Archive for the 'Audit' Category

Cost audit and its Objects

In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.

As per ICWA London “cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.”

In cost audit auditor has to perform the following duties:

  1. Examine the correctness of the cost records maintained by the concern and
  2. To report as to whether the cost accounting plans have been adhered to or not.

Cost audit is done to keep the cost per unit to the minimum.

Object of cost audit (Following are the basic object of cost audit)

  1. To verify the correctness of the cost accounting records.
  2. To find out whether the principles of cost accountancy have been fully and correctly applied in maintaining cost records.
  3. To search for the deficiencies in the cost record system of the company.
  4. To attain efficiency in cost accounting systems and procedures.

Difference between Cost Audit and Financial Audit

The basic nature of audit is checking and it holds good for both the cost audit as well as the financial audit. However following are the points of difference between these two audits:

1. Compulsory nature – Financial audit is compulsory for all the companies registered under companies act, 1956.

Cost audit is not compulsory for all the companies. Only in the case of manufacturing or mining companies they have been specifically asked by the central government to maintain cost accounts under section 209 and get those accounts audited under section 233b.

2. Purpose – The purpose of the financial audit is to report on the profit and loss account and balance sheet as to whether they show true and fair view of the business or not.
The purpose of the cost audit is to certify that whether the expenditure incurred on the production of items has been incurred prudently or not.

3. Expression of opinion – The financial auditor has to comment upon the accuracy of the transactions recorded and the cost auditor has to comment upon the correctness and wise ness of the decisions taken in production of items.

4. Instance – Financial audit is conducted at the instance of the shareholders.

Cost audit is done at the requirement of third parties like government, industrial organizations etc.

5. Appointment – Financial audit is appointed normally by the shareholders in the general meeting whereas the board of directors with the previous approval of the central government appoints a cost auditor.

6. Recurrence – Financial audit is conducted every year whereas a cost audit may be done in the year in which it is required by the government or any other agency.

7. Stock – In financial audit auditor has to check the exact value of closing stock for the purpose of balance sheet, whereas in the cost audit the auditor has to check the adequacy of the stock keeping in view of the needs of the concern.

8. Report – In the financial audit the report is submitted to the management to be laid in the general meeting of the shareholders, the report of the cost auditor is submitted to the company and also to the central government within 180 days from the end of the company’s financial year to which the cost audit

Auditing in an electronic data processing environment

There are certain special circumstances of the edp audit which make it different form other manual audit which make it different from other manual audits. These are discussed in brief below:

• Absence of audit trail – In the computerized accounting and processing it is possible that there may not exist the proper working sequence that is available in a manual accounting system. As a result it may pose serious hindrance for the checking of the auditor. For example, in a manual accounting the purchase vouchers are first entered in the purchase book then the entries are posted to the ledger.

From ledger accounts the trail balance is made. Trial balance makes the base for the preparation of the profit and loss account and the balance sheet. In an edp accounting, the data may be available in the final stage only after being entered in to the system. An auditor may fine only the end figure to verify, without getting the intermediary records. This makes his job of verification little difficult. Manipulations might have been done in the records that may be difficult to detect.

• Chances of manipulations – the records kept on computer are more vulnerable to manipulations. Best were the days when the accounting was done in the bounded books. Any changes in such records were noticeable immediately. Neither the figures could be changed, nor any pages of such records could be removed.

Now in an edp accounting figures as well as pages could be changed with the stroke of a finger. Moreover such after changes are not visible at all. Therefore the auditor should be very careful while checking the computerized accounts. It should be kept in mind that it might contain manipulations.

• Leakage of confidential information – It is very easy to copy delete or steal the records maintained on a computer. Any person who has an access to the computer can copy any important file or record within a fraction of a minute. The records kept on a computer should be properly guarded also.

• Computer virus and other failures- Records maintained on computer are prone to much distortion. The most important of such problems is the virus that can damage the whole data within no time. Computer and software breakdowns can damage the hard disc of the computer and as such the data may be lost permanently.

Proper safeguard against such misshapenness should be made. One solution for such problems is that proper backup of all the records be made and kept at a secure place.

Audit process in an edp environment

In an EDP (ELECTRONIC DATA PROCISSING) audit the auditor may not vouch each and every transaction but he must perform overall analytical checking to ensure that the financial records show true and fair view of the business entity.

