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Chapter 1

INTRODUCTION TO AUDITING.
The practice of auditing existed even in the Vedic period. Historical records show that Egyptians,
Greeks and Roman used to get this public account scrutinized by and independent official.
Kautaly in his book arthshastra has stated that all undertakings depend on finance, hence
foremost attention should be paid to the treasury.
Auditing as it exists today can be associated with the emerging a joint stock company during the
industrial revolution. The companys act of 1956 gives regulations regarding the audit work.

Meaning of Audit:
The word audit is derived from the Latin word AUDIRE which means to hear. Initially auditor
was a person appointed by the owners to check account whenever the suspected fraud, he was to
hear explanation given by the person responsible for financial transactions. Emergence of joint
stock companies changed the approach of auditing as ownership was pestered from management.
The emphasis now is clearly on the verification of accounting date with a view on the reliability
of accounting statement.
Definition:
Spicer and Peglar define auditing as An examination of the books, accounts and vouchers of a
businesss shall enable the auditor to satisfy himself whether or not the balance sheet is properly
drawn up so as to exhibit a true and correct view of the state of affairs of the business according
to his best of the information given to him and as shown by the book.
Mautz: defines auditing as being Concerned with the verification of accounting data with
determining the accuracy and reliability of accounting statements and reports.

Audit of ledger :
One of the most significant analytical procedures is reading, or scanning, the general ledger
account activity. Whether it's done manually or with the assistance of data extraction software,
this analytical procedure will produce significant amounts of substantive evidence.
Many auditors perform this procedure but fail to consider its effect on their audit strategy. After
unusual transactions are investigated and any errors are corrected by proposed journal entries, the
auditor has obtained significant, substantive evidence that relevant assertions for many account
balances are reasonable. Acceptable evidence obtained from this risk assessment procedure, along
with evidence from other risk assessment procedures, may enable the auditor to reduce the
assessed level of risk of material misstatement from a high level and thereby reduce the extent of
evidence desired from detailed tests of balances.
Special Purpose Frameworks
The Clarified Auditing Standards in the SAS, Terms of Engagement (AU-C 210), require an
auditor to assess the appropriateness and reasonableness of an entity's applicable reporting
framework. In other words, the auditor must determine that the framework results in a fair
presentation of the entity's financial statements. Once relevant personnel are satisfied with the
applicable reporting framework, an auditor's procedures will be designed to determine that the
principles of the framework have been properly applied through the entity's financial reporting
and internal control systemsthat is, that management's representations and financial statement
assertions are appropriate and reasonable.

For all reporting frameworks, particularly special purpose frameworks, an auditor must have a
thorough knowledge of the applicable accounting principles. For the AICPA's Financial
Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs), numerous
resources are available on the AICPA site. Interested accountants will be able to register for my
six one-hour, free webcasts on the FRF for SMEs to be presented by AccountingWeb.com later
this year.
The Procedure
Reading or scanning a general ledger is usually performed by looking for (1) unusual amounts or
postings; (2) transactions or general journal entries greater than the lower limit for individually
significant items; (3) checks or disbursements to be used in support tests; (4) other unusual
matters. The procedure may be performed by reading either a hard copy of the general ledger or
an electronic copy on a monitor, or by using data extraction software such as IDEA, ACL or
Monarch. Excel presentations of general ledger account activity also offer data manipulation
capabilities.
The Documentation
Documentation of the procedure should include the parameters of the test, the exceptions the test
revealed and the resolution of the exceptions in a spreadsheet, memo or other working paper.
Using a general ledger analysis worksheet can centralize the documentation of unusual matters
that comes from reading the general ledger and performing analytical procedures and other
auditing procedures. This worksheet can provide documentation of all unusual matters for control
by the in-charge accountant, and can serve as a central source for review by the engagement
leader. In addition, it can eliminate the time and work necessary to prepare numerous individual
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account analysis worksheets which otherwise must be indexed, cross-referenced, initialed and
dated by the preparer and reviewed, initialed and dated by a reviewer.
A general ledger analysis worksheet may contain these and other column headings:
1. The account number or location of the unusual item or potential misstatement.
2. A transaction identifier, either a date and document number or description of the
transaction identifying parties involved.
3. A description of the nature of the transaction or unusual item or matter.
4. The inquiry presented to management or accounting personnel.
5. The name of the person to whom the inquiry is presented.
6. The person's response to the inquiry.
7. The auditor's action, which may include performing additional substantive procedures,
determining that the unusual transaction or matter has been accounted for properly or
explaning why a proposed journal entry is necessary.
The substantive evidence from a general ledger analysis worksheet, when combined with
evidence from other risk assessment procedures, may provide sufficient evidence to assess risk of
material misstatement at some level less than high and enable an auditor to modify the nature,
extent and timing of detailed tests of balances, even on small audits. Other risk assessment
procedures will ordinarily include:

