ACG 201
AUDITING - I
SPECIAL GROUP : A - ACCOUNTING GROUP
M. Com (M 17) – Part I
Semester - II
YASHW
ANTRA
O CHA
VAN MAHARASHTRA OPEN UNIVERSITY
ASHWANTRA
ANTRAO
CHAV
Dnyangangotri, Near Gangapur Dam, Nashik 422 222, Maharashtra
Copyright © Yashwantrao Chavan Maharashtra
Open University, Nashik.
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YASHWANTRAO CHAVAN MAHARASHTRA OPEN UNIVERSITY
Vice-Chancellor : Dr. M. M. Salunkhe
Director (I/C), School of Commerce & Management : Dr. Prakash Deshmukh
State Level Advisory Committee
Dr. Pandit Palande
Hon. Vice Chancellor
Dr. B. R. Ambedkar University
Muaaffarpur, Bihar
Dr. Suhas Mahajan
Ex-Professor
Ness Wadia College of Commerce
Pune
Dr. V. V. Morajkar
Ex-Professor
B.Y.K. College, Nashik
Dr. Mahesh Kulkarni
Ex-Professor
B.Y.K. College, Nashik
Dr. J. F. Patil
Economist Kolhapur
Dr. Ashutosh Raravikar
Director, EDMU,
Ministry of Finance, New Delhi
Dr. A. G. Gosavi
Professor
Modern College,
Shivaji Nagar, Pune
Dr. Madhuri Sunil Deshpande
Professor
Swami Ramanand Teerth Marathwada
University, Nanded
Dr. Prakash Deshmukh
Director (I/C)
School of Commerce & Management
Y.C.M.O.U., Nashik
Dr. Parag Prakash Saraf
Director, Institute of Management
Science, Pimpri, Pune
Dr. S. V. Kuvalekar
Associate Professor and
Associate Dean (Training)(Finance )
National Institute of Bank Management,
Pune
Dr. Surendra Patole
Assistant Professor
School of Commerce & Management
Y.C.M.O.U., Nashik
Dr. Latika Ajitkumar Ajbani
Assistant Professor
School of Commerce & Management
Y.C.M.O.U., Nashik
Authors & Editors
Dr. Parag Prakash Saraf
Director, Institute of Management Science, Pimpri, Pune
Dr. Latika Ajitkumar Ajbani
Assistant Professor, School of Commerce & Management, Y.C.M.O.U., Nashik
Instructional Technology Editing & Programme Co-ordinator
Dr. Latika Ajitkumar Ajbani
Assistant Professor, School of Commerce & Management, Y.C.M.O.U., Nashik
Production
Shri. Anand Yadav
Manager, Print Production Centre
Y.C.M. Open University, Nashik - 422 222.
Copyright © Yashwantrao Chavan Maharashtra Open University, Nashik.
(First edition developed under DEC development grant)
q First Publication
:
September 2015
q Type Setting
:
Avinash R. Varpe (Sangamner, Mob.9960252514)
q Cover Print
:
q Printed by
:
q Publisher
:
Dr. Prakash Atkare, Registrar, Y.C.M.Open University, Nashik - 422 222.
INTRODUCTION
I am very please to placing the first and enlarge edition of this study material
on 'Auditing' to the students and practitioners of this subject. This book is design as
per the revise syllabus prescribed by the YCMOU Nashik from August 2015. It
gives equal importance to the theoretical aspects as well as to the practical case
studies. Hence this edition will be an ideal companion not only to the scholars but
also to the average students. I am sure that this present work a result of my sincere
and dedicated efforts would subserve the genuine interest of all the students concerned
in enriching their knowledge of this ever-growing Auditing discipline.
I have made a sincere attempt to make the subject easy to understand. For
this purpose the theory on each topic is written in a simple and lucid language to
enable the students to grasp the essence of subject. This book is also useful to the
students of CA, CWA and CS course.
It gives me great pleasure to introduce you to the world of Auditing and
Assurance. This book has got knowledge oriented and exam oriented approach. I
am tried to cover all Audit Assurance Standards (AAS) and provisions of amended
Company Act 2013. So let's start this lovely journey of learning in a positive way.
Any suggestions will be appreciated.
I am confident, that students will welcome new edition of this book.
With knowledge, hard work, marvelous success is just around the corner.
All The Best!
- Dr.Parag Prakash Saraf
Index
Unit No. Unit Name
Page No.
1
INTRODUCTION OF AUDIT
9
2
TYPES OF AUDIT
18
3
VOUCHER & VOUCHING
26
4
INTERNAL CHECK & ROLE OF INTERNAL
AUDITOR
36
5
DOCUMENTATION
45
6
FRAUDS - THEIR DETECTION & PREVENTION
52
7
VALUATION & VERIFICATION OF ASSETS
63
8
VALUATION & VERIFICATION OF LIABILITIES
73
9
COMPANY AUDIT IN BROAD LINE,
PROFIT AVAILABLE FOR DIVIDEND,
AUDITOR'S DUTIES REGARDING RESERVES
79
QUALIFICATION & APPOINTMENT OF
A COMPANY AUDITOR
89
RIGHTS, DUTIES AND RESPONSIBILITIES OF
A COMPANY AUDITOR
96
MISCELLANOUS MATTERS IN
COMPANY AUDIT
103
10
11
12
SYLLABUS - AUDIT -I
1) INTRODUCTION OF AUDIT
Definition, Objectives of an Audit, Scope of an Audit,
Restriction of scope, Advantages of an Audit, Limitations of an
audit, Audit Programme, Contents of Audit Programme,
Advantages of an Audit Programme, Disadvantages of an Audit
Programme, Audit Working Papers, Commencement of New Audit
2) TYPES OF AUDIT
Kinds of Audit, Statutory / Mandatory Audit, Voluntary /
Independent Audit, Interim Audit, Concurrent Audit, Continuous
Audit, Balance Sheet Audit, Financial Audit, Cost Audit,
Management Audit, Audit Techniques
3) VOUCHER & VOUCHING
Vouching, Purpose of vouching, Objectives of vouching,
Voucher, General Consideration in Audit of Ledger, Audit of
Different Ledgers, Bought Ledger, Sales Ledger, General Ledger,
Kinds of Frauds in relation to Ledgers
4) INTERNAL CHECK & ROLE OF INTERNAL
AUDITOR
Internal Control, Objectives of Internal Control, Essentials
of Good Internal Control System, Inherent Limitations of Internal
Control, Methods for the Proper Review & Evaluation of the
Adequacy of the Internal Control, Internal Check, Objects of
Internal Check, Internal Audit, Basic Principles of Establishing
Internal Auditing, Objectives of Internal Audit, Role of Internal
Auditor, Possible areas of co-operation & co-ordination
5) DOCUMENTATION
Documentation, Importance of Working Papers, Form &
Content of Working Papers, Lien on Working Papers, Classification
of Working Papers, Audit Note Book
6) FRAUDS - THEIR DETECTION & PREVENTION
Frauds, Errors, Reasons & Circumstances of Frauds &
Errors, Auditor's responsibility for non detection of frauds & errors,
Events which increases the risk of fraud or error, Inherent limitation
of an audit in relation to frauds & errors, Types of fraud, Internal
Audit, Internal Control, Elements of internal control, Investigation
for suspected frauds
7) VALUATION & VERIFICATION OF ASSETS
Verification of Assets, General Consideration for Valuation
& Verification of Assets, Valuation of Assets, Valuation of Fixed
Assets, Valuation of Current / Floating Assets, Inventories (Stock
in Trade), Long term Work in Progress, Trade Debtors, Investments,
Loans, Advances, Bank Balance, Cash balance on Hand
8) VALUATION & VERIFICATION OF LIABILITIES
General principles to be followed in verification of liabilities,
Verification of Liabilities, Valuation of Liabilities, Trade Creditors,
Bills Payables, Outstanding Liabilities for expenses, Provision for
Taxation, Contingent Liabilities, Debentures
9) COMPANY AUDIT IN BROAD LINE, PROFIT
AVAILABLE FOR DIVIDEND, AUDITOR'S DUTIES
REGARDING RESERVES
Company Audit, Share Capital Audit, Auditor's duties
regarding to audit of share capital, Shares underwritten placed for
commission, Shares issued at premium, Shares issued at a discount,
Audit of debentures, Preliminary Expenses, Statutory Meeting &
Statutory Report, Dividend, Interim dividend, Auditor's duty with
regard to payment of dividend, Transfer to reserve, Capita profits,
Revaluation reserve
10) QUALIFICATION & APPOINTMENT OF A
COMPANY AUDITOR
Qualification of Auditors, Disqualification of Auditors,
Appointment of Company Auditor, Removal of the auditor, Auditor's
Remuneration
11) RIGHTS, DUTIES AND RESPONSIBILITIES OFA
COMPANY AUDITOR
Rights & Powers of an Auditor, Duties & responsibilities
of the auditor, Scope of duties of an auditor
12) MISCELLANOUS MATTERS IN COMPANY
AUDIT
Statutory report, Audit of branch Accounts, Powers of
accompany auditor in relation to branch, Exemption to Branch
Audit, Special audit on direction of Central Government, Cost audit
UNIT - 1
INTRODUCTION OF AUDIT
NOTES
Structure
1.0
Introduction
1.1
Objectives
1.2
Definition
1.3
Objectives of an Audit
1.4
Scope of an Audit
1.4.1
Intoduction of Audit
Restriction of scope
1.5
Advantages of an Audit
1.6
Limitations of an audit
1.7
Audit Programme
1.7.1
Contents of Audit Programme
1.7.2
Advantages of an Audit Programme
1.7.3
Disadvantages of an Audit Programme
1.8
Audit Working Papers
1.9
Commencement of New Audit
1.10
Key concepts
1.11
Summary
1.12
Exercise & Questions
1.13
Further Reading and References
CHECK YOUR
PROGRESS
Define objectives of
Audit?
1.0 Introduction
The industrial revolution and the consequent explosion of technology have
resulted in an enormous increase in the size of all organizations, business
undertakings. So control on various aspects is required. This growth has had far
reaching effects on accounting and auditing. Auditing has now become an analytical
exercise which involves evaluating the effectiveness of internal control procedures
by examining selected samples of transactions and applying analytical procedure.
1.1 Objectives
After this unit you should be able :
1. To understand the concept of audit.
2. To find out scope and limitations of audit.
3. To know in detail the audit program.
4. To understand the importance of audit working papers.
1.2 Definition of an Audit
"An audit is 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."
AUDITING - I (9)
AUDITING - I
NOTES
According to general guidelines on internal Auditing issued by ICAI, auditing
is defined as a
"Systematic and independent examination of data, statements,
records, operations and performances (financial or otherwise) of an enterprise
for a stated purpose. In any auditing situation, the auditor receives and
recognizes the propositions before him for examination, collects evidence,
evaluates the same and on this basis, formulates his judgement which is
communicated through his Audit Report".
The above definitions of auditing have certain important elements. They
are:
CHECK YOUR
PROGRESS
1.
Independence - The auditor has to express an opinion on the financial
statements examined by him. Therefore, auditor should be free from any
interest which might detract his objectivity.
2.
Auditor's opinion - The auditor has to express an opinion on the financial
statements examined in the form of an audit report. The audit report is an
expression of opinion rather than a statement of verified facts.
3.
Financial statements -. The financial statements comprise of Balance Sheet,
Profit and Loss Account, notes and other statements, which collectively are
intended to give a proper understanding of the financial position. The auditor
has to express an opinion on the financial statements.
Define Concept of
Audit?
These three elements are contained in any kind of audit, whether profit oriented
or not and irrespective of its size or legal form.
1.3 Objectives of an Audit
(10) AUDITING - I
1.
Reporting: The primary objective of auditing is reporting - whether
the Financial Statements present a "true and fair view" of the financial position
(Balance Sheet) and the financial performance (Profit and Loss Account)
during the period.
