What is auditing? Explain features, objectives, principal and techniques

 INTRODUCTION


Auditing is a complex function having varied implications. The meaning, nature and scope of auditing have undergone a sea change with the growth of business organisations. Auditing, in modern days, has been a very specialized function having complex legal, economic and ethical implications. The report of auditor is one of the most significant bases of financial information to the stakeholders of business entities. Hence, in present day society, auditors hold a distinctive professional status.


DEFINITION OF AUDITING


The word "audit” has been derived from the Latin word "audire” which means "to hear." The owners used to appoint certain persons to check the accounts in case of any suspicion and they had to hear a number of things from the persons concerned in order to check the accounts. Luca Pacioli. Father of double entry system of book keeping, described the duties and responsibilities of an auditor in 1494 in black and white.


According to Webster's New Collegiate Dictionary, an audit is "a formal or official examination and verification of an account book ; a methodical examination and review."

Audit is an examination of the books of accounts and other records such as documents, vouchers etc. which confirm or support the correctness of the entries in the books of a business concern to enable an auditor to satisfy himself as to whether the profit and loss account and the balance sheet exhibit a true and fair view of the state of affairs of the concem according to the best of the information and explanation given to him. The following are some of the important definitions given by various organisations and luminaries of the subject :


"An audit is an examination of records to establish their reliability andt The reliability of statements drawn from them.”

-A.W. Hanson


FEATURES OF AUDITING


The following important characteristics ensue from the analysis of above definitions :-


(i) An audit is independent examination of books of accounts and other records of a business conducted by a qualified auditor.


(ii) An auditor is concerned with the examination of books of accounts only and he is not responsible for their preparation.

 

(iii) The examination of books of accounts enables the auditor to satisfy himself that the Balance Sheet and Profit and Loss

Account are properly drawn up and give a true and fair view of the financial state of affairs of the business for the financial period.


(iv) Detection of errors and frauds is an integral part of auditing.


(v) An auditor expresses an opinion on the financial statements presented to him. He is not required to certify the correctness in all respects because many of the figures which appear in the accounts are not amenable to precise verification.


(vi) The auditor checks the vouchers, documents, information and related evidence in order to report on the financial health of the business.


EVOLUTION OF AUDITING


Auditing is believed to have originated simultaneously with the development of system of accounting. The origin of auditing may be traced back to the 18th century when the practice of large-scale production was developed as a result of Industrial Revolution. Prior to this era, the concept of sole proprietorship was in vogue and the sole proprietor himself was responsible for maintaining and checking the accounts. History reveals that some systems of checks and counterchecks were applied for the purpose of maintaining public accounts as early as the days of ancient Egyptains, the Greeks and the Romans. There are certain references in The Mesopotamian relics of commercial transactions, Vedic literature, Ramayana and Mahabharta, which indicate the existence of accounting and auditing in those times. But it is a proven fact that the present shape of auditing is the outcome of Industrial Revolution.


OBJECTIVES OF AUDITING


A. Detection and Prevention of Errors :- An error is generally the unintentional mis-statement or mis description in the accounting books or records made by the employees or officers of the concern under audit. It is the result of carelessness and negligence. It is belleyed that an error is not committed deliberately rather it creeps in innocently. But sometimes it may be the result of willful manipulation by the person concerned. The term "error" refers to an unintentional mis-statement in the financial statements, including the omission of an amount or a disclosure, such as:


*A mistake in gathering or processing data from which financial statements are prepared


*An incorrect accounting estimate arising from oversight or misinterpretation of facts.

A mistake in the application of accounting principles relating to measurement, recognition, classification, presentation,disclosure.


1. Error of Omission :- This occurs when both the entries required for a transaction are completely omitted to be entered in the books. It is very difficult to detect such error because it will not affect the trial balance Transactions like purchase or sale of items, if these are not recorded at all in the account books, will not affect the agreement of trial balance. However, if one aspect of purchase or sale is recorded in the books, it will affect the trial balance and the omission will be detected easily.


2. Error of Commission :- This error occurs at the stage of recording the transaction or at the time of posting. Let us discuss some examples of incorrect recording-wholly or partially :-

When a transaction though recorded in the journal has been wrongly entered in the books of original entry, error ofcommission is said to a rise, eg, a purchase of R250 is entered in the purchase book as 520. Such an error does not affect the trial balance. The wrong recording in this case is 520 instead of 250.


Incorrect Posting :- This is another case. In this case transaction may be entered correctly in the journal. But the problem arises at the time of posting it into ledger. For example sale of 210 may be written as 120 in the ledger. This also doesn't affect the trial balance,


3. Compensating Error :- When two or more errors vanish the effect of each other, that is called compensating error and ultimately there will no effect in the trial balance. For example, if the purchase book is overcast by 2,500 and the sale book is also overcast by 2.500, the trial balance will not be affected. Similarly, if the rent is undercast by 300 and the wages account is overcast by 300, it will not affect the balance.


4. Error of Duplication :- An error of duplication occurs when same transaction is recorded more than once in the books of original entry and hence also posted more than once in the ledger. This may happen either due to failure on the part of recording clerks to distinctly mark the invoices and other vouchers after they have been entered in the books of original entry or because of confusion caused by the invoices and vouchers received in duplicate. Error of this nature may be difficult to detect through the trial balance as they will not lead to any disagreement therein.So, careful vouching is the only way to locate such errors.


B. Detection of Fraud :- Detection of fraud is also an important subsidiary object of auditing. A fraud has to be checked in the early stages; otherwise it is difficult to detect. The term "fraud" refers to an intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage. Although fraud is a broad legal concept, the auditor is concerned with fraudulent acts that cause a material mis-statement in the financial statements. Mis-statement of the financial statements may not be the objective of some frauds. Auditors do not make legal determinations of whether fraud has actually occurred. Fraud involving one or more members of management or those charged with governance is referred to as “management fraud", fraud involving only employees of the entity is referred to as "employee fraud". In either case,there may be collusion with third parties outside the entity. Frauds connected with accounts may take place either by-


(a) Misappropriation of cash or goods, or

(b) Manipulation (falsification) of accounts.


(i) Misappropriation of Cash :Misappropriation of cash may be done by the omission of receipts or and by the inclusion of fictitious payments. Some examples of misappropriation of cash are given below:

(A) Cash sale may not be recorded

(B) Record of credit sale may be omitted

(C) Method of teeming and lading máy be adopted

(d) Cash received from sale by V.P.P. or ‘Sale or Return' may be pocketed.


(ii) Misappropriation of goods :- Misappropriation of goods may take place in the case of goods which are more valuable and less bulky. It is not easy to detect them. A continued vigilance has always to be maintained over the issue of material, records of sales, purchases and stock. There must be adequate external security arrangement to see that no goods are taken out of the business premises without proper authority.


(iii) Manipulation of accounts - It is generally perpetrated by the directors, managers or other responsible officials of the concern. Some of the examples of manipulation of accounts 


C. Prevention of errors and frauds :- Prevention of errors and frauds is the responsibility of the management. The management should therefore implement and continuously operate an adequate system of internal control, though this can only reduce and not eliminate the possibility of errors and frauds. The auditor should evaluate the internal control system of the concern under audit and point out the weak points and offer his suggestions for making improvements in the management and internal control of the organisation so that chances of occurrence of errors and frauds may be minimised.


BASIC PRINCIPLES AND TECHNIQUES OF AUDITING

Fundamental principles are those according to which the books of business accounts are audited. These principles can be changed according the desire of the auditor. According to Arthur W. Holmes, "Audit principles are the basic truths, which are indicative of the objectives of auditing." The audit principles suggest the manner in which the objectives of audit are accompanied. Some basic principles of auditing are:


1. Principles of independence:

The audit work should be independent from accountancy and the auditor should examine the books of accountsindifferently and independently. Although the entity is the auditor's client, the auditor has a significant responsibility to users of the audit report. The auditor must not subordinate his judgment to any specific group, including his client. The auditor's independence, integrity, and objectivity encourages third parties to confidently use the audited financial statements.


2. Principle of objectivity:

The audit work should be based on evidences and should be done impartially. The principles of objectivity impose the obligation on auditors to be fair, intellectually honest, and free of conflicts of interest in relation to clients. For example, an auditor may not be financially involved with his client nor accept goods or services from him except on business terms no more favourable than those generally available to others. This ensures that an auditor is objective and therefore, enables the public to place faith in the audit function.


3. Principle of materiality :

This principle of materiality has always been fundamental to the whole process of accounting. An auditor has also to be quite concerned regarding the concept of materiality. The auditor has to analyse and take decisions regarding various items whether they are material or not during the course of an audit. In case the auditor finds that an item is quite material in nature, he would have to give careful consideration to its checking and would care for more evidences in support. If he is not careful about them, he may be held liable for the same.


TECHNIQUES OF AUDITING

Techniques of auditing mean the procedure or method which is adopted by the auditor in checking the accounts. The audit techniques are devices through which an auditor proceeds his work to obtain evidential matter


Following are the important techniques of audit:

1. Examination of Record : This technique is commonly used by the auditors. The inspection of books and documents is made to verity the validity of data. An auditor examines documentary evidences relating to recording of transactions in support and thus checks the authenticity of such records.


2. Inquiry : The auditor can also use the technique of inquiry. He can get the information from resource persons inside or outside the enterprise. It is technique with an auditor to contact responsible officials through interview and to communicate with the outside parties for ensuring that the transactions are authentic, valid and accurate.


3. Sampling : Auditor can select few items from whole accounting information. This technique enables the auditor to obtain and evaluate the evidence of some characteristics of the whole class. It is helpful in forming the conclusion


4. Confirmation : To ensure the accuracy of the data, an auditor can collect the information from the debtor. Confirmation is response to an inquiry to prove certain data recorded in the books. It is required specifically for the transactions of large value.


5. Comparison : To check the arithmetical accuracy of accounting record, the balancing accounts can be compared with the vouchers to test the reliability of data. To establish propriety and consistency of different entries, the record in the books from one source to another can be verified.