PRACTICAL AUDITING - UAF20503J

B.COM (A&F)- III YEAR- V SEMESTER

STUDY MATERIAL

MS.N.MANJU,

ASSISTANT PROFESSOR OF COMMERCE,

FACULTIES OF SCIENCE AND HUMANITIES

SRM-IST, RAMAPURAM

UNIT-1

Definition of Audit-Difference between Auditing and Accountancy -Scope of Auditing -Objectives of Auditing -Nature of Auditing-Internal check – Meaning -nature and scope of internal check-internal audit-Internal control - Meaning and Objectives

Definition of Audit

· Prof. L R Dicksee defined auditing as:

“Auditing is an examination of accounting records undertaken with a view to establish whether they correctly and completely reflect the transactions to which they relate.”

· Spicer and Peglar defined audit as:

“Audit is such an examination of the books, accounts and vouchers of a business, as shall enable the auditor to satisfy himself whether or not the balance sheet is properly drawn up, so as to exhibit a true and correct view of the state of the affairs of the business according to the best of his information and explanations given to him and as shown by the books; and if not, in what respects it is untrue or incorrect.”

Difference between Auditing and Accountancy

Accountancy		Auditing
Meaning
It is the process of recording, classifying, summarising and interpreting all the financial transactions.	It is the process of examining books of accounts and reporting on the financial statements.
Objectives
Its main objective is to find out profit earned or loss suffered by a company and to show the financial position of the company for a particular period.	Its main objective is to examine the correctness of the accounts and financial statements and certify that whether the company exhibits a true and fair view of state of affairs of the concern.
Nature of Employment
An accountant does not require any formal qualification.	An auditor should be a qualified chartered accountant certified by the Institute of Chartered Accountants of India.
Qualification
Accountant is not required to submit the report on the financial statements prepared by him.	Auditor should submit the report certifying the truth and fairness of the financial statements.
Reports
An accountant is remunerated in the form of salary.	An auditor is remunerated in the form of professional fees.
Remuneration
An accountant is a permanent employee of the organisation.	An auditor is an independent person and is not an employee of the organisation.
Commencement of work
Accountancy starts where Book-keeping ends.	Auditing starts where Accountancy ends
Scope
It entails preparation of financial statements and their interpretation.	Examination of accounts and records
Hierarchy
Accounting precedes the auditing	Auditing succeeds accounting
Accountability
accountant is accountable to management.	Auditor is accountable to shareholders
Work flow
Accounting work is flowing throughout the year	It is done generally at the year end after the accounts are closed

Scope of Auditing

The scope of auditing encompasses the following areas:

1. Financial Statement Auditing: Examining financial statements to ensure accuracy, completeness, and compliance with laws and regulations.

2. Internal Control Auditing: Evaluating the effectiveness of an organization's internal controls.

3. Compliance Auditing: Verifying adherence to laws, regulations, and internal policies.

4. Operational Auditing: Assessing the efficiency and effectiveness of business operations.

5. Management Auditing: Evaluating the performance and effectiveness of management.

6. Information Systems Auditing: Examining the security, integrity, and reliability of information systems.

7. Environmental Auditing: Assessing an organization's environmental policies and practices.

8. Social Auditing: Evaluating an organization's social responsibility and impact.

9. Forensic Auditing: Investigating financial crimes and irregularities.

10. Tax Auditing: Verifying compliance with tax laws and regulations.

11. Performance Auditing: Evaluating the achievement of organizational objectives.

12. IT Auditing: Examining the management and security of IT systems.

Nature of Auditing

1. Independent: Auditors maintain objectivity and independence to ensure unbiased opinions.

2. Systematic: Audits follow a structured approach, including planning, execution, and reporting, to ensure thoroughness and consistency.

3. Objective: Auditors focus on factual evidence and avoid personal opinions or biases.

4. Investigative: Auditors search for evidence to support their findings, using techniques like testing, observation, and inquiry.

5. Analytical: Auditors break down complex data to understand and interpret it, using tools like ratios, trends, and benchmarks.

6. Evaluative: Auditors assess the adequacy and effectiveness of systems, processes, and controls, identifying strengths and weaknesses.

