, Part II of Schedule VI of the companies act requires that any item of expenses exceeding 1% of the
total revenue of the company or Rs.5000 whichever is higher, shall be shown as a separate and a distinct
item under an appropriate accounts head in the profit and loss account and shall not be combined with any
other item to be shown under miscellaneous expenses. Similarly, if an item accounts for 10% or more of the
total value of raw materials consumed, it has to be shown separately and distinctly. Similarly, it is provided
in Schedule XIV of the Act that depreciation on assets whose actual cost does not exceed Rs.5000, shall be
provided at a rate of 100%; however; where the aggregate actual cost of individual items of plant and
machinery costing Rs.5000 or less constitutes mare than 10% of the total actual cost of plant and machinery,
rates of depreciation applicable to such items shall be those as specified in the Schedule. Thus, the law
recognizes that even items which are of small value individually should be considered as material if they are
so numerous to constitute more than 10% of the total actual cost. Percentages as indicators of materiality,
other than those specified by law, should be used with care and only as a rule of thumb because many other
factors also affect the materiality of an item, apart from its relative amount or quantity.
The relative significance of an item has to be viewed from many angles while judging its materiality.
Take, for example, an item in the profit and loss account. One indicator of its materiality will be its impact
on the overall figure of profit and loss. Thus, if the item affects the profit or loss figure significantly, it will
be a material item. Another indicator would be its impact on the total of the category of expenditure or
income to which it pertains. Thus, a particular amount received as dividend will be material if it
considerably effect the total amount of income from investments. Another angle to judge the materiality of
the item can be to compare it with the corresponding figure in the previous year.
In many circumstances, even small amount may be considered materials. Thus, if there is a statutory
requirement of disclosure of amounts paid as sitting fee to directors, the amount so paid should be disclosed
precisely and separately. Similarly, a payment of Rs.10000 to directors as remuneration in excess of the
statutory limits may be material. A small inaccuracy may be considered material if it converts a small lass
into profit or vice versa. Similarly, if it creates or eliminates a margin of solvency in the balance sheet it will
be a material item.
In offsetting and aggregating items, care should be taken to ensure that material items of different
nature are not set off against or aggregated with each other.

MATERIALITY AND THE AUDITOR:

The question of materiality arises at various stages during the course of audit. Thus, the auditor is
concerned with materiality when:
 Determining the nature, timing and extent of audit procedure;
 Evaluating the effects of misstatements on the measurement and classification of accounts; and
 Determining the appropriateness of presentation of financial information.
Many firms of auditors, particularly in USA, have developed approaches to auditing which requires
qualification of audit risk and the materiality level in the given situation. The quantification of the
materiality provides a threshold or a cutoff point to the auditor in planning and conducting the audit. The
materiality level is determined by the auditor on the basis of his perception of the audit risk inherent in the
situation.
AUDIT EVIDENCE:
According to SAP-5, “Audit Evidence” the inter related concepts of “sufficiency” and
“appropriateness” refers to quantum, relevance and reliability of audit evidence.
Audit Evidence, issued by the ICAI deals with the basic principles relating to audit evidence. The
main features of the statement are discussed below:
1. Sufficient appropriate audit evidence:
The auditor is required to obtain sufficient appropriate audit evidence to enable him to draw
reasonable conclusion therefrom on which base his opinion on the financial information. The term
“sufficient” refers to the quantum or adequacy of evidence. The term appropriate refers to relevance and
reliability of evidence. Thus, the auditor should obtain sufficient quantum of relevant and reliable evidence.
What constitutes sufficient appropriate audit evidence in a particular situation is a matter of the auditor’s
professional judgement.
2. Persuasive Evidence:
An auditor normally relies on evidence that is persuasive rather than conclusive in nature. In other
words, he looks for reasonable assurance, not absolute certainty.
3. Evidence on selective basis:
In formatting his opinion, the auditor may obtain audit evidence on a selective basis by way of either
judgemental of statistical sampling procedures. However, in doing so, he should keep in mind the basic
consideration that the evidence obtained should be sufficient (as well as appropriate).
4. Audit procedures:
The auditor obtains evidence through the performance of two kinds of procedures, viz. compliance
procedures and substantive procedures. Compliance procedures are tests designed to obtain reasonable
assurance that those internal controls on which audit reliance is to be places are in effect. In other words,
compliance procedures are audit tests which are designed to check the degree of compliance with prescribed
internal control. Thus, an auditor may choose to test whether an internal control. Whereby each cheques is
required to be signed by two managers is in operation or not. In performing compliance procedures, the
auditor checks the existence, effectiveness and continuity of control. The results of compliance procedure
determine, to a large degree, the nature, timing and extent of substantive procedure.
Substantive procedures are tests designed to obtain evidence as to the completeness, accuracy and
validity of the data produced by the accounting system. These are of two types-
(a) Tests of details of transactions and balances; and
(b) Analysis of significant ratios and trends including the resulting enquiry of unusual fluctuations and
items.
5. Reliability of audit evidence:
The auditor has to evaluate both the sufficiency as well as the relevance and reliability of audit
evidence. The reliability of audit evidence depends on its source and nature as well as on the circumstances
in which it is obtained. The following generalizations may be useful in evaluating the reliability of audit
evidence:
a) External evidence is usually more reliable than internal evidence. External evidences refers to the
evidences obtained from sources which are independent of the entity under audit. Thus, a confirmation
received from the customer is generally more reliable in a normal audit situation than the copy of the
invoice.
b) Internal evidence is more reliable when the related internal control is satisfactory. For example, an
auditor may place greater reliance on the counterfoils of receipts issued by an entity where there is a
well-designed system of controls as compared to a situation where such controls either do not exist or
are not effective.
c) Evidence in the form of documents and written representations is usually more reliable than oral
representations.
d) Evidence obtained by the auditor himself is more reliable than that obtained through the entity.
6. Consistency and reliability:
The auditor gains increased assurance when audit evidence obtained from different sources or of
different nature is consistent and vice versa. Thus, where the balance shown in the certificate obtained from
the bank cannot be reconciled with the ledger balance in the bank account, the auditor may have to perform
further audit procedures to resolve the inconsistency.

AUDIT TECHNIQUE:
The method by which an auditor obtains evidence is known as techniques of auditing. Both
compliance and substantive procedures are performed using those techniques. The selection of particular
audit technique in a given situation depends on the type of proposition under examination and the nature of
evidence available in their support of the proposition. Audit techniques, therefore, need to be continuously
reviewed and appropriately modified as the scope of auditing gets broadened; the methods of record-
keeping change and the complexities of enterprise grow.
The techniques of auditing as listed in SAP 5 are described below.
1. Inspection: This consists of examining records, documents or tangible assets.
a. Examination of records and documents: Examination of records and documents is one of the most
important techniques of auditing. An auditor has to examine a large number of documents in the
course of an audit since most transaction is supported only by documentary evidence. The
accounting systems of business enterprises are so designed that documentary evidence is created in
respect of each transaction. The importance of this technique can be judged from the fact that many
auditing texts, although erroneously, consider the examination of vouchers as synonymous with
auditing.
b. Documentary evidence: It is examined by the auditor with reference to its authenticity,
appropriateness, authorization and proper recording.
c. Physical examination of tangible assets: Inspection or physical examination of tangible assets is
possible only where the items to be examined are clearly identifiable and capable of measurement in
physical terms. Also, the auditor should be in a position to distinguish the quality of what he is
examining. Physical examination, thus, involves identification, determination of quantity (through
counting, measuring or weighing) and to a certain extent evaluation of the quality of the item.
2. Observation: Observation consists of witnessing a process or procedure being performed by others.
For example, the auditor may observe the physical stock taking being conducted by the staff of the
entity under audit.
3. Inquiry and confirmation: Inquiry consists of seeking appropriate information from knowledgeable
persons from inside and outside the entity. In most auditing situations, the auditor makes inquiry from
the personnel within the entity as well as from outside sources to obtain the information considered
necessary by him. Confirmation consists of the response to an inquiry to corroborate certain
information contained in the entity’s record. Thus, at the behest of the auditor, the entity under audit
may request its debtors to confirm their respective balances as shown in the entity’s books of prime
entry to the ledger.
4. Computation: this consists of checking the arithmetical accuracy of source documents and accounting
records or performing by retracting book-keeping procedures, i.e., an auditor himself follows the same
procedures as were followed by the accountant. For example, the auditor may trace the postings from
the books of prime entry to the ledger.
5. Analytical procedures: These consist of studying significant ratios and trends and investigating
unusual fluctuations and items. By correlating various sections of a statement, its harmony or
consistently as a whole can be examined. Thus, in an independent financial audit, the auditor can
analyze financial statements by correlating various figures with each other. The harmony or consistency
of the financial statements as a whole can be judged by calculating ratios which show the relationship
between one accounting figure and another.
In drawing up an audit programme, an auditor has to select such a combination of audit
techniques as would enable him to test the propositions under examination effectively and efficiently. An
auditor must, therefore, be able to assess the efficacy of each of the above techniques under the given
circumstances.

TYPES AND CONDUCT OF AUDIT:

Audit is a skilled job since an auditor has to detect the irregularities in the accounting records. An
audit is essentially a review function. The audit conducted by a professionally computer person independent
of the enterprise is concerned with reviewing whether the business events have been measured and
communicated through financial statements in accordance with the generally accepted principles of
accounting as per legal requirements as applicable.
Audit may be classified into two categories:
1. Based on Organisational structure of the business.
2. Based on Conduct of audit.
1. Based on organisational structure of business:
TYPES OF AUDIT

Based on Organisational structure of the business

Statutory Audit

Private Audit

Government Audit

Internal Audit

a. Statutory Audit: Where audit in the case of an enterprise is made compulsory by the statute or law, it
is called statutory audit. The scope of audit, qualification, disqualification, appointment, removal,
remuneration, duties, liabilities, rights of the auditor and the nature of audit report and certificate, etc.,
are regulated by the respective provision of various statutes. The audit of joint stock companies, audit
of trust, banking companies, insurance companies and cooperative societies are all regulated by the
concern acts.
b. Private Audit: the private institutions also get their accounts audited by some qualified auditors. Such
an audit is not required by statute. Hence it is called private audit. These bodies have their own
arrangements for audit and run for their own interest so that their accounts may be subject to a close
scrutiny to be made by a professional accountant. Audit of sole trader, audit of partnership firm, audit
of clubs, hospitals, libraries, colleges and schools come under this category.
c. Government Audit: Government audit is applicable to the government departments and departmental
undertakings. In India the president appoints the comptroller and auditor general of India under Article
149 of the constitution. Article 149 gives the powers and rights and fixes his responsibility for the audit
of government departments and institutions. Government audit is divided into several branches like
defence, railways, post and telegraph, etc.
d. Internal Audit: Internal audit is a continuous and systematic process of examining and reporting the
operations and record of a concern by its employees selected specially of this purpose. Internal audit is
one of the functions of management.
2. Based on the conduct of audit:
a. Continuous Audit: Continuous audit implies a detailed examination of the entire transactions by the
auditor continuously throughout the year. At the end of the financial period the auditor checks the
financial accounts. It is suitable only for big concerns.
b. Periodical Audit (Annual or final completion audit): Periodical audit is done at the close of the
financial or trading period when financial accounts are closed. In such a case, the auditor visits his client
only on in a year and checks the accounts in one visit till he is not in a position to cover the accounts
pertaining to the whole of the period. This type of audit is suitable only for small business houses.
c. Balance Sheet Audit: Balance sheet audit is recent growth as compared to other types of audit. This
type of audit is more popular in U.S.A. the term balance sheet audit means verification of value of assets,
liabilities, the balances of reserves and provisions and the amount of profit earned or loss suffered by a
firm during a year.
d. Complete Audit: Complete audit means an audit I which all the transactions recorded in the books
of accounts are thoroughly audited. In this system a detailed checking is done. It is neither practicable
nor feasible.
e. Interim Audit: Interim audit implies carrying out of audit work at any time during the year or in the
middle of the financial year in order to find out the interim profit or loss of the concern. In case of
interim audit, accounting records up to a certain date only are checked.
f. Partial Audit: when audit is conducted on some of the records and books of a part or whole of the
period, it is known as partial audit. It is not practicable again.
g. Propriety Audit: The propriety audit is confined to examine the validity of the appropriations or hi
is concerned with verifying that there is no leakage of revenue and wastage of funds knowingly or
unknowingly in disregard of any legal requirements or economic considerations. Under the propriety
audit, it is to be seen that the contracts entered into by the concern are in its best interest and there is a
proper check to ensure that the assets are safe. Thus it is a form of higher audit.
h. Performance Audit: Performance audit is a procedure for analyzing the profits and losses, of
economic activities carried out on by the business enterprises, examining the relationship between
production and sales and discovering the avenues for maximizing profits.
i. Occasional Audit: This type of audit is conducted as when the need arises and the client desires it to
be carried out. This is possible only in the case of proprietary concern such as sole proprietary business
or partnership firms.
j. Operational Audit: Operational auditing is same as internal auditing with its scope extending to
operational areas. The fact as remarked by Lawrence sawyer, operational audit is not a distinct or
separate type of auditing which is characterized by special programs or techniques. It is rather a manner
by which the internal auditor approaches his assignment, analyses the subject of his review and regards
the results. In this sense it is essentially a frame of mind, and a method of approach with which the
auditor views his work.
k. Standard Audit or Sample Checking: Standard audit had been defined as, “ A complete check and
analysis of certain items, and, and contingent upon effective check, an appropriate test check on
remaining items, the whole of the work being in on accord with general audit standards quite adequate to
justify an unqualified opinion. “ in a standard audit, the main concentration is on the detailed checking
and analysis of a selected number of items and only a sample checking of remaining items. The decision
as to which object should be subjected to a detailed analysis or a mere sample checking, will depend on
the effectiveness of the internal control system operating within the enterprise.
l. In-Depth Audit: In Depth audit is a technique of examination belonging to the family of sample
checking, with only this difference that under the former a selected number of transactions are subjected
to a detailed step up verification. In case of audit in depth of purchase invoice, for example, the auditor
 focuses his examination on all the stages through which purchase transaction passes and documents it
gives rise to, in the course of its journey. Thus he examines the requisition slip, clearance not by the
authorized official, tenders submitted by the supplier, purchase order, goods received note, goods
inspection note and the entries in the bin card and the stores ledger. When conducted alongside test
checking audit in depth provides the auditor with an overall picture of the proceeding being followed.
m.Post and Vouch Audit: A post and vouch audit is audit examination by detailed verification of
individual transactions. Under it each and every transaction of a business is examined from the point of
its appearance in the books of original entry till it had been posted. For this purpose the auditor uses
distinctive ticks or signs in different colors for each aspect of examination, i.e., totaling, posting,
balancing, carry forwards and so on. However, post and vouch audit is no longer conducted in case of
large sized enterprise where there is a vast increase both in number of complex business transactions,
and therefore an effective system of internal control is operated, or where the enterprise has adopted a
mechanized system of accounting.
n. Cost Audit: The term cost audit means an audit of cost records. The cost accountant is appointed to
check the cost accounting records in order to ascertain their accuracy and also to ensure that the cost
accounting plan as lain down by the company is carried out. It is an audit of actual performance. It acts
as an effective managerial tool for the detection of errors, frauds, inconsistencies and irregularities in
cost accounting records. The companies act, 1956, empowers the central government to order an audit of
cost accounts in case of specified companies.
o. Management Audit: The term management audit is a new concept in the sphere of auditing. As its
name signifies, management audit means the audit of management processes and functions. According
to W.P.Leonard, “The management audit may be defined as comprehensive and constructive
examination of an organisational structure of a company, institution or branch of government, or of any
component thereof, such as division of department, and its plan and objectives, its means of operation,
and use of human and physical facilities.” Thus, the auditor examines the policies and actions of the
management to ensure that there is a proper and maximum utilization of the available resources.
CONTINUOUS AUDIT: Continuous audit implies a detailed examination of all the transaction by the
auditor continuously throughout the year. At the end of financial period the auditor checks the financial
accounts. Continuous audit is also called Running Audit or Detailed Audit. Such audit is of immense help to
the bigger concerns.
According to R.G. Williams, “A continuous audit is one where the auditor or his staff is constantly
engaged in checking the accounts during the whole period or where the auditor or his staff attends at regular
intervals during the period.”
According to Dicksee, “The continuous audit is one which is commenced and carried on before the close
of the financial period of which it relates. And audit which is fully continuous involves the attendance of the
Auditor’s staff at the client’s office throughout the period under review.”
Business where Continuous Audit is Applicable:
Usually, a continuous audit is applicable in the following cases:
a) Where it is necessary to present the final accounts just at the closure of financial year, e.g., railways,
banks etc.
b) Where scope of business is wide;
c) Where cash transactions are more;
d) Where the systems of internal check is not satisfactory.
e) Where sales are very large and a detailed investigation is required.
f) Where the management required the review of financial position of their concern monthly or
quarterly.
Advantages of continuous audit: The following are the main advantages of continuous Audit:
a The first advantages of continuous audit is that under this system a detailed examination of accounts is
possible as the auditor gets one complete financial year for the purpose.
b The errors can be detected and rectified soon.
c The opportunities for complicated frauds are lessened and they can be detected before they attain
larger proportions.
d The regular supervision by the auditor brings increased efficiency and accuracy in the accounts of the
concern.
 e In the process of continuous audit each and every person of the deputed staff in the particular concern
is kept fully busy.
f The proprietor of the concern may get any desired information duly verified at any time without any
difficulty.
g It is more convenient to the auditor also as he is able to make easy arrangements for his work.
h Continuous audit creates more moral check upon the client’s staff.
i Continuous audit can be completed quickly and finally accounts can be presented sooner.

Disadvantages of continuous audit:

A continuous audit, however, has some advantages /weaknesses which are given under:-
i The auditor checks the books of accounts in several visits. The items or figures may be altered and
books of accounts may be tampered by client’s staff after the auditor has checked them on previous
days.
ii The technique of continuous audit cannot be afforded by smaller concerns, because it is very expensive.
iii Auditor’s frequent visits may cause inconvenience to the staff of the client.
iv Audit work is not carried on at a stretch. The auditor may lose the thread of his work. Under such
circumstances his queries may remain unanswered and the objects of audit may not be achieved.
v Under continuous audit, work becomes too mechanical since it continues throughout the year.
Precautions against the disadvantages of continuous audit: The auditor should take into consideration
the following precautions to avoid and minimize the dangers of continuous audit:
i An audit programme should be made in a through and systematic manner.
ii The auditor should use secret ticks and use the different colour to denote specific ticks during the
course of checking the different entries.
iii The auditor should give the specific instructions to the client’s staff not to make any alteration after the
checking of books of accounts.
iv The checking of impersonal accounts should be done at the end, as there is a greater possibility of
manipulation in them.
v The auditor should prepare the notes and the checklists on each visit to avoid the alteration.
vi The auditor should take proper care of the work to be done in time.
vii The auditor should pay surprise visit, so that the staff of the client may not be able to prepare, in
advance, against detection of some of its errors.
 UNIT – II
AUDIT PLANNING:
Audit planning signifies the basic principle that the auditor should plan his work to make the conduct
of audit effective, efficient and time stipulated.
An efficient audit planning facilitates:
a) To develop appropriate attention to important areas of audit;
b) To identify potential problems;
c) To expedite completion of work;
d) To utilize audit assistants properly and
e) To coordinate the work done by auditors and experts.
Audit planning involves two elements they are:
a) Developing an overall plan for the expected scope and conduct of audit;
b) Developing an audit program showing the nature, timing and extent of audit procedures.

AUDIT ENGAGEMENT LETTER:

An auditor’s engagement letter to his client signifies confirmation of his acceptance of appointment
of the auditor. It also states the objective and scope of the audit, extent of his responsibilities to the client
and the form of any reports.
FORM AND CONTENT OF ENGAGEMENT LETTER:
The form and content of the engagement letter will differ from client to client. But the letter should
generally make a reference to the following:
1. The objective of the audit of financial information.
2. Management’s responsibility for financial information.
3. Scope of the audit as specified by the statutory provisions, if any, and pronouncements of the
professional body to which the auditor is subject.
4. The form of reports or other communication of results of the engagement.
5. Recognition of the fact that because of inherent limitations of test checking and the system of
internal control, it is likely that even some material misstatement in the financial statements may
remain undiscovered.
6. Besides the letter may also refer to the following:
7. Arrangements as regards audit planning.
8. Request for written confirmation from management as regards representations concerning the audit.
9. Any other reports or letter which the auditor intends to send to the client.
10. Basis for computation of audit fees and billing arrangements.
11. Engagement of other auditors and/or experts for particular aspects of audit, such as, branch audit or
valuation of assets, if necessary.
12. Use of the services of internal auditor or other staff of the client for the purpose of audit.
13. Restrictions of the auditor’s liability.

