Audit:
Audit generally means examination taken from the Latin term “Audire” (hear). Audit, therefore, means listening to someone and deriving from the hearing, the usefulness of the action. In the case of a corporate body, audit takes the shape of examination of specific field of working viz. financial activities, organizational activities, management activities, social activities, etc. Each activity has a specific objective and responsibility and the function of Audit is to check and ensure fulfillment of responsibility delegated to the activity.
BASIC PRINCIPLES GOVERNING AN AUDIT
The basic principles governing an audit are covered under Auditing Assurance Standards (AAS-1), the essence of which are as follows:
An auditor is expected to comply with certain basic requirements and responsibilities while conducting an audit. Such compliance requires application of auditing procedures and reporting practices at appropriate circumstances.
Professional and personal requirements include:
Integrity: Moral excellence, honesty
Objectivity: Straightforwardness and fair
Independence: Self governing, Unprejudiced and unbiased
Confidentiality: Non disclosure and respect to certain information
Skill and Competence: Possess expertise & ability to perform work well
Audit Oriented requirements include:
Responsible for Work performed by others: Auditor stands responsible for the work that is performed by others. He is entitled to rely on work performed by others
Planning: Auditor should plan his work to conduct in effective and efficient audit
Audit evidence: Auditor should obtain sufficient and appropriate evidence through compliance and substantive procedures which would enable him to draw reasonable conclusions
Internal Audit
Evolution From Propriety Audit to Auditing for efficiency & effectiveness
Earlier, internal auditing was essentially to check the records after those had been created to ensure accuracy. These internal auditors were also concerned with the possibility of fraud. Thus, the main role of internal auditor was that of a verifier, or a “police-man,” or a “detective” to protect the companies’ assets.
The modern concept is that internal auditors are an arm of the management and are just as concerned with waste and inefficiency as with fraud. Thus, the main objective of the Internal Audit function has shifted from fraud detection to assisting managements in making decisions. It improves managerial control by:
- Rendering anindependent appraisal of - the measures of efficiency
- Professional evaluation of the effectiveness of other controls,
- and by maintaining a vigilant watch over risks.
It comprises a complete intra-company financial and operational review,by staff or external agencies assigned for that specific purpose.
It is primarily decided by the management.
However in view of recent developments as in the Sarbanes-Oxley Act in the US & Listing provisions of the Companies Act 1956 in India, it is more than likely that Managements will ensure that there will be adequate and effective internal audit department in all the listed companies.
According to the Institute of Internal Auditors, internal audit involves five areas of operations:
1. Reliability and integrity of financial and operating information: Internal auditors should review the reliability and integrity of financial and operating information and the means used to identify, measures, classify and report such information.
2. Compliance with laws, policies, plans, procedures and regulations:Internal auditor should review the systems established to ensure compliance with those policies, plan and procedures, law and regulations which could have a significant impact on operations and reports and should determine whether the organization is in compliance thereof.
3. Economic and efficient use of resources: Internal auditor should ensure the economic and efficient use of resources available.
4. Accomplishing of established objectives and goals for operations: Internal auditor should review operation or programmes to ascertain whether results are consistent with established objectives and goals and whether the operations or programmes are being carried out as planned.
5. Safeguarding of Assets: Internal auditors should verify the existence of assets and should review the means of safeguarding assets.
Independence of the Internal Auditor:
Should be sufficient so as to permit the accomplishment of the audit responsibilities. Hence the chief internal auditor should have direct communication with the Board of Directors. He should submit periodic reports to the Board highlighting significant audit findings.
Financial Audit:
Introduction:
“Financial Audit is a historically oriented, independent evaluation performed by internal auditor or external auditor for the purpose of attesting to the fairness, accuracy and reliability of the financial data, providing protection for the entity's assets; evaluating the adequacy and accomplishment of the system of internal control designed to provide for the aforementioned Fairness and Protection. Financial data, while not being the only source of evidence, are the primary evidential source. The evaluation is performed on a planned basis rather than a request".