7. Reporting: Auditors communicate their findings, conclusions, and recommendations to stakeholders through clear and concise reports.

8. Consultative: Auditors may provide advice and guidance to improve systems, processes, and controls, adding value to the organization.

9. Risk-based: Audits focus on areas with the highest risk of material misstatement, non-compliance, or inefficiency.

10. Continuous: Auditing is an ongoing process, with regular assessments and monitoring to ensure sustained effectiveness.

11. Dynamic: Auditing adapts to changing circumstances, laws, regulations, and industry developments.

12. Professional: Auditors adhere to strict ethical standards, professional codes of conduct, and regulatory requirements.

Additionally, auditing involves:

- Verification: Confirming the accuracy and completeness of data and information.

- Validation: Ensuring that processes and systems operate as intended.

- Compliance: Ensuring adherence to laws, regulations, and internal policies.

- Quality control: Maintaining high standards of audit work and reporting.

Objectives of Auditing

The objective of an audit is to express an opinion on financial statements. The auditor has to verify the financial statements and books of accounts to certify the truth and fairness of the financial position and operating results of the business. Therefore, the objectives of audit are categorized as primary or main objectives and secondary objectives.

Primary Objectives

The primary or main objective of audit is as follows:

To Examine the Accuracy of the Books of Accounts 1.

An auditor has to examine the accuracy of the books of accounts, vouchers and other records to certify that Profit and Loss Account discloses a true and fair view of profit or loss for the financial period and the Balance Sheet on a given date is properly drawn up to exhibit a true and fair view of the state of affairs of the business. Therefore the auditor should undertake the following steps:

· Verify the arithmetical accuracy of the books of accounts.

· Verify the existence and value of assets and liabilities of the companies.

· Verify whether all the statutory requirements on maintaining the book of accounts has been complied with.

To 2. Express Opinion on Financial Statements

After verifying the accuracy of the books of accounts, the auditor should express his expert opinion on the truthness and fairness of the financial statements. Finally, the auditor should certify that the Profit and Loss Account and Balance Sheet represent a true and fair view of the state of affairs of the company for a particular period.

Financial Statement includes the following:

· Trading and Profit and Loss Account, and

· Balance Sheet.

Elements of Financial Statements include the following:

· Assets: Assets include cash and bank balance, value of closing stock, debtors, bills receivable, investments, fixed assets, prepaid expenses and accrued income.

· Liabilities: Liabilities include capital, profit and loss balance, creditors, bills payable, outstanding expenses and income received in advance.

· Revenue: Revenue includes sales, collection from debtors, rent received, dividend, interest received and other incomes received.

· Expenditure: Expenditure includes purchases, payment to creditors, manufacturing and trade expenses, office expenses, selling and distribution expenses, interest and dividend paid.

Secondary Objectives

The secondary objectives of audit are: (1) Detection and Prevention of Errors, and (2) Detection and Prevention of Frauds.

Detection And Prevention of Errors

The Institute of Chartered Accountants of India defines an error as, “an unintentional mistake in the books of accounts.” Errors are the carelessness on the part of the person preparing the books of accounts or committing mistakes in the process of keeping accounting records. Errors which take place in the books of accounts and the duty of an auditor to locate such errors are discussed below:

CLERICAL ERROR 1.

Errors that are committed in posting, totalling and balancing of accounts are called as Clerical Errors. These errors may or may not affect the agreement of the Trial Balance.

Types of Clerical Errors:

(A) Errors of Omission:

When a transaction is not recorded or partially recorded in the books of account is known as Errors of Omission. Usually, it arises due to the mistake of clerks. Error of omission can occur due to complete omission or partial omission.

(1) Error of Complete Omission: When a transaction is totally or completely omitted to be recorded in the books it is called as “Error of Complete Omission”. It will not affect the agreement of the Trial Balance and hence it is difficult to detect such errors.

Example – 1: Goods purchased on credit from Mr. X on 10.5.2016 for Rs. 20,500, not recorded in Purchases Book.

Example – 2: Goods sold for cash to Ram for Rs. 10,000 on 1.7.2016, not recorded in Cash Book.

