INTERNAL AUDIT AND CONTROL MF0013

Q. 1 Define and explain the term auditing. Discuss, in brief, the advantages and limitations of auditing.

ANS. 1. The word 'Audit' is originated from the Latin word 'audire' which means 'to hear'. In the earlier days, whenever there is suspected fraud in a business organization, the owner of the business would appoint a person to check the accounts and hear the explanations given by the person responsible for keeping the account and funds. In those days, the audit is done to find out whether the payments and receipt are properly accounted or not. The objective of modern day accounting is not only for the verification of cash but to report the financial position of the undertaking as disclosed by its Balance sheet and Profit and Loss account. Definition of Auditing A precise definition of the term 'Auditing' is difficult to give. Some of the definitions given by different authors are as follows: According to Montgomery, a well known author, "auditing is a systematic examination of the books and records of a business or the organization in order to ascertain or verify and to report upon the facts regarding the financial operation and the result thereof. " Spicer and Pegler expanded the above definition as follows: "An audit may be said to be such an examination of the books, accounts and vouchers of a business as well enable the auditor to satisfy that the Balance Sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and whether the Profit or Loss for the financial period according to the best of his information and the explanations given to him and as shown by the books, and if not, in what respect he is not satisfied." 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." It is clear from the above definitions that auditing is the systematic and scientific examination of the books of a accounts and records of a business so as to enable the auditor to satisfy himself that the Balance Sheet and the Profit and Loss Account are properly drawn up so as to exhibit a true and fair view of the financial state of affairs of the business and profit or loss for the financial period. The Auditor will have to go through various books and accounts and related evidence to satisfy himself about the accuracy and authenticity to report the financial health of the business. Advantages of Auditing It is compulsory for all the organizations registered under the companies act must be audited. There are advantages in auditing the accounts even when there is no legal obligation for doing so. Some of the advantages are listed below: 1. Audited accounts are readily accepted in Government authorities like income Tax Dept., Sales Tax

dept., Land Revenue departments, banks etc. 2. By auditing the accounts Errors and frauds can be detected and rectified in time. 3. Audited accounts carry greater authority than the accounts which have not been audited. 4. For obtaining loan from financial institutions like Banks, LIC, HUDCO, HDFC, IFCI etc., previous years audited accounts evaluated for determining the capability of returning the loan. 5. Regular audit of account create fear among the employees in the accounts department and exercise a great moral influence on clients staff thereby restraining them from commit frauds and errors. 6. Audited accounts facilitate settlement of claims on the retirement/death of a partner. 7. In the event of loss of property by fire or on happening of the event insured against, Audited accounts help in the early settlement of claims from the insurance company. 8. In case of joint Stock Company where ownership is separated from management, audit of accounts ensure the shareholders that accounts have been properly maintained, funds are utilized for the right purpose and the management have not taken any undue advantage of their position. 9. To determine the value of the business in the event of purchase or sales of the business, audited account will be the treated as the base for the evaluation. 10. The audit of accounts by a qualified auditor also help the management to understand the financial position of the business and also it will help the management to take decision on various matters like report in internal control system of the organization or setting up of an internal audit department etc. 11. If the accounts have been audited by an independent person, disputes between the management and labor unions on payment of bonus and higher wages can be settled amicably. 12. In the event of admission of a new partner, audited accounts will facilitate the formation of terms and conditions for joining the new partner. Last 3 years audited accounts and balance sheet will give a general idea about the growth and financial position of the business to the new partner. ADVANTAGES & LIMITATION OF AUDIT Advantages of Auditing A. General 1. Unbiased professional opinion 2. Acts as a moral check on employees 3. Highlighting of weakness in the internal control system 4. Enables timely tax assessments and quick disposal of tax returns.

