Lesson 13 Concept of Auditing 377

PART B
FUNDAMENTALS OF AUDITING

LESSONS
LEARNING OBJECTIVES
From the time of ancient Egyptians, Greeks and
10. Concepts of Auditing
Romans, the practice of auditing the accounts of
public institutions existed. Checking clerks were
11. Types of Auditing
appointed in those days to check the public
accounts. To locate frauds as well as to find out
12. Tools of Auditing whether the receipts and payments are properly
recorded by the person responsible was the main
13. Audit and Auditors under Companies Act, objective of Auditing of those days.
2013 – Basic Provisions During the 18th century, the Company form of
organizations comes into existence. In these
companies capital is contributed by shareholders
but they do not have control over the day to day
working of the company. The shareholders who
have invested their money would naturally be
interested in knowing the financial position of the
company. This originated the need of an
independent person who would check the
accounts and report the shareholders on the
accuracy of the accounts and the safety of their
investment.

Now days many forms of organisations are

mandatorily required by the legislation to get their
accounts audited. So there is a need to have
understanding of the subject of auditing.

319
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Lesson 13
Concept of Auditing

LESSON OUTLINE
LEARNING OBJECTIVES

– Introduction The basic purpose of auditing is to confirm the

authenticity of books of accounts prepared by an
Accountant. It is well known saying that “where
– Meaning of Audit
the function of Accountant ends, audit begins to
determine the true and fair picture of such
– Principle aspects to be covered under
accounts”.
audit
Audit is performed to ascertain the validity and
reliability of information. Examination of books
– Benefits of auditing
of accounts with supporting vouchers and
documents in order to detect and prevent error
– Limitations of auditing and fraud is the main function of auditing. Auditor
has to check the effectiveness of internal control
– Review Questions system for determining the extent of checking to
be done for carrying out the audit. Other than
– Investigation internal control system auditor has to follow
certain other principal aspects of auditing. Audit
– Difference between Auditing and safeguards the financial interest of persons not
associated with the management like partners,
Investigation
shareholders, etc. Auditing also have some
inherent limitations such as the obtained
– Lesson Round UP
evidences are persuasive rather than conclusive.
Investigation and auditing are two different areas
– Glossary not linked with each other.

In this lesson, you will learn the meaning of audit;

– Self-Test Questions
principle aspects of auditing, advantages and
Limitations of audit and what is investigation and
how is it different from auditing.

I’m not suggesting there are any errors at all. I’m saying that without a proper audit, there’s no way to be
sure.
Pete Williams

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 Lesson 13 Concept of Auditing 379

INTRODUCTION

Evolution of Auditing
The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days a person used to listen
to the accounts read over by an accountant in order to check them. He was known as auditor. Auditing is as old
as accounting and there are signs of its existence in all ancient cultures such as Mesopotamia, Greece, Egypt.
Rome, U.K. and India. Arthshastra by Kautilya detailed rules for accounting and auditing of public finances.
Audit is performed to ascertain the validity and reliability of information. Examination of books of accounts with
supporting vouchers and documents in order to detect and prevent error and fraud is the main function of
auditing. The goal of an audit is to express an opinion on the financial or non-financial areas. Audit safeguards
the financial interest of persons not associated with the management like partners or shareholders, acts as a
moral check on the employees and prevents from committing fraud. However, due to constraints, an audit seeks
to provide only reasonable assurance that the statements are free from material error. In case of financial audit,
a set of financial statements are said to be true and fair when they are free of material misstatements. But
recently, argument that auditing should go beyond just true and fair is gaining momentum in view of recent
frauds by high profile organizations in connivance with the reputed audit firms.
Traditionally, audits were mainly associated with gaining information about financial systems and the financial
records of a company or a business. However, recently auditing has begun to include non-financial subject
areas, such as safety, security, information systems performance, and environmental concerns. With non-profit
organizations and government agencies, there has been an increasing need for performance audit, examining
their success in satisfying mission objectives of business.
In India the Companies Act, 2013 made audit of company accounts compulsory. With the increase in the 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, 2013 also prescribed for the
first time about the qualification of auditors. After the independence. The Indian Companies Act, 1956 was
implemented and detailed provisions were made in the Act regarding Audit and auditors. Recently Companies
Act, 2013 has been implemented w.e.f. 1st April, 2014 and this contains detailed provisions about statutory
audit, Cost Audit, Internal Audit and Secretarial Audit.

MEANING AND DEFINITIONS OF AUDITING

It is a bit difficult to give a precise definition of word audit in a word or two, originally its meaning and use was
confined merely to cash audit and the auditor had to ascertain whether the person responsible for the maintenance
of accounts had properly accounted for all the cash receipts and payment on behalf of this principle. But the
word “audit” has a wide usage and now it means a thorough scrutiny of the books of accounts and its ultimate
aim is to verify the financial position disclosed by the balance sheet and the profit and loss account of a company.
The following are some of the definitions of audit given by some writers
Lawrence R. Dicksee – “An audit is an examination of accounting records undertaken with a view to establishing
whether they correctly and completely reflect the transactions to which they purport to relate.”
Taylor and Perry – “Audit is defined as an investigation of some statements of figures involving examination of
certain evidence, so as to enable an auditor to make a report on the statement.
F.R.M. De Paula – “An audit denotes the examination of Balance Sheet and Profit and Loss Account prepared
by others together with the books of accounts and vouchers relating there to in such a manner that the auditor
may be able to satisfy himself and honestly report that, in his opinion, such Balance Sheet is properly drawn up
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so as to exhibit a true and correct view of the state of affairs of the particular concern according to the information
and explanations given to him and as shown by the books”.
Prof. Montgomery – “Auditing is a systematic examination of the books and records of business or other
organization in order to ascertain or verify and to report upon the facts regarding its financial operations and the
result thereof.”
Spicer & Pegler – “Audit such an examination of the books of accounts and vouchers of a business, as will
enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair
view of the state affairs of the business, and whether the profit and loss account gives a true and fair view of the
profit or loss for the financial period according to the best of his information and explanations given to him and as
shown by the books, and if not, in what respect he is not satisfied.”
Institute of Chartered Accountants of India (ICAI) defines Auditing as – “Auditing is defined as a systematic
and independent examination of data, statements, records, operations and performance of an enterprise for a
stated purpose. In any auditing situation, the auditor perceives and recognizes the propositions before him for
examination, collect evidences, evaluates the same and on this basis formulates his judgement which is
communicated through his audit report.”
In the close scrutiny of the different definitions, we found that there are different ways of expressing the concept
of auditing but having lot of similarity therein.
The meaning of an Audit contains
(i) an intelligent and critical examination of the books of accounts of business;
(ii) it is done by an independent qualified person;
(iii) it is done with the help of vouchers, documents, information and explanations received from the clients;
(iv) the auditor satisfies himself with the authenticity of the financial accounts prepared for a particular
period;

Features of Auditing
(i) Audit is a systematic and scientific examination of the books of accounts of a business;
(ii) Audit is undertaken by an independent person or body of persons who are duly qualified for the job.
(iii) Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown
by the balance sheet.
(iv) Audit is a critical review of the system of accounting and internal control.
(v) Audit is done with the help of vouchers, documents, information and explanations received from the
authorities.
(vi) The auditor has to satisfy himself with the authenticity of the financial statements and report that they
exhibit a true and fair view of the state of affairs of the concern.
(vii) The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions
and examine correspondence, minute book of share holders, directors, Memorandum of Association
and Articles of Association etc., in order to establish correctness of the books of accounts.

Objectives of Auditing
The objectives of auditing may be classified into two parts:
(i) The primary objective
 Lesson 13 Concept of Auditing 381

(ii) The secondary or incidental objective.

Primary objective – As per Section 143 of the Companies Act 2013, the primary duty (objective) of the auditor
is to report to the owners that the accounts, financial statements give a true and fair view of the state of the
company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other
matters as may be prescribed.
Secondary objective – It is also called the incidental objective as it is incidental to the satisfaction of the main
objective. The incidental objectives of auditing are:
(i) Detection and prevention of frauds, and
(ii) Detection and prevention of errors.
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 mis-stated. Fraud refers to intentional misrepresentation of financial information
with the intention to deceive. Frauds can take place in the form of manipulation of accounts, misappropriation of
cash and misappropriation of goods. It is of great importance for the auditor to detect any frauds, and prevent
their recurrence. Errors refer to unintentional mistake in the financial information arising on account of ignorance
of accounting principles i.e. principle errors, or error arising out of negligence of accounting staff i.e. clerical
errors.

Basic Principles Governing an Audit

SA 200 “Basic Principals Governing an Audit”, describes the basic principles which govern the auditor’s
professional responsibilities and which should be complied with wherever an audit is carried. They are described
below:
(i) Integrity objectivity and independence: An auditor should be honest, sincere, impartial and free from
biasness. He should be a man of high integrity and objectivity.
(ii) Confidentiality: The auditor should respect confidentiality of information acquired during the course of
his work and should not disclose the information without the prior permission of the client, unless there
is a legal duty to disclose.
(iii) Skill and competence: The auditor must acquire adequate training and experience. He should be
competent, skillful and keep himself abreast of the latest developments including pronouncements of
ICAI on accounting and auditing matters.
(iv) Work performed by others: If the auditor delegates some work to others and uses work performed by
others including that of an expert, he continues to be responsible for forming and expressing his opinion
on the financial information.)
(v) Documentation: The auditor should document matters which are important in providing evidence to
ensure that the audit was carried out in accordance with the basic principles.
(vi) Planning: The auditor should plan his work to enable him to conduct the audit in an effective, efficient
and timely manner. He should acquire knowledge of client’s accounting system, the extent of reliance
that could be placed on internal control and coordinate the work to be performed.
(vii) Audit evidence: The auditor should obtain sufficient appropriate evidences through the performance of
compliance and other substantive procedures to enable him to draw reasonable conclusions to form an
opinion on the financial information.
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(viii) Accounting system and internal control: The management is responsible for maintaining an adequate
accounting system incorporating various internal controls appropriate to the size and nature of business.
The auditor should assure himself that the accounting system is adequate and all the information which
should be recorded has been recorded. Internal control system contributes to such assurance.
(ix) Audit conclusions and reporting: On the basis of the audit evidence, he should review and assess
the audit conclusions. He should ascertain:
(i) as whether accounting policies have been consistently applied;
(ii) whether financial information complies with regulations and statutory requirements; and
(iii) there is adequate disclosure of material matters relevant to the presentation of financial information
subject to statutory requirements.
The auditor’s report should contain a clear written opinion on the financial information. A clean audit report
indicates the auditor’s satisfaction in all respects and when a qualified, adverse or a disclaimer of opinion is to
be given or reservation of opinion on any matter is to be made, the audit report should state the reasons thereof.

PRINCIPLE ASPECTS TO BE COVERED UNDER AUDITING

The following aspects are required to be covered by an auditor while doing audit of any organization. The
principle aspects can also be called the functions of audit:
(i) Review of System and Procedures: Review of system and procedure is the primary function of auditing
exercise. First an auditor needs to understand the system and procedures adopted by the entity to go
further in the auditing exercise.
(ii) Review of Internal Control System: Review of internal control system is very important for the auditor
as the effectives of internal control system will determine the extent of checking to be done by the
auditor. The compliance test and substantive procedures performed by the auditor will determine the
effectiveness of internal control system. If internal control system is effective, less checking is required
and vice-versa. Moreover As per Company Audit Report Order, 2003, an auditor need to comment on
the effectiveness of internal control system in the organization so the review of internal control is necessary
for carrying out the auditing exercise.
(iii) Routine Checking/Arithmetical Accuracy: It is the duty of the auditor to check the arithmetical accuracy
of the books of account by checking the proper posting and balances of the books of accounts.
(iv) Accounting Principles: Auditor has to ascertain whether proper distinction has been made between
the item of capital and revenue nature and also whether the item of income and expenditure of a
particular period has been adjusted in the books of accounts of that accounting period.
(v) Books and Statements: Auditor has to compare the balance sheet and profit and loss account or other
statement with the books of accounts and supporting vouchers to ascertain that the final accounts have
been made in accordance with the underlying records.
(vi) Verification of Assets: It is the duty of the auditor to physically inspect the assets and their recording in
the books of accounts and verify the legal and official documents to ascertain the existence, ownership,
possession, classification and valuation of assets of an entity.
(vii) Verification of Liabilities: It is the duty of the auditor to inspect the books of accounts and verify the
legal and official documents to ascertain the existence, obligation, completeness, valuation and disclosure
of liabilities of an entity.
(viii) True and Fair View: The auditor has to give its opinion whether the financial statements depicts the true
and fair view of the state of affairs of the organization.
(ix) Vouching: Auditor has to inspect documentary evidence that supports and substantiate a transaction
 Lesson 13 Concept of Auditing 383

(x) Statutory Compliance: Auditor has to ensure that all the statutory requirements has been complied by
the entity like provisions of Income Tax Act, 1961, the Companies Act, 2013 and other acts, if any.
(xi) Reporting: The auditor has to report to the authority appointing him for conducting the audit whether
the financial statements of accounts examined actually reveals true and fair view of the state of affairs
and of the profit or loss earned during the period by the organization.

