Define Auditing And Describe Its Different Techniques AIOU 5417 481
AUDITING
Audit is the procedure of checking and determining the accuracy, reliability, correctness, and completeness of financial records and their compliance with financial statements. In other words, we may say that auditing is an examination of the books of accounts and vouchers of a business.
Origin of Auditing
The work of audit originated when the necessity was felt to set up some system of check upon the persons who recorded receipt and disbursement of money on behalf of others. In the early stages of civilization, the methods of account were so crude and number of transactions to be recorded so small that each individual was able to check all the transactions himself.
From an early date, it was customary to perform an audit of the accounts of manors and estates, and the persons who performed this duty came to be known as auditors. The word auditor was originally derived from a Latin word ‘audire’, which means ‘to hear’ as the accounting parties were required to attend before the auditor, who heard their accounts. Business men used to appoint auditors to hear accounts matters relating to their business. The auditors have to rely on the statements of the accounting staff regarding the receipt and payments. When Principles of double entry were introduced and published in year 1494 at Venice by Luca Pacioli, the duties of the auditor correspondingly increased. With the passage of time, there have been developments in the field of accounting which resultantly made improvements in the field of audit.
The increase in volume of trading operations necessitated the use of more capital than was at the disposal of average trader; this induced them to combine in partnership with others for the purpose of obtaining the requisite funds. This tendency was an important factor in the evaluation of a more perfect system of accounts. In 19th century, an enormous increase in trade occurred which led to the formation of joint stock companies involving the use of large sums of capital under the management of a few individuals. Under these conditions, the professional management started to be hired for running business, which resulted in the separation of ownership from business administration. These revolutions made the audit a profession.
The main purpose of audit is to express opinion about the correctness and reliability of accounts and the financial position of the business concerned. The auditor is an expert in the field of auditing. It is due to his expertise and independence of his professional opinion that audited accounts are treated as reliable not only by owners but also by the government, business community and general public. His attitude, training, principles and the procedures that he employs have enabled him to attain the present high status that he occupies.
TECHNIQUES OF AUDITING
The audit techniques may be defined as the methods used by the auditors for collecting the necessary evidence in order to enable them to form and give a professional opinion. Auditor is concerned to collect valid evidences from the books of accounts of his client to form a fair opinion to be reported in the audit report; hence it is very important to select the appropriate technique/method of audit, which particularly suits the situation.
There are number of audit techniques which suit in different situations. The techniques are tools in the hands of the auditors for gathering the necessary evidence. These techniques are used within the framework of auditing principles.
To conclude, we can say that these techniques are tools of the auditor and like any skilled man’s tools, no attempt should be made to scale/rank them in order of superiority. All tools have their uses and for a given task, the appropriate tools should be selected.
Auditing is just like research: gathering all possible information and evaluating it. The methods used by the auditors for collecting the necessary evidence are called audit techniques, which are as follows: –
MAIN TECHNIQUES OF AUDITING
Some of the important audit techniques are as follows: –
- Vouching
- Physical Verification
- Confirmation
- Scanning
- Inquiry
- Reconciliation/ Correlation with related
- Retracing the bookkeeping procedure
- Re-computation
- Examination of the subsidiary ledger
- Observation
- Flow
Vouching/Examination of original document.
Every transaction has a document as evidence. These documents are the basis of records and evidence of a transaction. In examining the recorded transaction, the relevant documents will be examined. This examination of the documents and the transactions recorded on the basis of the documents is called “vouching”. While vouching, the following four points should always be kept in view by the auditor:
Appropriateness
It means that the transactions must be appropriate to that company. They must not be about the purchase of personal items for employees or transactions of another company.
Authenticity of documents
If the auditor is alert, he can discover a fraudulent document.
Proper approval
The proper signature of the competent authority approving a transaction is a must.
Proper recording
The recording should be under proper classification and under proper and correct head of account. In certain cases where the original is not available, duplicate of documents must be examined, e.g., sales invoice, shipping documents etc.
Physical Verification
The concept of physical verification is to satisfy that the thing exists. It is essential that the auditor must be able to identify a specific thing he is auditing, e.g., a machine or an item of inventory. He should also be able to recognize the quality of the thing, e.g., the quality of the item of inventory. If an auditor is unable to recognize the quality, the very purpose of physical examination would not be served. Genuineness of a thing is also to be considered by an auditor, but it does not mean that he must recognize, say, a counterfeit note. He is not considered an expert on the things he is auditing; but he is expected to be a responsibly alert and intelligent professional man.