Institute of Internal Auditor
Financial audit takes care of the protective aspect of the business and it does not normally carry out constructive appraisal function of the business operations. It helps in detection and prevention of fraud. It also verifies whether documentation and flow of activities arc in conformity with the internal control system introduced and developed within the organization. It helps coordinating with statutory auditor to help them in proper discharge of their function. Besides, financial audit also ensures compliance with statutory laws especially in financial and accounting matters.
Objectives of Financial Audit:
Primary Objectives:
The main purpose of audit is to judge the reliability of the financial statements and the supporting accounting records for a particular financial period. Such an examination will enable the auditor to report to his client on the financial condition and working results of the organization.
While carrying out the examination of the various books of accounts, relevant documents and evidences, the auditor may came across certain errors and frauds. Despite such a possibility the detecting of errors and frauds is an incidental object. However, laymen have always associated the detection of errors and frauds as the main function of an auditor which is not true. At the same time audit also discloses how far the accounting system adopted in the organisation is adequate and appropriate in recording the various transactions as well as the weakness of these systems.
Secondary Objectives:
An auditor has to examine the books of accounts and the relevant documents in order to report on the financial condition of the business. In the process of such an investigation of accounts certain errors and frauds may be detected. These are discussed under the following two heads:
Detection of Errors: Various types of errors are mentioned below:
Errors may occur due to various reasons and they are categorised as Clerical Errors: Errors of Commission, Errors of Omission, Compensating Errors & Errors of Principle. These are generally un-intentional but can adversely affect the reliability of the financial statements, if it is not detected and corrected.
Detection of Frauds:Frauds are always committed deliberately and intentionally to defraud the proprietors of the organization. If the frauds remain undetected, they may affect the opinion of the auditor on the financial condition and the working results of the organization. It is, therefore, necessary that the auditor should exercise utmost care to detect such frauds.
Prevention of Loss through Leakage & Fraud: The companies act makes it mandatory for the Auditor to explicitly comment on whether there are adequate internal control procedures commensurate with the size of the Company and the nature of its business for
purchaseof inventory and fixed assets and sale of goods and services. The Auditor should ensure that the controls that have been laid down are in fact effective and in practice.
To ensure compliance with the statutory laws:Especially statutes such as the Company Act 1956, The Income-Tax Act 1962 etc. that have a direct bearing on financial & accounting matters
To ensure compliance with Internal Policies & Procedures : The auditor needs to verify that the documentation & Work flow is proper and is as laid down by the management.
This may, among other things, include verifying:
I. All Expenditures are duly supported by Bills & other documentary evidence and duly booked under appropriate heads of accounts
II. All payments made are duly authorised & properly documented,.
III. All Receipts are accounted
IV. Due provision made for losses
V. That the preparation of salary and wage pay roll is proper.
VI. Credit control & Purchase procedure has been strictly followed.
VII. That the registers for recording Fixed assets, Inventory, Purchase & Sales and other books of accounts as required by law have been properly maintained-
VIII. Verifying whether scrap, salvage and surplus materials have been properly accounted for.
Salient Features of Financial Audit:
a. Audit is a systematic and scientific examination of the books of accounts of a business;
b. Audit is undertaken by an independent person or body of persons who are duly qualified for the job.
c. Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown by the balance sheet.
d. Audit is a critical review of the system of accounting and internal control.
e. Audit is done with the help of vouchers, documents, information and
Explanations received from the authorities.
f. The auditor has to satisfy himself with the authenticity of the financial statements and report that they exhibit a true and fair view of the state of affairs of the concern.
The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions and examine correspondence, minute books of share holders, directors, Memorandum of Association and Articles of association etc., in order to establish correctness of the books of accounts.
Introduction
Over a period of time Companies are confronted with the question whether the present management team meets the business requirements of the future and is prepared to
successfully manage the challenges of increasing business complexity and competition. Without doubt the top management has been gaining valuable experience as to the performance of the executives of the company over many years.
However, usually there is the distinct in-house and subjective appraisal perception of the
individual managers. Furthermore each company has been creating its own specific culture over many years which makes judgement sometimes difficult. State-of the-art top executives have realized the relevance of management audits to clearly display the track records of their core team members.