ADVANTAGES OF AUDIT
(i) Satisfaction of Owner: It is because of audit that the owner will be satisfied about the business operations
and working of its various departments.
(ii) Detection and Prevention of Errors and Frauds: The errors whether committed innocently or deliberately
are discovered by the process of audit and its presence prevents their occurrence in the future. No one will try to
commit error or fraud as the accounts are subject to audit and hence they will have a fear of being detected. Just
like errors, frauds are discovered by audit and its presence minimizes future possibility if not eliminated totally.
(iii) Verification of Books: Another advantage of audit is the verification of the books of accounts, this helps in
maintaining the records up to date at all times.
(iv) Independent Opinion: Auditing is very useful in obtaining the independent opinion of the auditor about
business condition. If the accounts are audited by an independent auditor, the report of the auditor will be true
and fair in all respects and it will be of extreme importance for the management of the company.
(v) Moral Check: The process of audit will establish a check on the minds of the staff working in the business
and they will not be able to commit any irregularity, as they will have a fear and will also be aware that the
accounts will be examined in the near future and that action would be taken against them if any irregularity is
discovered. Thus the audit prevents the happening of any irregularity before it starts and the staff hence becomes
more active and responsible.
(vi) Protection of the Rights and Interests of Shareholders: Audit helps in protecting the interests of
shareholders in case of joint stock company. Audit gives assurance to the shareholders that the accounts of the
company are being maintained properly and their interest will not suffer under any circumstances.
(vii) Create confidence among stakeholders : Outsiders like creditors, debenture holders and banks etc. can
rely on the books of accounts and financial statements of the business if the accounts and financial statements
are audited by an independent authority (external auditor).
(viii) Ensures Compliance with Legal Requirements: Audited statements are necessary to fulfill certain legal
requirements i.e. listing requirements of stock exchange etc.
(ix) Reinforce and Strengthen Internal Control: Since auditing exercise involves the review of internal control
system, an auditor will identify the gaps in internal control system and can suggest the necessary changes in the
internal control system.
(x) Loan Facility: Money can easily be borrowed on the basis of audited financial statement. If accounts are
audited, the true picture will be visible to banks and it will be easy for them to issue loans as early as possible.

LIMITATIONS OF AUDIT
Besides having various advantages, there are some inherent limitations of auditing. These are as follows :
(i) Higher Cost Burden: Due to Higher Cost Burden, the auditor limits his scope of work to selective
testing or sampling thus in depth checking of books of accounts is not possible.
(ii) Based on test checks. Generally an auditing exercise is based on test checking. Inferring a result on
the basis of test check always need not to be true.
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(iii) Insufficient Time: Generally an auditor needs to release the report up to a specified timeline. Sometime
this timeline become a constraint for auditor in carrying out the auditing exercise effectively. This time
constraint may affect the amount of evidence that can be obtained from concerned events and transactions
after the balance sheet date.
(iv) Inconclusiveness of Evidences: The evidences obtained by an auditor are persuasive rather than
conclusive. For example, an architect’s certificate of valuation for a newly constructed building of a
client may not be conclusive evidence of the correct value of building.
(v) Based on Estimates: Estimates are an inherent part of the accounting process, and no one, including
auditors, can foresee the outcome of uncertainties. Estimate range from the allowance for doubtful
accounts and an inventory obsolescence reserve to impairment tests of fixed assets and goodwill.
An audit cannot add exactness and certainty to financial statements when these factors do not
exist.
(vi) Based on the Information provided by the Management: The audit opinion is based on the information
provided by the management. Hence, outsiders cannot fully rely on the auditor’s report.

REVIEW QUESTION
1. The evidence obtained by an auditor is __________rather than conclusive.
2. The term ‘Audit’ originated from the Latin word “audire” means _________.
3. Auditing can be defined as an _______________ examination of records (financial
or non-financial).
4. If internal control system is effective, ___________ checking is required and vice-
versa.

INVESTIGATION
The investigation is related to critical checking of particular records. Investigation is done when a lapse already
exists to pin point the reason and person involved in it so that responsibility for such lapse could be fixed
whereas, audit is a process to check whether the accounts are properly maintained as per required norms or not
following all the procedures etc. and to point out any lapses in this line. The purpose of auditing and investigation
is different.

DIFFERENCE BETWEEN AUDITING AND INVESTIGATION

PARTICULARS INVESTIGATION AUDITING
1. Meaning Investigation implies systematic, critical An audit is independent examination of
and special examination of the records financial information of any entity, when
of a business for a specific purpose. such an examination is conducted with
a view to expressing an opinion thereon.
2. Nature Voluntary Mandatory for Companies. For others, it
is voluntary.
3. Conducted by Any person, who may not be a A Chartered Accountant within the
Chartered Accountant. meaning of the Chartered Accountants
Act 1949.
 Lesson 13 Concept of Auditing 385

4. Appointing Agency Owners or Management or even third Owners/Shareholders of the enterprise.

parties may appoint the investigator.
5. Protection of Work is carried out from the viewpoint Work is carried out on behalf of the
Interests of the appointing agency. owners, even if the power of appointment
is delegated to Board of Directors.
6. Scope and Coverage Specific – Seeks to answer only those General – when compared to
questions laid down in the engagement investigation – seeks to form an opinion
letter. on the Financial Statements.

7. Period Covered Not necessarily restricted to a financial Generally a period of one financial year.
year. It may be extended to a period
more than one year. Even it may be
less than one year.

8. Pre conceptions Its essence lies in going into the matter Audit is not based on suspicion unless
with some pre-conceived notion suited circumstances exist to arouse suspicion.
to the objective.
9. Evidence Seeks conclusive and corroborative Much of audit evidence is persuasive
evidence. rather than conclusive.
10. Form of Reporting There is no statutory form of The matters to be covered in the audit
investigation report. report are sometimes prescribed by law.

LESSON ROUND UP
– An Audit is an independent examination of financial or non-financial information of any entity; when
such an examination is conducted with a view to express an opinion thereon.
– Principle Aspects to be Covered under Audit: internal control system, review of system and
procedures, accounting principles, books and statements, verification of assets, verification of liabilities,
true and fair view, statutory compliance and report.
– Advantages of Audit: satisfaction of owner, detection and prevention of errors and frauds, verification
of books of accounts, independent opinion, moral check, protection of the rights and interests of
shareholders, ensures compliances with legal requirements, reinforce and strengthen internal control
system and reliance by outsiders
– Limitations of an Audit: Involves higher cost, audit involves reasonable length of time, based on test
checks, evidence obtained by an auditor are persuasive rather than conclusive, auditors cannot
determine the appropriateness of accounting estimates because of uncertainties involved in it and
audit is based on information provided by management.
– Difference between Investigation and Auditing: Investigation implies systematic, critical and special
examination of the records of a business for a specific purpose whereas, audit is an independent
examination of financial information of any entity, where examination is conducted with a view to express
an opinion thereon.

GLOSSARY
Connivance Agreement on a secret plot, collusion
Persuasive Intended or having the power to induce action or belief, convincing.
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Conclusive Forming an end or termination; especially putting an end to doubt or question;

“conclusive proof”; “the evidence is conclusive”
GAAP Generally Accepted Accounting Principles, a collection of rules and procedures and
conventions that define accepted accounting practice; includes broad guidelines as
well as detailed procedures.
Statutory Relating to or created by statutes; “statutory matters”; “statutory law”. Statute means a
law enacted by a government.
Corroborative To strengthen or support with additional evidence.

SELF-TEST QUESTIONS
1. What is the meaning of Auditing?
2. What are the principal aspects to be covered in auditing?
3. Why the need of auditing arises and what are advantages of auditing?
4. “The evidences obtained by the auditor are persuasive rather than conclusive”. Explain.
5. What do you mean by investigation and how is it different from auditing?

SUGGESTED READINGS
1. Fundamentals of Auditing – By Kamal Gupta
2. Auditing: Principles and Practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu

MULTIPLE CHOICE QUESTION

1. Audit Note Book contains: (A) Various dates of reference (B) Details of work done (C) Notes regarding
item requiring clarification explanations, etc. (D) All of the above
2. Which of the following has a broader scope?
(A) Internal control (B) Internal audit (C) Internal checking (D) None of the above
An Internal Auditor is:
(A) Temporary Employee (B) Permanent Employee (C) Daily wager (D) None of the above
3. The main object of vouching is :
(A) To prepare trial balance (B) conduct routine checking (C) verify authenticity and authority of
transactions (D) Checking of vouchers
4. Valuation is the base of:
(A) Verification (B) Marketing (C) Internal checking (D) Vouching
5. The first auditor or auditors are appointed by:
(A) Central Government
(B) Company Law Board
(C) Board of Directors
(D) Shareholders
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6. A number of checks and controls exercised in a business to ensure its efficient working is known as
________.
A) Internal check.
B) Internal control.
C) Internal audit.
D) Interim check.
7. Voucher relates to _________.
A) cash receipt.
B) cash payment.
C) credit transactions.
D) all the above.
8. Internal check is meant for ___________.
A) prevention of frauds.
B) detection of frauds.
C) helping audit is depth.
D) detection of errors.
9. Internal auditor is appointed by ________.
A) the management.
B) the shareholders
C) he government.
D) he statutory body.
10. Auditing begins where ______ ends.
A) Selling.
B) inventory valuation.
C) Accounting.
D) Purchases.
11. A good audit report must at least meet one of the following qualifications __________.
A) it should offer constructive and timely suggestions to the management.
B) it should not point out mistakes.
C) it should not be based on factual information.
D) it should not be based on balance sheet.
12. The work of one clerk is automatically check by another clerk is called _________.
A) Internal control.
B) Internal check.
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C) Internal audit.
D) None of the above.
13. The owners of the company are called __________.
A) Debenture holders.
B) Debtors.
C) Shareholders.
D) None of the above.
14. Verification is __________.
A) the art of recording the business transaction.
B) an examination of the books of accounts.
C) the act of establishing the accuracy of entries in the books of accounts.
D) none of the above.
15. The main objects of investigation is _________.
A) to discover errors and frauds.
B) to prevent errors and frauds.
C) to verify statements.
D) all the above.
16. Internal controls and internal check are ____________.
A) one and the same.
B) different.
C) internal control includes internal check.
D) None of the above.
17. An auditor is like a ______.
A) Watchman.
B) foolish dog.
C) mad dog.
D) watch dog.
18. Special audit is necessary for _________.
A) inefficient concern.
B) processing concern.
C) trading concern.
D) manufacturing concern.
19. The company’s auditor is expected to give _____________.
A) his expert opinion about the accounts.
 Lesson 13 Concept of Auditing 389

B) a factual position about the accounts.

