Objectives of Auditing

7/30/2019 Objectives of Auditing

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OBJECTIVES OF

AUDITING

Ansi Basheer 10906

Antony John 10907

Arjun M Jimmy 10908

Arjun Sivarajan 10909

Ashems Unni 10910


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The objectives of auditing can be classified into :

i) Primary or main objective and

ii) Secondary or incidental objectives.

Primary Objective

The main of objective of auditing is to verify the

accounts and to report whether the Profits and LossAccount and Balance Sheet are properly drawn upaccording to the Companies Act and they exhibit a trueand fair view of the state of affairs of the concern (Sec.227 of the Companies Act of 1956). It is actually an

evaluation of financial statements to see whether theytruly and fairly represent the actual financial position.For this the auditor must carry out a process ofexamination and verification of various accounts andother related documents. The auditor has to produce a

report on the financial condition and working results of aconcern after satisfying himselfwith the accuracy of the


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For the purpose, he must

1) Examine the system of internal check.

2) Check the arithmetic accuracy of the books of accounts.

3) Verify the authenticity and validity of transactions.

4) See that proper distinction has been mad between items ofcapital and revenue nature.

5) Verify and value the assets and liabilities.

6) Should make sure the system of accounting has been

followed correctly while recording transactions.

7) Verify that all statutory books of accounts are maintained

and in the prescribed manner.


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Secondary or Incidental Objectives

1. Detection of Errors

Accounting errors are mistakes and omissions

made unknowingly while recording transactions in thebooks of accounts. They are innocently made mistakes,without any malicious intent. Errors can be classified intotwo categories:

i) Clerical errorsThese occur when transactions are recorded,

posted in ledgers and totalling and balancing of accounts.Clerical errors can be further divided into:

Errors of Omission : - When a transaction is notentered in the books of accounts or is not posted toledgers, error of omission occurs. When a wholetransaction is missed, then is complete omission andwhen either debit or credit aspect is left out, it is partial


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Errors of Commission :- Errors committed when

transactions are incorrectly recorded are called errors of

commission. These can be caused by wrong posting,

wrong totalling, wrong carry forwards etc.

Errors of Duplication :- An error of duplication

occurs when the same transaction is recorded twice inthe books of original entry and hence is also posted twice

in ledger accounts. Errors of this nature is difficult to

detect because there will not be any disagreement within

the trial balance.

Compensating errors :- Compensating errors are

those errors which compensate each other. When two or

more errors occur in a manner that their effect on debit


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ii) Errors of Principles :

If any principle is violated in recording of a

transaction, it is an error of transaction. Errors of

principle are committed when proper distinction

between revenue and capital items are not made, i.e.,a capital expenditure is taken a revenue expenditure

and vice-versa. For example, carriage paid on

purchase of a machinery, if instead of debiting it to

Machinery A/C, it is debited to P&L A/C it is an errorof principle. Another example for an error of principle

is debiting the purchase of an asset in the purchases

account, instead of the particular asset account. Such

errors by themselves do not affect the agreement of


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Duties of an Auditor with regard to detection oferrors

Ordinarily, it is not the duty of the auditor to locate an errorin the books of accounts. But the auditor is often calledupon to discover the difference in books of accounts whenthe accountant is unable to trace it.

The auditor takes the following steps to locate these errors:

1. Check and recheck the totals of trial balance.

2. When a difference is detected in trial balance, look forant excluded item having the same balance.

3. Check the total list of debtors and creditors. Check thecarry forwards of the ledger accounts from one page orperiod to another.


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Detection of Frauds

"A fraud is intentionally created mistake committed todefraud the proprietors of the concern. It is the wilful

misrepresentation or deliberate concealment of a

material fact with a view to deceive, cheat or mislead

somebody".f raud means false representat ion or entry made

intent ional ly or w ithou t bel ief in i ts truth. frauds are

more serious than errors as they are committed

intentionally by responsible officers who are presumedto be honest.

Frauds may of three types.

i. Misappropriation or embezzlement of cash.

ii. Misappropriation of goods.


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i. MISAPPROPRIATION OR EMBEZZLEMENT OF

CASH

Misappropriation or embezzlement of cash meansfraudulent appropriation of cash belonging to another

person by one who handles it. Misappropriation of cash

may take place in any of the following ways:

a. Suppression or non-disclosure of cash receiptsSuppression or non-disclosure of cash receipts takes

place in the following ways:

i. Omitting to record the full cash sale proceeds, and

pocketing the money received from it.

ii. Recording the cash sale proceeds at a figure lower

than the actual cash sale, i.e., under recording of the

cash sales or recording only a part of the cash sale

proceeds, and pocketing the balance of the cash sale


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iii. Omitting to record the credit sales and pocketing themoney received from the customers or debtors.

iv. Teeming and lading : this is one of the methods ofmisappropriation of cash. Under this method, the moneyreceived from the first customer is misused ormisappropriated by the cashier, The money received fromthe second customer is credited to the account of firstcustomer, the money received from the third customer iscredited to the accounts of the second customer and so on.This practice is continued till such time that the cashierfinds it possible to put back the money misused by him ortill the fraud is detected. This method of misappropriation of

cash is also called lapping.v. Cash received from sale by V.P.P. or sale or returns maybe pocketed.

