AUDITING PART A- 2 MARKS

What is an Audit Notebook?

An audit notebook is a part of audit working papers that keeps a
record of a wide range of matters that are observed during the
course of the audit for which answers provided by the client are
either not satisfactory or which must be included in the audit report.

It is a diary or register that the audit staff keeps to note down any

errors or irregularities discovered during the audit.

When the auditor classifies his working papers into permanent and
current audit files. Of which audit notebook is a part of the current
working paper file because it is obligatory to maintain a fresh audit
notebook for each financial year.

It is one of the segments of auditor’s records of permanent nature

which is available for the purpose of reference in the future,
whenever required. It is in two parts:

 One that keeps a record of general information, relating to the

audit as a whole.
 One that enters special points that are discovered during the
audit process of different years.
Importance of Audit Notebook

An audit notebook is pertinent for an auditor particularly for the

preparation of an audit report, which is to be submitted to the
shareholders of the company. It is important because:

1. An auditor can use it as evidence when a charge of negligence

is registered against the auditor.
2. It facilitates the auditor to know the actual volume of work
performed by his/her audit staff.
 3. It helps in future reference and acts as a guide to draft audit
programme in future, as the points noted down in the
notebook highlight the loopholes in the accounting system of
the client which must be considered.
4. It also helps the auditor for correlating the audit work if the
related assistant is not present or the work is halted for the
short term.
5. It also records different queries that came up during the course
of the audit and their state of disposal.
6. Further, with regard to disposed queries, explanation received
and evidence encountered, would be recorded and
those queries which are not disposed of would be noted for
the purpose of follow up.

Contents of Audit Notebook

There is a list of matters which the audit notebook incorporates, this
includes:

 List of account books that the client maintains.

 Details of main officers, their powers, duties, and
responsibilities.
 Method of accounting adopted by the firm
 Technical jargon used in business
 Points that need more explanation.
 Particulars of vouchers that are missing and duplicates are to
be gathered.
 Commencement and completion date of the audit
 Any mistake, irregularity, or error identified during the course
of the audit.
 Total or balances of different books of accounts.
 Notes or queries needed for performing the subsequent audits.
 Points included in the audit report.
  Provisions in the company’s memorandum and articles of
association can affect the account and audit.
 Matters requiring discussion with the auditor or any senior
official.
 Audit queries that are not disposed of immediately.
 Extracts of minutes and contracts that influence the company’s
accounts.
 Relevant information about the company, which is not evident
from the books of accounts.
 Points that require to be taken into account while verification
of annual accounts.
Objectives of Audit Notebook

The objectives of the audit notebook are discussed hereunder:

To facilitate future audit: Current year’s audit notebook facilitates

the auditor when he commences audit in the subsequent year. It
helps in understanding the areas requiring special consideration and
attention.

To provide documentary evidence: It acts as evidence concerning

the extent of work performed and the level of skill and care
employed by the auditor while carrying out an audit. He can use it as
documentary evidence to defend himself when a charge of
negligence is filed.

To prepare audit report: It is quite obvious that the auditor cannot

keep all the irregularities and important matters and audit findings,
in his memory, which require consideration at the time of
preparation of the audit report. Hence, if the auditor maintains an
audit notebook, it helps in the preparation of the audit report.

To resolve queries arising at the time of audit: The client’s

accounting staff may feel annoyed when the auditor comes up with
queries before them on a frequent basis, during the course of the
audit. And so, for the convenience of the client’s staff, audit queries
must be noted down in the book whenever they arise and put
before the staff for explanation altogether.

To evaluate work: If the auditor goes through the audit notebook, it

is easier to understand the progress of the audit work performed
and the efficiency level of the audit staff.
Wrap Up

An audit notebook is a perfect guide for future reference. It also

ensures that the audit programme has been applied appropriately.
Further, the responsibility of the errors that remain unidentified can
be fixed on the staff concerned. It also keeps a record of day-to-day
work performed by the audit clerks. It must be noted that the audit
notebook needs to be maintained in a clear, complete, and
systematic manner.
What is Efficiency Audit? Objectives,
Purpose, Scope, Report
Cost Audit has two important phases. The first phase is known as Efficiency Audit
and the second phase is known as Propriety Audit. Let us consider information about
these two phases of the Cost Audit.

Efficiency Audit
Efficiecny audit is also known as ‘Performance Audit’ and ‘Profitability Audit’.
Efficiency audit may be defined as a systematic examination of management’s effort
to accomplish goals efficiently and effectively in order to determine adherence to the
management policies and stated requirements.

Efficiency audit is undertaken to point out actual and potential areas which create
trouble in the operations and working of the company and due to which the company
may not be able to achieve its pre-determined goals.

