Bachelor’s Degree Programme (BDP)
ASSIGNMENT (2020-21)
Elective Course in Commerce
ECO – 12: Elements of Auditing
Elective Course in Commerce

Dear Students,

As explained in the Programme Guide, you have to do one Tutor Marked Assignment in this Course.

Assignment is given 30% weightage in the final assessment. To be eligible to appear in the Term-end examination, it is compulsory for you to submit the assignment as per the schedule. Before attempting the assignments, you should carefully read the instructions given in the Programme Guide.

This assignment is valid for two admission cycles (July 2020 and January 2021). The validity is given below:

1)         Those who are enrolled in July 2020, it is valid up to June 2021.

2)         Those who are enrolled in January 2021, it is valid up to December 2021.

You have to submit the assignment of all the courses to The Coordinator of your Study Centre. For appearing in June Term-End Examination, you must submit assignment to the Coordinator of your study centre latest by 15th March. Similarly for appearing in December Term-End Examination, you must submit assignments to the Coordinator of your study centre latest by 15th September.


COVERAGE: ALL BLOCKS Maximum Marks: 100 

Attempt all the questions:
1. Explain the terms “Internal Control”, “Internal Check” and “Internal Audit”. What are the requisites of a good internal control system? (20)

Ans: Internal Control: Internal Control is a Systematic measures such as reviews, checks and balances, methods and procedures instituted by an organization to conduct its business in an orderly and efficient manner, safeguard its assets and resources, determine and detect errors, fraud, and theft, ensure accuracy and completeness of its accounting data, produce reliable and timely financial and management information, and ensure adherence to its policies and plans.

According to W.W.BIGG: “Internal Control is best regarded as indicating the whole system of controls, financial and otherwise, established by the management in the conduct of a business, including internal check, internal audit and other forms of control.”

Thus, internal control is the process, affected by an entity's Board of Trustees, management, and other personnel, designed to provide reasonable assurance regarding the achievement of the following objectives:

1.       To detect and prevent commission of errors and frauds.

2.       To promote accuracy and reliability in accounting and reporting data.

3.       To safeguard resources of the organisation against undue wastage or other such inefficiencies.

4.       To help in attaining sound company policies and measuring compliance with such policies.

5.       To help management in formulation of plans and policies regarding the working of the company.

6.       To promote and judge efficiency of all operations in all division of the organisation.

Internal Check (IC): The term internal check implies that the work of various members of the staff is allocated in such a way that the work done by one person is automatically checked by another. It is defined as “such an arrangement of book keeping routine where in errors and frauds are likely to be prevented or discovered by the very occupation of book keeping itself’.

Internal check is a system under which accounting methods and details of an establishment are laid out that the accounts and procedures are not under the absolute and independent control of any one person or the contrary the work of one employee is complementary to that of another. The system of IC is based upon the principle of division of labour; where in performance of each individual is automatically checked by another. This is possible by properly allocation the work and integration of function of the employees in such a manner their work complements each others.

Internal Auditing: Internal auditing may be defined as a service to the management regarding independent evaluation of various activities of organization. More clearly, internal auditing is an independent appraisal activity within an organization for the review of operations as a service to the management.

Internal audit is a regular activity performed by the employees of the organization, to ensure correctness of accounting data and to detect fraud by way of periodical review of organization system, procedures and policies. Internal audit is systematic and continuous process of examining and reporting the operations and records of a firm by its employees.

Objective of Internal Audit:

1.       To comment of the effectiveness of the internal control system in force and means of improving it.

2.       To verify correctness accuracy and authenticity of the records presented to management.

3.       To facilitate early detection of errors and frauds.

4.       To ensure that standard accounting practices are followed.

5.       To ensure that assets are properly acquired, safeguarded and accounted for.

6.       To investigate in the areas as requested by the management.

7.       To see that exhibited liabilities are valid.

Elements, features characteristics principles of a good Internal Control System: An effective internal control system should have the following factors:

1.       Competent and trust worthy staff: people in charge of internal control system must be reliable and highly competent about the work. Lack of knowledge and dishonesty will spoil the efficiency of the system.

2.       Records of financial and other organizational plans: A good internal control system must have good documentation system. Filing, recording, classifying, etc will help in this regard.

3.       Segregation of duties: normally, there should be a separate department for internal control this reduces frauds, bias etc. Normally, a clerk in charge of accounting function should not be in charge of assets also.

