These have to be determined on a consideration of :
- objectives of audit;
- various provisions in the Companies Act, 1956, especially those concerning accounts and audit; and
- the scope of the report that the auditor of a company is required to make in pursuance of the provisions contained in section 227 of the Act.
The objectives of an audit are :
- Verification of statements of account so as to express an opinion;
- Detection of errors and frauds; and
- Prevention of occurrence of errors and frauds.
Detection and prevention of frauds and errors were originally regarded as the main objectives of an audit. It was because the auditor, at that time, was looked upon as the watchdog over the assets that the business possessed as well as over its functioning in general. Such a concept of duties of auditors has its origin in the natural distrust that exists among human beings, especially where the course of business dealings involve several persons entrusting their monies or properties to others. So deep rooted is this belief that whenever, on a company being wound up, a fraud or error is discovered, even today there is a public outcry that the auditors should be held responsible for it. Though the broad objectives of an audit, to this day, continue to be the same as aforementioned, the emphasis has shifted from the detection of frauds and prevention of occurrence of errors to the verification of the statements of account. It is because in the context of present system of management of companies, it is of greater importance that the annual statement of account should exhibit a true and fair state of affairs of their working instead of auditor’s time and energy being devoted to tracking down petty frauds and error in accounts, which the internal staff of the company can be entrusted to detect or guard against. The function of an audit primarily, therefore, has come to be regarded as verification of statements of account and expressing an opinion thereon. The expression of opinion lends credibility to financial statements.
However, while conducting the audit, the auditor is expected to bear in mind the possibility of existence of a fraud or other irregularity in accounts. Nonetheless, he is not expected to conduct the audit with the objective of discovering all frauds or irregularities, for if that is to be done, the audit would take an unduly long time and the cost of it would be quite out of proportion to its benefit. Nevertheless, it is expected that the auditor would be vigilant and watchful and whenever he comes across a circumstance which arouses his suspicion, he should find out whether a fraud, or irregularity, in fact does exist and, if so, whether it is sufficiently material to necessitate qualifications of the audit report. It is generally accepted that the auditor is not an insurer and does not guarantee that the books of account truly reflect the company’s affairs. Such a view is based on the decision in the famous case, London and General Bank. The auditor, thus, is principally responsible for carrying out his duties exercising due care and skill consonance with the professional standards. If, despite the fact, any fraud or irregularity in accounts remains undetected, he cannot be held liable for the failure to detect it. Moreover, since the management is primarily responsible for safeguarding the assets and property of the company, the auditor, while framing his audit programme, is entitled to rely upon the internal controls in this regard instituted the management based on a proper evaluation.
It would be observed that Companies Act, 1956 also does not contemplate that an auditor is responsible for the detection of errors and frauds, except when they are so material as to vitiate the opinion expressed him that statements of account exhibit a true and fair state of affairs. The aforementioned shift of emphasis in the objectives of audit which also has the tacit acceptance of law, has come about primarily due to the extraordinary increase that has taken place in the size of corporate organisations as well as in the volume, complexity and variety of transactions handled them. On this account, it has become impracticable for the statutory auditor to frame a programme for carrying on a detailed audit for the detection of all frauds and irregularities. He is increasingly obliged to rely on the internal control measures. As such, he is not in a position to give a categorical assurance to the shareholders that there does not exist a fraud or irregularity in the books of account except to the limited extent that the fraud, if any, is not sufficiently material to affect true and fair position exhibited the statements of account. The auditor, nonetheless, is required to verify the final statements of account; also to check or verify all the matters affecting them so as to ensure fully that they exhibit a true and fair state of affairs of the business of the company. For the purpose, he may either carry out a detailed examination of the books or relying on the internal control measures in operation, after testing their strength, merely test the accuracy of transaction recorded therein.
It is permissible for an auditor to verify the accuracy of transactions recorded in the books of account the application of test checks, if he is satisfied that the system of internal control, in operation, is adequate and satisfactory. One of the refined forms that test checks can take is selection of a representative sample statistically from the area of accounts which is to be test checked and checking in depth the transactions comprised in the sample. Other forms that list checks take are procedural tests. These are applied to a variety of transactions selected from areas of account provided such areas, as selected for test checking, contain a representative sample of the transactions entered into the concern and the transactions are checked exhaustively. On this consideration, the practice of verification of transactions application of test-checks has come to be recognised universally. As against test checking, a detailed checking of 100% of transactions would only reveal arithmetical mistakes but still fail to ensure true and fair view. In any case, detailed checking would be very time consuming and almost impracticable having regard to size of organisation spread across the globe. However, the conditions under which test checks can be substituted for detailed checking, and the extent of test checks that must be applied in each case, are matters which the auditor must decide having regard to the circumstances of each case. On this consideration, while conducting the audit of a large business house which has on its staff a qualified accountant, as internal auditor, it is nowadays sometimes possible for the statutory auditor to somewhat reduce the scope and extent of his routine checking. He, instead of going over the facts and figures as have already been examined a competent and trustworthy internal staff, may limit his checking only to application of testchecks; if however, any significant mistakes are observed in the test period, the scope of the audit is suitably extended. A consciousness is growing in the profession that a greater co-ordination is possible between the work of the internal auditor and the statutory auditor which, if brought about, would enable the statutory auditor to make use of, to a greater extent, the detailed checking carried on the internal auditor in the discharge of his duties and responsibilities. The Institute of Chartered Accountants of India has published an Auditing and Assurance Standard (AAS) 7 on the subject.