AUDITING AND CORPORATE GOVERNANCE

UNIT 1 INRODUCTION
The word audit is derived from Latin word audire which means ‘to hear’. Auditing is a critical
examination of the records and books of account of a business by an independent qualified person fo
ascertaining the authenticity and the accuracy of entries appearing in the books of account and financ
statement. Spicer and Pegler have defined audit as “ such an examination of the books , accounts an
vouchers of a business as will enable the auditor to satisfy himself that the Balance Sheet is properl
drawn up, so as to give a true and fair view of the state of affairs of the business and whether the
profit and loss account gives a true and fair view of the profit or loss for the financial period ,
according to the best of his information and explanation given to him and is shown by the books an
not in what respect he is not satisfied.” Montgomery defined auditing as examination of the books
records of a business in order to ascertain or verify and report up on the facts regarding the financia
operations and the results thereof.
Auditing is defined as the systematic and independent examination of books, accounts, statutory records, document
and vouchers of an organization to ascertain how far the financial statements as well as non-financial disclosures prese
true and fair view of the concern.

The objective of an audit may be classified as 1. Primary Objective 2. Subsidiary Objective 3. Specific Objective

Primary Objective :
The main objective of auditing is to verify the accounts and records and to report to the owners of the business whether the profi
and loss account and the Balance sheet have been properly drawn up according to the requirements of law, and whether they ex
a true and fair view of the profit and the financial position of the business.

To ensure that the primary objective of audit is achieved, an auditor must:

 Examine the Internal Control and Internal Check.
 Verify whether all the books of accounts as required by law are kept.
 Verify whether proper accounting principles and procedures are followed.
 Check the arithmetical accuracy of the books of accounts.
 Verify the authenticity and validity of the transaction.

Subsidiary or Ancillary objectives

Subsidiary objectives of auditing are
1. Detection and prevention of errors.
2. Detection and prevention of frauds
Primary Objective or Main Objective The main objective of auditing is to verify the accounts and reco
and to report to the owners of the business whether the profit and loss account and the Balance shee
have been properly drawn up according to the requirements of law, and whether they exhibit a true a
fair view of the profit and the financial position of the business. To ensure that the primary objective
audit is achieved, an auditor must:
 Examine the Internal Control and Internal Check. Verify whether all the books of accounts as require
by law are kept. Verify whether proper accounting principles and procedures are followed. Check the
arithmetical accuracy of the books of accounts. Verify the authenticity and validity of the transactions
Confirm the existence and the values of the assets and liabilities by physical verification .Find out
whether the financial statement is properly drawn up. Report whether the profit and loss gives a true
and fair view of the profit or loss for the year and Balance sheet gives a true and fair view of the finan
position of the business at the end of the financial year.
Subsidiary or Ancillary objectives
Subsidiary objectives of auditing are 1. Detection and prevention of errors.
2. Detection and prevention of frauds.
Detection and prevention of Errors Errors refer to unintentional misstatements in the records or boo
Errors are two types namely  Clerical or technical errors and  Errors of principle. Clerical Errors
Clerical errors refer to all types of errors committed on account of clerical mistakes. They are
Errors of Omission:
Definition: Errors of omission occur when a transaction is completely left out or not recorded in the
financial records.
Example: A company fails to record a sale of inventory in its books of accounts. As a result, the revenu
and inventory balances are understated.
Errors of Commission:
Definition: Errors of commission occur when a transaction is recorded inaccurately, leading to incorre
financial information.
Example: A bookkeeper mistakenly records a payment made to a supplier twice, resulting in an
overstatement of expenses and an understatement of cash balance.
Compensating Errors:
Definition: Compensating errors are two or more errors that offset each other, resulting in the financ
statements appearing to be correct despite the presence of errors.
Example: An overstatement of sales revenue is offset by an equal overstatement of expenses. While t
individual errors exist, the net effect on the financial statements may appear minimal.

Errors of Duplication:
Definition: Errors of duplication occur when a transaction is recorded more than once, leading to
overstated figures in the financial records.
Example: A company mistakenly records the purchase of equipment twice, resulting in an overstatem
of assets and an understatement of cash or liability balances.
Errors of principle : occur when a transaction is recorded using an incorrect accounting principle or
method. Unlike errors of omission, commission, or duplication, errors of principle involve recording th
transaction but doing so in a way that violates accounting principles. Here's an example:

Example: A company purchases a piece of machinery for 10,000 and records it as an expense on the
income statement instead of capitalizing it as an asset on the balance sheet. This violates the matching
principle, which states that expenses should be recognized in the same period as the revenue they help
generate. Instead of spreading the cost of the machinery over its useful life and matching it with the
revenue it generates, the company improperly expensed the entire cost upfront, leading to an
understatement of assets and an overstatement of expenses.

. Specific objectives There will be specific objective in respect of each type of specific audits. For
example, in operational audit, the aim of audit is to evaluate the existing operations of the entity in
order to give expert advice to improve their efficiency. The cost audit is to check the cost records of th
entity in order to make a report on the proper ascertainment of cost of production of goods or servic
Depending upon the nature of specific audit, there may be different objective in respect of each spec
audit.

