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AUDITING SEM-4

INTRODUCTION OF AUDITING
Q-1. Meaning of Audit:
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 detailed rules for accounting and
auditing of public finances.
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.
Definition:
Spicer and Peglar define auditing as An examination of the
books, accounts and vouchers of a businesss shall enable the
auditor to satisfy himself whether or not the balance sheet is
properly drawn up so as to exhibit a true and correct view of the
state of affairs of the business according to his best of the
information given to him and as shown by the book.
Mautz: defines auditing as being Concerned with the
verification of accounting data with determining the accuracy and
reliability of accounting statements and reports.
Prof. L.R.Dicksee. "Auditing is an examination of accounting
records undertaken with a view to establish whether they correctly
and completely reflect the transactions to which they relate.
Q-2. FEATURES OF AUDITING
Audit is a systematic and scientific examination of the books of
accounts of a business;
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Audit is undertaken by an independent person or body of


persons who are duly qualified for the job.
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.
Audit is a critical review of the system of accounting and
internal control.
Audit is done with the help of vouchers, documents, information
and
explanations received from the authorities.
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.
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.
Q-3 Differences between Accounting and Auditing.
Accounting
1. Accounting is the act of
collecting, recording,
analyzing and interpretation
of financial transactions
2. Its a continuous process
carried out throughout the
year.
3. No prescribed qualification is
required to be an accountant.
4. An accountant is a employee
of the company.
5. An accountant gets regular

Auditing
Auditing is the act of
examination of books of
accounts and evidential
documents, so as to prove the
true and fair view of profitability
and financial position.
Its a one time activity after the
closure of accounting year.
He must be the member of
Institute of Chartered
Accountants of India to become
an auditor.
An auditor is an independent
professional.
He gets remuneration for his

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salary for his work.
6. Accounting is concerned with
recording of business
transactions systematically.
7. Accounting precedes,
auditing.

professional work. Audit fees.


Its concerned with verification of
accounts prepared by the
accountant.
Auditing succeeds accounting.

Q-4 AUDITING ADVANTAGES AND LIMITATIONS


1.

2.

3.
4.

5.
6.
7.

Advantages of Auditing
Assurance of true and fair accounts An audit provides an
assurance to the investors, government, lenders, creditors, owners,
management etc. That the final account presented shows the true
and fair picture of the profit and losses and financial position of the
concern
True and fair balance sheet The user of final accounts can
be sure that the assets and liabilities disclose true and fair view of
financial position of the concern, its neither more nor less, and its
free from window dressing or secret reserve.
True and fair profit and loss account The user of final
accounts should be sure that the profit and loss account show true
amount of profit or less as it is.
Tally with books of accounts The audited final accounts
should tally with the books of accounts of the concern. So it can be
easy to calculate the taxable income without checking all the
transactions.
Disclose all material facts The audited final accounts
should disclose all material facts, thus users can rely on them for
making useful decisions of lending, investing etc.
As per law The audited final accounts should be prepared as
per the rules and guidelines laid down by law.
Detection of errors and frauds It is assumed that the
audited final accounts are free from errors and frauds, the auditor
with his expertise knowledge would detect the errors and fraud so as
to show the true figure of final accounts.

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8.

Moral check on employees Auditing techniques such as


verification, vouching of cash, assets, stock etc. act as a moral check
on the employees, this forces them to keep the accounts up-to-date
and free from errors and frauds.
9.
Advice to concern Auditor can also advise the client about
internal control, taxation, finance, accounting system etc.
Limitations of Auditing
1.
2.

3.

4.

5.

All transactions cannot be checked It is not possible for an


auditor to check each and every transaction; he has to check them
on sample basis.
Evidence is not conclusive Audit evidence is not conclusive
in nature the confirmation of debtors is not conclusive evidence that
all amount will be collected, the conclusions are persuasive rather
than conclusive.
Not easy to detect some frauds Its not easy for an auditor
to detect the deeply laid frauds which involves acts designed to
conceal them such as forgery, false explanation, and not recording
transaction and so on.
Audit cannot assure about profitability or efficiency of
management Even though the accounts are audited it doesnt
that the user can take granted the future profitability or prospects of
concern as audit dont comment on efficiency of the management.
Rely on experts The auditor has to rely on experts like
lawyers, engineers, valuers etc. for estimation of contingent liability
and valuation of fixed assets.

