Assignment Code: ECO-12/TMA/2023-24

Course Code: ECO-12

Assignment Name: Elements of Auditing

Year: 2023-2024

Verification Status: Verified by Professor

Q1) Define the term auditing. Differentiate between Auditing and Investigation. What is continuous audit? Discuss its merits and demerits.

Ans) Definition of the terms Auditing, Investigation and Continuous audit:

Auditing:

Auditing is a systematic and independent examination of financial information and other relevant operations within an organization to ensure that they are accurate and comply with relevant laws, regulations, and accounting standards. The primary purpose of auditing is to provide assurance to stakeholders, such as shareholders, investors, and government authorities, that the financial statements and other information are reliable and trustworthy. Auditors evaluate the financial records, internal controls, and management practices of an entity to express an opinion on the fairness of its financial statements. The process involves gathering evidence, assessing risks, and making a report to stakeholders, typically in the form of an audit opinion.

Investigation:

Investigation, on the other hand, is a broader concept that involves a detailed inquiry into a specific issue or set of circumstances. It is not limited to financial matters but can encompass various aspects of an organization's operations, including financial, operational, or legal matters. Investigations are typically carried out in response to suspicions of wrongdoing, irregularities, fraud, or other specific concerns. The goal of an investigation is to uncover facts, gather evidence, and potentially take legal action or remedial measures based on the findings. Investigations may or may not be carried out by auditors; they can be conducted by internal or external professionals, including forensic accountants, lawyers, or law enforcement agencies.

Continuous Audit:

Continuous auditing is an audit approach that involves the ongoing and frequent monitoring of an organization's financial transactions and controls. Unlike traditional auditing, which is typically conducted periodically (e.g., annually), continuous auditing involves real-time or near-real-time assessment of an organization's financial data and processes. It is made possible by the use of technology, automated systems, and data analytics. Here are some merits and demerits of continuous auditing:

Merits:

a) Timeliness: Continuous auditing provides real-time insights into an organization's financial health, enabling quicker identification and response to issues or anomalies.

b) Enhanced Accuracy: Automation reduces the risk of human errors in data analysis and ensures a higher level of accuracy.

c) Improved Fraud Detection: Continuous monitoring can help identify fraudulent activities as they occur, deterring potential wrongdoers.

d) Better Risk Management: Organizations can proactively identify and mitigate risks, making the business more resilient.

e) Cost Savings: Over time, continuous auditing may reduce the overall audit costs by streamlining processes and minimizing the need for extensive manual testing.

Demerits:

a) Implementation Costs: Setting up and maintaining continuous auditing systems can be costly, especially for smaller organizations.

b) Complex Technology: Implementing continuous auditing requires a sophisticated technological infrastructure and skilled personnel.

c) Data Overload: Real-time monitoring generates a vast amount of data that may be overwhelming to analyse and interpret.

d) Limited Scope: Continuous auditing may primarily focus on financial data, potentially overlooking non-financial aspects of an organization.

e) Privacy Concerns: Continuous monitoring raises privacy issues as it involves constant surveillance of employees and their activities.

Comparison between Auditing and Investigation

Q2) Point out the difference between ‘Verification’ and ‘Valuation’ of assets. Discuss the objectives of verification of assets.

Ans) Comparison between Verification and Valuation:

The objectives of verifying assets are as follows

a) Existence: Confirm that the assets listed in the financial statements actually exist and are present on the specified date.

b) Ownership: Ensure that the assets are owned by the entity and are not subject to any encumbrances or disputes.

c) Condition: Assess the physical condition and state of repair of assets, particularly relevant for items like property, plant, and equipment.

d) Completeness: Verify that all significant assets are included in the financial statements and not omitted intentionally or unintentionally.

e) Valuation: Ensure that the assets are recorded at their appropriate carrying amounts, which may involve verifying that depreciation and impairment charges are correctly calculated.

f) Disclosure: Confirm that the assets are appropriately disclosed in the financial statements and that any related party transactions or contingencies are properly disclosed.

g) Compliance: Ensure that the company's accounting policies for asset recognition and presentation comply with relevant accounting standards and regulations.

