MEANING, DEFINITION AND SCOPE OF AUDITING

MEANING

The word Audit takes its origin from the Latin word ‘Audire’ which means to ‘hear’. In olden
days, whenever a trader suspected fraud in his mind about the books of accounts, he appointed a
person to hear the accounts from the accountant and give his opinion about its correctness.
Auditing at that time was carried to locate frauds and errors.

DEFINITIONS OF NARROW APPROACH

According to R.G.Williams

“Auditing may be defined as the examination of the books, accounts and vouchers of a business
with a view to ascertain whether or not the Balance Sheet is properly drawn up so as to show a
true and correct view of the state of affairs of the business”.

The Above definition is of narrow approach because it deals with the books of accounts of
business organizations only whereas in practice the books of accounts of non-profit making
organizations (such as College, hospital, club etc) are also audited.

DEFINITIONS OF WIDER APPROACH

According to Montgomery

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

According to W.H. Hanson

“An audit is an examination of such records to establish their reliability and the reliability of
statements drawn from them”.

So from the meaning and definition, the following basic characteristics of auditing are as
follows:

CHARACTERISTICS OF AUDITING

1. There must be an Institution: The work audit is done of an institution, whether it is

government, semi-government or non-government. Books of accounts of non-profit
making institutions are also audited.
2. An Auditor must be an Independent Person: The core idea of any audit exercise is an
independent evaluation of the available evidence. Audit will be useful only when it is
conducted by an independent and qualified person. Needless to say that audit is
 undertaken to exercise a check upon persons who handle receipts and payments of money
belonging to others.
3. To Examine Truthness and Fairness of Books: Audit is a systematic and independent
examination of the books of accounts to ascertain whether the Balance Sheets show a true
and fair view of the financial position and the Profit and Loss Account gives a true and
fair view of the profit and loss for the financial period.
The word ‘Systematic implies that an audit should be carefully planned. The audit
procedures to be applied should be arranged in a logical sequence and should be clearly
envisaged before carrying the audit.
4. Use of Vouchers: To examine the truthness and fairness of the books of accounts, every
transaction should be compared with concerned vouchers. In order words, there should
not be any transaction which is not supported by voucher and in the same way there
should not be any voucher which is not transacted.
5. To get Necessary Clarification: Sometimes, it is seen that vouchers fail to make the
things clear then the things should be cleared by making enquiry with the concerned
persons.
6. To follow the Principles: During the course of auditing, the auditor has to take in mind
some basic principles and he has to see whether the Profit and Loss Account and Balance
Sheet has been prepared in the prescribed form or not.
7. Collection and Evaluation of Evidence: Evidence consists of books of accounts, tax
returns, departmental budgets, human resources records, etc. In any audit situation, the
auditor should collect relevant evidence depending upon the proposition he needs to
examine. After collecting the evidence, the auditor should evaluate it on the basis of his
professional knowledge and skill.
8. Certain Period: The work of audit is concerned with the examination of books of
accounts of an organization for a certain period i.e., three months, half year or a year.
9. Tactfully: An auditor should perform the work of audit tactfully; otherwise ultimate
object cannot be obtained.
10. Report: The last stage in audit work is formulation of opinion by the auditor which is
communicated to the users of information through an audit report. The format and
contents of audit report depend upon many factors including the type of audit, statutory
requirements and purpose of audit.

FACTORS INFLUENCING EVOLUTION OF AUDITING

OR

WHY INCREASING NEED OF AUDITING

Following are the main factors influencing the evolution of Auditing:

