Audit: History, Meaning, Scope, Objective and Types

Introduction

As it is well known that business organizations began to grow during the industrial revolution, not just in India but globally, and because of globalization, business organizations started increasing the scale of their business operations.

The earlier form of business organization was a sole proprietorship, which was easily managed by the owners. However, due to the increased scale of operations, the sole proprietorship business structure changed to a joint stock company in which capital is invested by other persons called shareholders. Shareholders do not take part in the management of the company but do receive a dividend in return for investment in the company.

It becomes very obvious for the shareholders to know the real profit of the company in which they invested. So management has a duty to maintain the books of accounts and present them to shareholders, but some companies have been engaging in fraudulent activities and hiding losses from their shareholders. To prevent this, the Government has made the provision that the accounts of companies be reported by qualified persons other than the management.

History and Evolution of Auditing

During medieval times, officers were appointed by feudal Barons in Britain to ensure that the revenue produced by their serfs and tenant farmers was accurately accounted for and that their serfs were not cheating or hiding revenue. Accounting and auditing are as old as culture, with evidence found in Mesopotamia, Greece, Egypt, Rome, U.K., and India. Kautilya’s Arthasahthra explains the detailed rules for accounting and auditing of public finances. Furthermore, Luca Pacioli explained Double entry bookkeeping in 1494, as well as the responsibilities of an auditor.

In simple terms, auditing is the process of checking financial information and recorded data of any entity by an independent person or authority. 

Earlier auditors used to hear and examine the books of accounts orally without documentation, but afterward, it was recognized that detecting fraud and errors is the auditor’s responsibility to eliminate them from the entity’s books of accounts.

Every business needs bookkeeping and accounting to prepare and maintain financial records. However, the terms are often used interchangeably. Even though bookkeeping and accounting are not separate and there is a thin line between the two. Taking a closer look at the two, let’s make a distinction between the two:

Book-Keeping	Accounting
Bookkeeping simply refers to the process of maintaining and recording all financial transactions in the original book of entry of a business. It records day-to-day financial activities and transactions chronologically in a systematic manner.	Accounting can be defined as a process of analyzing, summarising, interpreting, and reporting the financial transaction of a business, and the person who does this process is called an accountant of that business who maintains and compiles the records of a company’s daily transactions into financial statements such as income statements and balance statement.

As we can see above, bookkeeping is part of accounting and accounting has a broader scope than bookkeeping.

Meaning of Auditing                                

The word “audit” derives from the Latin word audire which simply means “to hear”. Auditing simply refers to an independent checking and verification of financial information of any organization, whether their motive is profit oriented or not, regardless of its size or legal form so that an opinion can be expressed by the qualified auditor in the audit report.

Auditing in India has been defined in different ways but the definition given by the Institute of Chartered Accountants of India is given below-

“Auditing is a systematic and independent examination of data, statements, records, operations, and performance (financial or otherwise) of an enterprise for a stated purpose. In any auditing situation, the auditor receives and recognizes the propositions before him for examination, collects evidence, evaluates the same and on this basis, formulates his judgments which are communicated through his Audit Report.”

The above definitions of auditing have certain important terms which are explained below:

1. 1. Independence: The auditor should express his opinion on the financial information as well as statements that’s why he should be free from any interest and should not be bound to the entity.
   2. Financial Statements: The financial statement comprises of Balance sheet, Profit and Loss Statement, Cash Flow Statement, Statement of changes of equity, and notes to accounts which provides a proper understanding of the financial position.  The auditor has to express an opinion on the financial statement of the entity.
   3. Auditor’s Opinion: The Auditor has to express an opinion on the financial statements in the form of an audit report. The audit report is an only expression of opinion rather than a statement of verified facts.

Scope of Audit

The scope of auditing refers to the boundaries beyond which the auditor cannot perform his duties. Audit scope determines how long the process will take and how extensive the audit will be.

The scope of any audit is ascertained by the appointed auditor of any business entity as stated by their audit engagement and as per the applicable rules and regulations of authorized authority.

In determining the scope of the audit, one should consider the following points:

• • Configuring Audit in such a way as to thoroughly examine all aspects of the enterprise relevant to the financial statements audited.

• • Before expressing an opinion, the auditor should satisfy himself that all the recorded financial data in the books of accounts are authentic and adequate

• • All the entries related to financial data are properly disclosed for the preparation of financial statements.

• • An auditor should perform all the required audit procedures to verify the reliability and sufficiency of the financial inputs, accounting systems, and internal controls.

• •  He should not perform those duties which are outside the scope of his competence such as defining the physical health of fixed assets.

• • If there is any limitation that prevents the auditor from expressing an independent opinion on the financial accounts, it should be noted as a disclaimer in the audit report.