A new engagement letter may be necessary in the case of the repeat audit. However, if the auditor
feels that there is some misunderstanding on the part of the client as the scope or objective of the audit, so
there is a significant change in the nature and the size of the client’s business, or any new legal requirements
have been introduced concerning audit of information, the auditor must send a new engagement letter to
safeguard the client as well as his own interest.
In case of statutory audit the objective and the scope of audit is clearly described in the relevant law.
Special care should be taken to ensure that the client understands that the audit will not extend to checking
every business transaction in detail, and that the customary test checking and review of accounting
procedure will be enough in a general audit to express opinion as regards the truth and fairness or
representation in the financial statements. Also, that the audit is not designed to detect the frauds through it
is likely that a material fraud may be discovered in the process of the examination.
The auditor should also get the clear understanding about the extent of which confirmations may be
obtained from customers, bankers, creditors, etc., as regards book debts, bank balances, loans, etc.
Ordinarily, the process of seeking confirmation should be restriction free, but if the client holds accountancy
view, the auditor should take adequate precautions and be prepared to express a qualified opinion in his
report.
FACTORS CONSIDERED BEFORE COMMENCING A NEW AUDIT:
After having decided as to whether continuous audit or final audit is to be undertaken, the auditor
should prepare himself for the work. As auditor has to draw up his plans to conduct the audit work
depending upon the nature and the type of the audit he is required to conduct. The process of planning and
audit would include activities ranging from making arrangements for securing the date to be reviewed, to
designing the procedures to the followed in examining them.
How to prepare and proceed with the audit is another pertinent question to be examined. How much
time should be devoted by an auditor in auditing the accounts of a business concern will depend entirely
upon the circumstances of a particular case and the training, experience and knowledge of the auditor. This
much is certain that the auditor must prepare well before he actually conducts the audit. His preparation will
be decided by the scope of work assigned to him and the method in which he will proceed. To examine the
issue, we may proceed step to step in the following manner:
1. Purpose of the audit: The auditor must ascertain the purpose of audit for which he has been engaged.
It may be that the audit is required.
a. Credit purpose, i.e., where on the basis of audited statements, the business seeks to raise the loan,
or a banker seeks to grant a loan; or
b. For investment purpose, i.e., where a potential investor o the basis of audited accounts seeks to
make an investment in a business; or
c. For purchase of business, i.e., the valuation of assets and liabilities of a business; or
d. Determination of the nature and the extent of any fraud; or
e. Filing income tax return; or
f. To comply with the legal requirements, i.e., a statutory audit.
It is also necessary to ascertain the period to be covered by the audit, particularly in case of non-
statutory audit.
2. Scope of duties: In case of voluntary audit, the auditor must ascertain the precise nature of his duties so
as to avoid any liability in future. In case of statutory audit, the auditor has only to make a reference to
the law under which the audit has to be done with a view to be clear about his duties.
3. Nature of the business: The nature of the business plays a very important role in the planning of
auditing procedures and their application. Knowledge about the nature of business can be had from the
memorandum of association, partnership deed, etc. The auditor should also make himself familiar with
the working of the business so as to know the nature of the transaction.
4. Organization structure: The organization chart will show the pattern of authority and responsibility in
the managerial organization of the firm. This will help in the planning of audit procedures. The physical
organization will also influence the auditing procedures.
5. Key personnel: The auditor should obtain a list of key personnel of the business, and if possible, also
meet them in person to ascertain whether the personnel are performing the work as assigned for them.
6. Accounting system: The auditor should obtain the list of books as accounts and records maintained by
the business. He must also enquire about the system of internal control in the business.
7. Change of auditors: where the auditor has been appointed in the place of another auditor, he must
ascertain the reason as to the change of auditor. He should communicate with the retiring auditor to
confirm the reason as given out by the client.
8. Instructions to the client: the auditor should ask the client to direct his staff to prepare schedule of
debtors and creditors, schedule of investment, prepaid and outstanding expenses, etc.
9. Inventory observation: In case of good lying at distant branches, auditor must point out to the client
that the stock taking should be done under his observation.
10. Letter of engagement: The auditor should prepare a memorandum listing the points agreed upon
between him and his client and send a copy thereof to the client. In avoids subsequent
misunderstandings and enables the auditor and the client to sort out many questions before the
commencement of the audit.
AUDIT PROGRAMME:
An audit programme is the auditor’s plan of action. Prof. Meigs defines it as, a detailed plan of the
auditing work to be performed, specifying the procedure to be followed in verification of each item in the
financial statements, and giving the estimated time required.
An audit programme is a written scheme designed by the auditor to identify the work to be done
during the course of audit and to distribute the same among his staff. It indicates:
 a) What work is to be done during the course of audit;
b) By which member of his staff any particular portion of work is to be done; and
c) Within what time frame any particular work is to be accomplished;
An audit programme enables the auditor:
a) To maintain a close vigil over the performance of the audit work;
b) To ensure that the work is performed in an orderly manner;
c) To fix responsibility as regards individual staff member for the work done; and
d) To detect short comings and lapses in the distribution and performance of work such that the same to
do not occur again in the audit programme in the future.
For any audit programme to be effective, it must be related to the quality of the internal control
system operating within the enterprise. The internal control system may be conceptually quite sound but lack
operational conformity, in the sense that it is not being operated as it should be. Or, it may be weak
conceptually in which case operational conformity or the lack of it may not matter much. In either case, the
audit programme must be designed to take care of the weakness of the internal control system.
TYPES OF AUDIT PROGRAMME:
Audit programme may be classified as follows:
a) Fixed audit programmes;
b) Flexible, progressive or special audit programme.
a) Fixed audit programme:It contains general or standardized instructions and procedures to be
followed while conducting the audit examination. It incorporates all conceivable audit of procedures
irrespective of their applicability to any particular audit in hand.
A fixed audit programme is the product of organized thinking. It includes every audit procedure and
takes due care of every likely audit situation. But its main drawback is that it prescribes a rigid framework as
regards hound within period a particular work is to be done. As a result nothing seems to be left to the
imagination and initiative of the audit staff. Moreover, it is not suitable in case of enterprise where
conditions may vary from year to year. It also requires modifications appropriate to the requirements of the
audit engagement in hand.
b) Flexible audit programme: It outlines the general scope, character and limitations of the audit
engagement. However, there is no mention of the audit procedure to be followed, the nature of the work to
be performed by individual members of the audit staff, and time allocated for each piece of work. These
particulars are filled in as the situation begins to unfold and the reliability of the accounting procedures,
records and internal control system is determined.
A flexible audit programme allows discretion to the auditor in developing and adapting it with the
progress of the audit work. It also makes for the display of initiative on the part of the audit staff. But its
main drawback is that it may overlook certain important audit procedures in conducting the examination.
MODIFICATION OF AUDIT PROGRAMME:
An audit programme serves as a guide for the future. But even in a repeat audit, the past years audit
programme cannot automatically be adopted for audit examination in the current year. It will need to be
modified in the light of any changes since the last audit.
Modification in the case of a fixed audit programme is slightly difficult as the senior audit clerk is
allowed to make only minor changes therein, and for any major changes he has to get the approval of the
auditor. There is no such problem in case of flexible audit programme as audit tests and procedures in its
case are devised in accordance with needs of situation.
Before adapting any past programme for the current year’s audit examination, the following points
should be carefully followed:
1) Change in ownership: Examine the memorandum and articles of Association in case of a company
and the partnership deed in the case of a partnership firm.
2) Organisational rearrangements: Examine the organization chart to see if there is any change in
authority and responsibility patterns or in the personnel.
3) Working papers: See if any past year’s working papers can be dispensed with, or information
contained in any of them can be usefully combined with others.
4) Books and records: See if there is any change in the books and record, and evaluate its effect on the
current audit programme.
5) Internal control: See if the internal control system has become relatively loose or tight, and whether it
calls for redesigning the current year’s audit programme.
 6) Change in business or product line: Examine whether any significant changes have occurred in
business such as introduction of new product or entry in new territories. Desirability of changes in the
form or date of report.
MERITS OF AN AUDIT PROGRAMME:
1. Identification the work to be done. An audit programme spotlights the work to be done by the audit
staff.
2. Groundwork for audit operations. It lays down a firm basis for audit operations in the current as well
as future years.
3. Efficient distribution of work. It is prepared keeping in mind the level of competence and experience
of individual members of the audit staff.
4. Pinpointing or responsibility. It laydowns in clear terms what work is to be done, by whom, and
within what duration of time.
5. Evidence against the charge of negligence. The auditor can always cite it is a proof of a particular
work having been done by his staff during the course of audit.
6. Basis of subsequent revision. It serves as a basis of revision in the audit operations in the light of any
changes taking place within the enterprise, as also experience gained in the course of conducting the
past audit.
DEMERITS OF A AUDITY PROGRAMME:
1. Rigid adherence: It prescribes a routine for the performance of audit procedures with the stipulated
time. This breeds monotony and boredom. However, the drawback may be easily removed by granting
the audit staff reasonable freedom in modifying the programme in tune with the needs of a particular
situation. In any case, it should impress on the audit. It includes all those working papers which are
useful in conducting the audit examination tear after year. The information contained may have been
staff that an audit programme only serves to lay down basis for conducting audit, and it should not be
deemed to sacred so as to prevent even minor departs from it. The auditor must himself review the
programme regularly so as to modify it suitable as per the changes discovered in the course of the work.
2. Lack of original approach: A the audit staff gas to stick to the programme in all the cases; it does not
display initiative in exploring new ways or performing the work in hand. However, this limitation may
be removed by making it clear to the staff that an audit programme is only a means to make sure that all
auditing procedures in the original audit plan have been carried out, and in this respect only serves as an
instrument for coordinating the standards originally set for the audit engagement with the work actually
being done. Any programme can seldom be completed in every respect and it is always open to further
improvement. But while audit staff must always be encouraged to make innovation in their work, due
care ought to be taken to see that these fit into the framework of the operations at different levels, and
this can be possible when these are approved by the auditor who coordinates the entire work.
3. Lack of uniformity in various audit: Even the most detailed and comprehensive audit programme
cannot possibly provide for each and every aspect of different enterprise for the simple reason that each
may be following different accounting procedures. However, this shortcoming may be met by a suitable
designing of the audit programme. For example, the programme may be divided into two parts, i.e.,
detailing the work procedures for the desired flexibility, but also allow the audit staff sufficient scope to
display individual initiative and skill in devising suitable audit procedures on their own.
A SPECIMEN OF AUDIT PROGRAMME MESSERS ………….. & CO. LTD
YEAR / MONTH Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Cash Book Balance
Bank Balance Checked
Cash Book Vouched
Petty Cash Book Vouched
-do- Credit Side
Bought Ledger Vouchers
Bought Ledger Cash Posting
Sales Book Additions and Postings
Return Book Postings
Journal checked
Stock Sheet Checked
Bought Ledger Balances
Sales Ledger Balances Checked
Trial Balance Checked
General ledger Checked
P&L A/c Checked
Balance Sheet Checked
N.B. Each audit assistant has to put in his initial in the relevant column after he has checked a particular item
AUDIT FILES:
An auditor is often simultaneously occupied with a number of audits. Moreover, his is mostly bound
to his office in order to control and coordinate the activities of his staff working at different places. Hence, it
is necessary for him to maintain a record of each audit for ready reference. Such record is maintained in
files, called audit files.
Depending on the circumstances of the audit and personal preference of the auditor, the number and
contents of the files may vary. However, broadly, there are two types of files i.e., permanent and current
audit files.
Permanent audit files: It includes those working papers which are useful in conducting the audit
examination year after year. The information contained therein may have been obtained in the current or
past audits, but it will be useful even in future audits.
A glance through the permanent audit file would provide useful information as regards financial
history of the client, nature of business operations and the recurring items calling for review. Thus, it spares
the auditor, the necessity of going through all the documents at the client’s end to identify the items for
review. Particularly in the case of accounts which have few changes, the auditor is only requires to note the
additions or deletions that may have taken place in the year under review.
The permanent audit file should preferable be in a hard core board binder. It should also have on the
cover or on the first page itself a table of its contents. Names of the person revising its contents should also
be mentioned therein. According to SAP-3, “Documentation”, the permanent audit file would generally
include the following:
1. Client’s name, address and telephone numbers.
2. Brief description of business and its operations.
3. A plan of the client’s office lay out.
4. Information concerning the legal and organisational structure of the entity, such as Memorandum and
Articles of Association in the case of a company, and the relevant act and regulations in the case of
statutory corporation.
5. Extracts or copies of important legal documents, agreements and minutes to the audit.
6. A record of the study and evaluation of internal controls related to the accounting system, whether in
the form of narrative description, questionnaires, flow charts, etc.
7. Copies of audited financial statement of previous years.
8. Analysis of significant ratios and trends.
9. Copies of management letters issue by the auditor, if any, before acceptance of appointment as
auditor.
10. Notes regarding significant accounting policies.
11. Significant audit observations of earlier years.
Current audit files: The current audit files contain papers and information obtained or developed during the
current audit. At the end of the audit, items of continuing interest are transferred from these files to the
permanent audit file.
The content of the current file should be indexed either on the cover or on the first page. The content
will vary according to the type of business under the audit, but will generally comprise the following:
1. Correspondence relating to acceptance of annual appointment.
2. Extracts of important matters in the minutes of board meetings and general meetings, as are relevant
to audit.
3. Evidence of the planning process of the audit and the audit programme.
4. Analysis of transactions and balances.
5. Evidence that the work performed by assistants was supervised and reviewed.
6. Copies of communication with other auditors, experts and third parties.
7. Copies of letter of notes concerning audit matters communicated to, or discussed with the client,
including the terms of the engagement and material weaknesses in relevant internal controls.
8. Letters, representation or confirmations received from the clients.
9. Conclusion reached by the auditor concerning significant aspects of the audit, including the manner
in which exceptional and unusual matter, if any, disclosed by the auditor’s procedures were resolved
or treated.
10. Copies of the financial information being reported and the related audit reports.
11. Bank reconciliation statement.
 12. Financial statements.
13. Trial balance.
14. Audit adjustments, closing and contra entries suggested to the clients.
15. Leading schedules, e.g., debtors and creditors schedule.
16. Variance analysis.
17. Notes regarding examination of subsequent events.
18. Notes for the next audit.
Other files: In addition to the permanent and current audit files, the auditor may also prepare other files
based on the circumstances of the audit or his personal preference. These may be:
Correspondence file: It is maintained centrally in each office to accumulate copies of correspondence with
the client and memoranda during the year prepared as a result of meeting with the client. The material is
arranged chronologically by the client. Such of the correspondence as will be useful on the continuing basis,
will be removed to the permanent audit file.
Tax file: It contains all the documents relating to preparation and filing of the tax returns. The other items
include:
1. Duplicates of tax returns as filed.
2. Record of payments.
3. Record of receipts.
4. Working papers related to determination of tax liability and reconciliation of book and tax figure.
5. Correspondence with the client and tax authorities.
6. Assessment orders.
7. Evidence of tax payments, refund claims and refund orders.
8. Tax policies and procedures.

AUDIT NOTE BOOK:

The audit note book is maintained by the audit clerk. He keeps therein a record of his observations
during the course of any audit work as also the points to be discussed with his senior clerk or the auditor. It
is also a written record of the queries made by him and the replies thereto.
The audit note book may be in the form of a bound register or loose sheets filed together. In either
case, it is part of the permanent record of the audit office which is used by the auditor while preparing audit
report. It serves as a valuable aid to remember a plethora of information, queries and explanations sought
and rendered in the course of an audit.
The audit note book has also great evidentiary value in case of any charge of negligence or
impropriety is brought against the auditor by the client. In the case of city equitable fire insurance company,
one reason why the court’s verdict was in favour of the auditors was that they6 had kept a meticulous record
of the work performed by them at each stage.
Contents: Some of the important matters recorded in the audit note book are as follows:
1. Name of the business.
2. Organization structure of the enterprise.
3. Provision of the Memorandum and Articles of Association having a bearing on the audit.
4. Instructions from the management having relevance to the audit.
5. List of books of account maintained by the enterprise.
6. Accounting methods followed in the enterprise, and their defects.
7. Any irregularities in the observance of laws and notifications applicable to the enterprise.
8. Names of key personnel and their powers, duties and responsibilities.
9. List of missing vouchers and receipts.
10. Matters requiring explanations or clarifications.
11. Weaknesses of the internal control system.
12. Total and/or balances in important accounts.
13. Bank reconciliation statement.
14. Errors and frauds as discovered.
15. Books and records not made available for audit.
16. Points to be noted for subsequent audits.
17. Points to be included in the audit report.
18. Dates of commencement and completion of audit.
 It should be noted that an audit note book is meant to record only important and strategic items.
Matters which are, or can be, sorted out on the spot, or those of a trivial nature, need not be entered
therein.

WORKING PAPERS:
According to SAP-5, “Documentation”, issued by the institute of chartered accountants of India,
audit working papers consists of-
1. Evidence obtained during the audit examination.
2. Details of the methods and procedures followed by the auditor during such examination; and
3. Conclusions reached by him as regards the object of the audit.
Working papers are the medium through which the auditor expresses his technical knowledge of
accounting principles or procedures as applied in the production of reports, statements and analysis of
business information. To form his opinion as regards the representations in the financial statements, the
auditor has to select analyses and examine adequate evidence which stands the test of logic and veracity.
The evidence may be physical or documentary, and in the form of books of accounts, records or the
system of internal control operated by relevant evidence was obtained, analyses, examined and pieced
together to recall reasonably logical and verifiable conclusion.

TYPES OF WORKING PAPERS: Technically, the entire written material obtained or developed in the
course of the audit examination will constitute the audit working papers. The form and contents of working
papers will differ upon the audit type and the preference of the auditor. The following are the important
among the varied working papers:
1. Audit programme.
2. Schedule of debtors and creditors, fixed assets, investments, etc.
3. Certificates of officials with regard to bad debts.
4. Correspondence with debtors, customers, bankers, creditors, etc… and confirmat5ions obtained from
them.
5. Certificate as regards quantity and value of stock - in – trade.
6. Certificate from an authorized official with regard to inclusion of all outstanding assets and liabilities
in the final accounts.
7. Adjustment entries in the journal.
8. Particulars of investment, depreciation, etc.
9. Trial balance.
10. Copies of excerpts from the minutes of the meetings of the board of directors and shareholders.
11. Copies or excerpts of significant contracts, leases, etc.
12. Draft of audit report and final copy.
13. Nothing as to queries made in the course of audit and replies thereto.

OBJECTS OF WORKING PAPERS: The following are the important objects of working papers:
1. Planning, organizing, control and review of audit work: Working papers provide a means of
planning, organizing, controlling, administering and review of the work. They are evidence that the audit
was conducted as per the generally accepted auditing standards and practices.
2. Support for auditor’s opinion: Working papers provide a principal support for the report of the
auditor. They also provide a proof that conduct of the work. If the validity of the auditor’s opinion,
assertion or recommendation as to financial statement is later questioned, working papers can be
produces as evidence to establish the said opinion or ascertain. The auditor should therefore ensure that
the working papers are conclusive and complete in every aspect. Leaving no questions raised therein
unanswered.
3. Division of labour: Working papers helps on appropriate division of work among the audit staff, in
the sense that different working papers made be made the responsibility of different audit clerks under
the supervision of the senior clerk or the auditor himself. The progress of the work can thus be
effectively monitored. Even where the audit work extends to different or the branches of client, the audit
programme may be divided into so many parts, or separate audit programme may be prepared for each
place, and then working papers prepared at each place may be complied at the center office to have an
overall view of the work.
 4. Use as permanent record: Working papers constitute a permanent record of the auditing procedure
employed, and the financial records examined. The client can make use of these in case his own records
are altered or lost.
5. Bridge between original transactions and financial statements: Working papers provide an
important link between original transactions and financial statements. This is because an auditor’s work
mostly consists in tracing the business transactions, though on a sample basis from the original records
of the financial statements, and vice versa. Working papers also constitute the basis for making the
rectification and adjustment entries.
6. Basis for review and revision of internal control: Internal control questionnaire for part of the
working papers. Comments as to the working of the internal control system will also be found in the
working papers relating to audit tests in respect of each aspects of the enterprise. Thus, working papers
facilitate an in-depth review of the internal control system, which forms the basis of recommending
suitable changes therein.
7. Basis for evaluation and training of audit staff: Working papers provide means to test whether the
auditor and his staff have done their job as per the required standards. They serve as an index to the
auditors ability to plan and organize the audit, because at each stage of audit, he has to take decision as
to the nature of the evidence to be obtained and the testes to which each evidence should be subjected.
Review of the past years workings each evidence should be subjected. Review of the past years working
papers and reports submitted by senior audit clerks can also be used as basis to provide the requires
training to the staff.
8. Basis for further work: In the course of the examination, the auditor may come across certain
situations or conditions in the pattern of management of the client’s business which, though not directly
connected whit his work blushful in future planning. Thus, the notes and analysis prepared by the auditor
as a part of his working papers may also prove useful to the client in several other areas.

INTERNAL CHECK:
According to MONTGOMERY, ”Internal check comprises those accounting procedures or
physical, statistical or other controls designed to safeguard assets against defalcations or other similar
irregularities or against loss from other cause.”
According to RONALD A. IRISH, “Internal check refers to the organization of office duties in such
a way as to prevent or disclose both errors and frauds.”
Objects of internal check: The objects of internal check are as follows:
1. rTo allocate duties and responsibilities of every clerk in such a way that he may be held responsible
for a particular error or fraud.
2. To minimize the possibilities of errors, frauds or irregularities.
3. To detect errors or fraud easily if it is committed, as in an efficient system of internal check there is
provision for independent checking.
4. To enhance the efficiency of the clerk in a business as the assignment of duties is based on the
principle of division of labour.
5. To distribute work in such a way that no business transaction is left from recording.
6. To prepare final accounts with ease and efficiency. An efficient system of internal check can make
accounts more regular and reliable.
7. To exercise moral pressure over the staff.
Principles or features of good internal check system: The principles or features of a good internal check
system are mentioned below:
1. Fixed responsibility: The main feature of internal check system is that the responsibility of each
individual must be properly defined and fixed. There should be a schedule of duties of every
employee. The persons to be appointed should be honest. Persons should not be appointed on the
basis of approach or pressure.
2. Division of work: There should be proper division of responsibilities of the members of the staff.
The fundamental principle of division of labour is that there should be segregation of responsibilities
for carrying on the transaction recording the same.
3. Standard forms: There should be a standard ruling and arrangement of forms and accounting
records with numbering, etc.
 4. Appointment of educated and trained persons:For an efficient system of internal check, the
persons to be appointed should be educated and trained. If the appointed persons are not trained then
they can be made efficient through training.
5. Appointment of honest persons: For an efficient system of internal check, the persons to be
appointed should be honest. Persons should not be appointed on the basis of approach or pressure.
6. Rotation of employee: Where the employees are in large number, there should be internal transfers
of the members of staff from time to time from one department to another and from one job to
another. As far as practicable, they should not be allowed to do the same work for long.
7. Separation of accounting control: This is also an important feature of an efficient system of
internal check. No person should be able to establish accountability over his own operations.
8. Safeguard: An adequate safeguard should be prescribed to keep unused receipts, cheques books,
files, bills, etc., to avoid misuse.
9. Use of mechanized methods: As far as possible keeping in view the requirement of the concern the
mechanized system of accounting should be adopted so that the over writing or eraser can be
avoided.
10. Personal care: The senior and responsible official should take personal care regarding receipts and
payments of cash, issue of goods, valuation of stock, etc.
11. Use of self-balancing method: The self-balancing method should be used in accounts department so
that the employees may not get any information about the combined ledgers. The total account
should be under the control of the responsible officials of the concern.
12. Flexible: An efficient system of internal check should be flexible so that it may be changed
according to the changing requirements of the concern.
13. Proper use of assets: It is also an important feature of a good system of internal check. Proper use of
asset should be ensured and all unauthorized use should be prevented.
14. Control of goods: For purchases made on credit, proper system should be introduced for placing
orders and receiving goods. Proper record of the goods should be maintained. The goods should not
be allowed out of the premises of the concern without the permission of the responsible person.
15. Control on receipts and payments of cash: Receipts and payments of cash should be controlled
very carefully. The cashier should be under control. For petty cash transactions, the imprest system
must be carefully followed.
16. Filing system: There should be a proper filing system to file all the letters, documents, vouchers, etc.
17. Review: The system of internal check should be reviewed from time to time so that the
improvements may be introduced.
Advantages of internal check:
1. Moral influences of employees: System of internal check puts a moral check on members of staff
and enables them to learn honesty, hard work and straightforwardness.
2. Determination of employees’ liability: System of internal check determines the responsibilities of
employee. The member of the staff may be held responsible for any irregularities carried on by him.
3. Less possibility of frauds: There is a less possibility of frauds under the system of internal check
because errors or frauds may be detected at an early stage..
4. Auditing made easy: The system of internal check facilitates the work of auditor to a great extent by
enabling him to rely on test checking.
5. Increase in efficiency: The system of internal check ensures greater efficiency and speed because
the arrangements of internal check is based on division of labour.
6. Final accounts can be prepared: In internal check system P&LA/c and Balance Sheet is prepared
without any loss of time.
7. Correct and complete records of all transactions: The system of internal check may also result
into correct and complete records of all the transactions on each balancing of the books of accounts.
8. Detecting of dishonesty and irregularity: Any Dishonesty or irregularity in the concern by the
members of staff can be detected before they assume any complications.
9. Test checking possibility: If the auditor finds the system of internal check satisfactory, then by
taking into mind its defects or weak points he can take the help of test checking.
Disadvantages of internal check:
1. Expensive: The system of internal check is expensive and quite time consuming.
 2. Slackness in the work: This is also a serious defect of the system of internal check. The auditor may
show slackness of work. He may rely on the system of internal check blindfolds, which may affect
the quality of audit work adversely.
3. Not suitable for small concern: The system of internal check is not suitable for small concerns as it
may be uneconomical in small concerns.
4. Grouping among employees: If the employees of the concern join hands, they make the employer
in dark and may cause many irregularities defying and defection thereof. This groupism amongst the
employees may not be healthy.
Positions of an auditor in relation to internal check:
The position of an auditor in relation to internal check can be made from the following points:
1. Duties:
No auditors can bind the business concern to adopt the system of internal check. He should consider
carefully the system in force in the concern. For this he has to do following work:
(i) To receive a written statement from the concern regarding the system of internal check.
(ii) He must make sure of its effectiveness and not rely blindly on test checking.
(iii) He should find out its defects and weak points, if any, which may result into errors or frauds.
If he is satisfied through his careful analysis of the system then he prepares the work planning.
2. Dependence
The extent to which an auditor may rely upon the system of internal check would depend upon the
effectiveness of the operation of the system and the size of the business concern. He should follow the
guidelines given below:-
(i) If through his careful analysis of the system the auditor is not satisfied then he may depend upon the
test checking of the transactions.
(ii) The auditor may restrict the routine work to certain periods only which he may select by ways of tests.
(iii) If the slightest doubt arises, he should extent the scope of his checking and should check all the
entries as far as possible.
(iv)The auditor should not carry on test checking of cash transactions, even if he founds that strong
internal check system prevails.
3. Suggestions :
If the auditor finds that the system in force is not efficient, then he can give suggestions to avoid the
defects and weak points. In case this suggestion are not needed to and implemented he should make it clear
that he would not be responsible for any discrepancy on that account.
4. Liability:
An efficient system of internal check reduces the work of the auditor but does not reduce his liability. In
real sense, the final liability is of the auditor. He cannot rid of the liability that the system of the internal
check is faulty. If the auditor finds that the system in force is not efficient, then he should not depend upon
test checking of the transactions.

