What Is Auditing�

• Auditing originates from the Latin term “Audire”, which means “to hear,” - just as in ancient times auditors used to listen to officers and people of authority to confirm the validity of their words. Over the years, the role of auditing evolved to verifying written reports: specifically, the financial records of individuals and businesses.
• By definition, auditing is an official inspection and verification of the credibility of financial reports. Audits can be conducted by either a business’s management as an internal control process or by the government, in case they notice suspicious financial activity.

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• Auditing, or a financial audit, is an official examination and verification of a business’s financial records.
• The main goal of auditing is to make sure that a company’s financial statements are accurate and are following regulatory guidelines. Auditing also gives investors, creditors, and other stakeholders reasonable assurance that they can rely on a company and its integrity.
• Now, it’s important to note that auditing doesn’t provide a complete guarantee that every digit recorded in a company’s financial reports is accurate. Auditors work within a specific, reasonable margin of error known as materiality. The volume of materiality depends on the size of the company and its reported revenue and expenses.
• For small businesses, an accounting error of a few thousand dollars might be significant, but for a large corporation like Apple or Amazon, such a material mistake may be considered as a conventional mistake and not a cause for concern.
• Want to learn how to correctly manage and prepare your financial reports? Head over to our guide on financial reporting for small businesses.

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Auditing typically refers to financial statement audits or an objective examination and evaluation of a company’s financial statements – usually performed by an external third party.

Need For Company Audit�

• Auditing of book of accounts means verification of accounts by an independent professional to ensure that the accounting has been carried as per the relevant regulatory requirements and to check the veracity of transactions and make an opinion whether the books of Accounts shows a true and fair view of financial transactions by the business. 
• A limited company has to close its accounts every financial year and prepare the financial statements prepared as per the books of accounts depicting true and fair view of the affairs of the company. The financials shall then be audited by the statutory auditor and has to be placed before the members for approval.
• Every company has to get its accounts audited by its Statutory Auditor irrespective of size and turnover and file the same with the Registrar of Companies.
• The Companies Act 2013 mandates every company to keep its books of accounts and other relevant books and papers and financial statement giving a true and fair view on accrual basis and as per double entry system which shall be maintained at the registered office of the company for every financial year. However, the board of directors may keep the books of accounts at any other place in India after filing a notice with the Registrar of Companies.
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Purpose of Audit�

• a) Primary objective : As per Section 143 of the Companies Act, 2013, the primary duty of the auditor is to report to the owners that the accounts, financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.
• b) Secondary objective or incidental objective : It is also known as incidental objective. The incidental objectives are:-
• Detection and prevention of frauds
• Detection and prevention of errors

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Objectives of Auditing �

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Main Objective: The main objective of the auditing is

• To find reliability of financial position and profit and loss statements.
• To ensure that the accounts reveal a true and fair view of the business and its transactions.
• To verify and establish that at a given date balance sheet presents true and fair view of financial position of the business and the profit and loss account gives the true and fair view of profit or loss for the accounting period.
• To be established that accounting statements satisfy certain degree of reliability.
• To form an independent judgement and opinion about the reliability of accounts and truth and fairness of financial state of affairs and working results.

Subsidiary objectives:

1. Detection and prevention of fraud: the one of the important subsidiary objective of auditing is the detection and prevention of fraud. Fraud refers to intentional misrepresentation of financial information.

Fraud may involve:

1. Manipulation, falsification or alteration of records or documents
2. Misappropriation of assets.
3. Suppression of effect of transactions from records or documents.
4. Recording of transactions without substance.
5. Misapplication of accounting policies

2. Detection and prevention of errors: is another important objective of auditing. Auditing ensures that there is no mis-statement in the financial statements.

Errors can be detected through checking and vouching thoroughly books of accounts, ledger accounts, vouchers and other relevant information.

• Types of Errors
• A. Clerical Errors : Clerical errors are those which result on account of wrong posting that is posting an item to a wrong account, totalling and balancing. Such errors may be subdivided into:
• (i) Errors of Omission : An error of omission takes place when a transaction is completely or partially not recorded in books of account. For example, goods purchased from Narendra Kumar were not recorded any where in account books.
• (ii) Errors of Commission : Errors of commission take place when some transaction in incorrectly recorded ( wrongly entered) in books of account

For e.g. Error in writing amount in an account. For example, debiting Prem Chand' s Account with Rs. 107- instead of Rs. 100/-.

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• B. Errors of principle : Errors of Principle take place when a transaction is recorded without having regard to the fundamental principles of book-keeping and accountancy.
• For example if there is incorrect allocation of Expenditure or Receipt between Capital & Revenue
• C. Compensating Errors / off setting Errors :- Compensating errors arise when an error is counter balanced or compensated by any other error so that the adverse effect of one on debit (or credit) side is neutralised by that of another on credit (or debit) side.
• For example Anil's account was to be debited with Rs. 500, was credited for Rs. 500 similarly Sunil's account which was to be credited for Rs. 500 was debited for Rs. 500. Both these errors compensate each other's deficiency

D. Errors of Duplication

• Such errors arise when an entry in a book of original entry has been made twice & had also been posted twice.

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Types of Frauds

• These are intentional errors and wanted misrepresentations and failure to disclose the materialistic facts to the transactions in the books of accounts. Such as

1. Misuse of Cash: Cash is the highly exploitation asset in the business, auditor check receipts and payments of cash in order to detect and prevent cash embezzlement (Misappropriation) of cash.

• Cash may be misappropriated by,
• (a) Omitting to enter any cash which has been received; or
• (b) Entering less account than what has been actually received; or
• (c) making fictitious entries on the payment side of the cash book; or
• (d) entering more amount on the payment side of the Cash Book than what has been actually paid.

2. Misappropriation of Goods: Fraudulent application of goods by those who handle them e.g. recording purchase of large quantities receiving less quantity & than receiving the balance amount privately.

Proper methods of keeping accounts in regard to purchases and sales, stock, periodical checking of stocks, will help to avoid misappropriation of goods.

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Who can become Auditor of a Company�

• Only a qualified Chartered Accountant within the meaning of the Chartered Accountants Act, 1949 can be appointed as an auditor. However, the following points should also be considered for the appointment of auditor.
•  1.If the Chartered Accountant is holding a Certificate of Practice, and practicing in his individual capacity, he may be appointed as an auditor only as an individual.
• 2. If the Chartered Accountant is holding a Certificate of Practice and is a partner of a firm of chartered accountants, the firm may be appointed as auditor. Any partner of the firm may perform his duties in the name of the Firm.
• 3. If any person is holding a certificate authorizing him to act as an auditor, even though he is not a chartered accountant, he may be appointed as auditor. Such Certificates are not being issued since November 1, 1956.

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Who cannot become Auditors of a Company�

• 1. The auditing service is considered to be personal, therefore a body corporate cannot be appointed as auditor. This also ensures that the liability of the auditor does not become limited. A person holding any security of the company, carrying a voting right cannot be appointed as auditor. This provision came into effect since December 2001.
• 2. A person who is indebted to the company in excess of Rs. 1000/-.
• 3. A person who has given guarantee or security to the company in relation to the indebtedness of any third person for a sum exceeding Rs.1000/-.
• 4. An officer or employee of the company.
• We can say that the points (2), (3) and (4) mentioned above are laid down to ensure the independence of the service of an auditor.
• 5. If a person is disqualified to be appointed as auditor of any one company, he shall be disqualified to be appointed as auditor of
• its subsidiary company.
• its holding company.
• subsidiary company of its holding company.
• The above disqualification avoids any financial relationship between the auditor and the company.

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Additional disqualification as per Companies (Amendment) Bill 2003

An auditor who

• 1. has any direct financial interest in the company.
• 2. receives any loan or guarantee from or on behalf of the company.
• 3. has any business relationship (other than as an auditor) in the company.
• 4. has been in the employment in the company.
• 5. whose relative is in the employment of the company.

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Appointment of Auditors�

• 1. Section 224 (1B), prescribes limits for the chartered Accountants for holding company audits. A Chartered Accountant should ensure that his audits are within the limits prescribed before accepting the appointment as an auditor of the company.
• 2. There is no prohibition in appointing a relative of a director as auditor. However, under the Chartered Accountants Act 1949, he should disclose his interests/relationship in his audit report.
• 3. If the remuneration fixed for the auditor exceeds the prescribed limit, (as per Chartered Accountants Act), the auditor may be appointed by passing a special resolution. In some cases, approval of central Government is also required.

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Other Points to be noted regarding appointment of auditors�

• 1. If an employee of the Chartered Accountant in practice is director of a company, the chartered Accountant is not disqualified from being appointed as auditor.
• 2. A statutory auditor of a company cannot be appointed as an internal auditor.
• 3. An auditor of a company can however accept any other assignment with that company, as long as he she does not become the employee of the company.
• 4. IF a chartered accountant is indebted to a company, the firm( in which he is a partner) cannot be appointed as auditor. Similarly, if the firm is indebted to the company, the partner of the firm cannot be appointed as an auditor of the company.
• 5. After his appointment as an auditor to a company, if an auditor becomes disqualified due to any of the reasons stated above, his office will be deemed to be vacated.

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• Section 226 of the Companies Act, lays down the rules for qualification and disqualification of appointment of auditors, which will be discussed in detail later. The Companies (Amendment) Bill 2003 requires, a written certificate from the auditors, that appointment complies with prescribed conditions.

The Importance of Auditing�

• Credibility and Reliability
• Preventing Fraud
• Others

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Credibility and Reliability�

• With an internal auditing system, your business can create accurate and reliable financial reports through which you can gain insights on which segments or product lines are performing best and how to properly allocate resources. Additionally, regular auditing will make your shareholders trust that your accounts are true and fair and that it’s safe to invest in your business.

Preventing Fraud�

• If the government audits your financial statements and finds that your business has been manipulating its financial health, or hiding revenue and losses, you’ll likely deal with severe fees and legal punishments. Your business will also acquire a bad reputation, and you will most likely lose reliability in the eyes of your customers and stakeholders.
• Recurring internal audits by a professional auditor or accountant of the company play an important role in detecting these fraud cases before they become substantial and problematic. Having a rigorous auditing system set in place alone prevents and scares employees or vendors from attempting a scheme to defraud your business in the first place.

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• Audit satisfies the owner about the working of the business operations and the functioning of its various departments.
• The audit helps in the detection and prevention of errors and frauds.
• The audit helps in maintaining the records and verification of books of the books of accounts.
• The independent opinion of the auditor is extracted through auditing which is extremely essential for the management of the company.
• The audit establishes a moral check on the staff of the business so that they became aware of not committing any irregularity. This makes the staff more active and responsible.
• Audit protects the interests of the shareholders in the case of a joint-stock company by assuring them that their accounts are being managed properly and their interests will not suffer under any circumstances.
• Audit creates confidence among stakeholders such as creditors, debenture holders, and banks, etc.
• Audited statements ensure compliance with legal requirements such as listing requirements of stock exchange etc.
• Auditing reinforces and strengthens Internal control and provides suggestions necessary in the internal control system.
• Audited financial statements enable easy access to loans because it provides a crystal clear image to the banks.

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Types of Audits

• Internal audits
• External audits
• Government audits

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Internal audits�

• Internal audits are performed by the employees of a company or organization. These audits are not distributed outside the company. Instead, they are prepared for the use of management and other internal stakeholders.
• Internal audits are used to improve decision-making within a company by providing managers with actionable items to improve internal controls. They also ensure compliance with laws and regulations and maintain timely, fair, and accurate financial reporting.
• Management teams can also utilize internal audits to identify flaws or inefficiencies within the company before allowing external auditors to review the financial statements.

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External audits�

• Performed by external organizations and third parties, external audits provide an unbiased opinion that internal auditors might not be able to give. External financial audits are utilized to determine any material misstatements or errors in a company’s financial statements.
• When an auditor provides an unqualified opinion or clean opinion, it reflects that the auditor provides confidence that the financial statements are represented with accuracy and completeness.
• External audits are important for allowing various stakeholders to confidently make decisions surrounding the company being audited.
• The key difference between an external auditor and an internal auditor is that an external auditor is independent. It means that they are able to provide a more unbiased opinion rather than an internal auditor, whose independence may be compromised due to the employer-employee relationship.
• There are many well-established accounting firms that typically complete external audits for various corporations. The most well-known are the Big Four – Deloitte, KPMG, Ernst & Young (EY), and PricewaterhouseCoopers (PwC).

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Government audits�

• Government audits are performed to ensure that financial statements have been prepared accurately to not misrepresent the amount of taxable income of a company.
• Within the U.S., the Internal Revenue Services (IRS) performs audits that verify the accuracy of a taxpayer’s tax returns and transactions. The IRS’s Canadian counterpart is known as the Canada Revenue Agency (CRA).
• Audit selections are made to ensure that companies are not misrepresenting their taxable income. Misstating taxable income, whether intentional or not, is considered tax fraud. The IRS and CRA now use statistical formulas and machine learning to find taxpayers at high risk of committing tax fraud.
• Performing a government audit may result in a conclusion that there is:
• No change in the tax return
• A change that is accepted by the taxpayer
• A change that is not accepted by the taxpayer
• If a taxpayer ends up not accepting a change, the issue will go through a legal process of mediation or appeal.
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CONCLUSION�

• The basic function of auditing is to ascertain the authenticity of books of accounts prepared by the accountant. It is a well-known saying that “where the function of Accountant ends, the audit begins to determine the true and fair picture of such accounts.”
• In India, the Companies Act, 2013 has made the audit of company accounts mandatory.  With a sharp increase in the size of the companies and the volume of transactions day in and day out, the objective of auditing has changed. Now, auditing relies on fair representation of the financial efforts. The Companies Act, 2013 also prescribes for a qualification of the auditor. W.E.F from April 1, 2014, due to the amendment in the Companies Act, 2013 detailed provisions on cost audit, internal audit and secretarial audit can be found in the Act.

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