Q-5 Comparison between Audit and Investigation:


Audit
Description

Audit means the


inspection,
examination or
verification of a
person, organization,

Investigation
Investigation means
an inquiry, or is the
act of detail
examination of
activities so as to

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system, process,
enterprise, project or
product.

achieve certain
objectives.

Owners

Audit is conducted
on behalf of owners
only and they make
the appointment.

Investigation may be
conducted either by
owner of the
undertaking or by an
outsider.

Purpose

To determine the
true and fair view.

Varies from business


to business

Process

Routine process

Investigation is not a
regular process

Scope

It includes only an
examination of the
accounts of a
business

It covers an
examination of the
accounts bur also
covers an inquiry
into other matter
that are connected
with the purpose for
which it is
undertaken

Period

Year or six months

May cover several


years

Employees

Does not examine


personally

May examine
personally

Sequence

Usually conducted
before investigation
of accounts

Usually conducted
after the audit of
accounts

Person performing
work

Audit is to be
Investigation may be
conducted by a
take on even by a
chartered accountant non-chartered
accountant

Legal Obligations

Audit is mandatory

There is no such

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under law

legal obligations with


regard to
investigation

Q-6 Qualities of An Auditor:


1. Professionally Competent :It is a basic quality of an auditor. He must have a complete and
thorough knowledge of the accountancy. To understand the
accounting details he can apply his knowledge and skill. It is only
possible if he has a sound background in accountancy and he is
professionally competent.
2. Honest:It is also very important quality of an auditor. Justice Hindley says
"An auditor must be honest. He must not certify what he does not
believe to be true and he must take a reasonable care and skill
before he believes that what he certifies is true.
3. Auditing:An auditor's knowledge of auditing must be upto date. He must know
the techniques of auditing. He must have the knowledge of other
subjects relating to auditing.
4. Accounting Knowledge:The auditor should be at home in all the management accounting
cost accounting and general accounting.
5. Knowledge Of Business Law:An auditor must possess a considerable knowledge of business law.
He must be aware about his duties and rights given by law.
6. Knowledge Of Taxation Law:Various types taxes are imposed by the government on the business.
For example in some countries Income tax, sales tax, gift tax is
imposed. So if auditor has not a considerable knowledge about the
taxation. He can not perform his services properly.
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7. Computer Expert:The auditor must be able to operate the computer. Today the
business organizations are using computers. If auditor does not know
to use computer, he cannot work efficiently.
8. Knowledge Of management System:The auditor must have the knowledge of management information
system. It helps him to understand the internal set up of the
business concern and its operation.
9. Preparation Of Budget:The auditor must know that how the organization prepares the
budget. If he does not know then it will be not possible for him to
audit the various heads of the budget.
10. Intelligent:It is also important quality of an auditor that he should be intelligent.
He must be able to understand the technical details of any business.
11. Qualification:For a professional auditor it is necessary that he should be charted
accountant. According to companies ordinance it is essential
qualification for auditor.
12. Tactful:In a particular situation auditor should deal tactfully. He should ask
the questions in such a manner that it does not show about his
ignorance or weakness.
13. Maintain Secrecy:The auditors nature of work is confidential. He should maintain
secrecy from others about the affairs of his client.
14. Patience:There should be a quality of patience in the auditor. Before signing
on any paper he should check the evidence and then sign it. He
never checks the papers in hurry.
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15. Critical Attitude:It is also very essential quality of the auditor. He should examine the
statements critically. He should ask the various questions from the
client and try to find contradictions.
16. Bold And Courageous:Auditor should be bold and courageous person. He should not be
influenced by any authority. He should possess the courage to face
the difference of opinion between him and client on any issue.
17. Courteous:It is an important quality which the auditor should possess. His
attitude towards the staff of client should be very humble and polite.
He should also stress on his own staff to be courteous with the client.
18. Independent:The auditor should be impartial. He should not have such relations
with the organization which may affect his independence. He should
give his opinion independently.
19. Common Sense:The auditor must have the quality of common sense and judgement.
He may be able to assess the value of depreciation and bad debts.

