Chapter 1 Auditing
Meaning
In general concept, Auditing is to check the account and related statements. Auditing is an examination of books of accounts and other related documents by an independent entity to see that they are true, fair and correct or not. Auditing also includes the physical verification of assets and inventories. Preparation of report after investigation of all the accounting statements is the main part of auditing. The reporting is the conclusion of audit work therefore main focus goes on audit report.
The word “Audit” is derived from Latin word “Audire” which means “to listen”. In ancient time, (around the age of 4th century) the business owners use to appoint auditor when he suspected the fraud and auditor listen explanation given by person relating to financial transactions. Main duty of an auditor was to listen carefully the explanation and suggest to business owner. At that time, auditing was conducted only to locate errors and frauds. After the development of Double entry book keeping system by Luca Pacioli at 15th century the duty of an auditor was described. After the industrial revolution in England at 18th century the size and scope of business increased and scope of audit also increased. Now a day’s auditing is the act of checking books of accounts and preparing report by an independent person. An independent person who checks books of accounts is known as an auditor. An auditor conducts the audit job and prepares the report in favors of owner who hired to him.
Traditionally, audits were mainly associated with gaining information about financial systems and the financial records of a company or a business. In modern time the term “Audit” is used in broad sense. Audit is not limited in financial transactions. It covers wide area like Social Audit, Environmental Audit, System Audit, Information Security Audit, Energy Audit, Clinical Audit etc. The general definition of an audit is an evaluation of a person, organization, system, process, enterprise, project or product. The term most commonly refers to audits in accounting, internal auditing, Auditing of NGOs, INGOs, social organizations and government auditing, but similar concepts also exist in project management, quality management, water management, and energy conservation. Different auditing concepts are started used in modern auditing system like performance audit, risk based audit and IT audit. As the information technology is used in modern accounting system the audit work also should be conducted by using information technology. Therefore Information and System Audit is the recent trend in modern auditing system.
After industrial revolution
Auditing checking books of account
So nowadays “auditing is the act of checking whether the entire personal and impersonal ledgers shown properly or not. Accounting is maintained properly or not whether the frauds and errors are committed in the book of account or not.
An independent person who checks about of account is known as auditor
लेखापरिछ्यन भनेको त्यस्तो कार्य हो, जसले नगदहरुको हिनामिना भए नभए, लेखा ठिकसँग राखे नराखेको, वासलातमा सम्पूर्ण ब्यक्तिगत तथा अब्यक्तिगत खाताहरुको रकम देखाए नदेखाएको परिछ्यण गर्नु र त्यस्तो वासलातले ब्यवसायको सत्य र यथार्थ स्थिति प्रस्तुत गर्दछ कि गर्दैन सोको परिछ्यन गर्नु र नाफानोक्सान खाता, वासलातले देखाएको नाफानोक्सान र आर्थिक अवस्था सहि र सत्य छ भनि प्रमाणित गर्ने कार्य लेखापरिछ्यन हो। त्यस्तो जाचँ गर्ने ब्यक्तिलाई लेखापरिछ्यक भनिन्छ।
Definition:
“Auditing is a systematic examination of financial statements, records and related operations to determine adherence to generally accepted accounting principles, management policies or stated requirements.” —Robert E. Schlosser
“Auditing is the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.”—- Institute of Chartered Accountants of India (ICAI)
“Auditing can be defined as inspecting, comparing, checking, reviewing, couching, ascertaining, examining and verifying the books of accounts of a business concerned with a view to have a correct and true idea of its financial state of affairs.” — M.L. Shandilya
Characteristics
Evaluation of accounting record of business
Examination of profit and loss account and balance sheet true and fair view of business accounting period
Audit errors and frauds
Independent person
Financial reports go through voucher
Submit the report/accounting information
Evolution of auditing in Nepal
Auditing made long time back
But systematic auditing system at 18th century
Develop manager is not equals to owners
Develop business entity concept
In Nepal historical development of auditing
King Prithvi Narayan shah in 01/06/1828 BS Kumari Chowk Adda
King Rana bahadur shah 1850 read seals and copper inscription
PM Junga bahadur shah 1903 BS separate office and court
1973 pm Chandra smasher- new office in Kumari Chowk take action= jail
Expenditure, clearance- book of account
2007 scientific method of auditing
2008 budgeting system
2012 planning system
2015 constitutional body- office of auditor general
2016 government fund expenditure
2018 new accounting system
2063 companies maintain account
Accounting board and auditing board charter account (CA)
Objectives of auditing
The basic objective of the auditing is to prove true and fairness of results presented by financial statements. Its objectives are classified into 3 groups:
1. Primary objectives
· Internal check and control system
· Checking arithmetical accuracy of books of account
· Verifying transaction and validity of accounts
· Detection of capital and revenue transaction or Checking the proper distinction of capital and revenue nature of transactions
· Checking valuation of assets and liabilities
· Provide true and fair- P/L and balance sheet or Presenting true and fairness of operating results presented by financial statements
· Verifying whether all the statutory requirements are fulfilled or not
2. Subsidiary/Secondary objectives
A. Detection and prevention of errors
a) Errors of principle
The errors by the lack of proper accounting principles/knowledge is errors of principle .If an accountant maintains books of accounts against the principles of accounting then that error is error of principles.
