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GNDU Question Paper-2023
Bachelor of Commerce
(B.Com) 5
th
Semester
AUDITING
Time Allowed: Three Hours Max. Marks: 50
Note: Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTION-A
1. What are the different types of frauds in connection with accounts?
Give few examples of frauds and state how the auditor can detect and prevent such
frauds.
2. (i) Describe the qualities of an auditor.
(ii) What do you understand by Continuous Audit? How is it different from periodical
Audit ? Explain.
SECTION-B
3. What is meant by the Internal Check? What are the essential characteristics of a good
Internal Check systern? Also, describe the advantages and disadvantages of Internal
Check.
4. Describe the objectives of Internal Check system. Suggest a suitable system of Internal
Check for recording cash receipts and cash payments.
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SECTION-C
5. (i) What are the duties of an auditor in connection with sales and sales returns?
(ii) Discuss the general considerations, during the vouching of trading transactions.
6. (i) How would an auditor undertake vouching of credit purchases and purchase returns?
(ii) Which points should an auditor keep in mind while vouching the cash receipts?
SECTION-D
7. Discuss the rights and duties of an auditor with the help of relevant case law.
8. (i) Explain the various classifications of an Audit Report.
(ii) Write a detailed note on Management Audit.
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GNDU Answer Paper-2023
Bachelor of Commerce
(B.Com) 5
th
Semester
AUDITING
Time Allowed: Three Hours Max. Marks: 50
Note: Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTION-A
1. What are the different types of frauds in connection with accounts?
Give few examples of frauds and state how the auditor can detect and prevent such
frauds.
Ans: The Story of Hidden Tricks: Understanding Frauds in Accounts
Imagine you are the headmaster of a big school. Every day hundreds of students pay fees,
some parents donate money, and the government also gives funds for books and
infrastructure. All this money has to be collected, recorded, and properly spent. But what if
one of the clerks in the accounts office quietly pockets some of the money? Or what if
someone creates fake receipts to show that new benches were bought, while in reality
nothing was purchased? This is where frauds in accounts begin.
Just like in schools, offices, and businesses, money flows in and out. And wherever money is
involved, some clever minds may try to take advantage. That’s why auditors are like
detectives of the financial world. Their job is not just to add and subtract numbers but to
carefully look for any signs of trickery.
Let us take a journey to understand:
1. What types of frauds can happen in connection with accounts?
2. What are some real-life examples of such frauds?
3. How can an auditor detect and prevent these frauds?
We’ll treat this like an unfolding mystery story, where frauds are the villains, and auditors
are the guardians of honesty.
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Types of Frauds in Connection with Accounts
Frauds are like diseases—they come in many forms. Let’s divide them into simple categories
so you never get confused.
1. Misappropriation of Cash
This is the most common type of fraud. It means stealing or misusing cash that belongs to
the organization.
• Example: A cashier receives ₹10,000 as payment but records only ₹7,000 in the
books and keeps the rest.
• It is like a shopkeeper taking ₹100 from a customer but writing only ₹70 in his
notebook.
2. Misappropriation of Goods
Not all frauds are about money; sometimes it’s about products or goods.
• Example: An employee in a warehouse secretly sells 10 boxes of company products
to outsiders without recording the sale.
• In schools, imagine a storekeeper selling 50 notebooks meant for students and
keeping the money.
3. Manipulation of Accounts (Falsification of Accounts)
Here, numbers are twisted to show a false picture. It can be done for personal gain or to
mislead stakeholders.
• Example: Showing profit when the business is actually in loss, so that investors
continue trusting the company.
• Another example: Overstating assets to get more loans from the bank.
4. Teeming and Lading (Lapping of Accounts)
This is a clever trick with debtors (people who owe money).
• Example: Suppose customer A pays ₹5,000. The cashier does not record it but uses
customer B’s later payment to cover A’s account. Then uses customer C’s payment
to cover B’s account, and the chain continues.
• It’s like a juggling game where one payment hides the theft of another.
5. Forgery and Alteration of Documents
This involves creating fake documents, altering cheques, or signing fake receipts.
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• Example: An employee may forge the manager’s signature on a cheque and
withdraw money.
• Or someone might alter invoices to show higher expenses.
6. Payroll Frauds
This happens in organizations with many employees.
• Example: Adding fake employees (called “ghost workers”) in salary sheets and
pocketing their salaries.
• Or inflating overtime hours for extra payments.
7. Frauds in Recording Purchases and Sales
Sometimes fraud is hidden in simple bills.
• Example: Showing fake purchases to reduce profit (so that less tax is paid).
• Or recording fake sales to show higher turnover and attract investors.
8. Window Dressing
This is a fraud mainly done to mislead outsiders like investors, banks, or government.
• Example: Before the year-end, a company may temporarily show false profits or hide
liabilities to make financial statements look healthy.
• Like decorating a house with flowers only on the day of guest arrival, while inside
everything is broken.
Real-Life Style Examples of Frauds
Let’s imagine a company called BrightStar Pvt. Ltd. to see how frauds can take place in daily
life.
1. Cash Fraud: The cashier of BrightStar receives ₹1,00,000 from a client but records
only ₹80,000 in the books. He quietly pockets the remaining ₹20,000.
2. Goods Fraud: The store manager sells company laptops at half price in the black
market without informing the owners.
3. Accounts Manipulation: To impress shareholders, the accountant shows fake profits
by recording revenue that never existed.
4. Payroll Fraud: The HR officer adds his cousin’s name to the employee list even
though he doesn’t work there. Every month, the “ghost worker” receives salary,
which the HR officer withdraws.
5. Forgery: A junior employee steals a signed cheque from the director’s drawer,
changes the amount from ₹5,000 to ₹50,000, and encashes it.
6. Window Dressing: BrightStar, before applying for a big bank loan, hides its actual
debt and shows inflated asset values to appear financially strong.
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These examples show that frauds can be small or large, simple or highly complex—but the
danger is always the same: loss of trust and money.
Role of the Auditor: Detecting and Preventing Frauds
Now enters the hero of our story—the auditor. Imagine an auditor as Sherlock Holmes of
the accounting world. They don’t carry a magnifying glass but use their professional
skepticism and auditing tools to detect fraud.
Here’s how an auditor can detect and prevent each kind of fraud:
1. Detecting Cash Frauds
• Cross-checking cash receipts with bank deposits.
• Surprise cash counts.
• Comparing cash book with supporting documents.
Prevention: Keep proper division of duties—cashier should not also be responsible for
recording transactions.
2. Detecting Goods Frauds
• Physical verification of stock.
• Comparing stock records with sales and purchase invoices.
Prevention: Install strong inventory control and regular stock audits.
3. Detecting Manipulation of Accounts
• Analytical procedures: comparing ratios (like profit margin, current ratio) with past
years.
• Checking if revenues and expenses are correctly recorded.
Prevention: Strong internal checks and independent reviews.
4. Detecting Teeming and Lading
• Sending confirmation letters directly to debtors.
• Comparing timing of payments with recorded entries.
