Lecture 1

Basic of audit

Good Morning Friends

Lets start with the one of the most important subject of Professional course Audit.
In CA this subject is coming at two steps first it cones in IPCC and second it is
coming in the CA final.
1.
Why the audit should be studied?
First reason it is compulsory subject at both the steps means at CA IPCC as
well as at CA Final. Secondly Audit contains very broad meaning and importance
within it. Now a days audit is used to ensure the accuracy, trust, accountability and
system maintenance of the organization. It is also useful to detect frauds and errors.
Now there are questions like these what is audit? As being an auditor how can we
detect errors and frauds? Which tools we can use for doing audit? Which
terminologies are used in audit? And most interesting question how can we pass in
subject of Audit?
Before understanding all these things lets understand one story
Before lots of years ago there was one man named birbal who had been selected as
national advisor in the kingdom of Mughal Samrat Akabar. He was wise enough to
understand entire system of the government. One day king asked this man that find
out the reason why the income of nation is decreasing rapidly during few months?
Man replied that My lord please provide me 60 days for assessment. King gave the
time and ordered to report after these days.
Birbal started inquiry by studying the accounting process, lots of documents, such
as Payment voucher, sales, Purchase, receipt voucher, available inventory, available
jewellery, diamonds, valuable items, available balance sheet and profit and loss
accounts, He demanded confirmation from lots of sundry debtors and sundry
creditors, loan holders. He Verified originality of the transaction. He verified the
documents related construction made in the nation during the particular period. Not
only to that he also verified the documents purchase of horses, elephants and other
cattle. With that he also verified documents related to purchase of all arms such as
swords, bow and arrow, Bhala, Dhal and Bhakhtars (armours). He also verified
documents related to salary paid to lots of soldiers and staff. Expenditure made on
the welfare of the nation and losses made during the war. Compensation paid to the
all died soldiers. Benefit received from the won country.
Not only to that he also compared entire documentation with the actual situation
and also assessed that whether all these decision which has been taken by the all
these officials are true and fair to nation or not.

After 60 days Birbal went to akabars darbar and presented his report as following.

15000 staff members are paid salary of amount Rs. 7 crores who are not born
in this world till today.

Construction amount of Rs. 250 crores made whose valuation is not more
than Rs. 110 crore

Actual horses purchased from Arabia are 50000 when in the document it is
shown 70000 difference amount Rs. 1.25Crore. Actual elephants are 15000 on book
when on documentation it is shown of 20000 difference amount of Rs. 2.5 crore

Since last 1 year 80 % of officers who are 3000 in number have purchased
their own building, gold, jewellery amounting of Rs. 350 crores when their average
salary was not more than Rs. 70000 per month.

War armours and arms purchased actually available of Rs. 300 crores on book
it is shown at 325 crores.

Expenses wrongly debited in the profit and loss account is rs. 30 crores.

Loss to nation due to wrong decision amounting Rs. 150 Crores (No need to
expend money thereat still spent money.)
According to me profit and loss account and balance sheet does not provide true
picture of Nations position and corruption is the main reason behind reason of
decreasing the national income.
After listening all these Akabar became very angry. He ordered punishment to
personnel who were liable behind these. Not only to that he also ordered that now
such verification will be made once in each year so that true picture of nations
assets, liabilities, Income and expenditure can be known. He made Birbal chief
auditor of the Nation with handsome amount of salary and accommodation.
Conclusion

Dear students what do we understand by this story?

The process and tools used by the Birbal to find out all these is known as Audit.
The report submitted by Birbal to Akabar is known as Audit report in which Birbal
has provided his opinion.
Birbal is known as Auditor.
Akabars Kingdom is known as appointing authority.
Darbar of Akabar is known as General Meeting.
It was just a story but now come to real picture and some technicality.
Right now audit is compulsory for the companies as per the Companies Act, 1956
but why?


As we all know that company whether limited or unlimited, true owners are
share holders.

Share holders have not that much technical and business knowledge to
manage entire organization so they are appointing one managerial body which
known as Board of directors.

Share holders invest their money in to the company with hope that they
should get good return on their invested money. Not only to that, they are always
desiring about the growth of the company so that they can get more and more
benefit and returns.

But how can they ensure that whatever profit has been earned by the
company is true? investment made by the managerial body is fair with welfare of
the company?.

The answers of above question is by making the audit.

Auditor verify the system and transactions flow with the actual situation in
the company and issue his report thereon.

So, we can say that auditors are eyes of shareholders who verify the system
and transactions on behalf of the shareholders.

The companies Act, 1956 has also made provisions regarding propriety
verification and Audit provisions. Such as section 209 to 211 and CARO, 2004.
Now you will thing that what are these CARO, 2004 and these sections. But have
some patience we will discuss it later on.
2.

Now from the above story we can not say that Birbal would have checked or verify
each and transactions at the process he must have applied lots of audit tools.
Now what are these audit tools?
Audit tools are the tools which make the audit work easy and qualitative.
Which type of audit tools are available?
Compliance procedures

Audit Questionnaire

Flow chart analysis

Surprise Check

Substantive procedures

Vouching

Verification

Audit techniques

Inquiry

Information

Confirmation

Posting

Casting

Bank Reconciliation

Physical Examination

Re Computation

Auditing in depth
Analytical Process
Analytical Review
Sampling
Cut off procedures
Now students you will be in confusion once again. You will think that what these
things are? Most of the terminologies you are listening at first time. But dont worry
about it because we are going to understand each and every terminologies in the
next some paras.
Here you have to keep one thing in to the consideration that for knowing one
abovementioned concept u must have to know about another concept. For example
if you know about the Compliance procedures then you must have to know about
the Internal Control concept first. But we will discuss it lateron.
Why Audit tools are required?

When, auditor has to complete big audit within short period of time then he can not
verify each and every transaction and system due to having some inherent
limitation of audit.
Now again you will ask that what are these inherent limitations of audit?
Lets discuss it first then we will go for other concepts of Audit.

Inherent Limitations of Audit

Every system is working with some limitation.

There is no absolute surety that all kinds of frauds and errors will be detected by
making audit. In above story we can say that Birbals report may contain some data
which is not absolute.
Now again the question is arises that why these kinds of limitations are there?
Reasons are as follows
The main objective of the auditor is not to detect frauds and errors but to express
the opinion about the truth and fairness of the Financial statements.
The detection of frauds and errors is an incidental or secondary objective
There should be no suspicious mind during Audit process.
For Example Possible reasons for having less net profit in current year

Less Sales

High purchase prices

More expenses

Loss due to accident

More bed debt

More depreciation and interest

Some fraud and error

So here auditor can not assume initially that there is fraud and error. Any other
reasons from above may be thereat.
Auditor can expect fraud and error only up to his expression of opinion and not
beyond it. Auditor is only concern with his opinion and not concern with, how the
management is running??
If fraud and error is detected even after completing audit work auditor will not be
held guilty if he exercised reasonable care during his audit process.
Detecting fraud and error is the duty of management by implementing Internal
Control System.
Audit is Time binding activity. Auditor always facing lack of time during his audit
process so he has to apply some audit techniques to complete audit process within
reasonable time.
Now in the next lecture we will discuss compliance and substantive process. For that
we have to understand one of the beautiful concepts named Internal control
system.

Up to that take care all of you

We will meet very soon.