This article is written by Tulip Das, currently pursuing BBA L.L.B(H) from Amity University Kolkata.
An audit is an “independent examination of financial information of any entity, whether profit-oriented or not, irrespective of its size or legal nature when such an examination is conducted with a view to express an opinion thereon”. It even attempts to ensure that the books of accounts are properly maintained by the concern as required by law.
Auditing is the process of examining the financial statement and information of the entity. In this process, we examine whether the company is making a profit or not. It is a systematic method in which we analyse the economic condition and actions. Let us learn in more detail about it.
The International Federation of Accountants has given the following definition of an audit, “audit is an independent inspection of the financial information of any organization, whether profit-oriented or not profit-oriented, irrespective of its legal form, status or size when such examination is conducted with a way to express an opinion thereof”.
The one important thing to remember is that an audit is a close inspection of the books of accounts, but it does not absolutely guarantee error-free books. The auditor only expresses his opinion on the accuracy of the books, he does not give his opinion on the financial status of the company or predict its future.
Auditing in India- Origin and Development in India
In India, the Companies Act 1913 made an audit of company accounts compulsory. With the increase in the size and the number of the companies and the volume of transactions, the objective of audit shifted and the audit was expected to ascertain whether the accounts were loyal and fair rather than detective of errors and frauds.
Henceforth, the emphasis was not only on mathematical accuracy but also on a fair representation of the financial efforts the Indian Companies Act 1913 also prescribed for the first time the eligibility of auditors.
The previous 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 seeking the help of computers to examine digital accounts.
Features of an Audit
- Auditing is a systematic process. It is a logical and scientific procedure to examine the accounts of an organization for its accuracy. There are rules and procedures to follow.
- The audit is always done by an independent authority or a group of persons with the necessary qualifications. They have to be independent so their views and opinions can be completely unbiased. There should not be presence of any third-party in the process of auditing.
- An audit is the examination of all the books of accounts and financial information of the company. So, it is essentially a verification of the final accounts of the organization, i.e. the profit and loss statement and the balance sheet at the end of the financial year.
- Auditing is not only a review of the books of accounts but also the internal systems and internal control of the organization.
- To conduct the audit, one needs the help of various sources of information. This includes vouchers, documents, certificates, questionnaires, explanations, and all other required evidence. One may scrutinize any other documents he deems fit like Memorandum of Association, Articles of Associations, vouchers, minute books, shareholders register etc.
- The auditor must fully satisfy himself with the accuracy and authenticity of the financial statements. Only then can he arrive at the conclusion that they are true and fair statements. His opinion about his own self should never be questioned.
Classification of Types of Audits in India
There are many audit types in India, and all of them can be categorized into the following:
- Statutory audit:
- Statutory audits are conducted by the Indian government to check the financial state of the company/business. Qualified auditors, working as external or independent parties, take up the task of statutory audit. The Statutory audit report is made as per the directions and forms provided by the government.
- Internal audit:
- A company/business conducts an internal audit to check up on the financial health of the company. Internal audit is conducted by the internal staff or an independent contractor.
Statutory Audits in India
There are two common types of statutory audits that a company has to conduct each financial (fiscal year). They are as follows:
- Tax audits:
- Required under the Section 44AM of India’s Tax Act 1967, the tax audit is mandatory for every business with an annual turnover of over INR 1 Crore and for every professional who is earning more than INR 50 lakhs per year.
Tax audit report has to be filed in the prescribed format by September 30 after the end of the previous financial year. If the required person or the business fails to file that report, they have to face a penalty equal to 0.5 percent of turnover.
- Company audits:
- The details and provisions of company audits are explained in detail in the Companies Act, 2013. They state that every company, irrespective of its annual turnover or business type, has to get its financial accounts audited by a qualified professional (auditor).
As per the company laws, you can appoint an auditor for the duration of 6 annual general meetings. If you are a partnership/sole proprietorship, you can’t have the same auditor for more than two terms.
Internal Audits in India
There are several types of internal audits. So many in fact, that picking the most important among them is difficult. Therefore, let us give a brief introduction of some of the most common audit types of internal audit:
- Operational Audit: Operational audit is conducted to evaluate the efficiency of a particular aspect, function or department of a business. It doesn’t always require financial data, but the information about whether the department/function/aspect is performing its tasks properly or not.
- Compliance audit: There are many types of compliances that a company or any other type of business has to follow to stay in business. The compliance audit is therefore done to check whether the company/partnership/sole proprietorship is following the rules and regulations set up by the government.
- Financial audit: Financial audit is conducted to check the fairness, accuracy and reliability of the financial data. There are several companies that falsify their financial information to get a better PR. Financial auditing ensures that such fraudulent tactics don’t happen. Because accuracy and fairness are needed, independent contractors take up the task to conduct unbiased financial auditing.
- Investigative Auditing: Investigative audit takes place when there is some suspicious activity in the business entity’s finances. In other words, it’s done if there is something wrong in the financial details of the business. Another reason to do an investigative audit is to assess the risk factors of the business.
