AUDITING

By:- Utkarsh Singh Parihar

Unit 2
Internal Check System
Meaning of Internal Check

An internal check system is an arrangement within an organization where the work of one employee is
automatically checked by another. This system ensures that errors and frauds are minimized, and financial
records remain accurate.

According to Spicer and Pegler,

"An internal check is the arrangement of duties among members of a staff in such a manner that the work
performed by one person is checked independently by another person."

Objectives of Internal Check

• To prevent and detect errors and fraud.

• To ensure the division of duties so that no single employee has complete control over any financial
transaction.
• To maintain the accuracy and reliability of financial data.
• To promote efficiency and accountability within an organization.

Characteristics of a Good Internal Check System

• Proper division of work among employees.

• Cross-verification of transactions.
• Rotation of duties to prevent manipulation.
• Immediate reporting of any discrepancies found.
Advantages of Internal Check

• Reduces the chances of fraud and errors.

• Ensures efficient working of the organization.
• Saves time for auditors since preliminary checks are already done.
• Enhances the credibility of financial statements.

Disadvantages of Internal Check

• Can be expensive for small businesses.

• Employees may collaborate to commit fraud.
• Requires regular monitoring and updating.

2. Internal Control
Meaning of Internal Control

Internal control refers to the policies and procedures implemented by an organization to safeguard its assets,
ensure accuracy in accounting records, and promote operational efficiency.

According to the Committee of Sponsoring Organizations of the Treadway Commission (COSO),

"Internal control is a process designed to provide reasonable assurance regarding the achievement of
objectives related to operations, reporting, and compliance."

Objectives of Internal Control

• To protect business assets from theft, misuse, or loss.

• To ensure compliance with laws and regulations.
• To ensure the reliability of financial reporting.
• To improve operational effectiveness.
Components of Internal Control

1. Control Environment – The overall attitude and actions of management towards control procedures.
2. Risk Assessment – Identifying risks and taking steps to mitigate them.
3. Control Activities – Measures like approvals, verifications, and reconciliations.
4. Information and Communication – Effective flow of financial and operational information.
5. Monitoring – Regular review and evaluation of internal control effectiveness.

Types of Internal Control

• Preventive Controls – Designed to prevent fraud before it happens (e.g., segregation of duties).
• Detective Controls – Designed to detect fraud or errors after they occur (e.g., internal audits).
• Corrective Controls – Actions taken to correct identified problems (e.g., revising procedures).

3. Audit Procedure:

Vouching and Verification of Assets in Auditing

1. Vouching: Meaning, Importance, and Process
Meaning of Vouching
Vouching is the process of examining documentary evidence to verify the accuracy and authenticity of
transactions recorded in the books of accounts. It is a fundamental audit procedure that helps auditors confirm
whether the financial statements present a true and fair view of the organization's financial position.

Definition of Vouching

According to R.B. Bose, "Vouching means the examination of documentary evidence in order to ascertain the
accuracy of transactions recorded in the books of accounts."

Objectives of Vouching

• To ensure that all transactions recorded in the books have proper supporting documents.
• To verify that transactions are authorized and approved by responsible persons.
• To check whether transactions are recorded in the correct accounting period.
• To prevent fraud, errors, and misstatements in financial records.
• To confirm that transactions are in compliance with accounting standards and legal regulations.

Importance of Vouching

• Ensures Authenticity: Helps confirm whether recorded transactions are genuine and based on actual
business activities.
• Prevents Fraud and Errors: Detects fraudulent transactions and accounting manipulations.
• Verifies Accounting Accuracy: Ensures that transactions are correctly classified and posted.
• Supports Auditor’s Opinion: Provides strong evidence to support audit conclusions.

Types of Vouchers Used in Vouching

1. Primary Vouchers: Original documents such as bills, invoices, cash memos, and contracts.
2. Collateral Vouchers: Additional supporting documents like agreements, receipts, and confirmation
letters.
3. Internal Vouchers: Documents generated within the organization (e.g., purchase orders, salary slips).
4. External Vouchers: Documents from external parties (e.g., supplier invoices, bank statements).

General Principles of Vouching

 • Checking the Date: Ensuring transactions are recorded in the correct financial period.
• Checking the Amount: Verifying calculations and cross-checking with ledgers.
• Checking Authorization: Ensuring proper approval from management.
• Matching with Ledger: Ensuring recorded transactions correspond with supporting vouchers.
• Reviewing Nature of Transactions: Checking whether transactions are business-related and not
personal.

