UNIT- I
AN OVERVIEW OF AUDITING
Economic decisions in every society must be based upon the information available at the time the
decision is made. For example, the decision of a bank to make a loan to a business is based upon
previous financial relationships with that business, the financial condition of the company as reflected
by its financial statements and other factors. If decisions are to be consistent with the intention of the
decision makers, the information used in the decision process must be reliable. Unreliable information
can cause inefficient use of resources to the detriment of the society and to the decision makers
themselves. In the lending decision example, assume that the barfly makes the loan on the basis of
misleading financial statements and the borrower Company is ultimately unable to repay. As a result the
bank has lost both the principal and the interest. In addition, another company that could have used the
funds effectively was deprived of the money. As society become more complex, there is an increased
likelihood that unreliable information will be provided to decision makers. There are several reasons for
this: remoteness of information, voluminous data and the existence of complex exchange transactions 3
As a means of overcoming the problem of unreliable information, the decision-maker must develop a
method of assuring him that the information is sufficiently reliable for these decisions. In doing this he
must weigh the cost of obtaining more reliable information against the expected benefits. A common
way to obtain such reliable information is to have some type of verification (audit) performed by
independent persons. The audited information is then used in the decision making process on the
assumption that it is reasonably complete, accurate and unbiased.
EVOLUTION OF AUDITING
The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days an auditor
used to listen to the accounts read over by an accountant in order to check them Auditing is as old as
accounting. It was in use in all ancient countries such as Mesopotamia, Greece, Egypt. Rome, U.K. and
India. The Vedas contain reference to accounts and auditing. Arthasashthra by Kautilya detailed rules for
accounting and auditing of public finances. The original objective of auditing was to detect and prevent
errors and frauds Auditing evolved and grew rapidly after the industrial revolution in the 18th century
With the growth of the joint stock companies the ownership and management became separate. The
shareholders who were the owners needed a report from an independent expert on the accounts of the
company managed by the board of directors who were the employees. The objective of audit shifted
and audit was expected to ascertain whether the accounts were true and fair rather than detection of
errors and frauds. In India the companies Act 1913 made audit of company accounts compulsory. With
the increase in the size of the companies and the volume of transactions the main objective of audit
shifted to ascertaining whether the accounts were true and fair rather than true and correct. Hence the
emphasis was not on arithmetical accuracy but on a fair representation of the financial efforts The
companies Act.1913 also prescribed for the first time the qualification of auditors The International
Accounting Standards Committee and the Accounting Standard board of the Institute of Chartered
Accountants of India have developed standard accounting and auditing practices to guide the ........