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Chapter -2
OBJECTS OF AUDIT
Q-1Discuss the Objectives of Auditing.
Auditors are basically concerned with verifying whether the account
exhibit true and fair view of the business. The objectives of auditing
depends upon the purpose of his appointment.
Primary Objectives.
The primary objectives of an auditor is
to respect to the owners of his business expressing his opinion
whether account exhibits true and fair view of the state of
affairs of the business.
It should be remembered that in case of a company, he reports
to the shareholders who are the owners of the company and not
tot the director.

The auditor is also concerned with verifying how far the


accounting system is successful in correctly recording
transactions.
He had to see whether accounts are prepared in accordance
with recognized accounting policies and practices and as per
statutory requirements.
Secondary Objectives:
The following objectives are incidental to the main objective of
auditing.
1. Detection and prevention of errors: errors are mistakes
committed unintentionally because of ignorance, carelessness.
Errors are of many types:
a. Errors of Omission: These are the errors which arise on
account of transaction into being recorded in the books of
accounts either wholly partially. If a transaction has been totally
omitted it will not affect trial balance and hence it is more
difficult to detect. On the other hand if a transaction is partially
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b.

c.

d.

e.

10

recorded, the trial balance will not agree and hence it can be
easily detected.
Errors of Commission: When incorrect entries are made in
the books of accounts either wholly, partially such errors are
known as errors of commission. Eg: wrong entries, wrong
Calculations, postings, carry forwards etc such errors can be
located while verifying.
Compensating Errors: when two/more mistakes are
committed which counter balances each other. Such an error is
know an Compensating Error. Eg: if the amount is wrongly
debited by Rs 100 less and Wrongly Credited by Rs 100 such a
mistake is known as compensating error.
Error of Principle: These are the errors committed by not
properly following the accounting principles. These arise mainly
due to the lack of knowledge of accounting. Eg: Revenue
expenditure may be treated as Capital Expenditure.
Clerical Errors; A clerical error is one which arises on account
of ignorance, carelessness, negligence etc.

Location of Errors: It is not the duty of the auditor to identify the


errors but in the process of verifying accounts, he may discover
the errors in the accounts. The auditor should follow the following
procedure in this regard.
1. Check the trial balance.
2. Compare list of debtors and creditors with the trial balance.
3. Compare the names of account appearing in the ledger with the
names of accounting in the trial balance.
4. Check the totals and balances of all accounts and see that they
have been properly shown in the trial balance.
5. Check the posting of entries from various books into ledger.
2. Deduction and Prevention of Fraud: A fraud is an Error
committed intentionally to deceive/ to mislead/ to conceal the
truth/ the material fact. Frauds may be of 3 types.
a. Misappropriation of Cash: This is one of the majored frauds
in any organisation it normally occurs in the cash department.
This kind of fraud is either by showing more payments/ less
receipt.
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The cashier may show more expenses than what is actually


incurred and misuse the extra cash. Eg: showing wages to
dummy workers. Cash can also be misappropriated by showing
less receipts
Eg: not recording cash sales. Not allowing discounts to
customers. The cashier may also misappropriate the cash when
it is received. Cash received from 1st customer is misused when
the 2nd customer pays it is transferred to the 1st customers
account. When the 3rd customer pays it goes forever. Such a
fraud is known as Teaming and Lading. To prevent such frauds
the auditor must check in detail all books and documents,
vouchers, invoices etc.
b. Misappropriation of Goods: here records may be made for
the goods not purchase not issued to production department,
goods may be used for personal purpose. Such a fraud can be
deducted by checking stock records and physical verification of
goods.
c. Manipulation of Accounts: this is finalizing accounts with the
intention of misleading others. This is also known as WINDOWS
DRESSING. It is very difficult to locate because its usually
committed by higher level management such as directors. The
objective of WD may be to evade tax, to borrow money from
bank, to increase the share price etc.
To conclude it is not the main objective of the auditor to
discover frauds and irregularities. He is not an insurance
against frauds and errors. But if he finds anything of a
suspicious nature, he should inquire it in full.
THE AUDITOR SHOULD PERFORM THE FOLLOWING DUTIES IN
RESPECT OF FRAUD.
Examine all aspects of the finance.
Vouch all the receipts from the counterfoils or carbon copies or
cash
memos, sales mart reports etc.
Check thoroughly the salary and wages register.
Verify the methods of valuation of stocks.
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Check up stock register, goods inwards notes, goods out wards