Audit process in such a system may involve following steps:

Evaluation of the internal control system – Auditor should care fully evaluate the internal control system.

He should check the system existing in the entity, as well its actual use by the business.

It is possible that whereas a well designed system is present but it is not put to use by the management. Based upon the evaluation of such a system, the auditor should decide the degree of reliance that can be placed on it.

Checking the records – After checking the reliability of the internal control system auditor should proceed to checking the record produced by the system. He should check the basic records available in the entity. As far as possible auditor should insist on maintaining the supporting vouchers which can be checked with the books of accounts.

Explanation and information – Auditor should make inquiries from the management and staff regarding the work. Basing on such inquiries he can decide upon the truthfulness of the financial records.

Analysis of the financial statements – Auditor should then check the financial statement prepared form the books of account. All the other checking methods should be applied as are used in the manual auditing.

Definition of Internal Control

Internal control is a whole system of controls financial and otherwise, established by the management for the smooth running of business; it includes internal cheek, internal audit and other forms of controls.

According to sap-6 entitled, “Study and evolution of the accounting system and related internal control may be defined as “ the plan of organization and all the methods and procedures adopted by management’s objectives of ensuring as far as practicable the orderly and efficient conduct of its business including adherence to management policies the safe guarding of assets, prevention and detection of fraud and error, the accuracy and completeness of the accounting records and the timely preparation of reliable financial information. The system of internal control extends beyond those matters which relates control directly to the functioning of accounting system.”

Internal control is a combination of the following:

1. Financial controls, and
2. Other controls

According to the institute of chartered accountants of India internal control is the plan of organization and all the methods and procedures adopted by the management of an entity to assist in achieving management objective of ensuring as far as possible the orderly and efficient conduct of its business including adherence to management policies, the safe guarding of assets prevention and detection of frauds and error the accuracy and completeness of the accounting records and timely preparation of reliable financial information, the system of internal control extends beyond those matters which relate to the function of accounting system. In order words internal control system of controls laid down by the management for the smooth running of the business for the accomplishment of its objects. These controls can be divided in two parts i.e. financial control and other controls.


• Controls for recording accounting transactions properly.
• Controls for proper safe guarding company’s assets like cash stock bank debtor’s etc
• Early detection and prevention of errors and frauds.
• Properly and timely preparation of financial records I e balance sheet and profit and loss account.
• To maximize profit and minimize cost.

Other control – Other controls include the following:

• Quality controls.
• Control over raw materials.
• Control over finished products.
• Marketing control, etc

Some charecteristics of an internal check system.

Division of work – a work job should be divided into small parts and every part of the job should be allotted to a different worker. No one person should be allowed to handle a complete job.

Work rotation – The job among the clerks should be rotated over a period of time so that no one should occupy one position for a long period of time. Holding the same position over a period of time gives that parson chances of manipulations and his errors may also remain undetected.

Delegation of authority – There should be clear-cut delegation of authority. Every worker should know that they should be allowed to work within the level of their authority.

Fixing the responsibilities – responsibilities of all the workers should also be fixed. They should know that they are responsible for a particular type of errors or frauds.

Separating custodian and record keeper – A person who is responsible of keeping custody of a particular asset should never be the person responsible to record transaction regarding it.

Relying on internal check system – Before starting an audit, auditor should examine the internal check system if it is present in the organization. If the check system is efficient, he can rely on it and depend on test checking for the completion of audit.

He should carefully examine the system and then work with caution, if on the other hand during the checking of the books of accounts some point come to his thoroughly, if he ignores those irregularities and later on errors and frauds remain undetected he may be held liable a good internal check system can reduce the extent of work that an auditor has to put for doing the audit but in no case it can reduce his liability. Ultimate responsibility remains with the auditor.

Therefore, it is up to him to decide that how efficient is the internal check system and to what extent he can rely on it he should make a decision and then he should decide the level of his checking.

Difference between Internal Audit and Statutory Audit

Following are the main points of difference between internal audit and statutory audit:

1. Appointment – The management of the organization makes the appointment of an internal auditor. The statutory auditor is appointed by different authorities. First statutory auditors are appointed by the shareholders in the annual general meeting.

2. Qualification – Qualifications of the statutory auditor are prescribed in the companies act, 1956. Essentially a person should be a practicing chartered accountant to be appointed as a statutory auditor. There are no fixed qualification for the position of an internal auditor.

