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PURPOSE, MERITS AND DEMERITS OF AUDITING

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 would appoint a person to check the accounts and hear the explanations given by the person responsible for keeping the account and funds. In those days, the audit is done to find out whether the payments and receipt are properly accounted or not. The objective of modern day accounting is not only for the verification of cash but to report the financial position of the undertaking as disclosed by its Balance sheet and Profit and Loss account. A precise definition of the term 'Auditing' is difficult to give. Some of the definitions given by different authors are as follows: According to Montgomery, a well known author, "auditing is a systematic examination of the books and records of a business or the organization in order to ascertain or verify and to report upon the facts regarding the financial operation and the result thereof." Spicer and Pegler expanded the above definition as follows: "An audit may be said to be such an examination of the books, accounts and vouchers of a business as well enable the auditor to satisfy that the Balance Sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and whether the Profit or Loss for the financial period according to the best of his information and the explanations given to him and as shown by the books, and if not, in what respect he is not satisfied." According to Lawrence R. Dicksee, "an audit is an examination of accounting records undertaken with a view to establishing whether they correctly and completely reflect the transactions to which they relate. In some instances, it may be necessary to ascertain whether the transactions themselves are supported by authority." R. K. Mautz defines auditing as being "concerned with the verification of accounting data, with determining the accuracy and reliability accounting statement and reports."

It is clear from the above definitions that auditing is the systematic and scientific examination of the books of a accounts and records of a business so as to enable the auditor to satisfy himself that the Balance Sheet and the Profit and Loss Account are properly drawn up so as to exhibit a true and fair view of the financial state of affairs of the business and profit or loss for the financial period. The Auditor will have to go through various books and accounts and related evidence to satisfy himself about the accuracy and authenticity to report the financial health of the business.

DIFFERENCE BETWEEN AUDITING AND ACCOUNTING.


1. The role of accountancy is to record the transaction in the book of accounts, extraction of trial balance, preparation of Trading and profit and loss account and balance sheet etc. On the other hand auditing is the examination of books of account and checking the financial statement for the purpose of finding out the true and fair position and results of operation of a concern. Audit is concerned with detailed examination of the complete accounting records but it does not involve the preparation of accounts. 2. If the auditor is asked to write the books of accounts, extract an agreed trial balance and profit and loss account and Balance sheet, he would be doing the work of an accountant and not the work of an auditor. Preparation of account is not the part of auditing. An auditor, using his appointing authority, needs to check thoroughly, whether the Profit and Loss account and the Balance Sheet have been properly drawn up and revel the 'true and fair view' of the state of affairs and results of operation of the concern and report it to the parties interested. 3. Auditing without the prior existence of accounts is not possible. When the accountant finishes his work, the auditor starts his work.

Purpose of Audit
For a better understanding we could classify the Purpose of audit as: 1. Primary Purpose 2. Secondary Purpose.

Primary Purpose: 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 a

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 companys 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 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 are not the primary objective of the audit. They are come under the secondary objectives of audit. 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. Secondary Purpose: In order to report the financial condition of the business, 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 account is an example of 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 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 be nullifying 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 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 is not properly observed, these types of errors could occur. Over valuation 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 remain 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 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 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 "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 with high value goods are pray 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 share holders 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 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 dividend or paying lower dividend 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 kind of frauds, the auditor must be vigilant and should make searching inquiries to arrive at the true position.

MERITS AND DEMERITS OF AUDITING


Merits of Auditing 1. The biggest advantage of internal audit is that it will lead to discovery of errors and therefore when external audit is done those errors which were discovered during internal audit would have been rectified by then. 2. Since internal audit is done by the employees of the company there is no additional cost involved which again is a big advantage for a company which is doing internal audit. 3. As internal audit is a constant procedure where records are checked regularly it ensures that accounting staff of a company keep the records up to date. Demerits of Auditing 1. Internal audits report is not accepted by either the shareholders or tax authorities, it is the external auditor report which is required to be submitted to these parties. 2. Since internal audit is done by the employees of the company chances are that it may be biased and therefore company cannot depend on such reports. 3. Since an internal audit is not done by the professional auditor chances of internal auditor not detecting the errors are high.