2.
Expression of Opinion: The objective of an audit of Financial Statements,
prepared within a framework of recognized accounting policies and relevant
statutory requirements, is to enable an auditor to express an opinion on such
Financial Statements.
3.
True and Fair View: The Auditor's duty is to express an opinion on financial
statements.
(a) Auditor's opinion helps to determine the true and fair view of the operating
results & financial position of an enterprise.
(b) The user, however, should not assume that the Auditor's opinion is an
assurance as to the future viability of the enterprise of the efficiency or
effectiveness.
4.
Management Responsibility:
(a) The Management of an enterprise is primarily responsible for the preparation
of Financial Statements
(b) Management's responsibilities include maintenance of adequate accounting
records and internal controls, selection and application of accounting policies
and safeguarding the assets of the enterprise.
(c) Hence, the audit of the Financial Statements does not relieve Management
of its responsibilities.
1.4 Scope of an Audit
l
Scope:
Auditor will be determined the scope of an audit of financial statements with
regards to a) The terms of the engagements
b) The pronouncements of ICAI
c) The requirements of relevant legislation
l
Coverage of work:
The auditor should be organized to cover all operational aspects relevant to
the financial statements. He has to make study & evaluate the accounting
system & internal controls on which auditor wishes to rely.
l
Disclosure:
Auditor should ensure whether all relevant information is properly disclosed
in financial statements & as per statutory requirement. The disclosure
requirement can be verified by performing- Financial statement analysis &
- Evaluation of accounting policies.
l
Judgment:
Absolute certainty is not attainable in auditing because of the need to exercise
judgment. Auditor is also required to examine the reasonableness of judgment.
l
Materiality:
Material items are those, which might influence the decision of the users of
financial statements. Auditor should exercise his professional experience &
judgment with material items.
l
Technical aspects:
Auditor is not expected to perform duties, which fall outside the scope of his
competence. Auditor is not an expert in all fields. So, auditor can take the
advice of an expert for technical work.
Intoduction of Audit
NOTES
CHECK YOUR
PROGRESS
Give Scope of Audit?
1.4.1 Restriction of scope
a) The terms of engagement cannot restrict the scope of an audit in relation
to matters,which are prescribed by legislation or by the pronouncement of
the Institute.
b) Where the scope of work impairs the auditors ability to express an
unqualified opinion on such financial statements & he should state the
restriction.
1.5 Advantages of an Audit
The principle advantage of an audit is to get an informed, objectives &
forthright opinion on financial statements of the enterprises. This can be used in
making significant decisions by interested parties like shareholders, creditors, banks
AUDITING - I (11)
AUDITING - I
NOTES
CHECK YOUR
PROGRESS
Give advantages of
Audit?
etc. With the help of audit the shareholders of the company are assured that the
funds invested by them are safe & are used for the purpose for which they were
raised.
1)
A proprietary concern accounts may be audited to get funds from banks.
2)
In case of partnership firm accounts may be audited for the decision making
like valuation of goodwill of firms or settlement of accounts at the time of
admission, retirement or death of partner.
3)
There is a separation of ownership & management in case of company.
Shareholders have no direct control on the administration on the company. So
audited accounts may help to shareholders to get complete understanding
about company's affairs.
4)
Audit helps in locating the weaknesses, inadequacies in the financial statements.
5)
An audit also helps in detection of wastages & losses and suggests ways by
which they might be checked.
6)
Sometimes government may require audited & certified statements for giving
assistance or issue a license.
7)
An audit helps in setting liability of taxes, negotiating loans, determining purchase
consideration of business, setting trade disputes for higher wages & bonus.
8)
An audit also helps to control over inefficiency.
These are some advantages of an audit.
1.6 Limitations of an Audit
Though auditing has its advantages, it has certain limitations too.
1. An auditor has to depend on the books of accounts & other records presented
before him. If these accounts are prepared with malafide intentions, the auditor
may not fully detect them.
2. Auditor is not expected to be an expert in all the fields. He has to depend upon
the opinion of the expert.
3. Auditor has to depend upon the explanations & information given by the client.
But it is possible that such information & explanations may not be correct.
4. Audit evidence persuasive rather than conclusive in nature. Eg. Confirmation
of a debt by a customer is not conclusive that the debt is good & recoverable.
5. The auditor's independence is necessary to serve the purpose of audit. Though
under law shareholders appoint the auditor. In reality, directors appoint the
auditors.
6. Auditor has to make an assessment of internal control system & rely on them
if they are effective. However, there will always some risk of internal control;
it may be ineffective against fraud involving collusion among employees.
1.7 Audit Programme
(12) AUDITING - I
An audit programme is a predetermined plan of the auditing work to be
performed, specifying the procedure to be followed in verification of each item in
the financial statement, allocation of the audit staff and the time framed to be
followed in conducting audit. Audit programme is the written plan of audit work
which contains the audit objectives It also specifying what work to be done, when
to be done, & by whom to be done.
1) An Audit programme is detailed plan of work, prepared by the auditor
for carrying out an audit.
2) It constitutes the plan of the work which provides a basis for supervision
& control of work. It is a set techniques & procedures which auditor applies for
forming an opinion on financial statements.
Intoduction of Audit
NOTES
1.7.1 Contents of Audit Programme
Contents of an audit programme maybe divided as under:
1) A review of the system of internal check.
2) Audit of Balance Sheet accounts.
3) Audit of Profit and Loss account items.
4) Preparation of the audit report and co-ordination of all the
above-mentioned items.
CHECK YOUR
PROGRESS
1.7.2 Advantages of an Audit Programme:
1)
Instructions: The audit programme specifies the extent & manner of checking
& verification of different aspects of the accounting records.
2)
Checklist: It serves as a ready checklist of procedures and techniques to be
applied and minimizes the possibility of overlooking any of the important audit
steps.
3)
Phasing work: The work can be planned and phased properly.
4)
Selection of Team Members: The audit programme helps in selection of
assistants for jobs on the basis of their capability.
5)
Supervision: The work can be supervised and controlled better by periodic
reference to the programme.
6)
Work Review: The progress of the work at any point of time can be readily
known by reference to the entries on the audit programme.
7)
Future Planning: It serves as a guide for carrying out the current audit and
as a basis for drawing the future audit programmer-
8)
Responsibility: Responsibility for an audit examination is fixed on the team
member who has signed after completing a particular procedure under the
programme.
9)
Basis for opinion: It serves as evidence of the work performed and provides
a sound basis for the expression of the Auditor's opinion.
Give limitations of
Audit?
10) Record of Work: All work performed by auditor should be recorded. It is
the sufficient proof that the work was carried out with reasonable skill & care
that is of expected a professional.
1.7.3 Disadvantages of Audit Programme.
Following are the disadvantages of Audit Programme 1)
Mechanical work: The audit may be performed mechanically without
reference to the special circumstances of the client or to the development of
any new or unusual features in the client's business.
AUDITING - I (13)
AUDITING - I
2)
Rigidity: Additional procedures or techniques may be called for by the special
circumstances.
3)
False sense of security: Audit members may feel that everything is taken
care by the audit programme. They may fail to apply their mind in
circumstances that arise during the course of work.
4)
Lack of Initiative: Independent judgment and initiative of the staff may be
restricted. It may frustrate talented and efficient audit staff.
5)
Lack of Suitability: Procedures may be undertaken which may be
inappropriate to the circumstances of the client's business.
NOTES
How will you overcome from disadvantages of Audit Programme?
CHECK YOUR
PROGRESS
Define
Audit
program,
its
advantages and
limitations?
1.
Suitability: Audit programme should be suitable to the nature of entity, scale
of operations & volume of transactions & the efficacy of internal controls.
2.
Review of the internal controls: Internal controls should be reviewed and
evaluated to obtain knowledge of changes in the controls and systems and
procedures.
3.
Changed business operations: The Auditor should obtain information about
new systems to carry on the old business. The audit programme should be
recast or modified to suit the changed business operations and practices.
4.
Participative approach: The Auditor should encourage his audit assistants
to keep an open mind and make suggestions for amending the programmes.
5.
Flexibility: The audit programme should not become stereotyped. There
should be revision from time to time according to circumstances even though
no material change has taken place in the client's business operations and the
business practice. It means audit programme should be flexible according to
situation.
6.
Minimum Requirement: It should be impressed upon the audit assistants
that the programme provides for the minimum tests that should be carried out
and they should undertake tests and surprise checks, considered appropriate,
even though not provided in the programme
1.8 Audit working papers
The audit working paper constitutes the link between the auditor's report
and the client's records.SA 230 on "Documentation" refers to working papers
prepared or obtained by the auditor and retained by him in connection with the
performance of his audit. Working papers should record audit plans. The working
papers should provide fora. Means of controlling current audit work.
b. Supervision and review of the audit work.
c. Evidence of audit work performed to support the auditor's opinion.
Working papers should also prove the evidence of work performed in case
of charge of negligence brought against the auditors.
(14) AUDITING - I
1.9 Commencement of New Audit
Auditor should prepare himself before the commencement of a new audit;
following points should consider:
l
Initial Engagement: Initial engagement means appointment of an auditor for
first time by the client. First of all auditor should confirm his appointment
letter that fulfilling all its legal requirements.
l
Internal Control System: Auditor should evaluate the internal control system
of client's enterprise. The review of internal control system will helps the
auditor to know the weaknesses in system. Accordingly auditor develops the
audit plan.
l
Books of Accounts: The auditor should obtain the list of all the books of
account and should see that all books have been kept in accordance with
required policies & procedures. Auditor should see that required standards
were followed.
l
Documentation: The auditor should obtain the copy of the legal documents
and should study carefully before the commencement of audit. Eg.
Memorandum of association, Articles of association, Prospectus and Contract
with vendors etc.
l
Complexity of Audit: Auditor should know the nature of audit so that he may
prepare himself accordingly. The scope of work & responsibility should be
taken into account in determining the complexity of audit.
l
Internal Audit: Auditor should also study the internal audit system in the
business concern. He should make detailed inquiries, inspect books of
accounts and observe the actual procedure in operation.
l
Accounting System: Auditor must know the accounting system adopted by
client concern, before the commencement of new audit. He should thoroughly
investigate the whole system of book keeping and accounting.
l
Environment in which entity operates: Auditor should understand various
operational aspects of audit. Eg. Extent of computerization, general attitude
of personnel's, etc.
Intoduction of Audit
NOTES
CHECK YOUR
PROGRESS
Give brief about new
Audit concept?
l Audit Programme: Audit program is predetermined plan of audit. Keeping in
view the nature of audit, nature of business and extent of work, auditor
should work out an audit programme for the commencement of new audit.
l
List of important persons: Auditor should obtain the list of important persons
along with their powers & responsibilities.
l
Previous Experience with the client: Auditor should observe the last balance
sheet for the purpose of checking the opening entries for the period under
audit. The previous auditor report should also be inspected. Auditor should
pay particular attention to matters that required special consideration.
These are some points which are necessary to understand before the
commencement of audit. This will help the auditor to determine the nature,
timing & extent of audit.
AUDITING - I (15)
AUDITING - I
NOTES
1.10 Key Concepts
Audit - "An audit is 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."
Audit programme is the written plan of audit work which contains the
audit objectives It also specifying what work to be done, when to be done, & by
whom to be done.
Audit Working Paper constitutes the link between the auditor's report and the
client's records.
1.11 Summary
Systematic and independent examination of data, statements, records,
operations and performances (financial or otherwise) of an enterprise for a stated
purpose is known as audit.
Reporting, expression of auditor's opinion in a fair manner are some of the
objectives of an audit. It is beneficial for getting loan from bank valuation of goodwill.
Audit helps in locating the weaknesses, inadequacies in the financial statements. It
also helps in detection of wastages etc.
There are certain weaknesses of audit such as Auditor has to depend
upon the explanations & information given by the client which may not be correct.
