Auditing – Classifications

In this chapter, we will learn the various types/classes of Audit and their basis. The following table lists out the different types of audit.

Basis Types
Scope
  • Specific Audit − Cash audit, Cost audit, Standard audit, Tax audit, Interim audit, Audit in depth, Management audit, Operational audit, Secretarial audit, Partial audit, Post & vouch audit, etc. are common types of specific audit.
  • General Audit − It can be an internal or an independent Audit.
Activities
  • Commercial
  • Non-Commercial
Organization
  • Government
  • Private
Legal
  • Statutory − Insurance Company, Electricity Company, Banking Companies, Trust, Company, Corporations, Co-operative societies.
  • Non-statutory − Individual, Firm, Sole trader, etc.
Examination methods
  • Periodicals
  • Continuous
Who conducts
  • Internal Audit
  • Independent Audit

Let us now understand the important classifications of audit.

Audit of Individuals

Sources of income of any individual may be from his investments, property, shares, commission as agent, interest income, etc.

Following are the purposes and benefits if anyone opts for an audit −

  • To know the correct income from all of his sources.
  • Assurance of accuracy.
  • Prevention and detection of any fraud or misappropriation
  • Helpful and useful in Income Tax Assessment.
  • To keep moral check on accountant and agent.

Audit of Sole-Trader’s Books of Accounts

The scope of audit will depend on the instructions and agreement between Auditor and sole proprietor, the latter being an individual owner of the business; the sole proprietor decides himself the scope of audit.

The purpose and benefit of audit in a sole trader’s business are almost the same as for an individual. Following are some additional benefits −

  • Assurance about proper vouchers of his expenditure and preparation of his accounts with accuracy and correctness.
  • Assurance about true and fair picture of his business income and expenditure.
  • His accounts can be compared with the previous years’.

Audit of Partnership Firm

An Auditor for a partnership firm may be appointed by the partners with mutual consent. Mutual agreement between partners and Auditor is based on the latter’s rights, liabilities & the scope of his audit. Reference to the partnership deed is must for an Auditor and he should refer to the Partnership Act, 1932 in case where partnership deed is silent. Certificate of an Auditor will contain points related to the following −

  • Reliability of accounts depending upon the nature of business.
  • If any restrictions and limitations imposed by the partners on his audit scope.
  • Whether the auditor got all the required information and explanations or not.

Important provision of Partnership Act

An Auditor should refer to following provisions of the Partnership Act, 1932, where partnership deed is silent.

  • A minor can be admitted to a firm as a partner only for profits, he will not be liable for any loss.
  • Property of the firm can be exclusively used by the partners for business purpose.
  • Partners will share profit & loss equally.
  • There is no entitlement of any remuneration or salary to any of the partner.
  • 6% interest on capital will be paid to partner in case of any addition to capital made by any partner in excess of agreed amount.
  • Interest on capital will be payable out of profits only.
  • Goodwill of the firm will be treated as assets of the firm at the time of dissolution of the firm.
  • At the time of dissolution of the firm, the settlement of account will be done in the following order −
    • Out of profit
    • Out of capital
    • By the partners individually in their profit sharing ratio

Government Audit

Government of India maintains a separate department known as the Account and Audit Department and this department is headed by the Comptroller and Auditor General of India, which works only for government offices.

Important Features of the Government Audit

  • In almost every government department, prior sanction is must before any payment of expenditure.
  • Before making any payment, a preliminary examination of bills is done by the Treasury officer.
  • Nature of Government audit is always continuous due to large number of transactions and huge amount of expenditure.
  • Major portion of the accounts is prepared by the Accounts and Audit department which work independently.

Objectives

The following are the main objectives of Government audit −

  • To check and ensure that prescribed rules and regulations have been followed while making payments.
  • To ensure that expenditure should not be excessive.
  • To check and verify physical stock, stores and spares along with their proper valuation. Stock-taking should be done at regular intervals and the recording of stock in the stock register should be done correctly and up-to-date.
  • To check whether every payment is sanctioned by proper authority or not.
  • To ensure that expenditure should be done in public interest only by the right person and should be paid to the right person.
  • To ensure that no expenditure should be incurred for any personal benefit of any authority.
  • To give suggestion for any kind of improvement in efficiency and economy.
  • To verify that the amount due from others are properly recorded in the books and also to verify that such amount is regularly recovered.

