BCom 3rd Year Introduction to Auditing Notes Study Material
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Introduction to Auditing Notes Study Material
“Auditing is an important professional task carrying heavy responsibility and calling for commensurate skill and judgment.”
In the early stages of civilization, the methods of maintaining accounts were very crude. The size of business-houses was very small and with little amount of capital, the number of transactions to be recorded was so small that each individual was in a position to maintain his accounts and check for himself all his transactions. Hence, it was thought to be a sheer waste of time and money to get the accounts checked by someone from outside.
ORIGIN OF AUDITING
The origin of auditing may be traced back to the 18th century when the practice of large-scale production was developed as a result of Industrial Revolution. It was found that some systems of checks and counterchecks were applied for the purpose of maintaining public accounts, rather accounts of public institutions, as early as the days of the ancient Egyptians, the Greeks and the Romans.
The word ‘audit’ is derived from the Latin word, audire, which means ‘to hear’. Originally, it was customary for persons responsible for maintenance of accounts to go to some impartial and experienced persons, ordinarily judges, who used to hear these accounts and express their opinion about their correctness or otherwise. Such persons were known as ‘auditors’. Thus, the term ‘auditor’ means literally ‘hearer’, i.e., ‘one who hears’ and is used ever since the days when public accounts were accepted and approved on the basis of hearing the accounts read.
The last decade of the 15th century was an important period during which a great impetus was given to trade and commerce by the Renaissance in Italy and the principles of double-entry book-keeping were evolved and published in 1494 at Venice (in Italy) by Luca Paciolo. This system of accounts was quite capable of recording all kinds of mercantile transactions. Thus, the scope of audit automatically increased thereafter. Luca Paciolo also defined and described the duties and responsibilities of an auditor and since then, there have been various changes in the scope and definition of audit, and subsequently, the duties and responsibilities of an auditor have enormously increased.
The Industrial Revolution of England was another landmark in the history of trade and commerce. This led to a great increase in the volume of trading operations which necessitated the use of more capital and the average trader was compelled to combine in partnership with others. Consequently, big enterprises in the form of partnership firms and joint stock companies were formed. The growth of business enterprises before and after the Revolution was accompanied by improved accounting system. Besides this, the separation of ownership from management in British Companies made stock-holders realise that their interests could be well-protected by an independent and impartial audit.
Such developments had a direct effect on the evolution of the practice of auditing, but the audit of business accounts could not be common until the 19th century. The enormous increase in the trade, commercial and industrial activities further necessitated the use of proper devices of checking the accounts of big business-houses. Under these conditions, the commercial public became perfectly aware of the advantages of the services of auditors and the importance of audit increased to such an extent in those days that the accounts were thought to be misleading and incorrect unless they were audited professional and qualified auditors.
The Institute of Chartered Accountants in England and Wales was incorporated by Royal Charter on May 11, 1880 with the sole purpose of preparing auditors. Usually, auditors in India were also prepared by this Institute. In January 1923, the British Association of Accountants and Auditors was established and a person after passing his examination from this Association could be fully competent to work as professional auditor in India.
Auditing in India
From 1914 to 1932. The history of auditing in India dates back to April 1, 1914 when the Indian Companies Act, 1913 came into force. The growth of the accountancy profession in this country was actually an outcome of this Act, which made it obligatory on the part of every company registered under it to have the accounts audited at least once every year. The Act for the first time prescribed the qualifications for an auditor.(BCom Introduction to Auditing Notes Study Material)
Initially, the Government of Bombay was first to arrange for conducting the courses of study in this direction. The qualification of being an auditor was obtained by passing the examination of the Government Diploma in Accountancy (G.D.A) conducted by the Bombay Government.
From 1932 to 1949. Till 1932, it was the concern of the Provincial (now State) Governments to arrange for the education of and to prepare qualified auditors. Thereafter, the Central Government established an Indian Accountancy Board under the Auditors’ Certificate Rules, 1932. Under these Rules, Registered Accountants (R.A.) were authorised to work as qualified auditors.
From 1949 to 1956. The Chartered Accountants Act was passed in 1949 and it came into force on July 1, 1949. On the passing of this Act, the autonomy was granted to accountancy profession and as a result, the regulation, control and management of the profession passed from the Central Government to the professionals, i.e., in the hands of the Indian Institute of Chartered Accountants which was formed under the provisions of the said Act. Now, a person has to pass the examinations conducted by it. Only then he can obtain his certificate of Chartered Accountants (C.A.).
The Institute also maintains a register of its members. The members are of two types:
(i) Associates of the Institute of Chartered Accountants (A.C.A.). Associates are ordinary members of the Institute and their names appear in the register kept by it for the purpose. Such members can write the abbreviation, ‘A.C.A.’ after their names.(BCom Introduction to Auditing Notes Study Material)
(ii) Fellows of the Institute of Chartered Accountants (F.C.A.). Fellows are also members of the Institute. Associates become fellows after they have fulfilled certain prescribed conditions. e.g., at least 5 years’ practice, payment of the prescribed fee, etc. Such members can write the abbreviation, ‘F.C.A.’ after their names.(BCom Introduction to Auditing Notes Study Material)
From 1956 onwards. In 1960, some important amendments were made in the Companies Act, 1956 and the Companies Act, 2013 in the latest one in the series.