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To detect such trouble areas in efficiency audit, following points are examined by
the cost auditor:
 Utilisation of the resources in the form of manpower and equipment.

 The organisational structure of the company and its adequacy to carry out
the work for achieving the set goals.

 Adequacy and reliability of controls created for smooth functioning of

various operations.

 Implementation of policies and procedures.

 Extent to which co-operation exists among various departments and also in

the staff working at different levels.

 Methods of operations used in the company and whether they are

satisfactory or not.

 Variances between the targets fixed and the actual performance and the
causes due to which the variances have occured and the extent to which
variances have been reduced due to actions taken by the management.
Efficiency audit brings to notice uneconomic use of resources, idle and wasted
capacity of the machinery and equipments, improper decisions and loss suffered due
to such decisions, existence of rivalry among departments and lack of cooperation
which results in lower performance and inadequate staff-both in number and
knowledge – in certain departments.

The cost auditor also suggests ways and means through which these deficiencies can
be removed and performance of the company can be improved.

What is Efficiency Audit?

Efficiency Audit may be defined as a systematic examination of management’s efforts
to accomplish goals efficiently and effectively in order to determine adherence to the
management policies and stated requirements.

Efficiency audit is so designed as to determine the potential danger spots, to highlight

possible opportunities, to eliminate waste or unnecessary loss or to observe the
executive performance and evaluate the effectiveness of executive control.

Performance and Efficiency Audit’ is a diagnostic appraisal process for analysing

goals, plans, policies, and activities in every phase of operation to uncover
unsuspected weaknesses and to develop ideas for improvement in areas that have
escaped management attention.American Institute of Management

Objectives of Efficiency Audit

Objectives of the efficiency audit can be explained as under:

 To understand the objectives pre-determined for the organization.

 To find out the variance between planned objectives & achieved objectives.

 To find out the reasons due to which the variance has occurred.

 To recommend to the management the action to be taken to reduce the

causes that have resulted into waste and inefficiency.

Purpose of Efficiency Audit

The basic purpose of the efficiency audit is to reveal defects or irregularities in any of
the elements examined. Its aim is to assist management in achieving the most efficient
and effective administration of the operations performed. The intent is to examine and
appraise the methods and performance in all areas.

Scope of Efficiency Audit

Efficiency Audit does it to make a judgement regarding the efficiency of existing
practices. It shall, however include an enquiry into, whether, in carrying out its
responsibilities, the audited entity is giving due consideration to conserving its
resources and using the minimum effort to do its work.

Efficiency Audit Report

The Report should be written in good English and lucid style so that it may not be
misunderstood. The following are some of the important aspects of audit report:

 Significance
 Timeliness
 Carrying Convictions
 Accuracy & Adequacy
 Clarity & Simplicity
 Objectivity & Perspective
 Conciseness
 Completeness
What is Propriety Audit? Definition,
Functions
 Post last modified:20 April 2021
 Reading time:6 mins read
 Post category:Finance

What is Propriety Audit?

The propriety audit is confined to examine the validity of appropriations or is
concerned with verifying that there is no leakage of revenue and wastage of funds
knowingly or unknowingly in disregard to any legal requirement or financial or
economic consideration.
Under ‘propriety audit’, it is to be seen that the contracts entered into by the concern
are in its best interest and there is a proper check to ensure that the properties are safe.
Thus it is a form of super or higher audit. The propriety Audit is the inter-related
aspect of ‘Management Audit’ also.

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The management of an enterprise is expected to guarantee the propriety and validity
of all the transactions and the propriety auditor has to certify them. Thus, the audit is
meant to cover examination of propriety aspects of transactions as well as the review
of operational aspect of a concern. In a way, it is over and above the regular audit
conducted as per the requirement of the company legislation.

Propriety Audit: The term ‘propriety’ means ‘justness’ or ‘rightness’. When the term
is applied in audit it signifies the audit of rightness of expenditure incurred or the
rightness or optimum result or rightness of selecting alternative plan of action.

Definition of Propriety Audit

Propriety is that which meets the tests of public interest, commonly accepted customs
and standards of conducts and particularly as applied to professional performance, a
requirement of regulations and professional codesE.L. Kohler
It requires transactions (mainly expenditure) to confirm to certain general principles:

 Expense is not prima facia more than the occasion demand and same degree
of vigilance is exercised as should be exercised in respect of his own money.

 Authority exercises its power of sanctioning expenses to pass an order which

will not occur to its own advantage.

 Funds not utilized for benefit of a particular person/group.