Events that call for Management Audit:
The accomplishment of systematic management audits are very often caused by major changes in the businesses such as :
1. Change in Top Management: It is most useful for the Managing Director orCEO joining a new company to get the objective and qualified picture as to the strengths, chances and risks of his management team.
2. Mergers & Acquisitions: The accomplishment of management audits represents the objective as well as credible tool to identify the best qualified managers out of competing management teams.
3. Succession Planning Both internal and external candidates are audited to choose “the best”.
4. Restructuring / Strategic Alignment: Drastic dynamics in business bring about vital
risks and chances The success of the corporation does depend on the performance and potential of the complete executive team. By using the tool Management Audit risks will be minimized and changes exploited.
The Concept
According to T.G. Rose, “The management audit would therefore concern itself with the whole field of activities of the concern, from top to bottom, starting, as always where management control is concerned, from the top, because we are primarily concerned with whether the general management is functioning smoothly and satisfactorily. If it is not, it may be due to the functional management being faulty and, therefore, we pass on to examine that in its turn, in order to find the missing or faulty link which is causing the trouble.”
From the very able conceptualisation contained in the above quoted passage, it is somewhat clear what should be the scope and content of management audit. It should definitely cover everything that we know as operational audit and, in addition it should also include review of the adequacy and competence of the objectives, plans, policies and decisions of the top management. However, as has been indicated above, unanimity is lacking on this aspect and management audit has become a subject of debate.
Definitions:
Accordingly some of the more important definitions are reproduced below:
It is an audit performed with the object of examining the efficacy of the institution/control systems, management procedures towards the achievement of enterprise goals.
Churchill & Cyert
It is an objective and independent appraisal of the effectiveness of managers and the effectiveness of the corporate structure in the achievement of company objectives and policies. Its aim is to identify existing and potential management weaknesses within an organization and to recommend ways to rectify these weaknesses.
Chartered Institute of Management Accountants London
“A comprehensive and constructive examination of an organization, -the structure of a company, institution or branch of government -or of any components thereof, such as division or department -and its plans, objectives, -its means of operations -and its use of human and physical facilities”
William P. Leonard
Thus it can be seen that management audit is an examination, review and appraisal of the various policies and actions of the management. It is a tool for the evaluation of methods and performance in all the areas of the enterprise.
It is a complex task closely related with the process of management. It is highly result oriented. It requiresinter/multi-disciplinary approach as it involves examination, review and appraisal of various policies and actions of management on the basis of certain norms/standards.
It undertakes comprehensive and critical review of all organizational activities with wider perspective. It goes beyond conventional audit and audits the efficacy of the management itself.
Scope:
It should definitely cover everything that we know as operational audit and, in addition it should also include review of the adequacy and competence of the objectives, plans, policies and decisions of the top management.
It should also address the question as to whether management is getting information relevant to the decisions and actions which it must take. This will require a much more intensive analysis of information needs and the efficiency of the existing system in meeting them. The auditor will not have to decide whether management is making the right strategic and operative decisions but rather whether management has available to it and is using the relevant information and techniques necessary to evaluate rationally the various alternatives that exist”
The basic difference between the two audits, then, is not in method, but in the level of appraisal
Benefits of Management Accounting:
1. Management audit attests the quality of the management in the similar fashion as financial audit attests the accuracy of the records and financial statements.
2. It permits more objective and complete evaluation of the total management and operating structure. Systematic recognition, analysis and assessment of competencies and the actual behaviour of both individual executives as well as complete executive teams particularly with regard to the business' strategic requirements is an essential function of Management Audit. It would also encompass the relevance and effectiveness of the aims, duties and decisions of management at various levels.
3. It enables the management to find specific .problem areas where managers are unable to come out with fruitful solutions.
4. Identification of major Pain areas needing shoring up is made possible by the management audit.
5. A check can be made on new policies and practices for both their suitability and compliance. This can be extended to old policies and procedures in view of the drastic dynamics affecting the business
6. It indicates the extent to which the current managerial controls are effective or suitable .
7 Management audits are not meant to be mere compliance audits. Instead It focuses on results, evaluating the effectiveness and suitability of controls by challenging underlying rules, procedures and methods. When performed correctly, they are potentially the most useful of the evaluation methods, because they result in change. Hence It provides mechanism for continually updating the total management and operating structure of the firm.
