Essential Principles and Practices of Professional Auditing

Objectives of Auditing

There are two types of objectives of an audit: (1) Principal Objects (main object) and (2) Secondary or Supplementary Objects. The principal object of the audit is to confirm and convey the true and fair position of the business. The supplementary object includes the detection and prevention of errors and frauds.

Principal Objects

• Efficiency and Accuracy: To increase the efficiency and accuracy in bookkeeping.
• True and Fair View: The auditor must critically examine recorded transactions to ascertain whether final accounts reveal a true and fair view of the financial status.
• Compliance: To ensure accounts are maintained according to business rules and to locate any irregularities.

Secondary or Supplementary Objects

• Detection of Errors: Identifying unintentional mistakes such as double-recording, omissions, or incorrect amounts.
• Detection of Frauds: Identifying intentional misrepresentations or wrong entries made to defraud proprietors, such as misappropriation of cash or goods.
• Prevention of Errors and Frauds: By studying the internal check system and suggesting improvements, the auditor helps prevent future irregularities.
• Control of Employees: The presence of an audit acts as a deterrent, controlling the activities of employees in the accounts department.

Advantages of Auditing

Auditing has become a necessity for modern businesses. Key advantages include:

• Regularity: Helps in maintaining up-to-date books of accounts.
• Financial Clarity: Provides owners, partners, and shareholders with a true and fair view of business affairs.
• Purchase Consideration: Facilitates the calculation of business value during a sale.
• Partnership Harmony: Reduces future disputes among partners regarding accounts.
• Shareholder Protection: Acts as a safeguard for shareholders against potential management malpractice.

Nature and Scope of Auditing

Auditing is a systematic, scientific process performed by qualified experts. It involves an intelligent and critical review of accounts, including:

• Verification of arithmetical accuracy.
• Checking the record of every transaction.
• Verifying journal entries and ledger postings.
• Checking casting and balancing of ledger accounts.
• Verifying legal authenticity of supporting documents.
• Checking trial balance accuracy.
• Verification of trading accounts, profit and loss statements, and balance sheets.
• Verification of assets and liabilities.

Types of Fraud

1. Misappropriation of Cash: Requires creative and experienced auditing to detect.
2. Misappropriation of Goods: Best prevented through stock-taking and efficient internal checks.
3. Falsification of Accounts: Often committed by management to manipulate profit figures.

Statutory vs. Private Audit

Statutory Audit

Also known as legal audit, this is required by law (e.g., The Companies Act). Types include:

• Company Audit: Mandatory for incorporated companies.
• Trust Audit: For religious or charitable institutions.
• Co-operative Societies and Banks: Required for specific institutional compliance.

Private Audit

Also called a voluntary audit, this depends on the director's or owner's discretion. It is common for sole traders, partnerships, hospitals, and schools to ensure financial transparency and tax compliance.

Special Audit

Under Section 233A of the Companies (Amendment) Act 1960, the Central Government may order a special audit if a company is managed against sound business principles or if its solvency is at risk.

Annual Audit

An annual audit occurs at the end of the financial period. It is cost-effective for small concerns and highly efficient when a strong internal control system is in place.

Methods of Detecting and Preventing Errors

Auditors use trial balances to identify posting mistakes. To prevent errors, auditors provide guidance to employees, acting as a "watchdog" to ensure duties are discharged faithfully and skillfully.

Audit Programme

An audit programme provides clear instructions, consistency, and a master plan for audit staff. While it may sometimes lack flexibility, it serves as vital evidence in legal cases regarding negligence.

Internal Check and Internal Audit

Internal check focuses on daily error prevention, while internal audit is a continuous, critical review by salaried employees. Internal audit features include:

• Examination of books by permanent internal staff.
• Simplification of annual audit processes.
• Checking management efficiency.
• Acting as a safeguard for organizational resources.

Vouching Procedures

Petty Cash Book

Auditors must check the internal control system before vouching. Key steps include verifying the imprest amount, checking totals against vouchers, and ensuring revenue stamps are used for expenses over Rs. 500.

Bank Pass Book

Given the importance of banking in modern business, auditors must carefully verify bank transactions using pay-in slips and bank statements to ensure accuracy in current and savings accounts.