1. Adoption of Double Entry System of Book Keeping: Various transaction of any business
unit is recorded in the books of accounts on the basis of double entry system. As we
know from Journal entries various ledger accounts are prepared and balanced. On the
basis of these balances Trial Balance is prepared which provides material for preparing
final accounts. Accounting Equation, i.e., assets are equal to liabilities is also based upon
double entry system, on which auditing is based. An auditor examines the books of
accounts on the basis of double entry system.
2. Industrial Revolution: Industrial revolution opened the ways for the use of machines and
changed the scale of operation of the business firms. Production was done on large scale
which changed the size of business units. Use of power, developed the means of
transport, such as rail and road. This is turn brought a change in the business world and
also the nature of auditing. Now auditing is not restricted to vouching and posting only.
Its scope has tremendously changed. Now, the auditor has to see the efficiency of
management, effectiveness of internal control and to give a report about the true and fair
statement of financial affairs of the organization he has audited.
3. Divorce of Ownership and Management: The formation of joint stock companies has
created a divorce of ownership and management. The shareholders are the real owners of
the companies. They are not few in numbers. They are scattered all over the country and
abroad too. Therefore, it is not possible for them to attend to the daily needs of managing
the affairs of the companies owned by them. Most of them even do not attend the annual
general meetings of the companies. Therefore, they elect from amongst themselves a few
persons. These elected members from the Board of Directors. The Board managers the
company. The Board appoints an Executive Director or Managing Director or Manager.
The executives so appointed are made responsible and accountable for the day-to-day
management of the companies. Thus, all the real owners of the companies do not
participate in management like sole trading and partnership firms. The annual accounts
of these companies both Public and private Limited, are to be compulsorily audited by a
qualified person, who is usually a Chartered Accountant. This is a statutory requirement
under the Companies Act, 1956.
4. Social Objects of Business: In last few years, greater emphasis is given on the social
responsibility of business. Now business class is compelled to earn profit taking into
consideration the social objects too. This changing object of business has not only
increased the importance of audit but it has increased the liabilities of the auditors too.
Thus, in this changing environment, increasing importance of auditing has become a
common matter.
5. Decisions of the Court of Law: The Judiciary in a country has also changed its view point
regarding the scope of audit. Through the legal decisions, its expectations from the
auditors have increased during the present times and the society has also changed its
attitude and gives preference to audit the financial matters. The Judiciary has elevated the
auditors to change their duties to social responsibility more and more and prove helpful to
the society.
 6. Statutory Need of Audit: The expansion of trade and commerce has increased the size of
operation of business firms. Now-a days most of the firms prefer to be a joint stock
company registered with the Registrar of Companies. Every registered company has to
follow provisions of the Companies Act, 1956. The Companies Act has made compulsory
the audit of annual accounts. This audit is performed by a Chartered Accountant. Not
only the trading and manufacturing concerns, but also the banks, non-trading institutions,
co-operative societies, etc. have to get their accounts audited. Thus statutory need of audit
has a great impact on the growth of audit.
7. Use of Mechanized and Computerized Accounting: In fact, today is the age of computers.
Now the accounting records are being prepared with the help of computers. This has not
only saved labour, energy and time, but increased the authenticity of the accounting
records. Computers have simplified posting and balancing of ledger, accounts and
preparation of Financial Statements. This has also simplified audit work. Auditors have
been relieved of the work relating to counseling, totaling, posting etc. All these works are
now done easily by mechanical devices.
8. Establishment of International Accounting Standard: Now-a-days, a greater emphasis is
given on the establishment of International Accounting Standard. It will create uniformity
in the techniques and approaches adopted by the auditors of different countries.

QUALITIES OF AN AUDITOR

An auditor must have all the qualities of head and heart as he is required to perform a variety of
functions. He must be a man of character and good behavior. He must also be a hard task master
so as to do the work himself and get the work done through his assistants. In particular, he must
possess the following qualities:

1. Knowledge of Book-Keeping, accountancy and Auditing: An auditor must have

thorough and up-to-date knowledge of accounting and auditing principles, practices,
techniques and procedures. As accounting is a changing technique, he should be fully
aware of the new changes and developments in the field of accounting. He should not
pass any entry or accounts as correct unless he becomes sure of its correctness. Hence,
the knowledge of the principles of accounting becomes very much necessary for him.
2. Knowledge about Working of Business: The auditor should know the technical details
about the working of the business or the industry or trade carried on by his client, only
then he would be able to judge whether the profit of the business and its financial position
are truly reflected in the financial statements.
3. Knowledge of Economics: He should also be familiar with the principles of economics
and the economics laws. It is essential because a business has to work within some
specific social and economic conditions which have definite effect on the business.
4. Knowledge of Audit Case Laws: He should have good knowledge of the audit case
laws and important decisions, both past and present, which have gone a long way in
defining the duties and liabilities of an auditor under varying circumstances.
 5. Knowledge of Industrial Management: He should have good knowledge of industrial
management, financial administration and business organization.
6. Technical Knowledge: He must have thorough knowledge of the technical and other
details of the business so that he can elicit necessary information from the employees of
his client. This will also help him not to ask ridiculous questions from his client during
the course of audit work.
7. Knowledge of Latest Audit Techniques: He should be well versed in latest auditing
techniques, practices and procedures. He will do well if he participates in Seminars,
Conference and Convocations organized from time to time by the professional bodies in
India and abroad.
8. Knowledge of Tax Laws: He should have an up-to-date knowledge of Income tax Laws
particularly when he is to conduct tax audit.
9. Knowledge of Cost Accountancy: He must have thorough and up-to-date knowledge of
cost accountancy principles, practices, techniques and procedures in order to be a cost
auditor.
10. Honesty
11. Tactful: An auditor must be tactful so as to effectively deal with the client to get
necessary explanations for his audit work.
12. Secrecy: He must not disclose the secrets of his client otherwise he will have to make
good the loss suffered by his client. He will also loose the confidence of his client and
may not get audit work in future.
13. Courteous and Well Behaved: He should be courteous and well behaved as he is to deal
with the senior officers of his client. He should try to win their confidence so as to get
their whole hearted co-operation to carry out his duties as auditor.
14. Impartial: He should be impartial. He must not be influenced in the discharge of his
responsibilities directly or indirectly. In case he finds something suspicious, he should
thoroughly examine the matter to find the truth.
15. Common Sense: He must possess good common sense to deal effectively with the
employees who might be more experienced and clever than him.
16. Ability to Prepare Report: an auditor should have the ability to write his report to the
shareholders clearly, correctly, concisely and forcefully.