8. It is the objective of the process not to assess the individual manager in isolation but in context to their competitors and comparable roles outside the company. This benchmark information is most valuable and delivers conclusions as to the effectiveness of the management team.
Conducting Management Audit
Eligibility is not prescribed by statute.Management audit requires an interdisciplinary approach since it involves a review of all aspects of management functions. It has to be conducted by a team of experts because this requires varieties of skills, which one individual may not possess.
The team may consist of management experts, accountants, and the operation research specialists, the industry experts and even social scientists.
The auditors must have analytical mind and ability to look at a management function form the point of view of the organization as a whole. They therefore have to be properly trained in this aspect. They need to have through knowledge of the management science and they should be acquainted with the salient features of various functional areas.
Management Audit Program:
Cost Audit :
Introduction:
Methods and techniques of ‘cost accounting’ and audit of ‘cost accounts’ in India can be traced back
to the year 1925, when large number of firms were given contracts by the Government of India on
“cost plus” basis and the Government started verifying and investigating the cost structure of such
firms.
Further, need for large scale industrialization immediately after the independence required lot of
concessions and facilities to the entrepreneurs to establish industrial undertakings for production
of common man’s goods and essential services. However,there were only very few industrial groups and it was a suppliers market in almost all the areas.Therefore, consumers had very few choices and there were often complaints of excessive pricing, which encouraged smuggling and other malpractices like under-invoicing of imports to save custom duties or over-invoicing of exports to get higher export benefits.The high prices were often justified on the basis of higher indigenous cost of production. Thus the government felt the need for price controls.
Meaning & Defenitions:
Cost audit is the audit of cost records.
According to Chartered Institute of Management Accountants, London (CIMA), cost audit is “the verification of the correctness of cost accounts and of the adherence to the cost accounting plan”. In other words, cost audit is the verification of the cost of production of any product, service or activity on the basis of accounts maintained by an enterprise
in accordance with the accepted principles of cost accounting.
This definition of Cost Audit is relevant to the voluntary Cost Audit without any statutory backing.
The Institute of Cost and Works Accountants of India on the other hand, defines cost audit as “a system of audit introduced by the Government of India for the review, examination and appraisal of the cost accounting records and attendant information, required to be maintained by specified industries.” Thus the concept and scope of cost audit as defined in India is more specific and lays emphasis on the evaluation of the efficiency of operations and the propriety of management actions as introduced by the Government of India for specified industries.
Thus Cost Audit in India refers to the statutory Cost Audit of the selected companies covered under the relevant provisions (Section 233B) of the Companies Act, 1956. These requirements are mandatory and non-compliance may invite penal provisions also.
Need for Cost Audit: ( Significance / Relevance )
1. Information requirements of the Government
The main objective of Cost Audit when statutorily introduced under the provisions of Companies Act, 1956 was to meet the Government requirements for regulating the price mechanism in core industries like Cement, Sugar, Textiles and consumer industries like Vanaspati, Formulations and Automobiles. The objective was to provide an authentic data to the Government to regulate the demand and supply in the country through a price control mechanism.
Various departments of the Government rely on the authenticity of Government mandated Cost audit reports to fix Tariffs, determine subsidies to industries producing goods whose prices are administered (Fertilizers), fixation of prices of various drugs and formulations.
2. Tool for effective Corporate Governance:
Cost Audit Reports do not only contain merely the cost details, but are full of information related to all aspects of business organization which, if harnessed properly can provide a comprehensive analysis about the company, the industry and the economy as a whole. The Cost Audit Report serves as an effective tool of information in the hands of directors on the Board ensuring good corporate governance. Transparency is crucial in a globalized economy where, free competition co-exists with appropriate rules and regulations to ensure free trade and absence of unfair practices.
3. Defence against any allegation of dumping.
When dumping allegations are levied against the exports by the Indian companies to any foreign company, the Cost Audit Reports can provide the valuable feedback to protect the interest of Indian companies.
4. Defence against allegations of Selling below Cost
The practice of selling below cost to ward off competition attracts the penal provisions of the
Competition Law. This necessitates the availability of authentic cost details of the products
marketed by industry and business houses to determine normative pricing or fair pricing.
