An audit is often described as a check of the arithmetic. It is more than that. The auditor forms an opinion on whether the financial statements, taken as a whole, are free from material misstatement and are prepared in accordance with the applicable framework. The opinion is reached by gathering evidence in an order that can be explained, and the evidence is recorded in working papers.
1. Understanding the business and the risks
The work begins before any balance is tested. The auditor learns what the entity does, how it records transactions, who authorises them, and what could go wrong. Under the Standards on Auditing, this risk assessment decides where the effort goes. A business with large stock and thin controls over it will see more work on inventory. A business with a few large contracts will see more work on revenue recognition.
2. Planning and materiality
The auditor sets a level of materiality, the size of error that would change a reader’s decision, and a lower level for testing. Planning also covers the timetable, the records needed, and the use of other specialists, such as a valuer for property.
3. Testing the balances
Each balance in the statements is tested against what the standards call assertions. For an asset, the questions are whether it exists, whether the entity has rights to it, whether it is complete, and whether it is valued correctly. For a liability, the focus is on completeness: has everything owed been recorded?
- Fixed assets: additions vouched to invoices, depreciation recomputed, title documents inspected.
- Inventory: attendance at or review of the physical count, and valuation tested against cost and net realisable value.
- Debtors: confirmations from customers, subsequent receipts, and a review of old balances for recoverability.
- Creditors and provisions: search for unrecorded liabilities after the year end, and review of commitments.
- Cash and bank: bank confirmations and reconciliations agreed to the balance sheet date.
- Revenue and expenses: cut-off testing around the year end and analytical review of movements against the previous year.
- Statutory dues: tax, GST, provident fund, and other dues compared with returns and payments.
4. Evidence, in the order of reliability
Evidence from outside the entity, such as a bank confirmation, carries more weight than a document produced inside it. Evidence the auditor obtains directly, by inspection or recomputation, carries more weight than a representation. Written representations from management are obtained, but they do not replace testing.
5. Reporting matters beyond the opinion
For a company, the Companies Act, 2013 asks the auditor to report on other matters as well, including whether proper books have been kept, whether the accounting software has the audit-trail feature the rules require, and the effect of internal financial controls over financial reporting. The Companies (Auditor’s Report) Order, 2020 adds a set of matters for companies it covers.
6. The opinion
The report is addressed to the members or the persons responsible for the statements. It can be unmodified, or modified by a qualification, an adverse opinion, or a disclaimer, where misstatements are material or evidence could not be obtained. The report is not a guarantee against fraud, and it does not certify that the business is well run. It says what was examined and what conclusion the examination supports.
Records to keep ready
- Trial balance, ledgers, and draft statements agreed to each other
- Bank, loan, and debtor/creditor confirmations or statements
- Fixed asset register, stock sheets, and valuation workings
- Agreements, board minutes, and statutory registers
- Tax and statutory returns with payment challans for the year