 Apart from agreed remuneration, no other avenue is kept open to benefit

management personnel, employees and others.
Propriety Audit is directed towards examining the propriety of executive action
beyond the formality of expenditure to its wisdom, faithfulness, and economy. Under
this type of audit we try to bring out cases of improper, avoidable, or infractuos
expenditure even though the expenditure has been incurred in conformity with existing
rules and regulations.CMA Ramesh Krishnan

Functions of Auditor Related to

Propriety Audit
The functions of Auditor in the context of Propriety Audit may be specified as under :

 To see that all expenditure incurred are properly planned.

 To see that the size and channels of expenditure are rightful and expected to
give maximum results.

 To appraise (Audit) whether those expenditure are likely to give optimum

result.

 To see that any substitute plan of action can bring about an improvement on
current operation and as well as return from capital expenditure.

 To examine the actions and decisions of the management to see that they are
conductive to public interests and that they meet the standards of conduct.
The auditor conducting such an audit is not merely confined to the evidence relating to
the transactions audited but takes particular care to appraise each transaction carried
out by the manager as a man of prudence in a manner which is not irregular.

DIFFERENCE BETWEEN ROUTINE CHECKING AND

TEST CHECKING
Routine checking and test checking are common practices used in an
audit. They are different from each other in terms of the scope of
examination they hold. While routine checking is a kind of detailed
examination of each and every item especially to confirm the
arithmetical accuracy of entries, test checking is a form of selective
verification. Here, only a selected number of transactions are put
under scrutiny. In this blog, we have explained the two terms in detail
along with bringing out the key differences between them.

Meaning of routine checking

Routine checking is the checking of the daily transactions of a
business. It means checking the arithmetical accuracy of the entries in
the books of account to detect any clerical errors and minor frauds. All
transactions are checked on a regular basis to see that there is no
mismatch of debit and credit and that all ledger balances are drawn
correctly.

Routine checking helps in the conduct of the final audit because with
routine checks already being performed, an auditor can be assured
that the balancing and totals of ledger books are correct.

The scope of routine checking and its objectives include the following:

 To verify that the entries made in the books of account are

arithmetically correct.
 Checking calculations in the books of original entry with respect
to castings, sub-castings, carry forwards, and similar calculations.
 Checking the posting of entries from Journal to Ledger
 Checking the totalling and balancing of all accounts in the ledger
 Checking posting of balances from Ledger to trial balance
Meaning of test checking
Test checking is a method of verification of a selected number of items
from an entire population of similar items. Here, an auditor would
verify a representative set of items out of all of the client’s
transactions. For example, the sample chosen for examination may
vary anywhere from 5 to 50% of the total number of items. This
technique is a form of partial/selective verification where a random or
arbitrary percentage of transactions is selected. However, the quantum
of test checking is usually dependent on the judgment or experience of
the auditor and his overall assessment of the client’s operations.

Under test checking, the auditor would examine only a few

transactions in-depth (out of many) to draw an opinion on the whole
of them. If the sample is found to be satisfactory, the rest shall be
considered satisfactory too.

Some important points related to the approach of test checking are as

follows:

 When there are a significant number of identical or routine

transactions, test checking might be used.
 It may be helpful when the auditor needs to certify the accounts
shortly after the accounting period ends.
 It may be suitable when the auditor has prior knowledge of the
nature of the client’s transactions.
 Test checking is most helpful when an adequate internal
control and internal check system is in place.
 The test (or sample) should be chosen by the auditor
independently of any inputs from the client’s team.
 The test check should be designed in such a way that a
significant amount of each employee’s work gets checked.
 When deciding on the type and size of samples to verify, the
auditor should employ his prior experience.
 The auditor should choose entries for test checking with caution,
using his judgment and professional skill.
Why test checking rather than routine checking?

In most cases, the volume of transactions in a business concern is so

large that it becomes impossible (and unnecessary too) to examine
each and every transaction given the fixed and limited time available
with an auditor. Here, the test checking approach comes to the rescue.
It significantly reduces the workload of the auditor.
It is believed that detailed checking or routine checking of each and
every item is considered unnecessary in all situations, hence test
checking is mostly used in practice. It is only when an auditor feels that
it’s absolutely essential to get deep into an area of assessment that he
relies on detailed or in-depth scrutiny.

Drawing a line of distinction between the two

The key differences between test checking and routine checking are
compiled in the table below:

Basis Routine checking Test checking

Meaning Routine checking is a form of audit examination in Test checking is an established

which certain books and records that are common auditing process in which only a
to all types of businesses are checked. portion of the transactions is
verified to form an opinion rather
than checking all of the
transactions.