An Audit programme is detailed plan of work, prepared by the auditor for
carrying out an audit. Auditor should prepare himself before the commencement
of a new audit.
1.12 Exercise & Questions
1.
Define the term Audit & state the advantages of audit?
2.
What is mean by Audit Programme? State the disadvantages of Audit
Programme & how will you overcome from disadvantages of Audit
Programme?
3.
State the importance of Audit working papers?
4.
Which points should considered while commencement of new audit?
l
Fill in the blanks:
1)
The primary objective of auditing is ________________.
(Expression of opinion, Reporting, Vouching, Verification)
2)
The Auditor's duty is ___________________on financial statements.
(Reporting, to express an opinion, Vouching,
3)
The principle advantage of an audit is to get an informed, _____________
& forthright opinion on financial statements of the enterprises.
(Scope, Objectives, Disadvantages, Audit procedure)
(16) AUDITING - I
4)
Audit evidence _________________ rather than conclusive in nature.
Intoduction of Audit
(True, Persuasive, Fair, Correct)
5)
____________________ is detailed plan of work, prepared by the auditor
for carrying out an audit.
NOTES
(Audit Programme, Audit Plan, Audit Technique, Audit Working papers)
6)
--------------- should also prove the evidence of work performed in case of
charge of negligence brought against the auditors.
(Audit Programme, Internal Control, Working Papers, Internal Audit)
7)
Auditor should also study the ________________ in the business concern.
(Environment, Internal audit system, Business policies, Internal control)
8)
The -------------- constitutes the link between the auditor's report and the
client's records.
(Audit Working Papers, Audit Programme, Audit Plan, Internal Audit)
9)
Audit programme should be ______________ according to situation.
(Fixed, Flexible, Semi Flexible, Classified)
10)
All work performed by ____________ should be recorded.
(Director, Auditor, Management, Secretary)
11)
There is a separation of ____________ & management in case of company.
(Directorship, Responsibilities, Ownership, Control)
12)
Auditor can take the advice of an _______________for technical work.
(Internal auditor, cost auditor, Management, Expert)
13)
________________items are those, which might influence the decision of
the users of financial statements.
(Material, Capital, Revenue, Technical)
14)
Auditor should be free from any _____________which might detract his
objectivity.
(Item, Interest, Challenge, None)
15)
Reporting is beneficial for getting loan from bank valuation of
________________.
(Goodwill, Fixed assets, Current assets, Share capital)
(Answers: 1) Reporting, 2) to express an opinion, 3) objectives, 4) Persuasive,
5) Audit programme, 6) Working papers, 7) Internal audit system, 8) Audit
working papers, 9) Flexible, 10) Auditor, 11) Ownership, 12) Expert, 13)
Material, 14) Interest, 15) Goodwill)
1.13 Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
AUDITING - I (17)
AUDITING - I
UNIT - 2
TYPES OF AUDIT
NOTES
Structure
2.0
Introduction
2.1
Objectives
2.2
Kinds of Audit
2.2.1
Statutory / Mandatory Audit
2.2.2
Voluntary / Independent Audit
2.2.3
Interim Audit
2.2.4
Concurrent Audit
2.2.5
Continuous Audit
2.2.6
Balance Sheet Audit
2.2.7
Financial Audit
2.2.8
Cost Audit
2.2.9
Management Audit
2.3
Audit Techniques
2.4
Key concepts
2.5
Summary
2.6
Exercise & Questions
2.7
Further Reading and References
2.0 Introduction
There are various types of audit. Auditor may choose any audit procedure
for conducting audit of financial statements. Audit procedure may vary from
enterprise to enterprise according to the nature of business, audit period, etc.
2.1 Objectives
After this unit you should be able:
1. To be familiar with various types of audit.
2. To understand new audit techniques.
l
AUDIT:
"An audit is 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."
(18) AUDITING - I
Types of Audit
2.2 Kinds of Audit
2.2.1 Statutory / Mandatory Audit:
The audit which is prescribed by law i.e. governing by statute or by
regulations is called statutory audit. Where scope is defined by law, it can't be
restricted by the appointing authority. Only a person possessing the prescribed
qualification shall conduct the audit. The matters to be covered in the auditor's
report are generally defined by law.
NOTES
Examples of Statutory Audit
Enterprise
Governing Statute
Companies
Companies Act, 1956
Co-operative
Societies
Multi-state Co-operative Societies Act and
also State enactments
Banking Companies
Banking Regulation Act, 1949
Insurance Companies
Insurance Act and Companies Act, 1956
Electricity Companies
Indian Electricity Act, 1910 and Companies Act, 1956
Corporations
Statute by which the Corporation is created
e.g. IDBI Act, LIC, etc.
CHECK YOUR
PROGRESS
Explain different types
of Audit?
2.2.2Voluntary / Independent Audit:
This audit is purely optional and at discretion of the governing body. The
scope of audit is defined by the letter of engagement between the auditor and the
client. The format of report is prescribed by the scope of work.
Examples: Individuals, Private trusts, Partnership firms etc. which are
not governed by any audit provisions of act.
2.2.3 Interim Audit:
An audit which is conducted between two annual audits is called an interim
audit. Such type of audit conducted at a specific date as per client's requirement.
Eg. 30th September, 31st December. Financial statements are prepared for interim
audit period. Assets and liabilities are verified for interim balance sheet purposes.
Advantages of Interim audit
l
Immediate detection of errors & frauds: Errors & Frauds, if any, easily
detected.
l
Upto date accounts: The accounting staff of the client is motivated to keep
the books of accounts upto date.
l
Early final audit: The final audit can be completed in a short span of time.
l
Interim dividend: It helps the company to publish interim financial statements
for declaration of interim dividend.
l
Act as deterrent: Frequent attendance by audit staff deters persons from
committing a fraud.
l
Staff planning: Staff can be sent regularly by proper planning. Work scheduling
can be done effectively.
AUDITING - I (19)
AUDITING - I
NOTES
CHECK YOUR
PROGRESS
l
Interim reporting: Interim financial statement can be prepared easily & in
timely manner.
l
Detailed coverage: All verifications are carried out in detailed than in final
audit.
Disadvantages of Interim audit
l
Failure to keep track: Since work is carried out in several installments, the
audit staff may fail to keep track of things. As a result some of the transactions
may escape.
l
Tampering: The staff of the client may alter entries in the books of accounts
after checking thereof.
l
Uneconomic: The audit is uneconomic for small size concern as a great deal
of time & efforts would be wasted.
l
Missing links: Continuity in work may be lost when work is executed
l
Time consuming: Since all transactions are verified. Continuous audit will be
time consuming.
l
No guarantee for fraud detection: Complete verification of all transactions in
detail, does not guarantee detection of all errors & frauds. Some material
misstatements may still exist.
Define interim Audit,
its advantages and
disadvantages?
2.2.4 Concurrent Audit:
It implies verification of transactions of a year on a continuous basis. The
period of verification is primarily determined by the auditor. Financial statements
are not prepared. Assets & liabilities are verified only at the time of finalization at
the year end.
2.2.5 Continuous Audit:
When the Auditor's staff is engaged continuously in checking the accounts
of the client during the whole year round or when the staff attends audit work at
some intervals, it is called a Continuous Audit.
Advantages of continuous audit
(20) AUDITING - I
l
Immediate errors and frauds detection: Management can exercise a stricter
control over the accounts in as much as it is able to check sooner the causes
of any errors or frauds uncovered by such an audit.
l
Acts as Deterrent: The frequent attendance of the audit staff deters persons
from committing fraud.
l
Upto date accounts: The accounting staff of the client is motivated to keep
the books of account upto date.
l
Early Final Audit: The final audit can be completed in short span of time..
l
Knowledge of clients' affairs: The Auditor can obtain a more detailed
knowledge of the client's affairs, which helps the auditor to discharge his
duties more efficiently.
l
Detailed Coverage: All aspects of verification are carried out in detail than in
final audit.
Disadvantages of continuous audit
l
Failure to keep track: Since work is carried out in several installments, the
audit staff may fail to keep track of things. As a result some of the transactions
may escape.
l
Tampering: The Client's staff may alter entries in the books of account, after
checking thereof.
l
Uneconomic: The audit is uneconomic for small sized concerns as a great
deal of time and effort would be wasted each time in preparing for the audit.
l
Interruption of work: The presence of audit staff at regular intervals may
affect the regular work-flow of the client.
l
Boredom: Routine checking on a continuous basis may become mechanical.
l
Time consuming: Since all transactions are verified, continuous audit will be
time-consuming.
l
No guarantee for fraud detection: Complete verification of all transactions in
detail, does not guarantee detection of all errors and frauds. Some material
misstatements may still exist
How will you overcome the disadvantages of Continuous Audit?
Types of Audit
NOTES
CHECK YOUR
PROGRESS
Explain continuous
Audit?
Following are some precautions l
Stage-wise completion: The work should be completed upto a definite stage
during the .course of each visit. This will eliminate the possibility of loose
ends.
l
Documentation: Important balances should be noted down at the end of each
visit and the same should be compared at the time of the next visit. Proper
documentation should be maintained.
l
Surprise visit: The visits should be conducted at irregular intervals. Client
staff would not know the exact dates of the proposed visit.
l
Special auditing marks: The client's staff should be instructed not to alter or
correct audited figures. The Auditor should also device a special form of
ticks and places the same, against altered figures. The purpose or the
significance of such special marks should not be disclosed to the client's
staff.
2.2.6 Balance sheet audit:
The Balance Sheet Audit means Auditor reviews the Balance Sheet and
works back to the books of original entry and other evidences. In balance sheet
audit it is assumed that there is a reliable system of internal check & internal audit.
Much of the vouching, casting and posting and other routine audit is eliminated
considering the soundness of internal control system. Where internal controls are
considered weak, the Auditor might prefer more elaborate testing procedures to
obtain audit assurance.
Auditor performs analytical review of the items in the Financial Statements and
investigates the followingsl Material deviations from budgeted amounts;
l
Items of unusual and non-recurring nature;
l Items requiring statutory disclosure.
AUDITING - I (21)
AUDITING - I
Need for Balance sheet audit: The need for Balance Sheet Audit by departing
away from routine "ticking" of vouchers and "post and vouch" audit arises due to l
NOTES
Development of Industries.
l Adoption of very formal control system by organization.
l Growth in size of business.
l
Increase in number of transactions of homogeneous nature.
2.2.7 Financial Audit:
Financial audit means examination of financial statements to express an
opinion thereon. This audit is mandatory for all enterprises. It covers all the items
which form part of the financial statements. This audit helps to determine the true
& fair view of financial statements. Here propriety aspect is not considered in
detailed.
2.2.8 Cost Audit:
Cost audit means review of decisions & actions of management to analyse
performance. This is applicable to those companies specified under law. Cost audit
primarily covers the cost aspects of the enterprise.
2.2.9 Management Audit:
Review of decisions & actions of management. Propriety & efficiency of
decisions & managerial actions are studied. It covers all aspects like organizational
objectives, policies, procedures, structure, control & system.
Differentiate between Interim Audit & Concurrent Audit
(22) AUDITING - I
Particulars
Interim audit
Concurrent Audit
Meaning
An audit which taken up
between two annual audits
is called Interim Audit.
It implies verification of
transactions on a
continuous basis,
at various point of time in a year.
Time period A specific date, as per client's
Requirement.
Eg. 30th September,
31st December, week etc.
The period of verification
is determined by the auditor.
Eg. For a month/ fortnight.
Trial balance Trial balance is drawn &
verified with a view to
prepare financial Statements.
Trial balance may be drawn
with a view to establish
arithmetical Accuracy.
Financial
Statements
Financial statements are
prepared for the interim
audit period.
Financial statements are not
prepared.
Assets
verification
Assets & liabilities are verified Assets & liabilities are verified
for Interim balance sheet
only At time of finalization
purpose.
at year end.
