Auditing Procedures: Verification, Fraud, and Documentation
1. Verifying Rental Income
Procedures for verifying rental income:
- Rent Agreement / Lease Deed: Verify terms, period, and tenant details.
- Receipts / Bank Statement: Ensure rent is actually received and recorded.
- Comparison: Match rent billed versus rent received for accuracy.
- Tenant Ledger / Records: Check consistency of entries over the period.
- Authorisation & Tax Compliance: Ensure any concessions authorized and rent tax is correctly accounted for.
2. Verifying Investments
Procedures for verifying investments:
- Investment Schedule: Obtain a complete list from management.
- Supporting Documents: Check share certificates, bonds, mutual fund statements.
- Ownership & Purchase Details: Verify date, cost, and rightful owner.
- Authorisation & Valuation: Ensure investment approval by management and proper valuation method.
- Income & Pledge Verification: Confirm interest/dividends received and check if any investments are pledged as collateral.
3. Importance of Valuation
Valuation is crucial for several reasons:
- True Worth: Determines the actual value of assets and liabilities.
- Financial Statement Accuracy: Ensures books reflect correct figures.
- Investment & Decision Making: Helps management and investors in planning.
- Stakeholder Confidence: Fair reporting increases the trust of shareholders, lenders, etc.
- Compliance & Business Decisions: Supports loans, mergers, acquisitions, and adherence to accounting standards.
4. Note on Fraud
Understanding and addressing fraud:
- Meaning: Intentional act to deceive, misappropriate assets, or manipulate records.
- Types: Misappropriation of assets, financial statement manipulation, corruption, bribery.
- Detection: Through audits, internal control checks, and whistleblower reports.
- Prevention: Proper segregation of duties, authorisation, internal controls, and ethical culture.
- Impact: Causes financial loss, damages reputation, and may lead to legal action.
Difference Between Errors and Frauds
Meaning: Errors are unintentional mistakes in books of accounts due to carelessness, lack of knowledge, or misunderstanding. They arise naturally and do not involve any intention to deceive. Frauds are intentional misstatements or manipulation of accounts with the objective of cheating, hiding the truth, or gaining unlawful advantage.
Differences:
- Nature: Errors are accidental; frauds are deliberate and involve dishonesty.
- Cause: Errors are caused due to negligence or oversight; frauds are caused due to greed or personal benefit.
- Objective: Errors have no specific objective; frauds are always committed with a motive.
- Detection: Errors are relatively easier to detect through routine checking; frauds are often difficult to detect without deep investigation.
- Responsibility: Errors may be committed by any staff member; frauds are generally committed by higher officials or with collusion.
- Impact: Errors may or may not affect financial statements significantly; frauds always affect financial statements and mislead stakeholders.
- Examples: Errors include wrong posting or totaling mistakes; frauds include falsification of accounts or suppression of sales.
Conclusion: Errors can be prevented by careful accounting and supervision, while frauds require strong internal control, strict supervision, and independent audits.
Difference Between Internal Audit and Statutory Audit
Meaning:
Internal Audit is an independent review conducted by internal employees to evaluate internal control, operational efficiency, and compliance with policies.
Statutory Audit is a legally compulsory audit of financial statements conducted by an external auditor, as required by law.
Differences:
- Nature: Internal audit is voluntary; statutory audit is mandatory by law.
- Appointment: Internal auditor is appointed by management; statutory auditor is appointed by shareholders.
- Objective: Internal audit aims to improve efficiency and assist management; statutory audit aims to give a true and fair opinion on financial statements.
- Scope: Internal audit scope is flexible and decided by management; statutory audit scope is fixed by law.
- Qualification: An internal auditor may or may not be a Chartered Accountant; a statutory auditor must be a qualified Chartered Accountant.
- Reporting: Internal auditor reports only to management; statutory auditor reports to shareholders and government authorities.
- Legal Recognition: Internal audit has no legal recognition; statutory audit has full legal recognition.
Conclusion: Internal audit helps in internal improvement, while statutory audit ensures legal compliance and gives credibility to accounts.
Difference Between Vouching and Verification
Meaning:
Vouching means checking entries in books of accounts with the help of documentary evidence (invoices, bills, receipts) to verify the authenticity of transactions.