books and delivery challans etc
Calculate various ratios in order to detect fraudulent
manipulation of accounts
Go through the details of unusual items.
Probe into the details of the problems when there is a suspicion.
Exercise reasonable skill and care while performing the duty.
Make surprise visit to check the accounts.

TYPES OF AUDIT
I. CONTINUOUS AUDIT:
Meaning:
Continuous audit is defined by R.C. Williams as one
where the auditor is constantly or at (regular or irregular)
intervals engaged in checking the accounts during the period.
Continuous Audit means an audit at regular intervals
throughout the accounting year. Generally, the audit work
begins after the accounting year is over. But in case of
Continuous Audit, the work begins the accounting year itself.
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For example, if the accounting year begins on 1 st April


2012 and ends on 31st March, 2013 normally, audit work would
begin in April 2013 and continue thereafter. But in case of
Continuous Audit the work would begin in April 2012 itself and
continue at regular intervals till it is complete. Thus in
Continuous Audit, accounting and auditing work is done
almost side by side. Continuous Audit, however, does not
mean the audit work goes on for 365 days of the year. The
auditor may make periodical visits, say, every two or
three months during the year and at the end of year we would
verify the final statement of account.
Necessity
Continuous Audit is necessary in the following cases-

Where the volume of transaction is very large and


complex.
where the management requires monthly or
quarterly audited statements of accounts or the
statements of accounts are required immediately
after the accounting year;
Where the system of internal control or internal
check is weak.
Sometimes continuous audit becomes necessary for
self-survival
against
cut-throat
business
competition.
When interim dividend is to be declared.
Advantages of Continuous Audit

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Quick Preparation of Final accounts: Since, the


routine audit is done continuously; the Final
Accounts can be prepared immediately after the
year end.
Early
Dividends
to
Shareholders:
The
shareholders would be happy as they receive
dividends soon after the end of the financial year.
The Company can prepare interim accounts and pay
even interim dividends to the shareholders.
Up-to-date Accounts for Banks/Investors: The
up-to-date final accounts are useful to banks and
investors for taking decisions regarding loans and
investment.
Check on Employees: Since the auditors visit
regularly throughout the year, it acts as check on
the employees to keep the accounts ready and upto-date.
Prevents Errors and Frauds: Constant checking
by the auditors helps to detect and even prevent
errors and frauds.
Familiarity with Clients Business: Since the
auditor spends more time at the clients place, he
becomes familiar with all the aspects of clients
business.
Thorough Audit: The auditor has more time at his
disposal to do a through checking of all transactions.
This reduces the risk of missing any material items.

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Utilization of Audit Staff: Audit Staff can be kept


busy throughout the year. Audit work can be evenly
distributed to avoid overwork after year end.
Disadvantages of Continuous Audit:
Expensive: Since the auditor spends more time on the
audit work, the audit fees are much more. Continuous
Audit is thus expensive. However, only a large
organization should opt for a Continuous Audit.
Audit in Installments: Since the audit work is done at
intervals and not at one go, audit may be inefficient.
The queries during the last visit may remain unsolved.
It is difficult at each visit to take up the work precisely
at the stage of last visit. To overcome this
disadvantage, audit should be well-planned. All queries
should be noted in the Audit Note Book and cleared
before taking up fresh work. The work done up to end
of each visit, relevant voucher numbers, totals etc.
should be carefully noted in the Audit Note Book.
Dislocation of clients work: If a proper audit
programme is not adopted, continuous audit may
disrupt the routine accounting work of the client. Either
the audit staff may have to sit idle or the accounts staff
of the client may waste time for want of books of
accounts. Employees have to attend the auditor for
explanation. They have to keep aside their usual work
to attend the auditors for explanation.
Errors and Frauds in Books Already Checked: If an
employee changes some figures in the books already
checked by the auditor during his earlier visits, it
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would be difficult to detect such errors and frauds


subsequently.