Objective The ultimate objective of routine checking is to The objective of test checking is to
confirm the arithmetical accuracy of the entries obtain a reasonable level of
made in the books of account. It also ensures assurance about the authenticity of
accuracy of the casting of subsidiary books, posting a group of transactions by verifying
of entries, and balancing of ledger accounts. It only a representative sample.
further checks the correctness of the trial balance.

No. of Each and every transaction is checked here. Only a few selected transactions are
transactions checked.

Details Routine checking is a form of detailed and Test checking is done on a selective
thorough checking. basis.

Traditional It is one of the most traditional systems used in an Test checking is an unconventional
audit. method that has gained a lot of
traction over the past few years.

Also known It is also known as a form of extensive or detailed Test checking is also known as
as checking. selective examination.

Suitability Routine checking is most suitable in the case of It is most suitable for large
small entities. businesses where the volume of
transactions is enormous.
 Cost and time It may prove to be a more expensive and time- Test checking is somewhat cost-
taking exercise. effective and saves time too.

Nature of Only clerical errors and frauds of a very ordinary With test checking, some errors and
errors nature can be detected with the help of routine frauds can go undetected too. There
checking. is an element of doubt as well as a
risk when only a few transactions
are tested.

Monotony Due to its mechanical nature, routine checking can It is not monotonous.
get monotonous at times.

Cashbook Routine checking can be used to verify every entry For verification of cash book and
in the cash book. bank account entries, test checking
should not be used as they
necessitate 100% checking.

Volume of It encompasses a huge volume of work. It reduces the workload of the

work auditor.

Completion of The work of the auditor increases and this may It can assist in the quick completion
audit work delay the completion of an audit. of audit work.

Complicated Routine checking may form the foundation to Complicated or material

transactions identify the risks of material misstatement. transactions that need more
attention may not be apt for test
checking. For them, the approach of
auditing-in-depth is appropriate to
carry out an extensive examination.

Internal If the internal control system is not effective, the Test checking may not be suitable
control auditor must decide how much comprehensive when the internal control system is
verification/detailed checking he has to do to be weak.
satisfied that the business records are authentic.

Use of a balanced approach

As stated earlier, a detailed examination of transactions is only

possible in a few selected areas due to the constraint of time and
resources. Therefore, where the appraisal of the internal control
system of a client by the auditor shows satisfactory results, he can put
his work to rely on test checking rather than routine checking. If there
is an effective internal control system in place, the auditor can stay
assured about the authenticity of the client’s operations to a great
extent. Thus, he may limit the need for extensive checking.

Nevertheless, these two methods of checking shouldn’t be regarded as

a substitute for one another. Rather they are often supplementary to
each other. An audit makes combined use of these two methods. Thus,
test checking for selected items is often accompanied by routine
checking and also examination in-depth, particularly for areas that
require more attention.

DIFFERENCE BETWEEN ERROR AND FRAUD IN

AUDITING

Error and Fraud in Audit:

You must be knowing that the primary objective of an audit is to express an
opinion on the truthfulness and fairness of financial statements. And to form
such an opinion, an incidental objective works simultaneously which is to
detect and prevent frauds and errors. Unless an auditor establishes that there
are no frauds and errors in the books of account, he cannot express his
opinion on the true and fair view of financial statements. Thus, locating the
possibility of errors and fraud is important.

An error may be defined as an unintentional mistake in the measurement or

presentation of financial information. However, fraud refers to an intentional
misstatement in financial statements. It may be committed by the client’s
employees, the management, or third parties so as to obtain an illegal or
personal gain out of the business of the client.

The main difference between an error and a fraud is that of intent. While
frauds are committed intentionally, errors are not.
Further, the responsibility of an auditor for detecting errors and frauds is the
same as both of them result in misstatements in financial statements. But the
distinction between them is important because the existence of fraud raises
questions about the integrity of the client’s management and those charged
with governance.

Difference between Error and Fraud

In the context of an audit, the following points of difference can be drawn
between an error and a fraud:

Error Fraud

Meaning of Error Meaning of Fraud

The term “Error” refers to an unintentional mistake A fraud indicates an intentional misstatement that is
in the measurement or presentation of accounting material to financial statements. Materiality means that
and/or financial information. the existence of fraud is such that it can affect financial
statements to a large extent.

Unintentional Intentional

Errors are unintentional. Frauds are committed intentionally. The objective is to

derive some personal gain or an unfair advantage.