Q3) Discuss the position of an auditor in a company under the provisions of the Companies Act. State the qualifications and disqualifications of the auditor of a company.

Ans) Under the provisions of the Companies Act, the position of an auditor in a company is well-defined. The role of an auditor is critical in ensuring the integrity and accuracy of a company's financial statements. The Companies Act, which can vary from country to country, lays out the requirements and regulations concerning auditors. I'll provide a general overview of the role, qualifications, and disqualifications of auditors:

a) Position of an Auditor in a Company:

1) Appointment: Auditors are typically appointed by the shareholders of a company at the annual general meeting (AGM) or by the board of directors, depending on the company's constitution. The auditor's role is to independently examine the company's financial statements and provide an audit report.

2) Duties: The primary duty of an auditor is to assess whether the financial statements present a true and fair view of the company's financial position. Auditors are required to examine the company's accounting records, internal controls, and compliance with applicable laws and regulations. They must report any material misstatements, errors, or irregularities they discover.

3) Independence: Auditors are expected to maintain independence and objectivity. They should not have any financial or personal interest in the company that could compromise their impartiality.

b) Qualifications of an Auditor:

The qualifications of an auditor can vary by jurisdiction and the specific Companies Act. However, some common qualifications include:

1) Professional Certification: Auditors are often required to be certified professionals, such as Certified Public Accountants (CPAs), Chartered Accountants (CAs), or their equivalent in the respective country.

2) Experience: Auditors should have a certain level of practical experience in auditing and accounting.

3) Registration: In some countries, auditors must be registered with a relevant regulatory authority or auditing body.

4) Continuing Education: Auditors are typically required to engage in ongoing professional development to stay updated on changes in accounting standards and auditing practices.

c) Disqualifications of an Auditor:

The Companies Act also outlines conditions under which a person may be disqualified from acting as an auditor.

Some common disqualifications include:

1) Conflict of Interest: An auditor cannot act if they have a direct financial interest in the company, they are auditing.

2) Professional Misconduct: Previous instances of professional misconduct or unethical behaviour can lead to disqualification.

3) Insolvency: If the auditor is declared insolvent, it may result in disqualification.

4) Conviction: A criminal conviction or disqualification from being a director of a company can led to disqualification as an auditor.

5) Age Limit: In some jurisdictions, there is an age limit for auditors, and they may be disqualified after reaching a certain age.

6) Lack of Qualifications: Auditors who do not meet the necessary qualifications or registration requirements may be disqualified.

Q4) State the matters upon which the auditors must form an opinion while preparing their report as laid down in the Companies Act. What do you understand by the concept of ‘true and fair’ in an auditor’s report?

Ans) Auditors, in accordance with the Companies Act and accounting standards, are required to form an opinion on various matters when preparing their report. The specific matters upon which auditors must form an opinion may vary by jurisdiction, but they typically include the following key elements:

a) True and Fair View: Auditors must form an opinion on whether the financial statements present a true and fair view of the company's financial position, performance, and cash flows. This is the central and overarching responsibility of auditors.

b) Compliance with Accounting Standards: Auditors need to assess whether the financial statements comply with applicable accounting standards and regulations. They ensure that the company has followed the relevant accounting principles and methods.

c) Consistency: Auditors consider whether accounting policies applied are consistent with those of the previous year. Inconsistencies should be disclosed and explained.

d) Going Concern: Auditors evaluate the appropriateness of the going concern assumption, which means assessing whether the company can continue its operations for the foreseeable future. They report if there is a significant doubt about the company's ability to do so.

e) Material Misstatements: Auditors must express an opinion on whether the financial statements are free from material misstatements, whether due to fraud or error. They provide reasonable assurance that the statements are reliable.

f) Internal Controls: Auditors assess the company's internal controls, including financial reporting controls, and report on their effectiveness. They identify weaknesses in internal controls that could lead to material misstatements.

g) Audit Evidence: Auditors state that they have obtained sufficient and appropriate audit evidence to support their opinion. This includes examination of financial records, documents, and other sources of evidence.

h) Disclosure of Information: Auditors review the adequacy and appropriateness of the disclosures made in the financial statements. They ensure that all material information has been disclosed.

