ICAI Notes: Nature, Objective and Scope of Audit | Auditing and Ethics for CA Intermediate PDF Download

 Page 1


    
CHAPTER
1
 
LEARNING OUTCOMES 
 
  
NATURE, OBJECTIVE 
AND SCOPE OF AUDIT 
 
After studying this chapter, you would be able to understand- 
? Meaning, nature and scope of audit 
? Objectives of audit
? Inherent Limitations of audit 
? Benefits of audit 
? Meaning of assurance engagements 
? Difference between reasonable assurance engagement and 
limited assurance engagement      
? Meaning and basic purpose of engagement and quality control 
standards 
? Practicality of above concepts by studying through examples 
and case studies 
  
© The Institute of Chartered Accountants of India
Page 2


    
CHAPTER
1
 
LEARNING OUTCOMES 
 
  
NATURE, OBJECTIVE 
AND SCOPE OF AUDIT 
 
After studying this chapter, you would be able to understand- 
? Meaning, nature and scope of audit 
? Objectives of audit
? Inherent Limitations of audit 
? Benefits of audit 
? Meaning of assurance engagements 
? Difference between reasonable assurance engagement and 
limited assurance engagement      
? Meaning and basic purpose of engagement and quality control 
standards 
? Practicality of above concepts by studying through examples 
and case studies 
  
© The Institute of Chartered Accountants of India
 
 
AUDITING AND ETHICS  
 
 
1.2 
 
 
Sameer, a young CA aspirant, takes interest in events happening around him. 
Business and financial dealings of corporate world interest him very much. He 
regularly reads a newspaper publishing mainly business and economic news.  He 
also keeps track of particularly such news on social media handles. 
During last one year or so, he has seen audited financial results of many companies 
listed on stock exchanges being published in newspaper. He also visited web sites 
of some companies to go through their annual reports. The annual reports also, 
inter alia, contained audit reports signed by Chartered Accountants as auditors of 
companies.  
 
AUDIT
Meaning
Objective & 
Scope
Need & 
Benefits
Qualities of 
Auditor
Inherent 
Limitations
Audit with 
reference to 
Standards 
on Auditing
SA 200
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


    
CHAPTER
1
 
LEARNING OUTCOMES 
 
  
NATURE, OBJECTIVE 
AND SCOPE OF AUDIT 
 
After studying this chapter, you would be able to understand- 
? Meaning, nature and scope of audit 
? Objectives of audit
? Inherent Limitations of audit 
? Benefits of audit 
? Meaning of assurance engagements 
? Difference between reasonable assurance engagement and 
limited assurance engagement      
? Meaning and basic purpose of engagement and quality control 
standards 
? Practicality of above concepts by studying through examples 
and case studies 
  
© The Institute of Chartered Accountants of India
 
 
AUDITING AND ETHICS  
 
 
1.2 
 
 
Sameer, a young CA aspirant, takes interest in events happening around him. 
Business and financial dealings of corporate world interest him very much. He 
regularly reads a newspaper publishing mainly business and economic news.  He 
also keeps track of particularly such news on social media handles. 
During last one year or so, he has seen audited financial results of many companies 
listed on stock exchanges being published in newspaper. He also visited web sites 
of some companies to go through their annual reports. The annual reports also, 
inter alia, contained audit reports signed by Chartered Accountants as auditors of 
companies.  
 
AUDIT
Meaning
Objective & 
Scope
Need & 
Benefits
Qualities of 
Auditor
Inherent 
Limitations
Audit with 
reference to 
Standards 
on Auditing
SA 200
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 NATURE, OBJECTIVE AND SCOPE OF AUDIT  
 