INTERNAL CHECK AS TO CASH SALES: Cash sales may consist of the following:
1. Sales at the counter
2. Sales by travelling agents
3. Postal sales
1 SALES AT THE COUNTER:
i In case of a big retail business, a cash register should be maintained. Other machines for tabulation
work etc. should also be maintained.
ii Separate salesmen should be appointed for each counter, section or department who can look after
their respective counter, sections or departments
iii Each salesman should provide with a Sales Memo Book with three sets of receipts consecutively
numbered.
iv Different colour or number should be used for different counters, sections or departments so that they
may be recognized without any difficulty.
v When goods are sold, each salesman should enter details of goods sold with the amount to be
charged in the Sales Memo Book and take out two carbon copies.
vi The salesman should show the Memo book to any senior person who examines and verifies the
details.
 vii Two copies of the Memo Book including the original should be handed over to the customer who
then presents them to cashier.
viii The cashier should check the two copies presented to him and received the payment made to him.
ix The cashier should put his initials on the copies of the receipts and the stamp of paid.
x The cashier should then hand over the original copy to the customer and file the carbon copy with
him.
xi The customer should take the goods purchased form another counter on presentation of the receipt.
xii The cashier should enter the details of total sales of a day in cash sales sheet with the help of the
Memo filed by him.
xiii The cashier should also indicate the number of Memo in Cash Sales Sheet and ascertain the total
sales of the day.
xiv Each salesman should prepare a summary sheet with the help of the copy of Memo that remains with
him.
xv The amount of Total Cash Sales should be entered into the General Cash Book with the help of Cash
Sales Sheet and Summary Sheet.
2. SALES BY TRAVELLING AGENTS:
a The travelling agents should not be allowed to collect the sales amounts from the customer directly.
b The travelling agents should not be allowed to meet out any expenditure in connection with sales, out
of sale amount collected by them.
c If they themselves collect the amount of sales from the customers they should have clear instructions
to deposit in the local bank or to remit it intact to the central office in the name of the firm.
d The office should be kept informed about the balances which are over due.
e Remainder to the customers should also be send by the officer
f The officer should prepare statement about the debtors.
g The office should carry on correspondence with them and find out whether the balance indicated
therein a correct or not.
h The office should also make correspondence with those old customers from whom no orders have
been received for a long time.
i The area of travelling agents or salesmen should be changed from time to time.
j The periodical statement submitted by the travelling agent should be properly checked by some senior
person.
3. POSTAL SALES:
1 A separate V.P.P. Register should be maintained and the particulars about the following should be
recorded in it.
a) Customer
b) Quality of goods
c) Price
d) Date of dispatch
e) Amount received
2. A proper record should be maintained about the goods returned by the customers and received through
post office
3. The amount received from postal sales in a day should also be recorded in the V.P.P Register.
4. The responsible official should check the V.P.P Register frequently but not regularly and should
compare it with cash book.

INTERNAL CHECK AS REGARDS WAGES

1. MAINTENANCE OF WAGES RECORDS:
a Time records: The time spend by each worker should be correctly recorded. For this purpose time
recording clock, attendance register and job cards should be used. The foreman in-charge should initial
the entries on the card. At the end of the week, the cards should be collected and sent to the wage office.
b Piecework records: For piece-wage system each worker should be provided with a job bearing his
name, job number, nature of the work and the wage-rate. At the end, it checked and this card is initialed
by the pieceworker reviewer.
c Overtime records: Overtime cards should be sanctioned in advanced by some authority who should
issue overtime slips bearing the name and number of the worker. Such slips should be issued, filled, and
 initialed by some responsible official. At the end of the weak such slips should be sent to the timekeeper
who then forwards them to the wage office.
d Pass-out records: The workers should not be allowed to leave the factory without the written
permission. For this a pass-out slip is issued to the worker by same authority. Such slips handed over to
the gate-keeper. The wage office should also be given copy of it.

INTERNAL CHECK AS REGARDS WAGES

Maintenance of wages record preparation of wages sheet payment of

Wages

Time Records Piece Work Records Overtime Records Pass Out

Records

Time Recording Use of Tokens Attendance cards

II. PRPARATION OF WAGE SHEETS: page 106

III. PAYMENT OF WAGES:

1. Analysis: Payment of wages is done by the pay clerk or cashier who draws from the bank the amount
with coins required to cope with the wages.
2. Injunction: Wages should not be paid by a person who took part in the preparation of wages sheets.
3. Identification: Each worker should be asked to receive his wages personally in he presence of his
foreman to identify him.
4. Care: Care should be taken that no payment is made to someone on behalf of a worker who is an absent.
5. Cash department: Wages payment should be made by cash department, not by other persons.
6. Separate envelope: The amount of wages for each employee should be placed in an envelope bearing the
name and number of the person.
7. Payment to absentees: Some special arrangement should be made for payment to the absences.
8. Advance: Advances to workers should be discouraged and if it becomes unavoidable, they should be
given through the petty cashier.
9. Casual workers: If casual workers are also employed in the factory, a separate record should be
maintained about them. They should be paid daily. Their daily records should be checked from time to time
by some authority.
INTERNAL CONTROL:
In every well-organized concerns there exists a large number of ways and means where a check is
imposed on the accuracy of the executive work. These ways and means are called as the system of internal
control.
According to HOWARD F. STETTLER, “Internal control in a broader term, is generally used to
encompass both internal check and internal audit.”
The scope of internal control extends beyond the accounting controls and includes all operational
controls as:-
1. Quality control;
2. Budgetary control;
3. Work standards;
4. Periodic reporting;
5. Internal check; and
6. Internal audit.
Objectives of internal control: Internal control aims to achieve the following objectives:
 1. That all transactions are carried out with specific sanction and authorization of the management.
2. That the transactions are accounted in the related books of accounts, regularly, correctly and
systematically according to the accounting policies and procedures.
3. That there is complete accountability for all assets.
4. That use and access towards assets are made only with proper authorization’
5. That there is periodical verification and comparison of assets in existence with accounting records
and appropriate actions is taken with regard to any difference.
6. That adequate accounting system appropriate to size and nature of business is in existence.
Specific internal control procedures could be designed to achieve the aforesaid activities. That could
include:
i. Checking the arithmetical accuracy of the records;
ii. Maintenance of reconciliation;
iii. Auditing of routines, control accounts and trial balance;
iv. Approval and control of documents;
v. Comparison with external sources of information;
vi. Comparing the result of cash, security and inventories with accounting records;
vii. Limiting direct access to assets; and
viii. Comparison of results with budgets.
Limitations of internal control:
Internal control can offer only reasonable assurance that management objectives are reached. This is
because of certain inherent limitations laid down as under.
1. A control must be cost effective. The cost of the control procedures cannot be disproportionate to the
potential loss due to fraud or error.
2. Most of the controls are directed to anticipate usual type of transaction and not of unusual type.
Therefore transactions of unusual nature may not fall within the purview of internal control.
3. The effectiveness of the system is always affected due to carelessness, distraction and
misunderstanding of instructions. So much so the human weakness tune down the effectiveness of
internal control system.
4. The employee in collusion with others in the business unit or with third parties may find out
circumvention of controls.
5. The effectiveness of controls largely depends on the persons who implement them. If the persons
responsible for exercising controls abuse the responsibility, the control system may not have an
impact on the normal working of the business.
6. The changing circumstances in business environment may cause inadequacy in procedural conduct
of business and thereby compliance with procedures may become difficult or deteriorate,
Subject to above limitations the auditor must satisfy himself that the internal control procedure applied
in business unit are effective for the needed purpose.

INTERNAL AUDIT:
Internal audit may be defined as, “the continuous and systematic process of examining and reporting
on the administrative systems and accounting methods of a company or group of companies. It is generally
carried out by employees of the company with a view –
1. To confirming that the policies of management are being properly executed and drawing attention to
those areas where policies appear to be inadequate and
2. To verifying that the information used by management to control the undertaking is both adequate and
accurate.”
Objects of internal audit:
1. Evaluation of accounting and administrative systems and controls. Internal audit is concerned with
ensuring effective and efficient system of accounting control; standards cost budgetary control and
other administrative controls.
2. Compliance with established policies and procedures. It is concerned with reporting to management
as to the compliance with predetermined policies procedures and standard of performance.
3. Safeguarding of business assets. It ensues proper accounting and custody of business assets. It reports
to the management about utilization of existing assets and adequacy of return from investment.
 4. Reliability of management data. It ascertains the reliability of financial and operating reports
prepared throughout the enterprise. The management relies on the report of internal auditors as they
provide a continuous assurance as to validity of records and transactions of the enterprise.
5. Suggesting improvements. If the internal auditor discovers any inadequacy in the working of the
internal control system in any operational area, he makes appropriate recommendations to the
management for improvement of the system.
Duties of internal auditor:
The duties of internal auditor are indicated below:
1. To review the internal control system procedure and plug weaknesses in the control system and
suggest effective functioning.
2. To examine the custodianship and safeguarding the assets.
3. To verify the compliances with the policies, plans, procedures, laws and regulations and achieve the
company’s objectives.
4. To ascertain the relevance and reliability of information supplied to the management and available
with the company.
5. To examine the organisational structure and its suitability to achieve the objects and goals of the
enterprise.
6. To review the utilization of resources with economy and efficiency.
7. To review the achievements and performance of the enterprise with reference to its objectives.
8. To ensure the fact that proper and adequate statistical records are maintained for the need of the
management.
9. Performance of any other duties that may be assigned by the management to the internal auditor.
10. To give assistance to the statutory auditor in performance of his audit work.
11. To suggest improvements to the management in various functional areas in the context of managerial
requirements.

DIFFERENCE BETWEEN INTERNAL CHECK AND INTERNAL AUDIT:

SL.No Basis of Difference Internal Check Internal Audit
1. Objects The object of internal check is to The object of internal audit is
prevent errors and frauds to detect errors and frauds.
2. Name of work The work of recording and checking The checking of recorded
of entries is carried on simultaneously entries is made.
with the help of judicious allocation of
duties amongst the members of staff.
3. Time It is done in operation during the It starts after records have
course of transaction. already been made in the
books of accounts.
4. Scope of work The scope of internal check is very The scope is comparatively
limited. broad.
5. Appointment of the No new appointment is made for this The work is carried on by the
employee purpose. Every member of the staff is staff special assigned for this
involved in it. purpose.
6. discovery Error or fraud if any is discovered Error or fraud if any is
during the course of work discovered after the
completion of work.

DIFFERENCE BETWEEN INTERNAL AUDIT AND EXTERNAL AUDIT:

SL. Basis of Internal Audit External Audit
No Difference
1. Needs It is in the form of a review of In case of enterprise are under a statutory
operations and records to ensure obligation to have their accounts audited,
that the system of accounting are appointment of an external auditor is a must.
efficient and are working as Howsoever inconvenient or costly the
planned, belongs to a different proposition might be. Even the enterprises
 category. An enterprise will go in which are not legally require to get offered
for it only when it is convinced of and costs involved find the examination of
its utility in terms of the benefits. their accounts by an external auditor highly
rewarding.
2. Status of Internal auditor is an employee of External auditor is altogether independent of
auditor the enterprise, especially the enterprise hiring him for his services.
appointed for the purpose of
conducting internal audit.
3. Scope The scope is determined by the The scope in case it is legally compulsory, is
management and be curtailed or determined by the law applicable to the
enlarged at any time. enterprise under the audit. In case of non-
statutory external audit, the scope is
determined by an agreement between the
client and the auditor.
4. Approach The approach of internal auditor In case of statutory audit, the approach of
is governed by his duty to ensure external auditor is determined by the duties
that the system of accounting is and liabilities cast on him by relevant laws
adequate and effective such that and in case of non-statutory audit, by an
the information presented to the agreement under which he is appointed. In
management round the year is either case, his duty is to render an opinion on
true and disclose all material the truth and fairness of the assertions under
facts. his review.
5. Responsibility The internal auditor who is an The responsibility of the external auditor is
employee of the management is primarily to the owner who has appointed him
primarily responsible to the though in certain cases it may also extend to
management and, in any case, the interested third parties who have acted on the
independent status of external faith of his opinion as regards the financial
auditor is unthinkable in this case. statements examined by him.

VOUCHING OF CASH TRANSACTIONS:

Vouching is an essence of auditing. Vouching is a potential tool in the hands of auditors to ascertain
the accuracy of various transactions entered in the books of accounts the act of establishing the accuracy and
authenticity of entries in the books of accounts is called vouching. Vouching is a process of auditing. It is a
act of examining the vouchers on documentary evidence with the transactions recorded in the books of
accounts of the business.
RENOLD A.IRISH, “Vouching is a technical term which refers to the inspection of documentary
evidence supporting and substantiating a transaction.”
OBJECTS OF VOUCHING: The chief objects of vouching are as follows:
1. Vouching involves the collection of vouchers and related activities.
2. Vouching involves evaluating the collected evidence and vouchers.
3. Vouching involves finding out that there is no omission of any records.
4. Vouching involves the examination of books of accounts with the help of vouchers.
5. To ascertain the correctness of the transactions is also an important object of vouching.
6. Vouching implies finding out whether entries have been properly made in the books of account or
not.
7. One of the principal objects of vouching is to ascertain only that money has been actually paid away
by the business in respect of a business transaction.
8. It is to verify the cash in hand and cash at bank.
9. It is to ensure that no fraudulent payment has been made.
10. It forms the basis for final conclusion to be drawn by the auditor.
11. Vouching also refers to checking the entries with a view to find that transactions which are not
related to the business concern have not been recorded in the books of accounts.
IMPORTANCE OF VOUCHING:
Vouching is an important part of auditing. Auditing without vouching shall be incomplete. Vouching
consists in comparing entries in the books of accounts with documentary evidence in support thereof.
Vouching has been said to be the essence or backbone of auditing as it is one of the most potent tools in the
hands of auditors.
According to the Statement of Accounting Standards, of American Institute of Certified Public
Accountants, New York, “Sufficient competent evidential matter is to be obtained through inspection,
observation, inquiries and confirmations to afford a reasonable basis for an opinion regarding the financial
statements under examination.”
The auditor has to apply his acts to carry out his work in a proper way. On the fact, entries appear to
be innocent. Unless the auditor goes behind the books of accounts and traces the source of entries he cannot
ascertain the truth. Thus, it is not only the arithmetical accuracy of the books of accounts which is the
concern of the auditor but he has to go beyond it and satisfy himself that the entries are actually correct and
relate to the business concerned and the year under audit. The auditor with the help of vouching may find
out such entries which are contrary to facts.
This has been decided in the case of Armitage vs. Brewer & Knott (1932), where honorable justice
observed: it should be realized, however, that the very nature of vouching renders it a practically
indispensable phase of every audit and that where curtailment of the auditors duties in this direction is
contemplated, the risk that may be incurred should not be overlooked.
Having seen the importance of vouching, auditing people have started saying’ “vouching is the
backbone of auditing”. This statement seems to be true and correct. As the human structure is affected with
the weakening of the backbone, similarly the structure of auditing is adversely affected is the absence of
proper vouching. The more the auditor is careful while vouching, the more he makes his audit work simple,
trustworthy and facilitating.
With a broken backbone a human being can neither stand not walk properly. Similarly, with faulty
vouching the auditor cannot examine the truth and property of the transactions recorded in the books of
accounts. Accounting to Bose, “Truly it is said to be the essence of auditing since it is through vouching that
an auditor can satisfy himself about authenticity and completeness of the transactions recorded in the books.
The backbone of human structure is hard. Likewise, the work of vouching is very hard. In real sense,
vouching is not only the backbone or essence of auditing but also is its soul.

DEFINITION OF VOUCHER:
According to JOSEPH LANCASTER, “A voucher may be defined as any documentary evidence by
which the accuracy of the book entries may be substantiated.”
OBJECTS OF VOUCHING OF CASH BOOK:
Cash book is an important financial book for a business concern. Mostly, errors and frauds arise in
connection with receipts and payments of cash by making misappropriations, wherever possible. That is why
the auditor has to be on his guard in checking items of cash and he should ensure that no receipt or payment
of cash is unrecorded in the cash book and no fictitious payment has been entered in it. The main objects of
audit of cash book are as follows:
1. To ensure that all receipts are accounted for.
2. To know that all receipts and payments have been properly entered in the cash book.
3. To ensure that no fraudulent payment have been made.
4. To ensure that the payment has been made to the right person.
5. To ensure that the payments made are true payments.
6. To verify the cash in hand.
7. To verify the cash at bank.
Points to bear in mind while examing a vouchers:
1 In the name of the employer: The voucher should be made in the name of the employer of the
concern.
2 Printed: So far as possible, the voucher should be on a printed form.
3 Serial number: All the vouchers should be consecutively numbered and filled in order of the entries in
the various books.
4 Date: The auditor should check date, name of the party to whom the voucher is issued, the name of the
party issuing the voucher and the amount etc.
5 Stamped: The vouchers which are inspected by the auditor should be cancelled by the stamp so that it
cannot be produced again.
6 Related with the firm: The auditor should pay the special attention to these vouchers, which are in the
personal name of one of the partners, directors, manager or officer of the company.
7 Special mark: Such vouchers which require detailed checking, the auditor should put special mark on
them and he should check them carefully.
8 Signature of responsible officer: The auditor should see that every voucher passed correctly by a
responsible and senior officer of the concern and rubber stamps and signatures should be checked.
9 Revenue stamp: If the amount of voucher exceeds Rs.20, it must be stamped. The auditor should note
whether the voucher is stamped or not.
10 No help of the employees: The auditor should not take the help of employees of the concern whole
checking the vouchers.
11 Related with business: The auditor should see that the payments made by the concern relate with
business or not.
12 Payment for the concern: The auditor should see that the payments made by the concern relate to the
business or not.
13 Capital for the concern: The auditor should see as to which account the payment is posted i.e.,
whether it is capital or revenue.
14 Related to same year: The auditor should see that the vouchers are related to the same year in which
auditing is going on.
15 Amount in words and figures: The auditor should also see that the figures and words of the amount in
the vouching should be same.
16 Important points to be noted: A note should be made of the transaction which required further
verification of any other evidence. e.g., they may be memorandum of association, articles of
association, prospectus, partnership deed, etc..,
17 Invoice-no voucher: The received invoice should not be accepted as voucher. Because of chances of
double payment may be there once in the form of credit purchase and second time in the form of cash
purchase.
18 Mutilated vouchers: If the vouchers mutilated or there is cutting in the figure of amount, then the
auditor should not accept such vouchers unless signed by any senior and responsible officer of the
concern.
19 Paper-no voucher: Pad papers should not be accepted as voucher s because chances of dishonesty may
be there.
20 Time of payment: While checking the vouchers for insurance, rates, taxes etc., the auditor should see
the period for which the payment has been made. If payments are made in advance then the auditor
should see that correct adjustments are made or not.

VOUCHING OF CASH RECEIPTS (DEBITS SIDE):

1. Cash sales: (vouchers - carbon duplicates of cash memos, cashier’s summaries and salesmen’s
abstracts). There are many chances of fraud under this head and so much care should be taken. The
following points should be taken into consideration while vouching the cash sales.
 To check all the available evidence exhaustively.
 To check cash memo and daily sales summary
 To check the daily totals or receiving cashier’s cash book with the general cash book.
 To check the number of cash memo.
 If cash register is used in the concern, the auditor should check the daily totals recorded in the cash
book with the till rolls.
2. Receipts from debtor: (Vouchers - Counter foils, correspondence, etc.)
 The auditor should vouch the counter foils receipts with entries in the cash book.
 He should check the debtor’s ledger intelligently to find out any outstanding debts.
 As far as desirable, the auditor should correspond with the debtors and ascertain correct position.
 The auditor should correspond with debtors and ascertain the correct position.
 Any discrepancy revealed should be thoroughly enquired into.

