18  Auditing: Independent financial audit; Vouching; Verification and valuation of assets and liabilities; Audit of financial statements and audit report; Cost audit

18.1 Concept of Auditing

Auditing is “the independent examination of any entity, whether profit-oriented or not, irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon” (ICAI, Preface to SA). Auditing is conventionally distinguished from accounting: accounting records and reports transactions; auditing examines and reports on the reliability of those records. The word itself comes from the Latin audire — “to hear” — reflecting the early practice of accounts being read aloud and verified.

TipThree Authoritative Definitions
Source Definition (paraphrased) Foregrounds
Mautz & Sharaf Systematic examination of accounting records, statements and other underlying data Systematic process
R.K. Mautz Critical examination of books of account for opinion on truth and fairness Truth and fairness
ICAI Independent examination culminating in expression of opinion Independence + opinion

18.2 Features and Objectives

TipFeatures of an Audit
  • Systematic and independent examination.
  • Examination of evidence — both internal and external.
  • Expression of an opinion — not certification of accuracy.
  • Truth and fairness — the key test.
  • Statutory or contractual in scope.

The primary objective is to express an opinion on whether the financial statements give a true and fair view. Secondary objectives include detection and prevention of errors and fraud.

TipErrors vs Fraud
Aspect Error Fraud
Intent Unintentional Intentional
Common forms Omission, commission, principle, compensating Misappropriation of assets; fraudulent reporting (window-dressing)
Auditor’s role Detect through routine procedures Apply scepticism — SA 240

18.3 Classification of Audits

TipCommon Audit Classifications
Basis Categories
By law Statutory (Companies Act §139) · Non-statutory · Internal · Cost (§148) · Tax (§44AB IT Act) · GST · Bank · Cooperative
By time Final · Continuous · Interim · Periodic
By scope Complete · Partial · Detailed · Test
By approach Risk-based · Substantive · Compliance · System-based
By ownership Government · Private

18.4 Auditor under Companies Act 2013

TipStatutory Auditor — Key Sections
  • §139 Appointment — first auditor by the Board within 30 days; thereafter by AGM for 5-year tenure (subject to ratification removed by amendment).
  • §140 Removal — special resolution + Central Government approval.
  • §141 Eligibility — only a Chartered Accountant in practice or a CA firm; specified disqualifications.
  • §143 Powers and duties — right of access to books; reporting on truth and fairness; specific reporting matters (Schedule II of the Audit Report).
  • §144 Prohibited services — specified non-audit services (e.g., investment banking, accounting, internal audit).
  • §145 Signing of audit report.
  • §147 Penalty for contravention.
  • Rotation of auditors (§139(2)) — listed and prescribed companies — individual auditor 5 years; firm 10 years.

18.5 Vouching

Vouching is the examination of documentary evidence to verify the authenticity and accuracy of transactions recorded in the books. R.B. Bose called it the “essence of auditing”.

TipVouching Objectives
  • All transactions are recorded in the books (completeness).
  • They are properly authorised (authorisation).
  • They are correctly classified between capital and revenue (classification).
  • The supporting vouchers exist and are valid (existence and accuracy).
  • Posting and casting are arithmetically correct.

18.5.1 Audit Trail Items Routinely Vouched

TipVouching — Typical Items
Item Voucher examined
Cash sales Cash memos, daily summaries
Credit sales Sales invoices, dispatch records
Purchases Purchase invoices, GRN, purchase order
Wages Wage sheets, attendance, board sanction
Salaries Salary registers, payroll computation, tax challans
Rent Lease deed, receipt
Interest paid / received Loan agreement, bank statement
Travel expenses Bills, sanction, travel order

18.6 Verification and Valuation

While vouching examines transactions, verification establishes the existence, ownership, possession and proper valuation of assets and liabilities reported in the balance sheet.

