Internal Control Audit- Assignment

Institute of Business Administration
Jahangirnagar University
(IBA-JU)
BBA Programme 27th Batch
Taxation and Auditing
Lecture Handout - 1
(Covering Class 1 and 2)
Course Teacher:
Shish Haider Chowdhury
[e-mail]
Mobile: [phone]
06 April 2020

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1. Audit, Auditing
The word ‘audit’ has been defined by many distinguished authors and every one of them has attempted
to highlight one aspect or the other. Definitions of the word ‘audit’ given by authorities on the subject
are as follows:
“An audit is the independent examination of financial statements or related information of an entity,
whether profit oriented or not, and irrespective of its size, or legal form, when such an examination is
connected with a view to expressing an opinion thereon.”
[International Standard of Auditing 1]
“An audit is such an examination of the books, accounts and vouchers of business, as will enable the
auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair view
of the state of the affairs of the business and whether the Profit and Loss Account gives a true and fair
view of the profit or loss for financial period, according to the best of his information and explanations
given to him and as shown by the books; and if not, in what respects he is not satisfied”
[Spicer and Pegler]
“An audit is an examination of accounting records undertaken with a view to establishing whether they
correctly and completely reflect the transactions to which they purport to relate. In some instance it
may be necessary to ascertain whether the transactions themselves are supported by proper authority.
[L. R. Dicksee]
“An audit is an examination of such records to establish their reliability and reliability of statements
drawn from them.
[A.W. Hanson]
“Auditing is connected with the verification of accounting data with determining the accuracy and
reliability of accounting statements and reports.”
[R. K. Mautz]
“Auditing is a systematic examination of the books and records of business or other organizations in
order to ascertain or verify and to report upon, the facts regarding the financial operations and the
results thereof.”
[Montgomery]
It can be concluded that, the audit means critical and intelligent examination of facts- financial or
otherwise to give in the form of certificate or report an attestation, an expert opinion or expert advice.
2. Origin of Audit
The word ‘audit’ is derived from the Latin word “audire” which means to hear. In the good old days
whenever the proprietors of a concern suspected a fraud, certain people were appointed to hear verbal
evidence of transactions of barter etc., and to judge the facts. They ‘heard’ the points of view of those
who maintained the accounts. Lucas Pacilio who is commonly considered as the father of double entry
book-keeping wrote his treatise on the double entry book-keeping and described the duties and
responsibilities of an auditor in it. The roots of ‘modern audit’ lie deep in the birth of ‘Industrial
Revolution’, which brought large-scale production in its wake. The rapid growth of banking, transport &
insurance development, use of mechanical appliances and computers in business concerns and gigantic

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growth of joint stock companies have resulted in the growing importance of audit. The need of audit
became imminent when the management and ownership of business was divided among different
groups of people. The investor would naturally like to see that his investment is safe. For this purpose,
the accountants must be checked and audited, especially in case of joint stock companies. As it is not
possible for shareholders to check the accounts of the company they appoint a person who would audit
the accounts on their behalf. Formerly such a person used to be one of the shareholders who might not
technical knowledge of accountancy. To have an effective check, the custom to appoint professional
accountant began to develop.
3. Advantages of audit
1. Errors and frauds are located at an early date and in future no attempt is made to commit such
frauds or one is rather careful not to commit an error or fraud as accounts are subject to regular
audit.
2. The auditing of accounts keeps the accounts department regular and vigilant as they know that
the auditors would complain against them if the account is not prepared up-to date or there is
any irregularity.
3. Fund can be borrowed easily on the basis of previous audited Balance Sheet.
4. If the accounts have been prepared on a uniform basis, accounts of one year can be compared
with other years and if there is any discrepancy, the cause may be enquired into.
5. In case of any accident/mishap/untoward event, the insurance company may settle the claim on
the basis of audited accounts of the previous years.
4. What is accounting
Accounting means the compilation of accounts in such a way that one is in a position to know the state
of affairs of the business. It is a comprehensive information system begins with recognizing the event of
transaction, ends with analysis and interpretation. The man who performs this work is called an
accountant. His work is to interpret and review the accounts and draw conclusions with a view to guide
the management in chalking out the future policy of business.
4.1 Necessity, importance & role of accounting
1. To determine profit or loss: the most principle aim of a business organization is to achieve
profit. If the transactions of a business organization are written and maintained in the books of
accounts properly, it can be easy to determine the amount profit achieved within a certain
period.
2. To determine the financial condition: The financial condition of a business organization can be
known by preparing the balance sheet at the end of the year only through preserving the
accounts.
3. Comparative analysis: If the accounts are preserved in right way, the improvement or other
condition of business can be recognized by doing comparative analysis of one year’s income-
expense with that of another year.
4. To take care of the assets and repayment of debt: To know the amount of debt and to repay it
in time etc., it is necessary to keep any kinds of accounts of related to debt.
5. To determine the income tax: The income tax of a business organization is determined on the
basis of its income. So it is important to prepare a reliable Income statement after preserving
the accounts in a scientific way.