TEEMING AND LADDING OR LAPSING:

It is an ingenious method of concealing a cash shortage. It involves misappropriation of receipts from
one or more customers and covering the shortage of receipts from still other customers. Later, this shortage
may be made up with receipts from still other customers. Thus while the storage will continue to be there, it
will never be in the same account. For example, suppose, a cheque for Rs. 2000, received in full settlement
of a debt from A is misappropriated this means that debts will continue to remain outstanding. Suppose at a
later date a cheque for the same amount received from B may be shown as having received from A and
posted to his account. As a result now B’s account will appear as outstanding and it will be cleared when
another cheque for a similar account is received from some other customer.

How to detect teeming and ladding:

In order to detect such frauds the auditor should adopt the following procedure:
a. Examine carefully the debtor’s balances in the ledger and make special inquiry into accounts which
appear to be falling more and more into arrear. The auditor should pay particular attention to cases
where credits have been entered for payments on account but it has hitherto been the practice of the
customer to settle their accounts regularly.
b. If receipts for remittances are issued check the counterfoils of the receipts with the cash book, paying
particular attention to the amounts and the dates.
c. Compare the original bank pay-in-slips for the cheques received and sent to the bank with the entries in
the cash book to find out of any “splitting up” of cheques have been made.
d. If necessary, arrange with the client that statements of accounts prepared by or under the supervision of
the auditor’s staff be sent to all debtors, asking for confirmation of the balances in their accounts.
3. Interests and Dividends: (Vouchers for interest - Pass book, Agreement, Schedule Counter foils, for
Dividends - Counter foils, Dividend Warrants, Pass Book.)
 He should check the cash book, interest account and personal account.
 He should check the investment ledger usually maintained in the business concern.
 He should examine that all the interests and dividends have been received at due dates and have been
duly accounted for
 In case the rate of interests and dividends are fixed, he should calculate and check them.
 If the collection of interest or dividend is made through the bank, the pass book should be checked.
 The auditors should examine the advance and accrued interest very carefully.
4. Bills receivable: (Vouchers - Bills Receivable book, cash book, pass book.)
All details about bills receivable can be available in the bills receivable book. The receipts for bills
receivable can be in two ways:
a. Receipts from bills receivable: The bills receivable which have been discounted and have not
matured at the date of balance sheet, the cash so received should be properly entered in the cash book.
The amount deducted for discount on such bills should be separately debited in the discount account.
Contingent liability in the respect of such bills should be shown on the balance sheet.
b. Receipts from Bills Matured: The cash receipt for the bills available in respect of which the amount
has been received on maturity dates should be checked by comparing the bills receivable book with the
cash book and the pass book.
The auditor should take the following points into account while vouchering bills receivable:
(i) He should compare bills receivable book with cash book and pass book to verify that the amount has
been received on due date.
(ii) The auditor must take enquires about the bills which have matured but the amount has not been
received for them.
(iii) The auditor should see that the records have been properly made in the books related to discounts,
dishonor or retirement of bill.
5. Rent Receivables: (Vouchers- lease deeds and agreement, rent rolls, accounts received from the agents,
counter foils, correspondence etc.)
The auditor should consider the following points while vouching rent receivables.
(i) In case the client has a large number of properties given out on rent, the auditor should ask his client
of prepare rent register or maintain rent rolls in which the account of every tenant is maintained.
(ii) The auditor should examine the lease agreements with the tenants to note the rent receivable, the due
date and provision for repairs or other allowances.
(iii) The auditor should examine the counter foils of rent receipts with the cash book.
(iv)He should enquire in the arrears of rent, if any.
 (v) Rent received through the collecting agents shall be vouched with the statement or summaries
prepared by the collecting agents.
(vi)If rent is long outstanding, the explanation should be sought for to find out whether that is genuine.
6. Commission Received: (Vouchers - Agreements with the parties, counter foils of receipts etc.)
The auditor should consider the following points while vouching commission received.
(i) He should check the commission account with the accounts of parties from whom commission had
been received.
(ii) He should examine the agreements with the parties for the rate of commissions.
(iii) He should examine the counter foils of the receipt with the amount in the cash book.
(iv)He should make calculations to check the accuracy of the amount.
7. Sales of Investments: (Vouchers- Broker’s sold not, Bank Advice.)
While vouching sale of investments, the auditor should consider the following points:
(i) The auditor should examine the broker’s sold notes to vouch the proceeds from sale of investment.
(ii) If they have been sold through bank, examine the bank invoices.
(iii) If investments have been sold out cum- dividend, the auditor should see that the proceeds have been
properly apportioned between revenue and capital receipts.
8. Insurance Claims: (Vouchers- Accounts Correspondence.)
While vouching insurance claim, the following points should be cared for:
(i) The auditor should examine the insurance policies carefully to ascertain the terms of claims.
(ii) He should also check the claims register.
(iii) He should examine the insurance money received from an insurance company against the claim of
the firm help of correspondence.
9. Subscription Received: (Vouchers - Register of Subscriptions, Counter foils.)
(i) The auditor should check the subscription.
(ii) He should compare a reasonable number of entries, with the register of subscribers of members.
(iii) Care should be taken to see subscription due but outstanding and the same should b brought into
account.
10. Receipts from Hire Purchase: (Vouchers - Hire Purchase Agreement Counter foils of Receipts.)
While vouching receipts from purchase the following points would be cared for:
(i) The hire purchase agreement should be examined in detail so as to ascertain the duration of the
agreement the amount of installments and the total number of installments and the total number of
installments payable by the close of the period the accounts of which are under audit.
(ii) The auditor has to keep in mind that the installment includes properly apportioned between sales and
interest.
11. Proceeds from sale of fixed assets: (Vouchers - Auctioneer’s note or brokers sold note, sale deed, and
correspondent.)
(i) He should vouch fixed assets sales with correspondence, others account, sale contract, minute of
boards of directors or other evidence available.
(ii) If sold through auction, the auctioneer’s account should be examined by the auditor.
12. Share Capital: In the case o firms, the partnership deal should be examined to find out the amount of
capital contributed by each partner.
13. Bad Debts Dividend: (Vouchers - Counter foils)
The auditor should take the following points into consideration while vouching bad debts dividends:
(i) The auditor should vouch them by examining counter foils of the dividend warrants or other related
documents.
(ii) He should ascertain the amount of debt and rate of dividend from it.
(iii) He should also see that accurate amount has been received and entered in the book.

VOUCHING OF CASH PAYMENTS (CREDIT SIDE)

After having dealt the debit side of the cash book, the auditor being satisfied moves towards credit
side of the cash book. The auditor should vouch the payment (credit) side of the cash book very cautiously.
He should pay special attention to the following points:
1. The payments are concerning the transactions relating to the business.
2. The payments are relating to the period under audit.
3. If all payments are authorized.
 4. The payments have been duly received by the payee alone.
5. The correct records have been made in the cash book.
The various cash payments should be vouched as follows:
1. Cash purchase: (Vouchers - cash memos, goods inward book).
The auditor should consider the following points while vouching cash purchase.
i. The auditor should see that goods paid for have actually been received.
ii. He should examine the entries in cash book with the help of cash memos or receipted invoices issued by
suppliers and also the goods inward book or stock ledger.
iii. For cash purchases, he has especially to examine the genuineness of purchases, receipts of goods and
also the relevant vouchers.
iv. It is to be seen that only net amount (i.e.,) purchase minus trade discount has to be carried to the book of
accounts.
2. Payments to creditors for goods purchased: (Vouchers - receipts, statement of accounts, minutes,
and contracts). While vouching payments to creditors for goods purchased, the auditor should consider
the following points:
i He should see that purchases are duly authorized and vouch them with cash memos.
ii He should see that the invoices are duly checked.
iii For vouching the payments to creditors for credit purchases the receipts from creditors
acknowledging the amount received by them should be checked by the auditor.
iv He should enquire if periodical statements are sent by creditors.
3. Wages: (Vouchers - wages sheets, piece-work cards, time- work cards, records of casual labour)
Auditor’s duty regarding wages:
1. He has to depend upon the system of internal check for wages to great extent. If he is not satisfied
with the method adopted he must suggest the concern to follow the correct methods.
2. He must check the wages sheets which include entries from piece-work cards, time- work cards,
records of casual labour, overtime payments, advance payment or fines if imposed.
3. He should examine that wages sheets are duly initialed by those who prepare them and countersigned
by the officials.
4. He should also tally the totals with cash book.
5. He should check the total amount of wages payable with the amount of cheques drawn to see that
more money has not been withdrawn that was needed.
6. He should check the names of some of the workers in the wage sheets with the job cards and the
foreman registered to see that no dummy works are included.
7. He should pay a surprise visit on the day of payment of wages to see that they are paid according to
the method suggested.
8. The number of workers recorded in the wages sheet should be compared with the employees state
insurance cards, deduction of provident fund to find out the names of ghost workers will not
contribute appear on the register for they do not contribute anything.
9. Wages sheets of the previous months should be compared with the current month and if there is any
increase of the number of workers, enquiry must be made.
10. Total wages of each department should be compared with the original estimate made by the costing
department.
11. He should see that the receipt is duly signed or bears the thumb impression of the workers and that it
is duly stamped if the amount exceeds twenty rupees.
12. Leave register should be examined to find out whether leave was granted with or without salary.
13. Compare the signatures of the workers of two or three periods to examine their genuineness.
14. He should see that the name of the same person does not appear often in the list of the unpaid wages
payable have not been adjusted against and “advance payment” again and again.
15. Examine the system of employment of casual labour. If there is any loophole, go into details.
16. Test checks the signatures and thumb impressions of some of the workers with the previous months.
Vouchers-Wages Records, job cards wages sheets, etc.
4. Salaries: (Vouchers - Salary book, agreements, appointment letters, minutes, counter foils of cheque)
i He should vouch salaries with salary book.
ii He should examine that it is been duly signed by each employee and countersigned by the responsible
official.
 iii He should examine the board’s minute book for the salaries of secretary, manager or other senior
officials.
iv The employees State Insurance Register should be tallied for salaries and contributions.
5. Commissions: (Vouchers - agreements, statement of accounts.)
The following points should be taken into account while vouching commissions.
i The auditor should examine that the commission is calculated on the basis of agreements.
ii He should check the calculations.
iii He should see the records of commission if it is based on percentage of sales.
6. Travelling expenses: (Vouchers - bills, receipts etc.)
For vouching travelling expenses the auditor should take the following points into account:
i He should see the rules and conditions granting travelling allowances.
ii He should check that these expenses are connected with the business alone and have not been paid in
the advance.
iii He should examine the vouchers for travelling expenses.
iv He should see that directors are not entitled to travelling allowances unless authorized by Articles of
Association.
7. Establishment Expenses: (Vouchers - receipts etc.)
The auditor should vouch the following points in case of establishment expenses:
i. The auditor should see the relevant vouchers.
ii. He should examine that all the expenditure are related to period under audit.
8. Bills payable:(Vouchers - bills payable book, pass book, receipts, bills payable returned)
i. They should be checked with the bills returned by the payees.
ii. If paid through bank, pass book should be seen.
9. Partner’s drawing: (Vouchers - Memorandum drawing book, partner’s drawing book, partnership
deed.) To vouch the partners drawing the auditor should see the following points:
i. He should vouch partner’s drawings with Memorandum drawing book of partners drawing book.
ii. He should see that it is duly initialed by the partners.
iii. He should also examine the partnership deed to ascertain the rules of drawings by the partners.
iv. He should examine that the rules of drawing have been followed.
10. Capital expenditure:
1. Freehold and leasehold property: (Vouchers -Title deed, lease, auctioneer’s note. Broker’s note,
contract).
a) He should examine the document of title of property purchased.
b) If purchased through auction, the auditor should vouch the accounts of auctioneer.
c) Various expenditures incurred such as brokerage, commission of auctioneer, legal charges etc.
Should be vouched by their respective accounts.
2. Purchase of building: (Vouchers -Title deed, lease, auctioneer’s note, brokers note, receipts,
contract, certificate of architect).
a) In case any building has been purchased the auditor should vouch it with agreement for sale. Title
deeds or receipt for the money paid.
b) In the case building has been constructed under a contract, the auditor should examine the actual
contract.
c) If the buildings have been constructed by engaging labour, he should properly examine the
expenditure incurred on building material purchased, cartage paid, wages paid to the workers.
3. Plant and machinery: (Vouchers - Receipts, Invoice, Auctioneer’s Account, Hire Purchase
Agreement.)
a) He should examine the receipt from vendors.
b) He should examine the invoice from the vendors.
c) If purchased from auction, the auditor should examine the auctioneer’s accounts.
d) If purchased under the “Hire Purchase Agreement” the auditor should carefully examine the
agreement and the related vouchers.
4. Patents and Copyrights: (Voucher s- Agreement, Receipts, Agent.)
a) He should examine the actual patents.
b) He should examine the agent’s accounts to verify the fees paid to him.
 c) The fees paid to him should also be capitalized.
d) He should also examine the renewal fees paid and see that renewal fees are not capitalized.
5. Investments: (Vouchers - Broker’s Bought Note, Pass Book, Letters of Allotment, Share
Certificate, etc.,)
a) He should examine the broker’s bought note and receipts.
b) He should examine the securities themselves wherever it is possible.
c) In case the investment it has been made in the old shares, share certificate should be examined.
d) He should examine the pass book, if payments have been made through the bank.
e) If it is a case of new issue letters of allotment, share certificates etc., may be examined. It is
needless to say that the purchase of investments should be properly authorized.
f) If the investment consists of inscribed stocks, the certificate from the bank should be obtained.
6. Loans: (Vouchers - Agreement, title deed etc.,)
a) He should examine the authority of loans, etc.
b) He should examine the loan agreement to ascertain the terms of loan.
c) He should also examine the title deed of securities.
d) If loan have been given to the directors, he should examine the approval of Central Government
has been obtained under section 295 of the Indian companies act. 1956.
11. Payment under Hire Purchase and Installments:(Vouchers - Agreement, receipt etc.,)
a) He should vouch such payments with the periodical statements received from the hire-trader and
vouchers for the payment of installment.
b) He should also examine the agreement entered into.
c) Such vouchers should be checked and properly added to capital and interest accounts under
revenue head.
12. Director’s fees: (Vouchers- Minute book, Attendance Register, Articles of Association, Resolution of
Shareholders.)
i. He is to check if the Articles of Association prescribed for him the remuneration.
ii. He should examine the attendance Register of the board directors of minute book or Resolution
passed to that effect in the general meeting.
iii. For the payment of commission to the directors, the auditor should check the agreement to find out
the calculations of profit.
iv. He should see the fees or remunerations paid to the directors are shown in the profit and loss
account separately.
v. If a director has not taken or forgone his fee, the minute book should be referred by the auditor so
that no misappropriation is done.
13. Dividends :(Vouchers-dividend warrants, pass book, etc.,)
The payment of dividends can be examined with the help of dividend warrants returned. If the payment
is made through the bank, dividend warrants and pass book may be compared. The amount of unclaimed
dividend should tally with the balance given in the pass book on this account.
14. Remuneration to directors:(Vouchers - special resolution, approval note of Central Government,
minute book etc.,)
The amount of remuneration payable to the directors of public companies is controlled by the
provisions contained in section 309, subject to the overall limit and explanation contained in section 198 of
the companies Act.
Under the companies (Amendment) act. 1965 even a director who is neither in the whole time
employment of the company nor a managing director can be paid remuneration either by way of monthly
salary or by way of commission on profit., if payment is to be made as a commission, it can be done with a
sanction of the company by a special resolution and also with the approval of the Central Government if a
monthly, quarterly or annual payment is envisaged.
The amount of remuneration is, however, limited to 1 to 3 percent depending on whether or not the
company has the managing director or a whole time director. The auditor should see the legal provisions
have been duly complied with.
15. Payments of taxes:(Vouchers - 1.income tax assessment order form, notice of demand and receipted
challan, 2.sales tax return submitted by the dealer and treasury or bank receipt)
 To vouch the payment of taxes, the auditor should make reference to the copy of the assessment order,
assessment form, notice of demand and the receipted challan.
The advance payment of income-tax under section 207 should be verified with the notice of demand
and the relevant receipted challan. The interest allowed on advance payments of income tax under section
214 should be included as income and penal interest charged for non-payment of these should be debited to
the interest account as given in sections 215, 216 and 217.
Payment of sales-tax can be vouched by reference to the returns submitted by the dealer and treasury or
bank receipts. Such returns are submitted every month or quarter. At the final assessment for the year, if the
amount of tax falls short, he is asked to deposit the difference and it is in excess, He is allowed refund.
16. Insurance:
For payment made on account of insurance premiums, the receipts from the insurance company and the
policy itself may be examined. In case of renewal, all renewal receipt for the premium should be referred to.
The auditor should call for a Schedule of all the policies if their number is large and check them accordingly.
17. Petty cash book: For vouching petty cash book, the auditor should examine the following points.
1. He should see the system of internal check existing for petty cash.
2. He should disown any responsibility to the client if the system of internal check for the petty cash is
inadequate.
3. The cheques drawn for petty cash should be vouched from the credit side of cash book to debit side
of petty cash.
4. The auditor should be cautious about the validity of vouchers presented to him.
5. The auditor should examine that the petty cash book has been maintained on imprest system
properly.
6. The auditor should consult the postage book for purchases of stamps.
7. The auditor should examine cross-casts and balances of petty cash book.
8. He should also check the balance of petty cash in hand.
9. He may apply test checking in examining the petty cash vouchers at random since there may be
innumerable small transactions.
18. Bank pass book: The auditor should vouch the following points while examining bank.
1. He should vouch carefully the deposits into or withdrawals, from the bank are recorded in the bank
column of the cash book.
2. He should vouch the deposit into the bank with the counterfoils of pay-in-slip book.
3. He should examine that the dates of deposits entered into pass book and cash book do not differ.
4. He should be very much careful about the deposits made into the bank prior to the date of closing of
accounts.
5. He should vouch the withdrawals with the counter foils of the cheque book.
6. He should examine that the cheques dishonoured have been properly recorded in the cash book.
7. He should examine the bank pass book for bank charges, interests, discounts or other incidental
charges.
8. He should be vigilant regarding contra entries in cash book.
9. He should obtain opening and closing balances from the bank.
10. He should check carefully the copy of reconciliation statement prepared by the client’s staff.
11. He should guard against fictitious pass books being presented to him.

VOUCHING OF TRADING TRANSACTIONS:

1. Credit purchases: After having satisfied himself that there is a good internal check system
regarding the purchases, the auditor should now proceed to vouch the purchases book. Entries in the
purchase book or invoice book or bought book, as it is called by the different names, should be
vouched with the invoices relating to the purchases, and the goods inward books maintained by the
gate-keeper and the godown-keeper and the delivery notes, if any. He should see that the name of the
creditor is the same as has been entered in the ‘Particular’ column of the purchase book. Only credit
purchases are entered in this book.
While examining the invoices, the auditor should pay attention to the following points:
a. Whether the invoice is in the name of his client, as sometimes invoice have been produced of
goods which never been purchases for the business or good might have been purchases by an official
of the company for his personal use while the payment is made through the company.
 b. Who is authorized to place orders for goods? Only a responsible officer should be allowed to do so.
c. The date of the invoice should relate to the period under review. This is done to prevent the
production o old invoices for which the payments had already been made.
d. Whether the clerk, who has checked the invoice with the order book to see that only those goods
have been sent for which the order was placed and that the rates and quantities are correct, has signed
the invoice, he should also see that only those goods which are dealt with by the client have been
purchased.
e. The auditor should also see that the goods mentioned in the invoice are not capital goods. If they
are capital goods, they should not be carried to the purchase book but should be carried to the fixed
asset account.
f. He should, as a ‘test check’, compare some invoice with the goods inward book or the gate-
keeper’s inward book in order to see that the goods have been actually received. This would prevent
the inclusion of fictitious invoices or the duplicates as “original “ones.
g. The auditor should check the casts and cross-casts of the purchase book.
h. He should see whether trade discount has been deducted from the invoice before making the entry
in the purchase book. Expenses as freight, custom duty, octori duty, etc., which have been incurred in
connection with the purchase, should be debited to the purchase account.
i. He should compare the goods inward book and the stock sheets with the purchases book to ensure
that all goods taken into stock have been entered in the purchases book.
j. The auditor should stamp the invoice or cancel it after he has compared it with the entries in the
purchase book to prevent its being produced again.
k. Sometimes the officials of the company purchase goods through the company in order to take
advantage of the trade discount. In such a case, the account of the official should be debited and
goods account credited. If this is not done, it would mean the company pays for the goods purchased
by the officials.
l. While examining the invoices, if the auditor comes across invoices marked ‘copy’ or ‘duplicate’,
he should satisfy himself that they were obtained in respect of only those invoices which have been
actually lost remised and that they have not already been entered anywhere else in the purchase
book.
m.In order to be sure that all the invoices are included, the auditor should ask his client to write to all
the creditors to send their statements of account direct to the auditor who will compare them with the
ledger accounts.
n. If an invoice runs into several pages, the auditor should see that the grand total is correct.
2. Purchase returns: Where goods purchases are returned to the suppliers, it is essential that there is a
proper internal control system for ensuring that due credit is received, in the absence of such a
system, credit notes from suppliers might become easy instruments for misappropriation of funds.
As for vouching of purchase return, the auditor should check the returns outward book
maintained by the Despatch Department with the purchase return book. Credit notes a waiting
settlement should be attached to invoices from the supplier concerned, and it should be ensured that
proper deduction for the same is made at subsequent settlements.
At times, credit notes from suppliers may also be received in connection with an allowance
for damages, underweight overcharging, or errors in calculation. These should be checked with
correspondence with the suppliers concerned, and with relevant deduction for the same in subsequent
invoices.
3. Credit sales:
Internal Check regarding Credit sales: The auditor should now proceed to vouch the day book or the
sales book which records only credit sales. The auditor has to be more careful in the case of vouching sales;
documentary evidence is not as conclusive as in case of purchase. He should enquire into the internal check
system regarding the sales which may be outlined as below:
1. Whenever an order is received, it should be recorded in the Order Received book, giving details
regarding the date on which the order was received the name of the customer, the particulars about
the goods, date of delivery, mode of transport, etc.
2. The order or a copy of it is sent to the Despatch Department.
 3. When the Despatch Department has packed the goods, another clerk should compare the goods so
dispatched with the order to see that the whole of the order is complied with or another list is
prepare showing the goods in the package which list is sent to the Counting House.
4. A responsible official will now mark the rate at which the goods are to be charged.
5. A clerk will now make the extensions.
6. The invoice will then be prepared in duplicate or triplicate by means of
7. One copy of the invoice will be sent to the invoice clerk who enters it in the Sales Book and later on
this is sent to the customer, another copy will be sent to the gate-keeper who will record in the
Goods Outward Book that such and such goods left the premises; the third copy will be retained for
further reference.
8. If orders are received through the travelers, they should be given order books with triplicate copies
one copy to be handed over to the customer, the second to be sent to the Head Officer for necessary
compliance and the third one is to new retain by the traveler for his record.
Duties of an auditor in connection with credit sales:
1. He should see that the internal check system is efficient. If it is not so, he should disown his
responsibility. If it is efficient, he should apply a few ‘test checks’.
2. He should compare the date of the copy of the invoice with the date in the Sales book.
3. He should see that the sales are not omitted from being entered in the sales book. If it is done, it is
possible that when the customer sends cash or cheque in payment of the goods sold, such an amount
may be misappropriated. The fraud will not be detected because no entry was made when the goods
were sold and, therefore, if no entry is made when the payment is received, it will not affect the
accounts at all whereas cash when comparison is made with original records, e.g., copies of
invoices, Order Received Book, Goods Outward Book, Gate-keeper’s Outward Book, Delivery
Note duly signed by the purchaser, receipts issued by the transport company or the railways.
4. He should further see that the sale of an asset is not treated as ordinary sale, otherwise profit will be
inflated. If an old asset has been sold, purchaser’s account should be debited and particular asset
account should be credited.
5. With the permission of the client, the auditor should send Statements of account to the customers to
confirm the accuracy of the balance. This method will prove the accuracy of the credit sales as well
as thr receipts from debtors and is very effective to check frauds.
6. He should check the Sales Book for the last days or weeks of the financial period and the Returns
Inward book for a few days or weeks after the close of the period in order to see whether fictitious
sales or returns has been recorded to inflate profit.
7. He should check the casts and cross-casts of the sales book.
8. The cancelled invoices should be checked with the duplicate copy of the invoice.
9. Sales tax, Insurance charges, etc. which are recoverable from the customers should be debited to the
customer’s account and credited to appropriate account.
10. Sales to be allied or sister concerns should be carefully examined as they may be factious entries
with the view to inflate profits.
11. If there is a significant different of trade discount allowed to two different purchasers, he should
inquire into the reason of such a distinction.
4. Sales Returns: The procedure as to compilation of records upon the return of goods from customers
should be carefully examined. The entries in the Sales Return Book, should be vouched with credit
note issued and Goods Outward Book, in case goods are dispatched to customers to make up for any
short delivery earlier, or as replacement for damaged goods. The auditor should ascertain whether
records as to sales returns are being maintained by persons who are independent of cash and sales
departments. Likewise, issue of credit notes should be duly authorized by responsible officials.
5. Vouching of Goods sent on consignment: Consignment means delivery of goods to another for
sale or purchase. The persons who consigns the goods is called the consignor, and the one to whom
the goods are consigned, is called the consignee.
The consignor generally uses a Consignment Book to show profit and loss of each
consignment separately. There is a consignment Account which is debited with the cost of the goods
sent on consignment, as also all incidental expenses such as freight, terminal taxes, etc. and credited
with the amount of sales reported by the consignee as also the value of the unsold stock. The credit
balance of the account represents a profit and the debit balance, a loss.
 The auditor should ascertain that the goods are debited to the Consignment Account to cost,
and check the sales and consignment stock credited to the Account with the Account Sales submitted
by the consignment transaction only represents a transfer of goods from one place to another, the sale
being concluded only after the goods are disposed of by the consignee, it should be ensured that all
unsold stock with the consignees included in the closing stock and excluded from sales.
Where the goods on consignment are invoiced at the selling price, and not at cost, the auditor
must ensure that appropriate adjustment entries in respect of the difference between the selling price
and the cost, are made in the consignment account. The value of the unsold stock with the consignee
should similarly be adjusted and included in the closing stock figures. The proportionate amount of
expenses in dispatching the goods to the consignee, as also those incurred by the consigned him,
should also be included in the value of the unsold stock.
6. Vouching of Sale (or) Return Transactions: Sometimes goods may be sent to buyers on “sale or
return” basis, such that the buyer has the alternative of selling the goods and paying for them, or
returning the unsold goods to the client within a reasonable time.
While vouching such transactions, the auditor should ascertain whether records are being
maintained in respect of the goods sent on such understanding. If so, such goods should be excluded
from normal sales and should be included therein only where the buyer pays for them. However, if
the practice is to debit the ledger accounts of the prospective buyers and then to credit them if the
goods are returned, the auditor must check the record of goods dispatched and returned, with each
individual buyer’s account. He should also ask his client to prepare a consolidated list of goods held
by such buyers and reconcile the same with the individual accounts. The price of such goods should
then be excluded from the sales accounts and the debtor’s records. Further, the cost of such goods
should be included in the closing stock.
7. Vouching of Packages, Empties and Containers: In some cases, customers are supplied goods
with packages of containers (bags, gas cylinders, crates, can and jars etc.) which the customers have
to return to the suppliers or dealers. The auditor shall see that an effective system should exist to
record such packages and empties. Generally a memoranda system is adapted. Under the system the
customer is debited with the cost of such empties and credited when they are returned. The cost of
empties is not included in the sales invoices. They are entered in the sales return book, under a
separate column to be called as ‘Packages and Empties’. They should also be recorded by the gate-
keeper in the ‘Empties returns inward book’.
At the date of balance sheet, a list of empties ‘not returned’ by the customer should be
prepared and the value of such empties should be recorded in a separate block to be known as
‘Empties and Packages’ on valuation of empties for the purpose of balance sheet and see that correct
depreciation has been provided for those ‘Packages and Empties’ which are still in the hands of the
customers.
 Unit – III
VERIFICATION AND VALUATION OF ASSTS AND IABILITIES
MEANING OF VERIFICATION:
Verification means ‘truth proving’ or ‘confirming the truth’. Verification is the process by which the
auditor satisfies himself, by actual inspection or otherwise, as to the existence, ownership, valuation and
accuracy of the various items appearing in the Balance Sheet. Verification includes valuation.
In an audit, verification is concerned with establishing;
1. The existence of actual items of assets and liabilities;
2. Ownership and possession of assets; and
3. Proper classification and valuation of both assets and liabilities.
4. In other words, it is the process of substantiation, by means of physical examination, legal and
official documents and expert opinion, of all that has already partly been established by vouching.

OBJECTS OF VERIFICATION:
1. The auditor has to certify whether the balance sheet shows a true fair financial position and for this
he has to verify the assets and liabilities.
2. To certify the ownership and title of the assets appearing in the balance sheet.
3. To ascertain the existence of the particular assets appearing in the balance sheet.
4. To verify the fact whether assets are free from charge or not.
5. To detect the fraud and irregularities, if any, in the books of accounts of the concern.
6. To ensure the arithmetical accuracy of the books of accounts.
7. To verify the ownership and possession of the assets.

DIFFERENCE BETWEEN VOUCHING AND VERIFICATION:

Sl.N Basis of Vouching Verification
o Difference
1. Nature It examines the entries relating to the It examines the assets and liabilities
transactions recorded in the books of appearing in the balance sheet of the
accounts. concern.
2. Basis It is based only on the documentary It is based on the physical inspection
examination. as well as documentary examination.
3. Time Vouching of books of accounts is done It is done at the end of the year when
for the transactions of whole year. the balance sheet of the concern is
prepared.
4. Utility It indicates that a particular asset must It certifies the existence of assets and
be possessed by the concern. liabilities at balance sheet date.
5. Scope It does not primarily concern with It includes valuation in its scope.
valuation.
6. Personnel Vouching of books of accounts is done It is done by the auditor himself or
by juniors like audit clerk. by his assistants.

VERIFRICATION OF ASSETS:
According to ARTHUR HOLMES, “Verification is the proof of accuracy of extension footings,
postings, existence and ownership of assets.”

VALUATION OF ASSETS:
According to LANCASTER, “The valuation of assets is, therefore, an attempt to ensure the equitable
distribution of the original outlay on the period of the assets usefulness.”

INTERPRETATIONS USED IN VALUATION OF ASSETS:

The following are some of the interpretations of the value used in the valuation of assets:
 1. Cost Price:it is the price paid for the acquisition of an asset. As a matter of practice, the expenses
incurred in the purchase of an asset and its installation is included in the cost price of the asset.
2. Replacement Value: It is the price at which a particular asset can be replaced. In such a value, the
expenses, e.g., commission, freight etc. are also included.
3. Market value: If an asset has a market for it, a value which it will bring when sold in the market is
called market value.
4. Book Value: it is the value at which the asset appears in the books of accounts.it is usually the cost
less depreciation written off so far.
5. Realizable Value: A value which will be realized in the market and received from the sale of asset is
termed as realizable value. Usually expenses such as commission, brokerage, etc. re deducted from
it. The realizable value is normally used in the valuation of existing assets.
6. Breakup value & Scrap value: A value which may be obtained from the asset if it is sold as scrap
and unserviceable is known as breakup value.
7. Going concern value or the business as a going concern: This is also called conventional or token
of historical value. It is equivalent to the cost less a reasonable amount of depreciation written off.
DIFFERENCE BETWEEN VERIFICATION AND VALUATION:
Sl.No Basis of Verification Valuation
Difference
1. Scope It implies the process by which the It implies critical examination and
auditor satisfies the accuracy of the testing of determined values of assets
assets and liabilities appearing in the by the auditor based on generally
balance sheet by inspection of accepted conventions and accounting
documentary evidence available. principles.
2. Responsibility It is done by the auditor himself or by It is made by the managers of the
his any senior assistant. concern.
3. Advice The auditor does himself the work of The auditor may seek assistance and
verification of assets. opinion of the technical personnel, if
necessary, for ascertaining the value
of any particular asset.
4. Basis of Evidence It is based on physical inspection as For valuation, very few direct
well as documentary evidence. evidence are available. The auditor
has to depend upon the estimates of
managers to a large extent.
5. Guarantee The auditor is entirely responsible for For the accuracy of valuation of
the verification of assets. assets, the auditor does not give any
guarantee.
6. Implication It has a broader implication and in fact, It is a part of verification.
it includes valuation.

CLASSIFICATION OF ASSETS:
Assets are generally classified under the following main categories; 1. Fixed assets, 2.Floating or
Current or Circulation Assets, 3.Wasting Assets, 4.Intangible Assets, 5.Fictitious Assets.
1. Fixed Assets: Fixed assets are acquired for permanent use and continuous service rendered by them
for a pretty long time. They are neither meant for resale in the ordinary course of business nor consumed
totally or partially in the business. Thus, such assets are more or less of permanent character and are used
for the purpose of earning profits. The utility of these assets remains so long as they are in working
order. Land, building, plant, machinery, furniture, etc. are some of the examples of fixed assets. Out of
the fixed assets, land is peculiar in the sense that it is not subjected to depletion in value by its use.
Hence, its valuation is usually denied at cost price. The remaining assets depreciate on account of
their constant use such as, are of depreciable nature. They are, therefore, valued at what is popularly
known as a Going Concern Value or Historical or Token Value. The reason for it is that assets acquired
for the running of the business and put to their repeated uses. They are valued at cost less a reasonable
depreciation written off and any fluctuation in their prices is not cared for.
2. Current or Floating Assets: Assets required for resale with a view to earn profits are used during
the process of trade or manufacture, such as cash, stock in trade, book debts, bills receivable, etc. are
 shown in the balance sheet at their realizable value. They are valued either at cost price or at market
price whichever is lower. Generally, appreciation in the value of assets is ignored. General principle of
valuation of assets should be on the basis of a going concern.
3. Wasting Assets: There does not appear any necessity to provide depreciation on wasting assets like
mines, quarries, etc. in terms of the decision of the case of Lee vs. Nauchatel Asphalt Co. Ltd. (1889).
But as a matter of principle, the theory propounded in the case does not hold good. Wasting assets
exhaust by working and hence the process involves depletion of the capital employed.
Hence a charge should necessarily be made to maintain the capital employed so as to show a true
and fair value of the assets for the purpose of cost accounting. Wasting assets are of the fixed nature and
depleted gradually or exhausted in the process of earning income, such as mines, quarries, oil wells, etc.
But there is difference between fixed assets and wasting assets.
4. Intangible Assets:Assets are not perceptible by touch or visionary such as goodwill, patents, copy
right, trade names are known as intangible assets. They are valuable as other assets. They are valued in
the same manner in which fixed assets are valued. In examining such assets, the auditor should consider
the following points:
a. The basis on which the assets were originally valued.
b. The adequacy of the amortization programme or depreciation or write off procedure.
c. The benefit of privilege accruing to the business of the date of the balance sheet.
d. The consistency followed in recording such assets with proper principle of accounting.
e. The fact whether the value of such assets are shown properly and fairly in the books of accounts.
f. The manner in which the assets are acquired.
Some of the intangible assets are less liquid in the sense that they are unsalable unless the business or
party of it is sold.
5. Fictitious Assets: Fictitious assets are of peculiar nature and they are revenue expenditure,
capitalized with the object of spreading the expenditure over a period of years the benefit accrues.
Expenses such as preliminary expenses, development expenses, and special advertisement costs belong
to the category of the fictitious assets. They are shown in the balance sheet as the amount of actual
expenditure less any amount written off from year to year.

IMPORTANCE OF VALUATION:
Valuation of assets is an important step from the point of view of auditing. It is one of the important
duties of auditor to check that the assets and liabilities are accurately and properly valued. This accuracy as a
matter of fact determines the correctness of balance sheet and profit and loss account.
Though in every business, the valuation is done by responsible officers but ultimately it is the auditor
to check that valuation has been done on the basis of some scientific principles since balance sheet must
represent true and fair view of the financial state of assets and liabilities.
Thus auditor should not allow creation of secret reserves. Final statements should be fair to all the
parties interested in the affairs of the business concern.
Though auditor is not an expert valuer, he must be cautious and take all relevant facts and evidences
into consideration while ascertaining the fair value of assets and liabilities.
Thus valuation of assets and liabilities is quiet important as the correctness of balance sheet and
profit and loss account depends upon the correctness of valuation of assets and liabilities. Hence correct
valuation is necessary.

VERIFICATION AND VALUATION OF DIFFERENT KINDS OF ASSETS:

1. Cash in hand: The most common practice to verify cash in hand is obtain a certificate from the
accountant about the actual cash balance in the hand at the date of balance sheet. But this is not a sound
procedure to be adopted by the professionally qualified auditor to verify this item. Recently, the Council
of the Chartered Accountants of India also commented that council feels that this is not a correct
appreciation of the auditor’s responsibility in regards to the verification of the cash. Therefore, the
auditor should actually count the cash in hand.
2. Cash at bank: The auditor should compare the balances as shown in the bank passbook with the
balances as shown in the column of the bank cashbook. In order to ascertain the correct position with
regard to cheques issued by the organization but not yet presented for payment or cheques deposited by
the organization but not yet cleared, the auditor should prepare a bank reconciliation statement. The
auditor should also obtain separate certificates for Fixed Deposit Account, Current Account and Savings
Account from the bank. He should verify the balances of these accounts by comparing with the column
of the bank cash book. In case there are accounts with more than one bank, the auditor must verify them
individually.
3. Sundry debtors (Books Debts): Sundry Debtors fall in the category of the current assets. The task
of verifying this asset should be reduced to a great extent in case there is an efficient internal check
system recording sales and writing of sales ledger. The auditor should however take the following steps
to verify these assets:
a. He should see that debts are disclosed in the balance sheet are recoverable.
b. Obtain a certificate statement of book debts clearly distinguishing between good debts, secured
debts, unsecured debts, current debts bad and doubtful debts, debtors’ outstanding for a period
exceeding six months and other debts.
c. The balances of sales ledger should be checked with the schedule of the book debts by test
checking.
d. In case where certain amount of debt has been written off, the auditor should enquire into the
details.
e. In case of hire purchase debts the auditor should see that instalments yet to be paid by customers
should not be treated as bad debts.
f. In there are certain debts concerning empties and packages, the auditor should make enquiries
about the trade practices and the likely hood of the recovery of the debt.
4. Bills receivable:The following steps are taken by the auditor to verify the bills receivable
a. The bills receivable should be compared and counted with the actual bills in hand at the date of
balance sheet. This can be done by examining the bills receivable books or impressed ledger.
b. The bills might have matured and honored subsequent to the date of balance sheet but prior to the
date of audit.
c. The auditor should see that the bills are properly drawn, stamped and duly accepted and they are
not overdue.
d. Where the number of bills is large and they are usually kept with the bankers or agents for
collection, the auditor should obtain a detailed certificate from them to ascertain the clear position
of the bills.
e. The bills are discounted or endorsed but remain outstanding at the time of audit, then any
contingent liability in respect of such bill should be mentioned at the foot of the balance sheet.
f. The bills which have been dishonored before the date of the balance sheet should not be included
in the balance sheet as bills receivable in hand as they are no longer assets.
5. Property: The auditor should always verify this item in detail and for this purpose he should
distinguish between free hold property and the lease hold property.
a. Free Hold Property: Where free hold property has been purchased, he should examine the title
deeds. E.g., purchase deed, certificate of registration, the brokers note and the auctioneer’s account,
etc., in order to verify the correct opposition. As regards the purchase price of the freehold property,
the auditor should refer to the statement of the purchase received from the client and that the
conveyance deed has been registered in accordance with the Indian Registration Act.
b. Leasehold property: In case of a lease hold property the auditor should take the following steps
to verify the assets. He should examine the lease contract to find out the value and duration. A lease
exceeding one year is not valid unless a registered instrument has granted it (Section 7 of Transfer of
Property Act). He should see that the terms and conditions of the lease are properly complied with;
sometimes the lease deed may have some conditions.
6. Plant and Machinery: In case machines arte purchased in the current accounting period, the
invoices and the agreement with the vendor should be verified. If the machines were existing in the
previous accounting period, the auditor should examine the schedules of plant and machinery prepared
and certified by the engineer in charge to ascertain the capital outlay. In case where additions have been
made the machines, the auditor should vouch these additions and see that they are shown distinctly.
Expenses incurred on custom duty, freight an erection of machine etc. Must be debited to the machinery
account. Any expenditure on repairs and renewals should be charged to the revenue account.
7. Furniture and Fixtures: Furniture is purchased not with a view to resale but to help running and
managing business activities. Fixtures are either fitted on the wall or on the ground. The auditor should
 check the stock register to ascertain the current holding of both the furniture and fixture. He
shouldexamine the invoices of the dealer in case the assets have been acquired during the current
accounting period. Any expenses incurred in the purchase of this asset should be debited to the furniture
account. The additions made during the accounting period should be examined in the usual manner.
8. Patent Rights: The patent rights should be verified with the certificates granting such rights or in
case where patents have been purchased, the assignment ofthe interest or the assignment deed should be
inspected. He should see and be assured that they have been registered in the name of his client and are
the property of the client.
9. Copyrights: This is a right to produce or reproduce literary work. The effects of such copy right is
that the author or the publisher gets an exclusive rights to publish or reproduce the work for a certain
number of years or even it may be on a life time basis for the auditor or the publisher as the case may be.
The procedure for verification of this item is more or less the same as patents rights. The auditor should
also inspect the agreement between the author and the publisher. It is usually seen that the value of the
copy right is not stable because they will lose their value with the passage of time. Copyright must be
revalued at the date of the balance sheet. If the4 sale of the publication is not worth mentioning the
copyright should be written off. Generally copyright must be shown at cost less amounts written off
from time to time.
10. Trademarks: A trade mark is verified by examining the assignment deed duly endorsed by the
office of the registering authority. The auditor should see that they are registered in the name of the
client and is the property of the client. In case a trade mark has been purchased, the auditor should also
vouch the payment therefore. But where it is registered by the proprietor of the business himself, he
should examine registration documents and certificates issued by the office of the registrar of trademarks
and the last renewal payment fee receipt.
11. Goodwill: Goodwill is an intangible asset. It is the value of the reputation of the firm, which enables
the firm to earn more than normal rate of profit. Where some business has been purchased and payment
has been made for goodwill, the auditor should verify the agreement with the vendors. In that case,
goodwill may be an agreed sum or the excess of the amount paid for the purchase of the business over
the net assets take expenditure on experiments in introducing a new product or new invention in the
market. The auditor should see that such expenditure is capitalized and is known as deferred goodwill.
12. Investment: Investment may consist of certain securities like government loan bonds or company’s
bonds, shares and stocks. The auditor will take the following steps to verify these assets. The auditor
should ascertain the powers of the enterprise to make investment by examining the Memorandum of
Association in case the investment is by the company, to ensure that the investment is not ultravires the
company. He should also ascertain that all legal formalities relating to purchase of investment have been
complied with the person who has been authorized to invest on behalf of the company has acted within
such authority.
13. Stock in trade: The verification and valuation of the stock in trade is one of the most important
duties of an auditor in order to arrive at the correct profit and loss of the concern under audit. He should
take extra care while verifying this asset otherwise it may affect not only the profit of the business but
also the balance sheet. If the quantity and the value of the closing stock are not properly arrived at, the
financial statement will not present at authentic dimension of the concern. But it is practically impossible
for the auditor to physically verify every item of the stock in hand because of various reasons i.e.,
limited time and lack of technical knowledge etc.
14. Loans: Loans may have advanced-
a. Against the security of land and property; or
b. Against the security of stock and share; or
c. Against the4 security of goods; or
d. Against the security of insurance policies; or
e. Against personal security of the borrower, etc.
The auditor should see that the loans are shown in the balance sheet according to the Companies Act.

