The following points highlight the two main objectives of audit. The objectives are: 1. Confirmation of Accounts 2. Detection of Errors and Frauds.
Objective # 1. Confirmation of Accounts:
The need for some outside and independent agency to check transactions on behalf of shareholders and other owners of capital have already been discussed in Art. 2b.
Thus, the primary object of an audit is confirmation and certification of the results of business operations or other activities and of the financial state of affairs as revealed by the accounts. Such confirmation can be made on the basis of opinion formed in course of checking or verifying the accounts.
Objective # 2. Detection of Errors and Frauds:
In order to confirm accounts as aforesaid an auditor must be satisfied that neither any mistakes nor any deceitful manipulations are committed and allowed to stay in respect of the accounts in question. Discovery or detection of errors and frauds is, therefore, an essential prerequisite for confirmation of accounts and financial results. Such detection is only possible through a thorough examination of all financial and other concerned data.
If any auditor wants to carry out the detection work successfully he must know the nature and implications of the different kinds of mistakes and frauds as enumerated below:
Complete omission to enter a transaction in a subsidiary book or a compensating error involving one wrong entry being off-set by another wrong entry in the opposite direction is difficult to detect as none of them affects the agreement of the trial balance. An error of commission comprising the posting of an amount to a wrong account on the correct side or a mistake in calculation is difficult to find out for the same reason.
These errors can be detected only by a thorough checking, with supporting documents, intelligent enquiry and research. A partial omission, i.e., non-recording of one aspect of a transaction and an error of commission involving incorrect posting, casting or balancing is easier to discover as they directly disturb the agreement of the trial balance.
Clerical errors usually cover comparatively small amounts and do not have very serious effects on the results of business and the chances of these errors remaining undetected for long are remote under a good system of internal control. But an auditor should not neglect this type of error; he should systematically and carefully conduct routine checking—as far as practicable having regard to the circumstances of each particular case.
Errors of principle:
These errors arise out of transactions recorded in a way contrary to the accepted principles of accounting, viz., incorrect allocation of expenditure between capital and revenue, valuation of assets on a wrong basis, omission to take into account outstanding liabilities and improper provision for depreciation, bad and doubtful debts and other contingencies.
They constitute the most important group of errors which may vitiate the results of business and also the financial state of affairs as embodied in the final accounts. An auditor should, therefore, exercise utmost skill, care, vigilance and tact in order to detect them. They can be discovered by enquiries made intelligently and with searching eyes.
Misappropriation of cash:
This may be perpetrated by complete or partial omission to enter receipts of money in the cash book or by the inclusion of fictitious payments and of larger sums than have been actually paid. This may also be done through “teeming and lading” i.e., an amount received from one party is misappropriated and subsequent collection from another party credited to the former leaving the latter’s account outstanding.
This process is repeated continuously. Such frauds may be detected by a systematic, exhaustive and careful checking of the cash book with original vouchers, e.g., counterfoils of receipts, duplicate copies of cash memos, invoices, wages sheets, salesmen’s desk books, acknowledgements etc.
Misappropriation or pilferage of goods:
This involves pilferage of stock and is very difficult to detect, particularly in case of small pilferages, unless a strong and efficient system of stock recording and stock control is in operation showing in details every movement of goods inward or outward. For the purpose of discovering this type of fraud, gatemen’s inward and outward goods books, requisitions, challans, bin cards and store ledgers should be carefully scrutinised.
Falsification of accounts:
Accounts may be falsified through bolstering up of an insecure business by showing an artificially inflated profit in order to maintain confidence among shareholders and members of the public and to obtain fresh capital or credit.
Or it may be done by directors or managers for paying dividends which would not be payable otherwise, for securing higher sums of commission based on profit; or for disposing of their own shares at a good price before there is a collapse.
On the other hand, falsification may comprise an artificial reduction of profit with a view to forcing down share prices so as to be able to buy them cheaply, avoiding undue competition, minimising liability to taxes or eliminating governmental interference on grounds of profiteering. This category of fraud occurs less frequently than misappropriation of cash and goods but, once committed, it usually involves large sums of money.
It should be remembered that such frauds are difficult to detect as they are usually perpetrated by persons holding positions of trust and responsibility and are ingeniously designed and carefully guarded. The auditor should exercise the greatest degree of vigilance, skill and tact for their discovery.
Auditor’s Duties regarding Mistakes and Frauds:
While clerical errors should sufficiently engage the attention of an auditor, he should be more careful and particularly watchful in respect of errors of principle and frauds. An auditor should not be unduly suspicious nor should he always adopt an attitude of mistrust but he should constantly keep in mind possibilities of frauds, proceed with his eyes open and be alert. It was aptly remarked by the learned judge in the Kingston Cotton Mills Co. case that an auditor was a ‘watchdog’ and not a ‘bloodhound’.
An auditor should keep careful watch on all transactions but that does not mean that he should always adopt an attitude of distrust. He should be tactful and create a friendly atmosphere because in conducting an audit he has to depend on the cooperation of directors and other officers of the business.
If, however, he comes across any transaction which arouses in him the slightest suspicion he should investigate the matter thoroughly and, in case any misappropriation or falsification is traced, he should unhesitatingly report the fact to his employers even at the risk of losing the audit due to opposition of persons holding high and powerful positions who may be involved in the irregularity. In short, an auditor should conduct himself carefully and tactfully so as to avoid a friction with the management and, at the same time, discharge faithfully his duties to the employers.
Prevention of Errors and Frauds:
It should be remembered that an auditor is only an outside agent having no voice or effective control over the preparation of accounts and, as such, an audit is not expected to prevent errors and frauds directly. The responsibility for preventing them or at least minimising chances thereof ultimately rests on the internal system of working commonly known as the internal checking or internal control system.
As an auditor commences his work after the accounts are prepared he can only detect and not prevent errors and frauds that might have already been committed.
But the very knowledge that accounts would be subsequently subjected to scrutiny by an expert acts as a valuable moral check on careless and dishonest persons and thereby goes a long way in preventing errors and frauds indirectly. But an auditor cannot ensure or guarantee that accounts audited by him are free from errors and frauds. An auditor should, however, apply ordinary prudence and judgment in his work.
Besides, an auditor can render useful service to his clients by pointing out loopholes and weak spots/if any, in the existing system of internal checking and suggesting suitable improvements therein.
In view of – (a) universal character and growing magnitude of frauds, including white-collar frauds/crimes, (b) need for experts in fields other than auditing for fraud investigation, and (c) a number of Case Law decisions holding auditors liable for negligence for not detecting frauds, the Association of Certified Fraud Examiners was formed in U.S.A. in 1988.
This body has a large number of members comprising professional accountants, investigators, law enforcement professionals spread all over the world including India. If need be, an auditor may seek the help of that Association through the accountants’ body of which he is a member.
The Central Bureau of Investigations (CBI) has decided to set up a panel of professional accountants to detect accounting frauds. KPMG, one of the leading consultants, has also formed a 12-member team for ‘forensic accounting’ to enquire into various irregularities within organisations and to investigate the background of employees.
The Committee on Legal Aspects of Bank Frauds constituted by the Reserve Bank of India has suggested – (a) creation of a separate bureau to investigate, and (b) adoption of dual approach to minimise and tackle, bank and financial frauds.