Differentiate between statutory audit & Voluntary audit
Particulars
Statutory Audit
Meaning
Audit is prescribed by law i.e. Audit is purely optional &
governing statute or regulations. conducted as per requirement.
Voluntary Audit
Advantages
Statutory compliance is the
chief audit advantage.
Advantages of independent
audit will gain.
Qualifications
Only a person possessing the
prescribed qualification shall
conduct the audit.
Qualifications for conducting
audit are not prescribed by law.
Scope
It is defined by law.
It is defined by the letter of
engagement.
Rights &
Duties
Rights & duties of the auditor
are prescribed by law & can't
be restricted by appointing
authority.
Rights & duties of the auditor
defined by client.
Format of audit report
generally defined by law.
Format of audit report are
defined by the scope of work.
Format of
report
Types of Audit
NOTES
CHECK YOUR
PROGRESS
Differentiate between
Interim Audit &
Concurrent Audit?
2.3 Audit Techniques
It refers to the methods and means adopted by the auditor for collection
and evaluation of audit evidence in different auditing situations.
Techniques refer to the methods employed for carrying out the audit
procedure. Audit techniques are generally interdependent. A combination of
techniques is applied in a particular procedure.
For example,
l Physical Inspection
l Confirmation
l Inquiry
l Calculations of ratios
Audit techniques may vary from the organization to organization depending
upon the nature of business, number of transactions, etc. However it is important
to remember that the principles of auditing remain constant.
2.4 Key Concepts
The audit which is prescribed by law i.e. governing by statute or by
regulations is called statutory audit.
An audit which is conducted between two annual audits is called an interim
audit.
When the Auditor's staff is engaged continuously in checking the accounts
of the client during the whole year round it is called a Continuous Audit.
The Balance Sheet Audit means Auditor reviews the Balance Sheet and
works back to the books of original entry and other evidences.
AUDITING - I (23)
AUDITING - I
Financial audit means examination of financial statements to express an
opinion thereon.
Management Audit - Review of decisions & actions of management.
NOTES
Audit Techniques refer to the methods adopted by auditor for carrying
out audit procedure.
2.5 Summary
Types of audit includes Statutory / Mandatory Audit, Voluntary / Independent
Audit, Interim Audit, Concurrent Audit, Continuous Audit, Balance sheet audit,
Financial Audit, Cost Audit, Management Audit.
2.6 Exercise & Questions
1.
How many types of Audit? Explain each one of them.
2.
What are the disadvantages of Continuous Audit? How will you overcome
the disadvantages of Continuous audit?
3.
Differentiate between statutory audit & Voluntary audit.
4.
What is mean by Audit technique?
l
Fill in the blanks:
1)
Cost audit primarily covers the ___________aspects of the enterprise.
(Financial, Cost, Human, Behavioral)
2)
When the Auditor's staff is engaged continuously in checking the accounts of
the client during the whole year round or when the staff attends audit work at
some intervals, it is called a _______________.
(Concurrent audit, Voluntary audit, Continuous audit, Balance sheet audit)
3)
__________________means examination of financial statements to express
an opinion thereon.
(Financial Audit, Cost Audit, Balance Sheet Audit, Concurrent Audit)
4)
Propriety & efficiency of decisions & managerial actions are studied in
_______________ Audit.
(Cost, Statutory, Management, Financial)
5)
Audit technique refers to the methods and means adopted by the auditor for
collection and evaluation of ____________________.
(Financial Information, Audit Evidence, Cost Data, Audit Procedure)
6)
The audit which is prescribed by law i.e. governing by statute or by regulations
is called _____________
(Concurrent Audit, Statutory Audit, Voluntary Audit, Financial Audit)
7)
An audit which is conducted between two annual audits is called an
_________________.
(Interim Audit, Balance Sheet Audit, Concurrent Audit, Continuous audit)
(24) AUDITING - I
8)
________________ implies verification of transactions of a year on a
continuous basis.
Types of Audit
(Concurrent Audit, Continuous audit, Statutory Audit, Cost Audit)
9)
The ___________________ means Auditor reviews the Balance Sheet
and works back to the books of original entry and other evidences.
NOTES
(Balance sheet audit, Continuous audit, Concurrent Audit, Cost Audit)
10) ____________________ helps the company to publish interim financial
statements for declaration of interim dividend.
(Interim audit, Balance sheet audit, Continuous audit, Cost Audit)
11) The scope of Voluntary audit is defined by ________________________.
(Law, Letter of engagement, Pronouncement by ICAI, Prospectus)
12) Auditor performs ______________________ of the items in the Financial
Statements.
(analytical review, compliance procedure, testing, sampling)
13) _______________ refer to the methods employed for carrying out the audit
procedure.
(Sampling, Testing, Techniques, Materiality)
14) ____________________ is purely optional and at discretion of the governing
body.
(Concurrent Audit, Statutory Audit, Voluntary Audit, Financial Audit)
15) In _____________________Assets & liabilities are verified only at time
of finalization at year end.
(Concurrent Audit, Continuous audit, Statutory Audit, Cost Audit)
(Answers: 1) Cost, 2) Continuous audit, 3) Financial audit, 4) Management,
5) Audit evidence, 6) Statutory audit, 7) Interim audit, 8) Concurrent audit, 9)
Balance sheet audit, 10) Interim audit, 11) Letter of engagement, 12) Analytical
review, 13) Techniques, 14) Voluntary audit, 15) Concurrent audit)
2.7 Further Reading and References
1. Audit Assurance Standards (AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
AUDITING - I (25)
AUDITING - I
UNIT - 3
VOUCHER & VOUCHING
NOTES
Structure
3.0
Introduction
3.1
Objectives
3.2
Vouching
3.3
Purpose of vouching
3.4
Objectives of vouching
3.5
Voucher
3.6
General Consideration in Audit of Ledger
3.7
Audit of Different Ledgers
3.7.1
Bought Ledger
3.7.2
Sales Ledger
3.7.3
General Ledger
3.8
Kinds of Frauds in relation to Ledgers
3.9
Key Concepts
3.10
Summary
3.11
Exercise & Questions
3.12
Further Reading and References
3.0 Introduction
Auditing may be viewed as a practical application of the theory of evidence
or the science of proof to financial data. It is not just an inspection of evidence in
support and substantiation of accounting data but it involves and includes a critical
examination of the different business transactions themselves for an accounting
period. An auditor would like to assure himself of the validity, accuracy, adequacy,
authority and accountability.
3.1 Objectives
After this unit you should be able:
1. To understand the concept of Vouching.
2. To find out purpose and objectives of Vouching.
3. To be familiar with concept and various types of Voucher.
4. To know in detail about the audit of different ledgers.
5. To understand the nature of frauds in relation to ledgers.
(26) AUDITING - I
3.2 Vouching
Vouching means inspection by an auditor of documentary evidence
supporting & substantiating transactions. Vouching is the process of
checking documentary evidence that the transactions are properly recorded
& accounted for.
Voucher & Vouching
NOTES
The main aim of vouching is to inspect all receipts & payments are properly
accounted for & no fraudulent transactions are recorded. Vouching is a substantive
audit procedure to obtain evidence as to completeness, accuracy & validity. With
the help of vouching auditor come to know the genuineness of the transactions.
The duty of auditor is to see substantial accuracy of vouchers & then
make report thereon. Vouching is also the basis for assets & liabilities. Auditor
should be careful while vouching the transactions & entries in the books of accounts.
It is the backbone of auditing process. Thus, vouching may be considered as the
essence of auditing.
3.3 Purpose of Vouching
The purpose of vouching is to determine thatl
Classification: Transactions have been classified & disclose in accordance
with accounting policies.
l
Accurate amount: Accurate amount has been recorded.
l
Pertains to entity: Transactions are pertains to entity that took place during
the relevant period.
l
Actual occurred: Transactions which have actually occurred have been
recorded.
l
Proper Accounts: Transactions is recorded in proper account to proper
period.
CHECK YOUR
PROGRESS
Define objectives of
vouching?
3.4 Objectives of Vouching
Following are the objectives of vouchingl
To see that transactions & entries are properly recorded in the books of
accounts.
l
To see that entries & transactions are properly authenticated by reasonable
person.
l
To see that transactions have been properly classified & disclosed in
accordance with the accounting policies.
l
To see that no fraudulent transactions are recorded in books of accounts.
l
To see that all entries & transactions are supported by proper evidence.
3.5 Voucher
A voucher is documentary evidence in support of any transaction in books
of accounts. Voucher can originate within the organization or outside the organization
AUDITING - I (27)
AUDITING - I
NOTES
i.e. they can be internal or external. Eg. Internal voucher: invoices for purchase &
sale, receipts, counterfoils, slip of bank, etc. External voucher: consignment stock,
mortgage deed, etc.
Vouchers are of two types:
l Primary voucher: All written evidences in original are primary vouchers.
l Secondary voucher: Copies of original vouchers are called collateral vouchers.
Material Defects in Voucher:
Following are the material defect that disqualify the vouchers1. Voucher not addressed to the client.
2. Voucher not duly authorized for payment.
3. Voucher concerning purchases & expenses not related to business.
4. Voucher not pertaining to period under audit.
5. Payment not acknowledge against voucher.
6. Voucher in respect of which goods or services have not been received.
7. Date of voucher significantly different from the date on which entry was
made.
8. Amount of voucher not agreed with corresponding entry.
9. Amount altered, erased in voucher without proper authorization.
Care to be taken while Vouching:
1. Voucher must be dated & serially numbered.
2. Information on the voucher should fully explain the transactions.
3. Date of voucher should match with corresponding entry.
4. Auditor should satisfy that transactions are authentic i.e. genion
5. Voucher should be passed by responsible officer.
6. Distinction should be made between capital & revenue expenditure.
7. Amount on voucher should be checked.
8. The period for payment should be noted.
9. Proper care should be taken to see that transaction is not recorded twice.
10. Alteration in voucher must be authorized by proper person.
11. Prepare a list of missing & incomplete vouchers should be prepared.
12. Auditor should stamp the voucher seen.
3.6 General Considerations in Audit of Ledgers
Following steps involves in the audit of ledger1. Testing the strength & quality of internal check.
2. Tracing the opening balances from the previous year records.
(28) AUDITING - I
3. Checking the posting from the subsidiary books.
4. Checking the closing balances of individual accounts.
Voucher & Vouching
5. Checking the totals of ledger accounts, trial balance, schedules.
6. Verifying the balances in personal accounts, either through statement of
accounts or external confirmation.
NOTES
7. Scrutinizing the accounts generally & examining the composition of final
balances.
8. Ascertaining the clearness of balances brought forward from the previous
year.
9. Tallying the totals of balances in subsidiary ledgers which are kept on self
balancing system.
10. Verifying the balances in impersonal accounts viz. those of fixed assets,
bank balances, etc. with details of assets & liabilities.
Different ledgers:
l
Bought ledger
l
Sales ledger
l Nominal ledger
3.7 Audit of Different Ledgers
3.7.1 Bought Ledger:
Following are the steps for the audit of bought ledgera)
Verification of opening balances: Opening balances of the bought ledger
would be verified from audited accounts & schedules. For that purpose auditor
has to know whether audit of that enterprise would actually conduct or not.
b)
Internal Control System: Auditor has to check the internal control system.
He should verify the system & check whether proper allocation of functional
responsibilities within the organization.
c)
Checking of posting: Next step of audit of bought ledger is the checking of
posting into ledger from cash book, purchase register, bills payable book,
journal, & other relevant books of accounts. While checking the posting auditor
should see that correct amounts are posted on the correct side of proper
account.
d)
Checking of totals: Auditor should check the totals & casting of each
account. Carry forwards & brought forward should be properly checked.
e)
Checking of summary balances: Auditor should obtain the summary of
balances of the bought ledger. He should see the correct amount is shown
against every party.
f)
General checking:
l Scanning Accounts: The client should be requested to write in the ledger
also the bill number for which credit is given. Similarly a reference bill while
making the payment should also be made when the party's account is debited.