4.       Supervision: proper reviewing of the operations of the company regularly makes the control system effective.

5.       Authorization: all transactions must be properly authorized. In other words, the authority of each person should be well defined.

6.       Sound practices: the company should have well established procedures, policies, delegations organizational manuals etc.

7.       Internal Audit: it’s a part of internal control and it should be independent of internal check.

8.       Accounting Controls: proper accounting information systems should be established so that the information relating to accounts is properly collected, recorded and accounts prepared.

2. What is a voucher? How would you classify it? What are the special points an auditor should bear in mind while examining a voucher? (20)

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Ans: Voucher: Voucher is the original document in support of any payment or receipt of money pertaining to a transaction in a business.  It forms the basis of accuracy of any entry in the books of accounts. It is of two types – primary vouchers and secondary vouchers. Primary vouchers are original written evidence of supporting a transaction. Collateral vouchers are duplicate copies of primary vouchers.

Vouchers can be classified as:

a) Cash vouchers which is further classified as Debit and Credit vouchers.

b) Non-cash vouchers

a) Cash vouchers: These vouchers are documentary proof of cash receipts and payments. Cash vouchers can be further be classified as:

1. Debit vouchers: These vouchers are prepared when cash payments are made to third parties.

2. Credit vouchers: These vouchers are the documentary evidence of cash received by business.

b) No cash vouchers: These vouchers are the documentary evidence of all non cash transactions of the business. These vouchers are prepared for recording the following transactions:

1. Credit sale of fixed assets.

2. For return of goods by customers.

3. For return of goods by suppliers.

4. Credit sale of investments etc.

Important points to be considered while vouching or using vouchers:    (Precautions)

a)      Numbered, printed and serially filed: All the vouchers must be printed, serially numbered and filed. Any hand written voucher must be seen with suspicion. Accounting entries must correspond to serial number of vouchers.

b)      Date and Amount: The auditor should see that the date and amount of the voucher tallies with the date and amount of the transactions recorded in the books of accounts.

c)       Signature of the payee: The auditor should note the signature of the payee. Wherever possible, he should try to ascertain its genuineness.

d)      Cancelled: All the inspected vouchers are cancelled by a mark or stamp.

e)      Period: Voucher should belong to the period under audit and it should be in the name of client.

f)       Receipts: Receipt voucher should have signature of recipient if received in cash.

g)      Payments: Payment should be made through cheques only. Cash payment voucher should be examined in detail to detect embezzlement or misappropriation of money.

h)      Authenticity: All voucher should be seen and  signed by  the competent authority of business, i.e. voucher is duly authorised;

i)        Completeness: The voucher comprised all the relevant documents which could be expected to have been received or brought into existence on the transactions having been entered into, i.e., the voucher is complete in all respects and the account in which the amount of the voucher is adjusted is the one that would clearly disclose the character of the receipts or payments posted thereto on its inclusion in the final accounts.

j)        Reasonable: All expenses and expenditure should be reasonable in the eyes of auditor. He can always raise his eyebrows if any excessive payment is noticed.

k)      Personal: All vouchers should relate to business. Any voucher of personal expense should not be paid by the business.

l)        Verification of other Documents: If required, verify further with other documents like Memorandum of Association, Articles of Association, Prospectus, Partnership deed etc.

3. Discuss the position of an auditor in a company under the provisions of the Companies Act. What are the statutory duties of a company auditor? Discuss in detail. (20)

Ans: Status of a Company auditor: A company auditor is a central figure in the overall scheme of work. Different people may view him differently. The shareholders may regard a company auditor as their trustee or agent. The general public may think of him as an officer of the company. To many he may mean a mere employee of the company. His status should be viewed from the standard of responsibilities taking into consideration his appointing authorities, his accountability and his role as an auditor in the day to day affairs of the company.

1.       As an Officer of the company. In London and General Bank (1895) Lindley said, “It seems impossible to deny that for some purposes, and to some extent, an auditor is an officer of the company. He is appointed by the company and his position is described in the section as that of an officer of the company. He is not a servant of the directors, on the contrary, he is appointed by the company to check the directors and for some purposes and to some extent, and it seems to be quite impossible to say that he is not an officer of the company”.