· Treatment of revenue expenditure as capital expenditure and vice versa.
· Excess/Inadequate depreciation
· Under/over valuation of stock
· Making wrong provision for outstanding expenditure
Auditor should check in detail not only from trail balance
b) Errors of omission
· Omission of purchase
· Omission changing depreciation
· Omission sales
Auditor should check books of account thoroughly
c) Errors of commission
v Incorrect entry either wholly or partially
v Recorded Rs.500 instead of Rs.5000
v Posting of amount in wrong side
v Over or under casting of subsidiary book
Purchase Rs100 commissions on Rs1000 and in sales too
Purchase a/c …Dr 100
To cash a/c 1000
Cash a/c …..Dr 1000
To Sales a/c 100
Trail balance does not detect the above errors auditor should check in detail to find out such errors
B. Detection and prevention of frauds
a) Misappropriation
i. Embezzlement or Misappropriation of cash
· Inflating bill
· Canceling the purchase return
· Wages sheet- dummy name/ By entering dummy name of worker in wage sheet
· Omitting to record cash receipt
· Detect such fraud
Auditor should check
Cash book and repost
Bill receipt, salary sheet, etc
Cash a/c, debtor a/c sales report
ii. Misappropriation of goods
v Wrong entry of receipt and issue of goods.
v By exchanging low quality goods with high quality goods.
v By showing more scrap in production process.
v By recording new goods as old goods.
v By showing less quantity than the actual quantity
For detection check purchase book, sales book, stock book received by store and other related document
b) Manipulation/Misrepresentation/Falsification of account
This type of fraud is always internal, pre-determined and very difficult to detect by Auditor. This type of fraud is committed by responsible person (top management/director/manager).
· Making sales entries
· Involves very large amount
Account can be manipulated by various means:
ü Under/over valuation of closing stock and other assets and liabilities
ü Excess/less depreciation
ü Charging capital/reserve expenditure, doubtful debt and bad debts
i. Window dressing
Seem indicate- much better and sound financial position
ii. Secret reserve
Seem to disclose, worse financial position
Reduce tax, back share, and hide true position
C. Other objectives
v To provide information to income tax authority and other stakeholders
v To satisfy the provision of company act
v To have moral effect
v To verify the cost records by cost audit.
v To promote the efficiency of managerial function by management audit.
v To satisfy the legal provisions.
Methods of detecting errors (locating errors)
Trail balance checking
· List of debtors and creditors
· Amount of difference
· Ledger to trail balance
· Ledger to closing balance
Short-cut methods
· Wrong side posting
· Errors figure
· Difference around figure
· Large amount balance
· All posting check
· Original entries- ledger
Method of falsification in account
Staff, manager, director, and top management
· Depreciation
· Purchase
· Assets/liabilities evaluation
· Secret revenue
· Advance- income/expenses
· Dummy expenses
· Capital/revenue expense
· Making low income, etc.