This will enable both the accountant & the auditor to find out-
AUDITING - I (29)
AUDITING - I
i. Whether there is any dispute in respect of any invoice.
ii. Whether any posting is left out or wrongly done.
iii. Whether goods have been received against advance made.
NOTES
iv. The composition of the closing balances.
l Debit balances in the bought ledger: The auditor may come across
debit balances in some of the suppliers accounts in the bought ledger; this
requires a detailed scrutiny of such accounts. Sometimes, advance given
against the goods turn out to be more than the amount of bill. Here auditor
should find out whether the excess amount paid is received subsequently or
not. The auditor should verify in detailed & find out the reasons of such debit
balances & take all possible precautions.
l Confirmation of balances: The client may send the statement of account
to the party to confirm the same & then send it back. The client would be
requested to confirm the balance & write back. All replies should be
investigated independently of the person of in charge.
CHECK YOUR
PROGRESS
l Summary: Examination of the bought ledgers can be summarized as under-
Define procedure of
sales ledger Audit?
- Review of the internal control system.
- Check up the opening balances.
- Check up postings, castings, etc.
- Check up the summary of bought ledger & compare with control
accounts.
- Review of confirmation received.
- At the year end examine the cut off procedure, review the transactions
after the balance sheet date,
& secure the certificates.
3.7.2 Sales Ledger:
Sales ledger contains the accounts of customer. So, client's capital blocked
up in debtors & receivables. There must be proper control on all the receivables.
In the absence of such control, the receivables would not be collected in time & as
a result they may become doubtful of recovery & time barred. Following are the
stages for audit of sales ledgera)
Verification of Internal Control System: Auditor has to check the internal
control system. He should verify the system & check whether proper allocation
of functional responsibilities within the organization.
b)
Verification of Opening balances: The auditor will check up the opening
balances of sales ledger. The control accounts should be verified in the general
ledger.
c)
Checking of posting: The next stage of the audit of sales ledger is the
checking of posting into the ledger from cash book, Sales register, bills
receivable book, sales return register, & other relevant books of accounts.
While checking the posting, auditor should see that correct amounts are posted
on the correct side of the proper account.
l Credit balances in the sales ledger: If the party has sent money in
excess of the invoice value, then there may be a credit balances. If the credit
note is issued to the customer, the customer may send the amount after
deducting the amount of the credit note.
(30) AUDITING - I
l Confirmation of balances: Confirmation of balances received from
customer is one of the most important evidence in support of balances in
customer's ledgers.
d)
Checking of totals & casting: After the checking of posting, auditor should
verify the totals, carry forwards & brought over in each accounts.
e)
Checking of summary of balances: Auditor should obtain the summary of
the balances of sales ledger. The balance in each account would be traced
into the summary. Proper care should be taken to see that correct amount is
shown against the appropriate party.
f)
General checking:
Voucher & Vouching
NOTES
l Scanning of accounts: The client should be requested to mention in the
sales ledger the reference of the sales invoice while debiting the account of
the customer & also while receiving the amount or while adjusting the credit
note. This will enable the auditor to find outi. Whether there is any dispute in respect of any sales invoice.
ii. Whether any posting has been left out or any wrong posting has been
made.
iii. Whether goods have been dispatched against advances received.
The internal auditor or any other responsible officer should periodically see
that all the debtors periodically, at least once in year confirm the balances.
l Credit Policy of the Client: Auditor should collect the data regarding all
the customers, credit terms granted to these customers. He should also study
the credit policy granted by competitors.
l Classification of Debtors: While obtaining the summary of balances,
auditor also obtains the classification of all such debtors. Credit balances of
customer's ledger should be classified separately. Following points should
considered while verifying the classification of debtorsi. Debts considered secured.
ii. Debts considered unsecured but good.
iii. Debts considered unsecured but doubtful of recovery.
g)
Yearly Examination:
Yearly examination should includei. Cut - off procedure.
ii. Review of post Balance sheet transactions.
iii. Comparisons & ratios.
iv. Review of adequacy of the reserve of doubtful debts & reserve for discount.
v. Securing the confirmation of balances.
vi. Securing various classifications of the debtors.
AUDITING - I (31)
AUDITING - I
NOTES
3.7.3 General Ledger:
General ledger is also called as 'Nominal Ledger' or 'Impersonal Ledger'.
It contains all the balances which are ultimately included in profit & loss account &
balance sheet, it contains:
i. Nominal Accounts
ii. Real or Property Accounts
iii. Capital & Loan Accounts
iv. Control Accounts, etc.
l
Audit of General Ledger can be divided into following stages:
Following are the stages for the audit of general ledgerCHECK YOUR
PROGRESS
a)
Verification of Internal Control System: Auditor has to check the internal
control system. He should verify the system & check whether proper allocation
of functional responsibilities within the organization.
Define different kinds
of frauds in relation to
ledger?
b)
Checking of Opening balances: The opening balances of the general ledger
are checked from the audited accounts of the previous year.
c)
Checking of posting: Sales Register, Purchase Register, Return Register,
& other appropriate accounts. Entries are posted in general ledger from almost
all the books of accounts. Corresponding control accounts are also posted
from these books. While checking the posting, auditor should see that correct
amounts are posted in correct account & on correct side. He should also see
the item has remained un-posted.
d)
Checking of Totals & Casting: After the checking of posting auditor should
check up the totals & casting. He should check up whether figures are properly
& correctly carried over to the next page.
e)
Checking the balances in Trial Balance: The next stage of checking of
the balances of general ledger in trial balances. Because the books are
recorded on the principle of double entry system of book keeping. The total
of debit side must equal to the credit side of the trial balance.
f)
Scrutiny & Scanning of ledger accounts: The auditor must scrutinize all
the ledgers one by one & find out whether necessary adjustments are already
recorded. While scrutinizing the partner's capital accounts, auditor should
see whether the conditions laid down by the partnership deed are complied
with. Interest should be allowed on the capital at a rate decided by the
partnership deed.
3.8 Kinds of Frauds in Relation to Ledgers
Ledger keeper may commit some frauds by manipulating the entries in the
ledger. Some of the frauds which may be committed by ledger keeper are as
follows1.
In the Bought Ledger/ Purchase Ledger/ Creditors Ledger:
Frauds may occurs likea. Crediting the supplier's account on the basis of a fictitious invoice.
(32) AUDITING - I
Subsequently misappropriating the payment made against the credit in
the suppliers account.
Voucher & Vouching
b. Suppressing a credit note issued by a supplier & misappropriating an
amount equivalent there to out of the payment made to him.
c. Crediting an amount due to a supplier not in his account but under a
fictitious name & misappropriating the amount paid against the credit
balance.
2.
NOTES
In the Sales Ledger / Debtors Ledger:
a. Fraud through Teeming & Lading method.
b. Adjusting a unauthorized credit on fictitious rebate, discount in the account
with a view to reduce the balance.
c. Writing off the amount receivable from a customer's bad debt account &
misappropriating an amount equivalent to credit.
3.
In the Nominal Ledger:
a.
Allocating an item of income or expenditure wrongly.
b.
Understating or overstating the value of stocks, amount of prepaid expenses
or liabilities.
c.
Capital expenditure charged as revenue expenditure or vice- versa.
3.9 Key Concepts
Vouching is the process of checking documentary evidence that the
transactions are properly recorded & accounted for.
A voucher is documentary evidence in support of any transaction in
books of accounts.
Primary voucher: All written evidences in original are primary vouchers.
Secondary voucher: Copies of original vouchers are called collateral
vouchers.
General ledger is also called as 'Nominal Ledger' or 'Impersonal
Ledger'. It contains all the balances which are ultimately included in profit
& loss account & balance sheet
3.10 Summary
Vouching means inspection by an auditor of documentary evidence
supporting & substantiating transactions. The main aim of vouching is to inspect all
receipts & payments are properly accounted for & no fraudulent transactions are
recorded. A voucher is documentary evidence in support of any transaction in
books of accounts. There are two types Vouchers i.e. Primary voucher and
Secondary voucher. Voucher must be dated & serially numbered. Voucher should
be passed by responsible officer. Auditor should checked opening and closing
balances, totals, trial balance, subsidiary books etc. while doing the audit of ledgers.
Specific consideration should be given while auditing Bought ledger, Sales ledger,
Nominal ledger.
AUDITING - I (33)
AUDITING - I
3.11 Exercise & Questions
1. What is mean by Vouching? What are the objectives of vouching?
NOTES
2. Which care should be taken while vouching?
3. What is Voucher? State the material defects that disqualify the voucher?
4. How will you conduct the audit of bought ledger?
5. Which stapes will you follow while checking the sales ledger?
6. Explain some kinds of frauds which may occur in bought ledger & nominal
ledger?
l
Fill in the blanks:
1.
________________ is the process of checking documentary evidence that
the transactions are properly recorded & accounted for.
(Auditing, Vouching, Reporting, Verification)
2.
_______________ is documentary evidence in support of any transaction
in books of accounts.
(Audit Program, Financial Statements, Voucher, Ledger)
3.
Sales ledger contains the accounts of________________.
(Supplier, Customer, Lender, Banker)
4.
_________________ is also called as 'Nominal Ledger' or 'Impersonal
Ledger'
(General ledger, Sales ledger, Bought ledger, None)
5.
Ledger keeper may commit some ____________ by manipulating the entries
in the ledger.
(Error, Fraud, Plan, Program)
6.
With the help of ____________auditor come to know the genuineness of
the transactions.
(Vouching, Reporting, Verification, Auditing)
7.
The total of debit side must _______ to the credit side of the trial balance.
(more, lower, equal, more than or equal)
8.
There are two types Vouchers i.e. Primary voucher and _____________
voucher.
(Duplicate, Secondary, Multiple, Triplicate)
9.
Entries are posted in _____________from almost all the books of accounts.
(Journal, general ledger, trial balance, profit & loss a/c)
10. ____________ balances of customer's ledger should be classified separately.
(Credit, Debit, Both debit & credit, None)
11.
________________of balances received from customer is one of the most
important evidence in support of balances in customer's ledgers.
(Enquiry, Physical verification, Confirmation, Observation)
(34) AUDITING - I
12. ______________ may be considered as the essence of auditing.
Voucher & Vouching
(Sampling, Vouching, Reporting, Verification)
(Answers: 1)Vouching, 2) Voucher, 3) customer, 4) General ledger, 5) Fraud,
6) Vouching, 7) equal, 8) secondary, 9) general ledger, 10) credit, 11)
Confirmation, 12) Vouching)
NOTES
3.12 Further Reading and References
1. Audit Assurance Standards (AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
AUDITING - I (35)
AUDITING - I
UNIT 4
INTERNAL CHECK & ROLE OF
INTERNAL AUDITOR
NOTES
Structure
4.0
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
Introduction
Objectives
Internal Control
Objectives of Internal Control
Essentials of Good Internal Control System
Inherent Limitations of Internal Control
Methods for the Proper Review & Evaluation of the Adequacy
of the Internal Control
Internal Check
4.7.1 Objects of Internal Check
Internal Audit
4.8.1 Basic Principles of Establishing Internal Auditing
4.8.2 Objectives of Internal Audit
Role of Internal Auditor
Possible areas of co-operation & co-ordination
Key Concepts
Summary
Exercise & Questions
Further Reading and References
4.0 Introduction
In big organization internal audit is a part and parcel of internal control
system. In order to have detailed audit, internal audit is usually conducted in addition
to internal check system. An internal auditing consist of a continuous critical review
of financial and operating activities by a staff of auditors functioning as full time
salaried employees.
