IPCC Audit Notes 2

Chapter 1

Nature of Auditing

Part 2….

 

Scope of Audit of Financial Statements Scope will be determined by Auditor in regard to-terms of engagement-requirement of relevant legislation

-pronouncement of ICAI.

Terms of engagement cannot restrict scope of Audit in matters

-prescribed by legislation

-pronounced by ICAI.

Objective of Audit of Financial Statement Reliability & Sufficiency of Information The auditor assesses reliability & sufficiency of info by:-making a study & evaluation of accounting systems & internal controls on which he wishes to rely to determine the nature, timing & extent of audit procedures.

-carrying out other tests, enquiries & other verification procedures of accounting transactions & account balances he considers appropriate.

Disclosure of relevant info The auditor determines whether relevant info is properly disclosed in financial statements by:-comparing financial statements with underlying accounting records & other source data

-considering judgments that management has made in preparing financial statements

-assessing the selection & consistent application of accounting policies, classification of info & adequacy of disclosure.

Forming of Opinion -In forming an opinion, the auditor follows procedures which determine that financial statements reflect a true & fair view of financial position & operation results of enterprise.-There is an unavoidable risk that some material misstatements may remain undiscovered.

 

-Auditor cannot be relied upon to ensure the discovery of each & every fraud or error.

 

-Auditor is not expected to perform duties which fall outside the scope of his competence.

Inherent Limitations of Audit Judgment -Auditor’s work involves exercise of judgment.-Since many areas of accounting & auditing involved the use of judgment, different judgments cause different outcome.
Audit Evidence -Evidence available to the auditor only enables him to draw reasonable conclusions.-This is so because evidence obtained by auditor is generally persuasive in nature.

 

-Therefore absolute certainty in audit is rarely attainable.

Inherent Limitations of Internal Control -There is always risk of an internal control system failing to operate as designed.-Fraud involving collusion among employees cannot be detected by internal control system.
Management override of Controls -Certain levels of management may be in a position to override controls.-They can perpetrate greater fraud than the employees.
Difference between Audit & Investigation Definition Auditing is general examination of records in the ordinary course of business.Investigation is a critical examination of accounts with a special purpose.
Specific Areas Auditing takes each and every aspect of accounts into consideration.Investigation concerns only specified areas.
Pre-Conceived Notion There are no pre-conceived notions as to the outcome of auditing.Investigation is always conducted with some pre-conceived notion suited to the objective.
Statutory Obligation Audit is required by the statute.There is no such case where investigation is concerned.
Types of Audit Required Under Law -Companies under Companies Act-Banking Companies under Banking Regulations Act-Electricity Supply Co. under Electricity Supplies Act

-Co-Operative Societies under Co-Operative Societies Act

-Public & Charitable Trust

-Corporations set up under an Act of Parliament or Stare Legislature

- Specified Entities under Income Tax Act

Voluntary Audits -Proprietary Audit-Audit of Partnership Firm-HUF (Hindu Undivided Families)

There is no mandatory law requirement.

Advantages of Independent Audit Reliability The financial statements are more reliable if an independent audit is carried out.This is so because the auditor will then be free of any bias.
Safeguarding Financial Interest It safeguards the interest of persons who are not associated with the management of entity.
Moral Check It acts as a moral check on the employees from committing defalcations or embezzlement.
Settling Liability & Trade Disputes Audited statements of account helps in-settling liability for taxes

-negotiating loans

-determining purchase consideration for a business

-settling trade disputes

-settling claims for damage of property.

Detection of Losses -It can help in detection of wastages & losses.-It also shows different ways to check such losses.
Books of Account It ascertains whether proper books of accounts have been prepared or not & also helps in rectifying mistakes in this regard.
Appraisal It reviews the existence & operations of various controls on organization & reports weaknesses in them.
Settlement of Accounts Audited accounts are of great help in settlement of accounts at the time of admission or death of partner.
Statutory Requirement Government may require audited & certified statement before it gives assistance or issues a license.
Relationship of Auditing with other Disciplines Accounting -Auditor should have knowledge of generally accepted accounting principles before he can review the financial statements.
Law Auditor should be familiar with business laws affecting the entity. For example:-Law of contracts

-negotiable instruments

-taxation laws, etc.

Economics -Auditor is expected to be familiar with the overall economic environment in which his client is operating.-he should also be familiar with macro & micro economics though, micro is more important from auditing point of view.

 

-macro economics should include economic nature of force which affects the firm, relationship of price, productivity, role of government & government regulations.

Behavioral Science Auditor should be able to interact with people on a regular basis.He should have knowledge of human behavior to effectively discharge his duties.
Mathematics & Statistics With emergence of test check procedure the necessity of knowledge of statistics is gaining momentum.The knowledge of mathematics is also required particularly at the time of verification of inventories.
Data Processing -Now-a-days, the organizations are carrying out their financial accounting activities with the help of computers.-Therefore, the auditor should have good knowledge of components, general capability of the system and related terms.

 

-In fact, EDP auditing in itself is developing as a discipline in itself.

Financial Management In general, auditor is required to have knowledge of financial techniques such as-working capital management

-funds flow

-ratio analysis

-capital budgeting, etc.

 

He is also required to have knowledge about

 

-institutions comprising the market place

-government activities that influence operations of financial market.

Production -A good auditor is one who understands his client & his business.-He is required to evaluate transactions from accounting aspect in relation to processes through which it has passed.

 

-Knowledge of accounting of joint & by products is also required.

 

Auditor should also know about

 

-cost system in operation in factory

-terminology of production, etc.

Types of Errors Errors of Omission Where a transaction is omitted wholly or partially.
Errors of Commission Where a transaction has been mis-recorded either wholly or partially.
Compensating Errors Where there are two or more errors which exactly counter balance each other, so trial balance agrees in spite of them.
Procedural Errors Whatever errors occur in the implementation of the procedures.
Errors of Principle Errors arising as a result of transactions having been recorded in a fundamentally incorrect manner.

 

IMPORTANT NOTE:

Following are the categories of errors according to Mautz:

  1. Self-revealing errors
  2. Unintentional & intentional errors
  3. Unconcealed & concealed errors
  4. Affecting & not affecting general ledger balances

This entails the end of the first chapter…..

Stay tuned for more…..

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