QUALITIES OF AN AUDITOR
An auditor should be a Chartered Accountant. Without obtaining the certificate of a Chartered Accountant, he cannot be appointed an auditor of a public company. So far as his qualities are concerned, some of them are inherent in him while there are others that he has to acquire. He must possess the necessary technique of doing his work and the qualities or capacities. On the one hand, he should be an expert in his work while on the other hand, he should be a man of character and noble behaviour. Ordinarily, an auditor must possess the following qualifications (from 1 to 8) and qualities (from 9 to 20):
(1) An auditor must be well-versed in the fundamental principles, theories and practices of all the aspects of accounting. He must be familiar with the different systems of maintaining accounts and their aspects. After all, accounting is a changing technique and hence, he should be fully aware of the new changes and developments. (BCom Introduction to Auditing Notes Study Material)
(2) He should not pass an entry or account as correct unless he becomes sure of its correctness. Hence, the knowledge of the principles of accounting becomes very much necessary for him. (BCom 3rd Year Introduction to Auditing Notes Study Material)
(3) He must have a thorough knowledge of cost accounts so as to enable him to perform cost audit.
(4) He should not only be familiar with the scope and nature of the accounts of a business which he is auditing, but he should also know all the technical and minute details of the working of such a business. He can inspect the works of his client if he thinks it necessary before the commencement of his work.
(5) He should have a thorough knowledge of the Company and Mercantile Laws’ and also of the Principles and Practices of Auditing.
(6) He should also be familiar with the Principles of Economics and the Economic Laws. It is essential because a business has to work within some specific social and economic environments and its working is fully affected by their rapid change.
(7) He should study the audit case laws which have been decided by Courts in India and in other countries. These decisions have their own significance and go a long way in defining the powers and duties of an auditor.
(8) He should have a good knowledge of industrial management, financial administration and business organisation.
(9) He should be honest. He should always exercise reasonable skill and care? He should not work under pressure and should keep himself away from what he thinks to be untrue. (BCom 3rd Year Introduction to Auditing Notes Study Material)
(10) He should be impartial and must not be influenced directly or indirectly by others in the discharge of his responsibilities.
(11) He must be very cautious and vigilant. Sometimes he faces an awkward situation when his duty to his client is opposed to his own interests. In such a position, he should be bold enough to discharge his duties faithfully and honestly. It will pay him in the long-run.(Introduction to Auditing Notes Study Material)
(12) He should have abilities to trace out the facts and figures. He should possess a realistic attitude and an ability to pass accounts only when they reveal the true and fair state of affairs. (BCom 3rd Year Introduction to Auditing Notes Study Material)
(13) He should not disclose the secrets of his client. If he does so, the outsiders become suspicious of his character and the entire business may be put to a loss.
(14) He should be so clever that he may be able to extract the necessary information in full. For this, he should be capable of preparing a proper questionnaire having intelligent questions.
(15) He should not adopt an attitude of suspicion.” It means that he must not be unduly suspicious.(BCom Introduction to Auditing Notes Study Material)
(16) He should always be prepared to hear arguments and must be reasonable.
(17) He should be methodical, hardworking and accurate.
(18) He should be well-behaved and should try to inculcate faith and confidence in the minds of the staff of his client. He should be courteous throughout.
(19) He must have the necessary courage and ability to write out his report clearly, correctly, concisely and forcefully.
(20) He must possess some common sense. Nothing more can be put here than that “the common sense is a thing which is uncommon in man.”
MANAGEMENT AND AUDITOR
The information required by the management may be of three types as given below:
1. Financial Control
The management especially at the top requires information through regular statements which should involve the following points:
(i) In the first instance, the working capital position of the company and the probable changes in it throughout the period covered by the current production and financial programme should be made known to the management. This information is vital to determine the ability of the company to finance the plan and to understand the traditional requirements of the working capital.
