Concept of Auditing – CS Foundation Fundamentals of Accounting and Auditing Notes

→ Meaning of audit: Audit is originated from Latin word ‘audire’ which means to hear. In earlier times accounts were heard by auditors and were verified and certified. In those days, the audit is done to find out whether the payments and receipt are properly accounted or not. Over the time the auditing procedure has changed tremendously.

→ An audit is the examination and verification of the financial report of an organization. The financial report includes a balance sheet, an income statement, a statement of changes in equity, a cash flow statement, and notes comprising a summary of significant accounting policies and other explanatory notes. The goal of a financial statement audit is to form an opinion regarding whether financial statements are or aren’t free from error.

→ Traditionally auditing was confined to financial statements but now auditing is being done in other areas too like safety, environment, security, information etc.

→ Definition of auditing: Auditing is an examination of the accounting books and the relative documentary evidence so that an auditor may be able to find out the accuracy of figures and may be able to make report on the balance sheet and other financial statements which have been prepared by the end of accounting is the beginning of auditing.

→ Objectives of Auditing: Auditing main purpose or object is to find the opinion of an auditor about correctness and reliability of accounts and the financial position of the business concern.

→ Definitions of auditing given by different person
1 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.”

2 According to A.W. Hanson “An audit is an examination of accounting records to establish their reliability and the reliability of statements drawn there from.”

3 According to R.B. Bose “Audit may be said to the verification of the accuracy and correctness of the books of accounts by independent person qualified for the job and not in any way connected with the preparation of such accounts.”

→ There are differences between accounting and auditing:

accounting is recording all the financial transactions, preparing trial balance, balance sheet, profit and loss account while auditing is checking correctness of these records.
Moreover an auditor who is preparing financial statements is working as an accountant while an auditor doing auditing is checking the correctness of the records.
it is not required that all the accountants be auditor but all the auditors are required to be accountants.

→ Principle aspects to be covered in Auditing:
Effective audit is critical to the quality of financial reporting and the proper conduct of business. Thus some of the aspects to be covered when doing audit are

First is to understand the system and procedure adopted by the entity
Before beginning the auditing determine whether, and to what extent, to use specific work of the internal auditors
If using the specific work of internal auditors, to determine whether that work is adequate for the purposes of the audit and how effective is the internal control system.
To check the arithmetic calculations to trace out if any error in the books of accounts
to monitor the integrity of the financial statements of the company and any formal announcements
relating to the company’s financial performance
auditor has to ascertain that items of capital nature are identified and differentiated from items of revenue nature
Should review the clarity and completeness of disclosures in the financial statements and consider whether the disclosures made are set properly in context.
a proper adjustment has been made for income and expenditure of a particular period
to report to the board on how it has discharged its responsibilities.
if auditor is not satisfied with any aspect of the proposed financial reporting by the company, it shall report its views to the board.
Should ensure all statutory compliance related to income tax, companies Act etc. has been complied by entity
Should review and approve the statements included in the annual report in relation to internal control and the management of risk.
Should physically assess all the assets of the entity
Should inspect the documents to find whether liabilities have been correctly mentioned

→ Benefits of Audit:
The purpose of an audit is to form a view on whether the information presented in the financial report, taken as a whole, reflects the financial position of the organization at a given date, some of the benefits of auditing are

An audit helps to identify weaknesses in the accounting systems and enables us to suggest improvements
An audit assures directors not involved in the accounting functions on a day-to-day basis that the business is running in accordance with the information they are receiving, and helps reduce the scope for fraud and poor accounting
It helps to maintain books of accounts up to date
Auditing is also a legal requirement for some companies
An audit facilitates the provision of advice which can cover anything from the tightening of internal controls, to reducing the risk of fraud or tax planning
An audit adds credibility to published information for employees, customers, suppliers, investors and tax authorities
It helps in strengthening the internal system
An audit provides assurance to shareholders (if they are not directors closely involved in the business) that the figures in the accounts show a true and fair view

Limitations of audit:
→ Due to the inherent limitations of audit, auditors are only able to offer ‘reasonable assurance’ over the truth and fairness of the financial statements

→ Due to high cost auditor limits his scope of work to selective testing

→ Audit involves the use of judgment in the identification of audit risks. Although auditing standards provide guidelines to assist auditors in forming sound professional judgments, it is inevitable that an auditor may at times misjudge a situation which may cause the auditor to overlook a misstatement in the financial statement.

→ Generally an auditor is required to give audit report within specified time which doesn’t give him enough time to check all the records

→ they have to rely on the representations of management in order to assess the reasonableness of the matters concerning financial statements.

→ By their very nature, frauds are intended to be concealed which makes the work of auditors a little difficult

→ The perceived independence of an auditor is for instance impaired where a client accounts for the revenue of the audit firm

→ Investigation: Investigation is an examination of books and records for any specified purpose, sometimes differing in scope from the ordinary audit. Investigation implies an examination of and record for some special purpose. Investigation is carried out not in substitution of audit, but in addition to audit.