Completing client acceptance and continuance documentation.

Documenting internal controls.

Performing systems walk-through procedures and/or tests of controls.

Completing a planning document.

Chapter 2
General considerations
Steps:The audit of ledgers generally involves the following steps:
1. Internal Controls : Testing the strength and quality of internal controls;
2. Opening balances : Tracing the opening balances from the previous year records
3. Postings: checking the postings from subsidiary books and, if they are kept on the self
balancing system, also tallying the totals of balances in subsidiary ledgers with controls
accounts;
4. Closing balances: checking the closing balance of individual accounts in the schedules;
and then into the final accounts;
5. Totals : checking the totals of ledger accounts; trial balance , schedules and groupings;
6. Verification : verifying the balance in personal accounts, either with the statements of
account or confirmation of balances obtained from the parties; verifying the balances in
impersonal accounts, viz those of fixed assets, bank balances, etc with the schedules
containing details of assets and liabilities as well as those of nominal accounts
7. Scrutiny : Scrutinising the accounts generally and, in particular, examining the
composition of final balances; and ascertaining the extent of clearances of the balance
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brought forward from the previous year particularly those relating to receivables and
payables, sale or disposal of fixed assets and of inventories.
Scope:
1. Check balances and transactions : The audit of ledgers is an important step in the process
of verification of the correctness of final accounts. It is an occasion of review the
transactions entered during an accounting period, duly classified, in the totality. It also
involves analytical study of the relationship which exists between different sets of figures.
Ledgers, therefore, should be examined carefully and comprehensively. The composition
of the balance of each account should be scrutinized and if a doubt arises, the transaction
or the set of transactions, which have given rise to the doubt , should be examined in
depth.
2. Test check : When a comprehensive and effective system of internal control exists, it is
possible to limit the routine checking of ledgers by the application of test checks as stated
below: Verifying the posting into the ledgers from the various books of prime entry;
verifying the totals of the account; tracing the balances of the personal and nominal
accounts from the ledgers into the schedule of balances and; etc
3. Sample : The foregoing audit tests be applied to a selected group of entries in the ledgers.
In selecting the period of verification of posting and totals, preference should be given to
the accounts whose composition or correlation between debit and credit items is not clear.
A few accounts could be selected for test-check for the whole of the year.
Ledger keeper and frauds
1. Weak internal controls : If the system of internal control is found to be ineffective,
it would be necessary for the auditor to increase the scope of verification of
balances of the accounts in the ledgers. In doing so, the auditors should take into
account the existence of possibilities of frauds being committed through
manipulation of entries in the ledgers. Some frauds in a ledgers would not be
detected merely by extracting balances from the ledger and agreeing their totals
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with the balance in the respective Control Accounts, since the balances, despite the
fraud, would agree. It would be discovered either on postings being checked in
detail, or on obtaining detailed statements of account from customers and
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comparing them with those stated in the books of accounts.


Possibilities of fraud : For studying the various avenues which are open to a
ledger-keeper to commit a fraud, the auditor should find out whether the ledgerkeeper extracts balance of customers and creditors from the ledgers and agrees
their totals with their balances in the Total Accounts; also whether the balance
extracted, are subsequently checked by some official, further, whether he has
access to the debtors and creditors; also if he meets them, does he do so on his

own or in the presence of responsible official?