TipVerification vs Valuation
Aspect Verification Valuation
Object Existence, ownership, possession, completeness Determining proper monetary value
Examples Physical count of cash, stock; title deeds for property Valuing stock at lower of cost or NRV; depreciation rate
Performed by Auditor with management certification Mostly by management; verified by auditor

18.6.1 Verification of Selected Assets

TipVerification — Selected Assets
  • Cash on hand — physical count and reconciliation.
  • Bank balance — bank confirmation and reconciliation.
  • Land and building — title deeds, property tax receipts, encumbrance certificate.
  • Plant and machinery — fixed-asset register, physical verification, depreciation.
  • Stock — physical verification, cut-off testing, valuation under AS 2 / Ind AS 2 (lower of cost or NRV).
  • Debtors — confirmation, ageing analysis, provision for doubtful debts.
  • Investments — share certificates / DP statement, market value comparison.
  • Goodwill — purchase agreement; impairment review under AS 28 / Ind AS 36.

18.7 Internal Control and Internal Audit

Internal control is the system of policies and procedures designed to ensure (a) reliability of financial reporting, (b) effectiveness of operations, and (c) compliance with laws. Internal audit evaluates the effectiveness of internal control.

The COSO framework (Committee of Sponsoring Organizations, 1992; updated 2013) lists five components: control environment, risk assessment, control activities, information and communication, monitoring activities.

§138 of Companies Act 2013 (with Rule 13) requires internal audit by qualifying companies (listed, certain unlisted public, large private companies meeting thresholds).

18.8 Standards on Auditing (SA)

ICAI’s Auditing and Assurance Standards Board (AASB) issues Standards on Auditing (SAs), based on International Standards on Auditing (ISA) of IAASB. Major SAs:

TipSelected Standards on Auditing
SA Subject
SA 200 Overall objectives of the independent auditor
SA 210 Agreeing the terms of audit engagements
SA 230 Audit documentation
SA 240 Auditor’s responsibilities relating to fraud
SA 250 Consideration of laws and regulations
SA 260 Communication with those charged with governance
SA 300 Planning an audit
SA 315 Identifying and assessing risks
SA 320 Materiality
SA 330 Auditor’s response to assessed risks
SA 500-580 Audit evidence
SA 700, 701, 705, 706 Audit report opinions and KAM
SA 720 Other information in annual report

18.9 The Audit Report

The auditor’s report is the output of the audit. Under SA 700 the report contains: title, addressee, opinion paragraph, basis for opinion, key audit matters (SA 701 for listed companies), going-concern uncertainty, responsibilities of management and auditor, signature, place, date.

18.9.1 Types of Audit Opinion (SA 705)

TipFour Types of Audit Opinion
Opinion When given
Unmodified / Clean Financial statements give a true and fair view — no material misstatement
Qualified Material misstatement or scope limitation, but not pervasive (“except for…”)
Adverse Material and pervasive misstatement — statements do not give a true and fair view
Disclaimer Material and pervasive scope limitation — auditor cannot form an opinion 

flowchart LR
  M{Misstatement<br/>or scope<br/>limitation?} -->|No| U[Unmodified<br/>Opinion]
  M -->|Material, not pervasive| Q[Qualified]
  M -->|Misstatement<br/>pervasive| A[Adverse]
  M -->|Scope limitation<br/>pervasive| D[Disclaimer]
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

18.9.2 Key Audit Matters (KAM) — SA 701

For listed entities, the auditor reports Key Audit Matters — areas that required particular attention. KAM does not substitute for a modified opinion.

18.9.3 CARO 2020

The Companies (Auditor’s Report) Order 2020 requires reporting on specified matters (PPE, inventory, loans, statutory dues, CSR, fraud reporting, internal financial controls) in the audit reports of qualifying companies.

18.10 Cost Audit

Cost audit is the verification of cost accounts and a check on adherence to cost accounting principles, conducted by a Cost Accountant (CMA) in practice.

TipCost Audit — Key Features
  • Legal basis: §148 of Companies Act 2013 read with Cost Records and Audit Rules 2014.
  • Applicability: specified regulated industries (telecom, power, fertilizer, sugar, pharma) and non-regulated industries above threshold.
  • Auditor: Cost Accountant in practice (not the financial auditor).
  • Report: Form CRA-3 filed with MCA.
  • Approval of fees: by the Board.