vi. Making fictitious or false entries in the customersaccounts for return, bad debts, discounts and allowances,

and pocketing the money, when the money is received from


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b. Inflated the payments or showing false cashpayments

The following are the examples of this type of

misappropriation:

i. Recording fictitious or false cash purchases, andpocketing the amount.

ii. Inflating the cash purchases, i.e., recording cashpurchases at a figure higher than the actual amountand pocketing the difference.

iii. Recording payment to fictitious creditors for

purchases, and pocketing the money.iv. Recording payments to creditors at a figure higherthan the actual amount, and pocketing the difference.

v. Not recording the purchase returns, discount and

allowances from suppliers and creditors, and pocketing


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vi. Recording payments to dummy workers and

pocketing the money.

vii. recording fictitious payments of expenses, such as

refreshments and pocketing the money.

viii. Recording payments on some accounts at figures

higher than the actual payments, and pocketing the

difference.

Misappropriation or defalcation of cash is an

easy affair especially in large concerns where

proprietor has no close contact with the cashier. Soin big business houses there must be good internal

check system to control and check system to

control and check cash receipts and payments.


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ii) Misappropriation of Goods

The chances of misappropriation of goods are greater in

the case of goods which are less bulky but are more

valuable, of which detection is not easy.

Goods can be misappropriated by:a) The actual theft of stock

b) By issuing fictitious credit notes to customers.

A detailed checking is necessary to detect

misappropriation of goods. There must be strict control

over the issue of materials, records of sale, purchases

and stock.


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iii) Manipulation or falsification if Accounts

Falsification of accounts without misappropriation

is not as common as misappropriation of cash and

goods. It is undertaken to conceal the true position of the

concern. This is often conducted by managers, directors

or other responsible officers to understate or overstate

the profit and financial standing to suit their purposes.

Reasons for overstating profit:

i) To earn more commission, if it is based onprofit.

ii) To increase prices of shares owned by

them.

iii) To increase the shareholders trust in


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iv) To attract more investors to their concern.

v) To improve their credit ratings.

Reasons for understating profits:

i) To reduce tax liability.

ii) To deceive the competitors by creating

wrong impression about the

performance of the business.

iii) To induce a fall in the price of shares with

a view to buying them in bulk at lower

prices.

iv) To avoid payment of higher bonus to

workers and commission tomana ers.


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Different methods of Manipulation of Accounts:

1. Charging more or less amount of depreciation andprovision.

2. Undervaluation or overvaluation of stock or other assetsand liabilities.

3. Showing fictitious sales or purchases or returns in orderto show as incorrect figure of profit.

4. Recording revenue expenditure as capital expenditure orvice-versa.

5. Showing income and expenditure of the previous year orof the next year in the current years account.

6. Creation or utilisation of secret reserves.

7. Window dressing It implies a practice by which theBalance Sheet figures are inflated or deflated to create a

favourable picture of the company. It tends to paint a


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Auditors duties in relation to the detection and

prevention of errors and frauds

The auditor should exercise reasonable care and

skill to detect errors and frauds to prevent their

recurrence in future. It is very difficult to detect fraudsas they are committed by officers who are presumed to

be honest, sincere and responsible. The auditor must

be all these in addition to being systematic in his work.

Routine checking and vouching must be done verycarefully. His duty is mainly confined to making

intelligent and careful enquiry. In doing so, it is not

necessary that he must be successful. But, if he feels

that he has exercised a great degree of skill, care andtact his ob is over.


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If a fraud is detected after completion of an audit, the

auditor cannot be blamed in all circumstances. If he

certified the accounts were correct in his best

knowledge, skill and care, he cannot be held

responsible for an error or fraud which is still in their

accounts.

An auditor is not supposed to be actively involved in

the prevention of frauds and errors. He can only givesuggestions for the prevention of recurrence of errors

and frauds in the future. It is the proprietor who is

responsible for getting things done.


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The auditors duty in regard to the detection of errors

and frauds is clearly pointed out in the case Kingston

Cotton Mill & Co., 1896. The presiding judge made thisfamous statement that An auditor is only a watchdog

and not a bloodhound.

There are two points to this argument:

1) An auditor is a watchdog means he isappointed to look after the interest of those who happen

to be the owners of the business. Like a watchdog, he

is supposed to look after the interests of the concern

sincerely, honestly and faithfully.

2) An auditor is not a bloodhound. He does not

have investigatory powers unless specially appointed

for the purpose. If he comes across any manipulation or

malpractice, he should nonetheless inform the


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The auditor has to do the following in connection with

the detection and prevention of errors and frauds:

1) Check the internal check system and verify its

effectiveness.

2) Ensure compliance with accounting standardsand policies of the management.

3) Make sure accounts are prepared in

conformity with Companies Act.

4) Check the balance sheet to ensure that itexhibits true and fair view of the state of affairs.


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His responsibility for non-detection of errors will depend

on the following factors:

1) He has fulfilled his duty with the prevailing

statndards of performance adopted by the

profession.

2) He has exercised reasonable care, skill andintelligent in his work.

3) He has not overlooked materials that should

have raised suspicion.

4) The loss has not actually arisen on account ofhis negligence.

5) He has verified the accuracy of statements in a

detailed manner, apart from just checking arithmetic

accuracy.


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Objectives of Auditing

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