Prevention: Proper supervision of debtors’ accounts and rotation of duties.
5. Detecting Forgery
• Careful examination of handwriting, signatures, and alterations in documents.
• Direct confirmation from banks and creditors.
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Prevention: Secure custody of important documents and use digital signatures.
6. Detecting Payroll Frauds
• Cross-checking employee records with HR department.
• Surprise headcounts to verify existence of employees.
Prevention: Biometric attendance systems and computerized payroll software.
7. Detecting Purchase and Sales Frauds
• Verifying purchase invoices with goods received notes.
• Cross-checking sales invoices with delivery challans.
Prevention: Multiple authorizations for large purchases and sales.
8. Detecting Window Dressing
• Comparing figures with industry standards.
• Examining events after balance sheet date (post-balance sheet review).
Prevention: Strict compliance with accounting standards and regulations.
Why Fraud Detection Matters
Frauds are not just about money loss. They affect trust, reputation, and stability of the
business. Shareholders lose confidence, employees feel insecure, and customers doubt the
company.
That’s why auditors play a critical role in protecting not just the company but also the public
interest. Their responsibility is to ensure that financial statements tell the truth—not a
decorated lie.
Conclusion
To sum up, frauds in accounts are like hidden cracks in a beautiful building. On the surface,
everything looks fine, but inside, the structure is weak. These frauds can take many forms—
misappropriation of cash or goods, manipulation of accounts, forgery, payroll frauds, and
more.
Auditors act as the watchdogs who detect these cracks early and prevent them from
spreading. They use methods like surprise checks, confirmations, ratio analysis, and strong
internal controls to uncover the truth.
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So, whenever you hear the word “fraud,” don’t just think of big scams in newspapers. Even
small tricks in daily accounting can be frauds. And behind every honest financial report,
there is an auditor who worked hard—like a detective—to ensure the story written in the
accounts is not fiction but reality.
2. (i) Describe the qualities of an auditor.
(ii) What do you understand by Continuous Audit? How is it different from periodical
Audit ? Explain.
Ans: Chapter One — The Portrait of an Ideal Auditor
Scene 1: The First Impression
It’s a crisp Monday morning. The boardroom of “Silverline Exports Ltd.” is ready for the
annual audit. The door opens, and in walks Mr. Arvind Mehta, the auditor. He’s not just
carrying files — he’s carrying a reputation.
Everyone in the room knows that when Arvind signs a report, it means something. Why?
Because he embodies the qualities of a good auditor.
1. Integrity and Honesty
An auditor’s signature is only as good as their honesty.
• Arvind will never twist facts to please management or shareholders.
• He knows that public trust in financial statements depends on his moral backbone.
2. Independence
An auditor must be free from bias or influence.
• Arvind avoids situations where personal relationships or financial interests could
cloud his judgment.
• He maintains professional distance — friendly, but never compromised.
3. Professional Competence
Knowledge is his toolkit.
• He’s well-versed in accounting standards, auditing standards, tax laws, and corporate
regulations.
• He keeps learning — attending seminars, reading updates — because rules change,
and so must he.
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4. Skepticism and Inquisitiveness
A good auditor doesn’t accept things at face value.
• Arvind asks “Why?” and “How?” until he’s satisfied.
• If a figure looks unusual, he digs deeper — not because he suspects everyone, but
because it’s his job to verify.
5. Patience and Perseverance
Auditing can be tedious — long hours, repetitive checks.
• Arvind works methodically, never rushing through ledgers or skipping steps.
• He knows that missing a small detail can mean missing a big problem.
6. Good Communication Skills
Findings must be explained clearly.
• Arvind can write a crisp audit report and also explain complex issues in plain
language to non-accountants.
• He listens as well as he speaks — understanding client concerns before responding.
7. Tact and Diplomacy
Pointing out errors can bruise egos.
• Arvind delivers criticism constructively, focusing on solutions rather than blame.
• This keeps relationships professional and cooperative.
8. Organisational Ability
Audits involve mountains of data.
• Arvind keeps his working papers, schedules, and evidence neatly organised.
• This saves time and ensures nothing is overlooked.
9. Awareness of Business Environment
He understands the client’s industry, risks, and market conditions.
• This context helps him judge whether figures make sense and controls are adequate.
10. Confidentiality
An auditor is privy to sensitive information.
• Arvind never discloses client secrets unless required by law.
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• This builds trust and protects the client’s competitive position.
In short: A good auditor is part detective, part judge, part teacher — guided by ethics,
armed with knowledge, and skilled in human interaction.
Chapter Two — Continuous Audit vs Periodical Audit
Now, let’s follow Arvind into two different assignments to see how the style of audit
changes.
Scene 1: Continuous Audit — The Ongoing Watch
For “MetroBank Ltd.”, Arvind doesn’t just show up once a year. Instead:
• He visits every fortnight.
• Each visit, he checks the transactions since his last visit.
• By year-end, most of the work is already done.
Definition
A continuous audit is one where the auditor examines the books of accounts at regular
intervals throughout the accounting period, rather than in one block after year-end.
Features
• Frequent visits — weekly, fortnightly, or monthly.
• Detailed checking of transactions soon after they occur.
• Audit runs parallel to the accounting process.
• At year-end, finalisation is quick because most checking is complete.
Advantages
1. Early Detection of Errors/Frauds — Mistakes are caught quickly, limiting damage.
2. Quick Finalisation — Accounts can be presented soon after year-end.
3. Moral Check on Staff — Surprise visits keep employees alert.
4. Detailed Examination — More time to check thoroughly.
5. Interim Accounts Possible — Useful for declaring interim dividends.
6. Regular Feedback — Auditor can give timely suggestions.
Disadvantages
• Costly — Frequent visits mean higher fees.
• Disruption — Regular checking can interrupt staff work.
• Over-familiarity Risk — Too much contact may reduce auditor’s independence.
• Complacency — Staff may rely on auditor to catch mistakes instead of preventing
them.
Scene 2: Periodical Audit — The Annual Review
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For “Sunrise Traders”, Arvind’s approach is different:
• He visits once, after the books are closed for the year.
• He examines the records for the whole year in one continuous session.
Definition
A periodical audit (also called final or complete audit) is conducted after the end of the
accounting period, in one block, covering all transactions of that period.
Features
• Single visit after year-end.
• Audit work done in one continuous stretch.
• Focus on verifying the final accounts.
• Suitable for smaller businesses with fewer transactions.
Advantages
1. Less Expensive — Only one visit.
2. Minimal Disruption — Staff work is not interrupted during the year.
3. Quick Completion — Work is done in one go.
4. Reduced Risk of Collusion — Less frequent contact with staff.
5. Books Closed Before Audit — Less chance of tampering during audit.
Disadvantages
• Errors/Frauds Detected Late — Problems may go unnoticed for months.
• No Interim Feedback — Management can’t act on issues during the year.
• Detailed Checking Harder — Time pressure may limit depth of checking.