Objectives of the Auditing

There are some specified auditing standards (SA) issued by ICAI which are prepared by Auditing and Assurance Standard Board (AASB). SA200 “Overall Objectives of the Independent Auditor” describes the overall objectives of auditing the financial statements which are as follows:

• • To obtain reasonable assurance about whether the financial statement as a whole is free from material statements, whether due to fraud or error.

• • To report on the financial statements, and communicate as required by the SAs.

 Types of Audits

There are no legal requirements to conduct an audit by an auditor for all types of business organizations, Audit helps the business to run smoothly. Some audits are required by law (Such as Statutory Audit, Cost Audit, Tax Audit, etc.), but some are done on a voluntary basis. Here is the list of Audit that can be performed by an organization:

1. 1. Statutory Audit: A statutory audit is a review of a company’s or government’s financial statements and records that is mandated by law. The purpose of a statutory audit is to determine whether an organization provides a true and fair view of its financial statements by examining information such as bank balances, bookkeeping records, and financial transactions.
   2. GST Audit: An audit under GST involves an examination of records, returns, and other documents maintained by a GST-registered person. It also ensures the correctness of turnover declared, taxes paid, refund claimed, input tax credit availed, and assesses other such compliances under GST Act to be checked by an authorized expert. From FY 2020-21, compulsory GST Audit by CA/CMA exceeding the prescribed limit has been removed.
   3. Tax Audit: The Income Tax Act, 1961’s Section 44AB addresses the audit of the accounts of a specific class of people who are engaged in business or professions. The class of taxpayers described in this section is required by law to have an audit of their accounts performed by a chartered accountant. The Chartered Accountant drafts this report in which they present their conclusions and observations regarding the audited person’s compliance in form 3CA.
   4. Internal Audit: Internal audits evaluate a company’s internal controls, including its corporate governance and accounting processes. An internal audit offers risk management and evaluates the effectiveness of many different aspects of the company. Types of Areas of Internal Audits include financial, operational, compliance, environmental, IT, or for a very specific purpose.
   5. Cost Audit: A cost audit represents the verification of cost accounts and checking on adherence to the cost accounting plan. A cost audit ascertains the accuracy of cost accounting records to ensure that they are in conformity with cost accounting principles, plans, procedures, and objectives. The Cost Auditor shall be appointed within 180 days of the commencement of every Financial Year through passing a resolution in the Board Meeting.
   6. Operational Audit: Operational audit is a systematic review of effectiveness, efficiency, and economy of operation. An operational audit is a future-oriented, systematic, and independent evaluation of organizational activities. In an Operational audit, financial data may be used, but the primary sources of evidence are the operational policies and achievements related to organizational objectives. An operational audit is a more comprehensive form of an internal audit.
   7. CSR Audit: A corporate social audit is an assessment of your company’s performance on corporate social responsibility objectives. It evaluates measurable goals intended to help your business meet the expectations your stakeholder groups have regarding your social and environmental responsibilities.
   8. Management Audit: A management audit is an independent and systematic analysis and evaluation of a company’s overall activities and performances. It is a valuable tool used to determine the efficiency, functions, accomplishments, and achievements of the company. The primary objective of the management audit is to identify errors in management activities and suggest possible changes. It guides the management to manage the operations most effectively and productively.
   9. Forensic Audit: A Forensic Audit is an examination and evaluation of a firm’s or individual’s financial information for use as evidence in the court of law. A forensic audit can be conducted in order to prosecute a party for fraud, embezzlement, or other financial claims.
   10. Information System Audit: An information technology audit, or information systems audit, is an examination of the management controls within an Information technology (IT) infrastructure and business applications.
   11. Transfer Pricing Audit: A transfer pricing study examines the pricing of transactions between related two or more associates. By applying and documenting various test methods, it is determined whether the transactions are conducted under market conditions and survive the scrutiny of the IRS and other tax authorities. A study of transfer pricing shall justify how a particular method is selected for enterprises and transactions being reviewed.
   12. Secretarial Audit: A secretarial audit is a process to check an organization’s compliance with the rules. It helps facilitate compliance with rules and regulations in a company and maintains discipline amongst its administration, officials, and members.
   13. Performance audit: A performance audit is an independent, objective, and reliable examination of whether. public sector undertakings, systems, operations, programmes, activities, or organizations. operating in accordance with the principles of economy, efficiency, and effectiveness.
   14. Voluntary audit: Many business entities as a matter of internal rules and controls require an audit. Some entities like proprietorships, partnership firms, and Hindu-divided families have no basic requirement of an audit. These entities can conduct audits as per their requirements and voluntary purposes like for sanction of granting loans from banks etc.