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NON-FINANCIAL AUDIT:
RECENT TRENDS IN AUDITING
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1. INTRODUCTION
Traditionally, audits were mainly associated with gaining information about financial systems and the
financial records of a company or a business. However, recent auditing has begun to include non-financial
subject areas, such as safety, security, information systems performance, and environmental concerns. With
nonprofit organizations and government agencies, there has been an increasing need for performance audits,
examining their success in satisfying mission objectives.
There are fundamental differences between financial and non-financial auditing and this has been noted in
practice by companies who have attempted to undertake broader based auditing exercises. For example,
many aspects of the “social” part of the Triple Bottom Line are more difficult to quantify which creates a
problem when contrasted with the more precise financial auditing structures. As a result, there are now audit
professionals who specialize in security audits, information systems audits, and environmental audits. Under
this backdrop, this chapter is devoted for non-financial auditing such as; environmental audit, social audit,
and others
2. ENVIRONMENTAL AUDIT
Rapid industrialization has threatened the world ecological balance seriously. As a result the green house
effect and other related problems are posing threat to mankind world over. It is therefore the responsibility
of the mankind to think and act accordingly for the sustainable development of the environment.
In many countries, now a day, the environmental matters have become top most priority. There is more and
more demand for assessment of the environmental impact due to the production goods and provision of
services. There is growing pressure houses for business to consider environmental effect on their operations.
As a result, accounting and disclosure of environmental matters have been rapidly emerging as an important
dimension of 'Corporate Accounting and Reporting Practices'. It has become a global issue with a pressing
need to harmonies accounting and reporting of environmental costs and liabilities. The global community
considered it necessary to determine the best practices in accounting for environmental transactions and
events in the financial statements and associate notes. Ultimately accounting for the environment and its
disclosure for the various interested parties in the annual report of the companies has been emerging as an
important area of interest for the government, the public in general, environmentalist and business sector.
Any development activity is directly related to natural and environmental resources. Economic development
without environmental considerations can cause serious environmental damage in turn impairing the quality
of the life of present and future generations. Environmental problems of a country vary with its state of
development, structure of its economy, production technologies in use and environmental policies of the
government.
The old concept of natural resources are plenty and abundantly available as free gift of nature is no longer
valid. It will be wrong to assume that earth's resources are fixed assets. Natural resources are raw materials
and energy directly or indirectly obtained from the natural environment, which may broadly be divided into
renewable and non-renewable. Renewable resources are not unlimited when demand for them outpaces the
time taken for their natural replenishment or recycling. Non-renewable resources, on the other hand, are
either replenished extreme slowly, or for all practical purposes are not replenished at all. Moreover, global
economic growth has brought a host of undesirable side effects in its wake. Ozone depletion, global warming,
water and soil contamination, air pollution, deforestation and waste disposal all pose serious threats of
earth's environment.
Though industrialization is an essential pre-requisite for overall economic growth, yet its damaging effect on
ecological environment needs to be taken care of government of various nations have framed various rules
and regulations to protect the environment but the implementation process is very large, sluggish an
ineffective. In India, to make possible government enacted environment protection act in 1986 to provide for
the protection and improvement of environment.
The growing concern for environment protection is also reflected in the governmental policy of our country.
The 42nd amendment to the Indian Constitution in 1976, Article 48-A was added to the Directive Principles of
State Policy and stated that 'The state shall endeavour to protect and improve the environment and to
safeguard the forests and wild life of the country.' In the chapter of Fundamental Rights, Article 51(A)
provides that 'It shall be the duty of every citizen of India to protect and improve the natural environment
including forests, lakes, rivers, and wildlife and to have compassion for living creatures.' Moreover, the
entries dealing with forests and wild life were shifted from the state list to concurrent list. Several pieces of
legislation concerning environment were enacted before and after the aforesaid amendment to the
constitution.
Increasing awareness for environmental concerns should be translated into reality by taking certain concrete
steps by corporate section by practicing environmental accounting audit and play a vital role in making the
next millennium green millennium.