(ii) Immediately connected with the above information on working capital, the details of the budgeted costs of manufacture should also be made known so as to find out the materials and labour requirements.
(iii) Then, the burden of overheads, specially of fixed expenses, should be made known as to be able to compute the level of turnover to be attained at the break-even point.(BCom Introduction to Auditing Notes Study Material)
(iv) The relationship between profits and turnover must be known so as to determine the likely effects of fluctuations in turnover on selling prices.
(v) To plan and finance the business expansion programme and development activities, capital investment budgets are also required.
2. Cost Finding
Standard and sometimes actual costs must be made known so as to determine prices and Balance Sheet values.
(i) Details of records in regard to material, labour and overheads should be maintained to provide the basis of price fixation.
(ii) The elements of costs should be grouped into product costs so as to find out profit or loss for each product sold.
(iii) Product costs are significant for the pricing of stock and work-in-progress.
3. Cost Control
Cost finding relates to the collection and analysis of costs for some specific purposes, e.g., determining the actual total expenditure of a particular department, whole cost control is the check exercised on marketing of specific quantities of specific products made to a given standard of quality. Cost control is sometimes apart from the normal cost of business.
It would be evident that the auditor must have a comprehensive knowledge of cost and financial accountancy and of the use of budgetary control and standard costs. He must know what is in each budget. He must be able to establish the relationship between production data and financial data and as such, it becomes one of his important functions to ensure that financial results agree with the quantitative statistics of production. (BCom 3rd Year Introduction to Auditing Notes Study Material)
The auditor in order to function most effectively should be responsible to the top level of the management. This is true that the internal auditor, though an independent person with the company itself, is responsible to the directors while the external auditors are responsible to the proprietors.
Objects of an Audit
The main object of audit is to verify the accounts and to report whether the Balance Sheet and the Profit & Loss Account have been drawn properly according to the Companies Act and whether they exhibit a true and fair view of the state of affairs of the concern. Such verification of accounts and reporting to management are vital factors for promoting efficiency and accuracy in the maintenance of accounts so that the owners of a business may get accurate information about the financial condition of their business.
The verification of accounts is done to see if they are correct, complete and in conformity with the Law. For this, an auditor has to discover errors and fraud. As such, the subsidiary objects of audit are:
(i) detection of errors and fraud, and
(ii) prevention of the recurrence of those errors and of fraud.
If the accounts of a firm are full of errors and fraud and the auditor is in a position to discover such errors and fraud, he cannot certify them as correct. If he does so, it will be a great mistake on his part.
ERRORS
At the very outset, it would be apt to remark that errors generally arise out of the innocence or carelessness on the part of those responsible for the preparation of accounts, while fraud involves some intention to gain out of manipulating records.
1. Errors of Omission
Errors of omission generally arise due to the mistake of a clerk. If a transaction been omitted from being entered in the books of accounts, wholly or partially, it is a example of error of omission. There are items like purchases or sales which ought to have been recorded in the books of accounts but due to oversight or carelessness they have been wholly omitted from being recorded.
Apart from these, there are cases where items remain partially recorded, e.g., (i) the rent or interest may have been paid for 10 or 11 months and the remaining part of it which is unpaid or outstanding has not been recorded in the journal. It is, of course, true that such a mistake can be detected by careful audit but this is after all a case of clear omission. (ii) Secondly, if an item has been recorded in the journal but has not been posted in the ledger, error of omission may also arise. Really, this is an example of omission in ledger-posting in which a transaction has been recorded but not posted to the relevant accounts in the ledger.
The errors which arise due to non-recording of certain items will not affect the Trial Balance and, as such, the omission can be detected by careful scrutiny. But if one aspect of an item, e.g., purchases or sales, has been entered in the books, such an omission will affect the Trial Balance and, hence, will be easily detected. The errors which produce some effect on the agreement of Trial Balance are easily detectable.