5. Financial assistance made easier. 6. Solutions to trade disputes and labour disputes 7. Enables sanctioning of license by Govt. 8. Enables early settlement of Insurance claims B. From the point of view of partnership Firms 1. Mutual settlement of Accounts among the partners 2. Protects the interest of minors and non-resident partners 3. Determination of goodwill at the time of admission, retirement and death. 4. Determination of purchase consideration at the time of Amalgamation, Limitation of Audit 1) Excessive dependence in ICS which suffers from inherent weakness 2) Application of test check makes it less reliable 3) It only enables formation of overall opinion about state of health of entity and does not give assurance about the future viability of entity or the effectiveness of management by owners. 4) Audit evidence is more persuasive in nature rather than conclusive in nature Q. 2 Distinguish between Secretarial audit and Cost audit. Ans.2. Secretarial audit Secretarial audit may be called as legal audit. A company registered under the Companys Act, 1956 has to comply with various provisions of the Act. A company secretary ensures that the workings of the company are in accordance with the provisions of the Act and other applicable law. The Companies Act has made Secretarial audit mandatory for companies having paid up share capital of rupees two crores or more by a whole time secretary. The whole time should be a member of the Institute of Company Secretaries of India. In terms of section 233A of the Companies Act, the Central Government is empowered to order a special audit of the accounts of a company for a specified period where it is of the opinion that: The affairs of the Company are not being managed in accordance with sound business principles or prudent commercial principles; or Any company is being managed in a manner likely to cause serious injury or damage to the interest s of the trade ,industry or business to which it pertains; or That the financial position of any company is such as to endanger its solvency.

Special audit under the Act is conducted by professionally qualified Accountants in the same manner as any company audit with the main difference that the special auditor submits his report to the central Government instead of shareholders as in the case of a company auditor in the normal course. Cost audit Cost audit is the verification of the correctness of cost accounts based on cost accounting principles. Cost accounts are related to the cost of goods produced or service provided by the enterprises. As per the Companies Act, Cost audit is compulsory only for some specified companies. According to amended section 233B of the Companies Act, the Central Government may, if it feels necessary, by an order direct that an audit of the cost records kept by a company under section 209(1)(d) shall be conducted by a cost auditor within the meaning of the Cost and Works Accountants Act, 1959 in such manner as may be specified in the order. Cost audit being in the nature of efficiency audit is very beneficial to society at large. Q. 3 What is internal check? Explain with example. According to the Guidance note on terms used in Financial Statements issued by The Institute of Chartered Accountants of India, Internal Check means: A system of allocation of responsibility, division of work and method of recording transactions, whereby the work of an employee or group of employee is checked continuously by correlating it with the work of others. An essential feature is that no one employee or group of employees has exclusive control over any transaction or group of transactions. Internal check is an important process of internal control system. Under the system of internal check, it is ensured that the job performed by one employee gets checked, automatically by another employee. No employee, alone, allowed handling transactions from beginning to end. Example: When you visit a bank branch to encash a cheque. First, you produce the cheque to the counter, where the official concerned issue a token and enters the token number on the back of the cheque and in the token book. The cheque is then send to the ledger clerk, who verify the balance in your account and makes debit entry therein. The cheque then sent to an officer, who verify your signature on the cheque with bank records and if it tallies then he sends the cheque to the cashier to make payment. The cashier make the payment against the token handed over to you and records it in his cash register. This is an excellent example of internal check. Here arrangement is such that the job of one employee is automatically checked by other. We can summarize some characteristics of internal check as below: a) Proper segregation of duties. b) Automatic checking of job. c) Multiple recording of same transactions. d) Rotation of jobs. e) Prevention of errors and frauds. f) Separation of custodial and recording functions.

Q. 4. Discuss about the role of internal auditor as a part of management. Ans. The role of internal auditors should be to constantly review and monitor the policies, procedures, budget and targets of the organization. Deviations, if any, should be immediately reported to the appropriate authority. The role of internal auditor as a part of management are: 1. Review of Internal Control System: The internal auditor should review the internal control system of the organization. He should determine whether the existing control system is appropriate and adequate keeping in view the objectives of the organization. 2. Review of Safeguards for Assets: The main concern of management is to establish that all assets of company are adequately protected against any damage or loss of any kind. An internal auditor can play a very important role by reviewing the means used for safeguarding assets against losses mainly fire, theft, damage due to improper use etc. 3. Review of Compliance with Policies, Plans, Procedures and Regulations: Every company has its own policies, plans, procedures and regulations for conducting various managerial and non-managerial functions. In this context, internal auditor should verify that: a) There is an adequate system by which the policies and plans are communicated to all concerned, and b) There is proper compliance of policies, plans, procedures and regulation by all. 4. Review of Organization structure: The internal auditor should examine organization chart to find out whether the structure is simple and economical and that no functions enjoys an undue dominance over the others. 5. Review of Utilization of Resources: Internal auditor should compare the standards with actual and try to find out the deviations therein. Reasons for deviations should also be established. Identifying the facilities which are underutilized is an important function of internal auditor. 6. Review of Reliability of Information: Internal auditor should regularly evaluate the reliability and accuracy of financial and operating information of the organization. He should also check the format and design used for receiving and sending management information. 7. Review of Achievements of Goals and Objectives: Internal auditor should review the contribution of every department towards achievements of objectives. He serves as medium through whom the top management get reports of its accomplishment of objectives.

