Scope of auditing

An understanding of the Scope of Auditing

Auditing and its scope:

Over time, the scope of auditing has expanded. Earlier, auditors were expected to only check the arithmetical accuracy of accounts. But with time, their scope of work has expanded from checking arithmetical accuracy to determining adherence to GAAP, assessment of internal controls, checking statutory compliance and more.

Apart from financial audits, audit now also covers Cost Audit, Management Audit, Internal Audit, Energy Audit, Excise Audit, GST audit and Government audit too.

In this blog, we have discussed the general aspects that are covered in an audit of financial statements nowadays.

Basic function

Most importantly, as part of an audit, all items of financial statements, i.e., Balance Sheet and Profit and Loss Account are compared with the underlying records in support thereof to see that they are correct. The financial position depicted by the Balance Sheet as well as the results shown by the Profit and Loss Account are examined to see whether they are true and fair. This is the basic and the most important function of a financial audit.

The objective is to give an overall opinion on the reliability of financial information. But remember, the conclusions drawn by an auditor can only be reasonable and not absolute. Owing to the inherent limitations of an audit, absolute certainty in auditing may not be possible. Most of the time, auditors derive persuasive evidence and not conclusive evidence. Nonetheless, they play an important role in examining the financials of a business.

Some considerations in the scope of auditing

Every auditor is expected to determine the scope of his audit according to the terms of engagement, the requirements of relevant legislations and the pronouncements of ICAI.

With regard to the scope of an audit, here are a few points that may be considered:

  • An audit should be designed in such a manner that it adequately covers all the aspects of the business under audit. As far as financial audits are concerned, all the aspects relevant to the financial statements being audited must be covered.
  • To be able to give an opinion on the reliability of financial statements, the auditors should satisfy themselves with the reliability & sufficiency of underlying accounting records and source data. These form the basis for the preparation of FS.
  • Special attention should be given to the disclosure of information in financial statements. The auditor should check whether the information is properly disclosed & classified as per statutory requirements of Schedule III, Ind AS, etc.
  • The auditor should carry out all those tests, enquiries and other verification procedures as may be necessary to evaluate the validity of accounting transactions and account balances.
  • Moreover, the auditor should also assess the selection of accounting policies by the entity’s management and whether they are consistently applied.
  • Another important point is that an auditor is not expected to perform duties that fall outside the scope of his competence. For instance, an auditor is not expected to have the professional skill of a technical expert for determining the physical condition of assets.

What is the Scope of auditing?

In general, the following aspects are to be covered in every audit of financial statements:

Scope of auditing
Scope of Auditing

1. Examination of accounting system, procedures and internal controls:

An audit involves the examination of the accounting system and internal controls to check whether they are appropriate for the client’s business and if they help in properly recording all the transactions. It is very important to verify the existence and functioning of internal controls because if they are found to be adequate, the confidence of the auditor increases in the books of account and various transactions. If the internal controls and related procedures are adequate, the likelihood of fraud and errors also reduces.

2. Verification of the authenticity and validity of transactions:

Out of the most basic things of all, auditors are required to check the arithmetical accuracy of the books of account by verifying the postings, totalling, balances, etc. of ledger accounts and subsidiary books. Besides this, they are also required to examine the entries made in the books by checking the relevant supporting documents or vouchers. By comparing the entries with their supporting documents, auditors confirm the authenticity and validity of transactions.

None of the entries should have been omitted from being recorded and at the same time, nothing which is not in the books should find a place in the financial statements.

3. Proper distinction between revenue and capital:

Another important aspect to be covered in an audit is to ascertain whether or not the entity has made a proper distinction between capital and revenue items. Also, all amounts of income and expenditure should be adjusted in the accounts corresponding to the relevant accounting period.

4. Verification of the title, value and existence of assets:

In respect of all assets appearing in the client’s books, the auditor should check whether such assets actually exist or not, whether the client holds the rights in respect of them, whether all assets have been recorded or not, and whether they have been valued properly or not. Through this, the auditor confirms the truth of the assets, their ownership (do they belong to the client or not), and that they are not over-stated or under-stated.

5. Verification of liabilities:

Similar to assets, the auditor is also needed to check the existence and value of liabilities appearing in the books. Whether liabilities and equity interests exist, whether all liabilities have been appropriately recorded as well as valued, and whether they represent the obligations of the entity under audit – all of these aspects are verified.

6. Compliance with statutory requirements:

Auditors need to ensure that the financial statements of the client have been prepared in accordance with the requirements of applicable laws. Also, they must comply with the relevant Indian Accounting Standards, guidance notes issued by ICAI, etc. For instance, in the case of declaration of final & interim dividends, a company should comply with the requirements of the Companies Act and the relevant Rules made thereunder.

7. Reporting to the appropriate person/body:

Audit reports are the final stage of an audit. Whatever findings or conclusions are drawn by the auditor concerning the financial health of the client’s business, they are to be reported to the appropriate person/body. Audit reports are addressed to the company’s shareholders or the Board of Directors, as the case may be.

Constraints or limitations in the scope of an audit

Sometimes some constraints may be imposed on the scope of an auditor’s work either by the management or by government authorities in certain cases (e.g., when books are seized by tax authorities). This could lead to the inability of the auditor to obtain necessary information and to express an overall opinion on the financial statements. In such as case, the auditor may give a disclaimer of opinion or may also consider withdrawing from his engagement. He may also give a qualified opinion if the limitation is material but not pervasive (e.g., if it is only with respect to a particular item). Whatever the case is, it important that the auditor discloses the fact of such limitations in scope in his audit report.

Also, if such limitations in scope are imposed by the management or those charged with governance prior to the acceptance of audit engagement; and the auditor believes that such limitation would cause the auditor to disclaim the opinion, he shall not accept such a limited engagement except otherwise required by law.

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