 
1.3 
He was also eagerly tracking financial results of an IT company. The annual audited 
results of the company were declared on one Friday evening. However, shares of 
company took a beating on Monday as soon as markets opened. Curiosity led him 
to find reason for such an adverse market reaction. He got to know that audited 
profits of company were below market expectations and auditors had remarked 
adversely on some matters which was not taken kindly by markets. 
One of his uncles was expanding business and needed funds to meet business 
expansion requirements. Anticipating urgent financial needs, he approached a 
bank. Credit officer of bank requested for audited financial statements of past years 
of business to consider his loan application.
He was also thinking that companies must be paying taxes on profits shown in their 
audited financial statements.  A few months back, he was reading a news report 
pointing out substantial increase in direct tax collections of government as 
highlighted in Union Budget.   
Higher taxes paid by companies on basis of audited results may have been a 
significant contributing factor of such increase in direct tax collections, he thought 
in his mind. He was wondering upon enormous responsibility of auditors in this 
regard. He kept on pondering over significant role of auditors in economy and 
nation building.
1. INTRODUCTION 
What do such real-life situations highlight? Such instances underline importance of 
auditing in today’s complex business environment. Be it investors desirous of 
investing their money in companies, shareholders anxious to know financial 
position of companies they have invested in, banks or financial institutions willing 
to lend funds to credit-worthy organizations, governments desirous of collecting 
taxes from trade and industry in accordance with applicable laws, trade unions 
negotiating with corporate managements for better wages or insurance companies 
wanting to settle property claims caused by fire or other disasters- range of diverse 
users in equally diverse fields rely upon audited financial statements.  
Can you figure out reason behind such reliance? It is due to the fact that audited 
financial statements provide confidence to users of financial statements; audited 
financial statements provide assurance to users who may take their decisions on 
© The Institute of Chartered Accountants of India
Page 4


    
CHAPTER
1
 
LEARNING OUTCOMES 
 
  
NATURE, OBJECTIVE 
AND SCOPE OF AUDIT 
 
After studying this chapter, you would be able to understand- 
? Meaning, nature and scope of audit 
? Objectives of audit
? Inherent Limitations of audit 
? Benefits of audit 
? Meaning of assurance engagements 
? Difference between reasonable assurance engagement and 
limited assurance engagement      
? Meaning and basic purpose of engagement and quality control 
standards 
? Practicality of above concepts by studying through examples 
and case studies 
  
© The Institute of Chartered Accountants of India
 
 
AUDITING AND ETHICS  
 
 
1.2 
 
 
Sameer, a young CA aspirant, takes interest in events happening around him. 
Business and financial dealings of corporate world interest him very much. He 
regularly reads a newspaper publishing mainly business and economic news.  He 
also keeps track of particularly such news on social media handles. 
During last one year or so, he has seen audited financial results of many companies 
listed on stock exchanges being published in newspaper. He also visited web sites 
of some companies to go through their annual reports. The annual reports also, 
inter alia, contained audit reports signed by Chartered Accountants as auditors of 
companies.  
 
AUDIT
Meaning
Objective & 
Scope
Need & 
Benefits
Qualities of 
Auditor
Inherent 
Limitations
Audit with 
reference to 
Standards 
on Auditing
SA 200
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 NATURE, OBJECTIVE AND SCOPE OF AUDIT  
 
 
1.3 
He was also eagerly tracking financial results of an IT company. The annual audited 
results of the company were declared on one Friday evening. However, shares of 
company took a beating on Monday as soon as markets opened. Curiosity led him 
to find reason for such an adverse market reaction. He got to know that audited 
profits of company were below market expectations and auditors had remarked 
adversely on some matters which was not taken kindly by markets. 
One of his uncles was expanding business and needed funds to meet business 
expansion requirements. Anticipating urgent financial needs, he approached a 
bank. Credit officer of bank requested for audited financial statements of past years 
of business to consider his loan application.
He was also thinking that companies must be paying taxes on profits shown in their 
audited financial statements.  A few months back, he was reading a news report 
pointing out substantial increase in direct tax collections of government as 
highlighted in Union Budget.   
Higher taxes paid by companies on basis of audited results may have been a 
significant contributing factor of such increase in direct tax collections, he thought 
in his mind. He was wondering upon enormous responsibility of auditors in this 
regard. He kept on pondering over significant role of auditors in economy and 
nation building.
1. INTRODUCTION 
What do such real-life situations highlight? Such instances underline importance of 
auditing in today’s complex business environment. Be it investors desirous of 
investing their money in companies, shareholders anxious to know financial 
position of companies they have invested in, banks or financial institutions willing 
to lend funds to credit-worthy organizations, governments desirous of collecting 
taxes from trade and industry in accordance with applicable laws, trade unions 
negotiating with corporate managements for better wages or insurance companies 
wanting to settle property claims caused by fire or other disasters- range of diverse 
users in equally diverse fields rely upon audited financial statements.  
Can you figure out reason behind such reliance? It is due to the fact that audited 
financial statements provide confidence to users of financial statements; audited 
financial statements provide assurance to users who may take their decisions on 
© The Institute of Chartered Accountants of India
 