3. Types : Some of the frauds which may be committed by a ledger-keeper are stated
below:
i) In the Creditors Ledger
ii) In the Debtors Ledger
iii) In the General Ledger
Verification of Posting
1. Sample : The selection of accounts for checking postings should be made on the
same consideration as that of accounts whose balances are required to be
confirmed directly. Moreover, either all postings should be checked for only a part
of the period covered by the audit or only a few accounts selected for the whole
period.
2. Confirmation : Subsequently, when the closing balances in a ledger are checked, it
should be confirmed that postings in the ledger to the extent specified in the Audit
Programme have been checked; also that the totals of the balances have been
checked. Auditor should ascertain the reasons for any un-ticked item in any
account in a ledger, indicating that its posting has not been checked.
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3. Genuineness : Auditors should confirm that all the entries in a ledger account are
posted in a chronological order; no entry has been made in between two entries
and the figure of an entry have not been altered; and there is no entry which has
been posted directly into the ledger before being recorded in a book of original
entry. In each such case, the genuineness of the entry or entries should be verified,
for these could be the results of attempts made by the ledger-keeper with an
ulterior motive.
4. Balance : The opening balance should be checked, wherever practicable, with the
balances shown in the auditors own copy of trial balance, schedules and
groupings of the previous year. Alternatively, these should be checked with the
balances shown in the Balance Sheet, as at the end of the year. While checking the
closing balances or the groupings of balances, a memo should be prepared as
regards particulars of various balances which need to be disclosed in the adjusting
entries have to be passed.

Creditors ledger
The creditors ledger contains individual account of suppliers from whom goods or services have
been obtained on credit. Let us study (a) why scrutiny of creditors ledger is done; (b) what is
done before such scrutiny (c) how scrutiny of creditors ledger is done ; and finally (d) how such
scrutiny helps in other subsequent audit procedures.
Why scrutiny is done
The objective of scrutiny of creditors ledger is to obtain audit evidence so that the auditors is
satisfied that1. Existence : The balance shown in the creditors ledger are really due and payable, the liability
towards the creditors does exist.
2. Complete : The balances of all creditors are included in the creditors ledger, no amount is
omitted to be recorded.
3. Valuation : The balance amounts shown as due to the creditors are proper, neither more nor
less.
4. Disclosure : The balances of creditors shown in the creditors ledger are properly classified and
disclosed in the balance sheet.
What is done before scrutiny
Before making a scrutiny of creditors ledger, auditor should ensure that the following audit
procedures have been duly completed:

1. Study of Internal control : Auditor should have carried out the compliance procedure to study
and evaluate the accounting system and internal audit relating to creditors.
2. Vouching of purchases and payments : Then, based on the results of the above study, the
auditor should have carried out the substantive procedure of vouching of transactions affecting
creditors viz. Purchases, purchase return, cash payment and bank payments.
How scrutiny is done
Auditor can now begin the next procedure of scrutiny of creditors ledger which involves the
following steps 1. Checking opening balance
2. Checking posting from register, books and journals.
3. Checking casting and total of the ledger accounts.
4. Scanning of ledger accounts.
5. Checking summary and groupings.
6. Checking reporting requirements.
How scrutiny helps other audit procedures
Scrutiny of creditors ledger helps the auditor to carry out the subsequent audit steps as detailed
below:
1. Confirmation : Auditor should mark the bills pending at the year end against the payments
made in the next year. If all such bills are cleared in the next year, this confirms that such
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creditors balances at the end of the current year are genuine. In respect of other ledger balances,
confirmation letters should be sent to the creditors.

In respect of balances still remaining

unconfirmed, a certificate should be obtained from the management that such balances are
recoverable.
2. Checking summary & grouping : Auditor should check the final balance of the creditors ledger
into the trial balance and the grouping.
3. Checking reporting requirements
a. Book entries: Auditor has to enquire whether transaction of purchase etc. are not mere book
entries. Thus, if large purchases are made from a concern towards year end and these goods are
returned immediately in the beginning of the next year, these may be fictitious purchases to show
less profits. Further, if any transfer entry is passed between two party accounts, auditor should
ascertain that both the parties have agreed to and confirmed such transfer of balances. This
information can be obtained through an intelligent ledger scrutiny.
b. Purchases from group concerns : Auditor can ascertain from the ledger whether purchases are
made from a group concern during the year. If so, he has to report under CARO 2003 whether
the rates charged are reasonable compared to the market rate for similar items.

