Basic Concept of Auditing

The article 'Basic Concept of Auditing' primarily emphasises auditing, delving into its historical origins and key characteristics that have evolved over time. Additionally, the author explores the distinctions between the terms "auditing" and "accounting," elucidating their interconnectedness.

Introduction

Auditing refers to a structured examination and ratification of other businesses, institutes, and individuals' financial records, affirmations, operations, or financial activities. The word 'Audit' is derived from the word 'Audire' which means 'to listen' or 'to hear'. Primarily, Auditing aims to comply with the existing laws, be reliable, and provide accuracy.

Accounting is about recording business-related monetary transactions. Along with recording, financial transactions are analyzed, summarised, and reported to required institutions.

Corporate Governance basically refers to rules, processes, and systems used to control and provide directions to the company to achieve its goal. The Board of Directors play an important role in ensuring the ethical management of the company. In India, Corporate Governance aims to protect the rights of the minor shareholders, management, and the interest of the shareholders.

Accountability, fairness, and transparency are vital components of corporate governance. Corporate Governance is closely connected with auditing and accountancy in business and finance. It helps to operate as per the required elements for the regular flow of competitors in the capital market.

Origin and Development 

In the past, the accountants read the records for the auditors to check. Auditing and accounting were previously used in India, the U.K., Greece, and elsewhere. In India, 'Arthasashthra,' written by Kautilya, highlights the importance of accounting and Auditing. 

In the 18th century, there was a demand for independent auditors, as they were believed to certify the management's financial reports to the shareholders reasonably, have sharp eyes for deviations from the permitted accounting rules and perform audits per the established auditing rules and regulations. The Securities and Exchange Commission ("SEC") served the publicly traded companies. The need for voluntarily hired independent auditors arose after separate owners and managers were established. Without auditors, public companies survived for over a century. Still, in 1929, after the capital market crash, Congress strongly believed the economic conditions would not improve because of the insufficient provisions created to protect the investors and creditors. However, the public retrieved confidence in the financial market and passed two Acts in 1933 and 1934 to resolve their issues. In 1937, the SEC had the power to issue financial reports with standards and quality.

Objectives

Auditing classifies 3 types of objectives:

1. Primary Objective:

Auditing focuses on the details of the accounts and substantiates the records before reporting to the company's members about the profits and losses of the performance. A balance sheet is prepared per the relevant laws and exhibits fair and honest views of the gain and financial position of the company. To achieve the primary goal, auditors shall inspect the internal control and check, verifying the books of accounts are as per the essential laws, proper accounting rules, and regulations, limiting the arithmetical accuracy, authenticity, and rationality of the transactions. Even physically verifying the existing values of the assets and liabilities shall be taken care of.

2. Subsidiary Objective:

Detection and Prevention of Errors are unintentional mistreatments in records or books. It can be of two types: clerical or technical and errors of principle. Clerical errors are omitting transactions from the record books, commissioning is posting from subsidiary books to ledger accounts, duplication is made during the entry in books and published twice, and commission errors. The Principal errors are generally during the expenditure records or revenue or receipt expenditure as revenue receipts. However, these errors need detailed and thorough checking to avoid impacting the trial balance agreement.

Detection and Prevention of Frauds are fraud, which is said to be a voluntary or intentional secrecy of materials to deceive, cheat, or mislead someone. It also has types: misappropriation of cash and misuse of goods, that is, fraudulently annexing money of another person by whom it was invested. For example, quashing of cash receipts, entering less amount on counterfoils, not recording casual sales, misappropriately receiving cash from debtors, adopting the 'teeming and lading;' or lapping process," omission of cash donations, subdue of cash sales, proceeds of VPP sales, and under stating total cash book.

Another type is manipulating accounts, which is forging arrangements before the swindling of cash or goods, showing it more favourable than it already is—such as non-provision of depreciation on assets, overvaluations of support, showing short-term and long-term liabilities, and record sales of the revenue account for the coming year.

Specific Objectives are for every audit evaluating existing operations and resolving production costs or services.

Difference Between Accountancy and Auditing

Accounting refers to the process of recording business-related monetary transactions. Along with recording, transactions are analyzed, summarised, and then reported to the following:

• Tax collectors as in the Central and State Governments, and
  
•  Regulators like the Reserve Bank of India or Securities and Exchange Board of India, etc.