Monotonous- tiresome-tedious: Continuous visits


to the clients place may make the work tedious and
the audit staff loses interest from work consequently.
The quality of audit suffers.
Absence of link: In the absence of well-planned audit
work, an auditor may miss the thread of audit work.
Further, some important queries may be overlooked if no
proper audit notes and queries are recorded by the audit
staff during the course of the audit.
Conflict between audit and accounts staff: The
members of audit and accounts staff come in close
contact and sometimes it may result in spoiling the
healthy relations between them and thereby the quality
of audit may suffer.
Dependence of the accounts staff on the auditor:
The accounts staff may depend on the audit staff. They
may require the help of auditor for even small errors
which they can discover or avoid by taking proper care.
Precautions
Strict instructions: Strict instructions should be given to
clients staff not to alter the audited figures. Mistakes, if
any, should be rectified by passing rectification journal
entries and not by alteration of figures.
Audit programme: Proper audit programme should be
prepared by the auditor, so that the time of accounts and
audit staff is not wasted.
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Special ticks: Special ticks should be used for unaudited


altered figures. Auditor should write in the margin the
actual figures audited with his audit pencil.
Audit notes: the auditor should keep exhaustive audit
notes. The queries and their explanation by the client
should be properly recorded.
Checking the ledger: Checking the impersonal ledger
should be done only after the close of the accounting
year.
Surprise visits: Surprise visits should be made in
addition to the regular visits.
Rotation: There should be reasonable rotation of audit
staff and their duties so that they may not lose interest in
their work.
Better control and supervision: There should be better
control and supervision over the audit staff. All the
important figures in the balance sheet should be noted in
the audit diary and they should be rechecked at the time
of subsequent visits.
Rectification entry: Any alteration should be done by
means of a rectification entry in the journal.
Secret tick: The auditor should put a secret tick against
any figure already altered.

2. FINAL AUDIT/ANNUAL AUDIT


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It is also known as periodical audit. It is generally start after


the completion aspect more than the depth aspect of audit. The
danger of alteration of figures or manipulation of accounts is
totally absent. Generally, it starts after the close of the financial
period. There is very little impact on prevention of errors and
frauds by way of moral checks. It is best suited for small and
medium sized business. It saves in terms of time, energy and
money.

Final Audits have the following advantages


Inexpensive: Since the audit spends normal time on the
audit work, the audit fees are also normal. Final Audit is
thus inexpensive. Even a small organization (a sole trader
or a firm) can opt for a Final Audit to obtain the advantages
of an independent financial audit.
Audit at a Stretch: Since the audit work is done at a
stretch, without any gaps, audit is carried out efficiently. All
queries are solved immediately. The work is done
continuously and not in installments. The audit planning and
programme are simple
Less errors and Frauds: Since the books are checked at a
stretch, no employee can change any figures in the audited
books.
Do not Disrupt Accounts Work: The accounts staff is not
disturbed anytime during the accounting year. There is no
need for the accountants to attend to audit work every now
and then.

Final Audit has the following disadvantages


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Delay in final Accounts: Since the routine audit is


done after a year end, the Final accounts may be delayed
and ready long after the year end.

Late
Dividends
to
Shareholders:
The
shareholders would be unhappy as they receive dividends
long after the end of the financial year. It would be difficult
for a Company to prepare interim accounts and pay interim
dividends to the shareholders during the financial year.

Stale Accounts for Banks/Investors: The final


accounts are available long after the end of the accounting
year. Such stale accounts are not useful to banks and
investors fro taking decisions regarding loans and
investment.

No Moral check on Employees: Since the auditors


visit only at the end of the year, dishonest employee have a
chance to commit frauds during the year and clean up the
accounts just before the auditors arrive, e.g. teeming and
lading.