Statutory Audit

Where the appointment of a qualified Auditor is compulsory as per the law is called as a statutory audit. The following are the essential characteristics of statutory audit −

  • An Auditor must be a qualified accountant.
  • Norms of the appointment of Auditor are provided by the law. Rights, duties and liabilities of an Auditor are as defined by the statute; management cannot make any changes in it.
  • Organization cannot restrict the scope of statutory audit.
  • Statutory audit provides true and fair view of financial position to shareholders and members of an organization. It helps the shareholders to keep themselves protected from any fraud and misrepresentation.
  • Statutory audit is a compulsory audit. Auditor is an independent person and management doesn’t have any control over his work.

Following stakeholders are covered under the statutory or compulsory audit.

Audit of Companies

First time in India, the Indian Companies Act, 1913 made it compulsory for joint stock companies to get their accounts audited by a qualified person (chartered accountant). Appointments, duties, qualifications, powers and liabilities are amended through the Companies Act, 1956 and 2013.

Audit of Trust

The Public Trust Act provides compulsory audit of accounts by a qualified Auditor. Conditions and terms as laid down in Trust deed are the basis on which accounts of trusts are maintained. Any Beneficiary of trust does not have control or access over accounts of trust, therefore, there are more chances of fraud and misappropriations.

Audit of Co-operative Societies

The Companies Act is not applicable to societies; co-operative societies are established under the Co-operative Societies Act, 1912. It is a must for a qualified accountant to have the required expertise and he should be updated with various amendment of the Act. An Auditor should also have knowledge of the by-laws of this act.

Audit of other Institutions

Banks, Insurance companies and Electricity companies are audited as per the provisions of special Act of the Parliament.

Cost Audit

“Cost audit would apparently mean an examination of Cost books, Cost Accounts, Cost Statements and Subsidiary and prime documents with a view to satisfy the Auditor that these represent a fair and true view of the cost of production. This will naturally mean an examination of appropriateness of the cost accounting system adopted by business and effectiveness of its implementation.” J.G. Tickhe

Services of qualified cost accountants are necessary to have full control on the records of costs and cost variations. Big business houses and manufacturing units do understand the importance of cost accounting. Cost Auditors check the work done by Cost Accountants to ensure correctness of the accounting.

Objectives of Cost Audit

  • To verify arithmetical accuracy of cost accounting.
  • To help management to take decision about production and cost variations.
  • To detect error and frauds.
  • To have control over cost accounting department.
  • To give suggestions about efficiency of material, labour and machine.

Tax Audit

Under the provision of section 44AB of the Income Tax Act, 1961, every person carrying a business/Profession is required to get his accounts audited, if the total turnover or gross receipts during the previous year exceed Rs. 100 lacs in case of business and Rs. 25 lacs in case of profession.

Profit and Loss account of a business or profession is adjusted according to the provision of the Income Tax Act, therefore accounting profit and tax profit differ. The reason behind the difference in profit or loss may be because of the following −

  • Amount of depreciation
  • Under the Income Tax Act, certain expenses are allowed only on the basis of actual payment and those should be within the prescribed time as provided by law, like the payment of Provident Fund, ESI, Interest to financial institutions, VAT/Central Sales Tax, Employees related payments, etc.

Balance Sheet Audit

Balance sheet audit is very popular in the United States of America. Balance sheet audit is an annual audit and it covers each and every item of nominal accounts as appeared in profit and loss account, assets, liabilities, reserves, provisions, stocks and surplus. Balance sheet audit is also done by highly-skilled accountants.