Verification means physically inspecting and confirming assets and liabilities to ensure their existence, ownership, valuation, and presentation in the Balance Sheet.
Differences:
- Objective: Vouching ensures genuine transactions; verification ensures assets and liabilities shown in the Balance Sheet actually exist.
- Basis: Vouching is based on checking documents; verification is based on physical inspection and third-party confirmation.
- Stage: Vouching is done continuously while auditing books; verification is usually done at the end of the accounting period.
- Responsibility: Vouching may be done by audit staff or assistants; verification is the personal responsibility of the auditor.
- Coverage: Vouching covers day-to-day transactions (purchases, sales); verification covers assets (cash, stock, building).
- Result: Vouching ensures correctness of transactions recorded; verification ensures true and fair presentation of balances.
- Examples: Vouching: checking a purchase invoice; Verification: counting cash in hand.
Conclusion: Vouching checks the validity of transactions, while verification confirms the accuracy of balances. Both are essential to express a true and fair opinion.
1. Definition and Objectives of Financial Auditing
Definition of Auditing
Auditing is a systematic and independent examination of books of accounts, vouchers, documents, and financial statements of an organization with the objective of verifying their accuracy, authenticity, and fairness. It ensures that the financial statements present a true and fair view of the financial position of the business.
Objectives of Financial Audit
- Verification of Accounts: To check whether the financial statements have been properly prepared according to accounting principles and statutory requirements.
- Detection of Errors: To identify unintentional mistakes such as omissions, duplications, or incorrect postings.
- Detection of Frauds: To detect deliberate misstatements, manipulations, or misuse of funds.
- Ensuring True & Fair View: To ensure that the balance sheet shows the correct financial position and the profit & loss account shows the actual performance.
- Verification of Assets & Liabilities: To confirm that all assets and liabilities recorded in the books actually exist and are valued correctly.
- Compliance with Laws: To verify that the company has complied with provisions of the Companies Act, Income Tax Act, GST laws, etc.
- Protection of Stakeholders’ Interests: To provide assurance to shareholders, creditors, and investors about the reliability of financial statements.
- Detection of Window Dressing: To check if management has manipulated accounts to show an artificially strong financial position.
- Assisting Management: To provide useful suggestions for internal control and efficient business operations.
- Certification: To issue an audit report which certifies whether the financial statements are true and fair.
Conclusion: Thus, the main objective of financial auditing is not only to detect errors and frauds but also to ensure the reliability of accounts and safeguard the interest of all stakeholders.
2. Definition and Pre-commencement Considerations of Audit
Definition of Audit Planning
Audit planning refers to the process of developing a general strategy and a detailed approach for conducting an audit in an efficient and effective manner. It includes deciding the scope of the audit, areas to be checked in detail, nature and timing of audit procedures, and allocation of audit work among staff. Proper planning ensures that the audit is completed within time and without unnecessary delays or duplication of work.
Pre-commencement Considerations of Audit
Before starting the actual audit work, the auditor must consider the following important aspects:
- Knowledge of Client’s Business: The auditor should study the type of business, size of operations, nature of products/services, and industry practices to understand the environment in which the client operates.
- Examination of Legal Documents: Auditor must verify documents such as Memorandum of Association, Articles of Association, Partnership Deed, Board Resolutions, etc., to know the authority, objectives, and internal rules of the organization.
- Evaluation of Internal Control System: Before beginning, the auditor should assess the effectiveness of internal checks and internal control procedures adopted by the business. Strong internal control reduces audit work.
- Study of Previous Audit Reports: Auditor must review earlier audit reports to identify weak areas, recurring errors, and unresolved issues.
- Agreement of Audit Engagement: A clear agreement/engagement letter should be obtained from the client defining scope of work, responsibilities, and audit fees.
- Staff Requirements and Allocation: Auditor should estimate the manpower required for audit and allocate work according to the capability of assistants and clerks.
- Fixing Time Schedule: A proper timetable should be prepared in consultation with the client to ensure timely completion of audit work without disturbing business operations.
- Understanding Accounting System: Auditor should study the books of accounts maintained, method of recording, and the accounting software used by the client.
- Collection of Preliminary Information: Auditor should collect details such as important contracts, loan agreements, contingent liabilities, and commitments of the client.
- Compliance with Statutory Requirements: Auditor should check provisions of law applicable to the business (like Companies Act, Tax laws) before starting the audit.