4.1 Objectives
After this unit you should be able:
1. To understand the concept of internal control.
2. To understand the essentials of Good Internal Control System.
3. To find out objectives and limitations of internal control.
4. To be familiar with the concept of Internal Check and Internal Audit.
5. To understand the role of Internal Auditor.
6. To learn the documentation requirement for Internal Audit.
(36) AUDITING - I
4.2 Internal Control
Internal Check & Role of
Internal Auditor
The system of internal control has been defined as"The plan of organization and all the methods & procedures adopted
by the management of an entity to assist in achieving management's
objective of ensuring, as far as practicable,
NOTES
i. Orderly & efficient conduct of the business
ii. Adherence to management policies
iii. Safeguarding of assets
iv. Prevention & detection of frauds & errors
v. Ensuring accuracy & completeness of the accounting records
vi. Timely preparation of reliable finance information"
Usually the control is entirely centralized with the owner & there is no
significant delegation of duties. However as the business grows in size, it soon
reaches a stage where the owner can no longer keep himself intimately informed
about the detailed operations of his business in such a case internal control becomes
very important. The reliability of business operations can be judged by the
effectiveness of internal control.
CHECK YOUR
PROGRESS
Define concept of
internal control
system?
4.3 Objectives of Internal Control
i. Transactions are executed in accordance with management authorization.
ii. All transactions are recorded with appropriate amount & in appropriate
account.
iii. To prevent & detect frauds & errors.
iv. To prevent the assets from unauthorized access, use.
4.4 Essentials of Good Internal Control System
i.
Proper allocation of functional responsibilities within the organization.
ii. The quality of personnel is very important. They should be competent &
honest.
iii. Implementation of proper operating & accounting procedures to ensure
the accuracy & reliability.
iv. The review of the work of one individual by another whereby the possibility
of fraud or error in the absence of collusion is minimized.
4.5 Inherent Limitations of Internal Control
Due to some inherent limitations of internal control, objectives of internal
control cannot be absolutely achieved. These limitations are as follows1. Many times control does not tend to be directed at transactions of unusual
nature.
AUDITING - I (37)
AUDITING - I
2. Management's consideration that a control be cost effective.
3. The potential for human errors.
NOTES
4. The possibility that the person having higher authority may override a
control.
5. The possibility of deception of control through collusion with outside parties
or with employees of the entity.
6. The procedure may not work due to changes in conditions.
7. Manipulation by the management in the preparation of financial
statements.
4.6 Methods for the Proper Review & Evaluation of
the Adequacy of the Internal Control
Auditor can use the following tools to collect information required for the
proper review & evaluation of internal control1. Narrative Record:
a) It is complete & exhaustive description of the system as found in operation
by the auditor.
b) Actual testing & observation are necessary before such a record can be
developed. It is suitable for small businesses.
c) But it is difficult to understand the actual system.
d) There is weakness or gap in the internal control system cannot be easily
identified.
2. Check List:
a) This is series of instruction & / or questions which a member of the
auditing staff must follow & / or answer.
b) Answers to the check list instructions are usually Yes, No or Not
Applicable.
c) The auditor should study the complete check list to ascertain existence of
internal control & evaluate its implementation & efficiency.
3. Internal Control Questionnaire (ICQ):
a) Internal Control Questionnaire is a set of questions designed to provide a
thorough view of the state of internal control in an organization.
b) It contents the questions relating to- Purchases & Creditors
- Sales & Debtors
- Stocks
- Cash & Bank Receipts & Payments
- Fixed Assets etc.
(38) AUDITING - I
c) The purpose of ICQ areIdentifying Weaknesses:
Weakness in the Internal Control System can be known by examining
answers to the questions in the ICQ.
Internal Check & Role of
Internal Auditor
NOTES
Extent of checking:
ICQ analysis enables the auditor to decide the extent & depth of checking
required in accounting areas & can pursue his work more objectively.
Proper Sampling:
ICQ analysis helps the auditor to select samples in a rational manner. He
can adopt a more detailed checking in weak control areas.
Audit Planning:
The audit programme can be modified if required. The programme can
be tailor-made to the needs of the specific situations.
4. Flowchart:
a) It is a graphical presentation of each part of the company's system internal
control.
CHECK YOUR
PROGRESS
Give in brief
objectives of internal
check?
b) It is most concise way of recording the auditor's review of the system.
c) It minimizes the amount of narrative explanation & thereby achieves a
consideration or presentation not possible in any other form.
d) It can be easily spotted & improvements can be suggested.
4.7 Internal Check
The internal check is the part of the whole system of internal control.
Internal check is "the allocation of the authority & work in such a
manner as to enable checks of the routine transactions of day to
day work by means of the work of one person being probed
independently by another, or the work of a person being
complementary to that of another."
4.7.1 Objects of Internal Check:
a) Proper division of work:
Division of work based on each individual's ability, training & specification
leads to overall efficiency & effectiveness.
b) Fixation of Responsibility:
The total work is divided into small units & responsibility for the same
fixed on individual workers. Due to clear determination of responsibility
each member of the staff knows what is expected of him & for any
fraud error originating of going undetected at his end, he alone will be
held responsible.
c) Minimization of errors & frauds :
Work performed by each individual checked by another individual in
AUDITING - I (39)
AUDITING - I
ordinary course. There is considerable reduction in the incidence of errors
& fraud.
d) Reliability of books of accounts:
If an enterprise is operating an effective system of internal check, its
books of accounts & other records are relied upon by interested parties.
Even the statutory auditor confines his examination to selective test
checking, thus avoiding the need to undertake a detailed examination of
each & every transaction.
NOTES
e ) Early detection of errors & frauds:
Work performed by each individual checked by another individual so, any
errors & fraud committed by an employee is likely to be discovered in
one by another.
f) Early preparation of final accounts:
Accounting data emanating under an effective system of internal check
can safely be used to prepare final accounts of the business in time.
CHECK YOUR
PROGRESS
Define Internal Audit
briefly?
4.8 Internal Audit
Many large organizations have system of internal audit within the
organization as an internal part of the internal control. They have a separate audit
department. The scope & function of this department vary considerably from
organization to organization.
Internal audit is the review of the various operations of the company & of
its records by staff specially appointed for the purpose. This review may be periodical
or may be even continuous.
The Institute of Internal auditors defines internal audit as under"Internal auditing is an independent appraisal activity within an
organization for the review of the accounting, financial & other operations
as a basis for protective & constructive services to the management. It is
a type of control which functions by measuring & evaluating the
effectiveness of the other type of control. It deals primarily with accounting
& financial matters but it may also properly deal with matters of an operating
nature."
Internal Audit is an integral part of internal control. It should be understood
that internal control is not merely internal check or internal audit; it is a system of
control as a whole.
4.8.1 Basic Principles of Establishing Internal Auditing:
i.
Internal audit should have an independent status in the organization.
ii. Internal audit should be free from executive functions. Internal audit may
help in formulating executive decisions but it does not take part in
formulating the decisions.
iii. It must have unambiguous & clear understanding of the objectives.
iv. It can investigate any phase of the activities of the organization at any
time.
(40) AUDITING - I
v. The staff of internal audit department should be adequately qualified so
that is working is success.
4.8.2 Objectives of Internal Audit:
Internal Check & Role of
Internal Auditor
NOTES
a) Evaluation of accounting & administrative systems & controls:
Internal audit is concerned with ensuring effective & efficient system of
accounting control, standard cost control & other administrative controls.
b) Safeguarding of business assets:
It ascertains the accuracy, the integrity & the reliability of the financial &
other records. It assures the top management that the accounts & the
financial statements show a true view.
c) Compliance with established policies & procedures:
It is concerned with reporting to the management as to compliance with
predetermined policies, procedures & standards of performance.
d) Reliability of management data:
It assures the top management that the accounts & financial statements
show true & fair financial position.
e ) Prevention & detection of fraud:
It facilitates the prevention & detection of fraud & errors.
f) Making special investigations:
It takes up special investigation at the special request of the management.
g) Review of Internal Control System:
It reviews the operation of the overall internal control system & non
compliance to the notice of the appropriate level of management.
h) Suggesting improvements:
If the internal auditor finds any inadequacy & weakness in the working
of internal control in any area, he makes appropriate recommendations to
the management for the improvement of the system.
4.9 Role of Internal Auditor
1) Internal Auditor appointed by the management generally directors.
2) The scope of work is determined by management.
3) Internal auditor is responsible to the management.
4) The scope of work of an internal auditor may extend even beyond the
financial accounting & may include cost investigation, inquiries relating
to losses & wastages, production audit, performance audit etc.
5) He has to submit the audit report to the management.
6) Format of report is not prescribed.
AUDITING - I (41)
AUDITING - I
4.10 Possible areas of Co-operation & Co-Ordination
1.
Reliance on the work of Internal Auditor:
There should be co-ordination between statutory & internal auditor. The
internal auditor's report can provide valuable information on the working,
state of internal controls & specific areas of irregularities in the
organization. These reports help the statutory auditor to decide, whether
& to what extent, consistent with his statutory responsibilities he can rely
on the work of the internal auditor in order to reduce his own examination
of details. Statutory Auditor can rely on the work done by Internal Auditor
according to SA 610.
NOTES
His decision in this matter will depend upon his judgment on the facts of
each case, having regard in particulars to the followingi.
CHECK YOUR
PROGRESS
The extent & efficiency of the internal auditor. Statutory auditor should
examine the internal audit programmes, working papers & reports &
should make test as he think fit.
ii. The experience & qualification of the internal auditor.
Give the role of
Internal Auditor?
iii. Action taken by management on the basis of their report.
iv. Authority vested in the internal auditor & level of management to which
he is directly responsible.
In any event, the Statutory Auditor remains responsible for the
work done & report made by him irrespective of whether he has
put any reliance on the internal audit.
However, reliance on internal audit report does not relieve the
Statutory Auditor from any failure in the discharge of his
professional duty.
2.
Usefulness of Internal Audit to the Statutory Auditor:
i.
Generally the internal audit work carried out in organization is useful to
the statutory auditor because there are substantial similarities.
ii. He can concentrate on weak areas observed by internal audit or he may
curtail detailed checking when there was satisfactory coverage by internal
auditor.
iii. The degree of reliance on internal audit depends upon individual judgment
of the statutory auditor.
3.
CARO Requirement:
Under CARO reporting requirement, the statutory auditor under the
Companies Act 1956, is required to report in case of
l Listed Companies or
l Companies having a paid up capital & reserves exceeding Rs. 50 lakhs
or
l Companies having an average turnover exceeding Rs. 5 crores for the
three financial years immediately preceding the financial years concerned.
(42) AUDITING - I
Whether the Internal audit is commensurate with the size & nature of its
business.
4.
Reporting Responsibility:
The report of the External Auditor is his sole responsibility, & that
responsibility cannot by any means be reduced because of the reliance he places
on the Internal Auditor's work. The Internal Audit function cannot have the same
degree of independence as is essential when the external auditor expresses his
opinion on financial information.
Internal Check & Role of
Internal Auditor
NOTES
Thus, the relationship between internal & statutory auditor is a professional
relationship where in both can benefit from each other.
4.11 Key Concepts
Internal control is a system which judges the reliability of business
operations.
Internal check is "the allocation of the authority & work in such a manner
as to enable checks of the routine transactions of day to day work by means of the
work of one person being probed independently by another, or the work of a person
being complementary to that of another."
"Internal auditing is an independent appraisal activity within an
organization for the review of the accounting, financial & other operations as a
basis for protective & constructive services to the management. It is a type of
control which functions by measuring & evaluating the effectiveness of the other
type of control. It deals primarily with accounting & financial matters but it may
also properly deal with matters of an operating nature."
4.12 Summary
The reliability of business operations can be judged by the effectiveness of
internal control. Internal control is required to prevent & detect frauds, errors and
to prevent the assets from unauthorized access, use. Implementation of proper
operating & accounting procedures are essential to ensure the accuracy & reliability
of Internal Control System. Narrative Record, Check List, Internal Control
Questionnaire (ICQ), Flowchart are the methods for the proper review & evaluation
of the adequacy of the Internal Control. The internal check is the part of the whole
system of internal control. Internal audit is the review of the various operations of
the company & of its records by staff specially appointed for the purpose. There
should be co-ordination between statutory & internal auditor. In any event, the
Statutory Auditor remains responsible for the work done & report made by him
irrespective of whether he has put any reliance on the internal audit. However,
reliance on internal audit report does not relieve the Statutory Auditor from any
failure in the discharge of his professional duty.
