Auditing: Meaning, Objectives, Errors and Frauds

Auditing - Meaning, Objectives, Elements, Errors and Frauds

The system of accounting and auditing of slate revenue and expenditure is believed to have existed in India under Maurya and Hindu Kings. Kautilya in his Arthashastra had given details regarding accounting and auditing of state finances. According to him, “all undertakings depend on finance. Hence, foremost attention shall be paid to the treasury.” He had also mentioned various frauds and embezzlements and prescribed punishments for the same.

The word ‘audit’ is derived from the Latin word ‘audire’ which means ‘to hear’. In the olden days whenever the proprietors of a business concern suspected fraud, they appointed a person to check the accounts and to hear the explanations given by the persons responsible for keeping the accounts.

In modern period, Auditing, has its origins in industrial revolution. The industrial revolution resulted increase of trading and industrial operations which required huge amounts of capital, which  was not possible for small entrepreneurs due to their limited resources. This gave rise to new form of organisation, where, the shareholders contributed capital and had no control over the day-to-day working of the organisation.  As such, the need arose for appointing an independent person who would check the accounts and report to the shareholders on the accuracy of the accounts and the safety of their investment. This gave rise to profession of Auditing.

Definition of Auditing:

Auditing is the examination of accounting books & documentary evidences, through which an independent auditor finds out accuracy of figures & marks report on balance sheet and other financial statement. According to Montgomery, a celebrated author, “auditing is a systematic examination of .. the books and records of a business or the organisation in order to ascertain or verify and to report upon the facts regarding the financial operation and the result thereof.”

Objectives of Auditing

The objectives of an audit may broadly be classified as Primary objectives and Secondary objectives.

Primary Objective

  • The main purpose of audit is to determine the reliability and accuracy of the financial statements and the supporting accounting records for a particular financial period.

Secondary Objectives

  • Detection and Prevention of Errors
  • Detection and Prevention of Frauds

Types of Errors:

Errors of Principle: Such errors are committed when some fundamental principle 1 ‘.. bf accounting is not properly observed in recording a transaction
Clerical Errors: Such an error arises on account of wrong posting.

  • Errors of Commission : When amount of transaction or entry is incorrectly recorded in accounting books/ledger.
  • Errors of Omission : When the transactions are not recorded in the books of original entry or posted to the ledger.
  • Compensating Errors : When two or more errors are committed in such a way that the result df these errors on the debits and credits is nil.
  • Error of Duplication: When a transaction is recorded more than once.

Types of Frauds

Misappropriation of Cash: It is very common in big firms and can take place usually through:

  • Suppressing receipts
  • Recording less amount than the actual amount of receipt
  • Fictitious payments
  • Recording more amount than the actual amount of payment.

Misappropriation of Goods: This is common, especially, when goods are of high value but not bulky.

Falsification or Manipulation of account: Accounts may he manipulated by those responsible persons who are in top management of the organisation in order to achieve certain specific objectives.

Window dressing: When accounts are prepared in such a way that apparently  on the face of it, they indicate a much better picture than actually what they are.

Secret Reserves: When accounts are prepared in such a way that apparently  on the face of it, they disclose a worse picture than actually what they are.

Differences between Errors & Frauds

Errors Frauds
Reason of occurrence is ignorance It is made deliberately
Unplanned activity Planned Activity
Generally, not considered an offence Considered as Offence
Can cause undue profit, loss or even no impact These always result in loss
Very easy to detect Difficult to identify

Types of Audits

Basis Types
  • Specific Audit − Performance Audit, Efficiency Audit, Cash Audit, Receipt Audit
  • General Audit − It can be an internal or an independent Audit.
  • Commercial
  • Non-Commercial
  • Government
  • Private
  • Statutory/Required −  Banking Companies, Trust, Company, Corporations, Co-operative societies.
  • Non-statutory/ Voluntary − Individual, Trader, etc.
Time period
  • Periodical
  • Continuous
Who conducts
  • Internal Audit
  • Independent Audit

Advantages of Auditing:

  • It safeguards the financial interests of persons who are not associated with the management of the organisation e.g. partners or shareholders.
  • It acts as a moral check on employees from committing defalcations or embezzlement.
  • Auditing statements of accounts are helpful in settling of taxes, negotiating loans etc.
  • Auditing accounts facilitates settlement among partners.
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