C) a critical review of the accounts.
D) financial assistance.
20. Auditors of a joint stock company are appointed by ______________.
A) directors of the company.
B) annual general meeting.
C) election at the annual general meeting.
D) Debenture Holders
21. A company auditor can be removed by _________________.
A) board of directors.
B) managing director.
C) any director.
D) general meeting.
22. A vacancy caused by resignation of an auditor is filled by _________.
A) board of directors.
B) managing director.
C) general meeting.
D) central government.
23. Audit in depth means __________.
A) audit of each and every item.
B) intensive audit of each and every item.
C) intensive audit of a few items.
D) audit of a few selected items.
24. Concurrent audit is a part of ______________.
A) internal check system.
B) continuous audit.
C) internal audit system.
D) final audit.
25. Audit in depth is synonymous for ____________.
A) complete audit.
B) completed audit.
C) final audit.
D) detailed audit.
26. Balance sheet audit included verification of ________.
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A) assets.
B) liabilities.
C) income and expenditure accounts where appropriate.
D) all of the above.
27. Which of the following statements is not true about continuous audit?
A) It is conducted at regular interval.
B) It may be carried out on daily basis.
C) It is needed when the organisation has a good internal control system.
D) It is expensive.
28. Which of the following is not a fact of EPA?
A) Economic audit.
B) Efficiency audit.
C) Expenditure audit.
D) Effectiveness audit.
29. Balance sheet does not include ___________.
A) verification of assets and liabilities.
B) vouching of income and expense accounts related to assets and liabilities.
C) examination of adjusting and closing entries.
D) routine checks.
30. When issuing unqualified opinion the auditor who evaluated the audit findings should be satisfied that
the ______________.
A) amount of known misstatement is documented in working papers.
B) estimates of the total likely misstatement is less than materiality level.
C) estimated of the total likely misstatement is more than materiality level.
D) estimates of the total likely misstatement cannot be made.
 Lesson 14 Types of Auditing 391

Lesson 14
Types of Auditing

LESSON OUTLINE
LEARNING OBJECTIVES
– Financial/Statutory Audit In the last lesson the meaning, benefits and
– Internal Audit
limitations of audit is discussed. Here, we will see
– Advantages of Internal Auditing
the different types of audit. The requirement of
– Limitations of Internal Auditing
getting the books of accounts audited became
– Secretarial Audit
mandatory due to legislation. The nature and
– Cost Audit
scope of audit vary due to various factors such
– Tax Audit
as the size of organisation, the strength of internal
– Bank Audit
control system, legal requirement etc. In internal
– Co-operative Society Audit
Audit, the books of accounts may be audited by
– Insurance Audit
internal department of the organisation while in
– Partnership Audit
– Sole Proprietorship Audit, etc. other types of audit; such as statutory audit,

– Government Audit secretarial audit, cost audit, tax audit, bank audit,

– Management Audit insurance audit, co-operative society audit, trust

– Propriety Audit audit, sole proprietorship audit etc., the audit is

– Efficiency Audit done by independent person. In internal audit, the

– Lesson Round Up area of work is determined by the management
– Glossary whereas, in other types of audit, the area of work
– Self-Test Questions is determined by the legislation.

In this lesson, you will learn the different types of

audit such as internal audit, financial audit, tax

audit, secretarial audit, cost audit, bank audit, trust

audit, insurance audit, etc.

Companies will not receive a rubber stamp certification; this is an in-depth program that requires an exhaustive
and thorough audit of one’s processes.
John Kania
392 FP–FA&A

INTRODUCTION
Up to early decades of Twentieth Century, Auditing exercise was considered limited to auditing of books of
accounts i.e. finance audit, internal audit. After the advancement of trade/technology various types of audit have
come into existence i.e. operation audit, management audit, efficiency audit, propriety audit, information system
audit etc. Types of audit depend upon various factors such as the nature of work undertaken, approach used for
conducting audit, organization structure, legal requirements etc. The different types of audit have different
objectives. Here, now we will study the different types of audit along with their characteristics, merits and limitation.

TYPES OF AUDIT

AUDIT UNDER THE COMPANIES ACT, 2013

Companies Act, 2013 is focused on transparency and disclosure and gives audit its due recognition. In the new
Act, attempt has been made to cover each aspect of corporate functioning under audit by prescribing various
types of audits like internal audit and secretarial audit.

Statutory Audit
Statutory Audit is often called Financial Audit. Independent financial audit is generally conducted to ascertain
whether the Balance Sheet and Profit & Loss Account presents a true and fair view of the financial position of
the organization. The need for financial audit arises as the control of the company is vested in the hands of
the management of the company and the financial statements are also prepared by the management. The
owners (shareholders), therefore, need assurance that the financial statements prepared by the management
are reliable. The opinion of the auditor – an independent expert – assures the owners about the reliability of
the financial statements. Similarly, investors wish to invest their moneys in the shares of companies on the
basis of their profitability and financial position. They will also place greater reliance on financial statements if
the statements are audited by the external auditor. Other users of financial statements, e.g., trade creditors,
banks, financial institutions, tax authorities, other government authorities, labour unions, etc., also place
greater reliance on audited accounts.
Sections 139 to 147 covered under chapter X of the Companies Act, 2013 contain provisions regarding statutory
audit and auditors. Section 139 contains that at the first annual general meeting every company shall appoint an
individual or firm as it auditor who will hold office from the conclusion of that meeting till the conclusion of the
sixth annual general meeting. Section 141 contains that a person shall be eligible for appointment as an auditor
of a company only if, he is a chartered accountant and in case of a firm whereof majority of partners practising
in India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company.
Section 143 which contains provisions regarding powers and duties of auditors contains that, the statutory
auditor shall make a report to the members of the company on the accounts and financial statements examined
by him. The main provisions regarding statutory audit are:
• Auditor will have access to books of accounts and vouchers etc. at all times and he can seek information
from officers of the company as may be deemed necessary.
• In his report he must state, besides other things, whether the financial statements represent a true and
fair view of the state of company’s affairs as at the end of the financial year.
• In case of any qualifications in the audit report, the reason for same must be stated in the report.
• Auditor is required to comply with Auditing Standards.
• In case auditor suspects any fraud, he must immediately report the same to the Central Government.
 Lesson 14 Types of Auditing 393

INTERNAL AUDIT
Internal audit is an evaluation and analysis of the business operation conducted by the internal audit staff. It is
the part of overall system of internal control established in an organization.
Internal audit is the independent appraisal activity within an organization for the review of accounting, financial
and other business practices as protective and constructive arms of management. It is a type of control which
functions by measuring and evaluating the effectiveness of other type of controls.
According to Professor Walter B. Meigs, Internal Auditing means “Internal auditing consist of a continuous,
critical review of financial and operating activities by a staff of auditors functioning as full time salaried employees.”
In a big organization, an internal audit is carried out by the team of professionals in the organization. The internal
audit is not mandatory but organization gets the internal audit done with a view to evaluate the effectiveness of
internal control, the soundness of financial system, effectiveness of business processes etc. This provides
management an assurance about the control process in the organization and it aids in early detection of
inefficiencies/fraud etc. It helps the statutory auditor to conduct the statutory audit effectively.
Section 138 of the Companies Act, 2013 contains provisions regarding internal audit. As per Companies Act,
2013, certain class or classes of company as may be prescribed shall appoint an internal auditor, who will
conduct an audit of the functions and activities of the company and make a report thereon to the Board of
Directors. Any Chartered Accountant (except statutory auditor of the company) or Cost Account or other
professional as may be decided by the Board, can be appointed to conduct the internal audit.
According to Rule 13 of The Companies (Accounts) Rules, 2014 following class or classes of companies shall
be required to appoint an internal auditor or firm of internal auditors, namely:
(a) Every listed company;
(b) Every unlisted public company having-
(i) Paid up share capital of Rs.50 crore or more during the preceding financial year; or
(ii) Turnover of Rs.200 crore or more during the preceding financial year; or
(iii) Outstanding loans or borrowings from banks or public financial institutions exceeding Rs.100 crore
or more at any point of time during the preceding financial year; or
(iv) Outstanding deposits of Rs.25 crore or more at any point of time during the preceding financial
year; and
(c) Every private company having-
(i) Turnover of Rs.200 crore or more during the preceding financial year; or
(ii) Outstanding loans or borrowings from banks or public financial institutions exceeding Rs.100 crore
or more at any point of time during the preceding financial year:
The rules also provide that every existing company covered under above criteria in Financial Year 2013-14 shall
comply with requirements of Section 138 and Rule 13 of Companies (Accounts) Rules, 2014 before 30th
September, 2014 (within 6 months of the commencement of Section 138, i.e. 01st April, 2014).

OBJECTIVES OF INTERNAL AUDIT

(i) Proper Control: The purpose of internal Audit is to keep proper control over business activities. The internal
control can determine the degree of control over work.
(ii) Accounting System: The purpose of internal audit is to evaluate the accounting system. It is concerned with
394 FP–FA&A

checking proper authority for transactions like purchase, retirement and disposal of fixed assets. The voucher
can be compared with entries in order to determine that figures and facts.
(ii) Help Management: The purpose of internal audit is to help the management by pointing out the weaknesses.
Once the weaknesses are identified, management functions can be performed properly.
(iv) Working Review: The purpose of internal audit is to review the working of business. The working of current
year can be reviewed in detail. There is a need to locate the weak points. The corrective measures can be taken
for proper working.
(v) Asset Protection: The purpose of internal audit is to protect the assets by examinig the valuation, verification
and possession of the assets. The purchase and sale of assets must be made under proper authority.
(vi) Internal Check: The purpose of internal audit is to evaluate the internal check system. There is division of
duties among the employees. When all staff member are working properly, it means there is effective internal
check system. The work of an auditor is reduced. He can apply test checks to complete audit duty.
(vii) Fair Statements: The purpose of internal audit is to detect and remove the error in the accounting records.
The work of internal audit can help the management by ensuring that accounting record is in proper order.
(viii) Check Error: The purpose of internal audit is to detect the errors in the accounting records. Internal audit
goes side by side, therefore, it reduces the chances of errors. The accounting staff can rectify mistake to prepare
accounts at the end of year in order to help the external auditor.
(ix) Detect Fraud: The purpose of internal audit is to detect frauds in the books of accounting. When the work
of accounting staff is over, the internal audit is started. Accounting staff remains alert because there is no time
gap between recording and checking. Thus detection of fraud is possible with it.
(x) Determine Liability: The purpose of internal audit is to determine the accountability of employees. The
duties are divided among the staff. It is easy to note the negligence on the part of employees. The internal audit
can pin point the person responsible for carelessness.
(xi) Help in Independent Audit: The purpose of internal audit is to extend the help for independent audit. The
external auditor can rely on internal auditor and there is no need of cent percent checking as internal audit helps
in detecting the errors at ealry stage. In this way there is saving of time and money due to internal audit.
(xii) Performance Appraisal: The purpose of internal audit is to check the performance appraisal. The
management must achieve the targets fixed in budgets and plans. The internal audit is a tool to evaluate the
working of each management function.
(xiii) Provide Suggestions: The purpose of internal audit is to provide suggestions for improvement of business
activities. The internal audit staff can suggest the ways and means to remove the difficulties. Anyhow the internal
auditor cannot compel the management to implement suggestions.
(xiv) New Ideas: The purpose of internal audit is to seek new ideas relating to procedures, marketing, financing
and other business matters. The internal audit staff can provide new ideas about various business matters. The
viable ideas can be put in to practice for the benefit of business.
(xv) Use of Resources: The purpose of internal audit is to determine the proper use of resources. The misuse
of resources can increase the cost of doing the business. Early detection of errors helps the management in
maximising the use of resources.
(xvi) Accounting Policies: The purpose of internal audit is to examine the accounting policies. The understanding
of accounting system and procedure is helpful to device the effective audit plans & procedures.
(xvii) Special Investigation: The purpose of internal audit may be to conduct special investigation about any
business matter. Internal audit can be used as a tool to note the effectiveness of management function.
 Lesson 14 Types of Auditing 395