4.13 Exercise & Questions
1. Define the term Internal Control. What are the objectives of Internal
Control?
2. How many methods for evaluation of the adequacy of Internal Control?
Explain in brief.
3. What are the objectives of Internal Check?
4. Define Internal Audit. State the objectives of Internal Audit?
AUDITING - I (43)
AUDITING - I
NOTES
l
1)
2)
3)
4)
5)
6)
7)
8)
9)
10)
11)
12)
13)
Fill in the blanks:
The reliability of business operations can be judged by the effectiveness of
____________.
(Internal Check, Internal Audit, Internal Control, Internal Policy)
_________________ is not merely internal check or internal audit; it is a
system of control as a whole.
(Internal Control, Internal Check, Internal Audit, Business policy)
The --------------- can be tailor-made to the needs of the specific situations.
(Checklist, Flowchart, Audit Programme, Internal Control)
________________ is a graphical presentation of each part of the
company's system internal control.
(Checklist, Flowchart, Internal Control Questionnaire, Narrative Record)
--------------- is the review of the various operations of the company & of its
records by staff specially appointed for the purpose.
(Internal audit, Internal control, Internal check, Checklist)
In any event, the ---------------- remains responsible for the work done &
report made by him irrespective of whether he has put any reliance on the
internal audit.
(Internal Auditor, Management, Statutory Auditor, Cost Auditor)
___________________ is an integral part of internal control.
(Internal Check, Internal Audit, Internal Control, Internal Policy)
______________________ is a set of questions designed to provide a
thorough view of the state of internal control in an organization.
(Checklist, Flowchart, Internal Control Questionnaire, Narrative Record)
CARO applies to the companies having a paid up capital & reserves exceeding
Rs. _____________.
(25 lakhs, 5 crore, 50 lakhs, 70 lakhs)
There should be co-ordination between statutory &
_____________________.
(internal auditor, cost auditor, inspector, expert)
__________________ analysis helps the auditor to select samples in a
rational manner.
(Checklist, Flowchart, Internal Control Questionnaire, Narrative Record)
________________ is complete & exhaustive description of the system as
found in operation by the auditor.
(Narrative Record, Checklist, Flowchart, Internal Control Questionnaire)
Usually the control is entirely centralized with the _____________.
(Auditor, Owner, Manager, Secretary)
(Answers: 1) Internal control, 2) Internal control, 3) Audit programme, 4)
flowchart, 5) Internal audit, 6) Statutory audit, 7) Internal audit, 8) Internal
control Questionnaire, 9) 50 lakhs, 10) Internal auditor, 11) Internal control
Questionnaire, 12) Narrative record, 13) Owner)
4.14 Further Reading and References
(44) AUDITING - I
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
UNIT 5
DOCUMENTATION
Documentation
NOTES
Structure
5.0
Introduction
5.1
Objectives
5.2
Documentation
5.2.1
Importance of Working Papers
5.2.2
Form & Content of Working Papers
5.2.3
Lien on Working Papers
5.2.4
Classification of Working Papers
5.3
Audit Note Book
5.4
Key Concepts
5.5
Summary
5.6
Exercise & Questions
5.7
Further Reading and References
5.0 Introduction
Auditing has now become an analytical exercise which involves evaluating
the effectiveness of internal control procedures by examining selected samples of
transactions and applying analytical procedure. Auditor should document his overall
audit plan. The documentation will vary depending on the size, nature & complexity
of the audit. The auditor shall assemble the audit documentation in an audit file on
timely basis.
5.1 Objectives
After this unit you should be able:
1) To understand the importance of documentation.
2) To understand the concept of audit note book.
3) To know in detailed the lien on working papers.
5.2 Documentation
SA 230 on "Documentation" refers to working papers prepared or obtained
by the auditor & retained by him in connection with the performance of his audit.
The audit working paper constitutes the link between the auditor's report
& the client's records.
Working paper should record the audit plans. The nature, timing & extent
of auditing procedures performed & the conclusions drawn from the evidence
obtained. The working papers should provide for-
AUDITING - I (45)
AUDITING - I
a. Means of controlling current audit work.
b. Supervision & review of the audit work.
c. Evidence of audit work performed to support the auditor's opinion.
NOTES
Working papers should also prove the evidence of work performed
in case of charge of negligence brought against the auditors.
5.2.1 Importance of Working Papers:
The audit working papers are of vital importance whether the audit is statutory,
internal, or the management audit. Audit working papers are tool for accomplishing
the purpose of audit. Audit working papers record evidence gathered by the auditor
which will help him in arriving at his conclusions. Also they act as support for work
accomplished. Working papers are tool for accomplishing the purpose of audit.
The importance of working papers is as followsCHECK YOUR
PROGRESS
What is working
papers?
1) Provide the evidence of the audit work performed to support the auditor's
opinion.
2) Aid in planning & performance of audit.
3) Aid in the supervision & review of the audit work.
4) Record & demonstrate the audit work from one tear to another.
5) Plan the timing & extent of audit procedures to be performed.
6) Draw conclusions from the evidence obtained.
7) Standardize the working papers to improve the efficiency of the audit.
8) Facilitate the delegation of work as a means to control its quality.
9) Provide the guidance to the audit staff with regard to the manner of
checking schedules.
10) Fix responsibility on the staff members.
11) Act as evidence in Court of law when a charge of negligence is brought
against the auditor.
5.2.2 Form & Content of Working Papers:
The form & content of audit working papers may vary from one audit to
other. If the auditor identified inconsistent information, the auditor shall document
how the auditor addressed the inconsistency. The form & content of audit working
papers are affected by matters like:
a. Nature of Engagement.
b. Form of auditor's report.
c. Nature & complexity of client's business.
d. Nature & condition of client's records.
e. Degree of reliance on internal control.
(46) AUDITING - I
Format of working paper:
Documentation
Name of client
NOTES
(----------------------------------)
Date: ---------------Nature of engagement: ------------------Nature & complexity of client's business: -----------------------------Nature & conditions of client's records: ------------------------------Form of auditor's report: -------------------------------
Signature:
-------------------------(Name of Auditor)
CHECK YOUR
PROGRESS
Describe Lien on
working papers?
5.2.3 Lien on Working Papers:
I.
Ownership:
The working papers are the property of the Auditor. The Auditor may at
his discretion, make portions of or extracts from his working papers available to his
clients. The ownership of working papers belongs to the auditor. However he may
make copies available to the client.
II.
Custody:
The Auditor should take proper measures for custody & confidentiality of
his working papers.
III.
Retention Period:
The working papers should be retained for a period of time sufficient to
meet the needs of his practice & satisfy any legal or professional requirement of
record retention. Working papers should be requires to retain at least 7 years (earlier
10 years) from the date of auditor's report.
IV.
Lien:
Lien arises only in case of other person's property. Hence, the question of
lien on the working papers does not arise since they belong to the auditor.
5.2.4 Classification of Working Papers:
i.
Permanent Audit File
ii.
Current Audit File
The auditor shall assemble the audit documentation in an audit file &
completed the administrative process of assembling the final audit file on a timely
basis after the date of auditor's report.
After the assembly, the auditor shall not delete audit documentation before
the end of its retention period.
AUDITING - I (47)
AUDITING - I
i.
Permanent Audit File:
They are updated with information regarding legal & organizational structure
of the entity. This file contains all the papers & documents which have a long term
use. They can be referred to on a repetitive engagement from year to year.
NOTES
l
Contents of Permanent Audit File:
Following types of working papers are kept & maintained in the permanent
filea) Certified copies of the Memorandum of Association, Articles of
Association in case of companies & Partnership Deed in the case of
Partnership Firm.
b) Extracts of minutes from minute book of shareholders, directors.
c) Copies of all the important agreements & contracts & other documents.
CHECK YOUR
PROGRESS
d) Information about the companyI. History of company
What is Audit file?
II. Location of various offices & factories & nature of business.
III. List of Executives & Officers & their duties.
IV. Different departments & their functions.
e) Details of holding & subsidiary company.
f) A list of directors includingI. Details of their other directorship
II. Details of other firms & companies in which they are directly or
indirectly interested
III. Details of their membership of other companies or partnership firms
or proprietary business or membership of other public bodies, trusts, etc.
g) Information regarding internal control in the organization.
h) A list of books of accounts & other registers.
i) Compilation of tax returns & tax proceedings.
j) Important details of cases filed by or against the client.
k) Compilation of data of the balance sheet & profit & loss account
&comparative statements.
l
Advantages of Permanent Audit File:
1. It is very convenient for easy reference. All important data is available in
one file at one place.
2. It enables to auditor to prepare check list of all the important items.
3. It is a guide for the preparation of an audit programme.
4. It acts as reference book to seniors & other assistants who are fresh to
the work.
(48) AUDITING - I
5. It helps in finalizing the annual accounts & auditor's report. It also helps
to review the work of the client.
ii.
Current Audit File:
Documentation
They contain information relating primarily to the audit of single period.
All the papers which pertain to the year under audit are filed in current
file.
NOTES
l
Contents of Current Audit File:
The current file normally contains all the papers that pertains to the year under
audit. It includes the followinga)
The audit programme for the year.
b)
The internal control questionnaire issued to client & replies.
c)
Important adjustments or journal entries having a bearing on the final accounts.
d)
The working Trial balance.
e)
Bank reconciliation statements, all schedules, confirmation letters & replies.
f)
Audit notes.
g)
Record of work done.
h)
Schedule of depreciation, computation of tax liability, computation of dividend.
i)
Manuscript copies of current year's final accounts together with all annexure.
j)
The manuscript working copy of the auditor's report.
CHECK YOUR
PROGRESS
Describe in brief Audit
Notebook?
5.3 Audit Note Book
1.
Meaning:
An audit notebook is bound book in which a variety of matters observed
during the course of audit are recorded. It is a notebook containing points
or queries that require clarification, explanation & investigation & the
manner in which they are finally settled.
2.
Structure:
The Audit notebook is generally divided into two partsFor keeping a record of general information as regards the audit as whole
&
For regarding special points which have been observed during the course
of audit of the accounts of particular year.
3.
Contents:
l General information containing i.
Nature of business carried on
ii. Structure of the financial & administrative organization
iii. A list of books of accounts
iv. Names of principal officers, their duties & responsibilities
AUDITING - I (49)
AUDITING - I
v. Particulars of the accounting & financial policies followed
vi. Important contracts to which the client is a party.
NOTES
l Current information containingi.
Audit queries not cleared immediately
ii. Mistakes or irregularities observed during the course of audit
iii. Important matters for future reference
iv. Unsatisfactory bookkeeping arrangements, costing method, internal control,
etc.
v. Special points requiring considerations at time of verification of final
accounts
5.4 Key Concepts
"Documentation" refers to working papers prepared or obtained by the
auditor & retained by him in connection with the performance of his audit.
An audit notebook is bound book in which a variety of matters observed
during the course of audit are recorded.
5.5 Summary
Audit working papers record evidence gathered by the auditor which will
help him in arriving at his conclusions. The Auditor may at his discretion, make
portions of or extracts from his working papers available to his clients. The ownership
of working papers belongs to the auditor. Lien arises only in case of other person's
property. Permanent file contains all the papers & documents which have a long
term use. All the papers which pertain to the year under audit are filed in current
file.
5.6 Exercise & Questions
1. What is Documentation? State the importance of working papers.
2. Discuss the contents of permanent audit file.
3. What is the lien on working papers?
l
Fill in the blanks:
1)
SA 230 on "___________________" refers to working papers prepared or
obtained by the auditor & retained by him in connection with the performance
of his audit.