Concept of 'True and Fair' in an Auditor's Report

The concept of a "true and fair view" is fundamental to the auditor's report and is often a legal requirement in many jurisdictions. It implies that the financial statements should provide a faithful representation of the company's financial position and performance. Here's what it means:

a) True: The financial statements should accurately and faithfully represent the financial position and performance of the company. This means they should not contain material errors, misstatements, or omissions.

b) Fair: The financial statements should be free from bias or distortion. They should not be manipulated to present a more favourable or less favourable picture than what is warranted by the underlying financial transactions and events.

Q5) Write short notes on the following:

Q5a) Cost audit

Ans) Cost audit is a systematic examination of a company's cost accounting records, practices, and procedures to verify the accuracy of the costs reported and to ensure that they are in compliance with the cost accounting standards and relevant laws and regulations. Cost audit is primarily concerned with evaluating the efficiency and effectiveness of a company's cost control and cost management systems.

Key points about cost audit include:

a) Objective: The primary objective of cost audit is to determine whether a company's cost accounting practices are in conformity with the prescribed standards and whether the costs incurred in the production of goods and services are accurately reflected in the financial statements.

b) Mandatory in Certain Cases: In many countries, cost audits are mandatory for specific categories of companies, especially those in industries like manufacturing, mining, and utilities. The requirement for cost audit is typically determined by the government or regulatory authorities.

c) Scope: Cost audit covers a wide range of areas, including the examination of cost allocation, cost classification, inventory valuation, cost control systems, pricing policies, and compliance with cost accounting standards.

d) Independence: Cost audits are typically conducted by independent professionals or firms with expertise in cost accounting. They should be free from any conflicts of interest to ensure objectivity.

e) Compliance with Standards: The auditor evaluates whether the company's cost accounting practices align with the established cost accounting standards. This helps in ensuring uniformity and consistency in cost reporting.

f) Disclosure and Reporting: Upon completion of the audit, the cost auditor provides a report detailing their findings, along with recommendations for improvement. This report is submitted to the management, regulatory authorities, and shareholders, where applicable.

g) Cost Reduction and Efficiency: One of the significant benefits of cost audit is its potential to identify cost-saving opportunities and improve operational efficiency by addressing inefficiencies or cost overruns.

h) Legal Compliance: Non-compliance with cost audit requirements can result in legal consequences, including penalties and fines. It is essential for companies subject to cost audit to adhere to the relevant regulations.

Q5b) Redemption of preference shares

Ans) Redemption of preference shares refers to the process by which a company repurchases or redeems its outstanding preference shares, effectively reducing the number of preference shares in circulation. This is a financial transaction that allows a company to return the invested capital to the preference shareholders or adjust its capital structure as per its financial needs and objectives.

Some key points to consider regarding the redemption of preference shares:

a) Redemption Date: The redemption date is the specific date on which the company agrees to repay the preference shareholders their initial investment. This date is usually predetermined and stated when the preference shares are issued.

b) Redemption at Par or Premium: Preference shares can be redeemed at par value or at a premium. Redemption at par means the company repurchases the shares at their original face value, while redemption at a premium involves repurchasing the shares at a price higher than their face value. The premium amount is typically determined when the shares are issued.

c) Sources of Funds: The funds for the redemption of preference shares can come from various sources, including retained earnings, a new issue of shares, or other forms of capital, depending on the company's financial situation and its ability to meet the redemption obligation.

d) Legal Compliance: Companies need to comply with legal and regulatory requirements, including the provisions of the Companies Act (or equivalent legislation in their jurisdiction), while redeeming preference shares. These requirements can vary by country and may include seeking shareholder approval for the redemption.

e) Cancellation or Retention: Once redeemed, the preference shares are usually either cancelled or retained as treasury shares. Treasury shares can be reissued in the future or used for various corporate purposes.

f) Dividend Arrears: Companies must ensure that any outstanding or accumulated dividends on preference shares are paid to preference shareholders before or at the time of redemption. This is typically a contractual obligation.