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Debtors ledger
The debtor's ledger contains individual accounts of customer to whom goods or services have
been given on credit. Let us study (a) why scrutiny of debtors ledger is done; (b) what is done
before such scrutiny (c) how scrutiny of debtors ledger is done; and finally (d) how such scrutiny
helps in other subsequent audit procedures.
Why scrutiny is done
The objective of the scrutiny of debtors ledger is to obtain audit evidence so that the auditor is
satisfied that 1. Existence : The balances shown in the debtor ledger are receivable and recoverable, I.e. the
right to recover balance from the debtors does exist.
2. Complete : The balances of all debtors are included in the debtors ledger.
3. Valuation : The balance amounts shown as due from the debtors are proper.
4. Disclosure : The balances of debtors shown in the debtors ledger are properly classified and
disclosed in the balance sheet.
What is done before scrutiny
Before making a scrutiny of debtors ledger, auditor should ensure that the following audit
procedures have been duly completed:
1. Study of internal control : Auditor should have carried out the compliance procedure to study
and evaluate the accounting system and internal audit relating to debtors.

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2. Vouching of sales and receipts : Then, based on the results of the above study, the auditor
should have carried out the substantive procedure of vouching of transactions affecting debtors
viz sales, sales return, cash receipts and bank receipts.
How scrutiny is done
Auditor can now begin the next procedure of scrutiny of debtors ledger which involves the
following steps.
1. Checking opening balance.
2. Checking posting from register, books and journals.
3. Checking casting and total of the ledger accounts.
4. Scrutiny of ledger accounts.
5. Bad and doubtful debts.
6. Checking summary & grouping.
7. Classification of debtors vide schedule VI.
Bad and doubtful debts.
While making a scrutiny of the debtors account, auditor should watch for the following
circumstances which indicates a bad or doubtful debts A. The payment are always late
B. Payment are in the nature of on- account payments.

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C. An old bill has been partly paid, while subsequent bill are being settled.
D. Customers who earlier paid cash are now accepting bills of exchange.
E. A suit has been against the customers for recovery of debt.
F. Several reminder have been sent to the customers without any response.
G. The debt is not recoverable due to law of limitation.
H. Debtors have become insolvent or gone into liquidation or are not traceable or gave died.
Auditor should ascertain whether the provision for bad & doubtful debts is adequate.
How scrutiny helps other audit procedures
Scrutiny of debtors ledger helps the auditor to carry out the subsequent audit steps as detailed
below :
1. Confirmation : Auditor should mark the bill pending at the year end against the payments
received in the next year. If all such bulls are cleared in the clearly in the next year, this confirms
that such debtors balance at the end of the current year are genuine. In respect of other ledger
balances,

confirmation letters should be sent to the debtors.

In respect of balances still

remaining unconfirmed, a certificate should be obtained from the management that such balances
are payable.
2. Checking summary & grouping : Auditor should check the balance of the debtors control into
the trial balance and the grouping.

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3. Classification of debtors vide schedule VI : Scrutiny of debtors will also enable the auditor to
obtain information to meet the reporting requirements. While grouping the debtors accounts, care
should be taken to classify them as required by the Revised schedule VI to the Companies Act.
4. Book entries: Auditor has to enquire whether transaction of sales etc. are not mere book
entries. Thus, if large scale are made to a concern towards year end and these goods are returned
by that concern immediately in the beginning of the next year, these may be fictitious sales to
show more profit. Further, if any transfer entry is passed between two party accounts, auditor
should carefully verify that both parties have agreed to and confirmed such transfer or the transfer
is for rectification of a genuine error of posting etc.
5. Sales to group concerns : Auditor can ascertain from ledger account whether sales are made to
a group concern during the year. If so, he has ti report under CARO 2003 whether the rates
charged are reasonable compared to the market rate for similar items.