- Management Audit: Management audits are done by independent contractors who provide insight of the management structure of the business. Similar to operational audit, management audit is done to check the performance of business as a whole.
According to the National Association of Legal Fee Analysis (NALFA), legal auditing is a litigation management practice and a risk management mechanism, used by insurance and other consumers of legal services, to determine if hourly billing errors, abuses, and inefficiencies exist by carefully examining and identifying unreasonable attorney fees and expenses. Because the majority of the corporate law firms charge their clients on an hourly basis, base attorney promotion and compensation nearly entirely on the number of hours billed, rather than the results accomplished for clients, lawyers and law firms have much incentive to the bill as many hours as possible, and little incentive to work efficiently or to bill fewer hours. Legal audits have now become a necessity in all corporate law firms in order to keep business records.
Scope of an Audit
- Legal Requirements: The auditor can determine the extent of an audit of financial statements following the requirements of legislation, regulations or relevant professional bodies. The state can frame rules for determining the extent of audit work. In the same way, professional bodies can make rules to conduct audits.
- Entity Aspects: The audit should be organized to cover all aspects of the entity as far as they are relevant to the financial statements being audited. A business entity has many areas of working. A small entity may have few functions and a large entity has many functions. The auditor has to go through all the functions of the business.
The audit report must cover all the functions so that the reader may know all about the workings of a concern.
- Reliable Information: The auditor should gather reasonable assurance as to whether the information contained in the underlying accounting records and other source data is reliable and sufficient as the basis for the preparation of the financial statements.
The auditor can use various techniques to test the validity of data. All auditors while auditing, apply the compliance test and substance test. The auditor can show such information in the report as well.
- Proper Communication: The auditor should decide whether the relevant data is properly communicated in the financial statements or not. Accounting is an information system. Facts and figures must be so presented that the reader can easily get information about the business entity. The auditor can mention this fact in his report as well.
The principles of accounting can be applied to decide the disclosure of financial information in the statements.
- Evaluation: The one who audits, assesses the authenticity and sufficiency of the data contained in the underlying accounting records and other source data by creating a study and evaluation of accounting systems and internal controls to determine the type, extent, and timing of other auditing methods.
- Test: The auditor evaluates the reliability and sufficiency of the information so obtained in the underlying records of accounting and other source data by carrying out other tests, inquiries and other verification procedures of accounting transactions and account balances as he considers appropriate in the particular circumstances.
There are compliance and substantive tests to examine the information. The vouching, verifying and valuation technique is also used.
- Comparison: The auditor determines whether the relevant information is properly communicated by comparing the financial statements with the underlying accounting records and other source data to see whether they properly summarized the transactions and events recorded therein.
The auditor compares the accounting records with financial statements to check whether the same has been processed for preparing the final accounts of a business concern or not.
- Judgments: The auditor decides whether the relevant information is well communicated by considering the judgment that management has made in preparing the financial statements, accordingly.
The auditor assesses the selection and consistent application of accounting policies, how the information has been classified and the sufficiency of disclosure.
Objectives of an Audit
There are two objects of an audit: (1) Primary objectives and (2) Subsidiary objectives
- Primary objectives: –
- Examining the system of internal check.
- Checking arithmetical accuracy of books of accounts, verifying posting, casting, balancing, etc.
- Verifying the authenticity and validity of transactions.
- Checking the proper distinction between capital and revenue nature of transactions.
- Confirming the existence and value of assets and liabilities.
- Subsidiary objectives: –
These objectives help in attaining primary objectives. They are as follows:
- Detection and prevention of errors: Errors are those mistakes that are committed due to carelessness or negligence or lack of knowledge or without having vested interest. Errors may be committed without or with any vested interest. So, they are to be checked carefully. Errors are of various types. Some of them are:
- Errors of principle
- Errors of omission.
- Errors of commission.
- Compensating errors.
- Under-or-over-valuation of stocks
Normally such frauds are committed by the top-level executives of the business. So, the explanation given to the auditor also remains false. So, an auditor should detect such frauds using skill, knowledge, and facts.
- Other objectives
- To provide information to the income-tax authority.
- To satisfy the provisions of the Companies Act.
- To have a moral effect.
Advantages of Audit Program
- It acts as a permanent record or guide to the conduct of the audit work.
- The auditor can be assured that certain cardinal areas of audit works are covered.
- The progress of the work can be ascertained at any point in time and easy for auditing staff to carry on the work of another.
- It allows for budget and plan for staff allocation
Disadvantages of Audit Program
- It tends to stifle initiative and flexibility on the part of audit staff
- Audit staff may rush to complete a required schedule by placing “ticks” at programmes not yet covered hence errors and frauds may not be located.
- Client`s staff may exploit any loopholes in the conduct of the audit by committing fraud.
- Audit assistants may not be able to recommend amendments to the programs.
I would like to conclude by saying that audits are the most effective when performed by qualified professionals who work together and are focused on clear objectives. Auditing tasks is the determination of compliance of facts with pre-defined specifications. Auditing is the review of an organisation`s quality system in order to achieve quality throughout the process.
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