Auditing. Objectives, Advantages, Disadvantages, Types, Relationship of Audit with other disciplines17/11/2023
Auditing is the process of inspecting the books of accounts to authenticate their accuracy and reliability. It is an important process to the company itself, the government, the investors, creditors, shareholder etc. They all rely on audited accounts to make important decisions.
An audit is a systematic examination or review of a system, organization, process, or set of financial records to verify its accuracy, completeness, and compliance with established criteria or standards. The primary purpose of an audit is to provide an independent and objective assessment of the subject matter, allowing stakeholders to make informed decisions based on reliable information. Audits are conducted in various fields, including financial accounting, information technology, quality management, and compliance.
The term “audit” is derived from the Latin word “audire,” which means to hear. Historically, auditors would listen to the accounts being read aloud to ensure accuracy. Today, an audit involves a thorough examination and evaluation of information, records, systems, or processes.
Objectives of an Audit:
Reliability and Accuracy:
The primary objective of an audit is to ensure the reliability and accuracy of information. This is particularly crucial in financial audits where stakeholders rely on financial statements for decision-making.
Audits often assess whether the subject matter complies with applicable laws, regulations, policies, or standards. This could include financial regulations, industry standards, or internal organizational policies.
Audits help identify and assess risks associated with the subject matter. This includes the risk of fraud, errors, inefficiencies, or non-compliance.
Audits contribute to establishing accountability within an organization. By examining processes and records, auditors help ensure that individuals and entities are responsible for their actions.
Audits can provide valuable insights and recommendations for improvement. Whether it’s improving internal controls, operational efficiency, or overall effectiveness, audit findings can guide organizations in enhancing their processes.
One of the key objectives is to provide assurance to stakeholders that the information under examination is reliable and accurate. This is particularly important for financial audits, where external parties such as investors and creditors rely on audited financial statements.
Audits contribute to transparency by providing an unbiased and independent assessment. This transparency is essential for building trust among stakeholders.
Relationship of Audit with other disciplines
Relationship: Auditing and accounting are closely connected. Auditors often examine financial statements prepared by accountants to ensure they present a true and fair view of an organization’s financial position. Auditors may also assess accounting practices and adherence to accounting standards.
Relationship: Auditing plays a crucial role in financial management and decision-making. Financial audits provide assurance to investors, creditors, and other stakeholders about the accuracy and reliability of financial information, influencing financial decisions.
Relationship: Auditors assess risks during their examinations, including the risk of fraud, financial misstatements, and non-compliance. The findings of an audit can be valuable input for risk management strategies within an organization.
Information Technology (IT):
Relationship: With the increasing reliance on information systems, IT audits have become integral. IT auditors examine the controls and security measures in place to safeguard information assets. The field of information systems auditing is a subset that focuses specifically on IT-related controls and risks.
Relationship: Auditors may work with legal professionals to ensure that an organization’s activities comply with relevant laws and regulations. Legal considerations can be a crucial aspect of audits, especially in areas such as regulatory compliance and corporate governance.
Relationship: Auditing is an essential component of quality management systems. Quality audits assess whether an organization’s processes and products meet established quality standards. This is common in industries such as manufacturing and healthcare.
Relationship: Auditors often evaluate compliance with laws, regulations, and internal policies. Compliance audits help ensure that an organization adheres to established rules and guidelines, whether they are financial regulations, industry standards, or internal governance policies.
Relationship: Internal auditors work closely with management to assess and improve internal controls, risk management processes, and operational efficiency. The findings of internal audits can be instrumental in enhancing organizational performance.
Relationship: Audits, particularly financial audits, contribute to the economic landscape by providing stakeholders with reliable information for decision-making. The credibility of financial statements influences investment decisions and economic activities.
Environmental and Social Responsibility:
Relationship: Audits may extend to areas of environmental and social responsibility. For example, sustainability audits assess an organization’s environmental impact, and social audits evaluate its social and ethical practices.
Advantages of Auditing
Assurance to the Owners/Investors
One of the biggest advantages of auditing is that it offers assurances to the owners, investors, shareholders etc. The owners of the business will be assured about the accuracy of their books of accounts.
They will be satisfied with the workings of their various departments and the overall efficiency and profitability of their business operations. It is the same case with investors, who will find assurance in the books of accounts after auditing.
- Errors and Frauds
An error is something that is done without the intention to fraud the company, it is an innocent mistake. Fraud, on the other hand, is deliberate. During the process of auditing, both errors and frauds are discovered. Auditing also helps prevent such errors and frauds. It creates a fear of being detected.
So auditing helps us minimize the risks of errors and frauds in our books of accounts but does not eliminate the risk entirely. There is always the chance that the error may go unnoticed, and the fraud is very cleverly hidden so may go undetected.
If the auditor is an external auditor, the business can get a second opinion on their financial statements and their financial standing as well.
An external auditor will closely inspect the books and be completely true and fair in his opinion as he has no hidden agenda. If he says the accounts are true and fair, it has a lot of weightage with the company and the investors.