Types of Errors Types of Frauds

An auditor may come across many types of errors in On the other hand, fraud may take the form of
financial information. These may be clerical errors misappropriation of assets, manipulation or falsification
(i.e., errors in recording and posting of transactions), of accounts, and so on. The purpose may be to
errors of principle (i.e., failure to comply with deliberately misrepresent the financial position to evade
generally accepted accounting principles), taxes or to show a better performance of the
compensating errors, or errors of duplication where a management than it actually has. Further, it may be
single transaction is recorded twice. either employee fraud or management fraud.

Consequences of an error on the audit work Consequences of fraud on the audit work

Once errors are detected, the auditor should ensure When an auditor identifies or suspects fraud, he should
that the financial statements are adjusted in regard to consider its effect on financial statements and
them. All material errors should be communicated to communicate to the appropriate level of management.
the management. He should examine the reliability of management’s
representation in this regard. He should ensure that
appropriate disclosure of identified misstatements is
 made either in the financial statements by management
or in his audit report. Finally, he should further consider
whether he should withdraw from his engagement.

The possibility of detection is more The possibility of detection is less

Errors can be detected more easily. The possibility of detection of fraud is comparatively
less because the management makes conscious attempts
to conceal it.

Auditor’s duty with regard to detection of fraud and

errors
Even though the primary responsibility for the prevention and detection of
fraud rests with the management, auditors are expected to adopt a careful
approach and an attitude of professional skepticism at all times.

According to SA 240, an auditor conducts a financial audit of an entity in

order to obtain a reasonable assurance (and not absolute assurance) that its
financials are free from any fraud/error and material misstatements. On
identification of misstatements or where the auditor suspects fraud, he
must communicate it to the appropriate level of management. If he
suspects the management’s involvement in fraud, he must
communicate the same to those charged with governance and must
discuss with them the nature, timing, and extent of audit procedures
necessary to complete the audit.

Moreover, if there is a responsibility to report the occurrence of

misstatements to regulatory or enforcement authorities under any law,
the auditor must abide by that. For instance, reporting frauds to the
Central Government under Section 143 of the Companies Act 20
Audit Evidence
An audit is a systematic independent examination of financial
statements, records, documents with an objective to express an
opinion on the financial statements of an entity whether they are
giving a true and fair view or not. Auditor expresses his opinion
(whether the financial statements of an entity are giving a true and
fair view or not) on the basis of audit evidence collected by him.

Meaning and Features of Auditing

Essential of Audit Report
Basic Principles Governing an Audit

Audit Evidence
An auditor applies various audit procedure to obtain audit evidence
which enables him to form an opinion whether the financial
statements of an entity are free from material misstatement
and state a true and fair view or not.

Audit Evidence is the information that the auditor uses in arriving at a

conclusion on the basis of which he forms his opinion.
The auditor should obtain sufficient and appropriate evidence which
enables the auditor to arrive at a conclusion and supports his opinion.
Audit evidence forms the basis for forming an opinion whether
the financial statements of an entity state true and fair view or not.

Evidence collected by the auditor should support the contents of its

audit report. Sufficiency of audit evidence is the measure of the
quantity of audit evidence. Appropriateness of evidence is the quality
of the evidence, i.e., its relevance and reliability to support the
auditor’s opinion.

Audit evidence includes information provided in books of accounts

as well as information from other sources. For Example – Purchase
invoice and material received note prepared by the store’s department
are evidence to support the purchase.

Browse more Topics under Tools Of Auditing

 Audit Plan
 Audit Programme
 Working Papers

Essentials of good audit evidence

1. Sufficient: Sufficiency is the measure of quantity. Audit

evidence is sufficient when they are available in adequate
quantity. An auditor applies different audit procedures to
obtain sufficient audit evidence like test checking.
2. Reliable: Evidence obtained by the auditor is persuasive
rather than conclusive. We cannot consider such evidence
100% reliable for forming an opinion. Reliability of audit
evidence depends on its source and nature of such evidence.
3. Source: Audit evidence obtained within the enterprise is
known as the internal source. Evidence obtained from an
 outside enterprise like confirmation from the third party is
known as the external source. We consider the external
source to be more reliable.
4. Nature: Can be documentary (like bills, vouchers), visual (like
the physical verification of fixed assets), or oral (confirmation
from employees)
5. Relevant: Whether the audit evidence obtained by the
auditor is relevant or not depends on the purpose of audit
procedures.

There are some thumb rules which helps in identifying the

appropriateness of evidence

1. Written (documentary) evidence is better than testimonial

evidence.
2. Evidence from external sources is more reliable.
3. Original documents are preferable over their photocopies.
4. The auditor should have a good understanding of internal
control of the organization as it enables him to obtain
relevant evidence.
5. Evidence obtained by auditor through direct observation,
inspection, physical verification, and computations are better
than the evidence obtained indirectly.
Solved Example For You
Question: State the important factors that the auditor needs to
consider while obtaining evidence?