Key Differences Between Continuous and Periodical Audit
Basis
Continuous Audit
Periodical Audit
Timing
Throughout the year at intervals
Once after year-end
Frequency
Frequent visits
Single visit
Detection of
Errors/Frauds
Early detection possible
Detected late
Cost
Higher
Lower
Suitability
Large organisations, banks, companies
needing interim accounts
Small businesses with
simple records
Impact on Staff
Moral check due to surprise visits
Minimal disruption
during the year
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Basis
Continuous Audit
Periodical Audit
Finalisation Speed
Very quick at year-end
Takes time after audit
starts
Bringing It Together — The Auditor’s Choice
Arvind knows that the choice between continuous and periodical audit depends on:
• Size and complexity of the business.
• Need for interim accounts.
• Risk of fraud or error.
• Budget for audit fees.
In both cases, his qualities remain the same — integrity, independence, competence — but
the method changes to suit the client’s needs.
Exam-Ready Summary
(i) Qualities of an Auditor:
• Integrity and honesty.
• Independence.
• Professional competence.
• Skepticism and inquisitiveness.
• Patience and perseverance.
• Communication skills.
• Tact and diplomacy.
• Organisational ability.
• Business awareness.
• Confidentiality.
(ii) Continuous Audit:
• Definition: Audit at regular intervals during the year.
• Features: Frequent visits, detailed checking, parallel to accounting.
• Advantages: Early detection, quick finalisation, moral check, detailed examination,
interim accounts.
• Disadvantages: Costly, disruptive, over-familiarity risk.
Periodical Audit:
• Definition: Audit after year-end in one block.
• Features: Single visit, covers whole year, final accounts focus.
• Advantages: Less expensive, minimal disruption, quick completion, reduced
collusion.
• Disadvantages: Late detection, no interim feedback, less detailed checking.
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Differences: Timing, frequency, detection speed, cost, suitability, staff impact, finalisation
speed.
Final Takeaway: An auditor’s personal qualities are the foundation of trust and
effectiveness. Whether they work in a continuous or periodical style, those qualities —
integrity, independence, skill — are what turn an audit from a mechanical exercise into a
meaningful safeguard for the organisation.
SECTION-B
3. What is meant by the Internal Check? What are the essential characteristics of a good
Internal Check system? Also, describe the advantages and disadvantages of Internal
Check.
Ans: A Fresh Beginning: Imagine a Busy Shop
Let’s start with a small story.
Imagine you walk into a big shop — say a departmental store in your city. The store is
buzzing with activity: one employee is at the cash counter collecting payments, another is
arranging products on shelves, someone else is checking bills, and another staff member is
keeping watch on the stock in the warehouse.
Now, pause for a moment and think — what if the same person was responsible for buying
stock, arranging it, selling it, collecting cash, and also writing the accounts? That would be a
recipe for disaster! Mistakes could happen easily, or even worse, there would be a big
chance of fraud.
That’s where the concept of Internal Check comes in.
What is Internal Check?
Internal Check is like an inbuilt safety mechanism inside any business.
It means dividing work among employees in such a way that no single person has full
control over a transaction from start to finish. The work of one person is automatically
checked by another, making it difficult for errors or frauds to go unnoticed.
In simple words:
• Internal Check is a system of checks on day-to-day transactions where the
responsibility of work is divided among staff members in such a way that the work
of one person is checked by another.
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It is not a separate department or a machine — it is a smart arrangement of duties.
Example:
• The person who writes the cash receipts should not be the one who deposits the
money in the bank.
• The person maintaining stock records should be different from the one who
physically handles the stock.
So, Internal Check is basically about trust, but with verification.
Essential Characteristics of a Good Internal Check System
If Internal Check is like the “rules of the game” inside an organization, then a good system
should have some special features. Let’s break them down one by one, like ingredients of a
good recipe.
1. Proper Division of Work
Each job should be divided carefully so that no one person controls all stages of a
transaction.
• Example: One clerk prepares vouchers, another authorizes them, and a third enters
them in accounts.
2. Automatic Checking
The system should be designed in a way that the work of one employee is automatically
checked by another. This reduces the need for external supervision.
• Example: Cashier collects cash, but accounts department tallies it with daily sales
records.
3. Clear Allocation of Responsibility
Every employee should know exactly what their duty is. If something goes wrong,
responsibility can be fixed quickly.
4. Rotation of Duties
To avoid any employee becoming “too comfortable” in one role, duties should be rotated
periodically. This reduces the risk of fraud.
5. Regular Supervision
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Even though work is divided, supervisors should keep an eye on employees to ensure they
follow procedures.
6. Segregation of Duties
Recording, authorizing, and custody of assets should be in different hands.
• Example: The one who records cheques should not also sign them.
7. Use of Documents and Vouchers
A good internal check system always insists on proper documentation. Every transaction
should have supporting bills, vouchers, or receipts.
8. Efficient Communication
There should be proper flow of information between departments. Otherwise, confusion
can break the chain of checking.
In short, a good Internal Check system is like a well-choreographed dance performance
where everyone knows their steps, and the dance looks smooth because each person’s
move complements the other.
Advantages of Internal Check
Now let’s talk about the bright side of Internal Check. Businesses adopt it for several strong
reasons:
1. Prevention of Errors and Frauds
Since the work of one person is checked by another, it becomes very difficult for frauds to
occur unnoticed. Mistakes are also quickly caught.
2. Accuracy and Reliability of Accounts
Because of continuous checking, the accounts prepared are more reliable and accurate.
3. Increased Efficiency
Division of work according to specialization makes employees more efficient. Everyone
focuses on their part without confusion.
4. Fixing of Responsibility
If something goes wrong, it’s easy to trace who was responsible because duties are clearly
divided.
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5. Saves Time for Auditors
When there is a strong internal check system, auditors can rely on it and reduce detailed
checking. This saves time and cost.
6. Employee Honesty
Employees know their work will be reviewed, so they are less likely to cheat. It encourages
honesty and discipline.
7. Smooth Workflow
The system ensures that transactions are carried out in a systematic and orderly way
without bottlenecks.
Disadvantages of Internal Check
But just like every coin has two sides, Internal Check is not perfect. It comes with certain
limitations too:
1. Expensive
Maintaining such a system requires more staff and resources, which may be costly for small
businesses.
2. Possibility of Collusion
If two or more employees decide to cheat together, the system may fail.
• Example: Cashier and accountant working hand-in-hand to hide fraud.
3. Overconfidence
Management may become too dependent on the system and ignore independent
supervision. This can be risky.
4. Rigidity
A very strict system may reduce flexibility. Employees may feel burdened with too many
rules.
5. Not Foolproof
Even with the best system, some smart frauds may still go undetected.
6. Delay in Work
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Sometimes, the requirement of multiple checks can slow down the speed of transactions.
Story Connection: Back to the Shop
Now let’s revisit our shop example.
• The cashier collects the money, but at the end of the day, another staff member
matches it with the sales register.
• The store manager authorizes purchase orders, but stock records are updated by
someone else.
• At the end of the month, the accountant compares all records.