NECESSITY OF AUDITING

Auditing is not necessity in case of a small business but where there is divorce between
ownership and management i.e., in case of joint stock company audit becomes essential.
Auditing seems to be necessity due to the following reasons.

1. Accounting as per Rules and Regulations. Auditing ensures that the accounts of the
corners are kept and maintained according to rules and regulations concerned with the
organization.
 2. Reliability of Accounts: Audited accounts are reliable in the sense that these are
examined by an independent and qualified person. Reliability of accounts is very much
essential now a day for various purposes like assessment of tax, bonus to employees,
presentation of accounts to the share holders for their satisfaction, etc.
3. Computation of True Profit: It is expected that errors and frauds will be detected if the
accounts are audited. Thus the Profit and Loss Account certified by the auditor presents
true profits or loss of the concern.
4. To know the Real Position of the Business: The auditor certifies that the assets and
liabilities shown on the balance sheet are properly valued. So any person who is
concerned can know the real financial position of the business.
5. To Facilitate in Obtaining Capital and Loan: The audited accounts create trust among
those who wants to invest in share capital or who want to advance loan tom the company.
6. For increasing efficiency of the Employees: If the accounts are audited the errors
committed by the employees are detected and liability for the same is determined. As a
result the employees become cautions in nature, which increase the efficiency.
7. For increasing Goodwill of the business: Audited accounts create a confidence and trust
in the company by the outsiders which ultimately increase the goodwill of the concern.
8. Base for the distribution of Dividend and Bonus: The directors of the company come
to know the real position of the business and hence, they can declare dividend to
shareholders and bonus to employees, in the interest of the company.
9. Helpful in receiving Compensation from the Insurance Company: In case of losses
due to accidents etc. the Insurance Company rely upon the audited accounts as the
valuation of goods lost or destroyed can be easily valued. Hence it becomes easy for the
insurance company to award compensation for the goods lost or destroyed.
10. Helpful in determining Tax. The tax authorities can easily assess the tax liability of the
business on the basis of audited accounts. Thus, actual tax can be calculated.
11. Sale of Business and Amalgamation: In case of sale of business and amalgamation of
the companies. Purchase consideration is required to be calculated which is based on the
audited accounts. (actual assets and liabilities)
12. For an easy declaration of Insolvency: A company can move to court for declaring it
insolvent in case its liabilities exceeds assets. If is also done on the basis of audited
accounts the court also believes I the value of assets and liabilities on the basis of audited
accounts.

OBJECTS OF AUDITING

The object of audit depends on the type of audit to be conducted. The detection and prevention of
frauds and errors was the primary objectives of auditing. The auditors were required to report on
whether the financial statements gave a true and fair view of the state of affairs of a business.

The objects of audit may be classified in the following categories:

 I. Primary Objects
(i). Examination of accounting books
(ii). Verification of financial statements.
II. Secondary Objects
(i). Detection of errors.
(ii). Detection of frauds
(iii). Prevention of errors and frauds
(iv). Creation of healthy environment
(v). Fulfillment of the order of act.
(vi). To satisfy the Government Authorities.
(vii). Advice to the Managers
(viii). Moral effect on the Employees.

