Introduction to Auditing – Types | Features | Objectives

Auditing is the systematic examination and verification of a company's financial and operational records by a qualified professional, typically an auditor. The process aims to ensure the accuracy, completeness, and compliance of financial statements and operations with applicable standards and regulations. Auditing helps to enhance the credibility of financial reports, providing assurance to stakeholders such as investors, creditors, and regulators that the statements present a true and fair view of the company's financial position and performance.

Table of Contents

1. Introduction
2. Origin and Evolution
3. Definitions of Audit and Auditing
4. Features of Auditing
5. Importance of an Audit
6. Purpose of an Audit
7. Scope of Audit
8. Objectives of Auditing
9. Advantages and Inherent Limitations of Audit

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1. Introduction

Economic decisions in every society must be based upon the information available at the time the decisions are made. For example, the decision of a bank to sanction a loan to a business is based upon the previous financial relationships with that business, the financial condition of the company as reflected by its financial statements and other factors.

If the decisions are to be consistent with the intention of the decision makers, the information used in the Decision Process must be reliable. Unreliable information can cause inefficient use of resources to the detriment of the society and to the decision makers themselves. In the lending decision, for example, assume that the bank sanctions the loan on the basis of misleading financial statements and the borrowing company is ultimately unable to repay. As a result, the bank will lose both the principle and the interest. In addition, another company that could have used the funds effectively would be deprived of the money and opportunity.

As society becomes more complex, there is an increased likelihood that unreliable information may be provided to decision-makers. Some of the reasons are listed below :

1. Time and place of availability of information,
2. Data volume
3. Complexity of exchange transactions.

As a means of overcoming the problem of unreliable information, the decision-makers and other stakeholders like shareholders, investors, government, etc. need an assurance mechanism to ensure that the information provided to them forms a sufficiently reliable basis for their decisions. This forms the very genesis of audit, as audit verification is 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.

2. Origin and Evolution

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.

The practice of auditing is as old as accounting. It existed even in the Vedic period. Historical records show that the Egyptians, the Greeks and the Romans used to get the public accounts scrutinized by an independent official. The Vedas contain reference to accounts and auditing. ‘Arthashastra’ by Kautilya contains detailed rules for accounting and auditing of public finances. In his book, Kautilya stated that “all undertakings depend on finance, hence foremost attention should be paid to the treasury”.

The objective of auditing initially was to detect and prevent errors and frauds.

Auditing evolved and grew rapidly after the industrial revolution in the 18th Century. With the growth of the Joint Stock Companies, the ownership and management became distinct and different. The shareholders, who were the owners, needed a report from an independent expert on the accounts of the company managed by the Board of Directors who were the employees. The objective of audit shifted and audit was expected to ascertain whether the accounts were true and fair rather than detection of errors and frauds.

In India, the Companies Act, 1913 made audit of company accounts compulsory. With increase in the number and as also size of the companies and the volume of transactions, the main objective of audit shifted to ascertaining whether the accounts were true and fair, rather than true and correct. Hence the emphasis was not on arithmetical accuracy but on a fair representation of the financial efforts.

The Companies Act, 1913 also prescribed for the first time the qualification of auditors. As of now, Chapter X of The Companies Act, 2013 (Section 139 to Section 148) deals with Audit & Auditors. It deals with the appointment of auditors, their removal, resignation, eligibility, qualification, disqualification, remuneration, powers, ties and auditing standards.

The International Accounting Standards Committee and The Accounting Standards Board of The Institute of Chartered Accountants of India (ICAI) have developed standards on accounting and auditing practices to guide accountants and auditors in their discharge of duties.

The later developments in auditing pertain to the use of computers in accounting and auditing.

Conclusion

In conclusion it can be said that auditing has come a long way from hearing accounts to taking the help of computers to examine accounts. With the advent of technology and rapid changes taking place in technology and emergence of various risks, the importance of data analysis has increased to a great extent. Computer Aided Audit Techniques (CAATs) have become a part of the audit to process data of audit significance and to improve the effectiveness and efficiency of the audit process.