Here, Internal Check ensures that if the cashier tries to pocket extra money, the daily tally
will expose it. If the stockkeeper tries to hide missing items, the accountant’s comparison
will reveal it.
But, if the cashier and stockkeeper decide to collude, then fraud may still happen. That’s the
limitation of Internal Check.
Conclusion
To sum it up in human terms, Internal Check is like a security system in a house:
• The locks on doors (division of work).
• CCTV cameras (automatic checking).
• Security guards (supervisors).
This doesn’t guarantee 100% safety, but it drastically reduces the chances of theft or fraud.
So, Internal Check is the backbone of reliable accounting. A good system makes business
operations smooth, builds trust, and helps auditors. Yet, managers must remember its
limitations and not blindly rely on it.
4. Describe the objectives of Internal Check system. Suggest a suitable system of Internal
Check for recording cash receipts and cash payments.
Ans: Scene 1: The Company That Never Sleeps
It’s 10:00 a.m. at “BrightStar Traders Pvt. Ltd.”. The reception phone is ringing, customers
are walking in, and the accounts department is already counting yesterday’s cash sales.
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The Managing Director, Mr. Kapoor, knows that cash is the most tempting and vulnerable
asset. If there’s any weakness in the system, money can disappear without a trace. That’s
why he insists on a strong Internal Check system.
Part 1 — Objectives of an Internal Check System
Before we design the system, let’s understand what Internal Check means and why it’s
important.
What is Internal Check?
Internal Check is:
An arrangement of duties among the staff in such a way that the work of one person is
automatically checked by another, with the objective of preventing and detecting errors and
frauds at the earliest possible stage.
It’s like a relay race — each runner (employee) passes the baton (work) to the next, and
each checks that the baton is intact before running their part.
Objectives — The “Why” Behind Internal Check
1. Prevention of Errors and Frauds
o By dividing work and introducing cross-checks, it becomes harder for
mistakes or fraud to go unnoticed.
2. Early Detection
o If something does go wrong, the system ensures it’s spotted quickly — before
losses grow.
3. Proper Division of Work
o No single person handles a transaction from start to finish; this reduces
opportunities for manipulation.
4. Fixing Responsibility
o If an error occurs, it’s easier to trace who was responsible at each stage.
5. Operational Efficiency
o Work flows smoothly because duties are clearly defined and interlinked.
6. Accuracy and Reliability of Records
o Continuous checking ensures that books of account are correct and
trustworthy.
7. Safeguarding Assets
o Especially for cash, stock, and other movable assets, internal check acts as a
protective shield.
8. Building Public and Stakeholder Confidence
o Investors, banks, and auditors feel more secure when they know strong
internal checks are in place.
In short: Internal Check is like having a network of security cameras — not to catch people
after the crime, but to make committing the crime difficult in the first place.
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Part 2 — Designing an Internal Check System for Cash Receipts
Cash receipts can come from many sources: cash sales, collections from debtors, income
from investments, etc. Here’s how BrightStar Traders sets up its system.
A. Objectives for Cash Receipts Internal Check
• Ensure all cash received is recorded promptly and accurately.
• Prevent misappropriation before deposit into the bank.
• Ensure no suppression of receipts (e.g., treating cash sales as credit sales).
B. Step-by-Step System
1. Opening of Mail and Receiving Cash
o All incoming mail is opened by the Cashier in the presence of a responsible
officer (e.g., Accounts Manager).
o Any cheques/drafts are immediately crossed “A/C Payee Only”.
2. Immediate Recording
o Cash and cheques received are entered immediately in:
▪ Cash Book (for cash)
▪ Cheque Received Register (for cheques)
o A pre-numbered printed receipt is issued for every payment received, signed
by both the cashier and the responsible officer.
3. Deposit into Bank
o All receipts are deposited daily into the bank.
o Preparation of bank pay-in-slip is done by a person other than the one
depositing the cash.
4. Custody of Receipt Books
o Unused receipt books are kept under lock and key by a senior official.
o Cancelled receipts are kept intact in the book — never torn out.
5. Cash Received After Banking Hours
o Kept in a secure company locker, opened only in the presence of two
officials.
6. Surprise Checks
o Senior management conducts unannounced cash counts to verify balances.
7. Reconciliation
o Daily reconciliation between:
▪ Cash Book totals
▪ Bank deposit slips
▪ Receipts issued
Example in Action: Yesterday, BrightStar received ₹50,000 in cash sales and ₹30,000 in
cheques from debtors.
• The cashier issued receipts for each transaction.
• The accounts clerk prepared the bank pay-in-slip.
• The office assistant deposited the money.
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• The Accounts Manager matched the deposit slip with the Cash Book and receipts. At
every step, one person’s work was checked by another.
Part 3 — Designing an Internal Check System for Cash Payments
Cash payments include expenses, supplier payments, wages, etc. Here, the risk is making
fictitious or inflated payments.
A. Objectives for Cash Payments Internal Check
• Ensure all payments are authorised and supported by proper documents.
• Prevent fictitious or duplicate payments.
• Ensure correct recording in the books.
B. Step-by-Step System
1. Authorisation
o All payments must be supported by properly authorised vouchers.
o Large payments require approval from senior management.
2. Segregation of Duties
o The person preparing the payment voucher is different from the one signing
the cheque or making the payment.
3. Cheque Payments Preferred
o As far as possible, payments are made by cheque or bank transfer to
maintain a clear trail.
4. Cash Payments
o For petty expenses, a petty cash system is used with an imprest amount.
o Petty cash is replenished only after submission of expense vouchers.
5. Supporting Documents
o Every payment voucher is backed by:
▪ Supplier invoice
▪ Goods Received Note (GRN)
▪ Purchase Order (PO)
6. Cancellation of Vouchers
o Once paid, vouchers are stamped “PAID” to prevent reuse.
7. Recording
o Payments are entered in the Cash Book immediately after disbursement.
8. Bank Reconciliation
o Monthly reconciliation of bank statements with the Cash Book to detect
discrepancies.
9. Surprise Checks
o Periodic surprise verification of petty cash by a senior officer.
Example in Action: BrightStar needs to pay ₹1,20,000 to a supplier.
• The purchase department provides the PO and GRN.
• The accounts clerk prepares the voucher.
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• The Finance Manager approves it.
• The cashier issues the cheque.
• The accounts clerk records the payment in the Cash Book.
• The bank reconciliation at month-end confirms the cheque cleared.
Why This Works — The Built-In Safeguards
In both receipts and payments:
• No single person controls the entire transaction.
• Pre-numbered documents prevent omission or duplication.
• Authorisation and approval ensure legitimacy.
• Physical verification (cash counts) ensures actual existence.
• Reconciliation catches timing or recording errors.
Auditor’s Perspective
When an auditor examines BrightStar’s books:
• They’ll review the internal check system to assess reliability.
• A strong system means the auditor can place more reliance on the records, reducing
the need for detailed checking.
• Weaknesses will be reported with recommendations for improvement.
SECTION-C
5. (i) What are the duties of an auditor in connection with sales and sales returns?
(ii) Discuss the general considerations, during the vouching of trading transactions.
