Discuss the various Objective of Auditing.
The objectives of auditing maybe classified into two categories:
- Primary or main objects.
- Secondary or subsidiary objects.
Primary or Main Object of an Audit:
The main object of.a audit is to verify and establish that at a given date balance sheet presents a. true .and fair view of the financial position of the business and the Profit & Loss account gives the true and fair view of profit or loss for the accounting period. It is to be established that accounting statements satisfy certain degree of reliability.
It is required under Companies Act that whether the books of accounts are kept according to the Act and whether necessary accounting and audit standards are followed and they show true and fair view of the state of affairs of the company to the best of his information and knowledge.
The auditor has to conduct an independent review of financial statements about their reliability. To form such an opinion, the auditor must examine the system of internal control and internal check, arithmetical accuracy of books of accounts, validity of transactions entered in the books and confirm the existence and value of assets and liabilities.
Secondary or Subsidiary objects of an Audit:
Detection and Prevention of Fraud
When something is being done with an intent to deceive, to mislead or to conceal the truth, it is an art of fraud. It is done knowingly and intentionally to defraud the owners of the business. Frauds are more difficult to detect than unintentional errors. The detection of frauds is one of the objects of auditing.
Frauds divided into the Following categories:
Embezzlement Misappropriation of cash:
Misappropriation of cash is usually done by theft of cash receipts, cheques, negotiable instruments, showing fictitious payments to workers, creditors, purchases etc. When a person is not subject to any form of check, such person has a number of opportunities and methods of committing frauds in a small business, the possibility of such fraud remaining undetected is remote.
But with the increase in size of business, the opportunities of committing fraud also increase because the owners of business have no direct control over receipts and payments of cash. The transactions relating to the receipt of cash are omitted from the records or recorded with the lesser amount in the cash book, thereby all such cash or a part of it is pocketed by the cashier. Similarly, false payments of. cash or over -payment of cash is shown in the cash book.
A strict internal control system shall be adopted for receipts and payments of cash so that work of one clerk is automatically checked by another. It may be a good practice to check misappropriation of cash. The auditor should check cash transactions thoroughly.
Misappropriation of goods:
This type of misappropriation is difficult to detect unless proper stock records are maintained. It is easy to misappropriate goods which are less bulky and of high value. The goods may be removed by a member of the staff for his personal benefit.
The sales return may be misappropriated before such goods are received by the stokeeper.Efficient system of record keeping, periodical checking, internal check and adequate external security arrangements will be helpful to avoid misappropriation of goods. Misappropriation of goods can be detected by thorough checking of records and physical verification of stock.
Manipulation of Accounts:
The accounts of a business can be falsified or manipulated by making false entries regarding fictitious purchases, sales, expenses etc. Whenever such fraud is committed it usually involves large amounts and is intentional. The information is manipulated to suit the intentions of persons involved there in. Normally the intention is to increase or decrease the profits.
This type of fraud is usually committed by owners, managers, directors, board of directors etc. The object of showing low profits than the actual ones may be as follows: (a) To purchase shares from the market at’ a low price, (b) To reduce tax liability, and (c) To give wrong impression in the market about success of business.
The object of showing more profits than the actual ones may be as follows:
- To increase market price of shares.
- To mislead the competitors.
- To mislead shareholders in the Annual General meeting.
- To get more commission when it is paid on the basis of profits.
The manipulation of accounts may be done e.g.,
- Showing losses to avoid taxes and to deceive shareholders,
- Falsification of accounts to deceive creditors, bankers etc.
- Showing high profits than the actual to inflate the rate of dividends,
- Increasing sales by fictitious entries by certain officers to earn more commission.
The financial position is shown in such a way that it seems to be better than what it is. Window dressing is more of misrepresentation than fraud. Window dressing may be done in any of the following ways:
- Purchase of a year, may be shown as of next year.
- Income of preceding year may be recorded in the current year.
- Expenses of current year may be shown as of next year.
- Showing short-term liabilities as long-term liabilities.
- Providing inadequate depreciation and bad debts.
- Charging revenue expenditure as capital expenditure.
- Over or under valuation of assets and liabilities.
- Inflating the profits, or deflating losses by entering non- existent items of sales, purchases returns.
- Utilizing secret reserves during the depression period without making the fact known to shareholders.
Detection and Prevention of Errors
Errors of Principle:
When principles of book-keeping and accountancy are not followed such an error is error of principle. For examples. Treatment of revenue expenditure as capital expenditure or vice -versa e.g., repair of plant and machinery debited to plant and machinery account, or purchase of Plant and Machinery debited to purchase account.
Errors of Omission:
When a transaction is omitted fully or in part from the books of accounts, such errors are known as errors of omission. Where the transaction is totally omitted, it will not affect the Trial balance and is more difficult to detect.Following are its examples:
- Omission of purchases from Purchase Book or sales from Sales Book.
- Omitting the entry for charging depreciation in the books.
Omissions, which are completely omitted from the books, are difficult to locate. Thorough checking of sequence of vouchers may help the auditor to locate such omission. Attention must always be drawn if there is a big break in the series of vouchers. Omission of purchase vouchers from the books is difficult to locate. But when payment is made to a supplier for which no purchase entry appears in the account of such supplier, the omission can be located. Errors of omission may be intentional or otherwise. But in both the cases profit or loss of the year is affected.
Errors of Commission:
When entries made in the books of original entry or ledger are incorrect either wholly or partially, such errors are the errors of commission. For example, posting from original book of entry is wrongly made or made in wrong account on wrong side or of wrong amount is errors of commission. Some of the wrong entries affect Trial Balance and some other do not.
Errors of Duplication:
When a transaction is recorded twice and also posted twice in the ledger, such an error will not affect the Trial balance. Sometimes the supplier sends the invoice in duplicate and both the copies of the bill are recorded separately.It is more difficult to locate such errors. Only thorough checking and comparing of vouchers with entries in the books of original entry will reveal such errors. While going through an account, will reveal errors of duplication, if two entries on the same side are appearing with same amount,
When an error offsets the effect of another error, such errors are known as compensating errors. These errors do not affect agreement of Trial balance, hence can’t be located by the auditor easily.These errors can be located by checking the total, posting and casting. Some of these errors may affect the profits of the year.