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Chapter 3
Other income account
1. Sample checking : Other income account e.g. Scrap sales, rent received, dividends received
etc. being the incidental and not the main source of income are scrutinised on sample basis.
2. Cross- checking : Income amount is cross-checked with details available from other
memorandum registers such as scrap sales register, property register, investment register, etc.
3. Cut- off transaction : The cut-off transaction are checked in detail to ascertain whether (a)
income received in advance and (b) income accurate are adjusted. Dividend on shares relating to
pre-acquisition period should be adjusted in the cost of investment.
4. Transactions after balance sheet date : The transaction after the balance sheet date e.g. sale of
shares cum-dividend etc. are checked to find out if they affect the income account of the year
under audit.
5. Book entries : Auditor has to enquire whether transaction are not merely book entries.
6. Checking trial balance and grouping : Auditor should check the balance of the income account
into the trial balance and the grouping. He should ensure that any major item in the nature of
miscellaneous income is shown separately.

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Other expense account :


1. Sample checking : Other expenses accounts e.g. manufacturing expenses, sales and distribution
expenses etc. Should be scrutinised on sample basis.
2. Cross- checking : Expenses accounts should be cross-checked with details available from other
memorandum register such as excise register, sales tax returns , etc.
3.Cut-off transaction : The cut-off transaction are checked in detail to ascertain whether ( a ) all
outstanding expenses and (b) all pre-paid expenses are adjusted.
4. Transactions after balance sheet date : The transaction after the balance sheet date e.g payment
of expenses etc. Are checked to find out if they affect the expenses account of the year under
audit.
5. Book entries : Auditor has to enquire whether transaction are not mere book entries.
6. Checking trial balance and grouping : Auditor should check the balance of the expenses
accounts of the trial balance and the grouping. He should see that any major item in the nature of
miscellaneous expenses is shown separately.

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Sales account:
1. In-depth checking : Sales account being the main source of income is scrutinised in depth.
The monthly summary is checked from the sales register, debit/credit note register.
Posting from cash/bank/journal ate individual and not summary postings. These are
checked on sample basis.
2. Cross - checking : Sales account is cross-checked with figures of sales in the sales tax
returns, excise register, returns with government authorities like import and export
authorities etc.
3. Cut- off transaction : The cut - off transaction are checked in detail to ascertain whether
(a) all goods despatched have been billed and (b) bills are raised only against goods
despatched.
4. Transactions after balance sheet date : The transaction after the balance sheet date e.g
goods returned etc. are checked to find out if they affect the sales account of the year
under audit.
5. Analytical review: The sales account should be analytically reviewed; if the products and
prices are standard and constant during the year, sales should be equal to quantity sold x
standard price.
6. Book entries : Auditor has to enquire whether transaction of sales etc. are not mere book
entries. Thus, if large scale are made to a concern towards year end and these goods are
returned immediately in the beginning of the next year, these may be fictitious sales to
inflate profit.
7. Sales to group concerns : Auditor has to ascertain whether total sales to a group concern
during the year exceed Rs. 5,00,000. If so, he has to report under CARO 2003 whether the
rates charged are reasonable compared to the market rate for similar items.
8. Checking trial balance and grouping : Auditor should check the balance of the sales
account into the trial balance and the grouping. He should see that - (a) no account in the

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nature of miscellaneous income (b) the debit balance in the sales return account, if any, in
the ledger is deducted from the gross sales amount.
9. Revised schedule VI : Auditor should see that the sales are classified as required by the
Revised schedule VI of the companies Act.

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Purchase account:
1. In-depth checking : purchase account being the main item of expenditure is scrutinised in
depth. The monthly summary is checked from the purchase register and the debit/credit
note register. Posting from cash / bank / journal are individual and not summary postings.
These are checked on sample basis.
2. Cross - checking : Total purchase amount is cross - checked with figures of purchase in
the sales tax returns, excise register, returns with government authorities like import and
export authorities etc.
3. Cut-off transaction : The cut - off transaction are checked in detail to ascertain whether (a)
all goods received have been billed and (b) bills are booked only against goods received.
4. Transactions after balance sheet date : The transaction after the balance sheet date e.g
debit notes received, goods returned etc. are checked to find out if they affect the
purchase account of the year under audit.
5. Analytical review : The purchase account should be analytically reviewed. If the raw
materials and prices are standard and constant during the year purchases should be equal
to quantity x rates.
6. Book entries : Auditor has to enquire whether transaction of purchase etc. are not mere
book entries. Thus, if large purchases are made from a concern towards year end and
these goods are returned immediately in the beginning of the next year, these may be
fictitious purchases to suppress profit.
7. Purchase from group concerns : Auditor has to ascertain whether total purchases from a
group concern during the year exceed Rs. 50,000. If so, he has to report whether the rates
charged are reasonable compared to the market rate for similar items.
8. Checking trial balance and the grouping : Auditor should check the balance of the
purchase account into the trial balance and the grouping.