(2) Errors of Partial Omission: When a transaction is partly recorded, it is called as “Error of Partial Omission”. Such kind of errors can be detected easily as it will affect the agreement of the Trial Balance.

Example – 1: Credit purchase from Mr.C for Rs. 45,000 on 10.12.2016, is entered in the Purchases Book but not posted in Mr.C’s account.

Example – 2: Cash book total of Rs. 1,10,100 in Page 5 is not carried forward to next page.

(B) Errors of Commission:

Errors which are not supposed to be committed or done by carelessness is called as Error of Commission. Such errors arise in the following ways:

(1) Error of Recording,

(2) Error of Posting,

(3) Error of casting, or Error of Carry-forward.

(1) Error of Recording: The error arises when any transaction is incorrectly recorded in the books of original entry. This error does not affect the Trial Balance.

Example – 1: Goods purchased from Shyam for Rs. 1000 wrongly recorded in Purchases Day Book as Rs. 100.

Example – 2: Goods purchased from Ram for Rs. 1,000, instead of entering in Purchase Day Book wrongly entered in Sales Day Book.

(2) Error of Posting : The error arises when a transaction is correctly journalised but wrongly posted in ledger account.

Example – 1: Rent paid to landlord for Rs. 10,000 on 1.5.2016 is wrongly posted to debit side of Repairs account instead of debit side of Rent account.

Example – 2: Rent paid to landlord for Rs. 10,000 on 1.5.2016 is wrongly posted to credit side of Rent account instead of debit side of Rent account.

(3) Error of casting, or Error of Carry-forward: The error arises when a mistake is committed in carrying forward a total of one page on the next page. This error affects the Trial Balace.

Example – 1: Purchases Book is totalled as Rs. 10,000 instead of 1,000.

Example – 2: Total of Purchases Book is carried forward as Rs. 1,000 instead of Rs. 100.

ERROR OF DUPLICATION 2.

Errors of duplication arise when an entry in a book of original entry has been made twice and has also been posted twice. These errors do not affect the agreement of trial balance, hence it can’t located easily.

Example: Amount paid to Anbu, a creditor on 1.10.2016 for Rs. 75,000 wrongly accounted twice to Anbu’s account.

ERROR OF COMPENSATION (or) COMPENSATING ERRORS 3.

When one error on debit side is compensated by another entry on credit side to the same extent is called as Compensating Error. They are also called as Off-setting Errors. These errors do not affect the agreement of trial balance and hence it cannot be located.

Example: A’s account which was to be debited for Rs. 5,000 was credited as Rs. 5,000 and similarly B’s account which was to be credited for Rs. 5,000 was debited for Rs. 5,000.

ERROR OF PRINCIPLE 4.

An error of principle occurs when the generally accepted principles of accounting are not followed while recording the transactions in the books of account. These errors may be due to lack of knowledge on accounting principles and concepts. Errors of principle do not affect the trial balance and hence it is very difficult for an auditor to locate such type of errors.

Example – 1: Repairs to Office Building for Rs. 32,000, instead of debiting to repairs account is wrongly debited to building account.

Example – 2: Freight charges of Rs. 3,000 paid for a new machinery, instead of debiting to Machinery account wrongly debited to Freight account.

Detection and Prevention of Frauds

Fraud is the intentional or wilful misrepresentation of transactions in the books of accounts by the dishonest employees to deceive somebody. Thus detection and prevention of fraud is of great importance and constituents an important duty of an auditor. Fraud can be classified as:

MISAPPROPRIATION OF CASH 1.

This is a very common method of misappropriation of cash by the dishonest employees by giving false representation in the books of accounts intentionally. In order to detect and prevent misappropriation, the auditor should verify the system of internal check in operation and by making a detailed examination of records and documents. Cash may be misappropriated in the following ways:

(1) By omitting to enter cash which has been received.

Example: Cash received on account of cash sales for Rs. 35,000 is not accounted in the debit side of the cash book.

(2) By accounting less amount on the receipt side of cash book than the actual amount received.

Example: Cash received on account of cash sales for Rs. 35,000 is accounted in the debit side of the cash book as Rs. 25,000. The difference of Rs. 10,000 may be defrauded by the cashier.

