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The Auditor Must Be Vigilant And Should Make Searching Inquiries To Arrive At The True Position
Objectives of Audit
For a better understanding, we could classify the objective of audit as:
1. Primary Objectives
2. Secondary Objectives.
Primary Objectives: To determine and judge the reliability of the financial statement and the supporting accounting records of a particular financial period is the main purpose of the audit. As per the Indian Companies Act, 1956 it is mandatory for the organizations to appoint an auditor who, after the examination and verification of the books of account, disclose his opinion that whether the audited books of accounts, Profit and Loss Account and Balance Sheet are showing the true and fair view of the state of affairs of the company's business. To get a true and fair view of the companies affairs and express his opinion, he has to thoroughly check all the transactions and relevant documents of the company made during the audited period. Which will help the auditor to report the financial condition and the working result of the organization. While carrying out the process of audit, the auditor may come across certain errors and frauds. But detection of fraud or errors is not the primary objective of the audit. They come under the secondary objectives of the audit.
The audit also disclose whether the Accounting system adopted in the organization is adequate and appropriate in recording the various transactions as well as the setbacks of the system.
In order to report the financial condition of the business, the auditor has to examine the books of accounts and the relevant documents. In that process, he may come across some errors and frauds. We may classify these errors and frauds as below:
1. Detection and prevention of Errors
2. Detection and prevention of Frauds.
Detection and prevention of Errors: Following types of errors can be detected in the process of auditing.
1. Clerical Errors
2. Errors of Principle
Clerical Errors: Due to wrong posting such errors may occur. Money received from Microsoft credited to the Siemens's account is an example of a clerical error. Even though the account was posted wrongly, the trial balance will agree. We can classify clerical errors as below:
i. Errors of Commission
ii. Errors of Omission
iii. Compensating Errors.
i. Errors of Commission: These errors are errors caused due to wrong posting either wholly or partially of in the books of original entry or ledger accounts or wrong totaling, wrong calculations, wrong balancing, and wrong casting of subsidiary books. For example Rs. 5000 is paid to Microsoft for the supply of windows program and the same is recorded in the cash book. While posting the ledger the Microsoft's account is debited by Rs. 500. It may be due to the carelessness of the accountant. Most of these errors of commission are reflected in the trial balance and can be identified by routine checking of the books.
ii. Errors of Omission: When there is no record of transactions in the books of original entry or omission of posting in the ledger could lead to such errors. Sales not recorded in the sales book or omission to enter invoices in the purchase book are examples of Errors of Omission. Errors due to the entire omission will not affect the trial balance. Errors due to partial omission will affect the trial balance and can be detected.
iii. Compensating Errors are errors committed in such a way that the net result of these errors on the debit side and credit side would nullify the net effect of the error. For example, Ram's account which was to be debited for Rs. 5000 was credited for Rs. 5000 and similarly, Sita's Account which was to be credited for Rs. 5000 was debited for Rs. 5000. These two mistakes will nullify the effect of each other. Unless a detailed investigation is undertaken such errors are difficult to locate as both the sides of the trial balance are equally affected.
2. Errors of Principle: While recording a transaction, the fundamental principles of accounting are not properly observed, these types of errors could occur. Overvaluation of closing stock or incorrect allocation of expenditure or receipt between capital and revenue are some of the examples of such errors. Such errors will not affect the trial balance but will affect the Profit and Loss account. It may occur due to lack of knowledge of sound principles of accounting or can be committed deliberately to falsify the accounts. To detect such errors, the auditor has to do a careful examination of the books of account.
Detection and Prevention of frauds: To get money illegally from the organization or from the proprietor frauds are committed intentionally and deliberately. If it remains undetected, it could affect the opinion of the auditor on the financial condition and the working results of the organization. Therefore, it is necessary for the auditor to exercise the utmost care to detect such frauds. It can be committed by the top management or by the employees of the organization. Frauds could be of the following types:
1. Misappropriation of cash
2. Misappropriation of goods
3. Falsification or Manipulation of accounts
4. Window dressing
5. Secret Reserves
Detection and Prevention of Frauds
Misappropriation of Cash: Since the owner has very limited control over the receipt and payments of cash, misappropriation, or defalcation of cash is very common especially in big business organizations. Cash can be misappropriated by various ways as mentioned below:
a. Recording fictitious payments
b. Recording more amount than the actual amount of payment
c. Suppressing receipts
d. Recording less amount than the actual amount of payment.
There should be strict control over receipts and payments of cash known as the "Internal check system" to prevent such frauds. The auditor should check the Cash Book with original records, bills register, invoices, vouchers, counterfoils or receipt books, wage sheets, salesman's diary, bank statements, etc. in order to discover such frauds.
Misappropriation of goods: Companies handling high-value goods are prey to this kind of misappropriation. Without proper records of stock inward and stock outward, it is difficult for the auditor to find out such fraud. Periodical and surprise checking of stock and maintaining the proper record of inward and outward movement of stock can reduce the possibility of such fraud.
Falsification or manipulation of accounts: In order to achieve certain specific objectives, accounts may be manipulated by those responsible persons who are in the top management of the organization. They prepare accounts such a manner that they disclosed only a fake picture, not the true picture. Some of the ways used in manipulating the accounts are as follows:
1. Inflating or deflating expenses and incomes
2. Writing off of excess or less bad debts.
3. Over-valuation or under-valuation of closing stock.
4. Charging excess or less depreciation
5. Charging capital expenditures to revenue and vice-versa
6. Providing for excess or less doubtful debts.
7. Suppressing sales and purchase or showing fictitious sales and purchases etc.
Window dressing: is the way of presenting the financial data in a much better position than the original position. It is known as window dressing. Some of the reasons for doing window dressing are as follows:
1. To win the confidence of shareholders
2. To obtain further credit
3. To raise the price of shares in the market by paying higher dividend so that shares held may be sold
4. To attract prospective partners or shareholders.
5. To win the confidence of shareholders.
Secret Reserves: In secret reserves, accounts are prepared in such a way that they disclose a worse picture than actually what they are. The objectives of preparing accounts in this way are:
1. To conceal the true position from the competitors.
2. To avoid or reduce the tax liability.
3. To reduce the price of shares in the market by not paying a dividend or paying lower dividends so that the shares may be bought at a much lower price.
It is very difficult to detect such frauds since these frauds are committed by those persons in the organizations who are at the top positions like directors, managers, financial controllers, etc. To detect these kinds of frauds, the auditor must be vigilant and should make searching inquiries to arrive at the true position.
- Definition of Auditing
The word 'Audit' is originated from the Latin word 'audire' which means 'to hear'. In the earlier days, whenever there is suspected fraud in a business organization, the owner of the business...
- origin of auditing
From the time of ancient Egyptians, Greeks and Romans, the practice of auditing the accounts of public institutions existed. Checking clerks were appointed in those days to check the public accounts. To...
- Advantages of Auditing
Advantages of Auditing It is compulsory for all the organizations registered under the companies act must be audited. There are advantages in auditing the accounts even when there is no legal obligation for...
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.
© 2010 Helna
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the main objective of an audit is
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himanshu on December 21, 2011:
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Joseph Macharia on December 07, 2010:
hi scholars, thanks for your effort to enlighten us on issues to deal with auditing. however, i would like to get information on "te procedure that is followed during auditing"