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9. Revised schedule VI : Auditor should see that the purchase are classified as required by
the Revised schedule VI of the companies Act. The value and quantities of major items of
raw materials are disclosed separately.

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Asset account
1. Structure : The general structure of fixed asset account is : opening balance, additional
adjustment of profit or loss on sale and on account of deprecation and closing balance.
Auditor should enquire into every entry which does not conform to this pattern.
2. Accounting : He should check that expenses repairs have not been capitalised or
conversely those on additional to or renewal of assets have not been shown as expenses.
3. Sanction : It should be verified that purchase of assets or addition to them have been the
sanction of directors or partners or shareholder.
4. Goodwill : where the entire undertaking of a business had been taken over, the value
placed by the management on different assets and particularly the amount debited to
goodwill account or that credited to capital reserve account, should be verified by
reference to the vendors agreement.

The debit to the goodwill account would be

necessary only when the amount paid for the business is in excess of the total value of
asset taken over reduced by the amount of liabilities taken over.
5. Current assets : The value of various current assets held at the close of the year and their
composition should be compared with those held at the end of the previous year and if
there is material change I their amounts or the basis of their valuation, the reasons thereof
should be ascertained. If they appear to be unduly large.
6. Loans : It should be also verified that interest at reasonable rate has been charged on loans
advanced to directors, manager an all; also that loans were advanced under appropriate
authority either that of directors or shareholder.
7. Suspense account : The balance in the suspense account, if any, should be analysed and
the constituent amount included under appropriate heads of the balance sheet.
8. Disclosure : Finally, it should be confirmed that assets have been properly grouped under
different heads for purpose of disclosure in the balance sheet and the method of valuation
of each asset is shown as required by the form in which the balance sheet is required to be
presented.
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Illustration:
Why and how will you, as an auditor, make a scrutiny of the following ledger account?
What conclusions will you draw from such scrutiny ?
M/S M & Co.s Ledger
Dr
Mayurs Capital Account
Date Particular
F
Amt Date Particular
F
2011
2011
Jan.03 To Mores Capital
1
8,000 Jan.02 By Bank
3
[For Goodwill]
Dec.31 By Salary
9
To, Kekas Capital
3
12,000
By Interest on Capital 9
[For Goodwill]
By P & L Appr A/c 9
Sep.25 To Bank
8
8,000
Dec.25 To Bank
9
7,000
Dec.30 To Purchase
9
2,000
Dec.31 To Interest on Drw 9
600
To Balance c/d
72,300
1,09,900

Cr
Amt
80,000
24,000
1,600
4,300

1,09,900
Solution :
1. Nature of Account : Mr. Mayur is a partner of M/s. M & Co., a partnership firm.
2. Object of Scrutiny : The scrutiny of this account is to be done to obtain audit
evidence that (a) The closing balance shown in the accounts is really due as
capital. (b) The balance is properly valued i.e. neither more nor less. (c) The
balance is properly classified and disclosed in the Balance Sheet.
3. Opening Balance : There is no opening balance of the account. This shows that the
partner has been admitted to the partnership only during the current year.
4. Check posting : Scrutiny of the posting in the account shows that - the posting are
on the correct side of the account, no entry is altered, etc.
5. Check casting : The totals of the account are correct.
6. Check entries : Each entry will be checked and analysed.
7. Special points : All these entries should be checked with the copy of rhe
agreement among the partners. Auditor should specially look into (a) why the rate
of interest on capital is so low. (b) why his share of profit is so low; and (c) why
with such terms he has paid an unreasonably high amount to the old partners by
way of goodwill.
8. Closing balance : The closing balance of the account is a credit balance.
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9. Check into schedule : The final balance of this account should be checked into the
schedule of capital.

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Chapter 4
Bibliography

www.accountingweb.com
www.aicpa.org/
www.law.cornell.edu

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