Continuous Audit

Under continuous audit each and every transaction of the business is checked by the Auditor regularly. Continuous audit is required in large organizations where number of transactions is very high, internal control system is not effective, periodicals statements are required and final accounts are prepared immediately after the close of financial years like banks.

Advantages − Complete checking of records, up-to-date accounts, moral-check on staff and early finalization of financial statements are the main advantages of continuous audit.

Disadvantages − High cost of continuous audit, mechanical work of Auditor, chances of unhealthy relations with staff due to frequent visits, etc., are main disadvantages of continuous audit.

Annual Audit

In an organization where the number of transactions is not large, an Auditor usually comes after the close of financial year and completes his audit work in continuous session. In case of small business houses, annual audit gives satisfactory results.

Advantages − The work that is done by an Auditor in Annual Auditing does not affect the everyday routine of the organization and its people; the Auditor has full control over financial statements and records. Among other advantages, Annual Audit is cost-effective.

Disadvantages − There might come instances where the unavailability of Auditor may cause unnecessary delay in audit work; due to complete audit in one sitting, chances of undetected errors and frauds are high. This is not recommended for big business houses and the delay in annual general meeting is sometimes due to delay in audit which turns out to be a major disadvantage of annual audit.

Partial Audit

Partial audit is done only for a specific purpose; for example, to check the receipt side or the payment side of the cash book, to check cash sale, to check purchases or expenses only. The reason for calling out for a Partial Audit largely depends on the Management of the organization.

Internal Audit

Internal audit may be done by an independent person or by the employees of the company; internal Auditor may or may not be qualified person for audit. Internal audit is continuous in nature. As per section 144 of the Companies Act, an internal Auditor cannot render his services as Statutory Auditor for the same company.

As per the new section 138 of the Companies Act, internal audit has been made compulsory for certain categories of companies;

  • Certain class of companies or may be prescribed shall be required to appoint an internal Auditor, who shall either be a chartered accountant or cost accountant or such other professional as may be decided by the Board to conduct internal audit of the functions and activities of the company.
  • The central Government, may, by rules, prescribed the manner and intervals in which the internal audit shall be conducted and reported to the Board.

The following classes of companies are required to appoint an internal Auditor −

  • Listed companies.
  • Unlisted companies and Private companies meeting any of the following criteria.
Criteria Private Company Unlisted Company
Turnover Rs. 200 crore or more during the preceding financial year Rs. 200 crore or more during the preceding financial year
Paid up share capital No such criteria is applicable to private company Rs. 50 crore or more during the preceding financial year
Outstanding deposits No such criteria is applicable to private company Rs. 25 crore or more at any point of time during the preceding financial year
Outstanding Loans or borrowings from banks or public financial institutions Exceeding Rs. 100 crore at any point of time during the preceding financial year Exceeding Rs. 100 crore at any point of time during the preceding financial year.

Management Audit

Efforts are done to bring out an overall improvement in management efficiency through review of all the objectives, policies, procedures and functions of management. Only a person having good knowledge and experience of management techniques may be appointed as Management Auditor.

Objectives of Management Audit

Following are the main objectives of management audit −

  • To help management in setting sound objectives.
  • To ensure the fulfilment of objectives.
  • To give recommendation about change in policies and procedure for better results.
  • To help management in elaborating duties, rights and liabilities of the employees.
  • To help management in establishing good and sound relation with outsiders.

Post & Vouch Audit

Under this audit system, we have checking of every single original entry and their posting in ledger along with, balancing and totaling. This audit system is only advisable in small business units; in big business houses internal Auditor do this job and Auditor just check the effectiveness of internal control system of that organization.

Audit in Depth

Audit in depth means detailed step wise verification of some specific transactions; this helps an Auditor to understand the complete procedure of transaction as adopted by the organization to carry out any transaction. For example, to check the purchase transaction, an Auditor will check the quotations, purchase orders (P.O.), material receipt note (M.R.N), goods/material inspection note, bin card and stock ledger.

Interim Audit

Interim audit is done between two annual audits of an organization for a part of year. It enables the Board of Directors to declare interim dividend and also to determine interim figures of sales.