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6. To take loan: The financial institutions, want to watch the financial statements of a business to
assess the power of loan repayment before issuing loan.
7. To manage business: It helps the management to run the business in right way by supplying
different information.
5. Relationship between Accountancy and Auditing
Accountancy and auditing is specially related the work of auditing begins after that of accounting.
Accountant examines whether transactions are written accurately following the accounting theory or
rules and prepares financial statements with the help of books of accounts and other financial
information. And he presents and describes these to the owner or director in such a way, so that they
can be well informed about the financial condition of the business and can decide what to do in future.
Although an auditor does not prepare the accounts, he examines whether accounting rules are properly
followed to prepare these. However, it is not his principal duty. His main duty is to give his expert
opinion after judging independently and neutrally, the accounts and descriptions of business prepared
earlier, whether the financial condition of the business is presented logically.
From the above discussion it is clear that, there is a close relation between Auditing and Accounting.
Because it is the job of an accountant to assess the reality and dependability of financial statements
prepared and described by accountants on the basis of financial transactions written in accounting
books. The spade work is done by the accountant to enable the auditor to give a finishing touch. It has
been said that , where the work of an accountant ends, the work of an auditor begins.
6. Difference between Accounting and Auditing
Accounting Auditing
It is the act of maintaining books of accounts
of an organisation
It goes for the examination of the accounts
and reporting on their accuracy to the
stakeholders
The work is a preparatory work by the
accountant for a finishing touch by the
auditor.
The work of an auditor begins where the work
of an accountant ends.
The accountant of an organisation prepares
the financial statements and fund flow
statements along with some analytical
statements.
Auditor prepares the end product i.e. audit
report based on the work already done by the
accountant upon checking and examination
The law does not make compulsory about the
qualification of an accountant. It is the
management who stresses on the competence
of an accountant.
It is legally mandatory that an external auditor
i.e. the auditor of a public company must be a
Chartered Accountant (CA).
The accountant is appointed by the
management on its requirement.
The auditor is appointed by the shareholders
at the AGM of the Company.

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7. Audit Planning
An audit plan is a detailed outline of the auditor's plans and procedures used in conducting an audit. The
importance of good detailed documentation in the audit plan cannot be stressed enough. An audit plan
will include the following items:
• A description of the business activities;
• A schedule of planned audit procedures;
• A summary of the evaluation of the records;
• A description of special problems to be resolved in the audit.;
• Deviations from the plan if any, and why the deviations were made;
• The results of the audit;
• Listing of events/activities occurring during the audit.
Record of Audit Planning, Activities, and Results
The Record of Audit Planning, Activities, and Results are the form which documents the audit plan for
every audit performed. This form, which can be completed manually or on the computer, should be
completed as the audit progresses. The computerized audit plan can be accessed through the MS Word
program in Windows.
8. Audit Programme
It refers to the detailed listing of the steps to be taken by an Auditor, such as a CA when analyzing
transactions to determine the acceptability of financial statements. Major accounting firms may prepare
an audit program for each client and require the person who does the work to sign or initial each step
performed.
1. Identification of the audit procedures followed in an audit.
2. Outline and description of the steps and work to be conducted in an audit engagement.
Typically, it specifies the name of the auditor responsible for a given job including the estimated time to
conduct the audit task. The audit program guides and controls the work of staff assistants. When a task
is conducted, identification is made of who performed it and the date.
9. Audit working papers
Audit working papers are the documents which keeping all audit evidences obtained during financial
statements auditing. Audit working paper is to be able to support the audit works done in order,
sufficient and assurance audit evidences have been obtained and reasonable assurance audit conclusion
can be made in due course. Audit working papers are the property of the auditor. In order to keep
professional ethic, it cannot discover to third party without consent of the client unless limited specified
situations mentioned in ISA 230 Documentation and required by law, the examples are court order, for
public interest and so one.