(3) By recording fictitious entries on the payment side of cash book.

Example: Cash book is credited for Rs. 44,000 as amount paid to Mr.X for goods purchased on credit but actually no amount is paid. Hence, cashier misappropriates Rs. 44,000 of cash as paid to Mr.X.

(4) By accounting more amount on payments side of cash book than the actual amount paid.

Example: Amount paid to Gopal for Rs. 5,000 is accounted on the credit side of cash book as Rs. 15,000. The difference of Rs. 10,000 may be defrauded by the cashier.

(5) Teeming and Lading of Fraud which means cash received from one customer is misappropriated and remittance received from another debtor is posted to the first debtors account.

MISAPPROPRIATION OF GOODS 2.

Fraud which takes places in respect of goods is Misappropriation of Goods. Such a type of fraud is difficult to detect and usually takes place where the goods are less bulky and are of high value.

· By showing less amount of purchase than actual purchase in the books of accounts.

· By showing issue of material more than actual issue made.

· By showing good materials as obsolete or poor line of goods.

· By showing fictitious entries in the books of accounts.

Example – 1: Goods purchased amounting to Rs. 58,000 is wrongly accounted in Purchases Book as Rs. 50,000. Hence, showing less amount of purchases than the actual and misappropriating goods worth Rs. 8,000.

Example – 2: Goods issued from stores for 1000 units is wrongly accounted in the Ledger accounts as 3000 units issued. The difference of 2000 units may be misappropriated by the storeskeeper.

Example – 3: Entries in the Purchases Book may be suppressed or inflated to show more or less profit.

Detection of Misappropriation of goods is a difficult task for an Auditor. Only through efficient system of inventory control, periodical stock verification, internal check system and adequate security arrangement the scope for such frauds can be eliminated or minimized.

Auditor has to thoroughly scrutinize the inward and outward registers, invoices, sales memos, audit notes, etc., to detect the goods-related frauds.

MANIPULATION OF ACCOUNTS 3.

There is a very common practice almost in every organization, some dishonest employees have intention to commit this type of fraud. Manipulation of accounts is the procedure to alter books of accounts in such a way that there will be an increase or decrease in the amount of profit to achieve some personal objectives of the high officials. It is very difficult for the auditors to identify such frauds which may be due to manipulation of accounts.

Causes of Manipulation of Accounts

· There are different reasons for manipulation of accounts. The reasons are:

· To get more commission calculated on profit

· For evasion of income tax and sales tax

· To get huge loan from financial institutions by showing more profit in the books of accounts.

· To declare more dividend to the shareholders.

· By showing more profit than actual to get confidence of the shareholders.

· To make secret reserves by showing less income or by showing more expenses in the books of accounts.

Ways of Manipulation of Accounts

Manipulation of accounts may be made in the following ways:

· By showing more or less amount on fixed assets,

· By showing over valuation or under valuation of stock,

· Over or under valuation of liabilities,

· Creation of over or under provision for depreciation,

· Charging capital expenditure as revenue expenditure or vice versa,

· By making more or less provision for bad debts and for outstanding liabilities,

· By showing advance income or expenditure in the current year accounts.

Objectives of Manipulation of Accounts

The objectives of Manipulation may be window dressing or creation of secret reserves.

Window Dressing: In window dressing, accounts are manipulated in such a manner to reveal a much better and sound financial position of the business than what actually it is, in order to mislead the outsiders by inflating the profit.

Secret Reserves: Accounts are prepared in such a manner that they disclose a worse financial position than the real. The real picture of the business is concealed and a distorted one is revealed.

Internal check – Meaning

Internal Check is an integral function of the internal control system. It is an arrangement of duties of the staff members in such a way that the work performed by one person is automatically and independently checked by the other.

In the opinion of Spicer and Pegler, “A system of internal check is an arrangement of staff duties, whereby no one person is allowed to carry through and to record every aspect of a transaction so that without collusion between two or more persons, fraud is activated and at the same time the possibilities of errors are reduced to the minimum.”

L.R. Dicksee defines an internal check as “an arrangement of book-keeping routine that errors and frauds are likely to be prevented or discovered by the very operation of the book-keeping itself.”