5. Determining costs as a basis for Transfer Pricing.
The fundamentals of transfer pricing are based on “arm’s length” throughout the world. The cost details form the very basis of determining arm’s length transfer pricing policy of any country. An audited cost records and the resultant Cost Audit Report becomes a major source of information, which can be effectively used by both Indirect and Direct Tax Authorities
6. Ensuring reasonability inNon-competitive Govt. Procurement
A significant portion of the government budget is spent every year on procurements, where reasonability of purchase price is always an issue. Therefore, Cost Audit Reports can always fill the vacuum in government procurements ensuring reasonability of prices especially in Non competitive procurement..
Objectives of Cost Audit::
Cost audit has bothGeneral & Social objectives:
General Objectives:
i. Verification of cost accounts with a view to ascertaining that these have been properly maintained and compiled according to the cost accounting system followed by the enterprise.
ii. Ensuring that the prescribed procedures of cost accounting records rules are duly adhered to.
iii. Detection of errors and fraud.
iv. Verification of the cost of each “cost unit” and “cost center” to ensure that these have been
properly ascertained.
v. Determination of inventory valuation.
vi. Facilitating the fixation of prices of goods and services.
vii. Periodical reconciliation between cost accounts and financial accounts.
viii. Ensuring optimum utilization of human, physical and financial resources of the enterprise.
ix. Detection and correction of abnormal loss of material and time.
x. Inculcation of cost consciousness.
xi. Advising management, on the basis of inter-firm comparison of cost records, as regards the areas where performance calls for improvement.
xii. Promoting corporate governance through various operational disclosures to the directors.
Social objectives:
i. Facilitation in fixation of reasonable prices of goods and services produced by the enterprise.
ii. Improvement in productivity of human, physical and financial resources of the enterprise.
iii. Channelising of the enterprise resources to most optimum, productive and profitable areas.
iv. Availability of audited cost data as regards contracts containing escalation clauses.
v. Facilitation in settlement of bills in the case of cost-plus contracts entered into by the Government.
vi. Pinpointing areas of inefficiency and mismanagement, if any for the benefit of shareholders
Comparison of Audits:
Difference between Financial & Cost Audit
No | Criteria | Financial Audit | Cost Audit |
i. | Applicabilty | Compulsory for all Companies | Cost audit is to be conducted only when the Central Government directs such an audit. [Sec.233B(1)] |
iii. | Scope of Audit | Financial Auditor is required to state whether the accounts and the Financial Statements prepared from it from it gives a True and Fair view of the state of the company’s affairs ( Balance Sheet) and of the results of its operations ( Profit & Loss a/c) | To ensure that the Cost Audit Report and the detailed cost statements are in the form prescribed by the Cost Audit Report Rules by following sound professional practices |
iv. | Coverage | Covers all records kept by the company including Cost records. | Only Cost records for products or activities specified under the provisions of cost accounting records rules. |
ii. | Qualification | Sec. 233B(1), provides that only a person holding certificate of practice from the Institute of Cost and Works Accountants of India only can be appointed as a cost auditor. | |
iii. | Appointment | Section 233B (2) provides that the cost auditor shall be appointed by the Board of directors and with the previous approval of the Central Government. | |
v. | Reporting Authority | The cost auditor is to submit his report to the Central Government, with a copy to the company. |
Cost Audit and Management Audit
Cost audit report and the information to be furnished therein is prescribed by the Central
Government. However, most of the information contained in the cost audit report is relevant for making managerial decisions. Normally a management audit is an audit for the management and by the management. Such audit looks into the economy and the effectiveness of performance of various activities of an organization. Cost audit also looks into the effectiveness of performance and efficiency in various areas such as capacity, input costs of materials, utilities and other controllable areas so far as the manufacturing aspect is concerned. Detailed information on these areas has to be given in the cost audit report by the cost auditor comparing it with the standards and past actuals wherever necessary. Since Cost Audit is very useful to the management as it points out areas where performance can be improved, it can be called an audit for the management. Though cost audit is not done at the behest of the management, it does not change its character from being a management tool.
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