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9.1 Contents of auditor working papers
Permanent
• Memorandum and Articles of Association;
• Business registration certificate;
• Business License;
• Franchising certificate and agreements;
• Business agreements with bank, suppliers and customers;
• List of professional advisers (eg. lawyer) and outsourcing contractors;
• Auditor engagement letter;
• Management representation
Current
• Financial statements including balance sheet, income statement, cash flow statement, budget,
business forecast statement of the client and so on;
• Audit planning document including time sheet and human resource arrangement records of
audit staff;
• Risk assessment documentation;
• Audit evidence of the audit job;
• Audit sampling method and the sample size calculation;
• Schedule of unadjusted difference;
• Audit review points and highlight;
• Client's system Weakness letter and management letter.
9.2 Proper features of working papers
• Reviewed by auditors with supervisory;
• Signed, dated and approved by relevant level of audit staff with sufficient cross reference;
• With effective audit planning, work done, sufficient and quality evidence;
• Outstanding matters cleared in due course.
10. Internal Control Concept
Internal control refers to the whole system of control in conducting a business and includes internal
check, internal audit and any other form of control.
 Control in Organizations
• Controls are restraining and directive influences over the activities of a system
• General principles of control are applied in business organizations
• Accounting systems assist management in controlling operations
• Accounting internal controls assure that all transactions are authorized, all transactions are
recorded, access to assets is allowed only for authorized purposes and accounting records
describe only real assets.

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 "Administrative control includes but is not limited to, the plan of organization and the
procedures and records that are concerned with the decision processes leading to
management's authorization of transactions. Such authorization is a management function
directly associated with the responsibility for achieving the objectives of the organization and is
the starting point for establishing accounting control of transactions." (AU320.27)
 "Accounting control comprises the plan of organization and the procedures and records that are
concerned with the safeguarding of assets and reliability of financial records and consequently
are designed to provide reasonable assurance that:
 Threats, Exposure, Risk and Objectives of internal control
• Threat: Hazard, potential loss
• Risk: likelihood of potential loss
• Weakness: risk not reduced to a low level by internal controls
• Exposure: Size of potential loss associated with a control problem
• Expected loss = exposure X risk
• Objective of Controls: Minimize losses to organization resulting from threats
 Examples of threats (incompetence)
• wasteful and inefficient use of resources
• poor management decisions
• unintentional errors recording or processing data
• accidental loss or destruction of records
• loss of assets through employee carelessness
• lack of compliance by employees with management policies
 Examples of threats (illegal)
• lack of compliance with government regulations
• pilferage
• embezzlement: theft or misappropriation of assets by employees, accompanied by the
falsification of records designed to conceal the theft
• other illegal acts by employees, such as the taking of a bribe
 Control risk
"Control risk is the risk that error that could occur in an account balance or class of transactions and
could be material, when aggregated with error in other balances or classes, will not be prevented or
detected on a timely basis by the system of internal accounting controls."
 Control Weakness
"A material weakness in internal control is a condition in which the specific control procedures or the
degree of compliance with them do not reduce to a relatively low level the risk that errors or
irregularities in amounts that would be material in relation to the financial statements being audited
may occur and not be detected within a timely period by employees in the normal course of performing
their assigned tasks."

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 Four objectives for controls
• authorization (all transactions are authorized)
• recording (all transactions are recorded)
• access (allow access to assets only for authorized purposes)
• asset accountability (ensure that accounting records describe only real assets)
In addition, accounting and data processing must be operationally efficient.
 Cost and Benefits of Internal Control -The benefit of an internal control must exceed its cost
• Primary cost is personnel
• Benefits stem from reductions in expected loss
 Consider both effectiveness and timing
• a control that prevents a loss is superior to a control that detects a loss after it has occurred
• early detection is essential if prevention fails
• when a failures occurs, correction reduces future losses
 Reliability analysis
• assess effectiveness of specific control procedure in detecting and correcting a specific type of
error
• system reliability is probability that process will be completed with no errors
• risk is complement of system reliability
11. Internal and External Audit
The Main Differences
There are many key differences between internal and external audit and these are matters of basic
principle that should be fully recognized:
• The external auditor is an external entity and not an employee of the organization as is the
internal auditor.
• The external auditor seeks to provide an opinion on whether the accounts show a true and fair
view, whereas internal audit forms an opinion on the adequacy and effectiveness of systems of
risk management and internal control, many of which fall outside the main accounting systems.
The Main Similarities
The main similarities between internal and external audit are as follows:
1. Both the external and internal auditor carry out testing routines and this may involve examining
and analyzing many transactions.

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2. Both the internal auditor and the external auditor will be worried if procedures were very poor
and/or there was a basic ignorance of the importance of adhering to them.
3. Both tend to be deeply involved in information systems since this is a major element of
managerial control as well as being fundamental to the financial reporting process.
4. Both are based in a professional discipline and operate to professional standards.
5. Both seek active co-operation between the two functions.
6. Both are intimately tied up with the organization’s systems of internal control.
7. Both are concerned with the occurrence and effect of errors and misstatement that affect the
final accounts.
8. Both produce reports on their activities.
End of Lecture Handout-1