Q5c) Vouching

Ans) Vouching is a fundamental and integral part of the auditing process. It is a verification technique used by auditors to confirm the authenticity, accuracy, and legitimacy of transactions and entries in a company's financial records. This process involves examining supporting documents and evidence that substantiate the transactions recorded in the financial statements.

Some key points about vouching:

a) Purpose: The primary objective of vouching is to ensure that the transactions reported in the financial statements are valid, reliable, and consistent with established accounting principles and regulations. It helps in detecting errors, fraud, and misstatements in the accounting records.

b) Documents Examined: Auditors examine a variety of source documents, such as invoices, purchase orders, sales receipts, contracts, bank statements, and payment records. These documents serve as evidence to verify the occurrence of a transaction and its proper recording.

c) Audit Procedures: During vouching, auditors select a sample of transactions or journal entries from the company's records and trace them back to the supporting documents. This tracing process confirms the accuracy of the entries.

d) Internal Control Assessment: Vouching also helps auditors assess the effectiveness of the company's internal controls. It allows them to evaluate whether the established controls are followed in the recording and processing of financial transactions.

e) Fraud Detection: Vouching is a valuable tool for detecting financial fraud, such as unauthorized or fictitious transactions. Auditors look for irregularities or inconsistencies in the documents they examine.

f) Independence: Vouching is performed independently by auditors to ensure objectivity and reduce the risk of overlooking errors or irregularities.

g) Documentation: The results of vouching are documented in the auditor's working papers, and any exceptions or issues identified are reported in the auditor's opinion or report.

Q5d) Internal check

Ans) Internal check is an integral part of an organization's internal control system, designed to prevent and detect errors and fraud within its operations. It involves a system of checks and balances that are put in place to safeguard assets, ensure the accuracy of financial records, and promote operational efficiency.

Some key points about internal check:

a) Objective: The primary objective of internal check is to minimize the risk of errors, irregularities, and fraud within an organization. It helps ensure that financial and operational activities are conducted in a reliable and controlled manner.

b) Division of Duties: Internal check involves the separation of duties among employees. For example, the person who authorizes a financial transaction should not be the same person responsible for recording it or handling the associated funds. This separation reduces the likelihood of misuse or fraud.

c) Rotation of Duties: To prevent collusion and complacency, organizations may periodically rotate employees among different roles and responsibilities. This practice helps identify potential issues and inconsistencies.

d) Documentation and Records: Accurate and complete documentation and records are essential in internal check. This includes maintaining a clear audit trail of financial transactions, approvals, and authorizations.

e) Regular Reconciliation: Internal check encourages periodic reconciliations, such as bank reconciliations, to compare financial records against external statements. This helps identify discrepancies and errors.

f) Supervision and Review: Adequate supervision and review of activities by management are key components of internal check. Supervisors oversee the work of subordinates, checking for errors, irregularities, and compliance with established procedures.

g) Security Measures: Safeguarding assets and sensitive information is an important aspect of internal check. This includes measures such as secure access control, security cameras, and alarm systems.

h) Internal Audits: Internal auditors play a crucial role in evaluating the effectiveness of the internal check system. They conduct independent assessments to identify weaknesses and suggest improvements.

i) Compliance with Policies and Procedures: Internal check ensures that employees follow established policies and procedures. It promotes consistency and adherence to organizational guidelines.

j) Prevention and Detection: While the primary focus is on prevention, internal check also emphasizes the importance of timely detection and reporting of errors, irregularities, or fraud when they do occur.

k) Operational Efficiency: Besides control, internal check also aims to enhance operational efficiency. By streamlining processes and eliminating redundancies, it helps organizations run more smoothly.