Q. 5. Explain the different stages in internal audit planning. Ans.5. The different stages in Internal Audit Planning are: 1. Planning Stage: The internal auditors should plan his work in such a manner that he and his team can conduct audit in an efficient and timely manner. The main purposes of internal audit planning are: a) to determine priorities and to establish the most cost-effective means of achieving audit objectives; b) to assist in the direction and control of audit work; c) to help ensure that attention is devoted to critical aspects of audit work; and d) to help ensure that work is completed in accordance with pre-determined targets. The stages planning are: a) to identify the objectives of the organisation; b) to define internal audit objectives; c) to take account of relevant changes in legislation and other external factors; d) to obtain a comprehensive understanding of the organisation's systems, structure and operations; e) to identify, evaluate and rank risks to which the organisation is exposed; f) to take account of changes in structures or major systems in the organisation; g) to take account of known strengths and weaknesses in the internal control system; h) to take account of management concerns and expectations; i) to identify audit areas by service, functions and major systems; j) to determine the type of audit: e.g. systems, verification or value for money; k) to take account of the plans of external audit and other review agencies; and l) to assess staff resources required, and match with resources available. 2. Execution Of work: To carry out the work as per the detailed annual plan, a work allocation plan is prepared each month showing in detail the exact assignments to be handled by each member of the internal audit staff, the estimated time against each assignment, the name of the person to be contacted and the name of the assistant manager supervising the assignment. 3. Weekly Report: To exercise proper control over the progress of internal audit, weekly reports are prepared by each member of the staff. These reports are reviewed and discussed by the assistant manager concerned and internal audit manager every Monday. 4. Preparation Of Audit Reports: Based on the results of the various audit assignments, regular reports are prepared by the internal audit staff. These reports are reviewed by the audit manager and sent to the line manager concerned. 5. Discussions and follow up of Reports: Each report is discussed with the line manager concerned and the resultant action taken by the line manager noted. A summary of the salient points in various reports and the corresponding action taken is sent to the Managing Director very quarter.

Q. 6. Describe about the nature and significance of internal audit programme. Ans. 6. Nature of internal audit programme: An audit programme is planned and logically arranged procedure of audit. It is being used to achieve the audit objectives within a scheduled timeframe. Preparation of an audit programme necessitates the following activities: i) Collection of all necessary information regarding business of the organization. ii) Evaluation of internal control system. iii) Study of existing accounting practices of the organization. iv) Study of the various business operations of the organization. v) Fixation of audit objectives. An audit programme can be fixed or flexible. Fixed Audit Programme: It has fixed framework regarding how and within what period the particular audit work is to be completed. It includes every audit procedure and takes due care of every likely audit situation. Flexible Audit Programme: It has greater flexibility as compared to fixed audit programme. It outlines the general scope, character and limitations of the audit assignment. Significance of internal audit programme: The importance of Audit Programme can not be over emphasized. It is a future blue print of audit assignment. It highlights the work to be done by audit staff. It also helps in proper allocation of audit work amongst audit personnel. Routine work should be allotted to juniors, whereas, complicated tasks should be handed over to seniors. Audit programme lies down in clear terms what work is to be done, by whom and within what duration of time. This helps in pinpointing any omission or lapses on the part of audit personnel. The significance of the audit programme lies in the fact that it serves as a base of revision in the audit procedures in reference to any change in the accounting or operational procedures.