BENEFITS OF INTERNAL AUDIT

(i) Proper Accounting System: The benefit of internal audit is that proper accounting system is introduced.
Accounting system is a chain of activities in an entity by which transactions are processed for maintaining
financial record. There is a need of orderly devices to achieve desirable results.
(ii) Better Management: The benefit of internal audit is that there is better management of business concern.
The auditor can point out the weak areas of management. The goals of business can be achieved if there is
proper internal control, internal check and internal audit. It should be noted that management could rely on
internal audit for best results.
(iii) Progressive Review: The internal audit is beneficial to review progress of a business concern. The figures
of previous years are compared with this year. Moreover the performance result of similar companies can be
compared to determine the progress made by the entity. The management can review progress through internal
audit.
(iv) Effective Control: The internal audit is helpful to have effective control over business activities. Control is a
management function, which is related to supervision and direction of ongoing activities. The manager concerned
can remove the difficulties for smooth working of business.
(v) Assets Protection: The assets protection is possible through internal audit. The management can use the
assets for the benefit of business only. The assets cannot be used for private purposes. The embezzlement of
cash, misappropriation of stock and misuse of other assets is not possible as the internal auditor keeps close
watch over assets.
(vi) Division of Work: The internal audit is helpful to apply division of labour. The division of labour is necessary
to watch the activities of all employees including management. The auditor can suggest the way and means to
improve the performance of business.
(vii) No Error and fraud: The internal audit is used to protect accounting records from errors and fraud. The
accounting and auditing go side by side when accounting work is over the audit will start. In such situation errors
and fraud committed by the accounting staff will easily be detected and rectified.
(viii) Fixing Responsibility: Internal audit is used to fix the responsibility of people having poor performance.
The management establishes the performance standards. The internal auditor can evaluate the result of all
persons. The people can be held responsible for below standard work and action can be taken against them.
(ix) Helps External Auditing: The work performed by internal auditor can help external auditor in carrying
out the audit. The audit procedure of internal and external audit is almost the same. The auditor can go
through the internal audit report at the time of starting audit work. Anyhow external auditor is responsible for
external audit.
(x) Performance Improves: Internal auditor is helpful to improve the performance of the organization. The
achievements of previous year are the basis of preparing budget for the next years. The projected income
statement and balance sheet are drawn up. An attempt is made to get the positive result. Thus internal audit
improves performance of business and employees.
(xi) Proper Use of Resources: Internal audit is used to check the proper use of resources. The misuse of
resources can increase the cost of organization. The optimum use of resources can be determined to control
the cost of output. In this way internal audit is a tool to use the resources in the best interest of the business.
(xii) Investigation: Internal audit is of help to investigate in to the business matters. In case of doubt internal
auditor can be asked to examine the facts and figures to confirm or clear any doubt. The internal auditor can
investigate the matter in any manner. Such investigation can be made at the request of management or
owners.
396 FP–FA&A

LIMITATIONS OF INTERNAL AUDIT

(i) Staff Shortage: Internal audit requires reasonable audit staff to examine the record. Lack of adequate staff
creates hurdle to get benefit of internal audit.
(ii) Time Lag: The limitation of internal audit is that it starts when accounting ends. Thus, there is a time lag
between recording and checking of entries.
(iii) Error: Due to lack of expertise in internal audit staff, certain erros may remain undetected as it depends upon
the expertise of internal audit staff to detect such errors. If audit staff is competent there is less chance of error
being undetected. In case of poor audit staff there is no guarantee that audited accounts are free from errors.
(iv) Responsibility: The limitation of internal audit is that management may not feel their responsibility in
completing the audit formalities. The audit staff may give suggestion for proper working of business. The top-
level management may not pay attention to suggestions. In this way, the audit work cannot help the business.
(v) Duties: If the duties of audit staff are not properly divided, then the purpose of internal audit may be defeated.

Secretarial Audit
Secretarial Audit is a process to check compliance with the provisions of various laws and rules/regulations/
procedures, maintenance of books, records etc., by an independent professional to ensure that the company
has complied with the legal and procedural requirements and also followed the due processes. It is essentially
a mechanism to monitor compliance with the requirements of stated laws. It helps to detect non-compliance and
to take corrective measures.
A Company Secretary in Practice has been assigned the role of Secretarial Auditor under section 2(2)(c)(v) of
the Company Secretaries Act, 1980.
Ever-increasing complexities of laws and responsibilities of directors (especially non-executive directors) make
it imperative that a Practicing Company Secretary (PCS) reports whether or not there exists proper compliance
mechanism and systems in the corporate structure. PCS has also to verify whether diverse requirements under
applicable laws have been duly complied with or not and if there is a need for any corrective measures or
improvement in the system.
Secretarial Audit on a continuous basis would help the company in initiating corrective measures and strengthening
its compliance mechanism and processes. It is recommended that the Secretarial Audit be carried out periodically
(quarterly / half yearly) and adverse findings if any, be communicated to the Board for corrective action.
The multiplicity of laws, rules, regulations, etc. has necessitated introduction of a compliance management
system to ensure compliances of laws applicable to a company. This has a two-fold objective:
(i) to protect the interests of all the stakeholders;
(ii) to avoid any legal action against the company and its management.
As of now Secretarial Audit is not mandatory on the Companies. However, it is optionally undertaken by the
companies for maintaining good Corporate Governance practices.
Secretarial Audit is a new requirement which has been prescribed under Section 204 of the Companies Act,
2013. The provisions regarding secretarial audit are as follows :
Every listed company and other class of companies as may be prescribed is required to annex to the Board’s
Report, a Secretarial Audit Report.
As per rule 9 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, other
class of companies for the purpose of section 204 of the Companies Act, 2013 include:
 Lesson 14 Types of Auditing 397

(a) Every public company having a paid-up share capital of fifty crore rupees or more; or
(b) Every public company having a turnover of two hundred fifty crore rupees or more; or
Secretarial Audit has to be conducted by a Practising Company Secretary in respect of the secretarial and other
records of the company. Company is required to give all necessary information and assistance to the Practising
Company Secretary to conduct the audit.
The Board is required to provide explanation in the Board’s Report to every qualification, observation or other
adverse remark made by the company secretary in his report. The secretarial Auditor will submit his report in
Form MR-3.
If a company or any officer of the company or the company secretary in practice, contravenes the provisions of
this section, the company, every officer of the company or the company secretary in practice, who is in default,
shall be publishable with fine which shall not be less than one lakh rupees and can be extend to five lakh rupees
As per Section 143(14), all provisions regarding rights, duties and obligations of statutory auditors shall also
apply to Company Secretary in Practice conducting secretarial audit.

Cost Audit
The Institute of Cost and Works Accountants of India defines cost audit as “a system of audit introduced by the
Government of India for the review, examination, and appraisal of the cost accounting records and attendant
information, required to be maintained by specified industries.” According to CIMA, London, cost audit is “the
verification of the correctness of cost accounts and of adherence to the Cost Accounting Plan”. Thus, cost audit
comprises of:
(i) The verification of the cost accounting records such as the accuracy of the cost accounts, cost reports,
cost statements, cost data, costing techniques and
(ii) Examining these records to ensure that they adhere to the cost accounting, plans, procedures and
objectives.
Ministry of Corporate Affairs has issued mandatory cost audit orders on Companies engaged in Bulk drugs,
fertilization, sugar, telecommunications, industrial alcohol, and electricity & petroleum and if in immediate previous
year aggregate value of Net Worth exceeds the specified limits.
The cost auditor has to judge :
(i) Whether the planned expenditure is designed to give optimum results.
(ii) Whether the size and channels of expenditure were designed to produce the best results, and
(iii) Whether the return from expenditure on capital as well as current operations could be improved by
some other alternative plan of action.
Cost Audit is useful for the purpose of cost control; cost reduction and proper utilization of scarce resources.
Moreover, cost audit also ensures that proper records are kept as to purchases and utilisation of material and
expenses incurred on wages, overheads, etc. It also ensures that the unit has been run economically and efficiently.
Section 148 of the Act contains provisions regarding cost audit and contains that a cost audit wherever conducted
is in addition to statutory audit conducted under section 143.
The main provisions regarding cost audit as contained in the Act are :
• Certain class of companies engaged in the production of such goods or providing such services as may
be prescribed and which have a net worth or turnover of such amount as may be prescribed may be
directed to get their cost audit records audited.
398 FP–FA&A

• Cost audit has to be conducted by a Cost Accountant in practice, who is required to comply with cost
auditing standards
• It shall be the duty of the company to give all assistance and facilities to the Cost Auditor.
• As per Section 143(14), the qualifications, disqualifications, rights, duties and obligations applicable to
statutory auditors will also apply to a cost auditor.
·• Cost auditor has to submit his report to the Board of Directors, who in turn shall file it with the Central
Government within 30 days of the receipt of the report.

OTHER FORMS OF AUDIT

Tax Audit
In India, the Income Tax Act, 1961, Section 44AB provides for the compulsory audit of the accounts of certain
income tax assessee whose turnover or receipts exceed the specified limits. The objective of such audit is to
assist the tax authorities in making the correct income tax assessment of the assessee concerned. The tax
auditor has to specifically report on certain transactions which have an effect on the income tax liability of the
assessee concerned and are, thus important to the tax authorities. The Income Tax Act, 1961 also contains
various other provisions whereby audit report is required to be submitted to get certain deductions, exemptions
etc.
As per the income tax Act, every person carrying on business whose turnover or gross receipts exceeds Rs.
1,00,00,000 (Rs. 25,00,000 if carrying on profession) in the previous year shall get his accounts audited.

Bank Audit
The huge amount of public monies handled by the banks, make it imperative that the activities of the industry are
closely monitored and regulated without strangulating the spirit of entrepreneurship. Audit forms an integral and
important part of such monitoring and regulation. The Auditors have to certify that statement of accounts of the
bank as at the closure of the financial year reveal true and fair view of the Bank’ financial position, adequate
provision for Non-Performing Asset(NPA)/bad debts has been made in the books. All expenses/income have
been duly accounted for and profit is correctly worked out. The Banking Regulation Act, 1949 contains the
provisions relating to the maintenance of accounts and their audit.

Co-Operative Society Audit

There are certain features of co-operative which are similar to those of companies. As in the case of companies,
in co operative societies also, there is a separation of ownership from management while the capital of a co-
operative society is contributed by all the members. The management of its affairs is in the hands of only some
of the members’ elected for this purpose. This necessitates an independent financial audit of accounts of co-
operative societies. Considering this, audit of co­operative societies is required by law in India. However, an
important feature of co operative societies is that, unlike most companies, the affairs of co-operative societies
are often managed by persons who do not possess adequate managerial, technical or accounting skills. The
independent financial auditors of co-operative societies are, therefore, required to report on some aspects also.

Insurance Audit
The insurance audit is an examination of the operations, records and books of account of the insurance company.
Auditor performs an audit to ensure that the customer has paid the appropriate premium for risk cover provided
to him. The auditor should be conversant with the provisions of the Insurance Regulatory and Development, Act
1999, which contains the provision of the maintenance of accounts and audit of the insurance companies.
 Lesson 14 Types of Auditing 399

Partnership Firm Audit

Partnership Act, 1932 does not provide compulsory audit of Partnership Firms in India. But on satisfying the
prescribed criterion, partnership firms are required to get their accounts audited under the provisions of Income
Tax Act, 1961. Many partnership firms voluntarily gets their accounts audited as audited accounts helps in
proper valuation of goodwill, distribution of share of the deceased Partner to their legal heirs etc. The audited
accounts are also useful to get the loan sanctioned from the banks. The audit should be carried out as per the
terms of partnership deed and Partnership Act.

Sole Proprietorship Audit

Like partnership firms, sole proprietary concerns are also not legally required to get their financial statements
audited by independent financial auditors but on satisfying the prescribed criterion, partnership firms are required
to get their accounts audited under the provisions of Income Tax Act, 1961. However, many such concerns get
their financial statements audited voluntarily as it helps the sole proprietor to manage its books of accounts
properly and the audited books of accounts are relied well by the statutory authority like banks, insurance
companies etc.

Government Audit
Government audit aims at ensuring that the financial transactions of the government are executed properly
under sanctions and authorities and are correctly recorded in the books of accounts. It is the duty of Comptroller
and Auditor General of India (C&AG) to audit the receipts and expenditure of the Union Government and State
Government.
Further, government audit also includes the audit of government companies conducted by C&AG in accordance
with the provisions of Companies Act, 2013 and other relevant legislations.