The Income-tax Act, 1961 has made the audit of accounts of some individuals compulsory which is an important landmark in the history of the profession.
DEFINITION OF AUDITING
The word ‘audit’ has a wide usage and it now means a thorough scrutiny of the books of accounts and its ultimate aim is to verify the financial position disclosed by the Balance Sheet and the Profit & Loss Account of a Company. The following are some of the definitions of audit:
(1) Spicer and Pegler: “An audit may be said to be such an examination of the books, accounts and vouchers of a business as will 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 & 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 the explanations given to him and as shown by the books, and if not, in what respects he is not satisfied.”
(2) F.R.M. De Paula : “An audit denotes the examination of a Balance Sheet and Profit & Loss Account prepared by others together with the books, accounts and vouchers relating thereto in such a manner that the auditor may be able to satisfy himself and honestly report that, in his opinion, such Balance Sheet is properly drawn up so as to exhibit a true and correct view of the state of affairs of a particular concern according to the information and explanations given to him and as shown by the books.”(BCom Introduction to Auditing Notes Study Material)
(3) R.B. Bose: “Audit may be said to be the verification of the accuracy and correctness of the books of accounts by an independent person qualified for the job and not in any way connected with the preparation of such accounts.”
Thus, audit is the systematic and scientific examination of the accounts of a business. The fundamental question is how an auditor should perform this scrutiny to his satisfaction and according to the wishes and instructions of his client. For this, the following definition gives a clue:
(4) M.L. Shandilya: “Auditing may be defined as inspecting, comparing, checking reviewing, vouching, ascertaining, scrutinising, examining and verifying the books of accounts of a business concern with a view to have a correct and true idea of its financial state of affairs.”(BCom Introduction to Auditing Notes Study Material)
Briefly speaking, an audit is an intelligent and critical examination of the accounts of a business as is evident from the various definitions given above, but progressive writers, like Sri A.K. Chanda, former Comptroller and Auditor-General of India, have now gone still further in expressing their point of view on audit.
(5) A.K. Chanda: “Audit is not an inquisition and its mission is not one of fault-finding. Its purpose is to bring to the notice of the administration lacunae in the rules, regulations and lapses, and to suggest possible ways and means for the execution of plans and projects with greater expedition, efficiency and economy.”
This is entirely a new approach in which Sri Chanda clarifies the purpose for which audit is conducted. According to him, an auditor is required to point out to the authorities the lacunae and shortcomings and also to suggest remedial measures with a view to bringing about greater expedition and more efficiency and economy. This is a pragmatic approach to the subject.
(6) Taylor and Perry: “An audit is an investigation by an auditor into the evidence from which the final Revenue Accounts and Balance Sheet or other statements of an organisation have been prepared, in order to ascertain that they present a true and fair view of the summarised transactions for the period under review and of the financial state of the organisation at the end date, so enabling the auditor to report thereon.”(BCom Introduction to Auditing Notes Study Material)
This definition contains four important elements viz., (1) An audit is, first of all, an investigation: (2) Such investigation is necessarily of some statement of figures, but not necessarily of a Balance Sheet; (3) The investigation involves the examination of certain evidences: and (4) The primary object of the investigation is to enable the auditor to make a report on the statement. Thus, the definition appears to be more exhaustive and clear.
From a close scrutiny of the definitions given above, it would be evident that there are different methods of saying a particular thing but still, there is a lot of similarity therein. However, audit may be defined as:
(1) an intelligent and a critical examination of the books of accounts of a business, which
(2) is done by an independent person or body of persons qualified for the job,
(3) with the help of vouchers, documents, information and explanations received from the authorities, so that
(4) the auditor may satisfy himself with the authenticity of financial accounts prepared for a fixed term and ultimately report that
(i) the Balance Sheet exhibits a true and fair view of the state of affairs of the concern:
(ii) the Profit & Loss Account reveals the true and fair view of the profit or loss for the financial period; and
(iii) the accounts have been prepared in conformity with the Law.
Thus, it will be seen that the duty of an auditor is much more than mere comparison of the Balance Sheet and accounts with the books. But, apart from doing this, he has to satisfy himself that, according to his information and the explanations given to him, the books have a proper record of the transactions entered into. How he will do it and how much amount of skill and care will be reasonable under the individual circumstances of a particular case are some of the questions which he can directly and independently answer. Much will, of course, depend upon the instructions of the Law.
In short, an audit implies an investigation and a report. The process of checking and vouching continues until the investigation is completed and the auditor enables himself to report in accordance with the terms of his appointment.