3. Objects – The main object of the statutory audit is to form an opinion on the financial statement of the organization auditor has to state that whether the financial statements are showing the true and fair view of the affairs of the organization or not. The main object of the internal audit is to detect and prevent the errors and frauds.

4. Scope – The scope of the statutory audit is fixed by the company’s act 1956. it can not be changed by mutual consent between the auditor and the management of the audited business unit. The scope of the internal audit is fixed by the mutual consent of the auditor and the management of the unit under audit.

5. Remuneration – Remuneration of the statutory auditor is fixed by the appinting authority, I e in case of first auditors, the auditors the directors fix the Remuneration in case of the subsequent auditors the company in its general meeting fixes the remunration. In case of internal auditor the management who appoints him fixes his Remuneration.

6. Report – The statutory auditor submits his report to the shareholder of the company in its general meeting. The internal auditor submits his report to the management of the company who is also his appointing authority.

7. Removal – The procedure of removal of the statutory auditor is very complex. Only the company in the general meeting can remove the auditor. It also has to take the permission of the central government. The management of the entity can remove internal auditor.

Internal Check System

Internal check system is such a system in which duties of different assistants are divided and allocated to each other in such a way that their work is supplementary and dependent upon each other. By this system the work is automatically checked as it is done.

Since one particular job is not assigned to any single individual chances of mistakes are very less. Division of work and delegation of authority are two basic principles that help this system work.

For example withdrawal of money from a bank: – In this case on clerk enters the cheque in the books of account or ledger. Second person checks the credit balance available in the account and third person gives the payment. In this way, there is a division of work and authority and chances of mistake are minimized.

According to L.R. Dicksee: – “ internal check is such an arrangement of book keeping routine that errors are likely to be prevented or discovered by the very operation of the book-keeping itself”.

Internal control – what does it mean in India

Internal Control – Internal control system is best regarded as the whole system of controls financial and otherwise made by the management in the conduct of a business entity which include internal check system, internal audit and other forms of controls.

The management lays down internal control. This system contains plan methods and procedures of work done by various departments of an entity. It is the total system of controls and includes two basic parts:

1. Financial Control System, and
2. Other Control System.

1. Financial Control System – This part of internal control system deals with aspects relating to the financial matters. For example, control over bank accounts: control over cash in hand, bills payables, debtors and creditors.

In this control system payments received by the organization and payments made by the organization are totally controlled. It ensures that cash may not be misappropriated. For maintaining such a control, proper entries in books of accounts have to be maintained regarding the receipt and payments of cash.

2. Other Control Systems – Other Control Systems involve controls relating to the other activities of the organization. For example, production, advertising, marketing, quality etc.

First part of internal control system is a very important to the auditor as it deals with the financial matters. Second part is not so important to him.

Before starting the audit, auditor should study the internal control system of the organization thoroughly. It helps him to decide the extent of checking during the conduct of audit. If the auditor finds out the weaknesses in the system or its operation, he reports it to the management by a letter. Such a letter is called ‘letter of weakness’.

This letter of weakness lists down the areas of weakness in the system and offers suggestions for improvement. It helps management to amend the systems.

If the organization has good internal control system, the auditor can reduce the extent of checking and depend upon test checks. Otherwise, he has to conduct detailed checking during the audit.

Relationship between internal auditor and statutory auditor.

The relationship of the internal auditor and statutory auditor can be summed up as follows: -

1. As per manufacturing and other companies order 1988 issued under section 227 of the companies’ act the statutory auditor has to comment upon the effectiveness and suitability of internal audit system laid down be the management.

2. To discharge this responsibility: statutory auditor should evaluate the internal audit system he should evaluate the strength of the internal audit staff, their qualification and experience.

3. Evaluation of the actual work of internal auditor – After studying the internal audit system and structure actual work of the internal auditor should also be evaluated. Statutory auditor has to make use of the work of internal auditor. This he can do only when he himself puts faith in the work of internal auditor.

4. Relying on the work of internal auditor – statutory auditor has to decide that up to what extant he can rely upon the work of the internal auditor. This will decide the extent of his own checking. If he feels that internal auditor has properly done his work he can reduce the extent of his checking.

5. No reduction in responsibility – Relying on work of internal auditor in no way reduces the responsible for the discharge of his duties as statutory auditor.

Relying on the internal auditor can only reduce the burden of the statutory auditor.

For all his works statutory auditor would remain responsible.