No Familiarity with Clients Business: Since the


audit spends little time at the clients place, he cannot
become familiar with all the aspects of clients business.
They may affect the quality of audit.

Sample Check: Since the auditor has to complete


the audit in a short time, he has to resort to sample
checking. The increases the risk of missing material items.

Uneven Work-load for Audit Staff: Audit staff is


overworked immediately after year end and comparatively
less busy at other times.

3.. INTERIM AUDIT:


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Meaning:
Interim Audit is an audit conducted in between the
annual audits. It is conducted to find out the interim profit
and know the financial position at the end of a part of the
accounting year. For example, an audit of accounts prepared
for the period of six months from 1 st April to 30th September,
would be Interim Audit.

When Conducted:
Interim Audit is conducted in the following cases
Quarterly Results: Public Limited Companies listed on the
stock exchange has to declare their quarterly results. It is
preferable, though not compulsory, to declare such results on
the basis of interim audit.
Interim Dividends: Interim audit is also advisable when a
company intends to pay interim dividends. Interim audit
would ensure that there are enough profits to justify
payment of interim dividends.
Sale of Business: In case of a sole partnership firm, interim
audit becomes necessary on admission, retirement or death
of a partner, dissolution of partnership, sale of a firm to a
company, valuation of goodwill etc.
Changes in Firm: In case of a proprietor, interim audit may
be conducted when the business is proposed to be sold, to fix
the purchase consideration.
Changes in Firm: In case of a partnership firm, interim
audit becomes necessary on admission, retirement or death
of a partner, dissolution of partnership, sale of firm to a
company, valuation of goodwill etc.
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How Conducted:
An interim audit should be done as if it is the final audit
for the concerned period. Thus, it would involve not only
vouching but also verification of assets and liabilities,
valuation of closing stock, computation of depreciation,
confirmation from parties and so on. Once an interim audit is
done, at the time of the final audit, the auditor has to
concentrate only on the remaining period. Thus, interim audit
helps in timely completion of final audit. The auditor at the
time of final audit, however, should ensure that there are no
alterations in the books previously checked by him. He
should carefully compare the final accounts with the interim
accounts to find out if they are consistent.

Advantages
Interim audit is similar to Continuous Audit and enjoys similar
advantages:

Quarterly Results: A public limited company listed


on the stock exchange can comply with the
statutory provision of declaring quarterly results.
Interim Dividends to Shareholders: The
shareholders would be happy as the Company can
pay interim dividends to the shareholders.
Quick Preparation of Final Accounts: Since the
interim audit is already done, the Final Accounts can
be prepared immediately after the year end.

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Up-to-date Accounts for Banks/Investors: The


up-to-date interim accounts are useful to banks and
investors for taking decisions regarding loans and
investment.
Check on employees: Interim audit acts as check
on the employees to keep the accounts ready and
up-to-date.
Prevents errors and frauds: Checking by the
auditors for the purpose of interim audit helps to
detect and even prevent errors and frauds.
Thorough Final audit: The auditor has more time
at his disposal at the time of final audit, which
reduces the risk of missing any material items.
Utilization of Audit staff: audit staff can be
utilized in a better manner. Interim audit is done
when the audit staff is relatively free.

Disadvantages and Precautions:


Expensive: Since the auditor does two audits in
one year, the audit fees are more to that extent.
Interim Audit is thus expensive.

Audit in Installments: since the audit work is


done at two stages (interim and final) and not at
one go, audit may be inefficient. It is difficult at the
time of final audit to take up the work precisely at
the stage where it was left at the time of interim
audit. To overcome this, audit should be wellplanned. The work done up to end of the interim
audit, relevant voucher numbers, totals, etc. should
be carefully noted in the Audit Note book.
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AUDITING SEM-4

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Disrupts Accounts Work: Interim audit disrupts


the work of accounts staff. To avoid this
advantage, the audit programme should be coordinated with the client to avoid disruption in
routine accounts work. The client should appoint
an employee specially to co-ordinate with and
attend to the auditors.

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