Ans: Scene 1: Morning in the Sales Department
It’s 9:30 a.m. at “Sunrise Appliances Ltd.”. The auditor, Meera, arrives with her audit bag
and greets the sales manager. She’s here to review sales and sales returns — two areas that
directly affect the company’s revenue and profit.
Part (i) — Duties of an Auditor in Connection with Sales
Meera knows that sales are the lifeblood of the business — but also a common area for
errors or manipulation. Her duties here are clear.
1. Verify the Existence of Sales
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• Check Sales Invoices: Meera selects a sample of sales invoices and matches them
with:
o Customer orders.
o Dispatch notes or delivery challans.
o Gate passes (if applicable).
• Objective: Ensure every recorded sale actually took place and goods were delivered.
2. Ensure Proper Recording
• Sales Day Book: She checks that all invoices are entered promptly and accurately in
the sales day book.
• Cut-off Testing: She pays special attention to sales recorded near year-end to ensure
they belong to the correct accounting period.
3. Check Authorisation and Pricing
• Authorisation: Confirm that sales are approved by authorised personnel.
• Pricing: Compare invoice prices with the approved price list or contract terms to
ensure no under- or over-charging.
4. Verify Internal Controls
• Meera reviews the internal check system for sales:
o Are duties divided between order taking, dispatch, and invoicing?
o Is there a system to prevent recording fictitious sales?
5. Confirm Debtors
• For credit sales, she may send confirmation letters to customers to verify balances.
6. Check for Special Transactions
• Consignment Sales: Ensure these are not treated as ordinary sales until goods are
sold by the consignee.
• Installment Sales: Verify correct recognition of revenue.
7. Analytical Review
• Compare current year’s sales figures with previous years and investigate unusual
trends or spikes.
Duties in Connection with Sales Returns
After lunch, Meera moves to the sales returns section. Returns can be a red flag —
sometimes used to hide fraud or adjust inflated sales.
1. Verify the Legitimacy of Returns
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• Credit Notes: Check that every sales return is supported by a credit note issued to
the customer.
• Supporting Documents: Match credit notes with goods inward notes or return
challans to confirm goods were actually received back.
2. Check Authorisation
• Ensure returns are approved by a responsible officer — to prevent fake returns.
3. Ensure Proper Recording
• Verify that returns are recorded in the sales returns book and posted to the correct
customer account.
4. Cut-off Testing
• Returns near year-end are checked to ensure they relate to sales made before
year-end, not after.
5. Impact on Revenue
• Ensure that sales returns are deducted from gross sales in the trading account to
arrive at net sales.
6. Investigate Unusual Patterns
• High returns from a particular customer or product line may indicate quality issues
or fraud.
In short: For both sales and returns, Meera’s job is to ensure existence, accuracy,
authorisation, proper period, and correct impact on accounts.
Scene 2: Afternoon in the Audit Room — Vouching Trading Transactions
With sales and returns checked, Meera now turns to vouching trading transactions in
general. This includes purchases, purchase returns, sales, and sales returns — the core flow
of goods in and out.
Part (ii) — General Considerations During Vouching of Trading Transactions
Vouching is like detective work — tracing each transaction back to its source evidence to
confirm it’s genuine, accurate, and properly recorded.
1. Understand the Business and Internal Controls
• Before touching a voucher, Meera understands:
o The nature of the client’s business.
o The flow of documents for trading transactions.
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o The internal check system in place.
2. Check Original, Authentic Documents
• Only original invoices, bills, and challans are accepted as evidence.
• Photocopies are treated with caution unless properly certified.
3. Verify Authorisation
• Every transaction should be approved by the appropriate authority — purchase
manager for purchases, sales manager for sales, etc.
4. Match Related Documents
• For purchases: Purchase order → Goods received note → Supplier invoice.
• For sales: Customer order → Dispatch note → Sales invoice.
• For returns: Return note → Credit/Debit note.
5. Ensure Proper Recording
• Transactions must be entered in the correct subsidiary books (purchase book, sales
book, returns books) and posted to the right ledger accounts.
6. Check Period and Cut-off
• Transactions should be recorded in the correct accounting period to prevent
manipulation of profits.
7. Look for Unusual Items
• Large, round-figure transactions.
• Transactions with related parties.
• High-value returns or allowances.
8. Analytical Review
• Compare monthly or quarterly totals with previous periods.
• Investigate significant fluctuations.
9. Compliance with Accounting Standards
• Ensure revenue recognition and inventory valuation follow applicable standards
(e.g., AS 9 for revenue).
10. Prevention of Misappropriation of Goods
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• The main objective in vouching trading transactions is to ensure goods purchased are
actually received, and goods sold are actually dispatched — preventing theft or
fictitious entries.
Bringing It Together — The Auditor’s Mindset
Throughout the day, Meera’s approach is consistent:
• Skeptical but fair — trust, but verify.
• Detail-oriented — small errors can hide big problems.
• Process-driven — follow the trail from ledger to voucher to physical evidence.
Exam-Ready Summary
(i) Duties of an Auditor in Connection with Sales:
1. Verify existence of sales (invoices, orders, dispatch notes).
2. Ensure proper recording in sales day book.
3. Check authorisation and pricing.
4. Review internal controls.
5. Confirm debtors for credit sales.
6. Check special transactions (consignment, installment).
7. Analytical review of trends.
Duties in Connection with Sales Returns:
1. Verify legitimacy (credit notes, goods inward notes).
2. Check authorisation.
3. Ensure proper recording in returns book.
4. Cut-off testing.
5. Deduct from gross sales in accounts.
6. Investigate unusual patterns.
(ii) General Considerations During Vouching of Trading Transactions:
1. Understand business and internal controls.
2. Check original documents.
3. Verify authorisation.
4. Match related documents (order → receipt/dispatch → invoice).
5. Ensure proper recording in books.
6. Check period and cut-off.
7. Look for unusual items.
8. Analytical review of trends.
9. Compliance with accounting standards.
10. Prevent misappropriation of goods.
Final Takeaway: Auditing sales, returns, and trading transactions is like following the
journey of goods and money through the business — from order to delivery, from delivery
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to payment, and from payment to the books. The auditor’s role is to make sure every step is
real, authorised, accurate, timely, and honestly recorded.
6. (i) How would an auditor undertake vouching of credit purchases and purchase returns?
(ii) Which points should an auditor keep in mind while vouching the cash receipts?
Ans: A Cup of Tea with the Auditor
Imagine a young commerce student, Aarav, who is always scared of one particular subject—
Auditing. He feels it’s too technical, full of boring checklists and dull procedures. One
evening, while he was sipping tea with his uncle (who happened to be a practicing
Chartered Accountant), Aarav asked,
“Uncle, how on earth does an auditor actually check things like credit purchases, purchase
returns, or cash receipts? Do they just sit with big files and tick marks all day?”
The uncle smiled and replied,
“Auditing may look dull on paper, but in practice, it’s like being a detective. You’re constantly
connecting dots, verifying clues, and ensuring no one is playing tricks with money or
records.”