2. Errors of Commission
Errors of commission usually arise through negligence in the matter of recording some business transactions in the books of accounts. They are the outcome of a sort of wrong doing on the part of clerks. If an item is incorrectly recorded in the journal or posted in the ledger, it is an error of commission.
The following are some examples of errors of commission:
(i) Incorrect Recording – Wholly or Partially. When a transaction though recorded in the journal has been wrongly entered in the books of original entry, error of commission is said to arise, e.g., a sale of 100 is entered in the sales book as rupees 10. Such an error does not affect the Trial Balance.
(ii) Incorrect Posting or Posting an Item to a Wrong Account. This is another example of error of commission. It is possible that a transaction may be entered correctly in the journal, but when posted in the ledger, a wrong amount may be entered, e.g., sale of ₹100 may be written as ₹10 to the debit of the customer’s account, thus debiting ₹ 90 less than the real figure. The effect of this erroneous posting in the Trial Balance would be that the debit side would be short by ₹ 90 and it would show a difference.
Similarly, a wrong account may be debited instead of another when there is nothing wrong on the credit side. When an amount of ₹ 100 is posted to the debit of Mohan account instead of Ram’s account to whom goods are actually sold, error of commission may creep up by posting an item to a wrong account. Such an error will not affect the agreement of the Trial Balance.
(iii) Errors in Totaling and Balancing. Sometimes errors of commission arise in the books through incorrect castings and calculations. Such cases are also the errors of commission. Such errors will affect the Trial Balance. The result of such errors would be that the error in the total on the debit side would lead to the error on debit side of the Trial Balance and so on.
(iv) Errors in Carrying Forward Totals to Trial Balance. Errors of commission may creep into the books when balances of different accounts are carried forward to the Trial Balance. The balance of accounts may be carried forward less or more than the real figure or double of it and sometimes also to the other side of the Trial Balance. For example, the balance of ₹125 on the debit of an account may be carried forward to the debit column of the Trial Balance as ₹115 or ₹135 or ₹250, and even ₹125 may be written to the credit column of the Trial Balance, thus entering the correct figure against this account but in the wrong column.
Other Examples of Errors of Commission
(v) When an amount pertaining to the debit side is posted to the credit side of a ledger account and another different amount of credit side posted to the debit side, error of commission arises and such an error will affect the trial balance.
(vi) When an entry in a book of original entry has been made twice and is also posted twice, error of commission is said to arise. Some writers call such an error as an error of duplication. In fact, it is also a case of error of commission. Such an error will not affect the trial balance.
(vii) When an item is posted to only one side of a ledger account, it is a case of error of commission. Such a mistake will affect the trial balance.
(viii) When a wrong figure is entered in a particular account, error of commission may arise and it has its effect on the trial balance.
3. Compensating Errors
Compensating errors arise when an error is counter-balanced or compensated by any other error or errors so that the adverse effect of one on debit or credit side is neutralised by that of another on credit or debit side. For example, A’s account which was to be debited for ₹ 200 was credited for ₹ 200 and similarly. B’s account which was to be credited for ₹ 200 was debited for ₹200.
If ₹120 is posted to the debit of the wages account in place of 100 and similarly to the credit of rent account ₹ 120 is posted in place of 100, it is an example of compensating error. Such errors also creep up when an undercasting of an account is counterbalanced by the overcasting of another account to the same extent and on the same side. Compensating errors will not affect the trial balance and, as such, will not be detected easily. Hence, their detection requires a complete and exhaustive preparation on the part of an auditor.
Errors of Principles
Errors of principle generally arise out of a disregard for the principles of accountancy. Such errors are sometimes committed intentionally to falsify and manipulate accounts with an objective of showing more or less profits than their actual figures. The following are some of the examples of such types of errors:
(i) Incorrect Allocation of Expenditure between Capital and Revenue. When a revenue expenditure is treated as capital expenditure and profits are inflated thereby, it is a case of error of principle. For example, if repairs to machinery are treated as an addition to it! in the Machinery Account, it would be an error of this nature. The result would be an increase in the cost of machinery without any charge on the Profit and Loss Account and, as such, the Balance Sheet would not exhibit a true and correct position of the business.
