What is Auditing? | Definition, History, Goals and Working

Auditing, an essential component of the accounting practice is a process that entails examining and inspecting the activities, records and operations of an organisation to ascertain compliance with the established or standard organisational framework and regulatory requirements.

 Despite being a staple of accounting, it differs insofar as the latter is concerned with generating and maintaining financial reports of an organisation or business. 

In contrast to that, Auditing is concerned with verifying, checking and evaluating the accuracy of the financial statements generated through accounting.

Origin and Evolution of Auditing

Auditing as a process or practice is as old as Accounting. Both of them trace their origin in the ancient civilisations of Mesopotamia, Egypt, Greece, Rome and India. 

While ancient texts like the Vedas provide a brief reference to the task of Accounting and Auditing, Kautilya’s Arthashastra presents a detailed description of Accounting and Auditing.

It must be noted that the term ‘Audit’ has been derived from the Latin word ‘Audire’ meaning to hear or listen. Earlier, the auditors used to listen to the accountant’s reading of the accounts to check their accuracy and prevent frauds and errors.

However, Auditing started assuming its present form in the eighteenth century when the Industrial Revolution gave rise to joint-stock companies characterised by the separation of ownership and management. 

With the stakeholders now being the real owners of the company, Auditing increasingly became an essential instrument for checking the administrative activities of the company managers.

Accordingly, the goals of Auditing shifted from mere detection of frauds and errors to verification of the accounts being fair and trustworthy.

To ensure that the financial efforts of an organisation are fairly portrayed, the International Accounting Standards Committee have set out specific standard auditing and accounting practices to guide the day to day activities of Auditors and Accountants, respectively. 

Besides that, the advent of computers has further enhanced accounting and auditing systems.

Goals of Auditing

There are mainly two goals of Auditing.

  1. Primary Objective: The main objective of Auditing is to promote efficiency and accuracy by verifying whether the balance sheet and profit and loss accounts presented by the organisation managers are fair and trustworthy or not.
  2. Secondary Objective: Also known as incidental objective, as it is concomitant to the fulfilment of the main goal, it includes:
  • Exposure and thwarting of frauds, and
  • Disclosure and thwarting of errors.

How is Auditing done?

Being a rigorous process, Auditing helps in uncovering the real financial status of an organisation. However, the scope of an audit differs according to the organisation’s size and needs. Accordingly, the following steps are followed by the auditor during an Auditing process.

  1. Demanding financial records: Once the organisation has been notified regarding the audit, the auditor may inquire about the financial records enlisted under a preliminary audit checklist. These records may comprise of original ledgers, receipts, bank statements and copies of the past audit reports. Besides that, the auditor may also ask for organisational charts, accompanied by copies of the committee and board minutes and standing rules and bylaws.
  2. Planning for the Audit: After going through the essential records, the auditor may chalk out an outline of the forthcoming audit. If needed, a risk workshop may be administered to detect potential problems. Following which, the auditor shall draft an audit plan.
  3. Arranging for an opening meeting: Once the audit plan has been prepared, the auditor may call for an open discussion with the senior management and the core administrative personnel to enunciate the scope and the duration of the audit. During this meeting, the auditor may also ask the department heads to notify their respective staff regarding potential audit interviews.
  4. Administering on-site fieldwork: After gathering various information from the opening meeting, the auditor may finalise the audit plan and conduct the on-site fieldwork accordingly. The fieldwork shall include interviewing the staff members, examining the procedures and policies and checking their conformity with the established framework and standards. Besides that, the auditor may evaluate the adequacy of the internal controls and discuss the potential problems while giving the organisation a chance to answer.
  5. Preparing a Report: Once the fieldwork is completed, the auditor may record, summarise, analyse and present the findings in the form of a report. The results may include computation errors, authorised but unpaid payments, posting problems and other similar discrepancies. Besides the potential issues, the official commentary shall also suggest suitable solutions.
  6. Calling for a closing meeting: Following the drafting of the report, the auditor may arrange for a closing meeting allowing the management to disagree or agree with the findings of the audit. The objective of this gathering is to discuss and resolve any remaining issues with the audit report.
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Advantages of Auditing

Auditing provides several benefits, not only to the concerned organisation but also to the investing stakeholders. The following table will enunciate the advantages of auditing more clearly.

From the organisation’s PerspectiveFrom the stakeholders’ PerspectiveOther Benefits
1. Exposure of frauds and errors.1. Protection of shares and interests.1. Estimation of current financial position.
2. Getting loans from banks.2. Accurate estimation of investments.2. Quicker settlement of demands.
3. Accurate valuation of liabilities and assets.3. Ascertaining the accountability of the management.3. Using audit reports as evidence in courts.
4. Building and retaining good reputation.4. Ensuring adequate security.4. Ease in filing tax returns.
5. Gaining acceptance from the government.
6. Getting recommendations on potential reforms.
7. Updation of accounts.

Disadvantages of Auditing

Despite its several advantages, Auditing has some inherent limitations.

  1. Thorough verification not feasible: Auditing entails checking the financial statements of an entire year within just a few days. Consequently, a detailed evaluation is not possible.
  2. Dependence on other’s explanation and opinion: Auditing is highly dependent on the information, description and viewpoint presented by the responsible personnel. As the accountable staff may provide false information or explanation, the results of the audit may get heavily affected.
  3. No disclosure of errors or frauds: As Auditing is heavily based on the information provided by others, there is a high chance that no scams or mistakes may be exposed. Besides that, the concerned organisation may also adopt mala fide practices to ascertain that the auditor provides a favourable report.
  4. Intrinsic limitations of financial reports: Auditing primarily focuses on financial statements. However, financial statements alone cannot give an overall picture of the organisation’s liabilities and assets.

References

  1. https://proformas.ljmu.ac.uk/5099KFLAF.pdf