Management Audit
Management audit is an emerging concept of auditing. It has been originated from America. Management audit
is an act of evaluation of all the activities of all the departments with a view to provide appropriate suggestions
to the management to help their work. In other words, management auditing is a future oriented task which
evaluates timely at all the levels of management like production management, sales management etc. The main
objective of management audit is to improve the profit earning capacity, work of management, objectives of
program, social objectives and human resource development so that organizational goal can be easily attained.
It refers to the existence of control system, compliance of rules and regulations, process of managerial decisions
etc. Generally management audit/operational audit are not mandatory but it is recommendatory.

Propriety Audit
Kohler has defined propriety as that which meets the test of public interest, commonly accepted customs and
standard of conduct and particularly as applied to professional performance, requirements of Govt. regulations
and professional codes. Propriety Audit would mean whether the transactions have been done in conformity
with established rules, principles and some established standard.
The Propriety Audit would mean the verification of following main aspects to find out whether:
(i) Proper recording has been done in appropriate books of accounts.
(ii) The assets have not been misused and have been properly safeguarded.
(iii) The business funds have been utilized properly.
(iv) The concern is yielding the expected results.
400 FP–FA&A

The system of Propriety Audit is applied in respect to Government companies and Government Department
because public money and public interest are therein involved. It is an essential function of audit to bring to light
not only cases of clear irregularity but also every matter which in its judgement appears to involve improper
expenditure or waste of public money or stores, even though the accounts themselves may be insufficient to see
that sundry rules or orders of competent authority have been observed. It is of equal importance to ensure that
the broad principles of orthodox finance are borne in mind not only by disbursing officers but also by sanctioning
authorities.

Efficiency Audit
In essence, efficiency indicates how well an organization uses its resources to produce goods and services. It
focuses on resources (inputs), goods and services (outputs), and the rate (productivity) at which inputs is used
to produce or deliver the outputs. To understand the meaning of “efficiency”, it is necessary to understand the
following terms: inputs, outputs (including quantity and quality), productivity, and level of service.
Inputs are resources (e.g., human, financial, equipment, material, facilities, information, energy and land) used
to produce outputs
Outputs are goods and services produced to meet client needs. Outputs are defined in terms of quantity and
quality and are delivered within parameters relating to level of service
Quantity refers to the amount, volume, or number of outputs produced.
Quality refers to various attributes and characteristics of outputs such as reliability, accuracy, timeliness, service
courtesy, safety, and comfort.
Productivity is the ratio of the amount of acceptable goods and services produced (outputs) to the amount of
resources (inputs) used to produce them. Productivity is expressed in the form of a ratio such as cost or time per
unit of output.
Efficiency is a relative concept. It is measured by comparing achieved productivity with a desired norm, target, or
standard. Output quantity and quality achieved and the level of service provided are also compared to targets or
standards to determine to what extent they may have caused changes in efficiency. Efficiency is improved when
more outputs of a given quality are produced with the same or fewer resource inputs, or when the same amount
of output is produced with fewer resources.
Efficiency audit refers to comparing the actual results with the desired/projected results. It is directed towards
the measurement of whether plans have been effectively executed. It is concerned with the utilisation of the
resources in economic and most remunerative manner to achieve the objectives of the concern. It comprises
of studying the plans of organisation, comparing actual performance with plans and investigating the reasons
for variances to take remedial action

LESSON ROUND UP
In this lesson, we have discussed various types of audit such as internal audit, financial audit, secretarial
audit, cost audit, tax audit etc.
– Internal Audit- Internal audit is an evaluation and analysis of the business operation conducted by the
internal audit staff. It is the part of overall system of internal control established in an organization.
– Objective of Internal Audit- proper control, accounting system, help management, working review,
asset protection, internal check, fair statements, check error, detect fraud, determine accountability,
help in independent audit, performance appraisal, provide suggestions, new ideas, use of resources,
accounting policies, special investigation.
– Advantages of Internal Audit- proper accounting system, better management, progressive review,
 Lesson 14 Types of Auditing 401

effective control, assets protection, division of work, no error and fraud, fixing responsibility, helps
external auditing, performance improves, investigation, proper use of resources.
– Limitations of Internal Audit- staff shortage, time lag, error, responsibility, duties.
– Financial Audit- Independent financial audit is generally conducted to ascertain whether the balance
sheet and profit & loss account present a true and fair view of the financial position and working result
of the organization under audit.
– Secretarial Audit- Secretarial Audit is a process to check compliance with the provisions of various
laws and rules/regulations/procedures, maintenance of books, records etc., by an independent
professional to ensure that the company has complied with the legal and procedural requirements and
also followed the due process. It is essentially a mechanism to monitor compliance with the requirements
of stated laws. A Company Secretary in Practice has been assigned the role of Secretarial Auditor
under section 2(2)(c)(v) of the Company Secretaries Act, 1980.
– Cost Audit- A system of audit introduced by the Government of India to the review, examination, and
appraisal of the cost accounting records and attendant information, required to be maintained by specified
industries.
– Tax Audit: The objective of such audit is to assist the tax authorities in making the correct income tax
assessment of the assesses concerned.
– Bank Audit: The Banking Regulation Act, 1949 contains the provisions relating to the maintenance of
accounts and their audit.
– Co-Operative Society Audit: The management of the affairs of the co-operative societies is in the
hands of only some of the elected members. This necessitates an independent financial audit of accounts
of co-operative societies.
– Insurance Audit: Insurance Regulatory and Development Act, 1999, contains the provision of the
maintenance of accounts and audit of the insurance companies.
– Partnership Firm Audit: At present, partnership firms in India are not legally required to get their
financial statements audited. Still, many firms get their financial statements audited
– Sole Proprietorship Audit: Like partnership firms, sole proprietary concerns are also not legally required
to get their financial statements audited by independent financial auditors.
– Government Audit: It is the duty of Comptroller and Auditor General of India (C&AG) to audit the
receipts and expenditure of the Union Government and State Government.
– Management Audit: It is a structured review of the systems and procedures of an organization in
order to evaluate whether they are being conducted efficiently and effectively.
– Propriety Audit: Under this type of audit, the expenditure is analyzed with a view to ascertain the
cases of improper, avoidable or in fructuous expenditure even though the expenditure has been incurred
in conformity with the existing rules and regulations.
– Efficiency Audit: Efficiency audit or performance audit is a form of audit which is being carried out for
ascertaining the efficiency/performance of a system/process/input.

GLOSSARY
Constructive Arm Improve or promote development
Independence Free from the influence, guidance, or control of another or others; self-reliant :
402 FP–FA&A

an independent mind.
Practicing Company The member of ICSI who hold certificate of practice.
Secretary
Check An action or influence that stops motion or expression; a restraint

SELF-TEST QUESTIONS
1. What are the types of audit? Explain in brief.
2. What is meant by Internal Audit and what are its benefits and limitations?
3. What is meant by Financial Audit?
4. What is the difference between Internal Audit and Financial Audit?
5. What is Secretarial audit and who can be appointed as secretarial auditor?
6. What are the objectives of secretarial audit?
7. What do you mean by tax audit and on whom it is applicable?
8. What is cost audit and explain its usefulness in brief?

SUGGESTED READINGS
1. Fundamentals of Auditing – By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
 Lesson 15 Tools of Auditing 403

Lesson 15
Tools of Auditing

LESSON OUTLINE
LEARNING OBJECTIVES
– Audit Plan In the last lesson, the various types of audit have

– Audit Programme been discussed. In this lesson, the steps taken

by the auditor while carrying out an audit will be
– Advantages of Audit Programme
dealt. Auditor uses various types of tools such
– Disadvantages of Audit Programme as audit plan, audit programme etc. for carrying
– Remedies of Disadvantages of Audit out an audit. An audit plan lays down the
Programme strategies to be followed for carrying out an audit.

– Difference between Audit Plan and Audit It is the first step of audit. After preparing an audit
Programme plan, the auditor will make an audit programme
which contains the instructions to be followed by
– Review Questions
the audit staff. This helps the auditor in proper
– Audit Evidence
supervision of the audit. While doing an audit the
– Essentials of Audit Evidence auditor has to collect evidences in support of his

– Factors considered while obtaining opinion. The audit evidence provides grounds for
audit evidence believing that a particular thing is true or not by
providing support for a fact or a point in question.
– Techniques of obtaining audit
evidence Audit working papers are used to support the
audit work done in order to provide assurance
– Working papers
that the audit was performed in accordance with
– Types of working paper
the relevant auditing standards.
– Review Questions
In this lesson, you will learn how the Audit Plan is
– Lesson Round-Up important in an audit, the ways of laying down an

– Glossary audit Programme, importance of evidence and

working papers.
– Self-Test Questions

It’s an independent audit of the work and all the contracting issues to determine whether existing procedures
were complied with and whether there should be any changes in those procedures.
John Mullen
404 FP–FA&A

AUDIT PLAN
An audit plan lays out the strategies to be followed to conduct an audit. It includes the nature, timing and extent
of audit procedures to be performed by the team members. The auditor shall develop an audit plan while
considering the following:
(a) The nature, timing and extent of planned risk assessment procedures.
(b) The nature, timing and extent of audit procedures at the assertion level.
(c) Other planned audit procedures that are required to be carried out so that the engagement complies
with Standard on Auditing (SA).
The objective of the auditor is to plan the audit so that it may be performed in an effective manner.
The auditor should consider the following matters before planning for an audit:
(i) Terms of Engagement and any Statutory Responsibilities: While framing an audit plan, auditor
should ascertain his terms of appointment and responsibilities cast by various legislations on him. The
auditor should then prepare his audit plan based on what he is required to do.
(ii) Nature and Timing of Report or other Communications: Auditor should determine the form and the
timing of the report. This will help auditor in determining the scope and time schedule of the audit.
(iii) Accounting Policies followed by the Enterprise and Change in those Policies: Accounting policies
followed by the enterprise affect the audit plan. While preparing an audit plan due consideration may be
given to the areas where there is any change in accounting policies.
(iv) Effect of New Accounting or Auditing Requirements: Any change in accounting and auditing standards
may affect the scope of audit or the manner in which it is conducted. Therefore, these should be carefully
considered while drawing up the audit plan.
(v) Identification of Significant Audit Areas: It is important for the auditor to identify the areas which
involves greater audit risk, so that the audit can be planned in such a way that overall audit risk will be
less. More risky areas should be checked in detail and vice-versa.
(vi) Setting of Materiality Levels for Audit Purposes: At the planning stage, the auditor sets the materiality
levels. For example, the auditor may decide that in the case of audit of sales, he will examine all sales
transactions above Rs.5000.
(vii) Degree of Reliance Expected to be placed on Accounting System and Internal Control: While
laying down an audit plan, the auditor shall assess the effectiveness of accounting systems and internal
controls. On the basis of assessment, the auditor has to decide whether he will do test checking or more
extensive checking of transaction and balances.
(viii) Nature and Extent of Audit Evidence: The nature and extent of audit evidence will vary in different
auditing situations. For example, in one situation the auditor may rely more on physical examination,
confirmation from third parties whereas in another situation he may rely more on examination of
documentary evidence.
(ix) Work of Internal Auditors: Statutory auditor has to review the work done by the internal auditors to
determine the extent of reliance they can place on. It will help the auditor in determining the scope of
work under the audit plan.
(x) Establishing and Coordinating Staffing Requirements: Auditor shall determine the exact requirements
 Lesson 15 Tools of Auditing 405

of the staff along with the broad estimate of time required by each staff members. So that the audit work
will be completed on time.

AUDIT PROGRAMME
An audit programme is a set of instructions which are to be followed for proper execution of audit. After the
development of audit plan, a detailed written audit programme containing the various steps and procedures
shall be required. The audit programme contains the measures that are generally employed to determine what,
and how much evidence must be collected and evaluated. It also lays down the responsibilities for the whole
audit team for carrying out different tasks.
The prepared audit program may be revised if needed in accordance with the prevailing circumstances. An audit
program largely depends on the size of the organization and other relevant factors. Minimum essential work to
be done is Standard Programme and rest is according to circumstances. There is no standard audit programme
applicable to all situations.
Audit programme is documented in the Audit Working Papers, which are the official record that contains the
planning and execution of the audit agreement.