VERIFICATION AND VALUATION OF LIABILITIES:

Verification of liabilities is as important as verification of assets. If the liabilities are over stated or
understated the balance sheet shall not represent a true and fair view of state of affairs of the company.
Similarly the profit and loss account will be incorrect. Let us now see how different liabilities are verified
and valued:
1. Capital: Capital is the amount of money invested in an enterprise by its owner. The owners may be
sole proprietor, partners and shareholders in case of a public limited company. In case of partnership
firm, the auditor should examine the partnership agreement. He must find out the original capital
contributed by each partner and rate of interest payable on capital. He should see that capital accounts of
partners are correctly maintained and verify all transactions affecting the capital accounts. He should
examine the cash book, pass book, withdrawals of the partners and the profit and loss earned by the firm.
In case of a company, while verifying the share capital, the auditor should examine the
Memorandum of Association, Articles of Association, and cashbook; pass book and the minutes book of
the board of directors to find out the number and the different classes of share issues and the amount
received on each type of shares. In case of newly floated company, the auditor should undertake an
exhaustive checking of all share capital transactions.
2. Loans: The auditor must ascertain the borrowing powers of the company and for this purpose; he
should examine the Memorandum of Association and the Articles of Association of the company. He
should also see that any restriction on the borrowing powers of the company is not exceeded. He should
check the agreements pertaining to borrowings as they may be loans secured or unsecured or may be for
a short or a long period.
In case of loans are secured i.e., having a charge or mortgage on the assets of the company, he
should see that the requirements of the companies act been complied with and the assets so charged
should be indicated in the balance sheet. He should verify the actual amount of the loan.
Where debentures have been issued, having a charge on the assets of the company, the auditor
should see the terms and conditions of the issues of the debentures and their compliance. He should also
examine the arrangements made for the redemptions of debentures.
3. Trade Creditors: The auditor will verify trade creditors more or less on similar lines as in case of
sundry debtors. He should take a statement of balances of the trade creditors duly signed by the
authorized officer or the organization and he should verify the balances with the bough ledger or the
purchase ledger. He may also obtain confirmatory statements from the creditors. He should also examine
the invoices as sent by suppliers and an ‘Inward goods book’ if it is maintained. He should carry out test
checking of all the purchases made during the year particularly those made at the close of the year. He
should also compare the percentage of the gross profit with that of the previous year. If there are material
deviations, the reason should be enquired into. If debts have not been paid for a long time, he should
enquire into the situation into detail. Sometimes, it is seen that instead of paying to the creditor the
amount might have been misappropriated by the officials.
4. Outstanding Liabilities for Expenses: The auditor should obtain certificates from the authorized
officer of the company, stating that all outstanding liabilities for goods purchased or for expenses
incurred, have been brought into account. Expenses which have been due but remain unpaid by the close
of the year, must in all cases, be provided for shown as outstanding liabilities. The auditor can verify
those items of expenses which usually constitute outstanding liabilities. For example, salaries payable,
legal expenses or rent due for the twelfth month or wages due. He should ascertain the accuracy of the
accounting records and test the calculations of outstanding liabilities.
5. Bills Payable: These are acknowledgements of debts payable. The auditor should get a statement of
bills payable and compare it with the bills payable books and bills payable account. For bills which have
been met after the date of the balance sheet but before the time of audit, he should examine the cash
book and the bank pass book. The bills payable already paid should be checked from the cash book and
the auditor should examine the returned bills payable. He should ensure that the bills already paid are not
recorded as outstanding. He should get confirmation in respect of amounts due on the bills accepted by
the clients that are held by them. He should concile the total of bills payable outstanding at the end of the
year with the balance in the bills payable account.
6. Contingent Liabilities: A future uncertain liability which is dependent on the happening of some
other event is known as contingent liability. In other words, liabilities which have not arisen up to the
date of the balance sheet, but may arise out of the contingent contracts such liabilities are called as
contingent liabilities. For example, the liability on partly paid shares, liability on bills discounted and the
liabilities in respect of arrears of dividend of cumulative preference shares, etc.
 UNIT – IV
AUDIT OF LIMITED COMPANIES & SPECIAL AUDIT U/S 233A

NECESSITY OF COMPANY AUDIT:

The audit of accounts of a joint stock company is required to be compulsorily audited under
Companies Act, 1956. Thus, the study of principles and procedures of auditing as applicable to a joint stock
company is a great significance. The provisions off Companies Act lay down the qualifications and
disqualifications of company auditors, procedures regarding their appointment, removal, rights, duties,
powers, remuneration and reappointment. The provisions concerning the company auditors are contained in
Secs. 224 to 233 dealing with matters as follows:
Sec. 224 : Appointment and remuneration of auditors.
Sec. 224A : Appointment of auditors by special resolution in certain cases.
Sec. 225 : Provisions as to resolutions for appointing or removing auditors.
Sec. 226 : Qualifications and Disqualifications of auditors.
Sec. 227 : Powers and duties of Auditors.
Sec. 228 : Audit of accounts of branch office of company.
Sec. 229 : Signature of auditor’s report, etc.
Sec. 230 : Reading and inspection of Auditor’s report.
Sec. 231 : Right of auditor to attend general meeting.
Sec. 232 : Penalty for non-compliance with Sec.225 to 231.
Sec. 233 : Penalty for non-compliance by auditor with Sec.227 and 229.
Sec. 233A : Power of central government to direct special audit in certain cases.
Sec. 233B : Audit of cost accounts in certain cases.

QUALIFICATION OF AUDITORS [Sec. 226 (1) & (2)]:

1. Practicing chartered accountants [Sec.226 (1)]: A person shall not be qualified for appointment as
auditor of a company unless he is a chartered accountant within the meaning of the Charted Accountants
Act of 1949.
A chartered accountant means a person who is a member of the Institute of Chartered Accountants of
India. He will be “deemed to be in practice” when, individually or in partnership with any other chartered
accountants in practice, he in return for consideration received or to be received-
a) Engages himself in the practice of accountancy;
b) Offers to perform or performs the services involving the auditing or verification of financial
transactions, books, accounts or records, or the preparation, verification or certification of financial
accounting and related statements, or holds himself out to the public as an accountant; or
c) Renders professional service or assistance in or about matters of principle or detail relating to
accounting procedure or the recording, presentation of certification of financial facts of date; or
d) Renders such services as, in the opinion of the council, or may be rendered by chartered accountants
in practice.
2. Certified auditors [Sec.226 (2)]: Apart from the practicing chartered accountants, a person holding
a certificate under the Restricted Auditor’s Certificate (Part B States) Rules, 1956, is also qualified to be
appointed as an auditor of a company. Such certified auditors are subjects of the rules framed in this
behalf by the central government.
The object of the provisions as to qualification of the auditors is to ensure that only persons of
proven worth and standing, and under the discipline of a statutory body, are appointed as auditor.

DISQUALIFICATION OF AUDITORS [Sec.226 (3), (4) & (5)]:

The following persons shall not be qualified for appointment as auditors of a company:
a) A body corporate;
b) An office or an employee of a company;
c) A person who is a partner, or who is in the employment, of an officer or employee of the company.
d) A person who is indebted to a company for an amount exceeding Rs.1000 or who has given any
guarantee of any third person to the company for an amount exceeding Rs.1000 [Sec.226 (3)].
Other disqualifications: According to Sec.226 (4), a person shall not be qualified for appointment as
auditor of a company if he is disqualified, under any of the four clauses mentioned above, for appointment
of auditor of any other body corporate, and also he would be so disqualified if that body corporate is a) that
company’s subsidiary, or b) its holding company, or c) a subsidiary of its holding company.
Further, if the auditor already holds the appointment as auditor in specified number of companies as
per Sec.224 (1-B), he will be disqualified for further appointment as auditor in any other company.
Where an auditor incurs any of the above disqualifications after his appointment, he will be deemed
to have vacated his office [Sec.226 (5)].

APPOINTMENT OF AUDITORS:
1. Appointment of first auditors [Sec. 224 (5)]: The first Auditors of a company shall be appointed by
the board of directors within one month of the date of registration of the company. The auditor so
appointed shall hold office until the conclusion of the first annual general meeting. Appointment of first
auditors should be by a valid resolution at the board meeting; merely naming them in the articles will not
be recognized by the act.
In case the board does not exercise its power in this regard, the company in its general meeting shall
appoint the first auditors. But whether appointed by the board or by the company, information to the first
auditors about the fact of his appointment as such is not a necessary condition. The first auditors are also
not required to inform the registrar about his acceptance or refusal of the said appointment.
2. Appointment by company, i.e., shareholders [Sec.224 (1)]: Every company shall at the time of
annual general meeting appoint auditors to hold office from the conclusion of that meeting until the
conclusion of the next annual general meeting, and shall, within seven days of the appointment give
intimation thereof to every auditor so appointed. Ordinarily, the power to appoint directors vests in the
hands of shareholders of the company in the general meeting. Only in exceptional circumstances the
appointment can be made by the board, such as the first auditors, or auditors to fill casual vacancy or by
the central government.
Reappointment of auditor [Sec.224 (3)]:
Ordinarily, at any annual general meeting, the retiring auditor shall automatically be reappointed.
Neither the board nor the shareholders can refuse to appoint him. However, in the following cases, the
retiring auditor shall not be reappointed:
a) If he is not qualified for reappointment.
b) If he has given the company a notice in writing of his unwillingness to be reappointed.
c) If a resolution has been passed at the meeting-
a. To appoint somebody other than him; or
b. To provide expressly that he shall not be reappointed.
d) If a notice has been given of an intended resolution proposing the appointment of some other person
in the place of the retiring auditor.
3. Appointment by Central Government [Sec.224 (3)]: Where at an annual general meeting no
auditor is appointed or reappointed, the central government in a consequence of the company’s failure to
appoint an auditor at its general meeting. In such case, the company has within seven days of its failure
to appoint or reappoint an auditor, to apply to the regional director to whom the contra government’s
power to appoint an auditor in such an event has been delegated under Sec.637. The said application
must disclose in sufficient detail the reason why the company could not appoint the auditor at its general
meeting. In case of \default, the company and every office of the company who is in default shall be
punishable with a fine which may exceed to Res.500 [Sec.224 (4)].
4. Appointment in case of casual vacancy [Sec.224 (6)]:The board of directors may fill any casual
vacancy in the office of the auditor. But while any such vacancy continues, the remaining auditors if any
may act. However, where any casual vacancy is caused by the resignation of an auditor during the term
of his appointment, the vacancy shall only be filled by the company at the annual general meeting. The
term casual vacancy has not been defined in the act. In its natural connotation it means vacancy in the
office of auditor resulting from accidental of fortuitous circumstances such as death, incapacity of
disqualification of the auditor. But it implies that the person already appointed to, and holding the office
of auditor has ceased to continue as such.
5. Appointment by special resolution (Sec.224A): In case of a company, in which not less than 25%
of the subscribed share capital is singly or jointly held by-
 a. A public financial institution or a government company, or the central government, or any state
government; or
b. Any financial or any other institution established by any provincial or state act, in which a state
government holds not less than 51% of the subscribed share capital; or
c. A nationalized bank or an insurance company carrying on general insurance business, the
appointment or reappointment of an auditor shall be made by a special resolution.
6. Appointment of auditors of Government Companies (Sec. 619): Appointment of auditors in case
of a government company is subject to the provisions of Sec.619. This overrides Secs.224 to 233 dealing
with appointment, etc., of the auditors in case of non-government companies.Accordingly, the auditor of
the government company shall be appointed or reappointed by the central government on the advice of
the comptroller and auditor general of India. But while tendering advice or making the appointment;
effect shall be given to the provision relating to ceiling on company audits as per Sec.224 (1-B) and (a-
C).
7. Appointment of auditor of other companies (Sec. 619B): Provisions of Sec.619 shall apply also in
the case of a company in which not less than 51% of the paid up share capital is held, whether singly or
jointly, by
a. The central government and one or more government companies;
b. Any state governments or one or more government companies;
c. The central government, one or more state government and one or more government companies.
d. The central government and one or more corporations owned or controlled by the central
government.
e. The central government, one or more state governments, and one or more corporations owned or
controlled by the central government.
f. One or more corporations owned or controlled by the central government or the state government.
g. More than one Government Company.
In other words, auditor for such a company shall be appointed or reappointed by the central
government on the advice of the Comptroller of Auditor General of India. It is for the company falling
under this section to comply with the provisions thereof. In case of default, the appointment made by it
shall be void abinitio.

CELILING OF NUMBER OF AUDITS [SEC.224 (1-B)]:

Sec.224 (1-B) introduces a ceiling on the number of companies of which a person or a firm could be
the auditor. It says, “no company or its board of directors shall appoint or reappoint any person who is in full
in time employment elsewhere, or a firm as its auditor, if such person or firm is at the date of such
appointment or reappointment, holding appointment as auditor of a specified number of companies, or more
than the specified number of companies.”
The ceiling had a two-fold object: first, to bring about dissociation on auditors from group of
companies so that they might have no temptation to shield the shortcomings of the managements from the
shareholders. Secondly, to achieve a more equitable distribution of audit works amongst the different
auditors, so that the younger sections of the audit profession may have a better chance of advancement in the
profession.
An auditor should not be in full time employment. Auditor can be an auditor for maximum 20
Companies, of which only 10 can be Large Companies. Large Companies means a company with paid up
capital of or exceeding 25 lakhs. In a Firm of Auditors, the limit of 20 Companies is per Partner. As per
Companies (Amendment) Act, 2000, Private Companies will not be taken into account for counting the limit
of 20 Companies. However, as per ICAI notification, a person can carry out the audit of Maximum 30
companies including Private Companies. Joint audit assignments to be counted as one company for an
auditor. Branch Audits and Foreign companies audit are not included for counting the limit of 20
Companies. Guarantee companies having no share capital are also excluded for counting the limit of 20
Companies.

REMUNERATION OF AUDITOR [SEC.224 (8)]:

The remuneration of the auditor of the company may be either is fired by the company at its general
meeting, or left to be fixed in any manner determined in the general meeting. In case the auditor is appointed
by the board or by the central government, his remuneration may be fixed by the appointing authority. The
remuneration is inclusive of all expenses allowed to him and he is not entitled to any other payment, whether
as expense or otherwise. However, for legal or technical advice sought by him in connection with his duties
as auditor, he can claim the expenditure from the company.
Similarly, he may also be paid remuneration for services rendered in any other capacity, e.g., as
advisor in taxation matters, company law matters, management services, etc. But the profit and loss account
of the company must contain detailed information as regards all amounts paid to him.

REMOVAL OF AUDITOR [SEC.224 (7)]:

First Auditor(s): The members in the general meeting may remove the first auditor(s) of the company
appointed by the board of directors prior to the first annual general meeting. For this it is immaterial whether
the auditor has completed his place any other person nominated for this purpose by any member of the
company. But notice of such nomination, must be given at least 14 days before the date of the meeting.
In other cases: Any auditor may be removed from the office before the expiry of his term. But this can be
done only by the general meeting after obtaining the prior approval from the central government in that
behalf. Sec.225, which deals with resolutions for appointment and removal of directors, provides safeguards
against a unfair and unjust removal of an auditor.
Safeguards against unfair and unjust removal:
Under Sec.225 (2), reappointment of the retiring auditor, except in the specified cases, has virtually
been made automatic. However, where it is proposed to remove the present auditor, whether by appointing
someone else in his place, or by simply resolving that he shall not be reappointed, the procedure as
prescribed in Sec.225 has to be followed. The object of this is to safeguard the interests of an independent
and conscientious auditor against his unfair and unjust removal at the hands of an unscrupulous
management. The provisions of Sec.225 are as follows:
1. Special notice of resolution: For any resolution by shareholders for removal of the present auditor, a
special notice of the intention to move such a resolution has to be given to the company at least before
14 days of the annual general meeting.
2. Retiring auditor to be informed: On receipt of notice of such a resolution, the company shall
forthwith send a copy thereof to the retiring auditor.
3. Right to represent: The retiring auditor has the right to make a representation in writing, not
exceeding a reasonable length, to the company with respect to the said resolution as communicated to
him. He may also request the company to notify such representation to the members of the company.
4. Company to comply: Where the auditor makes the representation to the company and requests its
notification to the members, the company shall in any notice of this resolution given to the members- a)
state the fact of the representation having been made, and b) send a copy of the representation to every
member to whom the notice of the meeting is sent, whether before or after the receipt of the
representation be the company.
5. Where representation is not notified: In case a copy of the representation is not sent to members as
aforesaid, either because it was received too late or because of the company’s default, the auditor may
insist that the representation be read out at the general meeting. In addition to this, he may make an oral
statement at the meeting.
6. Right to attend meeting: The auditor, who is intended to be removed, has the right to attend the
general meeting at which his removal is to be discussed and decided upon. In fact this right is inherent in
his right to make an oral statement at the meeting as to his proposed removal.
7. Auditor not to abuse his right under Sec. 225: The right to make an oral or written representation
has been granted to the auditor to secure against his improper removal, because the facts disclosed by
him in such a representation may, in really bad cases, lead to a detailed investigation into the affairs of
the company concerned and the fear of such disclosure is intended to prevent a wily management from
removing the auditor, howsoever inconvenient he might be.
8. Provisions to have wide coverage: The above provisions are equally applicable to resolutions
whether they relate to – a) the removal of first auditor or any of them appointed by the directors under
Sec.224 (50 before the first annual general meeting; b) the removal of any auditor in its general meeting
with the previous approval of the central government; or c) appointment as auditor of a person other than
the retiring auditor.
9. New auditor to communicate with the outgoing auditor: While accompany is free to engage as
auditor whomsoever it chooses, the auditor should exercise care and caution before agreeing to work for
 a fellow professional’s client. Thus, where an auditor accepts position previously held by another
chartered accountant, he should be tantamount to breach of professional etiquette and would be
misconduct falling within the acts or commissions specified under Sec.22 of the Chartered Accountants
Act, 1949. It may lead to an enquiry into his conduct by the council of the Institution of Chartered
Accountants and if his guilt is established, he may be declared unfit to continue as a member of the
Institute.

POWERS OF COMPANY AUDITOR:

An auditor to perform his duties must have certain powers without which it may not be possible for
him to perform his duties honestly and thereby, he might be held liable for any loss which the company
might suffer. We are concerned here principally with those powers and duties which are detailed below:
1. Right of access t6o books of accounts [Sec.227 (1)]: The auditor of a company has a right of
access, at all times, to the books and accounts and vouchers of the company, whether kept at the head
office of the company or elsewhere and also to the returns submitted by the branch offices to the head
office. The terms books includes not only those which pertain to accounts but also all the statutory,
statistical, costing books and all documentary evidence.
2. Right to call for information and explanations [Sec. 227(1)]: The auditor has a right to call for
such information and explanations, from the officers of the company, as he may think necessary for the
performance of his duties as auditor.
3. Right to receive notices of and attend general meeting (Sec231): The auditor has a right to receive
all notices and other communications relating to any general meeting of the company, in the same way in
which any member of the company is entitled to have them sent to him. He has also a right to attend any
general meeting and to be heard thereof, on any part of the business, which concerns him as auditor.
4. Right to report to members [Sec. 227 (2)]: The auditor has a right as well as duty to make a report
to the member on the accounts examined by him, and to state whether I his opinion and to the best of his
information required by the companies act in the manner as required, and whether the financial statement
gives a true and fair picture of the state of affairs of the business of the company and as to the results of
its operations.
5. Right to sign audit report, etc.(Sec.229): Only the person appointed as auditor of the company can
sign the auditor’s report, or sign or authenticate any other document of the company which the law
requires to be signed or authenticated by the auditor. In case the auditor is a firm, only the partner of the
firm practicing in India can do so.
6. Right to visit branches [Sec. 228 (2)]: In case of accounts of any branch office are audited by a
person other than the company[‘s auditor, the company auditor- a) Shall be entitled to visit the branch
office, if he deems it necessary to do so for the performance of his duties as auditor; and b) Shall have
the right to access at all times to the books and accounts and vouchers of the company as maintained at
the branch office.
7. Right to have legal and technical advice: Where the auditor needs expert advice in respect of any
legal or technical matter for the proper discharge of his duties, he may seek it at the expense of the
company, for which the payment will be a permissible extra expenditure.
8. Right to receive remuneration [Sec. 224 (8)]: The auditor has the right to receive remuneration for
auditing the accounts of the company, though such right accrues only after he has completed his work. In
Herbert Alfred Burleigh V. Ingram Clerk Ltd (1990), it was held that the auditor could exercise lien on
certain books for his remuneration, but this case law is not found applicable in India.
9. Right to be indemnified [Sec. 633]: He has a right to be indemnified out of the assets of the
company against the liability incurred by him in defending himself against civil and criminal
proceedings by the company provided he has won the case.

DUTIES OF COMPANY AUDITOR: Duties of a company auditor may be discussed under the following
two heads: Statutory Duties and Duties under common law.
A. Statutory Duties:
1. Duty to report to members [Sec. 227 (2)]: The auditor is required to make a report to the members
of the company:
a. On the accounts examined by him.
b. On the balance sheet and profit and loss account; and
 c. On every other document declared by the companies act to be a part of, or annexed to the balance
sheet or profit and loss account, which are laid before the company in the general meeting during
his tenure of operation.
It is a fact that the report is required to be read before the company in the general meeting and to
speak there at on matters concerning him as auditor, it may be inferred that it is also his duty to see that
the report reaches the members in the meeting.
2. Duty to examine the books of accounts [Sec. 209 (3)]: The auditor has to state in his report
whether, in his opinion proper books of accounts are required by law have been kept by the company. As
required by law would include the requirement of Sec. 209 (30), i.e., that the books should be so kept as
to give a true and fair view of the state of affairs of the company explain its transactions.
3. Duty to annex documents: The auditor’s report has to deal not only with the accounts and balance
sheet and profit and loss account, but also with every other document which is declared by the act to be
part of, or annexed to, the Balance Sheet and Profit and Loss Account.
4. Duty to give true and fair view: The primary duty of the auditor is to express his opinion whether
balance sheet shows the true and fair view of the state of the company’s affairs as at the end of the
financial year, and whether the profit and loss account show us a true and fair view of the results of
operations of the company for that year.
5. Duty as to inquiry [Sec. 227 (1-A)]: Specifies six matters which are required to be enquired into as
by the company auditor. These are:
a. Loans and advances: He has to see whether loans and advances made by the company on the basis
of security have been properly secured, and whether the terms on which they6 have been made are
not prejudicial to the interests of the company or its members.
b. Transactions represented merely by book entries: He must see that transactions, which are not
supported by any facts or evidence, though recorded in the books, are not prejudicial to the interests
of the company.
c. Sale of investment at less than purchase price: Where the company is not an investment company
or banking company, the auditor is required to see whether it has sold any shares, debentures or
other securities at a price which is lower than the price at which these were purchased by it.
d. Loans and advances shown as deposits:He has to see whether loans and advances made by the
company have not been shown as deposits, to avoid scrutiny by the members or others.
e. Personal expenses: He should enquire whether any personal expenses have been charged to
revenue accounts of the company, so as to improperly utilize the funds of the company for the
individual benefit of persons directly or indirectly in control of the affairs of the company.
f. Allotment of shares for cash: Where it is stated in the books and papers of the company that any
share have been allotted for cash, the auditor must enquire whether cash has actually been received
in respect of such allotment, and if no cash has actually been received, whether the position as stated
in the books and the balance sheet is correct, regular and not misleading.
6. Report as to additional matters [Sec. 227 (4-a)]: Under this section the central government has
power to direct, by means of a general or special order, that in the case of companies specified in such
order, the auditor’s report shall also include a statement on such matters as may be specified there in. in
exercise of this power, the central government issued the manufacturing and other companies order
1988, superseding the order of 1975, which has become effective from 1st November 1988.
7. Duty to sign report (Sec. 229): It is the duty as also the right of the auditor to sign the report
prepared by him, in case the auditor is firmed only a partner of the firm practicing in India, may sign the
report.
8. Duty as to statutory report [Sec. 165(4)]: After the statutory report has been certified as correct by
the required number of director, the auditor of the company must certify it as correct to the extent it
relates to: a) Shares allotted by the company. b) Cash received in respect of such shares and c) Recei8pts
and payments of the company.
9. Duty as to prospectus [Sec. 56 (1)]: The format of the prospectus as given in Schedule II of
companies act has been revised effective from 1st November 1991. According to the revised Part II of
Schedule II, the prospectus of company will include a report by the auditor as regards the following:
a. Profits and losses and assets and liabilities in accordance with whether the company does or does
not have subsidiaries;
 b. The rate of dividend paid by the company in respect of each class of shares in the company for
each of the five financial years preceding the issue of the prospectus;
c. If any proceeds of the issue of shares or debentures are to be applied in the purchase of any interest
in any business exceeding 50% by way of capital or profits.
d. If any proceeds of the issue of shares and debentures is to be applied by the company to acquire
shares in any other body corporate which has the effect of making that body corporate a
subsidiary of the company.
e. The manner how the profits and losses of the other body corporate would in respect of the shares to
be acquired have concerned members of the company what allowance would have to be made in
relation to the assets and liabilities of other shares.
f. If the other body corporate has subsidiaries then the report will deal with the profits or losses and
assets and liabilities of the body corporate and its subsidiaries in the prescribed manner.
10. Duty as to report under voluntary winding up [Sec. 488 (2)]: Where a company has been wound
up voluntarily, and the required number of its directors has made declaration as to its solvency, the
declaration shall have no effect unless it is accompanied by a report if the auditor as to the Profit and
Loss Account and balance Sheet. Thus, the auditor is under a duty to prepare such report, as far as
circumstances admit, in accordance with the provisions of the Companies Act.
11. Duty to assist investigation (Sec.240): Where an inspector is appointed under Sec.235 or 237 to
investigate the affairs of the company, it is the duty of the auditor to preserve and to produce to the
inspector all books and papers of or relating to the company which are in his custody or power; and
otherwise to give to the inspector all assistance in connection with the investigation which he is
reasonably all to give.
Statutory duties not to be curtailed
The duties of an auditor as prescribed by the law, cannot in any way be curtailed either by the articles
or by the directors, or members though a company is always free to enlarge the scope of his duties by
passing a resolution at the general meeting, or making a provision in its articles.
B. Duties under common law:
1. Duty to perform contract: The auditor is under a duty to the party who has appointed him, and this
duty is discharged when he has performed the terms of the contract between him and the other party. As
already seen, the scope of statutory duties of a company auditor cannot in any way be curtailed. But
where it has been enlarged by passing a resolution at the general meeting or by making a provision in the
articles, the auditor has a duty to perform the additional work.
2. Duty of care and caution: The auditor holds himself out as an expert and must act honestly and
exercise due care and caution in the performance of his engagement. As an expert, he cannot claim
ignorance as a defence. He must prove that in the course of his audit he has employed skills that would
reasonably applied by any other auditor.