And that’s how our story of vouching credit purchases, purchase returns, and cash receipts
begins.
Part I: Vouching of Credit Purchases and Purchase Returns
To understand how an auditor checks credit purchases and purchase returns, Aarav’s uncle
gave him a real-life example:
Scene 1 – The Detective at the Warehouse
Think of a company that sells electronics. Every day, goods are arriving from suppliers—LED
TVs, refrigerators, and washing machines. Sometimes, due to damage or wrong supply,
goods are sent back. Now, the auditor’s detective job is to ensure that:
1. Purchases recorded in the books are genuine, not fake bills.
2. Purchase returns are real and not used as a trick to reduce liability or misappropriate
stock.
3. No double recording or inflated entries exist.
So how does the auditor do this? Let’s break it down step by step.
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Step 1: Examining Purchase Invoices
Every purchase on credit is supported by a supplier’s invoice. The auditor carefully checks:
• The name of supplier (Is it a real supplier or a fake name?).
• The date of invoice (Does it match the financial year?).
• The quantity and rate (Do they match the purchase order?).
• Any discounts or taxes mentioned.
Imagine if the books show a purchase of 500 televisions, but the invoice says 50—something
is fishy.
Step 2: Matching with Purchase Orders and Goods Received Notes (GRNs)
The auditor then cross-verifies:
• Did the company actually order those goods? (Check purchase order).
• Did the warehouse really receive them? (Check Goods Received Note).
If the invoice says 100 refrigerators, the purchase order must also be for 100, and the
storekeeper’s GRN should confirm that 100 were received.
This three-way check ensures no fictitious purchases are recorded.
Step 3: Checking Entries in Purchase Book and Ledger
Now the auditor moves to the purchase book and supplier’s account in the ledger.
• Do the amounts match the invoice?
• Is the supplier’s account correctly credited?
• Are purchase returns (if any) correctly deducted?
This prevents fraud like over-invoicing or double recording.
Step 4: Verification of Purchase Returns
Here comes the tricky part—purchase returns. Sometimes managers misuse this to cover
fraud. For example, they may show goods returned on paper but keep them for themselves.
The auditor checks:
• Debit Notes issued to suppliers.
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• Supplier’s credit note confirming receipt of returned goods.
• Goods Outward Note signed by the storekeeper.
He ensures the goods actually left the company and are not lying hidden in the godown.
Step 5: Looking for Red Flags
An auditor is always alert for suspicious patterns like:
• Frequent purchases and returns from the same supplier.
• Huge purchases at year-end just to inflate accounts.
• Purchase returns recorded without proper evidence.
In Simple Words
The auditor is like a watchman of truth. He makes sure that:
• Purchases recorded are not imaginary.
• No one is inflating expenses through fake bills.
• Purchase returns are not used to manipulate profits or cover theft.
Part II: Vouching of Cash Receipts
Now Aarav’s uncle moved to the second part.
“Beta, cash is like water—if you don’t control its flow, it slips away silently. That’s why
auditors are extra cautious with cash receipts.”
Cash receipts include things like money received from customers, sale of old assets, loans,
interest, rent, etc.
Let’s see how an auditor handles this.
Step 1: Checking Counterfoils of Receipts
Whenever the business receives cash, it issues a receipt to the payer.
• The auditor checks the counterfoils of receipt books.
• Are they serially numbered?
• Do they match with the entries in the cash book?
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This prevents fraud where employees pocket money without recording it.
Step 2: Matching with Bank Statements
Large cash receipts are usually deposited into the bank. The auditor compares:
• Cash Book → Bank Deposit Slips → Bank Statement.
If the cash book shows ₹1,00,000 received but only ₹70,000 is deposited, the missing
₹30,000 must be explained.
Step 3: Verification of Different Sources of Cash
The auditor checks the supporting evidence for all kinds of cash receipts:
• From Debtors: Check invoices, credit sales records, and debtor’s account.
• From Loans: Inspect loan agreements or bank correspondence.
• From Sale of Assets: Verify sale deeds, auction records, or scrap sale bills.
• From Others: Rent agreements, dividend warrants, etc.
This ensures cash is not shown from bogus sources.
Step 4: Ensuring Proper Accounting
The auditor checks whether:
• Cash receipts are entered immediately in the cash book.
• No delays are made in recording, which may allow misuse.
• The totals in the cash book match with supporting evidence.
Step 5: Guarding Against Common Frauds
Cash is tempting. Some tricks people play include:
1. Teeming and Lading (lapping): Delaying recording of receipts and using one
customer’s money to cover another.
2. Fake Receipts: Issuing receipts but not recording them in the books.
3. Under-recording: Showing less than actual received amount.
The auditor’s job is to spot these frauds by cross-checking all documents.
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Golden Rules the Auditor Keeps in Mind While Vouching Cash Receipts
To make it memorable, Aarav’s uncle summarized it like this:
• Authenticity: Is the source genuine?
• Completeness: Is every receipt recorded?
• Accuracy: Are amounts correct?
• Timing: Was it recorded on the right date?
• Deposits: Was cash deposited promptly in the bank?
• Fraud Detection: Is there any sign of manipulation?
Part III: Connecting the Two
By now Aarav was amazed. He realized auditing is not about dull tick marks—it’s about
ensuring fairness.
• In credit purchases and returns, the auditor makes sure expenses are not inflated
and liabilities are real.
• In cash receipts, he ensures income is not stolen or manipulated.
Both sides balance the story of truth in financial statements.
A Broader Lesson
At the end, his uncle told him,
“Remember Aarav, vouching is like testing the heartbeat of accounts. If purchases and cash
receipts are true, the financial statements are reliable. If not, even the biggest company may
collapse under fraud.”
And with that story, auditing suddenly became less scary for Aarav. He saw it not as a boring
subject, but as an adventure in truth-finding.
Conclusion
So, to wrap it up in exam style (but still engaging):
1. For credit purchases and purchase returns:
o Check invoices, purchase orders, GRNs.
o Verify purchase book entries.
o Cross-check debit/credit notes for returns.
o Ensure no fictitious or inflated entries.
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2. For cash receipts:
o Check receipt book counterfoils.
o Verify deposits with bank statements.
o Confirm source documents (sales, loans, assets, rent).
o Look for frauds like teeming and lading.
Through these steps, an auditor ensures the genuineness, accuracy, and reliability of both
purchases and receipts.
SECTION-D
7. Discuss the rights and duties of an auditor with the help of relevant case law.
Ans: Introduction – The Story Begins
Long ago, when trade and commerce started becoming bigger than small family shops, a
new challenge appeared. Owners of companies could not always keep track of the money,
especially when managers and employees were handling it. Mistakes could happen, or
worse – frauds could take place.
To solve this problem, a watchdog was appointed – not to bark at everything, but to
carefully examine whether the company’s financial statements were true, fair, and honest.
This watchdog is none other than the auditor.
Just like a judge cannot do whatever he likes but has powers given by law, and just like a
teacher not only enjoys respect but also carries the responsibility to guide students – in the
same way, an auditor has rights (to do his job properly) and duties (to ensure justice in
financial reporting).