18.11 Audit of Banks, Government and Special Entities

TipSpecial Audits
  • Bank audit — Section 30 of Banking Regulation Act; statutory central auditor + branch auditors; concurrent and stock audits.
  • Government audit — by Comptroller and Auditor General (CAG) under Article 148-151 of the Constitution; types include financial, compliance, performance.
  • Cooperative audit — under State Cooperative Societies Acts.
  • Tax audit — §44AB of the Income-tax Act, for entities crossing specified turnover thresholds.
  • GST audit — under CGST Act 2017 (department audit; reconciliation in GSTR-9C).

18.12 Practice Questions

Q 01 Concept Easy

The word "audit" comes from the Latin word:

  • A*Audire* — to hear
  • B*Auditum* — to count
  • C*Audium* — to certify
  • D*Audeo* — to dare
View solution
Correct Option: A
**Audire** means "to hear" — accounts were originally read aloud and verified.
Q 02 Objective Easy

The **primary** objective of an independent financial audit is to:

  • ADetect every error and fraud
  • BExpress an opinion on truth and fairness of the financial statements
  • CMaintain the books of account
  • DCalculate tax payable
View solution
Correct Option: B
Primary objective — **opinion on truth and fairness**; fraud detection is secondary.
Q 03 Vouching Easy

"Vouching is the essence of auditing" is associated with:

  • AR.K. Mautz
  • BSpicer & Pegler
  • CR.B. Bose
  • DLawrence Dicksee
View solution
Correct Option: C
R.B. Bose's famous dictum.
Q 04 Sections Medium

Match each Section of Companies Act 2013 with its content:

Section Content
(i) §139 (a) Powers and duties of auditor
(ii) §141 (b) Cost audit
(iii) §143 (c) Eligibility of auditor
(iv) §148 (d) Appointment of auditor
  • A(i)-(d), (ii)-(c), (iii)-(a), (iv)-(b)
  • B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
  • C(i)-(c), (ii)-(d), (iii)-(b), (iv)-(a)
  • D(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)
View solution
Correct Option: A
§139 — appointment; §141 — eligibility; §143 — powers/duties; §148 — cost audit.
Q 05 Rotation Medium

For listed companies, the maximum continuous tenure of an audit *firm* under §139(2) is:

  • A3 years
  • B5 years
  • C10 years
  • D15 years
View solution
Correct Option: C
Individual auditor — 5 years; **firm — 10 years (two terms of 5 each)**.
Q 06 Opinion Medium

When a misstatement is *material but not pervasive*, the auditor expresses:

  • AUnmodified opinion
  • BQualified opinion
  • CAdverse opinion
  • DDisclaimer of opinion
View solution
Correct Option: B
**Qualified** — "except for…" — material but not pervasive.
Q 07 Opinion Medium

A *Disclaimer of Opinion* is issued when:

  • AMisstatement is material but not pervasive
  • BMisstatement is material and pervasive
  • CScope limitation is material and pervasive
  • DStatements give a true and fair view
View solution
Correct Option: C
**Disclaimer** — scope limitation so severe the auditor cannot form an opinion.
Q 08 SA Medium

The Standard on Auditing dealing with auditor's responsibilities relating to fraud is:

  • ASA 200
  • BSA 240
  • CSA 315
  • DSA 700
View solution
Correct Option: B
**SA 240** — fraud.
Q 09 KAM Hard

Key Audit Matters (KAM) are required to be reported under:

  • ASA 700
  • BSA 701
  • CSA 705
  • DSA 706
View solution
Correct Option: B
**SA 701 — Communicating Key Audit Matters**; applies to listed entities.
Q 10 COSO Medium

The COSO framework on internal control has how many components?

