Types of Audit by Scope and by Compulsion
Chapter Fifteen
Syllabus topic 4, "Types of Audit – Meaning, Advantages, Disadvantages of Balance sheet Audit, Interim Audit, Continuous Audit, Concurrent Audit and Annual Audit, Statutory Audit and Social Audit."
Pages 39 to 41 of 98
Balance sheet audit
Meaning. An audit that begins with the items in the balance sheet and works back through the ledger into the original records, verifying the items on the face of the balance sheet and the revenue statement items that relate to them, rather than working forward from the vouchers.
Also called a backward audit, and it depends heavily on the strength of the internal control, because the transactions are not vouched exhaustively.
Suited to large companies with strong internal control and an internal audit department, and it is the ordinary approach where the volume of transactions makes vouching every one impossible.
| Advantages | Disadvantages |
|---|---|
| Quick, because the work concentrates on balances rather than on transactions | Depends entirely on internal control being sound; where it is not, the approach fails |
| Economical, so the fee is lower | Transactions that do not reach a balance may not be examined at all |
| Concentrates on what matters, since the balance sheet items are where the misstatement shows | A fraud that is self-cancelling within the year can pass unnoticed |
| Suits computerised systems, where the transaction trail is machine-produced and consistent | Requires experienced staff, since judgment replaces routine checking |
| Frees the auditor to use analytical procedures | Is not suitable for a small concern, which has no control system to rely on |
Statutory audit
Meaning. An audit required by a statute, conducted in the manner and by the person the statute lays down, and reporting to the persons the statute names.
For a company it is Chapter X of the Companies Act 2013, and its features are fixed by law and not by agreement.
| Feature | Fixed by |
|---|---|
| That there shall be an audit | Section 139 |
| Who may be appointed | Section 141 |
| The remuneration | Section 142 |
| The powers, the duties and the contents of the report | Section 143 |
| The services he may not render | Section 144 |
| The penalty for contravention | Section 147 |
Other statutory audits exist beside the company audit: the audit of a co-operative society under its State Act, of a trust under the Public Trusts Act, of a bank under the Banking Regulation Act, and the tax audit under section 44AB of the Income-tax law.
| Advantages | Disadvantages |
|---|---|
| Independence is protected by law, so the client cannot narrow the scope | The scope cannot be reduced even where the client wants less |
| The report goes to the members, not to management | It is a cost the company cannot avoid |
| Uniformity: every company is audited to the same requirements | The statutory form may not suit a particular business |
| The auditor has statutory rights of access, section 143(1) | Removal is difficult and slow, section 140, which cuts both ways |
| Reliance by outsiders is well founded |
Types of Audit by Scope and by Compulsion
The first row is the point. In a voluntary audit the client sets the scope; in a statutory audit the statute does, and an agreement to limit it is void.
Social audit
Meaning. An examination and report on the social and environmental performance of an organisation: what it has done for its employees, its consumers, the community and the environment, measured against what it undertook or what is expected of it.
It is not an audit of financial statements, and its subject matter is largely non-financial.
Where it appears in Indian law. Section 135 of the Companies Act 2013 requires prescribed companies to spend on corporate social responsibility and to report on it, and the Rules require an impact assessment for larger projects. The Mahatma Gandhi National Rural Employment Guarantee Act 2005 requires a social audit of works by the gram sabha, which is the best-known statutory social audit in India.
| Advantages | Disadvantages |
|---|---|
| Makes the organisation accountable for effects that never reach the accounts | No agreed measurement: how is a benefit to a community quantified? |
| Improves transparency and public confidence | No settled standards comparable to the accounting standards |
| Gives management information it does not otherwise collect | Subjective, and open to being used as publicity |
| Can prevent harm by identifying it early | Expensive, with a benefit that is hard to demonstrate |
| Involves the beneficiaries themselves, as the gram sabha audit does | Rarely compulsory, so it is done by those least likely to need it |
The three compared
| Balance sheet audit | Statutory audit | Social audit | |
|---|---|---|---|
| Subject | The balance sheet items and what produced them | The financial statements | Social and environmental performance |
| Compulsion | A method, not a requirement | Compulsory | Rarely compulsory |
| Governed by | The auditor's judgment | The statute | No settled standards |
| Reports to | Whoever engaged the audit | The members | The public, or the beneficiaries |
| Measurement | Money | Money | Largely non-financial |
Quick revision
| Balance sheet audit | Works backwards from the balance sheet; quick and economical; depends on internal control |
| Statutory audit | Required by statute, scope fixed by law, report to the members |
| The company's statute | Chapter X, sections 139 to 148 |
| Social audit | Social and environmental performance; MGNREGA gram sabha audit; section 135 CSR reporting |
| Social audit's weakness | No agreed measurement and no settled standards |
Test yourself
- Why is a balance sheet audit called a backward audit?
- What does a balance sheet audit depend on, and when does it fail?
- Name four things a statute fixes in a statutory audit.
- What is a social audit, and where is one required by Indian law?
- Give the chief weakness of a social audit.
Answer in one sentence
1. Because it begins with the items in the balance sheet and works back through the ledger into the original records, instead of working forward from the vouchers.
Types of Audit by Scope and by Compulsion
2. On the strength of the internal control system, and it fails in a small concern that has no such system to rely on.
3. That there shall be an audit, who may be appointed, the powers and duties of the auditor and the contents of his report, and the penalty for contravention.
4. An examination of and report on an organisation's social and environmental performance; the Mahatma Gandhi National Rural Employment Guarantee Act 2005 requires a social audit of works by the gram sabha.
5. That there is no agreed way to measure a social benefit and no settled standards comparable to the accounting standards, so the result is subjective.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.