Chapter 1

Auditing Concepts

Definition of Auditing:
According to American Accountants – A systematic examination
of books and records of a business or other organizations, in
order to check or verify and to report upon facts regarding its
financial operations and the results there of.
According to Institute of charted accountant of India – The
independent examination of financial information of any entity,
whether profit oriented or not and irrespective of its size and
legal form, when such an examination is connected with a view
legal form, when such an examination is connected with a view
to express an opinion there on.

Elements of Auditing:
1) Systematic Examination by Qualified person
2) Independent Examination
3) Express an opinion to the truth and fairness
4) Auditor collects and evaluates the evidence
5) Judgement of the auditor towards management
6) Review operations and performance of scope of audit

Principles of auditing:
1) Integrity, Objectivity and Independence
 2) Confidentiality
3) Skill and Competence
4) Documentation
5) Planning
6) Audit evidence
7) Accounting and internal control
8) Audit conclusion and Reporting

Functions of auditing:
1) Reviewing system and procedures
2) Examining documentary evidence
3) Reviewing the system of accounting and internal control
4) Verify the valuation and existence of assets
4) Verify the valuation and existence of assets
5) Examine the arithmetical accuracy of statements
6) Check whether the statutory requirement have complied
7) Ensure GAAP and accounting standards are followed
correctly
8) Reporting to what extend accounts exhibit truth and
fairness
9) Recommendations for improvement of internal control
and accounting system.
Verify the distinction between capital and revenue items
Difference between Accounting and Auditing:
BASIS ACCOUNTING AUDITING
Meaning Systematically keeping Auditing means
the records of the inspection of the books
accounts of an of accounts and
organization and financial statement of
preparation of financial organization
statement at the end of
financial year
Governed Accounting Standard Standards on auditing
by
Work Accountant Auditor
performed
by
Purpose To show the To reveal the fact that,
by
Purpose To show the To reveal the fact that,
performance of to which extend
financial position of the financial statements
organization gives true and fair
value
Period Accounting is a Auditing is a periodic
continuous process, process
day to day recording of
transactions are done.
Sequence Accounting starts at Auditing starts at end
end of book keeping of accounting
Objectives of auditing:
1) Primary objective:
• Promoting efficiency
• Promoting accuracy
2) Secondary objective:
a) Identification of error
• Clerical error
*Error of commission
* Error of omission
• Compensating error
• Error by principle
b) Identification of fraud
• Misappropriation of cash
 • Misappropriation of cash
• Misappropriation of goods
• Misappropriation of accounts
c) Secondary objective
• Prevention of error
• Prevention of fraud

Advantages of auditing:
1) Safeguarding the interest of persons not associated with
the management
2) Acts as a moral check on the employee
3) Helpful in settling liability for taxes
4) Useful for settling trade disputes
 5) Helps in deduction of wastages and losses
6) Govt may require audited and certified statement

Disadvantages of auditing:
1) Auditing is Costly
2) Auditing requires experts
3) Impossible to check all transactions
4) Unsuitable for small businesses
5) Bribes and threats

Types of auditing:
1) Audit requires under law
 1) Audit requires under law
2) In the voluntary category
3) Internal and external audit
4) Information system audit
5) Forensic audit