ADVANTAGES OF AUDIT PROGRAMME

1. It helps in ensuring that all important areas are appropriately covered during audit.
2. It helps in distributing the work among the assistants in accordance with the level of their competence
and experience.
3. It provides instructions to the audit staff and reduces scope for misunderstanding.
4. It helps in fixing the responsibility for the work done among the audit staff as work done may be traced
back to the individual staff member.
5. It helps in assessing the progress of work by ascertaining what part of audit work has been completed
and how much is left.
6. It serves as evidence against charge of negligence.
7. On completion of an audit, it serves the purpose of audit record which may be useful for future reference.

DISADVANTAGES OF AUDIT PROGRAMME

1. Rigidity: Audit programme can not be same for different types of organisation. Each business
has separate problems. So a single/same audit programme can not be laid down for each type of
business.
2. Reduces the Initiative of Efficient Staff: It kills the competency of taking initiative of capable persons.
Assistant can not suggest any improvement in the plan.
3. Audit Work becomes Mechanical: The Audit programme becomes mechanical when it ignores other
aspects like internal control.
4. New Areas may be Overlooked: With the passage of time new problems arising during the audit may
be over looked in the audit Programme.

REMEDY OF DISADVANTAGES
1. The remedy in such situations is that audit programme should be flexible. It must always be open to
changes and improvements.
406 FP–FA&A

2. The audit staff should be encouraged to draw the attention of the auditor to locate the defects in the programme.
3. The staff should be encouraged to explore fully unusual transaction and do not get restricted with the
audit programme.

DIFFERENCE BETWEEN AUDIT PLAN AND AUDIT PROGRAMME

Audit Plan Audit Programme
It lays down the audit strategies to be followed for Audit programme is an outline of how the audit is to
conducting an audit such as identifying the areas be done, who is to do what work and within what time.
where special audit attention in required to obtain
the knowledge of business etc.
Plans should be made to cover, other necessary It lays down the following audit procedure to be
things : followed :
(i) Acquiring knowledge of accounting systems, (i) Evaluation of internal control
policies and internal control procedures
(ii) Establishing the expected degree of reliance to (ii) Ascertain arithmetical accuracy of books of
be paced on the internal control accounts
(iii) Determining the nature, timing and extent of (iii) Vouching of transactions’
the audit procedures to be performed
(iv) Co-ordinating the work to be done (iv) Verification and valuation of assets and liabilities
(v) Ledger scrutiny
(vi) Checking of overall disclosure and presentation
of all items in the final accounts.
(vii) Preparation and submission of audit report.

REVIEW QUESTION
1. At the ___________ stage the auditor sets the materiality levels.
2. While laying down an audit plan, the auditor shall assess the effectiveness of accounting
systems and _______________.
3. An audit programme is a set of ______ which are to be followed for proper execution
of audit.
4. Audit programme is documented in the ______________, which are the official record
that contains the planning and execution of the audit agreement.

AUDIT EVIDENCE
The auditor has to obtain sufficient and appropriate evidence to substantiate his opinion on the financial statements.
The audit evidence provides grounds for believing that a particular thing is true or not by providing support for a fact
or a point in question. The evidences collected by the auditor must support the contents of the auditor’s report.

Essentials of good audit evidence

(a) Sufficient: The audit evidence are said to be sufficient when they are in adequate quantity. The audit
evidence enables the auditor to form an opinion on the financial information. Sufficient evidence can be
obtained by test checking instead of 100% checking.
 Lesson 15 Tools of Auditing 407

(b) Reliable: Evidences obtained by auditor are persuasive rather than conclusive in nature, therefore,
evidence cannot be100% reliable. The reliability of audit evidence depends upon:
(i) Source: whether the evidence obtained within the organisation i.e. internal and obtained from outside
i.e. external (confirmation by third party)
(ii) Nature: whether the evidence is verbal (explanation from clients staff), visual (physical verification
of stock) or documentary (bills attached to vouchers)
(c) Relevant: Audit evidence obtained must be relevant to the matter being checked i.e. the balance of in
hand to be checked then the relevant evidences have to be verified.
The following rules of thumb have proven helpful in judging the appropriateness of evidence:
(a) documentary evidence is usually better than testimonial evidence;
(b) audit evidence is more reliable when the auditor obtains consistent evidence from difference sources or
of a different nature.
(c) original documents are better than photocopies;
(d) evidence from credible third parties may be better than evidence generated within the audited organization;
(e) the quality of information generated from the audited organization is directly related to the strength of
the organization’s internal controls (the auditors should have a good understanding of internal controls
as they relate to the objectives of the audit); and
(f) evidence generated through the auditor’s direct observation, inspection and computation is usually
better than evidence obtained indirectly.
Important factors to be considered while obtaining audit evidence:
– the quality of the evidence (its relevance, reliability and validity);
– the level of materiality (Rupees terms) or the significance of the observation or conclusion (in general, the
higher the level of significance or materiality, the higher the standard that evidence will have to meet);
– whether an audit level of assurance (high) or a review level of assurance(moderate) is required (for
example, a higher level of assurance is required for evidence in order to support observations.
– the risk involved in making an incorrect observation or reaching an invalid conclusion (for example, if
any risk of legal action against the auditee results from reporting an observation, the standard of evidence
demanded will be high); and

TECHNIQUES OF OBTAINING EVIDENCE

(i) Inspection: Inspecting the documentary evidence like deed papers, certificates etc relating to the audit
whether in possession of the entity or the third parties.
(ii) Observation: Observing the process or procedure being performed by others. Like physical verification and
counting of inventory.
(iii) Enquiry: Enquiring from the client, his staff or third parties having knowledge about a particular item or activity.
(iv) Confirmation: Seeking information from third party having knowledge about a particular transaction.
(v) Computation: It involves checking of the arithmetical accuracy of a source documents and accounting
records.
(vi) Analytical Review Procedures: Analysis of significant ratios and trends for investigating unusual fluctuation
and items.
(vii) Independent Execution: In this, auditor performs the procedure and controls that were originally performed
as part of entity’s internal control system.
408 FP–FA&A

WORKING PAPERS
Audit working papers are the documents prepared or obtained by the auditors and retained by him in connection
with the audit. Audit working papers are used to support the audit work done in order to provide assurance that
the audit was performed in accordance with the relevant auditing standards. Working papers include all the
evidence gathered by auditor indicating what work has been done by him and the procedure he has followed in
verifying a particular asset or a liability and also provide information that whether:
– audit was properly planned;
– audit was carried out;
– audit was adequately supervised;
– the appropriate review was undertaken;
– the evidence is sufficient and appropriate to support the audit opinion.
Working papers are the connecting link between the client’s records and the audited accounts. These provide
permanent historical record. These also serve as a great guide to the staff to whom the work of audit has been
assigned after the previous year audit. These would come to the help of the auditor in future in case the client
files a suit against the auditor’s negligence. The working papers are the property of the auditor and the client
cannot ask the auditor for their custody. However it is the duty of the auditor to maintain confidentiality of the
client information. Further, if audit working papers are disclosed than it will amount to professional misconduct.

AUDIT WORKING
PAPERS

Clients Records such as

Journal, ledgers,
subsidiary books and Link Between Audit Report
other books

Advantages of maintenance of working papers

1. Working papers helps in proper planning and performance of audit.
2. Seniors can supervise the audit work performed by the juniors by examining their working papers.
3. It provide as evidence of the audit work performed to support the auditor’s opinion.

TYPES OF WORKING PAPERS

The Auditors Working Papers are divided into two parts:
1. Permanent Audit file
2. Current Audit file

Permanent File
The data in these file are the information, which is of continuous interest and relevant to succeeding audits.
Data in this file can include the following:
– Articles of incorporation
 Lesson 15 Tools of Auditing 409

– Loan agreements
– Documents related to understanding internal control
– Leases
– Significant audit observation of earlier years
– Notes regarding significant accounting policies

Current Audit File

These file contains information relating to the audit of the current period. Data in this file can include the following:
– Financial statements and audit report
– Working trial balance and worksheets
– Adjusting journal entries and reclassification entries
– Audit programs
– Documentation of the consideration of internal control and the consideration of fraud risk factors
– Record of test of controls and substantive tests
– Record of audit exceptions and their resolutions
– Letters of attorneys, representation letter and
– Confirmation responses

LESSON ROUND UP
– An audit plan lays out the strategies to be followed to conduct an audit. It includes the nature, timing
and extent of audit procedures to be performed.
– The auditor should consider the following matters while laying out an audit plan:
(a) Terms of engagement and any statutory responsibilities.
(b) Nature and timing of report or other communications.
(c) Accounting policies followed by the enterprise and change in those policies.
(d) Effect of new accounting or auditing requirements.
(e) Identification of significant audit areas.
(f) Setting of materiality levels for audit purposes.
(g) Degree of reliance expected to be placed on accounting system and internal control.
(h) Nature and extent of audit evidence.
– An Audit Programme is a set of instructions which are to be followed for proper execution of audit.
The audit programme contains the measures that are generally employed to determine what, and how
much evidence must be collected and evaluated. It also lays down the responsibilities of the whole
audit team for carrying out different tasks.
– Advantages of Audit Programme- It ensures that all important areas are covered during audit; it
distributes the work among the assistants as per their competence; it provides instructions to staff and
reduces scope for misunderstanding; it fixes the responsibility for the work done; it helps in assessing
the progress of work; it serves as evidence against charge of negligence; it serves the purpose of audit
record which may be useful for future reference.
– Disadvantages of Audit Programme- Losses its flexibility; It kills the competency of taking initiative
of capable persons; it is mechanical; Not suitable for small audits; new problems arises may be over
looked in the audit Programme.
410 FP–FA&A

– Remedial Actions- Programme should be flexible, staff should be encouraged to draw attention to
locate any defects, The staff should be encouraged to explore fully unusual transaction,
– Audit Working Papers are the documents prepared or obtained by the auditors and retained by him
in connection with the audit. Working papers include all the evidence gathered by auditor.
– Audit Evidence is information that is collected and used to provide a factual basis for developing
observations and conclusion against audit objectives. Evidence provides ground for believing that a
particular thing is true or not by providing persuasive support for a fact or a point in question. Audit
should have sufficient appropriate evidence to support the contents of the audit report. To make evidence
appropriate, the information must be relevant, reliable and valid. The quantity of evidence is sufficient
if its weight is adequate to provide persuasive support for the contents of the audit report.
– Techniques of Obtaining Evidence: Inspection, Observation, Enquiry, Confirmation, Computation,
Analytical review procedures, Independent execution.

GLOSSARY
Standard of SAs are standard on auditing issued by the Institute of Chartered Accountants of India.
Auditing (SAs) They are the guidelines to conduct an audit.
Documentary Evidence in the form of written papers or documents.
Evidence
Testimonial Something that recommends a person or thing as worthy or desirable.
Evidence
Audit Risk Audit risk is the risk of the auditor providing an inappropriate opinion on the financial
statements, particularly when those financial statements contain a material misstatement.
Analytical Any process by which a person or company looks at an account or financial statement
Review and attempts to identify any irregularities. This may involve comparing financial and
non-financial information. An analytical review is less thorough than an audit.

SELF-TEST QUESTIONS
1. What is audit plan? What are factors to be considered while preparing an audit plan?
2. Write short notes on :
(a) Permanent Audit File
(b) Current Audit File
3. What is Audit Programme and how does it helps in performing an audit?
4. Describe briefly the various techniques that an auditor applies to collect evidence?

