OBJECTIVES OF

AUDITING
Ansi Basheer Antony John Arjun M Jimmy Arjun Sivarajan Ashems Unni 10906 10907 10908 10909 10910

The objectives of auditing can be classified into : i) Primary or main objective and ii) Secondary or incidental objectives.

Primary Objective
The main of objective of auditing is to verify the accounts and to report whether the Profits and Loss Account and Balance Sheet are properly drawn up according to the Companies Act and they exhibit a true and fair view of the state of affairs of the concern (Sec. 227 of the Companies Act of 1956). It is actually an evaluation of financial statements to see whether they truly and fairly represent the actual financial position. For this the auditor must carry out a process of examination and verification of various accounts and other related documents. The auditor has to produce a report on the financial condition and working results of a concern after satisfying himself with the accuracy of the

For the purpose, he must 1) Examine the system of internal check. 2) Check the arithmetic accuracy of the books of accounts. 3) Verify the authenticity and validity of transactions. 4) See that proper distinction has been mad between items of capital and revenue nature. 5) Verify and value the assets and liabilities. 6) Should make sure the system of accounting has been

followed correctly while recording transactions.

7) Verify that all statutory books of accounts are maintained and in the prescribed manner.

Secondary or Incidental Objectives

1. Detection of Errors Accounting errors are mistakes and omissions made unknowingly while recording transactions in the books of accounts. They are innocently made mistakes, without any malicious intent. Errors can be classified into two categories: i) Clerical errors These occur when transactions are recorded, posted in ledgers and totalling and balancing of accounts. Clerical errors can be further divided into:
Errors of Omission : - When a transaction is not

entered in the books of accounts or is not posted to ledgers, error of omission occurs. When a whole transaction is missed, then is complete omission and when either debit or credit aspect is left out, it is partial

Errors of Commission :- Errors committed when

transactions are incorrectly recorded are called errors of commission. These can be caused by wrong posting, wrong totalling, wrong carry forwards etc.
Errors of Duplication :- An error of duplication

occurs when the same transaction is recorded twice in the books of original entry and hence is also posted twice in ledger accounts. Errors of this nature is difficult to detect because there will not be any disagreement within the trial balance.
Compensating errors :- Compensating errors are

those errors which compensate each other. When two or more errors occur in a manner that their effect on debit

ii) Errors of Principles :

If any principle is violated in recording of a transaction, it is an error of transaction. Errors of principle are committed when proper distinction between revenue and capital items are not made, i.e., a capital expenditure is taken a revenue expenditure and vice-versa. For example, carriage paid on purchase of a machinery, if instead of debiting it to Machinery A/C, it is debited to P&L A/C it is an error of principle. Another example for an error of principle is debiting the purchase of an asset in the purchases account, instead of the particular asset account. Such errors by themselves do not affect the agreement of

Duties of an Auditor with regard to detection of errors

Ordinarily, it is not the duty of the auditor to locate an error in the books of accounts. But the auditor is often called upon to discover the difference in books of accounts when the accountant is unable to trace it.

The auditor takes the following steps to locate these errors : 1. Check and recheck the totals of trial balance. 2. When a difference is detected in trial balance, look for ant excluded item having the same balance. 3. Check the total list of debtors and creditors. Check the carry forwards of the ledger accounts from one page or period to another.

Detection of Frauds
"A fraud is intentionally created mistake committed to defraud the proprietors of the concern. It is the wilful misrepresentation or deliberate concealment of a material fact with a view to deceive, cheat or mislead somebody". fraud means false representation or entry made intentionally or without belief in its truth. frauds are more serious than errors as they are committed intentionally by responsible officers who are presumed to be honest. Frauds may of three types. i. Misappropriation or embezzlement of cash. ii. Misappropriation of goods.

i. MISAPPROPRIATION OR EMBEZZLEMENT OF CASH Misappropriation or embezzlement of cash means fraudulent appropriation of cash belonging to another person by one who handles it. Misappropriation of cash may take place in any of the following ways: a. Suppression or non-disclosure of cash receipts Suppression or non-disclosure of cash receipts takes place in the following ways: i. Omitting to record the full cash sale proceeds, and pocketing the money received from it. ii. Recording the cash sale proceeds at a figure lower than the actual cash sale, i.e., under recording of the cash sales or recording only a part of the cash sale proceeds, and pocketing the balance of the cash sale

iii. Omitting to record the credit sales and pocketing the money received from the customers or debtors. iv. Teeming and lading : this is one of the methods of misappropriation of cash. Under this method, the money received from the first customer is misused or misappropriated by the cashier, The money received from the second customer is credited to the account of first customer, the money received from the third customer is credited to the accounts of the second customer and so on. This practice is continued till such time that the cashier finds it possible to put back the money misused by him or till the fraud is detected. This method of misappropriation of cash is also called lapping. v. Cash received from sale by V.P.P. or sale or returns may be pocketed. vi. Making fictitious or false entries in the customers accounts for return, bad debts, discounts and allowances, and pocketing the money, when the money is received from