Let us walk together through this journey of the auditor – first understanding his rights,
then his duties, and finally strengthening the story with important case laws that shaped
the principles of auditing in India and beyond.
Part I: Rights of an Auditor
An auditor cannot perform miracles with his eyes closed. The law grants him certain rights
so that he can discharge his duty effectively. Let’s treat these rights like “weapons” that our
watchdog carries.
1. Right of Access to Books of Accounts
The very first and most important right is that the auditor can inspect all the books,
vouchers, and accounts of the company. Without this, his role would be meaningless.
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Example: If management tries to hide the purchase register or debtors’ list, the auditor
can demand access.
Case law: Kingston Cotton Mills Co. (1896) – It was held that an auditor is not a
detective, but he must exercise reasonable care while checking books. This case established
that access to records is crucial.
2. Right to Obtain Information and Explanations
Numbers alone do not tell the full story. If something seems doubtful, the auditor has the
right to ask questions from directors, managers, or staff.
Example: If expenses on “repairs” suddenly jump five times, the auditor can ask: “Why?
Was it really repairs, or purchase of new machinery?”
Case law: Spicer & Pegler vs. Deloitte, Haskins & Sells – Auditors must demand
explanations where figures look suspicious.
3. Right to Visit Branch Offices
If a company has branches in different cities, the auditor has the right to check books at
those branches as well.
Example: If a Delhi head office shows “profit,” but its Mumbai branch hides huge losses,
the auditor must dig deeper.
4. Right to Receive Notices and Attend General Meetings
The auditor has the right to be present in all general meetings and receive notices, just like
shareholders.
Why? Because financial decisions and approvals happen there. The auditor may also
speak on matters concerning his report.
Case law: Newton vs. Birmingham Small Arms Co. – It was emphasized that auditors can
attend meetings to clarify their report if required.
5. Right to Remuneration
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Just like a teacher must be paid for his classes, an auditor has the right to fees or
remuneration as fixed by the company in a general meeting.
6. Right to Sign Audit Report
The audit report carries legal weight only when signed by the auditor. He has the exclusive
right to sign and issue it.
7. Right of Indemnity
If an auditor faces losses or legal troubles because of genuine actions performed during the
audit, he has a right to be protected (indemnified) by the company.
In short, these rights ensure that the auditor is not a powerless puppet but a
professional empowered to carry out his watchdog role.
Part II: Duties of an Auditor
Now comes the more serious side of the story. Rights are like “weapons,” but duties are like
“responsibilities.” A soldier with a sword must use it with discipline; otherwise, chaos
follows. Similarly, the auditor’s duties are sacred obligations toward the shareholders,
creditors, and even the public.
1. Duty of Care and Skill
An auditor must act with reasonable care, caution, and professional skill. He is not expected
to be a bloodhound, but he cannot be a careless sleeper either.
Case law: Re Kingston Cotton Mills Co. (1896) – Auditors are watchdogs, not
bloodhounds. They must check with reasonable care, not doubt everything like detectives.
2. Duty to Report on True and Fair View
The most important duty is to state whether the balance sheet and profit and loss account
present a true and fair view of the financial state of affairs.
Example: If a company hides its liabilities or overstates profits, the auditor must point it
out clearly.
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3. Duty to Verify Assets and Liabilities
Merely glancing at books is not enough. An auditor must verify existence and accuracy of
assets and liabilities.
Case law: London Oil Storage Co. Ltd. vs. Seear, Hasluck & Co. – Auditors were held
liable for not verifying actual existence of stock.
4. Duty to Detect Fraud and Errors (to a reasonable extent)
The auditor is not expected to catch every trick, but he must apply reasonable checks to
detect frauds and errors.
Case law: Davar & Sons Ltd. vs. Bombay Co. Pvt. Ltd. – Auditors cannot escape liability if
fraud could have been detected through normal diligence.
5. Duty of Confidentiality
An auditor sees sensitive information – salaries, debts, pending loans, losses – and must
keep it confidential. Sharing it without authority is a breach of trust.
6. Duty to Comply with Standards
Auditors must follow accounting standards, auditing standards, and provisions of the
Companies Act.
7. Duty towards Shareholders
Since auditors are appointed by shareholders, their ultimate duty is to protect shareholder
interest by giving an honest report.
Case law: In re London and General Bank (1895) – Auditors were held duty-bound to
shareholders, not directors.
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8. Duty to State Qualifications
If the auditor disagrees with figures or notices anything unusual, he must qualify his report
(write remarks). Silence would mean negligence.
Example: If a company shows goodwill at ₹10 crores without justification, the auditor
must note this in his report.
9. Duty to Ensure Legal Compliance
The auditor must check whether the company is following legal requirements like
depreciation, dividend rules, and disclosures.
Thus, duties make the auditor accountable. They remind him that his role is not just to
enjoy rights but also to serve as the guardian of truth in financial statements.
Part III: Case Laws – Shaping Auditor’s Role
To make the story stronger, let’s quickly revisit key cases that shaped auditing principles:
1. Re Kingston Cotton Mills (1896) – Auditors are watchdogs, not bloodhounds. They
need reasonable care, not suspicion in everything.
2. London and General Bank (1895) – Duty is toward shareholders, not directors.
3. London Oil Storage Co. Ltd. – Auditors must verify existence of stock.
4. Spicer & Pegler vs. Deloitte – Duty to demand explanations.
5. Davar & Sons Ltd. vs. Bombay Co. Pvt. Ltd. – Auditors liable if fraud could be
detected by diligence.
Each case slowly carved the boundary between “reasonable auditor” and “negligent
auditor.”
Conclusion – The Final Chapter
If we wrap up this story, the auditor stands like a guardian of trust between the company
and the public. His rights give him power to demand records, explanations, and presence in
meetings. His duties remind him to use this power with care, honesty, and professional
judgment.
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Case laws stand as “chapters of wisdom” guiding future auditors on how far their
responsibility goes.
So, whenever we think of an auditor, imagine him as a watchdog of commerce – not a lazy
pet, not a suspicious bloodhound, but a wise guardian ensuring fairness in the world of
business.
And that is why, the rights and duties of an auditor form one of the most important pillars of
corporate law.
8. (i) Explain the various classifications of an Audit Report.
(ii) Write a detailed note on Management Audit.
Ans: Chapter One — Classifications of an Audit Report
Scene 1: The Auditor’s Verdict
Imagine an auditor as a judge in a financial courtroom. After weeks of examining evidence
(the books, vouchers, controls), they must deliver a verdict — the audit report. This report
tells shareholders, investors, and other stakeholders whether the financial statements can
be trusted.
Audit reports aren’t all the same. Depending on what the auditor finds, the “verdict” can
take different forms.
1. Unqualified Audit Report (Clean Report)
• What it means: The auditor is satisfied that the financial statements give a true and
fair view of the company’s financial position and performance, in all material
respects, in accordance with the applicable accounting framework.