This technique can be successfully applied to examine material-in-transit, material-in-process, etc. The auditor should make advance preparation or such examination. This technique works well provided that advance preparation is done.
Confirmation
Confirmation means obtaining a written statement from outside parties who are qualified to affirm. This technique gives very reliable information and is normally used in case of bank balances, balances or customers accounts, contingent liabilities, items stored in a warehouse or a title to property. The confirmation request should be made by the company and not by the auditor because outside parties will not refuse to reply due to their commercial relations with the company. The company should, however, ask the customers to send their replies to the auditor direct. This procedure to control the confirmation will be discussed in a later unit. Where interception or alteration is possible, the technique cannot be relied upon.
Scanning
To scan, in ordinary language, means to examine point by point. In auditing, it has been defined as a critical study of accounts, a book of original entry or any other record or summary. The auditor develops a sense, which enables him to spot where the trouble is. Generally, it is said to be the sixth sense of an auditor but it is a misnomer. The fact is that he develops a sense to identify what are usual items, and what are unusual items of things, which are to be investigated for accuracy and correctness. The examples of unusual items are: sales of 13 months in a year; any unusual journal entry, an unusual item etc.
From the above, it will be seen that it is the most indefinite technique. There are no rules for it. Experience is the only guide but it is an effective tool in the hands of an experienced auditor.
Inquiry
Inquiry involves asking questions and obtaining their satisfactory answers. The answers may range form casual conversational comments to formal statements in writing. The auditor must put related questions to bring out relevant and required information. The answers should clear the obscure points. Telephone or verbal queries or one single answer are not good evidence for an auditor to rely on. The inquiry is an art, which is very useful for an auditor; the rules can at best be only guides. It is the experience, which counts.
Correlation with related information
In the double entry system, there are two aspects of transactions. The two aspects should be examined to establish their relationship with one another. Provision for bad and doubtful debts account and bad debt expense account have got relationship. Suppose that provision at the beginning of the year is Rs.900/- and addition to it at the end of the year is Rs.300/-. The auditor should check
whether the item “Bad Debt Expense Rs.300/-“ exists. In case the Bad Debt Expense Rs.300/- exists, it shows that the account is free from double entry error. Many similar examples are found. They are: Insurance Expense and Un-expired, Tax Expense and Accrued Taxes, Interest Expense and Accrued Interest, Interest Expense and Bills Payable, Cash Sales and Bank column of cash book, Sales in units and sales in rupees. This process is also called “Reconciliation,” i.e., relating one ledger account balance or other piece of information to another. To an experienced and alert auditor, this inter-relationship gives evidence or support to evidence.
Retracing the bookkeeping procedure
The auditor should check the postings: (1) to subsidiary and general ledger, (2) from general ledger balances to the trial balance, and (3) from subsidiary ledger balance to the trial balance of the subsidiary ledger.
Re-computation
Re-computation means that all the working should be re-totaled and re- calculated by the auditors. Even paper tapes of calculating machines should not be considered as authentic because such tapes may be so manipulated that they can show wrong total figures.
Further, components of the total figures must also be re-totaled. For example in case of wages, which are made of so many components e.g., rate of wages, hours worked, etc., each component should be recalculated and re-totaled.
Examination of the subsidiary ledger
The auditor should see that the subsidiary records are supported by certain evidences, which are considered by him as satisfactory. He should be particular to take note of the items, which have recently been introduced. The entries in the subsidiary records should be examined to see if they are entered: (1) carelessly, and (2) haphazardly. Such records should put him on the alert.
Observation
Of all the techniques of auditing, observation is the most general one. It is not limited to any particular verification nor tied to any particular work. During the course of his work, the auditor gets the opportunity to see and observe the activities, which are related to reliability of the financial statements. He sees the workers and officials working in the various departments. He sees how the assets are protected. He is alert to observe any condition or activity, which has effect on his pronouncement of opinion. For example, while moving in the company, he may observe that Mr. X. does work which is to be checked by another man Mr. Y, but in actual practice, both of them prepare the work, sign and pass it on. This state of affairs is against the internal check. The auditor must conclude that the internal check is not being practiced; it is only on paper. Handling of cash and treatment of obsolete and damaged inventories are other examples where the technique of observation can be very effective and useful.
Flow Charting
These charts illustrate in diagrammatic form, the flow of documents in their sequence from beginning of a transaction to its final entry in the books. They make use of symbols and lines to represent documents and their movement, respectively.