SPECIAL AUDIT U/S 233A: Sec. 233A deals with the powers of the central government to direct special
audit in the case of a company subject to certain conditions.
When special audit may be ordered: Where the central government is of opinion-
1. That the affairs of any company are not being managed in accordance with sound business principles
or prudent commercial practices; or
2. That any company is being managed in a manner likely to cause serious injury or damage to the
interests of the trade, industry or business to which it pertains; or
3. That the financial position of any company is such as to endanger its solvency.
APPOINTMENT OF SPECIAL AUDITOR:
The auditor for undertaking special audit is to be appointed by the central government. The person to
be appointed a special auditor must be a chartered accountant within the meaning of the Chartered
Accountants Act., though it is not necessary that he should also be in practice. The company’s own auditor
may also be appointed by the central government to conduct the special audit.
REMUNERATION:
All expenses concerning the special audit, including the special auditor’s remuneration shall be
determined by the central government and paid by the company. Determination of such expenses by the
central government shall be final.
RIGHTS OF SPECIAL AUDITOR:
The special auditor shall have the same rights, powers and duties as the auditor of a company under
Sec.227. But he will, instead of making the report to the members of the company, make the same to the
central government. Some important legal rights/ powers of the special auditors are outlined as under:
1. Right of access of books of accounts and vouchers: The auditor has a right to access at all times to
the books and vouchers of the company whether kept at the head office or elsewhere. It provides in
Sec.227 of the Companies Act at all times means at any time during the business.
2. Rights to receive information and explanation: A special auditor has a right to receive from the
directors and responsible officers of the company and information and explanation as he may think
necessary for the performance of his duties as an auditor. This is also an important power in the hands of
an auditor.
3. Rights to receive particulars: The auditorhas a right to get from an office or other person any
particulars or information required to be given in the balance sheet or profit and loss account of a
company or in any document required to be annexed or attached thereto. This is given in section 221.
4. Right to receive notices and attend general meeting: The auditor has a right to receive notices and
other communication relating to general meeting in the same way as a member of the company. this is
given in section 231.
5. Right to visit branches: According to section 228, the auditor has a right to visit the branch office
of the company if any, if the accounts of the company branch have not been audited by a duly qualified
auditor. He shall be entitled to visit the branch office if he deems it necessary to do so for the
performance of his duties as an auditor.
6. Right to seek opinion from experts: The auditor has a right to seek opinion of experts in different
fields, whenever he feels it necessary as he is not expert in all the areas. For example, he may seek
opinion or advice from bankers, engineers or lawyers.
7. Right to receive remuneration: The auditor is entitled to demand his remuneration from his client
after he has completed the work of auditing. Even if he is dismissed in the middle, he has the right to get
full remuneration of the year.

DUTIES OF SPECIAL AUDITOR:

The various duties of a special auditor imposed upon him by the Companies Act, are as follows:
1. Duty to submit report: It is an important duty of an auditor. Section 227 (2) and (3) provides that
the auditor shall make a report, to the members of the company, on the accounts examined by him. The
report so submitted shall contain the following:
a. Whether in his opinion, the profit and loss account referred to in his report shows a true and fair
view of profit and loss.
b. Whether in his opinion, the balance sheet referred in his report is properly drawn up so as to show
a true and fair view of the state of affairs of the business.
c. Whether the auditor has obtained all the information explanation which to the best of his
knowledge and belief was necessary for the purpose of his audit.
d. Whether in his opinion, proper books of accounts as required by law have been kept by the
company so far as appears from his examination of those books.
e. Whether the report on the accounts of any branch office auditor under the section 228 by a person
other than the company’s auditor has been forwarded to him and how he had dealt with the same
in preparing the auditor’s report.
f. Whether the company’s balance sheet and profit and loss account dealt with by the report are in
agreement with the books of accounts and returns.
2. Auditor’s duties to enquire into the affairs: Without prejudice to the provision to section 227(1A)
the special auditor shall enquire:
a. Whether loans and advances made by the company on the basis of security have been properly
secured and whether the terms on which they have been made are not prejudicial to the interest of
the company or its members.
b. Whether transactions of company which are represented merely by book entries are not prejudicial
to the interest of the company.
c. Whether the company is not an investment company within the meaning of Sec.372 of banking
company, whether so much of assets of the company.
 d. Whether personal expenses have been charged to revenue account.
e. Whether it is stated in the books and papers of the company that any shares have been allotted for
cash, whether cash has actually been received in respect of such allotment and if no cash has been
actually been received, whether the position as stated in the accounts books and the balance sheet
is correct, regular and not misleading.
3. Other statutory duties:
a. Under section 56(1), the prospectus issued by the existing company shall contain a report from the
auditor of the company regarding- a) profits and losses; b) assets and liabilities of company and its
subsidiary; and c) rates of dividends paid by the company for each of the five financial years
preceding the issue of prospectus. It is auditor’s duty to submit his report.
b. The auditor has to certify the statutory report as correct according to section 229 of the act.
c. The auditor has to sign the report u/s 229 of the act.
d. Section 240 of the act imposes a duty on the auditor in the event of investigation of the affairs of a
company as to give to the inspector all the help in connection with the investigation.
e. When a company goes into a voluntary winding up and a declaration of solvency is made by its
director’s u/s 488(1) such a declaration is to be accompanied by the report of the auditors of the
company u/s 488(2). It is duty of the auditor to make such a report.

DIRECTIONS FROM CENTRAL GOVERNMENT:

The central government may by order, direct any person to furnish to the special auditor within the
period specified, such information or additional information, as may be required by the special auditor in
connection with his special audit.

SPECIAL AUDITORS REPORT:

The report of the special auditor, as far as may be, include all the matters required in the auditor’s
report u/s 227 and as the central government directs, shall also include a statement on any other matter
which may be referred to him by the government.
u/s 227 (2), the special auditor is required to make a report to the central government- a) on the
accounts examined by him; b) on every balance sheet and profit and loss account which are laid before the
company in the general meeting during his tenure of office; and c) on every document declared to be a part
of or annexed to the balance sheet and profit and loss account.
The auditor’s report must state whether in his opinion, and to the best of, as consist of shares,
debentures and other securities have been sold at a price less than at which they are purchased by the
company. Whether loans and advances made by the company are shown as deposits.
His information and according to the explanations given to him, the said accounts give the information
required by this act in the manner so required and give a true and fair view- a) in the case of balance sheet of
the state of the company’s affairs as at the end of the financial year; and b) in the case of the profit and loss
account of the profit or loss of the financial year. Perusal of the legal requirements as regards an audit report
shows that the report has to be in two parts, namely a) scope of the audit; and b) opinion of the auditor as
regards to financial statement.
1. Scope part: The first part of the special audit report describes the scope of the audit and the
statements examined. It states in a matter of fact subject matter of audit examination are the accounts and
balance sheet and profit and loss account as a whole, it is being prescribed under the law and therefore
the scope of the examination cannot be in any way be curtailed.
Accordingly, the auditor is required to state in his report-
a. Whether he has obtain all the information and explanation which to the best of his knowledge and
belief were necessary for the purpose of the audit;
b. Whether in his opinion, proper books of accounts as required by the law have been kept by the
company so far as appears from his examination and proper returns adequate for the purpose of his
audit have been received from branches not visited by him.
c. Whether the report on the accounts of any branch audited u/s 228 by a person other than the
company auditor has been forwarded to him and how he has dealt with the same preparing his
report;
d. Whether the company’s balance sheet and profit and loss account dealt with by the report are in
agreement with the books of accounts and returns.
 2. Opinion part:The second part of the standard audit report is concerned with expressing the auditor’s
opinion with regard to that objectof review. The opinion covers the truth and fairness of the accounts and
balance sheet and profit and loss account, their conformity with the generally accepted accounting
principles and legal provisions, maintenance by the company of proper books of accounts as required by
the law, branch accounts not directly audited by him, and consistency of the accounts and balance sheet
and profit and loss account with the books of account and returns.
3. Special matters to be included in audit report:In addition to the requirements of section 227(2)
and (3) the auditor may also be required to report his opinion in regard to certain other matters. This can
be in respect of certain specified transactions of any company, or special matters in case of banking,
insurance, electric supply, manufacturing and other companies.

UNIT – V
INVESTIGATION AND ELECTRONIC DATA PROGRAMMING SYSTEM

MEANING OF INVESTIGATION:
An investigation may be defined as a close examination of the accounts and records and a search for
the relevant data, with a view to ascertaining any fact for some special purpose, e.g., to acquire authoritative
information, or seek confirmation with regard to a stated fact, or for a resolution or a doubt. Being a special
purpose examination, it has some exclusive features important among which are as follows:
1. Scope: The scope of the investigation is limited as regards the period or areas to be covered. An
investigation on behalf of a person proposing to buy or sell a business will, for example, be only
concerned with determination of the value of assets, reserves and liabilities of the business and its
existing potential and future prospects.
2. Objects: The object of an investigation is to collect, analyze and evaluate facts with a view to some
special purpose as determined by the person on whose behalf the investigation is undertaken.
3. Audit programme: It is not possible to envisage a standard audit programme as regards an
investigation.
4. Audit procedure: The audit procedure is extraordinary and extended.
5. Approach to the work: An investigation proceeds along a specific frame of reference. Investigator
subjects the entire data and information to a close scrutiny, applying for stricter standards of
evidence and proof.
6. Report: The report of an investigation is made to the person on whose behalf the investigation has
been undertaken.

OBJECTS OF INVESTIGATION:
Following are the usual circumstances, which most frequently call for various types of
investigations:
i. Investigation on behalf of a person who intends to join an established partnership.
ii. Investigation to find out the earning capacity of the running concern proposed to be taken over on
behalf of an individual, partnership firm or a joint stock company.
iii. Investigation in case of suspected fraud- misappropriations defalcations, theft of cash and other
property of the concern.
iv. Investigation on behalf of a person who wants to lend money to a concern. He would lie to know the
financial position of the concern.
v. Investigation on behalf of a prospective shareholder.
vi. Investigation for claims under as insurance policy covering consequential losses.
vii. Investigation under the Indian Companies Act, 1956, there are provisions in law where the
shareholders, creditors, registrar of joint stock companies and the central government may get the
affairs of the company investigated.

APPROACH TO INVESTIGATIONS AND REPORT:

The exact procedure to be followed in an investigation would very much depend upon the purpose
for which the investigation has been undertaken. It is not possible to lay down and standardized procedure.
However, the investigators should bear in mind the following aspects:
 1. Identification of objectives: Before starting an investigation, the investigator should obtain from his
client, clear instruction in writing regarding the objectives of the investigation, the period to be
covered and the limits imposed upon the extent of his inquiry.
2. Formulation of programme of investigation: A professional accountant should chalk out his
investigation programme according to the purpose of the investigation, the period to be covered and
other relevant things. He should not completely rely upon the audited accounts of the undertaking
under investigation.
3. Examination of records and collection of evidence: The exact nature and the extent of work to be
done during the course of an investigation would depend upon the circumstances of such case.
Where the aid of experts is necessary, it should be obtained and the report of such experts must be
attached to the investigation report. An investigator should also maintain his working papers properly
for future reference.
4. Analysis of findings and preparation of report: He should also keep full record of data and oral
conversation held with various personnel of the concerned business or the evidences examined
during the period of investigation for future reference and for finalizing his report. He should analyse
the data and the evidences or explanations collected by him and formulate the conclusions to be
presented in his report.
Finally, the investigator should prepare his investigation report after the completion of his
work. His report of the investigation must be drafted carefully. The report should be precise, clearly
worded and to the point. It should include the terms of reference clearly, stating the objectives of the
investigation, the scope of the study and the limitations imposed if any.

PROCEDURE FOR INVESTIGATION:

1. The professional accountant must acquaint himself duly with the nature of fraud.
2. He must secure a complete list of the books of accounts maintained by the concern and devise the
procedure of the investigation accordingly.
3. He should make enquiries and test check the system of internal check in regard of cash receipts and
payments.
4. He should also know the respective duties of the employees in order to find out what opportunities
they have for misappropriation.
5. He should thoroughly examine the system of recording cash sales besides paying attention to receipts
as shown by the cash memos and must carefully check the cash sale summary and tally it with entries
in the cash book. Sometimes, cash collected by the travelling salesmen of money received by money
order or cash sales of scrap or waste or from debtors previously written off may be misappropriated.
He should pay special attention to these cash receipts as they may be omitted from the books of
accounts.
6. The missing cash memos or any alterations on the cash memos must be closely scrutinized and
proper explanation must be asked for.
7. He must compare the counterfoils of paying in slip with the entries in the cash book. If there is any
difference between the tw3o, a proper explanation must be asked for.
8. The payments in respect of salaries and wages should be verified to ascertain that they are bonafied
and are duly authenticated. Dummy workers may be included in the wage sheets or the totals of the
wage sheets may be over cast and excess amount misappropriates. Sometimes, excessive payments
are made to some daily wages with prior arrangements to share the differences.
9. All cash payments must be vouched and duplicates of all missing vouchers should be asked from.
10. The petty cash must also be vouched. It is usually seen that petty cash transactions provide many
possibilities of frauds.
11. Receipts from the debtors should be vouched from the counterfoils of receipt books into the cash
book and from there to the credit of the customer’s account. Investigator should also verify actual
balances standing against their names by writing also letters to the debtors.
12. He must pay attention to transactions related to bills as well as examine the bills in hand. Sometimes,
bills might have been paid, amount received is being misappropriated and such bills might have been
shown as bills dishonored for non-payment.
13. An entry of unusual discount or allowance must be enquired into, as misappropriation can be done
by showing discount more than actually allowed.
 14. Investigator should see that the cash received from one customer is correctly credited to that
customer’s account. Sometimes, cash received from one customer is misappropriated and cash
received from another customer is credited to the first customer’s account and latter on when cash is
received from another customer, it is credited to the second customer and so on.
15. List of bad debts should be examined. Sometimes, money might have been received from the debtors
written off earlier and the amount received is misappropriated.
16. He should obtain the names of the person responsible for signing and endorsing the cheques.
17. Investigator should make full note of all the irregularities discovered and must probe into these
matters.

INVESTIGATION UNDER THE COMPANIES ACT:

Section 235 to 251 of the Companies Act, 1956, provide for the investigation into the affairs of a
company. The first type of investigation into the affairs of a company falls under sections 235 or 237
including investigations into the affairs of the related companies under sections 239. The term affairs of a
company implies to an investigation into all the business affairs of the company i.e., profit and loss,
investment, shareholdings in subsidiary companies, contracts or any other matters. The second types of
investigations are about the ownership of a company or into the associations with its ex-managing agents
under Section 247 and 249.
Investigations into the affairs of the company:
The central government may appoint one or more competent persons as inspectors or investigators to
investigate into the affairs of the company and to report thereon in the manner directed by it.
Member’s application:
 In the case of a company having share capital, on the application of 200 members or members
holding not less than one tenth of the total voting power therein it can make an application in this
regard u/s 235 (a) and
 In the case of a company not having share capital, on the application of not less than one fifth of the
members of the company, it can make an application in this regard u/s 235 (b).

According to section 236, when members apply for investigation, they must support their application
by evidence and give a security of one thousand rupees towards the cost of investigation. The evidence
must show the applicants have good reason for requiring the investigation.
On the report by the registration of joint stock companies,
i. If the registrar of the companies makes a written report to the central government that the company
has not furnished certain information or explanations as asked for from the company; or
ii. The information or explanation supplied to him by the company is unsatisfactory; or
iii. The company does not make a full and fair disclosure of the facts; or
iv. The business of the company s carried on for a fraudulent or unlawful purpose u/s 235 ©.
The central government has to appoint inspector for investigators to investigate into the affairs of the
company in the following 2 causesu/s 237 (a)
i. When the company by a special resolution of the court demands an investigation u/s 235 (a); or
ii. When the court, by order, declared that the affairs ought to be investigated by the inspector appointed
by the central government.
The central government may appoint investigators if it appears, u/s 237 (b):
1. That the business of the company is being conducted with intent to defraud its creditors, members or
any other persons dealing with the company; or,
2. That the business of the company is conducted for a fraudulent or unlawful purpose or in a manner
oppressive to any of its members or that the company was formed for any fraudulent or unlawful
purpose; or’
3. That the person concerned in the formation of the company of the management of its affairs have in
connection there with been guilty of fraud, misfeasance or other misconduct towards the company or
towards any of its members; or’
4. That the members of the company have not been given all the information with respect to its affairs
which they might reasonably expect including information relating to the calculation of the commission
payable to the managing or other director or manager of the company.
Investigation on behalf of a person who intends to join an establish partnership business as a partner
or on behalf of an incoming partner:
The object in view for such investigation is to find out whether it will be advisable or not for the
client to join the firm. In order to arrive at such a decision, the following points must be examined by the
professional accountant.
1. He should ascertain the bonafide reasons as to why partners of the firm are allowing a new person to
join their business.
2. He should find out whether the capital to be controlled by him or settling claims of a retiring partner or
a deceased partner or it would be utilized for the expansion of the business.
3. He should find out whether the amount of goodwill to be paid by his client in a reasonable one. He
should examine the past earnings and future prospects of the business and then he should recommend
the amount of goodwill which is client should pay. He should also ascertain as to how the goodwill
shall be written off from the books of accounts.
4. He should give special attention to the earning capacity of the business. He should make a comparative
study of the trading and profit and loss accounts for the periods covered by the investigation in order of
to ascertain the true earnings of the business. He should examine purchases, sales, stocks and expenses,
of the business and the percentage of profits on turnover.
5. He should examine the balance sheet of the firm and ensure that the valuation of the existing assets and
liabilities are as per the rules of valuation and assets are not shown at inflated values and no liabilities
are omitted.
6. He should ascertain the probable amount of profit which the incoming partner may expect to receive
from the business. It will help him to know whether his client will be able to get a fair return on his
capital contribution or not.
7. He should see whether any specialized or technical knowledge is necessary for the successful conduct
of the business. If the existing partners possess that knowledge and his client does not, the extent to
which he will find himself handicapped needs to be known.
8. He should study the terms of proposed partnership agreement, and the ‘partnership deed’ of the existing
partners to know their capital contribution, drawing rights, jobs allocation, financial management
system etc., in order to ascertain the fairness and reasonableness of the proposed agreement from the
point of view of his clients interest.
9. If the new partner is required to step into the place of a retired or deceased partner, the investigator
should enquire into the effects and consequences of such a death or retirement of a partner on the
business of the firm.
10. Investigator should also make enquiries about the financial standing of the existing partners.

Investigation on behalf of a purchaser to ascertain the earning capacity of a running business.