Objectives of Internal Check

Following are the main objectives of Internal Check −

· To protect business from carelessness, inefficiency and fraud.

· To ensure and produce adequate and reliable accounting information.

· To keep moral pressure over staff.

· To minimize the chances of errors and frauds and to detect them easily on early stage if it is committed.

· To divide the work in such a way that no business transaction should be left unrecorded.

· To fix the responsibility of every clerk according to the division of work.

Characteristics or Features of Internal Check System

8 qualities make an internal check system more effective and efficient.

1. Division of Work

2. Provision of Check

3. Use of Devices

4. Self-balancing System

5. Job Rotation

6. Specialization

7. Control

8. Authority Level

Division of Work

No one should be allowed to have the right to perform the work from origin to end.

For example – a transaction of sale may have to be split into a display of article by staff, the preparation of invoice by another, the receipt of cash against the invoice by a third clerk, the delivery of article against the proof of receipted invoice by another clerk, checking of outward movement of an article against delivery order by a clerk and so on.

In big business houses, such specialized tasks increase work speed and automatically introduce internal checks.

Provision of Check

An organization should set up such provisions so that work can be checked by other staff. An officer can check the work of one staff by transferring to the staff and again.

Use of Devices

In this modem world, various devices can perform various functions like time record machines, wage determination machines, etc. An organization should use machines that help to make the work of internal checks easier.

Self-balancing System

An organization can use self-balancing ledger accounts, which help to make the work of internal checks easier. Its effectiveness depends on its management.

Job Rotation

No individual clerk should be allowed to occupy a particular area of operation for long. Familiarity with and exclusiveness in a position offer a person greater flexibility to attempt manipulation with the system.

Specialization

Every staff may not have such specialized knowledge to maintain accounts properly. So, an organization should give training to increase their skills so that internal checks can be made more effective.

Control

There is more chance of fraud where there is direct contact between consumers or the public. So, a manager can keep an eye on those works so that the internal check system can be more effective.

Authority Level

There must be clear-cut authority levels according to sanctions for various transactions. Commensurate to the authority vested, responsibility must be extracted. The existence of authority levels results in a review of the operations of subordinates.

Let us now understand the principles of Internal Check −

· Responsibility − Allocation of business work amongst the various staff members should be done in such a way that their duties and responsibilities should be judiciously and clearly divided.

· Automatic check − Automatic checking of work of one employee by another forms part of a good Internal Check system.

· Rotation − Transfer or rotation of employees from one seat to another must be followed under good system of internal control.

· Supervision − Prescribed procedures and Internal Check should be strictly supervised.

· Safeguard − To safeguard files, securities, cheque books is also recommended in Internal Check.

· Formal Sanction − Without formal sanction, no deviation should be allowed from the established procedures.

· Reliance − Under good system, too much reliability on one employee should not be there.

· Review − From time to time, system of Internal Check should be reviewed to introduce improvement.

Advantages of Internal Check

Following are the advantages of a good system of Internal Check −

From the Owner’s Point of View

· Good system of Internal Check provides accurate, reliable and genuine accounting record and data to the owner of the business on which he can rely upon.

· Economy in operations and overall efficiency in system due to good Internal Check may result in more profits.

From the Auditors Point of View

· Due to efficient system of Internal Check, the statutory Auditor can avoid deep and detailed checking of transactions. He may rely on test checks, hence Internal Check provides convenience to Auditor.

· Since the Balance Sheet and the Profit and the Loss account is prepared without wasting of time, hence quick preparation of final accounts is possible.

For the Business

· Moral Check − Great check to commission of errors and frauds is possible with knowledge of subsequent checking of work of each employee by others.

· Detection of Errors and Frauds − This helps in early detection of errors and frauds because work of each clerk is checked by another automatically and no one is allowed to do complete work from the beginning to the end.

· Proper Division of Work − According to qualification, experience and area of specialization of work, proper and rational distribution of work among the members of staff is done.

· Increases Efficiency − A good internal control system provides increased efficiency of work coupled with overall economy.