SUGGESTED READINGS
1. Fundamentals of Auditing – By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
Lesson 15 Tools of Auditing 411
412 FP–FA&A
 Lesson 16 Audit and Auditors under Companies Act 2013 – Basic Provisions 413

Lesson 16
Audit and Auditors under Companies Act
2013 – Basic Provisions

LESSON OUTLINE
LEARNING OBJECTIVES

– Appointment of Auditors These days the focus of the government is on

– Appointment of Auditors of Government self regulation by the business community.
Companies
Society also wants less intervention of the
– Mandatory Rotation of Auditors
government in the functioning of the business.
– Eligibility or Qualification of the Auditor
Therefore various laws and legislation provide
– Disqualifications of the Auditor
for the appointment of independent auditor. The
– Remuneration of the Auditors
appointment of auditor, his rights, duties and
– Powers and Duties of Auditors
functions are governed by the legislations under
– Auditor’s Report
which he is appointed. The emphasis of all these
– Auditor not to render Certain Services
regulation is that the auditor should be
– Branch Audit
independent. In this chapter we have highlighted
– Secretarial Audit
the provisions of Companies Act, 2013 relating
– Audit Report
to the auditor and his reports.
– Contents of Auditor’s Report
In this lesson you will learn who is an auditor,
– Forming an Audit Opinion
how auditor can be appointed, what are the
– Types of Opinion
qualification, rights and duties of the auditor,
– LESSON ROUND UP
meaning of auditors report and how and when
– SELF TEST QUESTIONS
auditors will qualify his opinion.
414 FP–FA&A

APPOINTMENT OF AUDITORS
The Board of Directors of a company shall appoint an individual or firm as the first auditor of a company, other
than a Government company, within thirty days from the date of registration of the company. The appointment of
first auditor shall be ratified by members at the first annual general meeting. The auditor so appointed shall hold
the office from the conclusion of that meeting till the conclusion of sixth annual general meeting and thereafter till
the conclusion of every sixth meeting. The appointment of auditors shall be ratified by members at every annual
general meeting.
In the case of failure of the Board to appoint the first auditor, it shall inform the members of the company, who
shall within ninety days at an extraordinary general meeting appoint such auditor and such auditor shall hold
office till the conclusion of the first annual general meeting.
Any casual vacancy (except as a result of the resignation of an auditor) in the office of an auditor of a company,
other than a Government company, shall be filled by the Board of Directors within thirty days. If casual vacancy
is as a result of the resignation of an auditor, the Board of Directors shall fill the vacancy within thirty days but
such appointment shall also be approved by the company at a general meeting convened within three months
of the recommendation of the Board and he shall hold the office till the conclusion of the next annual general
meeting.
A retiring auditor may be re-appointed at an annual general meeting, if—
(a) he is not disqualified for re-appointment;
(b) he has not given the company a notice in writing of his unwillingness to be re-appointed; and
(c) a special resolution has not been passed at that meeting appointing some other auditor or providing
expressly that he shall not be re-appointed.
If at any annual general meeting, no auditor is appointed or re-appointed, the existing auditor shall continue to
be the auditor of the company.

Appointment of Auditors of Government Companies

Government companies means any company owned or controlled, directly or indirectly, by the Central
Government, or by any State Government or Governments, or partly by the Central Government and partly by
one or more State Governments.
The Comptroller and Auditor-General of India shall appoint the first auditor of the Government Company within
sixty days from the date of registration of the company. In case the Comptroller and Auditor-General of India
does not appoint such auditor within the said period, the Board of Directors of the company shall appoint such
auditor within the next thirty days; and in the case of failure of the Board to appoint such auditor within the next
thirty days, it shall inform the members of the company who shall appoint such auditor within the sixty days at an
extraordinary general meeting, who shall hold office till the conclusion of the first annual general meeting.
The Comptroller and Auditor-General of India in respect of a financial year shall appoint an auditor within a
period of one hundred and eighty days from the commencement of the financial year, who shall hold office till the
conclusion of the annual general meeting.
Any casual vacancy in the office of an auditor of a Government company shall be filled by the Comptroller and
Auditor-General of India within thirty days. In case of failure of the Comptroller and Auditor-General of India to fill
the vacancy within the said period, the Board of Directors shall fill the vacancy within next thirty days.
 Lesson 16 Audit and Auditors under Companies Act 2013 – Basic Provisions 415

Mandatory Rotation of Auditors

The Companies Act, 2013 has introduced the system of rotation of auditors which is applicable to-
• all listed companies;
• all unlisted public companies having paid up share capital of rupees 10 crore or more;
• all private limited companies having paid up share capital of rupees 20 crore or more;
• all companies having paid up share capital of below threshold limit mentioned above, but having public
borrowings from financial institutions, banks or public deposits of rupees 50 crore or more.
The concept of rotation of auditors shall not apply to one person companies and small companies.
All the companies mentioned above shall not appoint or re-appoint an individual as an auditor of the company
for more than 1 term of 5 consecutive years. An individual auditor, who has completed his term of 5 consecutive
years, shall not be eligible for re-appointment as auditor in the same company for 5 years from the date of
completion.
All the companies mentioned above shall not appoint or re-appoint an audit firm as an auditor of the company for
more than 2 terms of 5 consecutive years. An audit firm which has completed its 2 terms of 5 consecutive years
shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such
terms. If any firm/LLP which has one or more partners who are also partners in the outgoing audit firm/LLP
cannot be appointed as auditors during the 5 year period. In other words, if two or more audit firms have
common partner(s), and one of these firms has completed its 2 terms of 5 consecutive years, none of such audit
firms shall be eligible for re-appointment as auditor in the same company for 5 years.

Eligibility or Qualifications of the Auditor

• A person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant.
• A firm whereof majority of partners practising in India are chartered accountants may be appointed by its
firm name to be auditor of a company.
• If a limited liability partnership firm is appointed as an auditor of a company, only the partners who are
chartered accountants shall be authorised to act and sign on behalf of the firm.

Disqualifications of the Auditor

The following persons shall not be eligible for appointment as an auditor of a company-
(i) a body corporate other than a limited liability partnership
(ii) an officer or employee of the company
(iii) a person who is a partner, or who is in the employment, of an officer or employee of the company
(iv) a person who, or his relative or partner and holding any security of or interest in the company or its
subsidiary, or of its holding or associate company or a subsidiary of such holding company not exceeding
Rs. 1 lakh.
(v) a person who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or
associate company or a subsidiary of such holding company not exceeding Rs. 5 lakh.
(vi) a person who, or his relative or partner has given a guarantee or provided any security in connection
with the indebtedness of any third person to the company, or its subsidiary, or its holding or associate
company or a subsidiary of such holding company, not exceeding Rs. 1 lakh.
(vii) a person or a firm who, whether directly or indirectly, has business relationship with the company, or its
416 FP–FA&A

subsidiary, or its holding or associate company or subsidiary of such holding company or associate
company
(viii) a person whose relative is a director or is in the employment of the company as a director or key
managerial personnel;
(ix) a person who is in full time employment elsewhere or a person or a partner of a firm holding appointment
as its auditor, if such persons or partner is at the date of such appointment or reappointment holding
appointment as auditor of more than twenty companies;
(x) a person who has been convicted by a court of an offence involving fraud and a period of ten years has
not elapsed from the date of such conviction;
(xi) any person whose subsidiary or associate company or any other form of entity, is engaged as on the
date of appointment in consulting and specialised services as provided in section 144.
If any person appointed as an auditor of a company incurs any of the disqualifications mentioned above after his
appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual
vacancy in the office of the auditor.

Remuneration of the auditors

The remuneration of the auditor of a company shall be fixed in its general meeting. The Board may fix remuneration
of the first auditor appointed by it. The remuneration shall be in addition to the fee payable to an auditor, include
the expenses, if any, incurred by the auditor in connection with the audit of the company and any facility extended
to him. The remuneration fixed does not include any remuneration paid to him for any other service rendered by
him at the request of the company.

Powers and Duties of auditors

1. Every auditor of a company shall have a right of access at all times to the books of account and vouchers
of the company, whether kept at the registered office of the company or at any other place.
2. The auditor shall be entitled to require from the officers of the company such information and explanation
as he may consider necessary for the performance of his duties as auditor and amongst other matters
inquire into the following matters, namely:—
(a) whether loans and advances made by the company on the basis of security have been properly
secured and whether the terms on which they have been made are prejudicial to the interests of the
company or its members;
(b) whether transactions of the company which are represented merely by book entries are prejudicial
to the interests of the company;
(c) where the company not being an investment company or a banking company, whether so much of
the assets of the company as consist of shares, debentures and other securities have been sold at
a price less than that at which they were purchased by the company;
(d) whether loans and advances made by the company have been shown as deposits;
(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and documents of the company that any shares have been allotted
for cash, whether cash has actually been received in respect of such allotment, and if no cash has
actually been so received, whether the position as stated in the account books and the balance
sheet is correct, regular and not misleading:
 Lesson 16 Audit and Auditors under Companies Act 2013 – Basic Provisions 417

3. The auditor of a company which is a holding company shall also have the right of access to the records
of all its subsidiaries in so far as it relates to the consolidation of its financial statements with that of its
subsidiaries.
4. The auditor has right to receive notices of any general meeting and he shall attend either by himself or
through his authorised representative, who shall also be qualified to be an auditor, any general meeting
and shall have right to be heard at such meeting on any part of the business which concerns him as the
auditor.

Auditor’s Report
The auditor shall make a report to the members of the company on the accounts and financial statements
examined by him after taking into account the provisions of the Companies Act, the accounting standards and
auditing standards. The report shall be laid before the company in general meeting.
1. The auditor shall state in his report that to the best of his information and knowledge, the accounts and
financial statements give a true and fair view of the state of the company’s affairs as at the end of its
financial year and profit or loss and cash flow for the year. The auditor shall comply with the auditing
standards and sign the auditor’s report of the company. The auditor’s report shall also state following –
(a) whether he has sought and obtained all the information and explanations which to the best of his
knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and
the effect of such information on the financial statements;
(b) whether, in his opinion, proper books of account as required by law have been kept by the company
so far as appears from his examination of those books and proper returns adequate for the purposes
of his audit have been received from branches not visited by him;
(c) whether the report on the accounts of any branch office of the company audited by a person other
than the company’s auditor has been sent to him under and the manner in which he has dealt with
it in preparing his report;
(d) whether the company’s balance sheet and profit and loss account dealt with in the report are in
agreement with the books of account and returns;
(e) whether, in his opinion, the financial statements comply with the accounting standards;
(f) the observations or comments of the auditors on financial transactions or matters which have any
adverse effect on the functioning of the company;
(g) whether any director is disqualified from being appointed as a director
(h) any qualification, reservation or adverse remark relating to the maintenance of accounts and other
matters connected therewith;
2. If any of the matters required to be included in the audit report is answered in the negative or with a
qualification, the report shall also state the reasons for the same.
3. The qualifications, observations or comments on financial transactions or matters, which have any
adverse effect on the functioning of the company mentioned in the auditor’s report shall be read before
the company by the auditor in general meeting and shall be open to inspection by any member of the
company.
4. As per the Companies (Auditor’s Report) Order, 2015, an auditor should include a statement on the
following matters in the auditor’s report on the account of companies covered under this order-
(i) Fixed assets
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(ii) Inventory
(iii) Granting of loans to certain parties
(iv) Internal control system
(v) Acceptance of deposits
(vi) Maintenance of cost records
(vii) Deposit of statutory dues
(viii) Accumulated Losses and Cash Losses
(ix) Default in repayment of dues
(x) Guarantee for loans taken by others from bank or financial institutions
(xi) Application of term loans
(xii) Fraud Reporting

Auditor not to render certain services

An auditor appointed by the company will provide only such other services as are approved by the Board of
Directors or the audit committee. The auditor is prohibited to provide any of the following services whether
directly or indirectly to the company or its holding company or subsidiary company-
(i) accounting and book keeping services;
(ii) internal audit;
(iii) design and implementation of any financial information system;
(iv) actuarial services;
(v) investment advisory services;
(vi) investment banking services;
(vii) rendering of outsourced financial services;
(viii) management services; and
(ix) any other kind of services as may be prescribed.

Branch Audit
If any company has a branch office, the accounts of that office shall be audited either by the auditor of the
company or by any other person qualified for appointment as an auditor of the company or appointed as auditor
under the Act.
If the branch office is situated in a country outside India, the accounts of the branch office shall be audited either
by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the
accounts of the branch office in accordance with the laws of that country.
The duties and powers of the company’s auditor with reference to the audit of the branch shall be same. The
branch auditor shall prepare a report on the accounts of the branch examined by him and send it to the auditor
of the company who shall deal with it in his report in such manner as he considers necessary.