2.1 CONCEPT OF ENVIRONMENTAL AUDIT
The European Union Eco-Management and Audit Scheme Defines Environmental Auditing as,
'a management tool comprising a systematic, documented, periodic and objective evaluation of the
performance of the organization, management system and process designed to protect the
environment with aim of: (a) facilitating management control of environmental practices which may
have an impact on the environment; and (b) assessing the compliance with company environmental
policies including observance of the existing regulatory requirement-'
The Confederation of British Industry, 1990 (based on International Chamber of Commerce) defined
environmental audit as
'the systematic emanation of the interactions between any business operations and its surroundings,
this includes all emission to air, legal constrains, the effect on the neighboring community, landscape
and ecology, and the public's perception of the operating company in the local area... Environmental
audit does not stop at compliance with legislation, nor it is a 'green washing' public relations exercise
... Rather it is a total strategic approach to the organization's activities.'
In the words of N. Raja Raman,
Environmental Audit is a series of activities undertaken on the initiative of an organization
management to evaluate its environmental performance. In simple words EA is a managerial tool,
which includes the activity of systematic periodic and documented objective evaluation of have the
organization, management and equipments perform their environmental activities, so that it
facilitates the managerial control over practices and assessing compliance with company policies
would include meeting of regulatory requirements.
The International Chamber of Commerce (ICC, 1991) defines environmental auditing as,
“A management tool comprising a systematic, documented, periodic and objective evaluation of
how well environmental organisation, management and equipment are performing with the aim of
contributing to safeguarding the environment by:
facilitating management control of environmental practices; and
Assessing compliance with company policies, which would include meeting regulatory
requirements…”
2.2 CHARACTERISTICS OF ENVIRONMENTAL AUDIT
a) Management Tool
An environmental audit is but one of many environmental management tools which are used to assess,
evaluate and manage environmental and sustainability issues. This tool can be used in various ways but also
has its limitations. The audit is sometimes confused with an Environmental Impact Assessment (EIA). An EIA
is a tool used to predict, evaluate and analyse environmental impacts before a project commences, whereas
an environmental audit looks at environmental performance for an existing operation or activity.
b) Systematic
The environmental audit is a systematic process that must be carefully planned, structured and organised. As
it is part of a long term process of evaluation and checking, it needs to be a repeatable process which can be
readily replicated by (if necessary) different teams of people in such a way that the results are comparable
and can reflect change in both a quantifiable and qualifiable manner.
c) Documented
The base of any environmental audit is that its findings are supported by documents and verifiable
information. The audit process will seek, on a sampled basis, to track past actions, activities, events, and
procedures to ensure that they are carried out according to systems requirements and in the correct manner.
Document trails are vital in verifying verbal answers to questions and ensuring that persons are carrying out
their duties and tasks according the correct procedures and training.
d) Periodic
Environmental audits form part of a process. Although they are individual events, the real value of
environmental audits is the fact that they are carried out, at defined intervals, and their results can illustrate
improvement or change over time. It can sometimes take as long as three iterations of an audit before
sustainable environmental change and improvement can be tracked clearly. This is because the audit will
often identify the need for behavioural change which cannot always be implemented immediately,
particularly if training programmes have to be altered and terms and conditions of service changed.
e) Objective Evaluation
Although environmental audits are carried out using policies, procedures, documented systems and
objectives as a test, there is always an element of subjectivity in an audit. This flexibility reflects the fact that
different auditors have different life and professional skills and experience and they may bring different
interpretations to site situations and circumstances. Having audit teams that include specialist skills and who
come back annually to repeat audits, will tend to level out any variance caused by individual skills and
experience.
f) Environmental Performance
The essence of any environmental audit is to find out how well the environmental organisation,
environmental management and environmental equipment are performing. Each of the three components is
crucial in ensuring that the organisation’s environmental performance meets the goals set in its
environmental policy. The individual functioning and the success of integration will all play a role in the
degree of success or failure of the organisation’s environmental performance.
g) Facilitating management control of environmental practices
Environmental practices can happen with or without direct or specific instructions. The key to good
environmental performance is to ensure that these practices happen according to procedure, guidelines,
training and systems requirements. For example, a tanker driver may be told to take a load of liquid waste to
a licensed waste site. On the way, he may want to save his employers some money and discharge his load into
a stream. He may have good intentions but if he has not be given clear instructions supported by training to
follow specific instructions, the consequences of his actions can be severe.
h) Compliance with company policies and regulatory requirements
Compliance is traditionally thought of as meaning compliance with the law. However, compliance with
corporate policies is the primary base, which will include legal compliance as a part of any organisation’s
governance policies. It could be argued that all legal compliance is the minimum requirement and that
companies should have more stringent internal targets to take account of occasions when compliance is not
possible due to mechanical breakdown, power failures or other emergency events. Thus there should be
greater focus upon compliance with corporate policies which should include the requirement for
environmental performance to be better than the minimum legal requirement.