(ii) Posting Revenue Items to the wrong class of Revenue Account. When an item of wages is posted to general expenses account and similarly, an amount on salary account is posted to Advertisement Account, such errors culminate in accounts. Such errors will not affect the ultimate profit and hence, are said to be minor errors of principle. But after all, accounts of a concern are falsified and become incorrect.
(iii) Posting an Item of Revenue or Expenditure to a Personal Account. If rent paid to a landlord is posted to the debit of his personal account, it is an example of error of principle. The result of such an error would be that profits would be inflated and the Balance Sheet would be wrong.
(iv) Valuation of Assets against Fundamental Principles of Accountancy. When different types of assets are not valued in accordance with the principles of accountancy, major errors of principles arise and directly affect the profit and ultimately the Balance Sheet.
Thus, errors of principles are serious types of errors and they can be detected only if the auditor makes a searching and exhaustive scrutiny. Nevertheless, errors of principles do not affect the trial balance.
Other Examples of Errors of Principle
The following are some other examples of errors of principle:
(i) Provision for inadequate or excess depreciation;
(ii) Non-provision of depreciation;
(iii) Wrong provision for outstanding expenses and income accrued;
(iv) Wrong adjustment of prepaid expenses;
(v) Wrong provision for bad and doubtful debts; and
(vi) Undervaluation and overvaluation of stock.
How to Detect Errors?
Then, there is a serious question as to how the auditor should locate the error when he is called upon to do so, although it is not always his duty to do so. It is true that the officials of a business have failed to locate the error and they ask the auditor to detect it, it is naturally his duty to do so. If an auditor does so, he works as an accountant and not as an auditor.
How he would proceed in the matter is a big question to decide. Much will depend upon the circumstances of a particular case and on his own discretion. The auditor may pass the small differences provided that he is himself satisfied that the books of accounts have been thoroughly examined. But it is always to be remembered that there is a danger in passing a difference in the agreement of a set of books of accounts. (BCom 3rd Year Introduction to Auditing Notes Study Material)
The auditor should take note of the following devices to locate an error:
(i) If the books are maintained on the self-balancing system, errors can be located with an exhaustive scrutiny of the books of accounts.
(ii) If the books are not maintained on the self-balancing system, the trial balance should be thoroughly checked and the castings of ledger accounts should be tallied with those given in the trial balance.
(iii) If necessary, books of original entry may be checked and postings into the ledger verified.
(iv) The names of the accounts in the ledger should be compared with the names of accounts recorded in the trial balance. There are possibilities where some balances have not been carried forward to the trial balance.
(v) The lists of debtors and creditors should be totalled and should be properly compared with the trial balance.
(vi) Errors can also be located if the various items given in the trial balance of the current year are tallied with those given in the trial balance pertaining to the previous year. (BCom 3rd Year Introduction to Auditing Notes Study Material)
(vii) The figures which appear to be doubtful and are struck off for some fraudulent purpose should be carefully checked.
(viii) To check difference involving round figures, as 10,000, 1.000, casts and carry-forwards should be examined and wrong totalling, if any, should be corrected. The difference in rupees and paise should be traced through checking of postings and balancing of accounts.
(ix) If the difference is divisible by two, it may be due to wrong posting or posting to the wrong side of an account in particular, e.g., a difference of Rs 50 in the trial balance may be due to the posting of Rs 25 to the debit side in place of the credit side of an account.
(x) Sometimes, errors culminate due to misplacement or transposition of figures. Putting 45 for 54, 18 for 81, 27 for 72, etc. are some of such examples. If such a difference is divisible by 9, it should be noted that the reason for this difference is misplacement of figures.
(xi) After all, careful and intensive scrutiny is the only remedy for locating a particular error. The task is, in fact, tedious and arduous.