Disadvantages of Internal Check

Let us now discuss the disadvantages of Internal Check −

It is costly for small business units.
If Internal Check system is not properly organized, there are chances of disorder in the working of business.
There might be instances where the quality of the product and the work is compromised with by the staff members due to greater importance to faster results.
An Auditor cannot be relied on if he does not conduct tests with procedures of his own.

Internal Audit

Internal Audit is a phenomenon for when an organization or department is tasked with providing their independent reviews of the system in an unbiased way along with the processes. Internal Audit is performed within a company in a direct manner with keeping the company standards in mind. Some people confuse it with statutory audits, from which Internal Audits are quite different.

Scope of Internal Audit

Following is the scope of Internal Audit according to the Institute of Internal Auditors −

· Safeguarding the assets.

· Economical and efficient use of resources.

· Reliability and integrity of information.

· Accomplishment of established objectives and goals for operations or programs.

Objectives of Internal Audit

Following are the main objectives of internal audit −

· To comment about effectiveness of internal control system in force.

· To give suggestions about improvement of internal control system in organization.

· To check and ensure whether policies and procedure as laid down by the top management are being followed or not.

· Whether assets of organization are properly accounted for and safeguarded.

· To ensure whether standard accounting practices are followed by the organization.

· Earlier detection and prevention of errors and frauds.

· To ensure correctness, accuracy and authenticity of financial accounting.

· To do investigation at the special request of the management.

· To check whether liabilities of organization are valid and legitimate.

Nature of Internal Check in Auditing

1. Preventive Focus: Internal checks are designed to prevent errors and fraud before they occur. For example, ensuring that no single person handles both the approval and recording of a financial transaction helps to prevent fraudulent activities.

2. Real-Time Monitoring: Internal checks operate continuously within the day-to-day operations of the organization. This means they are integrated into routine processes and not just periodic reviews.

3. Segregation of Duties: This principle involves dividing responsibilities among different employees to reduce the risk of error or fraud. For example, one employee might handle cash receipts while another handles accounting records.

4. Authority and Approval: Internal checks require transactions and activities to be authorized by appropriate personnel. This ensures that expenditures and financial actions are reviewed and approved before they are finalized.

5. Documentation and Recording: Accurate and complete documentation of transactions and internal checks is essential. Proper records help in verifying that controls are operating effectively and provide a trail for auditing purposes.

Scope of Internal Check in Auditing

1. Financial Transactions: Internal checks cover all financial transactions within an organization, including revenue, expenditures, investments, and payroll. The scope involves ensuring that these transactions are recorded accurately and authorized appropriately.

2. Operational Activities: The scope extends to operational procedures such as inventory management, procurement processes, and compliance with company policies. For instance, internal checks might involve reviewing inventory counts and ensuring purchase orders are properly approved.

3. Compliance with Regulations: Ensures that internal controls and checks comply with relevant laws, regulations, and standards. This includes adherence to accounting standards, tax laws, and industry-specific regulations.

4. Asset Protection: Internal checks help safeguard both tangible and intangible assets from theft, loss, or misuse. This includes controls over physical assets like inventory and cash, as well as intangible assets like intellectual property.

5. Risk Management: Internal checks play a role in identifying, assessing, and mitigating risks. Auditors evaluate whether internal checks are effectively managing risks related to financial reporting, compliance, and operational efficiency.

6. Review and Evaluation: Auditors review and evaluate the effectiveness of internal checks as part of their audit procedures. This includes assessing whether the internal checks are functioning as intended and identifying areas for improvement.

Internal Check V/S Internal Audit

Basis	Internal Check	Internal Audit
Meaning	It is an arrangement of the duties of staff members in such a manner that work performed by one person is automatically and independently checked by the other	Internal Audit is a review of various operations and records of the company by staff specially appointed for this purpose.
Object	To prevent and minimize the possibilities of errors, frauds or irregularities.	To detect errors and frauds which have already been committed.
Timing	Internal Check works during the course of transactions.	Internal Audit begins after the completion of accounting process of different transactions.
Scope	Scope of Internal Check is very limited.	Scope of Internal Audit is very broad.
Staff	The arrangement of the duties is done with the existing staff, no new member of staff is required for Internal Check.	Separate staff is required to do internal audit.
Nature	Internal Check checks the progress of work automatically.	Internal Auditor reports to the management and suggest improvement about various inefficiencies.
Involvement	A large number of employees are involved in the Internal Check system.	For implementation of Internal Audit, a small team with limited members can also perform the audit.
Device	Internal Check acts like a device and keeps check on the work.	Internal Audit is a device for checking the work.