3. SOCIAL AUDIT
The term ‘social audit’ may be interpreted in several ways. As far as common understanding goes, it is an
essential assessment of how well a company has discharged its social obligations. However experts see it as a
systematic and comprehensive evaluation of an organization’s ‘social performance’ which is interpreted as
organizational efforts in enriching the general welfare of the whole community and the whole society.
The need for social audit arises because of various reasons. In order to reach the objective of enriching
economic wealth for the shareholders, the firm does it at the cost of social and environmental disorder. And
since many would not take into account the social costs of such negative implications, their prices do not
reflect the real cost. The organizations do it more because of competitive reasons. However if the larger
interest of society is to be preserved, there has to be some consideration for social good.
The company is expected to behave and function as a socially responsible member of the society like any
other individual. It cannot ignore moral values nor can it ignore actual compulsions. There is a need for some
form of accountability on part of the management which is not only limited to shareholder alone. In modern
times, the objective of business has to be the proper utilization of resources for the benefit of others. A profit
may still be a necessary part of the total picture but it should not be the only purpose. The company must
accept its obligation to be socially responsible and to work for the larger benefit of the community.
Society expects businesses to share the fruits of progress and growth. Moreover, the social concern by the
organization proves to be an asset for them in the long run especially under environmental distress because
of the goodwill and the positive image earned all through these years.
3.1 DEFINITION OF SOCIAL AUDIT
Different people have interpreted the expression social audit differently. To some authors, it means the public
disclosure of a company’s social performance; to others it means internal evaluation of a company’s social
responsibility performance. Some authors think that social audit is a comprehensive evaluation of the way a
company discharges all its responsibilities to its shareholders, customers, employees, and to the wider
community. Thus, there is a total disagreement among the scholars as to the exact meaning, and the
components of this novel concept. However, we shall give a brief account of the opinion of experts as below.
“Social Auditing is a process that enables an organization to assess and demonstrate it’s social, economic,
and environmental benefits and limitations. It is a way of measuring the extent to which an organization
lives up to the shared values and objectives it has committed itself to. Social auditing provides an
assessment of the impact of an organization’s non-financial objectives through systematically and
regularly monitoring its performance and the views of its stakeholders.”
_ Caledonia Centre for Social Development, United Kingdom
“The social audit is an idea whose time has come, but which is not ready to be taken off the drawing
board and put to work”.
_ Melvin Aushen
“Social audit is a commitment to systematic assessment and reporting on some meaningful, definable
domain of a company’s activities that have a social impact”.
_ De Boweni
From the above definitions, it could be deduced that social audits have the following characteristics:
(i) Social Audit is a process for evaluating, reporting on, and improving an organizations performance and
behavior, and for measuring its effect on society. The social audit can be used to produce a measure of
the social responsibility of an organisation.
(ii) Social Audit is an Audit of the non-financial impact of an organization on society.
(iii) Social Audit is a review of the public interest non-profit and social activities of a business. These audits
usually are performed primarily for internal benefit and typical are not released to the public. Internal
or external consulting groups, as part of regular internal audits, may perform the social audit routinely.
These evaluations consider social and environmental impacts of business activities.
(iv) Social audit means method of measuring a company’s level of social responsibility.
(v) Social audit is an audit in which social performance is analysed to know whether the activities of an
entity have affected the society positively or negatively.
(vi) Furthermore the evaluation of socio economic effect from any business, companies, enterprise Govt.
policies etc. is called Social Audit.