In Connell v. Himalaya Bank, it was held that auditors, if appointed at a general meeting of the company and if also paid by the company were officers of the company. However, a casual auditor may fail to qualify as an officer of the company. Lord Lindley specified in the case of the Western Countries Steam Bakeries and Milling Company Ltd. “If all persons who did auditor’s work of a company were officers of the company, the case would be easy but no decision has yet gone into this length. An auditor need not be an officer of a company. So may anybody else, e.g. a banker or a solicitor. Prima facie such persons are not offices. To be an officer there must be an office and office imparts a recognised position with rights and duties annexed to it, and it would be abuse of words to call a person an officer who fills no position either de jure or de facto, but who happens to do some of the work which he would have to do if he were officer in the proper sense of the word.”

Thus casual auditors appointed by a company to do a particular accounting work are not officers. In Lindley V. Waddell it was held that an accountant to whom books have been handed over to prepare a balance sheet is not an officer. The case Hudson V. Official Liquidating Dehradun Mussoorie Electric Tramway Company 1989, held that auditors were not officers except for the purpose of sections mentioned therein.

According to Sec. 2(60) of the Indian Companies Act the definition of the term “Officer includes an auditor for the purposes of Sec. 299, 300, 447, 305, 342, 439 and 463.

a)         Section 299 refers to the Court’s power in winding up, to summon persons suspected of having property or books or papers of the company.

b)         Section 300 deals with Court’s power to order public examinations of the promoters, directors or persons guilty of frauds, etc.

c)          Section 447 stipulated penalties for the falsification of accounts and other books.

d)         Section 305 deals with the power of the Court. In the coursed winding up, to assess damages against delinquent officers.

e)         Section 342 deals with the prosecution of delinquent officers and members of the company.

f)          Section 439 takes cognizance of offences under the Act.

g)         Section 463 empowers the Court to grant relief in certain cases, i.e., in proceedings for negligence, default, breach of duty, misfeasance, etc.

Thus, except for the above quoted provisions a company auditor is not one of the officers.

2.       As Agent of the Shareholder. A company auditor works for and on behalf of the shareholders. Thus, it is but natural that he is treated as the agent of shareholders. Barring first auditors and shareholders have the exclusive right to appoint auditors. It is only when they fail to do so under special but specified reasons that the central government intervene and appoints them. An auditor has to safeguard the interests of the shareholders. Accordingly, he must be considered as an agent of the shareholders.

In Spockman v. Evans said Lord Cranworth, “the auditor may be agents of the shareholders so far as it relates to the audit of the accounts. For the purposes of audit the auditors will bind the shareholders.”

In the same case Lord Chemsford clarified the extent of the agency though agreeing that the auditor is the agent of the shareholders. He opined that although auditors may be the agents of the shareholders, the latter could not be deemed to be precluded from objecting to any actions of the directors or others merely on the grounds that the auditors were aware of such actions. The mutuality between principal and agent as applied to shareholders and the auditor works only when the auditor informs them through the Report. In Nicls case re. Royal British Bank Turner L. J. said, “There were auditors of the company appointed by the shareholders. These auditors were within the scope of their duty, at least as much the agent of the shareholders as the directors were, and the false and fraudulent representations were discoverable by them.”

Duties of a Company Auditor

According to Sec. 143 of the Companies Act, 2013, the duties of auditors are classified under the following headings:

a)      Duty to Enquire: It is the duty of auditor to inquire into the following matters:

i.         Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members.

ii.       Whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company.

iii.      Whether loans and advances made by the company have been shown as deposits.

iv.     Whether personal expenses have been charged to revenue accounts.

v.       Whether or not cash has actually been received from allotment of shares.

vi.     Where the company not being an investment company or a banking company, whether so such of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than at which they were purchased by the company.

b)      Duty to make report: The auditor shall make a report to the members of the company. In his report, the auditor shall report on:

                     i.            Whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief necessary for the purpose of his audit and if not, the details thereof and the effect of such information on financial statements.

                   ii.            Whether in his opinion, proper books of account are required by law have been kept by the company so far as appears from his examination.

                  iii.            Whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of accounts and returns.

                 iv.            Whether in his opinion, the financial statements comply with the accounting standards.

                   v.            Whether any director is disqualified from being appointed as a director.

                 vi.            Whether the company has adequate internal financial control system in place and the operating effectiveness of such control.

                vii.            Such other matters as may be prescribed under rule 11: The auditor’s report shall also include views and comments on the following matters.