Area/Scope of audit
In ancient period- no development of business- audit- increase by stakeholders
Not possible only book of account
I. Auditing related-examination of bills, stock, evidence and physical verification, etc
So, auditor applies test, check and use effective internal check system
For find out the fact
II. Auditor should analyze the suspected fraud and depend on the information by concerned office
Also an auditor should prepare present report, p/l, and b/s
III. Auditor should set the mind in that area where he is not satisfied with the record
IV. Check
Truth and fairness of book of account
Verification of assets and liabilities
Check the available evidence
Check arithmetical accuracy
Expressing independent opening
Preparing and presenting fair report
Consideration while conducting Audit
Auditor should check book of account, profit and loss account
Auditor should prove and disclose fact so auditor should consider:
Ø Report present in Annual General Meeting (AGM)
Ø Take case use discretion/idea
Ø Apply internal check and control system
Ø Satisfy himself with record/statement
Ø Depend himself with technical verification
Ø Investigate suspicion/doubt
Advantages of Audit
Auditing- essential or compulsory task
For business, social, industrial, trading or organization
Now-a-days, owners and business are separate and essential for manager, stakeholders
ü Help to prevent and detect errors and frauds
ü Help to maintain account properly and regularly
ü Help to compensation
ü Help to obtain loan
ü Help to sale of business valuation of assets/liabilities determine of pre-price of product
ü Help to assess tax
ü Facilitates to compare
ü Help to present as proof
ü Provides information about profit/loss
ü Help to partner
Difference between Auditing and accounting
Accountancy- related –collecting, recording, analyzing and interpreting of financial transaction, but
Auditing- examination of book of account with evidential document
1. Meaning
Accountancy- collecting, recording, analyzing and interpreting
Auditing- examination of book of account with evidential document+ prove –true and fair
2. Beginning of work
Accountancy- financial transaction – book
Auditing- end of accounting
3. Scope
Accountancy-prepare- book of account, P/L, B/S +statement
Auditing- check of book of account, fairness + company act or not
4. Nature of work
Accountancy- keeping record of financial transaction
Auditing- check and verify of account
5. Staff
Accountancy- permanent staff
Auditing- independent person + specific tenure/period
6. Presentation of report
Accountancy- not prepares but when require
Auditing- prepare + present report
7. Responsibility
Accountancy- responsibility to management
Auditing- responsibility to owners/shareholders
Difference between audit and investigation
Audit- examines the book of account, provide true and fair
Investigation- detail examination of activities- achieve objective
1. Purpose/Objective
Audit- fair view of P/L, B/S
Investigation- of fact/ particular purpose
Earning capacity, etc
2. On the behalf of
Audit- proprietor of business
Investigation- proprietor or outside person, etc
3. Scope
Audit- accounting business
Investigation- accounting + enquiry + related matter
4. Use of techniques
Audit- test checking
Investigation- examination + more evidence
5. Period
Audit- 6 months/1 year
Investigation- several years 3, 4, 5 years
6. Statutory obligation
Audit-joint stock company, partnership audit is compulsory
Investigation- no statutory
7. Examination use of policies
Audit-Valuation, account policies
Investigation- no-bound by account policies
8. Use of evidence
Audit- errors plus fraud
Investigation-cases and evidence
9. Time
Audit- time period
Investigation- anytime- no period
Chapter 2 Planning an audit
Plan= programma when and how to work, etc
Audit program detail plan of auditing work
Characteristics
1) Detailed work plan
2) Duration for task
3) Audit procedure
4) Senior staff prepare
5) Generally accepted points
6) Junior staff put tick mark
Method of audit programs
A. Guide and control the junior staff
B. Classified work of junior staff
C. Internal check and control
Detail information of work
Prepare program according to the nature of client
Help to making program
Separate list of work assigned
Fixed time period
Assistant sign
Sample is in page 34
Objective of audit programme
Audit program- detail work plan of audit
1) Help in preparing proper plan
2) Help to conduct fair audit
3) Work of audit in less time
4) To help to make staff responsible
5) Help to new staff to perform works
Advantages of audit programme
i. Save time and labour
ii. Increase in work efficiency
iii. Help to control their work
iv. Help to maintain work uniformity
v. Help to make responsible
vi. Help to maintain work continuity
vii. Help to present as audit proof
Types of audit programme
A. Fixed audit programme
Prepare suggestion/recommendation of assistant staff
Cannot be changed during audit
Use all the organization
Advantages
i. Save the time/ use all the organization
ii. Complete within the time no change
iii. Prepare report on time
iv. Fixed responsibility
Disadvantages
i. Not use in all size of organization
ii. Not use I small/ big organization
iii. Impracticable/ unscientific for all time and situation
iv. Harasses to staff not use of knowledge
B. Flexible Audit programme
Can change/reviewed by assistant’s suggestion
Change/use knowledge
Change feeling management
Advantages
i. Auditing effective by change
ii. Staff happy programme change according to staff
iii. Change by time/situation
iv. Programme effective
Audit Note Book (ANB)
Prepare by audit staff
Note down unclear queries
Day to day work performed
All the types of errors noted down and other
Part of permanent life
Contents of Audit/Audit note book
Ø Important document of business Memorandum Articles Partnership, etc
Ø Name of the client, audit year, officer/manager
Ø List of book of account
Ø Duties and responsibilities
Ø Internal check in the business/ financial system
Ø Account and financial policies
Ø Bank statement/Bank reconciliation statement
Ø Value of finished stock-change
Ø Depreciation method normally 25%
Objective of Audit note book
Ø Know about business
Ø Errors and frauds no leave
Ø Easier to future audit
Ø List of debtors/creditors above 50 lakhs
Ø Know of fact
Ø To present as proof
Ø To assure the audit
Advantages
Ø No need to do repeated task by notebook save time and cost
Ø Help to get clearance to case (court)
Ø Help to refer in future
Ø Way to new staff
Ø Measure efficiency of staff performance of individual staff, allocate the job to staff
Organization of Audit staff and division of work
After getting information from client- structure, size, nature, internal check and control.