Ans. Some important factors to consider while obtaining evidence are

as follows: –

1. Quality of evidence (its relevance, reliability, and

appropriateness)
2. The materiality of evidence, their significance
3. Whether there is a requirement of an audit level of
assurance (high) or a review level of assurance (moderate).
4. The risk involved in making an incorrect conclusion

Contingent Liability: What Is It, and What Are Some

Examples?

What Is a Contingent Liability?

A contingent liability is a liability that may occur depending on the outcome
of an uncertain future event. Contingent liabilities are recorded if the
contingency is likely and the amount of the liability can be reasonably
estimated. The liability may be disclosed in a footnote on the financial
statements unless both conditions are not met.

How Contingent Liabilities Work

Pending lawsuits and product warranties are common contingent liability
examples because their outcomes are uncertain. The accounting rules for
reporting a contingent liability differ depending on the estimated dollar
amount of the liability and the likelihood of the event occurring. The
accounting rules ensure that financial statement readers receive sufficient
information.

 
An estimated liability is certain to occur—so, an amount is always entered
into the accounts even if the precise amount is not known at the time of
data entry.

When Do I Need to Be Aware of Contingent

Liability?
If you run a business or oversee the accounts of one, you need to be
aware of the contingent liabilities that you have taken on. You’ll also need
to record these. Both GAAP (generally accepted accounting
principles) and IFRS (International Financial Reporting Standards) require
companies to record contingent liabilities in accordance with the three
accounting principles: full disclosure, materiality, and prudence.12

A contingent liability has to be recorded if the contingency is likely and the

amount of the liability can be reasonably estimated. GAAP recognizes
three categories of contingent liabilities: probable, possible, and remote.
Probable contingent liabilities can be reasonably estimated (and must be
reflected within financial statements). Possible contingent liabilities are as
likely to occur as not (and need only be disclosed in the financial statement
footnotes). Remote contingent liabilities are extremely unlikely to occur
(and do not need to be included in financial statements at all).

What Is Important to Know About Contingent

Liability?
Contingent liabilities adversely impact a company’s assets and net
profitability. As a result, knowledge of both contingencies and
commitments is extremely important to users of financial statements
because they represent the encumbrance of potentially material amounts
of resources during future periods, and thus affect the future cash flows
available to creditors and investors.

Contingent liabilities are also important for potential lenders to a company,

who will take these liabilities into account when deciding on their lending
terms. Business leaders should also be aware of contingent liabilities,
because they should be considered when making strategic decisions
about a company’s future.

Example of a Contingent Liability

Assume that a company is facing a lawsuit from a rival firm for patent
infringement. The company’s legal department thinks that the rival firm has
a strong case, and the business estimates a $2 million loss if the firm loses
the case. Because the liability is both probable and easy to estimate, the
firm posts an accounting entry on the balance sheet to debit (increase)
legal expenses for $2 million and to credit (increase) accrued expense for
$2 million.

The accrual account permits the firm to immediately post an expense

without the need for an immediate cash payment. If the lawsuit results in a
loss, a debit is applied to the accrued account (deduction) and cash is
credited (reduced) by $2 million.

Now assume that a lawsuit liability is possible but not probable and the
dollar amount is estimated to be $2 million. Under these circumstances,
the company discloses the contingent liability in the footnotes of the
financial statements. If the firm determines that the likelihood of the liability
occurring is remote, the company does not need to disclose the potential
liability.

A warranty is another common contingent liability because the number of

products returned under a warranty is unknown. Assume, for example, that
a bike manufacturer offers a three-year warranty on bicycle seats, which
cost $50 each. If the firm manufactures 1,000 bicycle seats in a year and
offers a warranty per seat, the firm needs to estimate the number of seats
that may be returned under warranty each year.

If, for example, the company forecasts that 200 seats must be replaced
under warranty for $50, the firm posts a debit (increase) to warranty
expense for $10,000 and a credit (increase) to accrued warranty liability for
$10,000. At the end of the year, the accounts are adjusted for the actual
warranty expense incurred.

What is a contingent liability?

A contingent liability is a liability that may occur depending on the outcome
of an uncertain future event. A contingent liability has to be recorded if the
contingency is likely and the amount of the liability can be reasonably
estimated. Both generally accepted accounting principles (GAAP) and
International Financial Reporting Standards (IFRS) require companies to
record contingent liabilities.12

What are the 3 types of contingent liabilities?