 
AUDITING AND ETHICS  
 
 
1.4 
the basis of such audited financial statements. Herein lies the importance of 
auditing. You can very well understand how significant is role of auditing profession 
and auditors in modern world involving multitude of economic activities being 
carried out in equally dynamic legal and regulatory environments.  
Here, comes a vital question. What do we mean by auditing? What is its nature and 
scope? What it includes and What it does not? What are its limitations? We shall 
try to find out answers to these questions in succeeding paras. 
2. ORIGIN OF AUDITING 
Before we get to understand meaning and nature of auditing, let’s travel back in 
time to know about origin of auditing. Auditing has existed even in ancient times 
in many societies of world including India. The reference to auditing is found in 
Kautilya’s Arthshastra even in 4
th
 century BC. It talks about fixed accounting year, a 
process for closure of accounts and audit for the same. Concepts of periodical 
checking and verification existed even in those times. Even there are references in 
his monumental work to misstatements in financial statements due to abuse of 
power. Wasn’t he far ahead of his times? 
The word “audit” originates from Latin word “audire” meaning “to hear”. In medieval 
times, auditors used to hear the accounts read out to them to check that employees 
were not careless and negligent. Industrial revolution in Europe led to astronomical 
expansion in volume of trade and consequently demand of auditors. 
Coming to more recent history, the first Auditor General of India was appointed in 
British India in 1860 having both accounting and auditing functions. Later on, office 
of Auditor General was given statutory recognition.  Presently, Comptroller and 
Auditor General of India is an independent constitutional authority responsible for 
auditing government receipts and expenditures. 
The Institute of Chartered Accountants of India was established as a statutory body 
under an Act of Parliament in 1949 for regulating the profession of Chartered 
Accountancy in the country. 
 
© The Institute of Chartered Accountants of India
Page 5


    
CHAPTER
1
 
LEARNING OUTCOMES 
 
  
NATURE, OBJECTIVE 
AND SCOPE OF AUDIT 
 
After studying this chapter, you would be able to understand- 
? Meaning, nature and scope of audit 
? Objectives of audit
? Inherent Limitations of audit 
? Benefits of audit 
? Meaning of assurance engagements 
? Difference between reasonable assurance engagement and 
limited assurance engagement      
? Meaning and basic purpose of engagement and quality control 
standards 
? Practicality of above concepts by studying through examples 
and case studies 
  
© The Institute of Chartered Accountants of India
 
 
AUDITING AND ETHICS  
 
 
1.2 
 
 
Sameer, a young CA aspirant, takes interest in events happening around him. 
Business and financial dealings of corporate world interest him very much. He 
regularly reads a newspaper publishing mainly business and economic news.  He 
also keeps track of particularly such news on social media handles. 
During last one year or so, he has seen audited financial results of many companies 
listed on stock exchanges being published in newspaper. He also visited web sites 
of some companies to go through their annual reports. The annual reports also, 
inter alia, contained audit reports signed by Chartered Accountants as auditors of 
companies.  
 
AUDIT
Meaning
Objective & 
Scope
Need & 
Benefits
Qualities of 
Auditor
Inherent 
Limitations
Audit with 
reference to 
Standards 
on Auditing
SA 200
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 NATURE, OBJECTIVE AND SCOPE OF AUDIT  
 
 
1.3 
He was also eagerly tracking financial results of an IT company. The annual audited 
results of the company were declared on one Friday evening. However, shares of 
company took a beating on Monday as soon as markets opened. Curiosity led him 
to find reason for such an adverse market reaction. He got to know that audited 
profits of company were below market expectations and auditors had remarked 
adversely on some matters which was not taken kindly by markets. 
One of his uncles was expanding business and needed funds to meet business 
expansion requirements. Anticipating urgent financial needs, he approached a 
bank. Credit officer of bank requested for audited financial statements of past years 
of business to consider his loan application.
He was also thinking that companies must be paying taxes on profits shown in their 
audited financial statements.  A few months back, he was reading a news report 
pointing out substantial increase in direct tax collections of government as 
highlighted in Union Budget.   
Higher taxes paid by companies on basis of audited results may have been a 
significant contributing factor of such increase in direct tax collections, he thought 
in his mind. He was wondering upon enormous responsibility of auditors in this 
regard. He kept on pondering over significant role of auditors in economy and 
nation building.
1. INTRODUCTION 
What do such real-life situations highlight? Such instances underline importance of 
auditing in today’s complex business environment. Be it investors desirous of 
investing their money in companies, shareholders anxious to know financial 
position of companies they have invested in, banks or financial institutions willing 
to lend funds to credit-worthy organizations, governments desirous of collecting 
taxes from trade and industry in accordance with applicable laws, trade unions 
negotiating with corporate managements for better wages or insurance companies 
wanting to settle property claims caused by fire or other disasters- range of diverse 
users in equally diverse fields rely upon audited financial statements.  
Can you figure out reason behind such reliance? It is due to the fact that audited 
financial statements provide confidence to users of financial statements; audited 
financial statements provide assurance to users who may take their decisions on 
© The Institute of Chartered Accountants of India
 