In the past, there have been substantial efforts to define common themes in social audit. From the experience
of all those involved, a good social audit carries all the following characteristics:
a) Improved social performance - This is the overarching principle, and this refers to the continuous
improvement in performance by the organization relative to the chosen social objectives as a result of
social audit.
b) Multiple stakeholder perspective - It is important for all groups affected or who affect the organization
to be included in the process of social audit.
c) Comparability - The process should allow for comparison with other organizations, over time and
between stakeholder groups.
d) Comprehensiveness - The process should be designed to collect all relevant materials and areas of
concern should not be left out simply because the organization would not like the result.
e) Regularity of coverage - To facilitate comparability and to demonstrate a commitment to the process, it
should be regular, with a frequency of once every two years.
f) Independent verification - Verification by independent auditors gives the process credibility.
g) Transparent reporting - The result (or a synopsis) of the social audit should be published so that the
stakeholders can see the results, and this will accordingly encourage openness.
The purpose of conducting Social Audit is not to find fault with the individual functionaries but to assess the
performance in terms of social, environmental and community goals of the organizations. It is a way of
measuring the extent to which an organisation lives up the shared values and objectives it has committed
itself too. It provides an assessment of the impact of an organization’s non- financial objectives through
systematic and regular monitoring based on the views of its stakeholders.
Social audit tries to make the traditional economic and technical values as two-sub system within the larger
social system social audit primarily tries to cover the following areas:
a) Ethical Issues: They offer basis for determining what is right and what is wrong in terms of a given
situations. Ethics is best understood when we cite examples relating to unethical conduct. A few such
examples can be price discrimination, unfair trade practices, cheating customers pirating employee’s
ideas, learning the job without observing the contract.
b) Equal Opportunities: A second relevant social issue, which comes under social audit, is the enquiry of
treatment in employment and a fair justice system in the organisation Employment decisions in an
organisation should be based on merit and ability and not on the basis of arbitrary quotas based on
gender, race or religion.
c) Quality of Work Life: Besides demands for safe, healthy and human work environment people are
seeking greater meaning in their lives greater responsibility, growth, freedom and flexibility fair reward
system are a few things which employees have preference for. There is also a growing demand for
employee assistance programmes keeping in mind the present day stressful situations they are exposed
too.
d) Consumerism: Business has a special obligation towards the consumer as the business exists to serve
and satisfy the needs of the consumers. It is the principal duty of business to make available to the
consumer items of daily needs in the right quantity at a right time, and price of the right quality.
However many Indian products are not safe at all and the consumer suffers at hands of corrupt and
dishonest corporate houses.
e) Environmental Protection: Growing water, air and environmental pollution by various industries in
recent times has led to a public outcry demanding environmental protection at any cost.
f) Checking Corruption: Bringing transparency and checking corruption are two other objectives of social
audit too. Transparency here is not merely display of information in a board mentioning total estimated
budget and total expenditure or broad framework of the programme. It is about providing detail of head
wise budget and expenditure with copy of bills and vouchers in case of finance and copy of other
relevant records to help people understand detail of the process adopted including all decisions taken
and selections made.
g) Identifying Critical Areas of Improvements: Another objective of social Audit is to help an
implementing agency to know and identify its critical areas of improvements and how best the
programme can be implemented through people’s participation. It is a way towards successful
implementation of programme for the people and by the implementation. Taking into account the views
of most vulnerable people in the society including single women headed family, people with disability,
uncared aged and poorest of the poor is another important objective of social audit.
h) The purpose of conducting social audit is not to find fault with the individual function areas but to assess
the performance in terms of social, environmental and community goal of the organisation. It is a way of
measuring the extent to which an organisation lives up to the shared values and objectives it has
committed itself too. It provides an assessment of the impact of an organisation’s non- financial
objectives through systematic and regular monitoring, based on the views of its stakeholders.
There are several benefits that Social Audit can bring to an organization. Some of them are as follows:
a) Enhanced credibility: Social Audit enhances the credibility of an organization with its stakeholders. For
a corporate enterprise it could mean enhancement of the brand image which could result in higher
equity with stakeholders. In case of a positive report from the Social Audit, the value added to the
owners’ financial capital could far outweigh the auditing cost incurred.
b) Helps in policy decision: Based on the Social Audit findings, the policymakers of the organization could
re-strategize for course corrections to ensure that its social impact is as intended.
c) Positive support from stakeholders: Organizations that emerge with a positive Social Impact through
their objectives and actions tend to have a higher sustainability as they enjoy the support of the social
environment in which they operate.
d) Increased social focus – tool for risk management: Organizations can better manage it’s risks, as it can
enhance its social focus by covering any adverse social impacts highlighted by it in a social audit report.
