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Auditing Theory

Notes frauds in the books of accounts. Different classes of audit and locating different errors are
explained.

1.1 Origin of Audit

From the time of ancient Egyptians, Greeks and Romans, the practice of auditing the accounts of
public institutions existed. Checking clerks were appointed in those days to check the public
accounts. To locate frauds as well as to find out whether the receipts and payments are properly
recorded by the person responsible was the main objective of auditing of those days.

During the 18th century industrial revolution brought in large scale production, steam power,
improved facilities and better means of communication. This resulted in the origin of joint stock
form of organizations. Shareholders contribute capital of these companies but do not have
control over the day-to-day working of the organization. The shareholders who have invested
their money would naturally be interested in knowing the financial position of the company.
This originated the need of an independent person who would check the accounts and report the
shareholders on the accuracy of the accounts and the safety of their investment.

The Indian Companies Act, 1913 defined the qualification, power, duties and procedure of
appointment of the Auditor. The audit of Joint Stock Company made compulsory by this Act.
Educational qualification certificate were issued by the Central and State Governments to those
who undergone the prescribed course. In the year 1949, Chartered Accountants Act was passed.
Company’s Act, 1956 further elaborated the provisions related to the auditing and accounts of
the companies. Now a person to do the auditing must be qualified as per the standards of the
Institute of Chartered Accountants of India.
The word ’Audit’ is originated from the Latin word ‘audire’ which means ‘to hear’. In the earlier
days, whenever there is suspected fraud in a business organization, the owner of the business
would appoint a person to check the accounts and hear the explanations given by the person
responsible for keeping the account and funds. In those days, the audit is done to find out
whether the payments and receipt are properly accounted or not. The objective of modern day
accounting is not only for the verification of cash but to report the financial position of the
undertaking as disclosed by its Balance sheet and Profit and Loss Account.

1.2 Defining Audit

Audit may be defined as ‘an official inspection of an individual’s or organization’s accounts,
typically by an independent body’. A precise definition of the term ‘Auditing’ is difficult to give.
Some of the definitions given by different authors are as follows:

According to Montgomery, a well known author, “auditing is a systematic examination of the books
and records of a business or the organization in order to ascertain or verify and to report upon the facts
regarding the financial operation and the result thereof”.
“Spicer and Pegler expanded the above definition as follows:

“An audit may be said to be such an examination of the books, accounts and vouchers of a business as well
enable the auditor to satisfy that the Balance Sheet is properly drawn up, so as to give a true and fair view
of the state of affairs of the business and whether the Profit or Loss for the financial period according to the
best of his information and the explanations given to him and as shown by the books, and if not, in what
respect he is not satisfied.”

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