Relationship of auditing with other disciplines

a) Auditing and Accounting:
It has been pointed out earlier that both accounting and
auditing are closely related with each other as auditing reviews
the financial statements which are nothing but a result of the
overall accounting process. It naturally calls on the part of the
auditor to have a thorough and sound knowledge of generally
accepted principles of accounting before he can review the
financial statements.
b) Auditing and Law
The relationship between auditing and law is very close one.
Auditing involves examination of various transactions from the
view point of whether or not these have been properly entered
into. It necessitates that an auditor should have a good
knowledge of business laws affecting the entity. He should be
familiar with the law of contracts, negotiable instruments, etc.
c) Auditing and Economics
As, it is well known, accounting is concerned with the
accumulation and presentation of data relating to economic
activity. Though the concept of income as put forward by
accumulation and presentation of data relating to economic
activity. Though the concept of income as put forward by
economists is different as compared to the accountants
concept of income, still, there are lot of similar grounds on
which the accounting has flourished. From the auditing view
point, the auditors are more concerned with Micro economics
rather than with the Macroeconomics.
d) Auditing and Behavioral Science
The field of auditing as a discipline involves review of various
assertions; both in financial as well as in non-financial terms,
with a view to prove the veracity of such assertions and
expression of opinion by auditor on the same. Thus, it is quite
logical and natural that the function of audit can be performed
if and only if the person also possesses a good knowledge about
the fields in respect of which he is conducting such a review.
d) Auditing and Statistics & Mathematics
With the passage of time, test check procedures in auditing
have become part of generally accepted auditing procedures.
With the emergence of test check procedure, discipline of
statistics has come quite close to auditing as the auditor is also
expected to have the knowledge of statistical sampling so as to
arrive at meaningful conclusions.
e) Auditing and Data Processing
Today, organizations are witnessing revolution in the field of
data processing of accounts. Many organizations are carrying
out their financial accounting activities with the help of
data processing of accounts. Many organizations are carrying
out their financial accounting activities with the help of
computers which can document, record, collate, allocate and
value accounting data and information in very large quantity at
very high speed.
f) Auditing and Financial Management
Auditing is also closely related with other functional fields of
business such as finance, production, marketing, personnel and
other general areas of business management. With the
overgrowing field of auditing, the financial services sector
occupies a dominant place in our system.
 g) Auditing and Production
Regarding production function, it may be stated that a good
auditor is one who understands the client and his business.
While carrying out the audit activity, the auditor is required to
evaluate transactions from the accounting aspect in relation to
the process through which it has passed through as accounting
for by-products; joint-products may also require to be done.

Standard Setting Process

International Auditing and Standard Setting Board:

The IAASB functions as an independent standard-setting body
The IAASB functions as an independent standard-setting body
under the auspices of IFAC. The objective of the IAASB is to
serve the public interest by setting high quality auditing
standards and by facilitating the convergence of international
and national standards, thereby enhancing the quality and
uniformity of practice throughout the world and strengthening
public confidence in the global auditing and assurance
profession.
Objective:
• Established high quality accounting standards
• Guidance for financial statement audits
• Guidance for assurance services for both financial and non
– financial matters
Auditing and Assurance Standard Boards:
The Institute of Chartered Accountants of India constituted the
Auditing Practices Committee (APC) in 1982. The main function
of the APC is to review the existing auditing practices in India
and to develop Statements on Standard Auditing Practices
(SAPs) so that these may be issued by the Council of the
Institute.
In July, 2002, the Auditing Practices Committee has been
converted into an Auditing and Assurance Standards Board
(AASB) by the Council of the Institute, to be in line with the
international trend.
AASB are now renamed based on the type of assurance
AASB are now renamed based on the type of assurance
provided by the engagement undertaken by a member:

Engagement Standards

1) SAs – Standards on Auditing

It is to be understood that Standards on Auditing (SAs)
apply in "audit of historical financial information" which is
reasonable assurance engagement, whereas
 2) SREs – Standards on Review Engagements
Standards on Review Engagements (SRES) apply in "review
of historical financial information" which is limited
assurance engagement.
"Historical financial information means" information
expressed in financial terms in relation to a particular entity,
derived primarily from that entity's accounting system, about
economic events occurring in past time periods or about
economic conditions or circumstances at points in time in the
past.

Here, we have to broadly understand that "audit" and

"review" are two different terms.
"review" are two different terms.
“Audit” is a reasonable assurance engagement and its
objective is reduction in assurance engagement risk to an
acceptably low level in the circumstances of the engagement.
However, "review" is a limited assurance engagement and its
objective is a reduction in assurance engagement risk to a level
that is acceptable in the circumstances of the engagement.

3) SAEs – Standard on Assurance Engagements

Assurance engagements dealing with subject matters
other than historical financial information. Such assurance
engagements do not include "audit" or "review" of
 historical financial information. These standards are
known as Standards on Assurance Engagements.
An assurance engagement relating to examination of
prospective financial information.

Prospective financial information means financial information

based on assumptions about events that may occur in the
future and possible actions by an entity. It can be in the form a
forecast or projection or combination of both.

4) SRSs – Standards on related service

These standards apply in engagements to perform agreed-
These standards apply in engagements to perform agreed-
upon procedures regarding financial information. For
example, an engagement to perform agreed-upon
procedures may require the auditor to perform certain
procedures concerning individual items of financial data,
say, accounts payable, accounts receivable, purchases
from related parties and sales and profits of a segment of
an entity, or a financial statement, say, a balance sheet or
even a complete set of financial statements.