Special Benefits of Social Audit for Government Departments
The following are the benefits of social audit especially for government departments.
a) Enhances reputation: The information generated from a social audit can provide crucial knowledge
about the departments/institutions’ ethical performance and how stakeholders perceive the services
offered by the government. The social angle in the delivery of services, real or perceived, can be a major
factor adding to the reputation of the department and its functionaries. In an era where all the services
are benchmarked against and citizens are becoming more aware about the services through citizens’
charters, the government departments are also aiming towards building their reputations. Social auditing
helps the legislature and executive in identifying the problem areas and provides an opportunity to take a
proactive stance and create solutions.
b) Alerts policymakers to stakeholder trends: Social auditing is a tool that helps managers understand and
anticipate stakeholder concerns. This tool provides essential information about the interests,
perspectives, and expectations of stakeholders, facilitating the interdependency that exists between the
government and the community.
c) Affects positive organisational change: Social auditing identifies specific organisational improvement
goals and highlights progress on their implementation and completeness. Also, by integrating social
auditing into existing management systems, employees responsible for day-to-day decision making can
more effectively consider stakeholders’ issues and concerns.
d) Increases accountability: Due to the strong emphasis on openness and accountability for government
departments, the information disclosed needs to be fair and accurate. Social auditing uses external
verification to validate that the social audit is inclusive and complete. An externally verified audit can add
credibility to the department’s efforts. But the greatest demonstration of a social audit’s authenticity
must be seen in how the performance of the department improves over time in relation to its mission,
values and objectives.
e) Assists in reorienting and refocusing priorities: Social auditing could be a useful tool to help the
departments reshape their priorities in tune with people’s expectations.
f) Provides increased confidence in social areas: Social audit can enable departments/institutions to act
with greater confidence in social areas that have been neglected in the past or have been given a lower
priority.
3.8 SUMMARY
Social Audit in business intends to examine an organization’s efforts in enriching the general welfare of the
whole community and the whole society. In modern times, the objective of business is to provide benefits to
others and the society expects businesses to share the fruits of progress and growth. Corporate accountability
encompasses the systems which a company establishes in order to develop policies, indicators, targets and
processes to manage the full range of its activities towards society. Demand for increased corporate
accountability today comes from all sectors and various types of social audit system is being developed in
order to take such accounts. Few key developments enabled by technology and information revolution has
broadened the scope for such an audit to be made within organizations and shared in public.
A human resource audit is defined as an investigative, analytical and comparative process that
attempts to reflect the effectiveness of human resource function_ Jack J. Phillips
HR Audit is a process of examining policies, procedure, documentation, system and practices with
respect to an organization HR Functions_ NewsWeek, 1997
HR Audit can be identified from functional audit, as could say they HR audit assist the
organization to modify their HR functions through evaluating and assessing their responsibilities
which they are performing, it’s a systematic assessment of the limitations, powers and need of
development in hr functions_Flamholtz, 1987
HR Audit is based on two basic functions it must be a management information system which
includes the managing process of HR development within the umbrella of legal review with the
help of HR department, on the other hand it’s a way to control and assess the all policies that are
being applied, and the result can be valued through the implementation of its HR function.
Walker
HR Audit, “measures of human resource outputs and effectiveness under the given circumstances
and the degree of utilization of human resource outputs in the best possible manner conducive to
the organization” _Arain, 2001.
HR Audit is an analytical term, its indicate the message to all professional managers and
executives to manage their own ways to analyze performance on the account of goals, objectives
and achievements gain from the experience for their particular departments and units, executives
has been encourage to adopt such type of applications which diagnostic the ways which best
suited to their own circumstances. Werther & Davis, 1996
4.8 CONCLUSION
The Human Resources (HR) Audit is a process of examining policies, procedures, documentation, systems,
and practices with respect to an organization’s HR functions. The purpose of the audit is to reveal the
strengths and weaknesses in the human resources system, and any issues needing resolution. The audit
works best when the focus is on analyzing and improving the HR function in the organization.