(III). Social Objects

(i). Protection to shareholders

(ii). To stop evasion of tax,

(iii). To stop capital erosion

(iv). Measurement of fair wages for labourer,

(v). Reasonable prices for consumers

(vi). Fair return and justice to the investors

(vii). Evaluation of social cost and benefits.

I. PRIMARY OBJECTS:

Primary objects of audit can also be classified under two categories, they are:

1. Examination of Accounting Books: The main object of audit is to examine accounting

books. Here, examination means to compare the records with vouchers on the basis of
which records have been made. For every record, there must be voucher. Generally,
voucher is a written document. As every record must be supported by voucher, in the
same way every voucher must be recorded. An auditor has also to see that vouchers are
true.
2. Verification of Financial Statements: The second part of primary objects of an audit is to
establish, by an examination of books, vouchers and other appropriate records, that the
Balance Sheet, at a given date, is properly drawn up so as to show a true and fair view of
the state of affairs of the business and the Profit and Loss account for the accounting
period ended that date also discloses a true and fair view of profit or loss for the period.
II. SECONDARY OBJECTS
The work of audit is done to fulfill the following objects:
1. Detection of Errors: Errors are generally committed innocently. But an auditors
should be very careful about it; because sometimes errors which might appear as
innocent are the results of the fraudulent manipulation. For example, a debtor
sends Rs 500. The accountant forgets to make an entry, it is an error. On the other
hand, if the accountant intentionally keeps the money with him and spends it for
his own use and does not make an entry, it becomes a fraud. Thus an auditor must
pay particular attention to it.
2. Detection of Frauds: Detection of frauds is not the direct responsibility of the
auditor and it is not the primary object of audit. Audit does not aim at detection of
frauds. If the fraud is suspected, an investigation becomes necessary, which is
different from audit. In fact, frauds can be committed in a number of ways.
Different types of frauds can be detected by the auditor in the manner given
below:
(i). Fraud involving Misappropriation of Cash: The debit and credit sides of the
cash book have to be carefully vouched and the cash balance at the close of the
year should be physically verified.
(ii). Frauds involving Misappropriation of Goods: Frauds involving
misappropriation of goods are difficult to detect. Special attention should be given
to goods which are costly and less bulky. The internal check system should be
examined and records relating to receipts, issue and stock including accounting
records of sales, purchases and returns should be examined with the help of basic
documents to the extent necessary.
(iii). Fraudulent Manipulation of Accounts: The type of fraud is very difficult to
detect, because in most cases, the management remains involved in such frauds
and such frauds are deftly executed. The auditor should conduct routine checking
and vouching with skill and caution, keeping in view correctness of entries
passed, correct allocation of expenses and receipts between capital and revenue
expenditure, etc. He should see that all adjustments have been rightly passed and
provisions have been created in right amounts.
3. Prevention of Errors and Frauds: Prevention of errors and frauds is the
responsibility of management. By introducing and activating effective internal
control, which comprises of internal check and internal audit, the management of
an organization is required to prevent errors and frauds. Audit is not expected to
prevent errors and frauds. As a matter of fact, in spite of audit, errors and frauds
may and do occur.
4. Creation of Healthy Environment: The object of audit is also to create healthy
environment in and around the organization. When employees know that their
work and activities are to be examined by some experts (auditors), they become
serious towards their duties or work and as a result the possibility of errors and
 frauds is minimized. Thus, the auditor creates healthy fear psychosis among the
employees and accountants so that the environment of honesty, responsibility and
truthfulness is created.
5. Fulfillment of the Order of Act: An audit also gives emphasis on the fulfillment of
the order of Act. i.e., the laws under which the Company has to work. In certain
cases, legal provisions must be faithfully honored. For example the Companies
Act, 2013, has made compulsory audit of financial accounts of every joint stock
company.
6. To Satisfy the Government Authorities: The object of audit is also to satisfy
Government authorities in respect of the books of accounts and the statements
prepared by the organization. The audited statements and accounts are treated to
be trustworthy and there is no room left for suspicion about them. Therefore,
income-tax, sales-tax and excise duty are computed by the concerned authorities
on the basis of these audited accounts. These authorities have to work with the
assumption that the accounts and statements prepared by the organization and
audited by an auditor are true and correct.
7. Advice to the Managers: During the course of audit and auditor comes across with
various short comings and errors. Hence, it is the duty of the auditor that the he
should give advice to the management regarding these shortcomings and errors.
Although it is not the statutory duty of the auditor to provide information to the
management.
8. Moral Effect on the Employees: The work of audit creates fear in the minds of the
employees that errors and frauds committed by them would be detected by the
morally upgraded and discharges their duties honestly and effectively.

