Auditing

Text book: principles of Auditing by Khawaja Amjad Saeed

Presented By: Muhammad Waris

Introduction to Auditing
Chapter 1
 Origin of Audit
• The word audit is derived from Latin word “Audire” which means to
hear .In the old days whenever the proprietors of a concern
suspected a fraud, certain people were appointed to hear verbal
evidence of transaction of barter and to judge the facts. They heard
the point of views of those who maintained the accounts.
 Cont….
• With the formation of joint stock companies and corporations
involving large volume of capital and members under the
management of few individuals compelled and demand the services
of auditors and further the provision of compulsory audit incase of
public limited companies gives a great importance to this profession.
Definitions of Auditing
• In different times Authors and professional Accountants have given
different definitions of audit , some of them are as follows:
• “Auditing is the systematic examination and verification of the
accounting records and other legal records and documents of a
private and public business organizations”. Given by A. W Holmes
 Cont….
• “Auditing is the process of examining and evaluating
accounting records intended to show financial
conditions and results of operations in order to
provide basis for opinion regarding the reliability of
the records”. Given by Silvoso and bauer.
 Cont….
• “Auditing is concerned with the verification of accounting data, to
determine the accuracy and reliability of accounting statements and
reports”. Given by R.K Mautz
• “ Audit is examination indented to serve as a basis for an expression
of opinion regarding the fairness, consistency and conformity with
Generally Accepted Accounting Principles, in preparation of financial
statements of the corporation”.
 Cont…..
• Auditing involves a critical analysis and examination of the
transactions and records of a concerned with the purpose of forming
an opinion regarding the records and financial statements of the
client.
• An investigation of financial statements designed to determine their
fairness in relation to Generally accepted accounting principles.
Book keeping, Auditing, and Accounting
• Book keeping is the art of recording business transactions in various
books of accounts maintained in an organization. It is the work of
more or less mechanical in nature, in the performance of which
machinery and electric devices are being used in advanced countries.
• The work of book keeping is interested to junior employees know as
book keeper or accounts clerks.
Book keeping process
• The process of book keeping involves the following stages:
• Entering transaction in various books
• Transferring data from such books to relevant accounts in ledger
• Casting the ledger accounts and extracting their balances.
Accounting
• Accounting includes book keeping but it is principally concerned with
the summary analysis of the record furnished by the book keeping or
we can say that it is compilation of accounts in such a way that one is
in position to know the financial position and results of operations of
a business. Accounting involves:
• Making adjusting entries necessary at the end of accounting period.
• Preparation of financial statements
 Cont…
• Interpretation of financial statements
• Designing suitable accounting system
Auditing
• Audit is an independent examination of
evidence from which the financial statement of
the enterprise are derived in order to give the
readers of those statements confidence as to
the truth and fairness of the state of affairs
which they disclose.
• In other words audit is an analytical and critical
examination of the books of accounts,
checking and verification of evidence in
supports of entries appearing in the books of
accounts and ascertaining the authenticity of
the financial statements.
 Cont…
• To conclude book keeping, accounting and auditing
are three different stages of same business
activity.
• In a business accounts as has to be maintained
which is book keeping aspect, they have to be
summarized in the form of financial statements
which is accounting aspect and finally for the
satisfaction of the owners or shareholders such
accounts and financial statements has to be
checked to confirm accuracy and fairness of these
which is auditing aspect.
Difference between Accounting and Auditing
Accounting Auditing
1. It is concerned with recording aspect 1. It is concerned with the examination
of all the financial activities in of the accounting record and
appropriate books of accounts and reporting their accuracy.
compiling financial statements.
2. The accountant prepares the financial 2. The Auditor submits the report after
statements from the books of examination of books of accounts
accounts. and financial statements.
3. No prescribed qualifications are 3. It is mandatory that Auditor of a
legally required to an Accountant. Public Limited company must be a
Chartered Accountant.
4. The job of an Accountant is generally 4. The Auditor of a Public Limited
entrusted to him by management and company is appointed by
he is expected to perform the same. shareholders of the company.
5. An Accountant is responsible for his
work to the management. 5. The auditor’s rights, duties and
liabilities are defined by Law
(Companies Ordinance 1984).
 Auditor
• An individual qualified (at the state level) to conduct audits. An
auditor may be an internal auditor (an individual whose primary job
function is to audit his or her own company) or an external auditor
(an individual from outside the company, who typically is employed
by an auditing firm who handles many different clients).
Qualities Required for an Auditor
1. Professional competence:
• the auditor must be well versed in the fundamental principles and
theories of all branches of accounting such as general accounting,
cost accounting and management accounting etc.
• He should posses a sound knowledge of the techniques of audit,
taxation laws of the country like income tax and sales tax and
should be familiar with the company and mercantile laws.
 Cont…
• He should have thorough training in business organization,
management and finance.
• He should have an understanding of the general principles of
economics and business statistics.
 Integrity
• The word integrity implies complete
honesty together with strength of mind.
• An auditor must be tactful and honest,
i.e. he must not certify what he does not
believes to be true, and he must take
reasonable care and skill before he
believes what he certifies is true.
 Cont…
• He must posses qualities of withstanding and resisting the
influence(direct or indirect) exerted by others in the course of the
discharge of his duties.
• He should never compromise his principles with being rigid in his
attitude.
 General Skills
• He should be able to grasp quickly the technical details of his clients’
business. He must have the tact of putting intelligent questions to
extract full information.
• He must be prepared to hear arguments and decide on logical
grounds.
• He should have the ability to write his report in a concise, clear and
correct manner.
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 and he should maintain an impartial attitude.
 Confidentiality
• The auditor should maintain 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.
 Object of an Audit
• The objectives of modern auditing are different from those of classical
auditing. The present day objectives are:
a) Assisting management in maintaining adequate internal control by
pointing out weak areas.
b) Giving advise to client on matters of controlling, forecasting,
analyzing and reporting.
 Main object
• The main object of audit is to prove accuracy and reliability of the
accounts and financial statements prepared by the organization, and
if they are found accurate then auditor should prepare and issue
audit report accordingly.
 Subsidiary object
• If on the other hand books of accounts and financial statements are
not found correct then subsidiary objectives may be:
a) To detect error
b) To detect fraud
c) To prevent errors and frauds
 Errors in Accounts
1. Errors of Omission
• These errors occur where the transaction has been
either omitted entirely or partially.
• Such errors do not affect the accuracy of the trial
balance but a searching eye and a critical scrutiny
of the accounts only can uncover such errors.
• For example: scrutiny of salaries account in ledger
may indicate that salaries for only 11 months have
been accounted for and the outstanding amount
for the 12th month has not been accounted for.
 2. Errors of commission
• These consists of incorrect additions, wrong postings and entries.
Some of examples these are:
a) Errors in additions, carry forwards in the books of original entries
or ledger.
b) Errors or incorrect postings like debit amount posted to credit,
wrong amount posted to an account, an amount posted twice.
c) Error in taking out balances of ledger accounts.
 Cont.….
• These errors will affect the agreement of the trial balance.
• Checking the arithmetical accuracy of books of original entries and
ledger and posting from the books of original entries to ledger would
reveal these errors.
 3. Errors of Principles
• These errors arise where a particular transaction has
not been recorded in accordance with generally
accepted accounting principles. These errors include:
a) Incorrect allocation: An item of expense may be
debited to an asset account instead of expense
account.
 b). Omission of Outstanding assets and
liabilities:

For example, prepayment are ignored and the amount charged to

expense and outstanding expense in respect of rent, salaries,
commission etc., are ignored and not accounted for.
c). Incorrect valuation of assets:
Current assets are not valued at cost and market value whichever is
lower. Fixed assets not valued at cost less depreciation.
4. Compensatory Error
• It is an error which is counter-balanced by another error of same
amount in the opposite direction. For example, an over casting of an
account by $1000 may be counter balanced by under casting of an
other account by same amount.
• Such types of errors will not affect the agreement of the trial balance.
• Checking of arithmetical accuracy of books of accounts and postings
would detect such errors.
 Locating of Errors
• If there is difference in the trial balance and
the auditor is agreed to discover it then he
should take the following steps:
1. Look through folio columns of the books of
original entry to see if any items are not
posted to ledger.
2. Re-check the trial balance with the ledger
balances.
3. Re-check the balancing of ledger accounts
and carry forward of balances seeing that all
opening balances were properly brought
down.
 Cont.…
4. Check all postings from books of original entries to ledger.
 Frauds in Accounts
1. Misappropriation of cash
misappropriation of cash by dishonest employee is concealed either
by omitting to enter of receipts or by entering fictitious payments. This
can be done in following ways:
a) Omission of sales and the misappropriation of cash received by the
customers.
b) Theft of unusual receipts of cash like, from sale of waste, recovery
of bad debts written off in the past.
 Cont.….
c). Cash refund arising out of the invoice overpayment
may not be recorded and amount misappropriated.
d). Recording fictitious purchases and expenses.
e). Cheques for personal purposes may be charged as
business expenses.
f). Vouchers once approved and paid may be used in
support of further reimbursements.
g). Misappropriation of cash drawn in respect of wages
may be done by either inserting dummy names in the
wages sheet or by overcasting the wages sheet.
 2. Misappropriation of Goods
• Goods purchased may be stolen or used for personal benefits.
• Proper method of keeping accounts in respect of purchases, sales,
consumption, periodical physical checking of stocks and comparing
them with the records would help in preventing frauds.
 3. Manipulation of Accounts
• This type of fraud is comparatively difficult to detect than those
discussed earlier, as this is usually committed by directors and
management with the object of showing either more profits or less
profits than they actually are. Examples of such fraud are:
• Recording fictitious sales or omission of sales.
• Recording fictitious purchase and omission of purchases.
 Cont.
• Recording fictitious expenses and omission of expenses.
• Over-valuation or under-valuation of inventory.