GAAP recognizes three categories of contingent liabilities: probable,
possible, and remote. Probable contingent liabilities can be reasonably
estimated (and must be reflected within financial statements). Possible
contingent liabilities are as likely to occur as not (and need only be
disclosed in the financial statement footnotes). Remote contingent
liabilities are extremely unlikely to occur (and do not need to be included in
financial statements at all).

What are examples of contingent liability?

Pending lawsuits and warranties are common contingent liabilities.
Pending lawsuits are considered contingent because the outcome is
unknown. A warranty is considered contingent because the number of
products that will be returned under a warranty is unknown.

Is contingent liability an actual liability?

Yes. Although contingent liabilities are necessarily estimates, they only
exist where it is probable that some amount of payment will be made. This
is why they need to be reported via accounting procedures, and why they
are regarded as “real” liabilities.

The Bottom Line

A contingent liability is a potential liability that may occur in the future, such
as pending lawsuits or honoring product warranties. If the liability is likely
to occur and the amount can be reasonably estimated, the liability should
be recorded in the accounting records of a firm.

Contingent liabilities are recorded to ensure that the financial statements

are accurate and meet GAAP or IFRS requirements. GAAP recognizes
three categories of contingent liabilities: probable, possible, and remote.
Pending lawsuits and warranties are common contingent liabilities.

INVESTIGATIVE AUDITING
Investigative Auditing consists of the prevention, detection and quantification of
fraud, money laundering, terror finance and corruption. Investigative Auditing
involves the examination of accounts and the use of accounting procedures to
discover financial irregularities and to follow the movement of funds and assets in
and out of organisations.
The objects of Investigative Auditing include, inter alia:

 Identification of suspects;
 Determination of damages;
 Quantification of damages;
 Prevention of damage;
 Identification of financial activity;
 Tracing of financial assets.

Barlev provides it customers around the world a broad range of Investigative

Auditing services, including:

Fraud Prevention

 Examination of the financial and operating procedures within an

organisation;
 Fraud Vulnerability Studies intended to expose vulnerability to fraud and
embezzlement;
 Integration of controls and enforcement.

Fraud Quantification

 Quantification of actual damages based upon Investigative Audit findings in

furtherance of legal and other procedures.

Computer (Cyber) Fraud

 Exposure and verification of suspicions and fraudulent systems;

 Submission of expert testimony based upon Investigative Audit findings;
 Identification of fraud perpetrated by digitized, cyber and computerized
tools.

Insurance Support

 Quantification of damages for purposes of claims;

 Definition of factual and accounting basis for estimating damages.

Advice and Assistance to Attorneys

 Liquidations, dissolutions, suspension of procedures, and cessation of

payment;
 Location of stolen assets and assistance in their recovery;
 Evaluation and proof of securities fraud;
 Business disputes;
 Matters involving non-profit organizations;
 Litigation support;
  Arbitration;
 Lifting of the corporate veil;
 Expert opinions and testimony with respect to the above.

Due Diligence Examinations Prior to Mergers and Acquisitions

 Examination of the credibility of financial statements and third-party

documents.

QUALIFICATIONS AND DISQUALIFICAtion of the auditor:

There are certain criteria set for a person to be appointed as an auditor of the
company. The same is discussed in this article. Read on to know more.

Qualifications for Appointment as the Auditor

A person in order to be appointed as the auditor should meet the following
qualifications-
A person shall be a Chartered Accountant.
A firm where majority of the partners practising in India are qualified for
appointment may be appointed by its firm name to be the auditor of the company.
In case of an LLP, only those partners who are Chartered Accountants shall be
authorized to act and sign on behalf of the firm.

Disqualifications of Auditor
The following persons are not eligible to be appointed as the auditor-
1. A body corporate except an LLP registered under Limited Liability Act,2008.
2. An employee or officer of the company.
3. A person who is a partner or who is in employment of an officer or employee of
the company.
4. A person who or his relative or partner is having interest or holding security in a
company. However, a relative can hold security or interest in a company not
exceeding the face value of Rs. 1,000 or Rs. 1,00,000 as prescribed by the rules. In
case the amount of security or interest held by a relative exceeds the threshold
limits, a corrective action shall be taken by the auditor to maintain the limits,
within 60 days from the date of such acquisition or interest.
5. A person who or his relative or partner has indebted to a company or its holding
or its subsidiary or an associate company or a subsidiary of such holding company
for an amount exceeding Rs. 5,00,000.
  6. A person who or his relative or partner has given guarantee to the indebtedness
of any third party to the company or its holding or its subsidiary or an associate
company or a subsidiary of such holding company for an amount exceeding Rs.
1,00,000.
7. A person or a firm who, whether directly or indirectly has any business
relationship with the company or its holding or its subsidiary or an associate
company or a subsidiary of such holding company. However, the commercial
transactions in the nature of professional services permitted to be rendered an
auditor or an audit firm under Chartered Accountants Act, 1949 and the rules and
regulations made thereunder and the commercial transactions which are made in
the ordinary course of business of the company at an arm’s length price shall not be
considered as business relationship.
8. A person whose Relative is a director or is in employment of the company as
director or Key Managerial Personnel of the company.
9. A person who is full-time employed elsewhere.
10. A person who is convicted of an offence involving fraud and a period of ten
years has not elapsed from the date of such conviction.
11. A person who directly or indirectly renders any service referred to in section
144 of the Companies Act, 2013 to the company or its holding company or its
subsidiary Compa
Differences Between Verification and Valuation
Verification and valuation are interlinked and interdependent. It is a combined
process by which the position of different assets appearing in the Balance Sheet
is examined. However, the following are the differences between the two terms.