Accounting is considered an essential part of business, usually done by the company employees. The financial statement for a year is prepared as a summary and divided into different company brands, such as cost accounting, management accounting, etc. Accounting is an everyday process done by the company's accountants.

Auditing is the final process of assembling the financial statement and accounts. Properly examining the company's financial records is to review and rightfully audit the financial reports. Auditing has two types: the Internal audit, mostly the employees of the company, and the External audit, i.e., the shareholders. Auditing is done periodically, whether every month, quarterly, or yearly.

Difference between Auditing and Accounting

• The responsibility of the accountants is only to prepare the account, but auditors must prepare and submit the audit report.
• Accounting is governed by accounting principles and auditors follow standards for it.
• Auditors can attend the meetings with the shareholders, but the accountants cannot.
• Auditors can be sued for misconduct, but accountants cannot be sued for malfeasance.
• Accountants could suggest improvement in accounting, but the auditors generally don’t.
• The report prepared is submitted to the management by the accountants and the auditors submit the information to the shareholders.
• The accountants receive a salary, but an auditor receives auditing fees.

Salient Features

Auditing mainly consists of six salient features:

1. Systematic process: includes examining the process of planning, researching, documentation, examining, and communicating.

2. Independence: guaranteeing impartiality and objectivity, the auditors shall be independent of the company or are auditing. This independence benefits in delivering objective and credible opinions.

3. Validation and Analysing: Verify and analyse the financial records and reports thoroughly, accurately, and fairly. It includes documents, conducting interviews, and performing significant tests.

4. Evidence: The auditors assess the financial statements, complying with accounting standards and rules. They shall be fairly and thoroughly examined as per the financial position and performance of the company.

5. Professional Judgement: these judgments are minutely examined for the auditing process. It includes ideas on the fairness of financial statements and recommendations for improving internal control and financial reporting.

6. Reporting: communicating the research and opinions from the audit reports. These reports include fair analysis and recommendations to improve internal and financial reporting.

Circumstances under which an auditor can be suspected of fraud 

Section 240 of Auditing Standards (“SA”) mentions the liability auditors would take during the fraud committed in the financial statement. The suspicions are detected through:

- Dependence on the Company: The auditors are required to be independent in nature and not dependent on the company. The auditor having close relations with the company can result in compromised independence.

- Unprofessional Skepticism: The auditor's approach towards his work should be professional doubts, meaning they question and critically analyse data provided by the client. If an auditor fails to overly trust or challenge questionable transactions, this could raise doubts.

- Suspicious relations with the Management: If the Auditor socializing with the management outside work or receiving gifts and incentives personally, this can raise suspicions as well.

- Whistleblower Allegations: The charges from the whistleblower within the auditing firm are detected or the client company should be investigated properly. These charges could be fraud-related actions that involve the investors.

Conclusion

Auditors could be referred to as important gatekeepers of the company. They need to make sure the rights of the investors are protected, and solutions for the problems are provided with a reasonable level of certainty that the financial statements are free of substantial mistreatment, either in the case of fraud or error.

The words auditing, accounting, and corporate governance are integral components of the financial ecosystem that work parallel to ensure transparency, accuracy, and accountability within organizations. The objectives are multifaceted, encompassing the verification of financial records, the detection and prevention of errors, and, crucially, the identification and prevention of fraud. Auditors play a pivotal role in safeguarding the interests of shareholders, investors, and the broader financial market by critically assessing an organization's financial health. In today's complex financial landscape, auditing remains a vital component of corporate governance and regulatory compliance. It serves as a critical mechanism for upholding transparency and trust in financial reporting, thereby contributing to the stability and credibility of the global financial system.

References

[1] Auditing and Corporate Governance, Available Here

[2] Eugene A. Imhoff, Jr., Accounting Quality, Auditing and Corporate Governance, Available Here

[3] The Securities Act, 1933

[4] The Securities Exchange Act, 1934

[5] Generally Accepted Accounting Principles (GAAP)

[6]  The auditor’s responsibility for fraud detection, Available Here

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