Objectives and advantages of Audit

The objectives of an audit may broadly be classified as
1. Primary Objectives
2. Secondary objectives

Primary Objectives:

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

The Companies Act, 1956 requires that the auditor of a company has to state whether in his opinion the accounts disclose a true and fair view of the state of company's affairs, profit and Loss Account and Balance Sheet of the state of affairs of a business, the auditor carries out a process of examination and verification of books of accounts and relevant documents.  Such an examination will enable the auditor to report to his client on the financial condition and working results of the organization.  While carrying out the examination of the various books of accounts, relevant documents and evidences, the auditor may came across certain errors and frauds.  Despite such a possibility the detecting of errors and frauds is an incidental object.  However, laymen have always associated the detection of errors and frauds as the main function of an auditor which is not true. At the same time audit also discloses how far the accounting system adopted in the organisation is adequate and appropriate in recording the various transactions as well as the weakness of these systems.

Secondary Objectives:

As stated above, an auditor has to examine the books of accounts and the relevant documents in order to report on the financial condition of the business.  In the process of such an investigation of accounts certain errors and frauds may be detected.  These are discussed under the following two heads:

A.  Detection and Prevention of Errors

B.  Detection and Prevention of Frauds

Detection and prevention of Errors:  Various types of errors are mentioned below:

1. Clerical Errors: Such an error arises on account of wrong posting.  For example, an amount received from Thomas is credited to Sunny.  Though there is wrong posting still the trial balance will agree.  Clerical errors are of three types as follows:

i)   Errors of Commission: There errors are caused due to wrong posting either wholly or partially of the amount in the books of original entry or ledger accounts or wrong calculations, wrong totaling, wrong balancing, and wrong casting of subsidiary books.  For example Rs. 500 is paid to a vendor and the same is recorded in the cash book.  While posting to the ledger, the Vendor's account is debited by Rs. 500.  It may be due to carelessness of the clerk.  Most of the errors of commission are reflected in the trial balance and these can be discovered by routine checking of the books.
ii)   Errors of Omission: Such errors arise when the transactions are not recorded in the books of original entry or posted to the ledger.  For example, sales are note recorded in the sales book or omission to enter invoices in the purchase book.  For example Rs. 200 is paid to a vendor.  The entry in the cash book is made on the credit side but posting to the vendor side is omitted.  Errors due to entire omission will not affect the trial balance whereas errors due to partial omission will affect the trial balance and can be detected.

iii)   Compensating Errors:  When two or more errors are committed in such a way that the result of these errors on the debits and credits is nil, they are referred to as a compensating errors. For example, Anil's account which was to be debited for Rs. 500 was credited for Rs. 500 and similarly, Sunil's account which was to be credited for Rs. 500 was debited for Rs.500.  These two mistakes will nullify the effect of each other.  Both the sides of the trial balance are equally affected.  As such, these errors are difficult to locate unless detailed investigation is undertaken.
2.  Errors of Principle: Such errors are committed when some fundamental principle of accounting is not properly observed in recording transaction.  For example, if there is incorrect allocation of expenditure or receipt between capital and revenue or when closing stock is over-valued.  Though trial balance will not disagree, the Profit and Loss Account may be very much affected.  Sometimes, such errors are committed deliberately to falsify the accounts or unintentionally due to lack of knowledge or sound principles of accounting.  Thus, a thorough examination is to be done to locate such errors.

Detection and Prevention of Frauds: Frauds are always committed deliberately and intentionally to defraud the proprietors of the organization.  If the frauds remain undetected, they may affect the opinion of the auditor on the financial condition and the working results of the organization.  It is, therefore, necessary that the auditor should exercise utmost care to detect such frauds.   It can be committed by the top management or by the employees of the organization. Frauds could be of the following types

1. Misappropriation of cash2. Misappropriation of goods3. Falsification or Manipulation of accounts

4. Window dressing5. Secret Reserves

Misappropriation of Cash: Since the owner has very limited control over the receipt and payments of cash, misappropriation or defalcation of cash is very common specially in big business organizations.   Cash can be misappropriated by various ways as mentioned below:

a.  Recording fictitious payments b. Recording more amount than the actual amount of payment

c. Suppressing receipts d. Recording less amount than the actual amount of payment.

There should be strict control over receipts and payments of cash known as "Internal check system" to prevent such frauds.  The auditor should check the Cash Book with original records, bills register, invoices, vouchers, counterfoils or receipt books,  wage sheets, salesman's diary, bank statements etc. in order to discover such frauds
Misappropriation of goods: Companies handling with high value goods are pray to this kind of misappropriation.  Without proper records of stock inward and stock outward, it is difficult for the auditor to find out such fraud.  Periodical and surprise checking of stock and maintaining the proper record of inward and outward movement of stock can reduce the possibility of such fraud.

Falsification or manipulation of accounts: In order to achieve certain specific objectives, accounts may be manipulated by those responsible persons who are in the top management of the organization.  They prepare accounts such a manner that they disclosed only a fake picture not the true picture.  Some of the ways used in manipulating the accounts are as follows:

1.  Inflating or deflating expenses and incomes

2.  Writing off of excess or less bad debts.

3.  Over-valuation or under-valuation of closing stock.

4.  Charging excess or less depreciation

5.  Charging capital expenditures to revenue and vice-versa

6.  Providing for excess or less doubtful debts.

7.  Suppressing sales and purchase or showing fictitious sales and purchases etc.

Window dressing: is the way of presenting the financial data in a much better position than the original position. It is known as window dressing. Some of the reasons for doing window dressing are as follows:

1. To win the confidence of share holders

2. To obtain further credit\3. To raise the price of shares in the market  by paying higher dividend so that shares held may be sold

4. To attract prospective parters or shareholders.

5. To win the confidence of shareholders.

Secret Reserves: In secret reserves, accounts are prepared in such a way that they disclose worse picture than actually what they are.  The objectives of preparing accounts in this way are:

1.  To conceal the true position from the competitors.

2.  To avoid or reduce the tax liability

3.  To reduce the price of shares in the market by not paying dividend or paying lower dividend so that the shares may

be bought at a much lower price.

It is very difficult to detect such frauds since these frauds are committed by those persons in the organizations who are at the top positions like directors, managers, financial controllers etc.  To detect these kind of frauds, the auditor must be vigilant and should make searching inquiries to arrive  at the true position.