• When issued: No material misstatements found; any issues were corrected before
the report was finalised.
• Example: “In our opinion, the financial statements present fairly, in all material
respects…”
This is the report every company hopes for — it’s like a clean bill of health.
2. Qualified Audit Report
• What it means: The auditor found a material misstatement or a limitation in scope,
but it’s not pervasive — it affects only a specific area, not the financial statements as
a whole.
• When issued:
o A certain account balance is misstated.
o The auditor couldn’t get enough evidence for a specific item.
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• Example: “Except for the matter described in the Basis for Qualified Opinion
paragraph…”
It’s like saying, “Overall you’re fine, but there’s a problem with your left arm — get it
checked.”
3. Adverse Audit Report
• What it means: The auditor concludes that misstatements are both material and
pervasive — the financial statements as a whole are misleading.
• When issued:
o Significant departures from accounting standards.
o Misstatements that distort the overall picture.
• Example: “Because of the significance of the matters described…, the financial
statements do not present fairly…”
This is the equivalent of a doctor saying, “Your test results are seriously wrong — immediate
action needed.”
4. Disclaimer of Opinion
• What it means: The auditor cannot form an opinion due to a severe limitation in
scope or uncertainty, and any undetected misstatements could be both material and
pervasive.
• When issued:
o Records are missing or incomplete.
o Auditor is denied access to key information.
• Example: “We do not express an opinion on the financial statements…”
This is like a doctor saying, “I can’t give you a diagnosis because I wasn’t allowed to run the
necessary tests.”
Why These Classifications Matter
• For shareholders: They indicate the reliability of the financial statements.
• For management: They highlight areas needing correction.
• For regulators: They signal compliance or non-compliance with laws and standards.
Quick Comparison Table:
Type of
Report
Misstatement?
Scope Limitation?
Effect
Unqualified
No
No
Clean opinion
Qualified
Yes (material, not
pervasive)
Or limited scope (not
pervasive)
“Except for…”
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Type of
Report
Misstatement?
Scope Limitation?
Effect
Adverse
Yes (material &
pervasive)
No
Financial statements
misleading
Disclaimer
Possible (material &
pervasive)
Severe limitation
No opinion given
Chapter Two — Management Audit
Scene 1: Beyond the Numbers
Now, let’s leave the auditor’s courtroom and walk into the boardroom of “Everbright
Manufacturing Ltd.”. The company is profitable, but growth has stalled. The board suspects
the issue isn’t in the accounts — it’s in the way the company is being managed.
They call in a Management Audit team.
What is a Management Audit?
A management audit is:
An independent, systematic evaluation of the management’s policies, procedures, and
performance to assess their efficiency, effectiveness, and ability to achieve organisational
objectives.
It’s not about checking if the numbers add up — it’s about checking if the decisions,
strategies, and leadership are taking the company in the right direction.
Objectives of a Management Audit
1. Evaluate Efficiency — Are resources (human, financial, physical) being used
optimally?
2. Assess Effectiveness — Are goals being achieved as planned?
3. Review Policies and Procedures — Are they relevant, up-to-date, and followed?
4. Identify Weaknesses — Spot bottlenecks, duplication of work, or outdated practices.
5. Suggest Improvements — Recommend better systems, structures, or strategies.
6. Enhance Coordination — Improve communication and cooperation between
departments.
7. Risk Management — Identify potential risks and suggest mitigation.
Scope of a Management Audit
The scope is broad — it can cover almost every aspect of the organisation:
1. Organisational Objectives and Planning
o Are objectives clear, realistic, and aligned with the mission?
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o Is planning short-term and long-term, with measurable targets?
2. Organisation Structure
o Is the structure clear, with defined authority and responsibility?
o Are reporting lines efficient?
3. Decision-Making Process
o Are decisions timely, data-driven, and reviewed for effectiveness?
4. Control Systems
o Are there effective internal controls to monitor performance and
compliance?
5. Human Resource Management
o Recruitment, training, motivation, and retention policies.
o Leadership quality and succession planning.
6. Financial Management
o Capital structure, budgeting, cost control, and investment decisions.
7. Marketing and Production
o Effectiveness of marketing strategies.
o Productivity, quality control, and innovation in production.
8. Corporate Social Responsibility (CSR) and Ethics
o Compliance with ethical standards and social obligations.
Process of a Management Audit
1. Preliminary Survey — Understand the organisation’s structure, policies, and
environment.
2. Detailed Examination — Review documents, interview managers, observe
operations.
3. Analysis — Compare actual performance with objectives and benchmarks.
4. Reporting — Present findings, highlighting strengths, weaknesses, and
recommendations.
5. Follow-Up — Check if recommendations are implemented and effective.
Benefits Management Can Derive
1. Objective Evaluation — An unbiased view of management performance.
2. Improved Efficiency — Identifies waste and suggests cost-saving measures.
3. Better Decision-Making — Highlights strengths and weaknesses in the decision
process.
4. Enhanced Coordination — Suggests ways to improve inter-departmental
cooperation.
5. Risk Identification — Spots potential risks before they become crises.
6. Strategic Alignment — Ensures all activities are aligned with organisational goals.
7. Stakeholder Confidence — Shows commitment to continuous improvement.
Example in Action
In Everbright Manufacturing’s case:
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• The audit found that marketing and production teams weren’t coordinating —
leading to overproduction of slow-moving items.
• Decision-making was centralised, causing delays.
• Recommendations included better demand forecasting, decentralising certain
approvals, and introducing cross-functional meetings.
Within a year, sales improved, inventory costs dropped, and morale went up.
Bringing It Together — The Two Sides of Audit
• Audit Report Classifications tell the world how reliable the financial statements are
— they’re the external verdict.
• Management Audit tells the company how well it’s steering the ship — it’s the
internal health check.
One focuses on compliance and accuracy; the other on efficiency and effectiveness.
Together, they give a complete picture of an organisation’s health.
Exam-Ready Summary
(i) Classifications of Audit Report:
1. Unqualified Report — Clean opinion; no material misstatements.
2. Qualified Report — Material but not pervasive issues; “Except for…” opinion.
3. Adverse Report — Material and pervasive misstatements; statements misleading.
4. Disclaimer of Opinion — Severe scope limitation; no opinion given.
(ii) Management Audit:
• Definition: Independent evaluation of management’s efficiency, effectiveness, and
policies.
• Objectives: Evaluate efficiency, assess effectiveness, review policies, identify
weaknesses, suggest improvements, enhance coordination, manage risks.
• Scope: Objectives & planning, structure, decision-making, controls, HR, finance,
marketing, production, CSR.
• Process: Preliminary survey → Detailed examination → Analysis → Reporting →
Follow-up.
• Benefits: Objective evaluation, improved efficiency, better decisions, enhanced
coordination, risk identification, strategic alignment, stakeholder confidence.
Final Takeaway: Think of the auditor’s unqualified report as a green light to the outside
world — “These accounts are trustworthy.” Think of the management audit as a GPS
recalibration for the company — “
“This paper has been carefully prepared for educational purposes. If you notice any mistakes or
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