→ Difference between Audit and Investigation: Following are the important distinctive features in both the term.

Audit which is conducted for a particular object is called investigation while auditing is the examination of financial statements of any entity
Investigation is carried out on behalf of the outsiders who want to know the financial position of the business.
While audit is conducted on behalf of the share holders.
Audit of annual financial statements is compulsory under the law but Investigation is not compulsory under law but voluntary, depending upon necessity.
Investigation can be conducted by anyone and he may not be an auditor while auditing can be done only by auditor
The report of the investigation is submitted to the party appointing him for investigation while the report of audit is submitted to the share holders.
Investigators are appointed by management or owners or any third party but auditors are appointed by shareholders or owners of the entity.
Investigation may cover a period more then a financial year while auditing covers the period of one financial year.
Investigation is conducted for a particular purpose or object while the object of auditing is to find out the correctness of statements and exhibit a true and fair view about the affairs of the business.
Investigation seeks conclusive and corroborative evidence while most of the auditing evidences are persuasive

Concept of Auditing MCQ Questions – CS Foundation Fundamentals of Accounting and Auditing

Question 1.
…………………………….. are not legally required to get their financial statements audited
a. Companies
b. Banks
c. Partnership firm
d. Insurance companies
Answer:
c. Partnership firm

Hint:
Audit which is prescribed by a state/legislation e.g. Company audit as per Companies Act, audit of Banking Companies, electricity supply companies, public and charitable trust, co-operative schemes which have been set up under the Act of Parliament and other audits required as per law Partnership firms are not required legally to get their accounts statement audited.

Question 2.
In audit, investigation exercise is
a. Mandatory
b. Recommendatory
c. Voluntary
d. Voluntary but recommendatory in all cases
Answer:
c. Voluntary

Hint:
Audit of annual financial statements is compulsory under the law but Investigation is not compulsory under law but voluntary, depending upon necessity.

Question 3.
The format of investigation report is
a. Prescribed by law
b. Not prescribed by any law
c. Standardized
d. Neither standardized nor prescribed by any law
Answer:
d. Neither standardized nor prescribed by any law

Hint:
The report of the investigation is submitted to the party appointing him for investigation while the report of audit is submitted to the share holders.
The format of audit report has been prescribed by law whereas there is no statutory form of investigation report neither any form has been prescribed by law.

Question 4.
Which of the following is true about audit?
a. Audit starts after accounting ends
b. Accounting starts after auditing ends
c. Accounting and auditing exercise are parallel
d. Accounting is complementary to auditing
Answer:
a. Audit starts after accounting ends

Hint:
Definition of auditing: Auditing is an examination of the accounting books and the relative documentary evidence so that an auditor may be able to find out the accuracy of figures and may be able to make report on the balance sheet and other financial statements which have been prepared by the end of accounting is the beginning of auditing.

Question 5.
Which of the following is a type of persuasive audit evidence for the auditor?
a. Client’s Bank statements
b. Documents obtained by auditor directly from third parties
c. Carbon copies of sales invoices
d. Computations made by the auditor himself
Answer:
c. Carbon copies of sales invoices

Hint:
Audit evidence is information obtained by the auditor to draw conclusions to support opinion on the Financial statements. Persuasive audit evidence will be those evidence which are good at persuading someone to do or believe something through reasoning or the use of temptation.
A, b, d are conclusive evidence . Only c is persuasive evidence.

Question 6.
For an auditor, to check arithmetical accuracy is
a. Not required
b. Mandatory
c. Voluntary
d. Recommendatory
Answer:
b. Mandatory

Hint:
To check the arithmetic calculations to trace out if any error in the books of accounts is one of the important aspect of auditing.

Question 7.
Verification of assets is done to ascertain
(X) Existence of asset
(Y) Ownership of asset
(Z) Possession of asset The correct option is:
a. (X) and (Y)
b. (Y)and(Z)
c. (X)and(Z)
d. (X), (Y) and (Z)
Answer:
d. (X), (Y) and (Z)

Hint:
It is the duty of the auditor to physically inspect the assets and their recording in the books of accounts and verify the legal and official documents to ascertain the existence, ownership, possession, classification and valuation of assets of an entity.

Question 8.
Which of the following is not correct about investigation?
a. Investigation may be done by any person having the knowledge of entity’s business
b. Investigation is mandatory in nature and needs to be done on yearly basis
c. The scope of investigation is decided by the appointing authority
d. There is no standard format of investigation report.
Answer:
b. Investigation is mandatory in nature and needs to be done on yearly basis

Hint:
Investigation: Investigation is an examination of books and records for any specified purpose, sometimes differing in scope from the ordinary audit. Investigation implies an examination of and record for some special purpose. Investigation is carried out not in substitution of audit, but in addition to audit. Investigation is carried out on behalf of the outsiders who want to know the financial position of the business. Investigation can be conducted by anyone and he may not be an auditor. There is no format of investigation report.