b. Inflated the payments or showing false cash payments The following are the examples of this type of misappropriation: i. Recording fictitious or false cash purchases, and pocketing the amount. ii. Inflating the cash purchases, i.e., recording cash purchases at a figure higher than the actual amount and pocketing the difference. iii. Recording payment to fictitious creditors for purchases, and pocketing the money. iv. Recording payments to creditors at a figure higher than the actual amount, and pocketing the difference. v. Not recording the purchase returns, discount and allowances from suppliers and creditors, and pocketing

vi. Recording payments to dummy workers and pocketing the money. vii. recording fictitious payments of expenses, such as refreshments and pocketing the money. viii. Recording payments on some accounts at figures higher than the actual payments, and pocketing the difference.

Misappropriation or defalcation of cash is an easy affair especially in large concerns where proprietor has no close contact with the cashier. So in big business houses there must be good internal check system to control and check system to control and check cash receipts and payments.

ii) Misappropriation of Goods

The chances of misappropriation of goods are greater in the case of goods which are less bulky but are more valuable, of which detection is not easy. Goods can be misappropriated by: a) The actual theft of stock b) By issuing fictitious credit notes to customers. A detailed checking is necessary to detect misappropriation of goods. There must be strict control over the issue of materials, records of sale, purchases and stock.

iii) Manipulation or falsification if Accounts Falsification of accounts without misappropriation is not as common as misappropriation of cash and goods. It is undertaken to conceal the true position of the concern. This is often conducted by managers, directors or other responsible officers to understate or overstate the profit and financial standing to suit their purposes.
Reasons for overstating profit:

i) To earn more commission, if it is based on

profit.
ii) To increase prices of shares owned by them.

iii) To increase the shareholders trust in

iv) To attract more investors to their concern. v) To improve their credit ratings.
Reasons for understating profits:

i) To reduce tax liability. ii) To deceive the competitors by creating wrong impression about the performance of the business. iii) To induce a fall in the price of shares with a view to buying them in bulk at lower prices. iv) To avoid payment of higher bonus to workers and commission to managers.

Different methods of Manipulation of Accounts:

1. Charging more or less amount of depreciation and provision. 2. Undervaluation or overvaluation of stock or other assets and liabilities. 3. Showing fictitious sales or purchases or returns in order to show as incorrect figure of profit. 4. Recording revenue expenditure as capital expenditure or vice-versa. 5. Showing income and expenditure of the previous year or of the next year in the current years account. 6. Creation or utilisation of secret reserves. 7. Window dressing It implies a practice by which the Balance Sheet figures are inflated or deflated to create a favourable picture of the company. It tends to paint a

Auditors duties in relation to the detection and prevention of errors and frauds

The auditor should exercise reasonable care and skill to detect errors and frauds to prevent their recurrence in future. It is very difficult to detect frauds as they are committed by officers who are presumed to be honest, sincere and responsible. The auditor must be all these in addition to being systematic in his work. Routine checking and vouching must be done very carefully. His duty is mainly confined to making intelligent and careful enquiry. In doing so, it is not necessary that he must be successful. But, if he feels that he has exercised a great degree of skill, care and tact his job is over.

If a fraud is detected after completion of an audit, the auditor cannot be blamed in all circumstances. If he certified the accounts were correct in his best knowledge, skill and care, he cannot be held responsible for an error or fraud which is still in their accounts. An auditor is not supposed to be actively involved in the prevention of frauds and errors. He can only give suggestions for the prevention of recurrence of errors and frauds in the future. It is the proprietor who is responsible for getting things done.

The auditors duty in regard to the detection of errors and frauds is clearly pointed out in the case Kingston Cotton Mill & Co., 1896. The presiding judge made this famous statement that An auditor is only a watchdog and not a bloodhound. There are two points to this argument: 1) An auditor is a watchdog means he is appointed to look after the interest of those who happen to be the owners of the business. Like a watchdog, he is supposed to look after the interests of the concern sincerely, honestly and faithfully. 2) An auditor is not a bloodhound. He does not have investigatory powers unless specially appointed for the purpose. If he comes across any manipulation or malpractice, he should nonetheless inform the

The auditor has to do the following in connection with the detection and prevention of errors and frauds: 1) Check the internal check system and verify its effectiveness. 2) Ensure compliance with accounting standards and policies of the management. 3) Make sure accounts are prepared in conformity with Companies Act. 4) Check the balance sheet to ensure that it exhibits true and fair view of the state of affairs.

His responsibility for non-detection of errors will depend on the following factors: 1) He has fulfilled his duty with the prevailing statndards of performance adopted by the profession. 2) He has exercised reasonable care, skill and intelligent in his work. 3) He has not overlooked materials that should have raised suspicion. 4) The loss has not actually arisen on account of his negligence. 5) He has verified the accuracy of statements in a detailed manner, apart from just checking arithmetic accuracy.