Module 1

Introduction
To
Audit

Syllabus
Origin of audit, meaning, definition, purpose and functions of
audit, factors responsible for the growth of auditing, advantages
and limitations of audit. Difference between book keeping,
accountancy and audit, Objects of Audit Main object &
Secondary objectives, Errors , Location of errors, Position of
Auditors in relation to errors & frauds,different types of audit
and their relative advantages, statutory audit - partial audit cash audit - interim audit, balance sheet audit, cost audit and
occasions audit.

Introduction

If decisions are to be consistent with the intention of the decision makers, the
information used in the decision process must be reliable.

As society become more complex, there is an increased likelihood that

unreliable information will be provided to decision makers. There are several
reasons for this: remoteness of information, voluminous data and the existence
of complex exchange transactions.

As a means of overcoming the problem of unreliable information, the decisionmaker must develop a method of assuring him that the information is
sufficiently reliable for these decisions.

In doing this he must weigh the cost of obtaining more reliable information
against the expected benefits.

A common way to obtain such reliable

information is to have some type of verification (audit) performed by

independent persons. The audited information is then used in the decision
making process on the assumption that it is reasonably complete, accurate and
unbiased.

Origin
and
Evolution
The term audit is derived from the Latin word audire,

which

means to hear.

In early days an auditor used to listen to the accounts read

over by an accountant in order to check them. Auditing is as
old as accounting.

It was in use in all ancient countries such as Mesopotamia,

Greece, Egypt, Rome, U.K. and India.

The Vedas contain reference to accounts and auditing.

Arthasashthra by Kautilya had emphasized the importance of
accounting and auditing.

Conti
The original objective of auditing was to detect and prevent errors
and frauds.

Auditing evolved and grew rapidly after the industrial revolution

in the 18th century with the growth of the joint stock companies
the ownership and management became separate.

The shareholders who were the owners needed a report from an

independent expert on the accounts of the company managed by the
board of directors who were the employees.

The objective of audit shifted and audit was expected to ascertain

whether the accounts were true and fair rather than detection
of errors and frauds.

Historical background

It can be traced back from Ancient China, Greece and Rome.

The attitude of profit maximization from end middle ages merchant houses in Italy.

Double-entry bookkeeping was first described in Italy

(Pacioli 1494).

Industrial Revolution Great-Britain 1780 lead to the

emergence of large industrial companies. 1853 the Society
of Accountants in Edinburgh was founded.

The function of auditing is to lend

credibility to the financial statements

Is the company a going concern?

Is it free of fraud?

Is it managed properly?

Is there integrity in its database?

Do directors have proper and adequate information to make

decisions?

Are there adequate controls?

What effect do the company's products and by-products

have on the environment?

Can an unfortunate mistake bring this company to its

knees?

In India

In India, the companies Act 1913 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.1913 also prescribed for the first time the qualification of
auditors.

The International Accounting Standards Committee and the Accounting Standard

board of the Institute of Chartered Accountants of India have developed standard
accounting and auditing practices to guide the accountants and auditors in the day to
day work.

The later developments in auditing pertain to the use of computers in accounting and
auditing.

In conclusion it can be said that auditing has come a long way from hearing of
accounts to taking the help of computers to examine computerized accounts.

Meaning
The word audit is derived from Latin word audire which means to
hear.
Auditing is a critical examination of the records and books of
account of a business by an independent qualified person for
ascertaining

the

authenticity

and

the

accuracy

of

entries

appearing in the books of account and financial statement.

Definition
Montgomery defined auditing as examination of the books and
records of a business in order to ascertain or verify and report up on
the facts regarding the financial operations and the results thereof.

Features of Auditing

1. Audit is a systematic and scientific examination of the books of accounts of a

business;
2. Audit is undertaken by an independent person or body of persons who are duly
qualified for the job.
3 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.
4. Audit is a critical review of the system of accounting and internal control.
5. Audit is done with the help of vouchers, documents, information and explanations
received from the authorities.
6. 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.
7. The auditor has to inspect, compare, check, review, scrutinize the vouchers
supporting the transactions and examine correspondence, minute books of share
holders, directors, Memorandum of Association and Articles of association etc., in order to
establish correctness of the books of accounts.

True and Fair View

An audit of accounts by an independent expert assures the outside users

that the accounts are proper and reliable. The outsiders can rely on the
accounts if the auditor reports that the accounts are true and fair. The
accounts are said to be true and Fair;
1. When the Profit or Loss shown in the Profit or Loss Account is
true and fair, and
2. Also when the value of assets and liabilities shown in the balance
sheet is true and fair.
3. Disclose all material facts.
4. Legal requirements.
5. Requirements of Institute of Chartered Accountants of India.

Objectives of Auditing
There are two main objectives of auditing. The primary objective and the
secondary or incidental objective.
a. Primary objective as per Section 227 of the Companies Act 1956, the
primary duty (objective) of the auditor is to report to the owners whether the
balance sheet gives a true and fair view of the Companys state of affairs and the
profit and loss A/c gives a correct figure of profit of loss for the financial year.
b. Secondary objective it is also called the incidental objective as it is
incidental to the satisfaction of the main objective. The incidental objective of
auditing are:

i. Detection and prevention of Frauds, and

ii. Detection and prevention of Errors.