Thus, while the overall objective and scope of audit do not change simply because the data is maintained on Computers, the procedures followed by the auditor in his study and evaluation of:

1. the accounting system
2. related Internal Controls
3. the nature, timing and extent of his other audit procedures

are affected in a Computerised Information System environment. Audit Procedures are now transformed from ‘Auditing around the Computer’ to ‘Auditing through the computer’. In present day audit, there is paradigm shift from ‘ticks’ to ‘clicks’.

3. Definitions of Audit and Auditing

The term auditing/audit has been defined by different authors/entities as under:

• Spicer and Peglar defined audit as:

“Audit is such an examination of the books, accounts and vouchers of a business, as shall enable the auditor to satisfy himself whether or not the balance sheet is properly drawn up, so as to exhibit a true and correct view of the state of the affairs of the business according to the best of his information and explanations given to him and as shown by the books; and if not, in what respects it is untrue or incorrect.”

• Prof. L R Dicksee defined auditing as:

“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.”

• The International auditing practices committee defined auditing as:

“The independent examination of financial information of any entity whether profit oriented or not and irrespective of size/legal form, when such an examination is conducted with a view to express an opinion thereon.”

• The book “An Introduction to Indian Government Accounts and Audit” issued
  by the Comptroller and Auditor General of India, defines audit as:

“An instrument of financial control. It acts as a safeguard on behalf of the proprietor (whether an individual or group of persons) against extravagance, carelessness or fraud on the part of the proprietor’s agents or servants in the realization and utilisation of the money or other assets and it ensures on the proprietor’s behalf that the accounts maintained truly represent facts and that the expenditure has been incurred with due regularity and propriety. The agency employed for this purpose is called an auditor.”

• Wikipedia defines audit as:

“A systematic and independent examination of books, accounts, statutory records, documents, and vouchers of an organisation to ascertain how far the financial statements as well as non-financial disclosures present a true and fair view of the concern.”

• Investopedia defines Audit as under:

“An audit is an objective examination and evaluation of the financial statements of an organisation to make sure that the records are a fair and accurate representation of the transactions they claim to represent.”

• As defined in ISO 19011: 2011 (Revised 2018) – Guidelines for auditing management systems,

“An audit is a systematic, independent and documented process for obtaining audit evidence [i.e. records, statements of fact or other information which are relevant and verifiable] and evaluating it objectively to determine the extent to which the audit criteria [set of policies, procedures or requirements] are fulfilled.” @ To check

4. Features of Auditing

5. Importance of an Audit

Without a system of internal controls or audit systems to verify the efficacy thereof, an entity would not be able to create reliable financial statements for internal or external purposes. Accordingly an audit system is crucial in preventing material misstatements in an entity’s financial statements.

6. Purpose of an Audit

The main purpose of an audit is to provide

1. An objective and independent examination of the financial statements
2. To enhance the credibility of the financial statements prepared by the organisation
3. To increase the confidence of users in the financial statements
4. To reduce risk to investors

Thus, the basic purpose of an audit can be described as:

1. To assess whether or not the financial statements are in conformity with Generally Accepted Accounting Principles (GAAP) and the prescribed accounting standards.
2. To provide assurance about the accuracy of financials.
3. To ensure compliance with established internal control procedures by examining
   records, reports, operating practices and documentation.
4. To certify the assets and liabilities by comparing same to available documentation.
5. To verify compliance, conformance or performance.
6. To follow-up on the completed/contemplated corrective action plan of an
   organisation.

7. Scope of Audit

The scope of audit is increasing with the increase in the complexities of the business. It is said that the long-term objectives of audit should be to serve as a guide to the Management’s future decisions. The scope of audit encompasses verification of accounts with an intention of giving opinion on its reliability. Hence it covers cost audit, management audit, social audit, etc.

It should be remembered that an auditor just expresses his opinion on the authenticity of the accounts. He has no power to take action against anybody. That is why it is said that “an auditor is a watchdog but not a bloodhound.”

8. Objectives of Auditing

Auditors are basically concerned with verifying whether the accounts exhibit a true and fair view of the business. The objectives of auditing depends upon the purpose of his appointment.

Primary objective

As per Section 227/143 of the Companies Act, 1956/2013, the primary duty (objective) of the auditor is to report to the owners whether the Balance Sheet gives a true and fair view of the company’s state of affairs and the profit and loss account gives a correct figure of profit and loss for the financial year. The auditor is also concerned with verifying how far the accounting system is successful in correctly recording transactions and to ascertain whether the accounts are prepared in accordance with the recognised accounting policies and practices and as per statutory requirements and in his opinion, the financial statements comply with the accounting standards.