External vs. Internal Audit

Basis	External Audit	Internal Audit
Appointment	Appointment of External Auditor is compulsory by the law; he is appointed either by the Shareholder or by the Government.	Appointment of Internal Auditor is optional and he is appointed by the management.
Status	External Auditor is an independent person.	Internal Auditor is a paid employee of the company.
Scope	Scope of work of External Auditor is laid down by the laws.	Scope of work and rights, duties and responsibilities of Internal Audit is laid down by the management.
Object	Assurance about whether the financial statements are presented fairly in all material respects and according to applicable financial reporting framework or not.	Object of Internal Audit is to serve the need of the management and to prevent errors, fraud and irregularities.
Remuneration	Remuneration is fixed by the shareholders of the company.	Remuneration is fixed by the management of the company.
Duration	External Audit starts after the preparation of final accounts.	Internal Audit is carried out throughout the year.
Reporting	Report is submitted to the shareholders of the company.	Report of Internal Audit is submitted to the management.
Shareholder Meeting	External Auditor has a legal right to attend shareholders meeting.	Internal Auditor doesn’t have the right to attend the shareholders meeting.
Audit Procedure	Mostly External Auditor does text checking.	Internal Auditor mostly does detailed checking and examination of books of accounts and records.

What is Internal Control?

Internal control comprises of the policies and procedures adopted by the management of an entity to assist in achieving the following objectives:

(a) Orderly and efficient conduct of business.

(b) Adherence to management policies

(d) Prevention and detection of fraud and errors

(e) Accuracy and completeness of accounting records

(f) Timely preparation of financial statements

“Internal control is regarded as the whole system of controls, financial and otherwise established by the management in the conduct of a business including internal check, internal audit and other forms of control. “ According to American Institute of Certified Public Accountants:” Internal control comprises of the plan of organization and all the coordinate methods and measures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency and to encourage adherence to prescribed managerial policies.”

Internal control is an all-embracing term. It comprises of financial controls, non-financial controls, internal check and internal audit.

2. Objectives

To encourage adherence to prescribed policies: The system of internal control is introduced to provide reasonable assurance that the various plans, policies and procedures laid down by the entity are being followed.
To avoid frauds and errors: The main objective of any control system is to detect and prevent frauds and errors by keeping an inherent check.
To promote operational efficiency: The internal controls within an organization are meant to prevent unnecessary duplication of efforts, protect against waste and discourage any inefficient use of resources of the organization.
To safeguard assets and records: The other important objective of internal control system is to safeguard the assets and records from unauthorized access, use and disposition.
To provide accurate and reliable data: The internal control system ensures that all the transactions are recorded in the correct amount, in the appropriate account and in the accounting period to which they relate.
To assist in timely preparation of Financial Information: Information is of no use if it is not provided in time. Internal control system facilitates timely preparation of financial statements.

2.1 Limitations

SA-315 (earlier AAS 6) issued by Institute of Chartered Accountants of India highlights the inherent limitations of internal control, which are mentioned below:

Internal Control System involves expenditure of time and money. Management’s consideration that internal control system should be cost-effective weakens the effectiveness of the system.
Internal control is more concerned with the transactions of routine nature, so unusual and irregular transactions may be overlooked.
It has the potential for human error especially when a new employee is involved in the internal control system without proper orientation.
Possible collusion may circumvent internal control system Internal Control system involves division of duties between employees of the organization. Collusions among employees may perpetuate the frauds within an organization.
There is always a possibility that a person responsible for exercising control may abuse his authority e.g., embezzlement of cash by cashier, misappropriation of goods by store keeper etc.
The changes in conditions may make the procedures ineffective and it may deteriorate the internal control system.
The manipulations by the management may defeat the objectives of internal control.

Elements of Internal Control System

PRACTICAL AUDITING - UAF20503J- unit 1