 
AUDITING AND ETHICS  
 
 
1.4 
the basis of such audited financial statements. Herein lies the importance of 
auditing. You can very well understand how significant is role of auditing profession 
and auditors in modern world involving multitude of economic activities being 
carried out in equally dynamic legal and regulatory environments.  
Here, comes a vital question. What do we mean by auditing? What is its nature and 
scope? What it includes and What it does not? What are its limitations? We shall 
try to find out answers to these questions in succeeding paras. 
2. ORIGIN OF AUDITING 
Before we get to understand meaning and nature of auditing, let’s travel back in 
time to know about origin of auditing. Auditing has existed even in ancient times 
in many societies of world including India. The reference to auditing is found in 
Kautilya’s Arthshastra even in 4
th
 century BC. It talks about fixed accounting year, a 
process for closure of accounts and audit for the same. Concepts of periodical 
checking and verification existed even in those times. Even there are references in 
his monumental work to misstatements in financial statements due to abuse of 
power. Wasn’t he far ahead of his times? 
The word “audit” originates from Latin word “audire” meaning “to hear”. In medieval 
times, auditors used to hear the accounts read out to them to check that employees 
were not careless and negligent. Industrial revolution in Europe led to astronomical 
expansion in volume of trade and consequently demand of auditors. 
Coming to more recent history, the first Auditor General of India was appointed in 
British India in 1860 having both accounting and auditing functions. Later on, office 
of Auditor General was given statutory recognition.  Presently, Comptroller and 
Auditor General of India is an independent constitutional authority responsible for 
auditing government receipts and expenditures. 
The Institute of Chartered Accountants of India was established as a statutory body 
under an Act of Parliament in 1949 for regulating the profession of Chartered 
Accountancy in the country. 
 
© The Institute of Chartered Accountants of India
 NATURE, OBJECTIVE AND SCOPE OF AUDIT  
 
 
1.5 
3. MEANING AND NATURE OF AUDITING  
“An audit is an independent examination of financial information of any entity, 
whether profit oriented or not, and irrespective of its size or legal form, when such an 
examination is conducted with a view to expressing an opinion thereon”. 
An incisive analysis of above meaning of auditing brings out following points clearly: - 
? Audit is an independent examination of financial information.  
 Independence, here, implies that the judgement of a person is not subordinate 
to the wishes or direction of another person who might have engaged him. 
The auditor should be independent of entity whose financial statements are 
subject to audit so that he can form an opinion without being affected by any 
influence. Independence increases auditor’s ability to act objectively without 
creeping in of any biases. 
 Consider, for example, a person who requests his brother, a Chartered 
Accountant, to audit accounts of his proprietary concern and issue a report. 
Can CA audit accounts of concern in which his brother is sole proprietor? No, 
he cannot. It is due to the fact that there would be no independence in such 
a case due to relationship by birth between CA and his brother. He would be 
subject to influence from his brother. 
 Take another case where a CA has invested in shares of a company. Can he 
audit accounts of such a company in which he holds shares? The answer is 
resounding NO. It is due to the fact that by holding shares of the company, 
his own self-interest gets involved. His own money is invested in the company 
and he may not be able to form judgment independently on the financial 
statements of the company. 
? The entity whose financial information is examined need not necessarily be 
profit oriented like in case of a business. It can be a non-profit organization 
like an NGO or a charitable trust. Audit can be undertaken in respect of any 
organization be it a small, medium or large. Further, it can be conducted for 
any entity irrespective of its legal structure i.e. such an entity may be a 
proprietary concern, a partnership firm, a LLP, a private company, a public 
company, a society or a trust. 
? The purpose of audit is to express an opinion on the financial statements. 
 
© The Institute of Chartered Accountants of India