One of the other advantages of auditing is that the staff and the workers of the company do not try to steal or defraud the company. They are under constant scrutiny since they know that the accounts will be audited. Any irregularities can be identified during such an audit, and they will be caught eventually. This helps the staff in being honest and responsible at all times.
- Stakeholders Confidence
After auditing stakeholders like creditors, investors, banks, debenture holders etc. can rely on the books of accounts with more confidence. And so after auditing by an independent authority, the financial statements have more credibility.
Limitations of Auditing
A very thorough and detailed audit would be a costly affair. It is not cost effective. So the auditor has to limit the scope of his audit and use techniques like sampling and test checking.
- Time Factor
Auditors generally work on a very specific timeline. Sometimes this is due to statutory requirements. This means he has to audit a whole year’s accounts in a few weeks. Hence insufficient time is one of the main limitations of auditing.
- Inconclusive Evidence
Generally, the audit evidence the auditor collects is persuasive in nature, not conclusive in nature. So there is never cent percent conclusive evidence in most cases while auditing.
This is one of the major limitations of auditing. There also a lot of use of estimates in accounting. The auditor cannot measure or comment on the exact accuracy of these estimates. He has to rely on his knowledge.
The term ‘audit’ means examination of books of accounts and vouchers so as to establish their accuracy. It is defined as “a systematic examination of financial statements, records and related operations to determine adherence to generally accepted accounting principles, management policies or stated requirements”.
According to International Federation of Accountants, “An audit is the independent examination of financial information of any entity whether profit-oriented or not and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereof.”
The essential features of auditing (as per ICWAI, India) are:
- Making a critical review of the system and procedures in an organization
- Making such tests and enquiries into the results as well as the operation of such systems and procedures, as the auditor may consider necessary to form an opinion;
- Expressing that opinion in the accepted phraseology that has been developed;
- Ensuring that the opinion covers all aspects which are required to be covered by law or accepted professional norms.
The value of audit is in its independence and the auditor should report directly to the managing director.
Types of Functional Audit
Following are the main types of functional audit:
- Propriety (or Higher) Audit
This audit is the audit of such executive actions and plans of management which have a bearing on the finance and expenditure of the company.
Here the cost auditor has got an important advisory function and has to judge:
(а) Whether or not the planned expenditure would give maximum results;
(b) Whether the size and channels of expenditure were designed to produce the best possible results; and
(c) Whether the return from expenditure on capital as well as current operations could not be bettered by some other alternative plan of action. Thus, it is the audit with an objective to examine the propriety of the transaction. It attempts to evaluate the correctness of conduct of persons concerned in auditing the transactions. It safeguards the tax-payer’s money and the shareholders’ capital.
Efficiency (or Performance or Profitability) Audit
This audit is the appraisal of performance so as to ascertain whether the plan has been effectively and efficiently executed. It is concerned with the utilisation of the resources in optimum manner to achieve the objectives of the concern. Efficiency audit ensures application of basic economic principle that resources flow into the most remunerative channels.
It starts with the study of the plan and extends to the comparison of the actual performance against the budgeted performance and investigation into the reasons of variances. The main function of efficiency audit is to ensure that every rupee invested in capital or in other fields gives the optimum return and that balancing of investment between different functions and aspects of the company is designed to give optimum results. In this type of audit a survey of activities is made to appraise the management and accounting standards and practices.
- Operational Audit
This type of audit appraises the activities of each operation as production, sales, administration, accounting, engineering etc., in relation to the overall objective of the concern. It also checks the control systems introduced in various operations of the business in order to know their satisfactory working, the aim being to improve the system and its operation wherever feasible.
- Voucher Audit
This audit is done to judge the honesty and integrity and carried out with the help of vouchers. It ensures that the transactions of a business are correct and true and can be verified with the help of receipts and vouchers. Every transaction must be supported by valid voucher which should be properly drawn and authenticated by a responsible person authorised to do so.
- Regulation Audit
A set of rules and regulations are prescribed in government departments, statutory bodies and in private sector organizations which govern day-to-day operations of these organizations and are contained in manuals. This audit ensures that these rules and procedures are correctly and faithfully adhered to.
- Statutory Audit
This audit is conducted in accordance with the provisions of any Act or Statute laid down by the Government. It may be both financial audit and cost audit. Such audit of the accounts of the Government departments and statutory bodies is conducted by the representative of the Comptroller and Auditor General of India.
- Social Audit
In order to utilise the nation’s resources properly, many large scale corporations have come into existence. Like individual, these corporations have also some social responsibilities towards the society to which they belong. Social audit, therefore, becomes the review of assessing to what extent the corporations have discharged their responsibilities and at what cost.
There are various ways by which these corporations can render social services to the society. Some measures will not impose financial burden on the corporation but most of actions would involve social costs. This audit covers both cost and non-cost aspects of social performance in order to see how far the social obligations have been met by these corporations and whether the cost incurred have been commensurate with the benefit rendered to the society.
This audit is a new concept in India and is undertaken by TISCO to see whether the company has met successfully its social responsibilities to the consumers, employees, shareholders, society and the local community.
- Cost Audit
Cost audit is mainly a preventive measure. It acts as a guide for policy formulation and decision making. It is to judge the efficiency of expenditure while the work is in progress.