Secretarial Audit
Secretarial Audit is an audit to check compliance of various legislations including the Companies Act and other
 Lesson 16 Audit and Auditors under Companies Act 2013 – Basic Provisions 419

corporate and economic laws applicable to the company. The Secretarial Auditor expresses an opinion as to
whether there exist adequate systems and processes in the company commensurate with the size and operations
of the company to monitor and ensure compliance with applicable laws, rules, regulations and guidelines.
Secretarial Audit helps to detect the instances of non-compliance and facilitates taking corrective measures. It
audits the adherence of good corporate practices by the company. It is therefore an independent and objective
assurance intended to add value and improve operations of the Company. It helps to accomplish the organisation’s
objectives by bringing a systematic, disciplined approach to evaluate and improve effectiveness of risk
management, control, and governance processes. Secretarial Audit thus provides necessary comfort to the
management, regulators and the stakeholders, as to the statutory compliance, good governance and the existence
of proper and adequate systems and processes.
As per Companies Act, 2013 and the Companies (Appointment and Remuneration of Managerial Personnel)
Rules, 2014, the following companies are required to obtain Secretarial Audit Report:
• Every listed company;
• Every public company having a paid-up share capital of fifty crore rupees or more; or
• Every public company having a turnover of two hundred fifty crore rupees or more.
Companies which are not covered above may obtain Secretarial Audit Report voluntarily as it provides an
independent assurance of the compliances in the company.
Eligibility of Secretarial auditor - Only a member of the Institute of Company Secretaries of India holding certificate
of practice (company secretary in practice) can conduct Secretarial Audit and furnish the Secretarial Audit Report
to the company.
The Secretarial Auditor needs to examine and report on the compliance of the following five specific laws:
(i) The Companies Act, 2013 (the Act) and the rules made thereunder;
(ii) The Securities Contracts (Regulation) Act, 1956 (SCRA) and the rules made thereunder;
(iii) The Depositories Act, 1996 and the Regulations and Bye-laws framed thereunder;
(iv) Foreign Exchange Management Act, 1999 and the rules and regulations made thereunder
(v) The following Regulations and Guidelines prescribed under the Securities and Exchange Board of India
Act, 1992 (SEBI Act):-
• The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 2011;
• The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992;
• The Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements)
Regulations, 2009;
• The Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock
Purchase Scheme) Guidelines, 1999;
• The Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations,
2008;
• The Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agents)
Regulations, 1993 regarding the Companies Act and dealing with client;
• The Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009; and
• The Securities and Exchange Board of India (Buyback of Securities) Regulations, 1998;
420 FP–FA&A

(vi) Any other laws as may be applicable specifically to the company.

The Secretarial Audit Report should be signed by the Secretarial Auditor who has been engaged by the company
to conduct the Secretarial Audit and in case of a firm of Company Secretaries, by the partner under whose
supervision the Secretarial Audit was conducted.

Audit Report
The auditor’s report is a formal opinion, issued by either an internal auditor or an independent external auditor
as a result of an internal or external audit or evaluation performed on an organisation. The auditor should review
and assess whether the financial statements have been prepared in accordance with an acceptable financial
reporting framework applicable to the entity under audit. It is also necessary to consider whether the financial
statements comply with the relevant statutory requirements and then the audit report is prepared. The report is
subsequently provided to the stakeholders such as shareholders, creditors, financial institutions, banks,
government, or the general public at large as an assurance service so that the user can make decisions based
on the results of the audit. Therefore, the auditor’s report should contain a clear written expression of opinion on
the financial statements taken as a whole.

Contents of an Auditor’s Report

The auditor’s report shall be in writing. The auditor’s report should include a minimum of the following elements:
(a) A title;
(b) An addressee
(c) An introductory paragraph that identifies the financial statements audited;
(d) A description of the responsibility of management for the preparation of the financial statements;
(e) A description of the auditor’s responsibility to express an opinion on the financial statements and the
scope of the audit
(f) An opinion paragraph containing an expression of opinion on the financial statements and a reference
to the applicable financial reporting framework used to prepare the financial statements
(g) The auditor’s signature;
(h) The date of the auditor’s report; and
(i) The place of signature.

Forming an Audit Opinion

Audits are conducted to express a true and fair view of a company’s financial statements. Therefore in the audit
report, the auditor’s opinion is expressed on the basis of the information reviewed and analyzed during the
verification of financial statements.
The auditor shall form an opinion on whether the financial statements are prepared, in all material respects, in
accordance with the applicable financial reporting framework. In order to form that opinion, the auditor shall
conclude as to whether the auditor has obtained reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud or error.
The auditor shall evaluate whether the financial statements are prepared, in all material respects, in accordance
with the requirements of the applicable financial reporting framework. This evaluation shall include consideration
of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s
judgments.
 Lesson 16 Audit and Auditors under Companies Act 2013 – Basic Provisions 421

In particular, the auditor shall evaluate whether:

(a) The financial statements adequately disclose the significant accounting policies selected and applied;
(b) The accounting policies selected and applied are consistent with the applicable financial reporting
framework and are appropriate;
(c) The accounting estimates made by management are reasonable;
(d) The information presented in the financial statements is relevant, reliable, comparable and
understandable;
(e) The financial statements provide adequate disclosures to enable the intended users to understand the
effect of material transactions and events on the information conveyed in the financial statements; and
(f) The terminology used in the financial statements, including the title of each financial statement, is
appropriate
The opinion paragraph of the auditor’s report should clearly indicate the financial reporting framework used to
prepare the financial statements and state the auditor’s opinion as to whether the financial statements give a
true and fair view in accordance with that financial reporting framework and, where appropriate, whether the
financial statements comply with the statutory requirements.

Types of opinion
The auditor may express one of the following four opinions:
• Unqualified Opinion
• Qualified Opinion
• Disclaimer of Opinion
• Adverse Opinion

Unqualified Opinion
An unqualified opinion is expressed when the auditor concludes that the financial statements give a true and fair
view in accordance with the financial reporting framework used for the preparation and presentation of the
financial statements. An unqualified opinion indicates, implicitly, that any changes in the accounting principles or
in the method of their application, and the effects thereof, have been properly determined and disclosed in the
financial statements. An unqualified opinion also indicates that-
(a) the financial statements have been prepared using the generally accepted accounting principles, which
have been consistently applied;
(b) the financial statements comply with relevant statutory requirements and regulations; and
(c) there is adequate disclosure of all material matters relevant to the proper presentation of the financial
information, subject to statutory requirements, where applicable.
The following is an illustration of an auditor’s report expressing an unqualified opinion.
AUDITOR’S REPORT
(Appropriate Addressee)
We have audited the attached Balance Sheet of ...... (Name of the entity) as at 31st March 2XXX and also the
Profit and Loss Account for the year ended on that date annexed thereto. These financial statements are the
responsibility of the entity’s management. Our responsibility is to express an opinion on these financial statements
422 FP–FA&A

based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in India. Those Standards
require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion and to the best of our information and according to the explanations given to us, the financial
statements give a true and fair view in conformity with the accounting principles generally accepted in India:
(a) In the case of the Balance Sheet, of the state of affairs of..... (Name of the entity) as at 31st March 2XXX;
and
(b) In the case of the Profit and Loss Account, of the profit/loss for the year ended on that date.

Modified Report
An auditor’s report is considered to be modified when it includes:
(a) Matters That Do Not Affect the Auditor’s Opinion
• emphasis of matter
(b) Matters That Do Affect the Auditor’s Opinion
• qualified opinion
• disclaimer of opinion
• adverse opinion
(a) Matters That Do Not Affect the Auditor’s Opinion
In certain circumstances, an auditor’s report may be modified by adding an emphasis of matter paragraph
to highlight a matter affecting the financial statements. The auditor considers modifying the auditor’s
report by adding a paragraph if there is a significant uncertainty (other than going concern problem), the
resolution of which is dependent upon future events and which may affect the financial statements. The
addition of such an emphasis of matter paragraph does not affect the auditor’s opinion. It would ordinarily
refer to the fact that the auditor’s opinion is not qualified in this respect.
(b) Matters That Do Affect the Auditor’s Opinion
An auditor may not be able to express an unqualified opinion when either of the following circumstances
exists and, in the auditor’s judgment, the effect of the matter is or may be material to the financial
statements:
• there is a limitation on the scope of the auditor’s work; or
• there is a disagreement with management regarding the acceptability of the accounting policies
selected, the method of their application or the adequacy of financial statement disclosures.
The circumstances described in (a) could lead to a qualified opinion or a disclaimer of opinion. The circumstances
described in (b) could lead to a qualified opinion or an adverse opinion.

Qualified Opinion
A qualified opinion is expressed when the auditor concludes that an unqualified opinion cannot be expressed,
but that the effect of any disagreement with management is not so material and pervasive as to require an
 Lesson 16 Audit and Auditors under Companies Act 2013 – Basic Provisions 423

adverse opinion, or the limitation of scope is not so material and pervasive as to require a disclaimer of opinion.
A qualified opinion should be expressed as being “subject to’” or “except for” the effects of the matter to which
the qualification relates.

Disclaimer of Opinion
A disclaimer of opinion is expressed when the possible effect of a limitation on scope is so material and pervasive
that the auditor has not been able to obtain sufficient appropriate audit evidence and is, therefore, unable to
express an opinion on the financial statements.

Adverse Opinion
An adverse opinion is expressed when the effect of a disagreement is so material and pervasive to the financial
statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading
or incomplete nature of the financial statements.
At the end of the audit report, it is signed by the auditor. The audit report is the medium of communication of the
auditor’s expert views on the financial statements and it has a significant bearing on the credibility of such
statements. By expressing views in the report, the auditor takes upon himself a great responsibility because a
large number of people are likely to put reliance on the financial statements. Therefore, he is necessarily to be
careful, clear and objective in the matter of preparation of the report. A good audit report should clearly express
an opinion as to whether the financial statements of the company present the financial information truly and
fairly in conformity with accounting principles and legal requirements.

LESSON ROUND UP
– The Board of Directors of a company shall appoint an individual or firm as the first auditor of a company,
other than a Government company, within thirty days from the date of registration of the company.
– Government companies means any company owned or controlled, directly or indirectly, by the Central
Government, or by any State Government or Governments, or partly by the Central Government and
partly by one or more State Governments. The Comptroller and Auditor-General of India shall appoint
the first auditor of the Government Company within sixty days from the date of registration of the
company.
– The remuneration of the auditor of a company shall be fixed in its general meeting. The Board may fix
remuneration of the first auditor appointed by it.
– Every auditor of a company shall have a right of access at all times to the books of account and
vouchers of the company, whether kept at the registered office of the company or at any other place.
– The auditor shall make a report to the members of the company on the accounts and financial statements
examined by him after taking into account the provisions of the Companies Act, the accounting standards
and auditing standards. The report shall be laid before the company in general meeting.
– If any company has a branch office, the accounts of that office shall be audited either by the auditor of
the company or by any other person qualified for appointment as an auditor of the company or appointed
as auditor under the Act.
– Secretarial Audit is an audit to check compliance of various legislations including the Companies Act
and other corporate and economic laws applicable to the company. The Secretarial Auditor expresses
an opinion as to whether there exist adequate systems and processes in the company commensurate
with the size and operations of the company to monitor and ensure compliance with applicable laws,
424 FP–FA&A

rules, regulations and guidelines.

– The auditor’s report is a formal opinion, issued by either an internal auditor or an independent external
auditor as a result of an internal or external audit or evaluation performed on an organisation.
– Audits are conducted to express a true and fair view of a company’s financial statements. Therefore in
the audit report, the auditor’s opinion is expressed on the basis of the information reviewed and analyzed
during the verification of financial statements.
– An unqualified opinion is expressed when the auditor concludes that the financial statements give a
true and fair view in accordance with the financial reporting framework used for the preparation and
presentation of the financial statements.

SELF-TEST QUESTIONS
1. Who can be appointed as the auditor of a company?
2. How the first auditor of the company is appointed?
3. What is a casual vacancy? What are the rules regarding appointment for the casual vacancy on account
of resignation?
4. What are the powers of the company auditor?
5. Can a company restrict the rights of its statutory auditor?

SUGGESTED READINGS
1. Fundamentals of Auditing – By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu