Introduction To Auditing

Download as pdf or txt
Download as pdf or txt
You are on page 1of 8

BBA 6th Semester | Auditing (MGT362)

Chapter One: Introduction to Auditing


1. Meaning of Audit

The word "Audit" is derived from Latin word 'Audire" which means to listen. In early days,
an auditor was used to listen to the accounts read over by an accountant to check them. At that
time, auditing was focused on locating errors. After the industrial revolution in England the
size, volume and transaction of the business had increased. With this increase, the owner could
not manage their business. They appointed separate management team to run the business.
From this period, they feel separate and independent person to check the transaction is named
an auditor. In this way auditing, has been developed as a separate discipline.

Now a day, audit has made compulsory by the government. Government and independent
institutions has been established to regulate and monitor the auditing profession. The ancient
period objective of locating error has been changed. Therefore, the auditing can be defined as
auditing is a systematic and scientific examination of the books of accounts, data, records of
business, operation and performance to enable the auditor to satisfy himself that the profit and
loss account and the balance sheet are properly drawn up to exhibit a true and fair view of the
financial state of affairs of the business and profit / loss for the financial period. In other words,
auditing is an examination of accounting records undertaken with a view to establish whether
they correctly and completely reflect the transactions to which they relate.
Thus, we can summarize the meaning of audit as follows.
1. Audit is a systematic and scientific examination of the books of accounts of a business;
2. Audit is undertaken by an independent person or body of persons who are duly qualified
for the job;
Nature of 3. Audit is a verification of the results shown by the profit and loss account and the state
Auditing
of affairs as shown by the balance sheet;
4. Audit is a critical review of the system of accounting and internal control.
5. Audit is done with the help of vouchers, documents, information and explanations
received from the authorities.
6. The auditor should satisfy himself with the authenticity of the financial statements and
report that they exhibit a true and fair view of the state of affairs of the concern.
7. The auditor should inspect, compare, check, review, scrutinize the vouchers supporting
the transactions and examine correspondence, minute books of shareholders, directors,
Memorandum of Association and Articles of Association etc., to establish correctness
of the books of accounts.

2. Nature of Auditing

Economic decisions in every organization must be based upon the information available at the time the
decision is made. For example, the decision of a bank to make a loan to a business is based upon
previous financial relationships with that business, the financial condition of the company as reflected
by its financial statements and other factors. If decisions are to be consistent with the intention of the
decision makers, the information used in the decision-making process must be reliable. Unreliable
information can cause inefficient use of resources and to the decision makers themselves.

1
BBA 6th Semester | Auditing (MGT362)

As organization become more complex, there is an increased likelihood that unreliable information will
be provided to decision makers. There are several reasons for this: remoteness of information,
voluminous data and the existence of complex exchange transactions. As a means of overcoming the
problem of unreliable information, the decision-maker must develop a method of assuring him that the
information is sufficiently reliable for these decisions. In doing this, he must weigh the cost of obtaining
more reliable information against the expected benefits. A common way to obtain such reliable
information is to have some type of verification (audit) performed by independent persons. The audited
information is then used in the decision-making process on the assumption that it is reasonably
complete, accurate and unbiased.

3. Objective of Audit
Major Objective
The objective of an audit of financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared, in all material respects, in accordance with an identified financial
reporting framework. The phrases used to express the auditor's opinion are "give a true and fair view"
or "present fairly in all material respects" which are equivalent terms.
Although the auditor's opinion enhances the credibility of the financial statements, the user cannot
assume that the opinion is an assurance as to the future viability of the entity nor the efficiency or
effectiveness with which management has conducted the affairs of the entity.
The subsidiary objectives are:
To detect errors and fraud
To prevent errors and fraud
To help the client to improve upon his accounting and internal control systems.
It must be emphasized that audit is not designed to identify errors, detect fraud and discover significant
weaknesses in the client's systems but the audit work should be carried out in such a manner as to be
able to unearth errors, frauds and weaknesses (if they exist).
1. Expression of opinions: The main objective of auditing is examining the books of account and
express their opinion either the books of account reflect the true and fair result of the
organization. Generally, it includes;
• To examine the internal control system
• To examine the arithmetic accuracy
• To examine either the proper accounting principal is applied or not
• To examine the financial statement (income statement, balance sheet) and verify it.

2. Detection of errors
The next important objective is to detect the error on financial statement. They are;
Error of principal: The error which occurs due to not following the basic principle of
accounting while recording the transaction. For example, recording the wage account instead
of machinery account for the wage paid of installation of machine.

Error of omission: The errors committed by not recording a transaction either in the books of
original entry or in the ledger books are called error of omission. The omission may be complete
or partial. Sold good of Rs. 10,000 were not recorded in sales book, Sale of goods to Ram Rs.
4000 is recorded in the sales book but failed to record to Ram's account.

2
BBA 6th Semester | Auditing (MGT362)

Error of commission: When the transaction has been recorded, but has been wrongly entered
in the books of original entry or posted in the ledger is called called error of commission. For
example, posting a wrong amount in subsidiary books and ledgers, posting in wrong account,
posting on wrong side, wrong totaling of subsidiary book etc.

Compensating error: The errors refers to two or more errors which mutually compensate the
effect of one another. For example, Rs. 500 posted in customer account for sale of goods for
Rs. 5000 and Rs. 500 posted in supplier account for purchase of goods for 5000 compensate
their effect on the trial balance as both the account remained short by Rs. 4500 on both debit
and credit side.

3. Detection of fraud
Next objective of auditing is to detect any fraud that occurred in the book of account. They are,
Misappropriation of cash: Cash is very important assets that can be embezzlements in the
organization. The various ways of embezzling cash are showing overpayment, showing lower
cash entry than actual sales, making fictitious payment etc.
Misappropriation
of Asset Misappropriation of goods: This is another important item that can be misused in the
organization. Small quantity goods having high value have more chance of misusing. The
various ways of misusing of goods are not recording the goods in the stock book, making over
issue of goods etc.

Financial Fraud Manipulation of account: The various ways of manipulating the books of account are
showing more or less profit, undervaluation/ overvaluation of assets and liabilities, not
providing depreciation or providing less depreciation etc. So, to identify and make necessary
suggestions to the management of such frauds that can affect on true and fair result of the
financial statements.

4. Evolution of Audit in Nepal


The term audit is derived from the Latin term ‘Audire,’ which means to hear. In early days, an auditor
used to listen to the accounts read over by an accountant in order to check them. After the industrial
revolution in 18 centuries, with the increase in the size of the companies and the volume of transactions
the importance of audit has been increased.
In Nepal, 1828 BS Shree Panch Prithivi Narayan Shah had established "Kumari chok Adda " and started There has
always
formal recording of financial transaction. This organization had given authority to record and inspect been a
the income and expenditure on behalf of the country. general
practices
In 1903 Prime minister Janga Bahadur Rana has given additional authority to Kumari Chok Adda for of auditing
recording and inspection of income and expenditure of the country. from
ancient
After the democracy 2007, the systematic and scientific recording system of income and expenses was time.
developed. In 2008 the budget speech was started. Similarly, in 2013 five-year plan was also started.
Along with these activities, the recording and inspection activities being developed. First
Systematic
In 2015 The department of Auditor General was established; it was the first step of modern auditing. Practice
Along with this different forms were also developed for recording and auditing the financial statements. by PN.
in 2048 the Audit Act was introduced. In 2053 the institute of chartered accountant act was passed and Shah in
separate entity was established to promote and govern accounting and auditing. Baishakh
6, 1828.
The International Accounting Standards Committee and the Accounting Standard board of the Institute
of Chartered Accountants of Nepal have developed standard accounting and auditing practices to guide Systematic
and
First budgeting 2008BS Scientific
First National Planning 2013BS 3 Practices
Auditor General Office in 2015BS after the
Company act 2048 & 2053 and 2063 democracy
BBA 6th Semester | Auditing (MGT362)

the accountants and auditors in the day to day work. The later developments in auditing pertain to the
use of computers in accounting and auditing.
In conclusion, it can be said that auditing has come a long way from hearing of accounts to taking the
help of computers to examine computerized accounts.

5. Scope of an Audit

The scope of an audit of financial statements will be determined by the auditor having regard to the
terms of the engagement, the requirements of relevant legislation and the pronouncements of the
Institute. The terms of engagement cannot, however, restrict the scope of an audit in relation to
matters which are prescribed by legislation or by the pronouncements of the Institute.

The audit should be organized to cover adequately all aspects of the enterprise as far as they are
relevant to the financial statements being audited. To form an opinion on the financial statements, the
auditor should be reasonably satisfied as to whether the information contained in the underlying
accounting records and other source data is reliable and sufficient as the basis for the preparation of
the financial statements. In forming his opinion, the auditor should also decide whether the relevant
information is properly disclosed in the financial statements subject to statutory requirements, where
applicable.

The auditor assesses the reliability and sufficiency of the information contained in the underlying
accounting records and other source data by:

(a) making a study and evaluation of accounting systems and internal controls on which he wishes to
rely and testing those internal controls to determine the nature, extent and timing of other auditing
procedures; and

(b) carrying out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as he considers appropriate in the particular circumstances.

The auditor determines whether the relevant information is properly disclosed in the financial
statements by:

(a) comparing the financial statements with the underlying accounting records and other source data
to see whether they properly summarize the transactions and events recorded therein; and

(b) considering the judgements that management has made in preparing the financial statements;
accordingly, the auditor assesses the selection and consistent application of accounting policies, the
manner in which the information has been classified, and the adequacy of disclosure.

In forming his opinion on the financial statements, the auditor follows procedures designed to satisfy
himself that the financial statements reflect a true and fair view of the financial position and operating
results of the enterprise. The auditor recognizes that because of the test nature and other inherent
limitations of an audit, together with the inherent limitations of any system of internal control, there is
an unavoidable risk that some material misstatement may remain undiscovered. The audit cannot,
therefore, be relied upon to ensure the discovery of all frauds or errors but where the auditor has any
indication that some fraud or error may have occurred which could result in material misstatement,
the auditor should extend his procedures to confirm or dispel his suspicions.

4
BBA 6th Semester | Auditing (MGT362)

The auditor is primarily concerned with items which either individually or as a group are material in
relation to the affairs of an enterprise. However, it is difficult to lay down any definite standard by
which materiality can be judged. Material items are those which might influence the decisions of the
user of the financial statements. It is a matter in which a decision is arrived at on the basis of the
auditor’s professional experience and judgement.

6. Principles Governing of Audit


Standard Auditing Practices and Assurance (SAPA-1) and Nepal Standard on Auditing (NSA-1)
describes the basic principles which governs the auditors' professional responsibilities and which should
be complied with whenever an audit is carried out. Compliance with the basic principles requires the
application of auditing procedures and reporting practices appropriate to the particular circumstances.
the basic principles in this guideline are:
1. Integrity, objectivity and independence
2. Confidentiality
3. Skills and competence
4. Work performed by others
5. Documentation
6. Planning
7. Audit evidence
8. Accounting system and internal control
9. Audit conclusion and reporting
1. Integrity, Objectivity 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 objectivity. He should maintain an
impartial attitude and both be and appear to be free of any interest which might be regarded, whatever
its actual effect, as being incompatible with integrity and objectivity.
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 or unless there is a
legal or professional duty to disclose.
3. Skills and Competence
The audit should be performed and the report should be prepared with due professional care by persons
who have adequate training, experience and competence in auditing. The auditor requires specialized
skills and competence which are acquired through a combination of general education, technical
knowledge obtained through study and formal courses concluded by a qualifying examination
recognized for this purpose and practical experience under proper supervision.
4.Work Performed by Others
When the auditor delegates work to 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.
However, he will be entitled to rely on work performed by others, provided he exercises adequate skill
and care and is not aware of any reason to believe that he should not have so relied. The auditor should

5
BBA 6th Semester | Auditing (MGT362)

carefully direct, supervise and review work delegated to assistants. The auditor should obtain reasonable
assurance that work performed by other auditors or experts is adequate for his purpose.
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. Plans should be based on a knowledge of the client’s business. Plans should be
made to cover, among other things: (a) acquiring knowledge of the client’s accounting system, policies
and internal control procedures; (b) establishing the expected degree of reliance to be placed on internal
control; (c) determining and programming the nature, timing, and extent of the audit procedures to be
performed; and (d) coordinating the work to be performed.
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 therefrom on which to base
his opinion on the financial information. Compliance procedures are tests designed to obtain reasonable
assurance that those internal controls on which audit reliance is to be placed are in effect. Substantive
procedures are designed to obtain evidence as to the completeness, accuracy and validity of the data
produced by the accounting system.
They are of two types: (i) tests of details of transactions and balances; (ii) analysis of significant ratios
and trends including the resulting enquiry of unusual fluctuations and items.
8. Accounting System and Internal Control
Management is responsible for maintaining an adequate accounting system incorporating various
internal controls to the extent appropriate to the size and nature of the business. The auditor should
reasonably assure himself that the accounting system is adequate and that all the accounting information
which should be recorded has in fact been recorded. Internal controls normally contribute to such
assurance. 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 business of the entity as the basis for the expression of his opinion on the financial
information. This review and assessment involves forming an overall conclusion as to whether: (a) the
financial information has been prepared using acceptable accounting policies, which have been
consistently applied; (b) the financial information complies with relevant regulations and statutory
requirements; (c) there is adequate disclosure of all material matters relevant to the proper presentation
of the financial information, subject to statutory requirements, where applicable.

6
BBA 6th Semester | Auditing (MGT362)

6. Difference between accounting and auditing

Sn Base for Accounting Auditing


comparison
1 Meaning Accounting means systematically Auditing means inspection of the
keeping the records of the accounts books of account and financial
of an organization and preparation statements of an organization.
of financial statements at the end of
the financial year.
2 Governed By Accounting Standards Standards on Auditing

3 Work performed Accountant Auditor


by

4 Purpose To show the performance, To reveal the fact, that to which


profitability and financial position extent financial statement of an
of an organization. organization gives true and fair
view.

5 Start Accounting starts where Auditing starts where accounting


bookkeeping ends. ends.

6 Period Accounting is a continuous process, Auditing is a periodic process.


i.e. day to day recording of
transactions are done.

8. Difference between auditing and investigation

The investigation is related to critical checking of particular records. Investigation is done when a lapse
already exists to pin point the reason and person involved in it so that responsibility for such lapse could
be fixed whereas audit is a process to check whether the accounts are properly maintained as per
required norms following all the procedures etc. And to point out any lapses in this line. The purpose
of auditing and investigation is different.

Sn Base for Auditing Investigation


comparison
1 Meaning The process of inspecting the An inquiry conducted, for
books of accounts of an entity establishing a specific fact or truth is
and reporting on it, is known known as Investigation.
as Auditing.

2 Nature General Examination Critical and in depth examination.

3 Time Horizon Annually As per requirement

4 Performed by Chartered Accountant/ Experts


Registered Auditor

5 Reporting General Purpose Confidential

6 Obligatory Yes No

IT

7
BBA 6th Semester | Auditing (MGT362)

9. Auditing Standard Issued by The Institute of Chartered Accountant of Nepal (ICAN)

NSAs Name Effective date


1 Objectives and General Principles Governing an Audit of
Financial Statements
2 Terms of Audit Engagements

3 Documentation

4 Audit Evidence

5 The Auditor's Responsibility to Consider Fraud and Error in


an Audit of Financial Statements
6 Audit Materiality

7 Planning
8 Auditors Report on Financial Statement

9 Audit Sampling and other Selective Testing Procedures

10 Going Concern

11 Management Representation

13 Communication of Audit Matters with Those Charged with


Governance
14 Knowledge of the business

15 Consideration of Laws and Regulations in an Audit of


Financial Statements
16 Subsequent Events

17 External Confirmations

18 Using the work of Another Auditor

19 Considering the Work of Internal Auditor

20 Using the Work of an Expert

21 Initial Engagements- Opening Balances

22 Other Information in Documents Containing Audited


Financial Statements
23 Audit of accounting estimate

24 Comparatives

25 Related parties

26 The Auditor's Report on Special Purpose Audit Engagements

You might also like