When someone intends to purchase an existing business as a going concern, he should be interested
to know the reason for the sale of the business, the earning capacity, the correct values of the assets and
liabilities to be taken over, reasonability of the purchased concern, estimation of the value of goodwill and
the probable future prospects of the business. Therefore, he should pay attention to the following points:
1. He should make a thorough enquiry into the reasons which cause the present proprietor to sell the
business.
2. He should find out whether the business requires particular skill or influence. In case the concern
requires special type of skill which the purchaser may not possess, it would not be in his interest to
invest money in such a concern.
3. He should make sure that the assets and liabilities have been properly valued.
4. He should see that the assets and liabilities are shown in the balance sheet at their correct values and
proper provision for bad and doubtful debts and depreciation has been made.
5. The goodwill of the concern should be properly valued and the auditor should study the basis of its
valuation.
6. He should also see the present conditions of the various plants, and machinery’s. It will help him in
finding out the future life of these important assets.
7. He should examine the previous year’s audit report, if any
8. Actual profit of a business may be quite different from it net profits as disclosed by the profit and loss
account. He should therefore, ascertain the true earning capacity of the concern, he should do the
following things;
a) He should make careful examination of is profit and loss account for the period covered by the
investigation.
b) He should re-draft the profit and loss account in a tabular form. This will facilitate comparison of
figures for several preceding years. This will facilitate comparison of figures for several preceding
years. If there has been any change in the accounting policies during these years, the figures may
be re-adjusted so as to set them out on a uniform pattern.
c) He should make a careful examination of the accounts of the previous years in order to see that
there has been no attempt at window dressing.
d) He should undertake detailed examinations and vouching of the books of accounts, particularly of
capital and revenue expenditure as well as the deferred revenue expenditure.
9. He should find out the amount of working capital and ensure that it is sufficient to carry on the
business.
10. He should also see the terms of contract with the existing employees.
11. He should examine the condition of stock-in-trade.
12. He should make full enquiries regarding the verification and valuation of stock-in-trade. This item is
subject to greater manipulation.
13. The amounts of debtors and creditors to be taken over should be thoroughly checked.
14. He should examine the memorandum of association, articles of association and the prospects of the
company.
15. He should find out the amount of authorized, issued, called up and paid up capital of the company. He
should also note down the amount of uncalled capital and the calls in arrears.
16. He should examine the rights attached to the different classes of shareholders of the company.
17. He should also enquire about the rate of dividend which has been paid by the company to its
shareholders in the last three to five years.
18. He should find out the present value of the share from the stock exchange.
19. He should also make a correct valuation of all the assets and the liabilities of the company.
20. He should also inspect the ’register of mortgages and charges’ to ascertain mortgages and charge etc. on
the assets of the company.
21. He should also seek information regarding the price to be paid for the shares of the company.

Investigation on behalf of a lender of money:

Generally, scheduled banks or any indigenous banker and the financial institutions are the main
sources from where one can borrow money. Therefore, these institutions would like that the financial
position of the borrowing concerns is thoroughly examined before they lend money. The main objective of
appraisal is to judge whether and applicant will be able to generate sufficient funds to pay interest on the
loans and repay the principal amounts as per the terms of loan agreement. For this purpose financial
institutions conduct a special review of the technical, commercial and managerial aspects of the project for
which the loan application has been made before the grant of loans. A copy of the projected financial
statements for the following 5 to 7 years and the protected cash flow statement which shows the impact of
future activities on the cash portion shall be obtained from the applicants. It is through the examination of
these various statements that the future repaying capacity of the applicants can be determined.
After a careful scrutiny of these statements (financial; and cash flow) And the projected financial statements,
an investigator must examine the following to establish correctness of these statements:
 Gestation period
 Capacity utilization
 Cost structure
 Taxation, and
 Debt- equity rates.
Besides the above points, the investigator should also pay attention to the following points:
1. The circumstance which have been rise to the need for loan. Sometimes, the additional fund is required
by the enterprise as its funds have been locked in some unproductive or speculative purpose.
 2. He shall ascertain the exact financial standing of the firm by preparing schedules of all the assets of the
firm. In this way, he will also find out the schedules of all the assets of the firm. In this way, he will
also find out the repayment capacity of the enterprise.
3. He will collect complete data about the existing liabilities, their duration and rate of interest. He should
also ascertain the details with regard to the contingent liabilities, if any, of the borrowing enterprise.
4. The income-tax assessment of the enterprise based on the accounts of the last two to three years.
5. The nature and the exact value of the securities offered for obtaining loans. In case of a public limited
company, the position of mortgages may be found out with the help of the registrar of mortgages.
6. He should also ascertain the ration of current liabilities to liquid assets.
7. He should also obtain the names of the officers of the enterprise and should make full enquiries about
the abilities, experience, character and integrity etc. of these persons.
8. Particulars of any capital commitments of the enterprise.
9. He should also find out the normal earning capacity of the borrowers.
10. In case an applicant is a public limited company, had shall ensure that the proposed loan is within the
borrowing power of the company he will also obtain a list of directors and their antecedents.

An investigation on behalf of a prospective shareholder:

The shares of a private limited company cannot be sold or purchase in the open market. Therefore,
the articles of association for a private company may empower that the shares may be transferred, only to
the existing shareholders of the company, at a fair value. The fair value can be determined by the auditors of
the company but still the prospective purchaser would like to seek the advice of an investigator to know their
fair value before purchasing such shares. The investigator, while determining the fair value of shares, must
consider the following points:
i. Safety to the capital,
ii. Earning capacity of the business.
iii. Any old sale and purchase price of the shares, and
iv. Current level of dividend.
After collecting the above info, he starts the work of finding out the ‘fair value’ of the shares. He can
determine it by applying two methods:
1. On the basis of average past profits, and
2. On the net assets of the company. Here, the net assets mean the book value of assets minus
liabilities (all types of outside creditors.)
It shall also be useful if the investigator finds out general business trend, capital and money market
position, resources and abilities of management, dividend policy and adequacy of reserves etc.,
POWERS OF INSPECTOR [SECTION 240]:
According to section 240, it is obligatory for all officers, employees and agents of the company or
related body corporates under investigation to preserve and to produce to the inspector all books and papers
of the company which are in their custody and are also required to give to the inspector all the assistance in
connection with the investigation. With the previous approval of the central government, the inspector can
also ask any body corporate to furnish such information or produce such books into the affairs of the
company. The inspector can keep such books and papers in his custody for a period of six months. The
inspector also has employees of the company under investigation. Where an inspector finds that a person,
who he has no power to examine on oath, ought to be so examined, he may apply to the central government
for necessary permission. Penalties have been prescribed for persons who do not appear or produce books,
documents and other required information before the inspector.
Section 240 (A) gives power to the inspector to make an application to first class magistrate and
obtain in a order for the seizure of such books and papers of the company under investigations to of any
related body corporates or of the managing director or manager of the company or the body corporate, if he
has reasonable ground to believe that relevant books or papers may be destroyed or falsified. The order may
also authorize him to enter the place where such books are kept, to search the place and seize them. He can
make identification marks on all such documents and books. At the conclusion of the investigation, the
investigator must return all the documents and books.

INSPECTOR’S REPORT:
 The inspector has to prepare and submit an interim report or a final report to the central government.
The government is bound to forward a copy of the report to the company at its registered office and also to
any related bodies corporate under investigation or managing agents, secretaries or treasurers or associates
dealt with in the report by virtue of section 239. Where the inspector was appointed on the application of the
members, a copy of the final report is to be furnished to them and where he was appointed on the court’s
order, a copy must be sent to the court. The government may publish the report and other interested parties
may obtain it on payment of the prescribed fee.
Section 242 to 244 deal with the follow up of the inspector’s report and state if the inspector’s report
shows that any person has committed any offence for which he is criminally liable, and the government
may, on the basis of their report apply to the court for the winding up of the company or make an application
for and order for the prevention of oppression and mismanagement u/s 297 and 298. If it appears from the
report that some fraud, misconduct or misappropriation-misapplication of property has been committed, the
central government may institute proceedings for the recovery of damages regarding fraud or misconduct or
for recovery of the misapplied property.
Section 246 states that the inspector’s report shall be admissible in any legal proceedings as evidence
of the opinion of the inspector in relation to any matter contained in the report.
The expenses of the investigation are to be defrayed in the first instance by the central government.
However the government is entitled to be reimbursed by any person who has been convicted on the
prosecution instituted in pursuance of the report or required to pay damages as result of the report.
The company in whose name proceedings are brought is also bound to reimburse the government.
Reimbursement can also be made from any managerial personnel dealt with by the report and from the
applicants.
Section 250 (A) of the Companies Act, provides that an investigation under the provisions of Section
235-249 can be initiated even if the company has passed a special resolution for the voluntary winding up or
if an application has been made for and order u/s 397 or 398 of the Act.

ELECTRONIC DATA PROCESSING (EDP):

With the seemingly unending innovations in information technology, resulting in higher capacities
and lower costs of computers, all business organizations are increasingly using computers for data
processing, often referred to as Electronic Data Processing or EDP.
EDP system consists of equipment known as hardware and software. The hardware consists of
components such as CPU and other peripherals. The CPU is having
a) Control Unit.
b) Storage Unit.
c) Arithmetic Unit.

CHARACTERISTICS OF AN EDP ENVIRONMENT:

There can be different types of EDP environments, each having its own special feature. For example,
an EDP environment where stand-alone personal computers are used may have different characteristics as
compared to a situation where a complex system is operating. However, despite these differences, there are
certain characteristics, which are more or less common to all EDP environments.
1. Organisational Structure and Procedures: The organizational structure and procedures to manage
the functions of EDP in an entity are generally such that there is a concentration of different jobs, of
knowledge regarding the system, and of programs and data.
2. Specialized Knowledge: In an EDP environment, the number of persons involved in the processing
of information is significantly lower than that in a manual system. This means that certain
conventional controls which are based on segregation of incompatible functions may not exist or may
be less effective. Moreover, it often happens that certain EDP personnel acquire a specialized
knowledge of sources and processing of data as well as the distribution and use of output. They may
be in a position to alter programs or data. Many computer frauds are known to have occurred because
of this reason.
3. Central Computer Installation: The organisational structure in EDP environments is generally such
that most programs and data are concentrated at one location or, at best, at a few locations as in the
case of distributed data processing system. It is therefore easier to access the data and programs and
alter them.
 4. Controls: General Controls and EDP Application controls
General controls: If general controls are ineffective, there may be potential (ability to develop) for
material misstatement in each computer based accounting application. It is related to all parts of the
EDP system and they apply to any one application, to ensure the integrity of application development
and implementation and to ensure that computer operations are properly administered to protect
hardware, programmes and data files. There are five main types of general controls:
a. Organization of EDP department - There should be segregation of duties within EDP
Department, so as to prevent EDP personnel from authorizing and recording transactions to hide
theft of assets, and to minimize the possibility of recording and processing errors. In principle, no
one individual should be able to (a) access the data; (b) alter the computer system or programme,
and (c) access the computer.
b. Application Development and Maintenance Controls - to ensure that the client adequately
controls computer programmes and related documentation.
c. Hardware Controls - are built into the equipment by the manufacturer to detect equipment failure.
d. Access to Computer Equipment, Data Files and Programmes - for safeguarding EDP
equipment and records. It is accomplished through locked doors, segregation of duties, locked
cabinets containing data files, passwords or security codes and reports of jobs run on the computer.
e. Data or Procedural Controls - Copies of all important files and programmes should be kept “off
site”. This may prevent losses due to accidental erasure, intentional vandalism (damage / destroy),
or catastrophic loss (e.g. because of fire).
Application controls: Controls specific to a particular accounting application. It is to ensure the
completeness and accuracy of all processing and the validity of the accounting entries made. There
are four main types of application controls:
a. Input controls - to assure that the information processed by the computer is valid, complete, and
accurate. Common input controls include check digits, batch totals, cash totals, limits or
reasonableness tests, validity checks etc.
b. Processing controls - to assure that data input into the system is accurately processed. Common
examples include control totals, logic tests, and completeness tests.
c. Output controls - to assure that data generated by the computer are valid, accurate, and complete.
d. Controls over Master File information - Many transactions depend on the accuracy of
information in the Master File. For example, all sales transactions depend on price list, or all
payroll amounts depend on hourly rate or salary rate. User departments should get periodic reports
containing the contents of the Master File. There should be procedures in place to verify that the
correct version of the Master File is being used.

CHARACTERISTICS OF COMPUTERIZED ACCOUNTING SYSTEMS

1 Audit trail: A transaction trail that can be used for audit purposes might only exist for a short
period of time or only be in computer readable form. This is because computerized accounting
systems eliminate some steps and some documents used that would otherwise be present in manual
systems.
2 Nature of processing errors: Clerical errors are ordinarily associated with manual processing. In an
EDP environment, processing errors are mainly caused by programming errors or systematic
errors in the hardware or software. Furthermore, in computerized systems, data must be converted
into machine-readable form; this introduces the possibility of input errors, which are supposed to be
detected by input controls.
3 Central processing of transactions: When transactions are centrally processed in an EDP
department, sometimes many incompatible functions are combined. To keep incompatible duties
separate, segregation of duties is often established.
4 Alteration of data or files: Permanent data (such as a worker’s hourly rate) stored in master file can
often be altered without being detected; this kind of fraud may not be detected for a long time.

DIFFERENCE BETWEEN MANUAL SYSTEM AND EDP SYSTEM:

The procedure for processing of transactions in an EDP environment differs from a manual
environment in several ways, as discussed below.
 1. Absence of Input Documents: In manual accounting system, a transaction is recorded on the basis
of a supporting document, e.g., voucher, invoice, receipt, etc. However, such documentation may not
always be available in the case of computerized system, where some data may be entered directly
into the system without supporting documents. For example, in an online system, sales transaction
may be fed into the computer directly by the salesman without there being any supporting document.
Similarly, some transactions may be generated by the system itself based on program instructions,
e.g., credit of interest on deposit accounts in a bank.
2. Lack of visible transaction trail: The transaction trail or the audit trail refers to the successive
stages in the recording of the transaction in the books of accounts through which an auditor may be
able to trace accounting entries in the books back to their initiation and vice versa. In a manual
accounting system, there is generally a transaction trail for every transaction as shown in the diagram
below:
Audit Trail Under Manual Accounting

Documentation, Entr Prime books of Postin Principal books, Financial

voucher, invoice, accounts, journal, g day books, etc. statements,
receipt, etc. etc. ledgers, etc.

First recognition Chronological Classification by Output

of transaction. classification. nature.
In an EDP environment, however, it is not necessary that every transaction is supported by a source
document or the posting in a principal book is made only after the related entry has been made in the prime
book.
3. Lack of visible output: In some EDP systems, the result of processing may not be printed or may be
printed only in a summary form. The lack of visible output may, in cases result in the need to access
data retained in files readable only by computer.
4. Ease of access to data and programs: In a computerized system, data and computer programs may
be easily accessed and altered at the computer or through terminals to remote locations. Thus, unless
appropriate controls are instituted, there is an increase potential for unauthorized access to, and
alteration of data and programs.
ADVANTAGES OF COMPUTER IN AUDITING:
The computer is increasingly used as an audit tool itself. Following are the advantages of computer if
used for audit purpose:
1. Detailed records: Much more detailed records and accurate and upto date records are readily
available for accounting purposes. This will improve upon the overall control of the management and
will assist the auditor in testing.
2. Repetitive ability: The auditor can place more reliance on a small volume of compliance testing.
3. Mathematical ability: The computers, as compared to the human being, have a high degree of
mathematical ability. The auditor thus needs less testing on his accounts.
4. Regular reconciliations: The computer offers the facilities of more regular and frequent
reconciliations which are otherwise performed only periodically.
5. Instant rejection and exception reports: The computer supplies both rejection and exception
reports instantly. The auditor will come to know of the standard of input from the quantity of
rejections. Exception reports facilitate management by exception.
6. Sophisticated techniques: The computer is a sophisticated technique which can be used by the
auditor to assist himself in audit testing. He may use test packs to determine whether the client’s
programme controls are working effectively.

COMPUTER-ASSISTED AUDIT TECHNIQUES (CAAT):

CAATs are computer programs and data that the auditor uses as part of the audit procedures to
process data of audit significance, contained in an entity’s information systems
CAATs may be used in performing various auditing procedures, including the following:
1. Tests of details of transactions and balances, for example, the use of audit software for recalculating
interest or the extraction of invoices over a certain value from computer records
2. Analytical procedures, for example, identifying inconsistencies or significant fluctuations;
3.Tests of general controls, for example, testing the set-up or configuration of the operating system or
access procedures to the program libraries or by using code comparison software to check that the version of
the program in use is the version approved by management ;
4. Sampling programs to extract data for audit testing;
5. Re performing calculations performed by the entity’s accounting systems.
Process of CAATs
The major steps to be undertaken by the auditors in the application of a CAAT are to:
a. Set the objective of the CAAT application;
b. Determine the content and accessibility of the entity's files;
c. Identify the specific files or databases to be examined;
d. Understand the relationship between the data tables where a database is to be examined;
e. Define the specific tests or procedures and related transactions and balances affected;
f. Define the output requirements;
g. Arrange with the user and IT departments, if appropriate, for copies of the relevant files or
database tables to be made at the appropriate cutoff date and time;
h. Identify the personnel who may participate in the design and application of the CAAT;
i. Refine the estimates of costs and benefits;
j. Ensure that the use of the CAAT is properly controlled and documented;
k. Arrange the administrative activities, including the necessary skills and computer facilities;
l. Reconcile data to be used for the CAAT with the accounting records;
m. Execute the CAAT application; and
n. Evaluate the results.
Techniques which use the computer itself for audit purpose are known as computer assisted audit
techniques. Some of these techniques are discussed below:
1. Test Decks: This is special set of input data prepared specifically to test a program or a set of
programs of the entity under audit. The test decks also known as test data or test packs include
transactions of different types illustrating all valid and invalid conditions. The test are run on the client’s
computer with programs of the client but under auditor’s supervision. The results on the computer are
checked against predetermined solution, calculated from the test data. The auditor can thus, test the
efficacy of the client’s program.
The auditor may prepare the data himself by including test transactions of all kinds. Alternatively, he
may select the transactions from the actual data of the client, without disturbing the live data. The
auditor can also make use of test data, if any, prepared by the internal audit department of the client.
Preparation of test data requires a good deal of expertise.
The type of transaction to be included in the test data should also be determined carefully. The data
should cover significant variations.
There are many advantages of using test data:
a. They provide an assurance about the correct functioning of the programs that are tested.
b. Once the basic data have been designed, the running costs are not very high.
However, test data involve certain limitations and difficulties:
a. The use of test data requires an expert knowledge of computers on the part of the auditor.
b. They also require computer time and their initial costs are high.
c. Moreover, testing of a particular program does not prove that the program was actually in
use.
Test data techniques are sometimes used during an audit by entering data (for example, a sample
of transactions) into an entity's computer system, and comparing the results obtained with
predetermined results. Auditors might use test data to -
i. Test specific controls in computer programs, such as on-line password and data access
controls;
ii. Test transactions selected from previously processed transactions or created by the
auditors to test specific processing characteristics of an entity's information systems. Such
transactions are generally processed separately from the entity's normal processing; and
 2. Facility for integrated test: A modification of the test data technique is integrated test facility.
Under this technique, the auditor makes arrangements with the enterprise for creating a dummy entity.
The test transactions for the dummy entity are processed along with the normal processing of
transactions of the enterprise. The results of processing of test transactions are compared with the
predetermined results to evaluate whether the programs being used in the entity correctly process the
transactions. The integrated facility technique ensures that the test transactions are run using the same
computer programs as are used for routine processing of the transactions of the enterprise. The
increasing power and sophistication of PCs, particularly laptops, has resulted in other tools for the
auditors to use. In some cases, the laptops will be linked to the auditors' main computer systems.
3. Generalized audit software: The auditor can also process the data relating to the enterprise using
his own programs. For examples, the auditor can run his own computer program to prepare the ageing
schedule of debtors on the basis of the data stored in the computer of the enterprise and then compare it
with the ageing schedule processed by the computer system of the enterprise.
In some cases, the auditors use audit software which is specially developed in the context of the
circumstances of a particular audit. In many cases, however, the auditors use what are commonly known
as generalised audit software.
A generalised audit software is set of computer programs that can perform certain data processing
functions such as reading computer files, selecting records, performing calculations, printing reports, etc.
generalised audit software have been developed by software development agencies and by large firms of
auditors.
4. Parallel Simulation: The use of an auditor-written program to process client data and
comparison of its output to the output generated by the client’s program. Auditor writes or
obtains a copy of the program that simulates key features or processes to be reviewed /
tested –
a. Auditor gains a thorough understanding of the application under review.
b. Auditor identifies those processes and controls critical to the application.
c. Auditor creates the simulation using program or Generalized Audit Software (GAS).
d. Auditor runs the simulated program using selected data and files.
e. Auditor evaluates results and reconciles differences.
f. Finds out the Out of date approach.
5. Tracing: Tracing means performing an electronic walk-through of the application’s internal
logic. Implementing tracing requires a detailed understanding of the application’s internal
logic. It is an excellent means of debugging / clear up i.e., detects and remove a faulty program.
Tracing involves three steps:
a The application under review must undergo a special compilation to activate the trace
option.
b Specific transactions or types of transactions are created as test data.
c The test data transactions are traced through all processing stages of the program, and a
listing is produced of all programmed instructions that were executed during the test.
Examples of such techniques include:
a Expert systems, for example in the design of audit programs and in audit planning and risk
assessment;
b Tools to evaluate a client's risk management procedures;
c Electronic working papers, which provide for the direct extraction of data from the client's
computer records, for example, by downloading the general ledger for audit testing; and
d Corporate and financial modeling programs for use as predictive audit tests.

USES OF CAAT:
1. Verification of calculations: The auditor may use GAS to determine the mathematical accuracy of
the calculations performed by the EDP system for the enterprise. For example, the auditor may
recalculate the depreciation on fixed assets, interest on debentures, wages payable to workers, etc.
2. Examination of correctness, consistency and completeness of the records: GAS may be used by
the auditor to examine the correctness, consistency and completeness of the records of the enterprise.
For example, the auditor may review the payroll files to determine whether they include any
terminated employees, review debtor balances to identify debts which exceed a certain amount or
 which are outstanding beyond the credit period, etc. in these cases, GAS examines the relevant
records and prints a list of those records which confirm to, or depart from, the criteria specified by
the auditor, e.g., debts overdue beyond the credit period.
3. Comparison of data obtained through other audit procedures with the records of the
enterprise: For example, the auditor may compare the balances as confirmed by the debtors with the
balances appearing in the records of the enterprise has to be first converted into machine-readable
form.
4. Compare data on separate file: The auditor can use GAS to compare data on different files of the
enterprise to determine whether the two sets of data match. For example, the auditor may compare
the basic salaries of employees as appearing in the payroll records with the corresponding
information appearing in the personnel records.
5. Summarizing the data: GAS may be used to change the format of data, or to resequence or
summarise them. For example, the auditor may resequence the inventor data by location for planning
the observation of stock taking. Similarly, the auditor may resequence the dispatch document
numbers to identify any missing dispatch documents.
6. Selecting statistical samples: The auditor can use GAS to select samples from data on computer
files. GAS can select statistical sampling, monetary unit sampling, etc. the auditor can also have the
samples data printed, e.g., the auditor can select the sample debtors and print the balances due on the
letters of requests for confirmation. GAS can also assist the auditor in evaluation of sample results.
7. Creation of Electronic Work Papers: Keeping electronic work papers on a centralized audit
file or database will allow the auditor to navigate through current and archived working
papers with ease. The database will make it easier for auditors to coordinate current audits
and ensure they consider findings from prior or related projects. Additionally, the auditor will
be able to electronically standardize audit forms and formats, which can improve both the
quality and consistency of the audit working papers.