  • AThree
  • BFour
  • CFive
  • DSeven
View solution
Correct Option: C
**Five COSO components** — control environment, risk assessment, control activities, info & communication, monitoring.
Q 11 CAG Medium

The Comptroller and Auditor General of India derives authority from:

  • ACompanies Act 2013
  • BConstitution of India — Articles 148-151
  • CBanking Regulation Act
  • DRBI Act 1934
View solution
Correct Option: B
CAG — **Articles 148-151** of the Constitution.
Q 12 Tax Audit Medium

Tax audit under the Income-tax Act is mandated by:

  • A§44AB
  • B§44AD
  • C§80C
  • D§234A
View solution
Correct Option: A
**§44AB** of the Income-tax Act mandates tax audit above specified turnover/receipt thresholds.
Q 13 Cost Audit Medium

Cost audit is conducted by a:

  • AChartered Accountant in practice
  • BCost Accountant (CMA) in practice
  • CCompany Secretary in practice
  • DInternal Auditor
View solution
Correct Option: B
Cost audit must be done by a **Cost Accountant (CMA)** in practice.
Q 14 Vouching vs Verification Medium

Examination of *transactions* recorded in the books is called:

  • AVerification
  • BValuation
  • CVouching
  • DScrutiny
View solution
Correct Option: C
**Vouching** examines transactions; **verification** examines balance-sheet items.
Q 15 Tenure Medium

For an individual auditor of a listed company, the maximum continuous term is:

  • A3 years
  • B5 years
  • C10 years
  • D15 years
View solution
Correct Option: B
Individual auditor — **5 years**; firm — 10 years.
Q 16 CARO Hard

The Companies (Auditor's Report) Order currently in force is:

  • ACARO 2003
  • BCARO 2015
  • CCARO 2016
  • DCARO 2020
View solution
Correct Option: D
**CARO 2020** — effective from FY 2021-22.
Q 17 SA 700 Easy

The Standard on Auditing dealing with forming an opinion and reporting on financial statements is:

  • ASA 200
  • BSA 240
  • CSA 700
  • DSA 720
View solution
Correct Option: C
**SA 700** — Forming an opinion and reporting on financial statements.
Q 18 Errors Medium

A purchase of machinery for ₹1,00,000 wrongly debited to Repairs account is an example of:

  • AError of omission
  • BError of commission
  • CError of principle
  • DCompensating error
View solution
Correct Option: C
A capital expenditure treated as revenue is an **error of principle** — violates the basic distinction.
Q 19 Internal Audit Medium

Internal audit is required for specified companies under which section of Companies Act 2013?

  • A§134
  • B§138
  • C§143
  • D§148
View solution
Correct Option: B
**§138** of Companies Act 2013 + Rule 13 of Companies (Accounts) Rules.
Q 20 Bank Audit Medium

Statutory audit of a banking company is governed by:

  • ACompanies Act 2013 only
  • BBanking Regulation Act 1949 §30
  • CRBI Act 1934
  • DSEBI LODR
View solution
Correct Option: B
**Section 30 of the Banking Regulation Act 1949** governs audit of banking companies.

18.13 Quick Recall

ImportantQuick recall
  • Audit — independent examination → opinion on truth and fairness. From Latin audire “to hear”.
  • Companies Act 2013 sections: §139 appointment, §140 removal, §141 eligibility (CA only), §143 powers/duties, §144 prohibited services, §148 cost audit. §139(2) rotation — individual 5 yrs, firm 10 yrs.
  • Vouching — examine transactions (R.B. Bose’s “essence”); Verification — examine assets/liabilities for existence, ownership, valuation.
  • SA framework — issued by ICAI’s AASB, aligned with ISA. Key: SA 200, 240, 300, 315, 320, 500, 700, 701, 705, 706.
  • Opinions (SA 705): Unmodified / Qualified / Adverse / Disclaimer. Pervasive misstatement → adverse; pervasive scope limitation → disclaimer.
  • KAM under SA 701 — listed entities.
  • CARO 2020 — additional reporting matters.
  • COSO internal control — five components (control environment, risk assessment, control activities, info & communication, monitoring).
  • Other audits: Tax — §44AB IT Act, Cost — §148 + Cost Audit Rules 2014 by CMA, Bank — §30 BR Act, CAG — Articles 148-151 Constitution, GST — CGST Act 2017 (GSTR-9C), Internal — §138.
  • Errors — omission, commission, principle (capital vs revenue mix-up), compensating. Fraud — intentional (SA 240).