Question 9.
Principal aspects to be covered in an audit involves:
(X) Review of system and procedures
(Y) Review of internal control system
(Z) Ensuring statutory compliance The correct option is:
a. (X) and (Y)
b. (Y) and (Z)
c. (X) and (Z)
d. (X). (Y) and (Z)
Answer:
d. (X). (Y) and (Z)

Hint:
Principle aspects to be covered in Auditing
Effective audit is critical to the quality of financial reporting and the proper conduct of business. Thus some of the aspects to be covered when doing audit are

First is to understand the system and procedure adopted by the entity
Before beginning the auditing determine whether, and to what extent, to use specific work of the internal auditors
If using the specific work of internal auditors, to determine whether that work is adequate for the purposes of the audit and how effective is the internal control system.
To check the arithmetic calculations to trace out if any error in the books of accounts
to monitor the integrity of the financial statements of the company and any formal announcements relating to the company’s financial performance
auditor has to ascertain that items of capital nature are identified and differentiated from items of revenue nature
Should review the clarity and completeness of disclosures in the financial statements and consider whether the disclosures made are set properly in context.
a proper adjustment has been made for income and expenditure of a particular period
to report to the board on how it has discharged its responsibilities.
if auditor is not satisfied with any aspect of the proposed financial reporting by the company, it shall report its views to the board.
Should ensure all statutory compliance related to income tax, companies Act etc. has been complied by entity
Should review and approve the statements included in the annual report in relation to internal control and the management of risk.
Should physically assess all the assets of the entity
Should inspect the documents to find whether liabilities have been correctly mentioned

Question 10.
Detection and prevention of fraud is the ……………………… objective of auditing activity.
a. Primary
b. Secondary
c. Single
d. Specific
Answer:
b. Secondary

Hint:
Auditing is an examination of the accounting books and the relative documentary evidence so that an auditor may be able to find out the accuracy of figures and may be able to make report on the balance sheet and other financial statements which have been prepared by the end of accounting is the beginning of auditing.

Auditing main purpose or object is to find the opinion of an auditor about correctness and reliability of accounts and the financial position of the business concern.
Thus detection and prevention of fraud is the secondary objective of auditing.

Question 11.
Quality of auditor to be free from influence is defined by which term?
a. Independence
b. Confidentiality
c. Skill
d. Integrity
Answer:
a. Independence

Hint:
According to R.B. Bose “Audit may be said to the verification of the accuracy and correctness of the books of accounts by independent person qualified for the job and not in any way connected with the preparation of such accounts.”
Thus, quality of auditor to be free from influence is defined by Independence.

Question 12.
Auditing exercise includes:
(i) Checking of accounts
(ii) Verification of accounts
(iii) Examination of accounts The options are:
a. I and III
b. I, II and III
c. I and II
d. Hand 11.1
Answer:
b. I, II and III

Hint:
Auditing exercise includes:

Checking of accounts
Verification of accounts
Examination of accounts
Investigation of some statements
Examination of evidence

Question 13.
In case of investigation, the period of investigation coverage
a. Is 2 years
b. Is 1 year
c. Differs on case to case basis
d. Is 6 months.
Answer:
c. Differs on case to case basis

Hint:
Investigation may cover a period more than a financial year as it depends on case to case basis while auditing covers the period of one financial year.

Question 14.
The primary objective of statutory auditing is to – (x) detect errors (y) prevent errors (z) express an opinion. The options are:
a. (x) and (y)
b. (z) only
c. (y) only
d. (x), (y) and (z).
Answer:
b. (z) only

Hint:
Auditing main purpose or object is to find the opinion of an auditor about correctness and reliability of accounts and the financial position of the business concern.

Question 15.
Audit working papers are the property of
a. Income Tax Department
b. Auditor
c. Owner
d. Government.
Answer:
b. Auditor

Question 16.
Which of the following is disqualified for appointment as auditor of a company?
a. An Officer or Employee of the company
b. A limited liability partnership
c. A Chartered Accountant holding a certificate of practice
d. A firm of Chartered Accountants.
Answer:
a. An Officer or Employee of the company

Hint:
According to Sec. 141(3) there are some persons who are disqualified or not eligible for appointment as an auditor namely:

an officer or employee of the company
a body corporate other than LLP registered under LLP Act, 2008.
A person who IS a partner

Question 17.
Which of the following best describes the primary purpose of audit programme preparation?
a. To detect errors or fraud
b. To assets audit risk
c. Together sufficient appropriate evidence
d. To comply with GAAP.
Answer:
c. Together sufficient appropriate evidence

Hint:
The main purpose of audit programme is that every material area has been audited appropriately and sufficient appropriate audit evidence has been obtained in respect of every important areas of audit.