Process of Vouching

1. Collecting Supporting Documents: Gathering relevant invoices, bills, bank statements, contracts, etc.
2. Checking Authorization: Ensuring transactions are approved by the appropriate authority.
3. Matching with Books of Accounts: Verifying entries in the ledger with supporting vouchers.
4. Verifying Amounts and Calculations: Ensuring mathematical accuracy.
5. Confirming Transaction Legitimacy: Ensuring transactions relate to business operations and not
personal expenses.
6. Ensuring Proper Classification: Checking whether transactions are recorded under correct heads (e.g.,
capital vs. revenue expenditure).

Example of Vouching

• Purchase Transaction:
o Auditor checks the purchase invoice, purchase order, goods received note (GRN), and supplier
payment records.
o Ensures that the purchase is recorded correctly in the purchase ledger.
o Confirms that payment has been made to the correct supplier through bank statements.
• Salary Payment:
o Auditor verifies the salary register, employee attendance records, payroll slips, and bank
payment records.
o Ensures deductions (e.g., taxes, provident fund) are properly accounted for.

2. Verification of Assets in Auditing

Verification of assets is the process of confirming the existence, ownership, valuation, and proper recording of
assets in financial statements.
Objectives of Verification

• To confirm the existence of assets.

• To verify the ownership of assets.
• To assess the valuation of assets according to accounting standards.
• To check for any fraudulent practices like overstatement or understatement.

Types of Assets and Their Verification Process

1. Fixed Assets (Land, Buildings, Machinery, Vehicles, etc.)

• Existence: Physically inspect assets.

• Ownership: Check title deeds, property registration, and purchase agreements.
• Valuation: Verify depreciation calculations, revaluation records, and market price comparisons.
• Example: If a company has a building, the auditor checks the property registration, insurance
documents, and past maintenance expenses to confirm its authenticity.

2. Plant and Machinery

• Existence: Physical inspection in factory or office.

• Ownership: Check purchase invoices, warranty papers, and insurance policies.
• Valuation: Verify depreciation rates applied as per accounting standards.
• Example: If a company purchased machinery for ₹10,00,000, the auditor checks the supplier's invoice
and depreciation records to ensure correct valuation.

3. Inventory (Stock Verification)

• Existence: Physical stock counting and warehouse visit.

• Ownership: Review purchase invoices and supplier agreements.
• Valuation: Check FIFO (First-In, First-Out) or Weighted Average method used for valuation.
• Example: If a company claims an inventory worth ₹50,00,000, the auditor checks warehouse records
and physical stock count to ensure its accuracy.

4. Cash and Bank Balances

• Existence: Verify cash in hand and match with cash book records.
• Ownership: Check bank statements and passbooks.
• Valuation: Reconcile bank statements with the cash book.
• Example: If the balance in the cash book is ₹5,00,000, the auditor checks the bank passbook and
reconciles any differences.

5. Investments

• Existence: Verify investment certificates and demat account statements.

• Ownership: Check whether investments are in the company’s name.
• Valuation: Assess fair market value by comparing with stock market rates.
• Example: If a company invested ₹10,00,000 in government bonds, the auditor verifies bond certificates
and interest income records.

6. Debtors (Accounts Receivable)

 • Existence: Confirm outstanding balances through debtor confirmations.
• Ownership: Check sales invoices and agreements.
• Valuation: Assess recoverability of debts and create provisions for bad debts if necessary.
• Example: If a company has ₹20,00,000 in receivables, the auditor checks debtor ledgers and sends
confirmation letters to customers.

7. Goodwill and Intangible Assets (Patents, Trademarks, Copyrights)

• Existence: Check legal agreements and registration documents.

• Ownership: Verify trademark registration or patent certificates.
• Valuation: Ensure correct amortization and impairment testing.
• Example: If goodwill is recorded as ₹5,00,000, the auditor checks acquisition agreements and market
position to confirm its reasonableness.

IMPORTANT POINTS TO REMEMBER

• Vouching ensures that transactions are real, authorized, and correctly recorded in financial
statements.
• Verification ensures that assets exist, are owned by the company, and are valued correctly
according to accounting standards.
• These auditing processes prevent fraud, misstatements, and accounting errors, thereby maintaining
the reliability of financial statements.