What is the meaning of teeming

and lading in accounts?
Teeming and lading is a term that describes a practice whereby
organisations attempt to hide a cash loss in one customer’s account
by moving in money from another customer’s account. It is
sometimes referred to as lapping, short banking, or delayed
accounting. Essentially, teeming and lading is a strategy that delays
a payment deficit from showing up on a customer’s account by
moving money around. Hence, older payments appear to have been
covered before customers, or other organisation members might
notice any disparity.

Is teeming and lading illegal?

Teeming and lading is a type of accounting fraud – although it is not
classified as theft – and consequently, it is illegal. It may be picked
up by regulatory bodies or internal members of the organisation.
Furthermore, teeming and lading is likely to be identified in a
company audit. This can have serious consequences both for the
individuals involved and the organisation as a whole, which may
have vicarious liability for failing to safeguard customer accounts.

Why does teeming and lading

happen?
Most often, teeming and lading is a strategy used by employees who
have used a customer’s money for personal purposes to cover their
tracks. It may also be used by an employee that has used one
customer’s money for another customer’s benefit. In both examples,
teeming and lading helps keep the activity from being found out by
delaying a deficit from showing up in the books and manipulating
the company accounts.
How do you identify teeming and
lading in auditing?
The methods for identifying teeming and lading often depend on
whether individuals or organisations are already under suspicion.
Some methods are more exhaustive than others – both for the
auditor and those being audited – but can make it easier to catch
any illicit activity.
One straightforward way of identifying potential teeming and lading
activity is to contact debtors directly to verify the information in
your records and flag any potential fraud. Another way to check for
any accounting fraud is to implement bank slip testing, which
involves checking cheques and debt details at the end of the working
day to identify any potential red flags.

It’s worth noting that the most common form of teeming and lading
is in relation to money and accounts, but the practice can actually
take place with any asset or property.

How do you prevent teeming and

lading?
When an individual is practicing teeming and lading, it often
requires ongoing manipulation and movement. As such, rotating
staff is one common way of avoiding teeming and lading. Not only
does this make it harder for the process to take place, but it also
makes it more likely that someone else will notice the disparity in
the accounts.
Other potential strategies include issuing receipts, which can make it
easier to track and prove any payments, as well as sending out
regular statements so that customers may flag any apparent
discrepancies in their accounts.

What are some examples of

teeming and lading?
Teeming and lading is most often associated with
accountants/bookkeepers or bank cashiers because of their direct
involvement with customer accounts. However, there have been
examples of teeming and lading in other professions, such as
the 2015 case of a solicitor discovered by the Solicitors Regulation
Authority to be teeming and lading.
Difference between Internal Check
and Internal Control
Nature of difference Internal Check Internal Control
Internal check means the
division of work in such a Internal control is a plan of
manner that the works of organization providing all v
one individual is procedures methods taken by the
automatically checked by management to ensure the
1. Meanings another. working.
Intermediate check is only Internal control includes internal
one aspect of internal check, internal audit and other
2. Scope control system. form of control.
The objective of internal The whole system of control to
check is to prevent errors safeguard its assets and secure as
and frauds during the far as possible the accuracy and
3. Objectives course of work. reliability of its records.
Division of work is
designed in the manner Internal control is a plan of
that the work of one organization providing for
individual is automatically appropriate division of functional
4. Nature checked by another. responsibilities.
For internal check more For the conduct of internal
5. More staff staff is not required. control more staff is required.
Under internal checks no
employee is incharge of It is a clear plan establishing the
any work completely from line of authority responsibility
6. Sense of responsibility beginning to end. and proper division of work.
The important area of Its area of work deals with two
internal check is main controls i.e., administrative
7. Area of work verification. and accounting control.