Auditor allocate the job of audit (job for staff)
1) Senior staff (SS)
Senior staff link between auditor and clients
Senior staff supervise, assigned to junior provide suggestions, work method, co-ordinate.
Senior staff checks stock, reserve, depreciation, contract, partnership, memorandum, articles, and decisions and develop audit report, present report
2) Junior staff (JS)
Depends on direction of senior staff
Junior staff performs basic work check subsidiary book, journal, ledger, cash book, bill, voucher but senior staffs check time and again, give suggestion and decision to work.
Instruction to clients
Before starting the audit give some major instruction to clients
· Prepare all the books of account, profit and loss and balance sheet
· Arrange all the vouchers into order of dates
· Prepare all the important documents like loan, contract, etc
· Make valuation of stock
· List of outstanding expenses and accrued income
· List of capital expenses and different revenue expenses
· Cash statement, bank deposit, bank reconciliation statement
Knowledge about the business
· Before conducting an audit get information
· Objective of the business
· Objective of corporate work
· Staffs and responsibility
· Financial transaction and decision
· Current and fixed assets of business
· Stock of raw materials/semi finished goods
· Policy of business
· Nature of business (resources needed or not)
· Organizational structure
Preparation by auditor
A. Audit file
· Keep the document
· Classification honestly
· Facts/ details investigation
· Prove of work
i. Current file
Use in auditing work
· Audit programme
· Method of internal control
· Statement of board of directors
· Trail balance
· Balance sheet
· Signature of authorized authority
ii. Permanent file
Used for long period of time
· Memorandum/ articles of association
· Decision of meeting
· Letter of commencement
· Organizational structure
· Branches of business
· Assets of depreciation
B. Audit working paper
· Recording important information of data
· Fact record- during the audit- analysis summery of comment
· Use of re-audit
· जगदिश प्रकाश,”लेखा परिछ्यण कार्यपात्र फाईदाको बिश्लेषण, समिछ्या, टिप्पणी र कागजातहरु जुन लेखा परिछ्यकले लेखा परिछ्यणको समयमा तयार पार्दछ त्यसलाई जनाऊदछ”
Generally some points are included below:
Ø Trail balance
Ø Debtors and creditors, fixed assets, investment, investment certificate
Ø Adjusting journal entries
Ø Minute book
Ø Depreciation
Ø Details of queries of explanation, etc
Objectives or aim of working paper
ü Support the auditors’ report
ü Check efficiency of audit- clerk
ü Remain and permanent record
ü Training to audit clerk
ü Point out the weakness
ü Help to the auditor plan
ü Save the time to make report
ü To make some previous working papers
Essentials of good working paper
v Completeness all information
v Organization and arrangement
v Clarity simple word and language
v Ready fact information
v Quality paper not damage
v Size of paper convenient
v Arrangement of papers subject matter/ logical orders
v Space sufficient space in the note/paper
Conduct of Audit
v Preparing audit program
Observation
Documentation
Interview
Test/check analysis
v Review of internal control system
v Conducting test: profit and loss, balance sheet and other
Collection, use and recoding of evidence
Field visit and inspection
Discussion and interview
Data collection
Comparative study analysis
Developing audit point
Conducting audit report
Types of Audit
Audit determined owner and auditors
1. Continuous audit/detail audit/regular audit
One month/per month
Three month visit audit as per requirement
Applicable for business
Ø Very large transaction
Ø Presented to management
Ø No satisfaction
Ø No internal check
Ø Report present the just after the close of financial year (bank)
Advantages
v Easy to detect/discover errors and frauds
v Quick presentation of account
v Keeps the clients staff alert (moral check to clients)
v Helps in business operation less chance to remain unrecorded transaction
Disadvantages
v Alteration/change figure
v Disturbance to clients work
v Expensive
v Lose the threats and queries
v Increase of dependency upon auditors
v Extensive/longer note taking
2. Periodical audit/final audit/complete audit
After profit and loss, balance sheet and other financial statement are prepared audit visit his client only once a year- check until audit work completed
Application for business
ü Check after preparation of final account
ü Auditor correcting irregularities
ü Auditor use special sign
ü Audit explanation from officer
Objective
· Maintaining regular book of account (journal)
· Profit and loss of business (true and fair)
· Balance sheet of business (financial position)
Advantages
v Less expensive
v No disturbance to client
v Less chance to alter figure
Disadvantages
v Unsuitable for big organization
v Possibility of leaving errors
v Difficult to detect planed frauds
v Impossible to prepare final account in time
3. Interim audit interim period 2/4/6 month
4. Partial audit particular subject (cash, debtors, creditors)
5. Cash audit
6. Cost audit
7. Management audit
8. Government audit/tax audit