1)      Whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement.

2)      Whether the company has made provisions, as required under any law or accounting standards, for material losses, if any on long term contracts including derivative contracts.

3)      Whether there has been any delay in transferring amounts, required to be transferred, to the investor education and protection fund by the company.

c)       Duty to report on frauds u/s 143 and rules 13: If an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offense involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the central government within such time and in such manner prescribed in rule 13.

4. What is Cost Audit? What are its objectives? Enumerate the points that need special attention in course of cost audit. (20)

Ans: Cost Audit: It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.

As per ICWA London’ “cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.”

The ICWAI defines cost audit as “system of audit introduced by the government of India for the review, examination and appraisal of the cost accounting records and attendant information required to be maintained by specified industries"

From above definition of cost audit, it is clear that cost audit is a systematic examination of cost accounts to verify correctness of cost accounting records.

Objectives of Cost Audit:

1.       To determine whether cost accounts have been correctly prepared according to the system and techniques employed by the organisation with a view to enforce cost control and proper cost ascertainment.

2.       To ensure that cost accounting plan is adhered to and the routines laid down are carried out.

3.       To detect and prevent errors and frauds in preparing cost records.

4.       To ensure the integration of cost accounting system and technique into the total system of the organsiation.

5.       To verify that the proper process of cost accounting has been maintained by the management as per the requirements of the industry.

6.       To ensure that the process of cost accountancy is adequate to the management for taking effective decision.

In the course of cost audit, the following points need special attention:

It would be ideal to prepare a cost audit manual for the purpose of outlining procedure and the framework within which the cost audit programme is to operate. This will include the following:

1. The objectives of cost audit.

2. The organisation for cost audit, the authority and responsibility of the staff.

3. Definition of inter-relationship of cost audit with management accounting, cost accounting and financial accounting.

4. Cost audit procedure based on cost accounting system and the management system in general.

5. Cost audit programme integrated with the cost audit procedures.

6. Cost audit report.

7. Follow-up of cost audit report.

Cost audit Procedure

1. Vouching: Vouching is the examination of documentary evidence to support and substantiate a particular transaction. It implies that the transaction is properly authorised, recorded and entered in the books of accounts. For example, where overtime work is allowed, the authorization the allocation to the job concerned etc, should be properly recorded in the books.

2. Checking and ticking: The auditor puts check marks or tick marks in pen or coloured pencil to confirm that totals, calculations, posting, etc, have been checked.

3. Test checking: In large organisations, with numerous products, divisions or departments, it is almost impossible to check each and every item of cost. The detailed checking may be left to the internal audit staff while a random sampling check should be made by cost auditor.

4. Working papers: The cost auditor should obtain the organisation manual/chart, costing manual, uniform costing manual, cost audit manual and other such related documents and accounts which are essential for conducting cost audit.

5. Audit note: The auditor should record facts in the audit notes in order to seek clarification from the concerned  executives and to make suggestions for improving cost accounting and management accounting organisation.

6. Questionnaires: The cost auditor should frame suitable questionnaires to be included in the cost audit manual to collect information about cost elements. The auditor would do well to make use of them and even check their suitability in the context of changing cost audit needs. These questionnaires should be brief, adequate and seek answers in a very brief form.

7. Audit report: After the cost audit has been completed, the cost auditor has to prepare cost audit report incorporating a certificate regarding correctness of the accounts. This report should also contain suggestions, if any, for improvement I the system. It is not to be sent to the registrar of companies or to the shareholders. It is not to be disclosed in the annual reports.

5. Write short notes on the following:   (4X5)

(a) Errors of principle

Ans: Errors of Principle: Errors of principle generally arise due to disregard of the fundamental principles of accountancy. Such errors are sometimes committed intentionally to falsify and manipulate accounts with an objective of showing more or less profits than their actual figure. In other words, when the basic rules of debit and credit are violated either out of lack of knowledge or intentionally, such errors are called ‘Errors of Principles’. These errors do not affect the agreement of trial balance.


a)      Wrong allocation of revenue and capital expenditure. When a revenue expenditure is treated as capital expenditure or vice versa, the profits will be effected and Balance Sheet will also not show correct position e.g., repair Rs. 500 paid for machinery is wrongly debited to Machinery Account instead of Repair Account. Repair is a revenue item and machinery is a capital item. It is an error of principle, because revenue item is wrongly treated as capital item.