Conclusion: Hence, audit planning and proper pre-commencement considerations act as a roadmap for the auditor. They ensure that the audit is systematic, efficient, and free from unnecessary errors or omissions.
3. Definition and Essential Elements of Audit Programme
Definition of Audit Programme
An audit programme is a detailed written plan which specifies the nature, timing, and extent of audit work to be performed by the audit staff. It acts as a guideline for auditors by listing out the exact audit procedures to be followed.
Essential Elements of Audit Programme
- Clear Objectives: The programme must specify what each audit step aims to achieve, such as verifying purchases, checking depreciation, etc.
- Scope of Work: It should clearly define the scope of checking—whether full check or test check—and which areas are to be covered.
- Division of Work: The tasks should be divided among audit staff to avoid duplication and ensure accountability.
- Time Schedule: A proper timetable should be mentioned for completion of each stage of audit.
- List of Records to be Examined: It should mention which books of accounts, vouchers, and documents are to be checked.
- Procedures to be Applied: It should contain step-by-step audit procedures such as vouching, verification, reconciliation, etc.
- Extent of Checking: The programme should clarify whether 100% verification or sampling method will be used.
- Supervision & Review: It should mention who will supervise audit assistants and how work will be reviewed by the senior auditor.
- Flexibility: The programme should not be rigid; it must be flexible to allow changes as per audit requirements.
- Authentication: The audit programme should be signed and approved by the audit manager or partner to ensure authority.
Conclusion: Thus, an audit programme serves as a blueprint for audit work and ensures uniformity, efficiency, and accountability in the audit process.
4. Audit Working Papers: Elaboration and Content
Meaning of Audit Working Papers
Audit working papers are the detailed records and documents prepared and maintained by the auditor during the course of an audit. They serve as evidence of the work performed, procedures applied, information obtained, and conclusions drawn by the auditor. They show that the auditor has discharged his duties with due care, diligence, and honesty. Working papers are confidential documents belonging to the auditor and must be preserved carefully.
Importance of Audit Working Papers
- Evidence of Audit Work: They provide proof that audit procedures were properly carried out.
- Basis for Audit Report: Final audit opinion is prepared on the basis of observations noted in working papers.
- Future Reference: They help in planning future audits of the same client.
- Facilitate Supervision: Senior auditors can review and check the work done by junior staff.
- Legal Protection: In case of charges of negligence, working papers act as legal evidence to prove the auditor’s diligence.
- Continuity of Work: If an auditor is replaced, the next auditor can refer to past working papers for guidance.
- Helps in Coordination: Maintains smooth coordination between audit staff as each one records their findings.
Contents of Audit Working Papers
A complete set of audit working papers generally contains the following:
- General Information of Client: Name of the organization, address, nature of business, accounting period, and organizational structure.
- Audit Engagement Letter & Plan: Copy of audit engagement letter, audit planning documents, risk assessment, and scope of audit.
- Audit Programme: The detailed programme containing audit procedures, division of work, and time schedule.
- Details of Accounting System & Internal Control: Notes on client’s accounting system, methods of recording, and evaluation of internal control system.
- Evidence Collected: Verification of assets, physical stock counts, confirmations from debtors/creditors, and reconciliations.
- Schedules and Statements Prepared: Schedules of fixed assets, depreciation charts, details of outstanding expenses, prepaid expenses, etc.
- Details of Audit Tests: Test checking results, routine checking notes, and findings of vouching/verification.
- Errors & Frauds Detected: Specific details of mistakes, irregularities, or suspected frauds found during audit.
- Correspondence and Discussion Notes: Notes of meetings with management, correspondence with bankers, lawyers, or other parties.
- Adjustments & Recommendations: Details of audit adjustments suggested by the auditor and their acceptance/rejection by management.
Conclusion: Audit working papers are a vital part of the audit process. They act as evidence, memory aid, supervisory tool, and legal protection for the auditor. A properly maintained set of working papers ensures that the audit report is reliable, credible, and based on documented facts.
Q5. Define Test Check and Its Features
Meaning / Definition of Test Check
Test check is an auditing technique in which instead of checking each and every transaction, the auditor verifies a representative sample of entries from the books of accounts. The idea is that if the selected transactions are correct, then there is a reasonable assurance that the remaining transactions are also reliable. This method saves time and cost while still maintaining audit accuracy.