The basic principles of auditing are planning, honesty, secrecy, audit evidence, internal control syste
skill and competence, work done by others, working papers, and legal frameworks.
Planning: Planning is crucial in auditing as it involves outlining the scope, objectives, and procedures o
the audit engagement. It helps auditors to allocate resources effectively, assess risks, and develop an
audit strategy to achieve the audit objectives efficiently.
Honesty: Auditors are expected to conduct themselves with honesty and integrity throughout the au
process. This includes being truthful in their findings, maintaining independence and objectivity, and
accurately reporting their observations without bias or influence.
Secrecy: Secrecy refers to maintaining confidentiality regarding the information obtained during the
audit process. Auditors are required to keep sensitive information confidential to prevent unauthorize
access or disclosure, thereby preserving the privacy and integrity of the audit process and the
information being audited.
Audit Evidence: Audit evidence is the information gathered and evaluated by auditors to form
conclusions and support their findings and opinions. Auditors must obtain sufficient, appropriate, and
reliable audit evidence through various audit procedures such as inspection, observation, inquiry, and
analytical procedures.
Internal Control System: Auditors evaluate the adequacy and effectiveness of the internal control
system in place within an organization. This includes assessing the design and implementation of
internal controls to prevent and detect errors, fraud, and non-compliance with laws and regulations.
Skill and Competence: Auditors are expected to possess the necessary knowledge, skills, and profess
competence to perform their duties effectively. This includes staying abreast of auditing standards,
 regulations, and industry practices, as well as continuously developing their technical expertise and
professional judgment.
Work Done by Others: Auditors may rely on work performed by others, such as internal auditors
or specialists, to obtain audit evidence and support their findings. However, they are responsible
for evaluating the competence and independence of those who perform the work and
determining the extent of reliance on their work.
Working Papers: Working papers are the documentation of audit evidence, procedures,
findings, and conclusions obtained during the audit engagement. They serve as a record of the
audit work performed and support the auditor's judgments and opinions. Working papers also
facilitate review, supervision, and communication among audit team members and provide
documentation for external inspections or inquiries.
Legal Frameworks: Auditors operate within a legal framework that includes auditing standards,
regulations, and ethical guidelines. They are required to comply with applicable laws and
regulations, as well as professional standards and codes of conduct, to ensure the quality,
independence, and integrity of the audit process.
Audits can be classified based on various criteria, including the nature of work, scope, purpose, and timing. Here's an
overview of the common classifications of audits:

Nature of Work:

Financial Audit: This type of audit focuses on examining financial statements and related records to ensure accuracy,
completeness, and compliance with accounting standards and regulations. The primary objective is to express an opinion on
the fairness of the financial statements.

Operational Audit: Operational audits assess the efficiency and effectiveness of an organization's operations, processes, and
procedures. They aim to identify opportunities for improvement in areas such as management practices, resource utilization,
and risk management.

Scope:

Internal Audit: Internal audits are conducted by internal auditors who are employees of the organization. They examine
internal controls, risk management practices, and compliance with policies and procedures. The scope of internal audits can
be broad and may cover financial, operational, and compliance aspects.

External Audit: External audits are performed by independent external auditors who are not employees of the organization.
They provide an objective assessment of the financial statements and may also evaluate compliance with laws, regulations,
and contractual agreements. External audits are often required by stakeholders such as shareholders, creditors, and
regulatory authorities.

Purpose:

Statutory Audit: Statutory audits are conducted to fulfill legal or regulatory requirements imposed by government
authorities. For example, companies may be required to undergo statutory audits to comply with company law or tax
regulations.

Tax Audit: Tax audits are specifically focused on verifying the accuracy and completeness of tax returns filed by individuals
or organizations. They ensure compliance with tax laws and regulations and may be conducted by tax authorities or external
auditors.
Timing:

Preliminary Audit: Preliminary audits, also known as interim audits, are conducted during the accounting period to assess
the reliability of financial information and internal controls before the end of the reporting period. They help identify issues
early and take corrective action if necessary.

Final Audit: Final audits, also known as year-end audits, are performed after the close of the accounting period. They involve
a comprehensive examination of financial statements, transactions, and records to provide assurance on the accuracy and
fairness of the financial information presented.

These classifications provide a framework for understanding the different types and purposes of audits conducted by
organizations to ensure transparency, accountability, and compliance with legal and regulatory requirements.

o Audit planning refers to the design of an audit, outlining the overall audit strategy and guidelines for
conducting the audit. It sets the stage for a successful completion of the audit process.
o During planning, auditors analyze key focus areas, proactively manage potential issues, and allocate
responsibilities to team members1.
2. Importance of Audit Planning:
o A well-prepared audit plan helps auditors:
 Identify and manage risks effectively.
 Improve audit efficiency.
 Achieve audit objectives with minimal effort.
o Cooperation from management is essential during the planning phase.
o Auditors have the authority to question relevant personnel if discrepancies arise 1.
3. Audit Plan Process:
o Based on international auditing standards (ISA), the audit plan should align with the overall audit
strategy.
o Key steps include:
 Risk Assessment Procedures: Identifying risks and assessing their impact.
 Further Audit Procedures: Specific procedures at the assertion level.
 Compliance with Professional Standards: Ensuring the engagement adheres to standards.
4. Pre-Audit Activities:
o Client Due Diligence: Understanding the client’s nature of business, funding sources, and major
activities to avoid illegal or money laundering-related engagements.
o Understanding Client and Firm: Ensuring independence and managing conflicts of interest.
o Client Integrity Consideration: Assessing client integrity before accepting the audit engagement.
o Terms and Conditions of Engagement: Clarifying engagement terms.
5. Planning Activities:
o Establishing an overall audit strategy:
 Defines scope, timing, and direction.
 Guides the development of the detailed audit plan.
o Identifying the characteristics of the engagement:
 Determines the audit’s focus (e.g., financial statement audit or review).
o Documenting the audit engagement letter to ensure alignment with client needs.