b)      Revenue item is charged to personal account. When a revenue item is wrongly debited to personal account, it is a case of error of principle. This will not affect the agreement of trial balance e.g., rent paid Rs. 200 to landlord was posted to the debit of landlord’s personal account instead of rent account.

c)       Income is treated as liability. When an income is treated as liability, it will not affect the trial balance e.g., commission Rs. 600 received from Jaideep was credited to Jaideep’s personal account instead of commission account.

d)      A liability is treated as income. Suppose, a loan of Rs. 5,000 is taken from Punjab Finance Corporation. It was wrongly credited to commission account instead of loan account. This error will not affect the two sides of trial balance.

Other Examples of errors of principle are:

1)         Error in valuation of stock.

2)         Error in identifying sales and purchases.

3)         Error in computing depreciation.

4)         Error in providing outstanding expenses and accrued incomes.

5)         Error in adjustment of prepaid expenses.

It is important to note that the errors of principle are not clerical errors. These errors occur because of wrong choice and wrong application of accounting policies.

(b) Audit of Reserves

Ans: In order to save the business from risks and uncertainties, it is necessary to make provisions and reserves in every business. This has become a normal practice in all business concerns. Reserves are simply a part of the profits, which is set aside for any known or unknown contingencies, liabilities or diminution in the value of as asset. Reserve may be general or specific. Specific reserves are created for specific purpose. Proper audit of reserves are necessary. In case of specific reserves, the auditor must ascertain whether the reserve is adequate and reasonable having regard to the object for which it has been created, though the extent of adequacy and reasonableness will differ from business to business.

Creation of a general reserve is not a legal necessity. Only a management endowed with foresight and a sense of judgement will create and maintain it. It reduces the work of an auditor as he has only to ascertain whether the creation of general reserves is in the interests of the business and that if the company has framed certain rules in this regard, they are duly adhered to.

(c) Prevention and detection of fraud

Ans: Detection and Prevention of Fraud: A fraud is an Error committed intentionally to deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.

a.       Misappropriation of Cash: This is one of the majored frauds in any organisation it normally occurs in the cash department. This kind of fraud is either by showing more payments/ less receipt. The cashier may show more expenses than what is actually incurred and misuse the extra cash. E.g.: showing wages to dummy workers. Cash can also be misappropriated by showing less receipts E.g.: not recording cash sales. Not allowing discounts to customers. The cashier may also misappropriate the cash when it is received. Cash received from 1st customer is misused when the 2nd customer pays it is transferred to the 1st customer’s account. When the 3rd customer pays it goes forever. Such a fraud is known as “Teaming and Lading”. To prevent such frauds the auditor must check in detail all books and documents, vouchers, invoices etc.

b.      Misappropriation of Goods: Here records may be made for the goods not purchase not issued to production department; goods may be used for personal purpose. Such a fraud can be deducted by checking stock records and physical verification of goods.

c.       Manipulation of Accounts: this is finalizing accounts with the intention of misleading others. This is also known as “WINDOWS DRESSING”. It is very difficult to locate because it is usually committed by higher level management such as directors. The objective of WD may be to evade tax, to borrow money from bank, to increase the share price etc.

To conclude it can be said that, it is not the main objective of the auditor to discover frauds and irregularities. He is not an insurance against frauds and errors. But if he finds anything of a suspicious nature, he should probe it to the full.

(d) Audit Planning

Ans: Audit planning is a process in which auditor decides in advance what is to be done, who is to do it, how it is done  and when it is to be done by the auditor, so that he can be able to complete his work effectively. Before beginning the audit work, an auditor must review the various arrangements with his client to decide his future course of action. Usually, the following point must be considered in this connection.

1.       The Client: An auditor must know about his appointee will in advance. Whom to report? and  Who will pay his fees?

2.       Scope of Duties: the auditor should ascertain the scope of his duties and responsibilities from statues, or from the instructions received from those employing his services.

3.       Period to be covered: The auditor should ascertain the period to be covered in the audit.

4.       Use of client’s staff: The auditor may have his own staff or may take the assistance of his client’s staff where some clerical work is also to be performed.

5.       Place of Audit Work: The auditor should know the place of his work. This place is where he will open his office with his staff and conduct his enquiries.

Audit planning is very important for auditors because it helps them in accomplishment of duties, identify the problem areas and helps in timely completion of work.

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