Features of Test Check
- Selective Examination: Only a part of the total transactions is checked; the auditor selects entries on a sample basis.
- Representative Sample: The transactions chosen must represent the whole population, covering different periods, amounts, and types of transactions.
- Time-Saving Technique: Test check reduces the time and cost of audit because the auditor avoids full-scale checking of voluminous data.
- Based on Auditor’s Judgment: The size and type of sample depend on the auditor’s skill, knowledge, and professional judgment.
- Risk Involved: Since not all transactions are verified, there is always a possibility that errors or frauds in unchecked entries may remain undetected.
- Requires Proper Internal Control: Test checking is effective only if the organization has a strong system of internal control.
- Flexibility: The auditor can increase or decrease the size of sample depending upon the importance of the account and the risk involved.
Conclusion: Test check is a practical and widely used auditing technique. If applied with care and supported by an effective system of internal control, it helps the auditor save time and effort while ensuring that the accounts give a true and fair view.
Q6. Define Routine Checking and Its Features
Meaning / Definition of Routine Checking
Routine checking refers to the regular and mechanical checking of books of accounts. It mainly includes checking of casting, posting, totaling, balancing, carry-forwards, and cross-referencing of accounting entries. It ensures that the arithmetical accuracy of accounts is maintained and that entries are properly recorded in the ledgers. It is considered the first step of auditing work.
Features of Routine Checking
- Mechanical Nature: Routine checking is mainly concerned with mechanical aspects like addition, subtraction, posting, and carry-forward of balances.
- Covers Day-to-Day Transactions: It involves checking transactions recorded in the books on a daily basis to ensure accuracy in the flow of accounting data.
- Detection of Clerical Errors: Routine checking helps in locating clerical mistakes such as wrong totaling, wrong posting, omissions, or duplications.
- No Guarantee Against Fraud: While it can detect small errors, it may not always help in identifying frauds, especially if fraud is committed deliberately.
- Time Consuming: Since every transaction is checked in detail, routine checking may take more time compared to test checking.
- Basis for Further Audit: Once basic accuracy is confirmed, the auditor can move towards advanced checking like vouching and verification.
- Requires Patience & Accuracy: This process demands continuous attention, patience, and accuracy on the part of the auditor’s staff.
Conclusion: Routine checking is a fundamental audit procedure that ensures the arithmetical accuracy of accounts. Although it does not completely prevent fraud, it is essential for detecting clerical errors and providing a reliable base for further stages of auditing.
Q7. Define Vouching and Its Importance
Meaning / Definition of Vouching
Vouching is considered the backbone of auditing. It refers to the process of examining documentary evidence (vouchers) to verify the truth, validity, and authenticity of accounting entries recorded in the books of accounts. A voucher may be a receipt, invoice, bill, cash memo, or contract. By checking vouchers, the auditor ensures that no fictitious, duplicate, or unauthorized transactions are recorded.
In simple terms, vouching means “proving the truth of transactions recorded in the books with the help of supporting documents.”
Importance of Vouching
- Verification of Authenticity: Vouching confirms whether the transactions recorded in the books are genuine, authorized, and supported by valid documentary evidence.
- Detection of Errors and Frauds: By checking vouchers, the auditor can detect misstatements, fictitious transactions, false entries, or misappropriation of cash and goods.
- Ensures Proper Authorisation: Vouching ensures that every transaction is carried out with the approval of the responsible authority.
- Basis for Audit Opinion: Since vouching helps in verifying the accuracy of transactions, it forms the foundation for the auditor’s final opinion on financial statements.
- Prevents Manipulation: Regular and strict vouching discourages employees from manipulating accounts.
- Accuracy of Financial Statements: Vouching ensures that the Profit & Loss Account and Balance Sheet reflect the true financial position of the business.
- Helps in Future Reference: Properly vouched documents act as evidence in case of disputes or legal matters.
- Ensures Compliance: Vouching also checks whether the transactions comply with accounting standards, company policies, and statutory requirements.
Conclusion: Thus, vouching is the most important audit technique because it verifies not just the arithmetical accuracy but also the truth and legality of transactions. Without proper vouching, the reliability of audited accounts cannot be guaranteed.