Secondary Objectives

The following objectives are incidental to the satisfaction of the main objective of auditing. The incidental objectives of auditing are:

• Detection and prevention of errors and
• Detection and prevention of frauds.

Detection of material frauds and errors as an incidental objective of independent financial auditing flows from the main objective of determining whether or not the financial statements give a true and fair view. As the statement on auditing practices issued by the Institute of Chartered Accountants of India states, an auditor should bear in mind the possibility of the existence of frauds or errors in the accounts under audit since they may cause the financial position to be misstated.

Errors refer to unintentional mistake in the financial information arising on account of ignorance of accounting principles i.e. errors of principle, or error arising out of negligence of accounting staff i.e. clerical errors.

I. Errors are mistakes committed unintentionally because of ignorance or carelessness.

Types of Errors

Location of Errors

It is not the duty of the auditor to identify the errors but in the process of verifying accounts, he may discover the errors in the accounts. The auditor should may follow one or more of the following procedure in this regard to locate errors and to rectify same:

1. Check the trial balance,
2. Compare supplementary totals of debtors and creditors with balances of main ledger extracted to the trial balance,
3. Compare the names of accounts appearing in the Ledger with the names of accounts in the Trial Balance,
4. Verify the totals and balances of all accounts and see that they have been properly shown in the Trial Balance,
5. Check the posting of entries from various books into ledger.
6. Check differences involving round figures such as 10, 100, 1000 etc. and whether difference is divisible by 9 which could mean interchange of figures or totalling mistakes etc.

Timely careful scrutiny is the only remedy for detection of errors.

II. Detection and Prevention of Fraud:

A fraud is an error committed intentionally to deceive/to mislead/to conceal the truth or material facts. Frauds may be of three types.

Till recently, the principal emphasis was on arithmetical accuracy.

The Companies Act, 1956 required the auditor to state inter alia whether the statements of account are true and fair. This is what we can take as the present day audit objective. There has been a shift of emphasis from arithmetical accuracy to the question of reliability of the financial statements.

The Companies Act, 2013 (section 143) now requires the auditor to express his opinion on whether the financial statements comply with the accounting standards.

It is not the main objective of the auditor to discover frauds and errors. But if he finds anything of a suspicious nature, he needs to make a detailed enquiry and verification report his findings. The provisions of the Companies (Audit and Auditors) Amendment Rules, 2015 issued in December 2015 require inter alia (These rules get amended from time to time (last amendment came in effect from April 1, 2021)

1. Reporting by statutory auditor to Central Government for frauds which involve/ are expected to involve individually an amount of Rs. one crore or above.
2. In case of fraud involving lesser than above amount, statutory auditor has to report the matter to the audit committee/Board of the Company.

9. Advantages and Inherent Limitations of Audit

The public good derived from auditing is reasonable assurance that financial statements and disclosures are free from material misstatements.

The following advantages from various view points are derived from audit:

1. Business Point of view
2. Investors Point of view
3. Others Point of view

(I) Advantages of Audit

(II) Limitations of Auditing

The inherent limitations are:

1. First of all, the auditors work involves exercise of judgment, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgment and estimates made by the Management in preparing financial statements. Further much of the evidence available to the auditor can enable him to draw only reasonable conclusions therefrom. The audit evidence obtained by an auditor is generally persuasive in nature rather than conclusive in nature. Because of these factors, the auditor can only express an opinion. Therefore, absolute certainty in auditing is rarely attainable. There is also a likelihood that some material misstatements in the financial information resulting from fraud or error, if either exists, may not be detected.
2. The entire audit process is generally dependent upon the existence of an effective system of Internal Control. Further, it is clearly evident that there will always be some risk of an internal control System failing to operate as designed. No doubt, the Internal Control system also suffers from certain inherent limitations. Any system of Internal control may be ineffective against fraud involving collusion among employees or fraud committed by management. Certain levels of management may be in a position to override controls, for example, by directing subordinates to record transactions incorrectly or to conceal them, or by suppressing information relating to transactions.

Such inherent limitations of internal control system also contribute to inherent limitations of an Audit.

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