III. SOCIAL OBJECTS

1. Protection to Shareholders: Protection to shareholders means protection to

shareholders interest in the Company. Auditors are the representatives of the
Shareholders, naturally it is the duty of an auditor to see whether the interest of
the shareholders is protected or not.
2. To Stop Evasion of Tax: The auditor can see that the national interest is
protected. The national interest can be protected only when cases of evasion of
taxes are prevented.
3. Measurement of Fair Wages for Labourer: It should be the social object of an
audit to see whether the wages for labourers are fair and inconformity with
general price index and to see the basis of measurement for such wages for
labourers.
 4. Reasonable Prices for Consumers: It should be the social object of an audit to
assess the reasonable price of commodities in relation to individual circumstances
and environment of a particular situation.
5. Fair Return and Justice to the Investors: The fair return of a particular company
can be judged with the rate of return of similar type of Company or the type of
industry which the Company belongs to.
6. Evaluation of Social Cost and Benefit: This indicates the appraisal of benefits
which a business is expected to render for the betterment of society. It should be
the social object of an audit to see whether the benefits expected to derive from a
business, product line, product design, etc., all come within the purview of
evaluation of social cost and benefits.

Advantages and Importance of Audit

Every business enterprise whether its scale is small or big, private or public has to maintain
accounting records. It becomes the duty of the owner of the enterprise to run the business
effectively and smoothly. Therefore, it becomes necessary for him to keep the accounting
records and also get them audited by a qualified person, called auditor. The auditor must be a
Chartered Accountant.

The advantages of audit can be grouped under the following heads:

I. GENERAL ADVANTAGES
1. Knowledge of Accounting Errors and Frauds: Audit is helpful in detecting
errors and frauds committed in the books of accounts and efforts are made that
these errors should not be repeated. If books of accounts are audited then it
implies that whatever is recorded is correct and nothing has been left to be
recorded. The owners of the business, authorities and outside parties have
faith in audited books of accounts.
2. Helpful in maintaining Discipline: Discipline is of great importance in the
day-to- day life of human being. It plays an important role in the field of
business too, which requires books of accounts to be audited time to time. So
that important suggestions can be obtained to remove the weaknesses therein.
Examination of books of accounts makes the employees disciplined and
creates interest in them to perform the allotted work effectively.
3. Knowledge of True Economic Position of the Business: Audit proves that
Profit and Loss Account and Balance Sheet prepared by the organization show
true and fair view of it and items shown therein are truthful. It is helpful in the
determination of economic policy of the organization.
4. Increase in Efficiency: Audit keeps the employees of the organization
watchful and careful and to perform their duties and responsibilities properly
because it creates a healthy fear in their minds which keeps them aware of
their duties and responsibilities. If an employee proves to be indulged in any
fraud, their goodwill is adversely affected. As a result they want to be neat and
clean and their efficiency is enhanced.
5. Protection to Investor: Now days everyone wants to earn a lot even by doing
left and right. The Directors of the Company can earn a lot by doing wrong.
But they are surrounded by two obstacles, i.e., the Act and the Auditing.
These two obstacles compel the Directors of the enterprises not to earn a lot
by doing wrong and thus, investor’s interest is protected.
6. End of Corruption: Audit plays an important role in removing corruption. If
audit is not done, the employees of the organization can misappropriate goods
and cash being fear-free. But, by adopting the work of audit, corruption can be
controlled to some extent.
7. Helpful in Computing Various Taxes: the various tax authorities are able to
compute the tax payable by the organization easily and correctly when the
books of accounts of such organizations are audited and appended by an
Auditor’s.
8. Compensation of Incidental Losses: The audited books of accounts help in
settling claims from insurance companies or from persons responsible for
incurring losses.
9. Procurement of Precious Suggestions: The managers of the business
enterprises can also get technical consultancy and proper advice from the
auditors wherever it is needed because the auditor is an expert of the field.
10. Helpful in Dividend and Bonus: Before the declaration of dividend and bonus,
a certificate for the truthfulness of profit and loss to be taken so that no doubt
is arises in the minds of shareholders and the workers because they have a
confidence in audited books of accounts.