The audit itself is a diagnostic tool, not a prescriptive instrument. It helps to identify what you are missing or
need to improve, but it can’t tell you what you need to do to address these issues. It is most useful when an
organization is ready to act on the findings, and to evolve its HR function to a level where its full potential to
support the organization’s mission and objectives can be realized.
5. FORENSIC AUDIT
5.1 INTRODUCTION
The continuous tax related fraud resulting to corporate collapse (viz., Enron, WorldCom,
Madoff, Satyam, etc.) and the failure of the statutory audit to det ect and prevent fraudulent
activities, which had led to the misery of investors, had given rise to the need for forensic
audit. Indeed, Forensic Audit (FA) integrates accounting, auditing and investigative skills to
conduct investigations in variety of fraud cases.
We all are familiar with the word forensic science which means, ‘forensic science is the
application of science to criminal and civil laws mainly on the criminal side during criminal
investigation, as governed by the legal standards of admissible evidence and criminal
procedure.’
Now, the world needs to be familiar with another word i.e. forensic audit.
Increase in number of scandals related to accountancy and finance sector like Enron, Satyam,
Worldtel and stock market scams of Harshad Mehta and Ketan Parekh, the need for better
practices of accountancy as well as auditing also increased. This finally led to the introduction
of ‘Forensic Audit’.
Forensic audit= Audit + Forensic science
5.3 DEFINITION
Elements of
External Audit Forensic audit
differences
Expression of professional,
independent and competent
Prevention, investigation and
Objective opinion on the truthfulness,
detection of fraud
correctness and accuracy of
financial statements
Method of In the normal course and plan- Alert, doubt, request the client and
detecting fraud review other ways
The forensic auditors or fraud auditors have the responsibilities that are listed below:
Conducting Investigation:
The forensic auditor does not carry out procedural audit, but carries an audit which conducts investigation as
to detect fraud or crime using computer programs or scientific knowledge. This means the forensic auditor
should have the capability to use computer forensic tools that could be both software and hardware in
carrying out its function as to detect or prevent fraudulent activities. Thus by using the computer forensic
tools in carrying out his responsibilities, sophisticated fraudulent activities can be combated.
Analyzing Financial Transaction:
Forensic auditor in carrying out his function analyzes financial transaction involving unauthorized transfers
of cash between companies. The forensic auditors are required to have special skills in inspecting documents
for authenticity, alteration, forgery or counterfeiting. Hence, by possessing such skills, the forensic auditor in
carrying out his duties can easily detect errors, fraudulent activities and omissions thereby preventing and
reducing fraudulent activities. The forensic auditor is responsible for analyzing, identifying the kinds of fraud
that could occur and their symptoms.
Reconstruction of incomplete accounting records:
The forensic auditor in carrying out his function reconstructs incomplete accounting records as to settle
insurance claims, over inventory valuation, proving money laundering activities by reconstructing cash
transactions. In order to combat fraudulent activities, the forensic auditor with his skills (Technological,
communication and expertise skills) in accounting knowledge can reconstruct incomplete accounting records,
hence helping to detect and prevent fraud and ensuring good internal control system and good corporate
governance.
Embezzlement investigation:
In carrying out embezzlement investigation and providing documentation, and negotiation of insurance
settlements the forensic auditor uses his special skill and experience, thus helping to detect the culprit and
amount embezzled. The duties of forensic auditors do include:
Fraud detection, documentation and presentation in criminal trials and claims.
Calculate economic damages; trace income and assets, often in an attempt to find hidden assets or
income,
Reconstruction of financial statement that may have been destroyed or manipulated.
The above responsibilities listed show that the forensic auditors must be specialist (experts) in financial
matters and must have legal knowledge which could enable him detect fraudulent activities which are to be
presented in the law suit.
QUESTIONS
1. Explain the meaning of social audit
2. State the scope and objectives of social audit
3. Emphasize the need for social audit
4. Identify different types of social audit
5. What is social audit and what is its relevance for business organization?
6. How social audit specially beneficial to the Government?
7. How do you differentiate between Partial social audit and Comprehensive audit?
8. What are the legal requirements of social audit?