(Planning, Documentation, Audit Evidence, Materiality)
2)
(50) AUDITING - I
----------------- is bound book in which a variety of matters observed during
the course of audit are recorded.
(Audit Notebook, Audit File, Audit Programme, Audit Plan)
3)
_____________ arises only in case of other person's property.
Documentation
(Lease, Pledge, Lien, Mortgage)
4)
The audit working paper constitutes the link between the ________________
& the client's records.
NOTES
(Board's Report, Auditor's Report, Annual Report, Combine Report)
5)
______________________are tool for accomplishing the purpose of audit.
(Working papers, Audit Programme, Audit Report, Annual Report)
6)
_____________________provide the evidence of the audit work performed
to support the auditor's opinion.
(Audit program, Audit report, Audit working paper, Annual report)
7)
All the papers which pertain to the year under audit are filed in
______________.
(Permanent file, Current file, Folder file, Computer file)
8)
____________file contains all the papers & documents which have a long
term use.
(Permanent file, Current file, Folder file, Computer file)
9)
The working papers are the property of the ______________.
(Client, Director, Auditor, Management)
10) The question of lien on the ____________________ does not arise since
they belong to the auditor.
(Working papers, Audit Programme, Audit Report, Annual Report)
11) The Auditor should take proper measures for custody & confidentiality of his
working papers.
(Director, Auditor, Manager, Secretary)
12) The auditor shall not delete audit documentation before the end of its
____________ period.
(Retention, Audit, Lien, Permanent)
(Answers: 1) Documentation, 2) Audit notebook, 3) Lien, 4) Auditor's report,
5) working papers, 6) Audit working papers, 7) Current file, 8) permanent
file, 9) Auditor, 10) Working papers, 11) Auditor, 12) Retention)
5.7 Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
AUDITING - I (51)
AUDITING - I
UNIT - 6
FRAUDS - THEIR DETECTION &
PREVENTION
NOTES
Structure
6.0
Introduction
6.1
Objectives
6.2
Frauds
6.3
Errors
6.4
Reasons & Circumstances of Frauds & Errors
6.5
Auditor's responsibility for non detection of frauds & errors
6.6
Events which increases the risk of fraud or error
6.7
Inherent limitation of an audit in relation to frauds & errors
6.8
Types of fraud
6.9
Internal Audit
6.10
Internal Control
6.10.1 Elements of internal control
6.11
Investigation for suspected frauds
6.12
Key Concepts
6.13
Summary
6.14
Exercise & Questions
6.15
Further Reading and References
6.0 Introduction
Audit means systematic examination of records with a view to give opinion
of true and fair view of financial statement .Such opinion is depend upon evidences
which collected in audit procedure. Internal control is important tool in the hands of
management and auditor to prevent fraud and mal practices in business.
6.1 Objectives
After this unit you should be able:
1. To understand the concept of fraud and error.
2. To analyze the reasons & circumstances of Frauds & Errors
3. To find out events which increases the risk of fraud or error
4. To be familiar with types of fraud
5. To understand the elements of internal control.
6. To learn the investigation process for suspected frauds
(52) AUDITING - I
6.2 Frauds
According to SA 240 "The fraud refers to intentional misrepresentations
regarding financial information by one or more individuals among management,
employees or third parties."
Frauds - Their Detection
& Prevention
NOTES
Fraud may involve:
a. Manipulation, falsification or alteration of records or documents.
b. Misappropriation of assets.
c. Suppression or omission of transactions from records.
d. Recording of transaction without substance.
e. Misapplication of the accounting policies knowingly.
Fraud may be classified asi. Misappropriation or embezzlement of cash
ii. Teeming & lading
iii. Misappropriation of goods
CHECK YOUR
PROGRESS
Difference between
Fraud and Error?
iv. Forgery of vouchers
v. Services rendered but not accounted for
vi. Manipulation & falsification of accounts
vii. Window dressing
6.3 Errors
"The term error refers to unintentional mistake in financial information."
Error includes:
a. Mathematical or clerical mistake in the records.
b. Oversight or misinterpretation of facts.
c. Misapplication of accounting policies unknowingly.
Fraud may be perpetrated by manipulation of accounts. Errors on the other
hand, may creep in accounts due to omission or clerical errors on the part of
employees.
Errors may classified asi. Errors of omission
ii. Errors of commission
iii. Errors of principle
iv. Errors of duplication
v. Compensating errors
AUDITING - I (53)
AUDITING - I
6.4 Reasons & Circumstances of Frauds & Errors
1. Ignorance of employees about accepted accounting principles & policies.
This happens due to not knowing something.
NOTES
2. Inappropriate account classification by employees during reconciliation
of subsidiary ledgers with the controlling accounts.
3. Carelessness on the part of those involved in the accounting work.
4. A desire to conceal the effect of defalcations or shortages of one kind or
another.
5. A tendency of the management to permit prejudice or bias to influence
the interpretation of transactions or their presentation in the financial
statements.
6. With the purpose of tax evasion.
7. Intentional efforts committed by persona. To show up or depress the picture
b. Convert the error to a personal benefit.
6.5 Auditor’s responsibility for non detection of
Frauds & Errors
The responsibility of prevention & detection of fraud & error rests with
the management through the implementation & continued operation of an adequate
system of internal control.
i.
A financial audit is conducted by the auditor to obtain reasonable assurance
that financial statements are free from material misstatements caused by
fraud or error.
ii. Due to certain inherent limitations even & audit which is properly planned
& performed in accordance with generally accepted auditing standards,
may fail to detect a cleverly concealed fraud. This particularly happens
in cases of frauds involving forgery or collusion among employees or
management. The auditor thus, cannot be held responsible for the
prevention & detection of frauds & error.
iii. The term reasonable assurance implies that some risk of material
misstatement could be present in financial statements which auditor may
fails to detect. So, he should consider the risk of material misstatement
resulting from fraud during all stages of the audit process.
iv. The auditor should approach his work with a certain degree of professional
skepticism in order to be alert to any signals of misstatement. However,
does not imply that he should approach his work with suspicion. Unless
there is a reasonable ground of doubt the auditor should not question the
authenticity of documents & records.
(54) AUDITING - I
v. Auditor should discuss with his audit team about the susceptibility of the
entity's financial statements & design audit procedure accordingly.
vi. To assess the risk of material misstatement resulting from fraud, the auditor
should-considered whether fraud risk factors are present that indicate
the possibility of fraud. Make enquiries of the management to obtain
information about its understanding & assessment of likelihood of fraud
occurring within the entity.
Frauds - Their Detection
& Prevention
NOTES
6.6 Events which increases the risk of fraud or Error
SA 240 on fraud & errors lists the following events which may increase
the risk of fraud & errori.
Weakness in design of internal control system & non-compliance with
laid down control procedures.
ii. Doubts about the integrity or competence of the management.
iii. Unusual pressures within the entity.
iv. Unusual transactions such as transactions with related parties, excessive
payment for certain services.
CHECK YOUR
PROGRESS
Describe Inherent
limitation of an Audit
in relation to Frauds
and Errors?
v. Problems in obtaining sufficient & appropriate audit evidence.
6.7 Inherent limitation of an Audit in relation to
Frauds & Errors
i.
Management role:
Primarily it is the responsibility of management to design & implement
the suitable system of internal control tol Safeguard the assets &
l Prevent frauds & defalcations.
ii.
Auditor's role:
During the audit auditor shouldl Bear in mind the possibility of existence of fraud or other irregularities.
l Devise procedures & use techniques to ensure discovery of all frauds &
errors.
l Extent his audit procedure to confirm his suspicion on the probable
existence of any fraud or error.
iii.
Objective of an audit:
An auditor is not intended & cannot be relied to disclose all defalcations
& other irregularities. However, the auditor does not guarantee that once
he has signed the report on the accounts no fraud exists.
AUDITING - I (55)
AUDITING - I
iv.
Auditor's responsibility:
The auditor is only requires to conduct the audit by exercising reasonable
care & skill in consonance with professional standards expected of him.
NOTES
6.8 Types of Fraud
i.
Misappropriation or embezzlement of cash:
Misappropriation means wrongful conversion or fraudulent application of cash.
Embezzlement means any fraudulent application of another's property by
any person to whom it has been entrusted.
Misappropriation or embezzlement may be committed byl Non recording of cash sales.
l Making false entries in account of customers.
CHECK YOUR
PROGRESS
l Showing payments against purchases never made.
l Non recording of credit notes for purchase return.
Give different types of
Fraud?
l Non recording of cash received against unusual sales.
ii.
Misappropriation of goods:
It may be committed by recording wrong purchases. Fraud by way of
misappropriation of goods is easier to commit in case of goods which though
high priced & not bulky. Fraud of such nature can be detected byl Proper maintenance of accounts as to purchases & sales.
l Regular stocktaking.
l Strict check on incoming & outgoing goods.
iii.
Fraudulent manipulation of accounts:
Such fraud is caused when a person
l Make or causes a false entry in the business records.
l Altered, erased, removed or destroyed a true entry from records.
l Prevents the making of a true entry or causes the omission there of.
Generally, fraud by manipulation of accounts is committed by person holding
high positions in the business.
iv.
Teeming & lading:
It is the one of the type of fraud that is committed in connection with the
receipt of cash. It means using the funds of the company for personal purpose
without any authority. If this type of fraud not prevented in time, it may lead
to bigger fraud. This can be prevented byl The transactions are in cheques.
(56) AUDITING - I
l The work of collecting cash, depositing into bank, recording the same in
cashbook & of issuing receipts shall be allocated that no one person in charge
of all these activities.
v.
Window dressing:
It means the practice of arranging the disposition of assets & liabilities in
such a way that affairs of business as shown in subsequent balance sheet do
not truly represent the normal financial position.
a. Meaning:
Frauds - Their Detection
& Prevention
NOTES
Window dressing stands for mis-presentation of accounts with a view to
present a better picture of the state of financial affairs than it's actual. The
window dressing thus shows an improved financial position than what it really
is.
b. Difficult to detect:
The detection of such manipulation of account is difficult becausel Generally the persons in higher management are associated with this
manipulation &
CHECK YOUR
PROGRESS
l It is done in methodical manner.
c. Methods:
Define Internal Audit?
Window dressing can be done in various waysl Selecting inappropriate accounting principles. Eg. Method of depreciation
l Capitalizing revenue expenses or vice versa.
l Grouping items in different manner.
l Treating certain items differently on the basis of legal interpretation, etc.
d. Objects of window dressing:
l To show more profit & to give managerial personnel more remuneration
where remuneration is linked with profit.
l To attract more loans, credits etc. from bankers & financial institutions.
l To avoid incidence of income tax or other taxes.
l To declare dividends when there are insufficient profits.
l To attract potential investors for subscribing the public issues.
6.9 Internal Audit
Many large organizations have system of internal audit within the
organization as an internal part of the internal control. They have a separate audit
department. The scope & function of this department vary considerably from
organization to organization.
Internal audit is the review of the various operations of the company & of
its records by staff specially appointed for the purpose. This review may be periodical
or may be even continuous.
The Institute of Internal auditors defines internal audit as under"Internal auditing is an independent appraisal activity within an
organization for the review of the accounting, financial & other operations
AUDITING - I (57)
AUDITING - I
NOTES
as a basis for protective & constructive services to the management. It is
a type of control which functions by measuring & evaluating the
effectiveness of the other type of control. It deals primarily with accounting
& financial matters but it may also properly deal with matters of an operating
nature."
Internal Audit is an integral part of internal control. It should be understood
that internal control is not merely internal check or internal audit; it is a system of
control as a whole.
6.10 Internal Control
Internal Controls are to be an integral part of any organization's financial
and business policies and procedures. Internal controls consist of all the measures
taken by the organization for the purpose of;
CHECK YOUR
PROGRESS
Define
Control?
Internal
l Protecting its resources against waste, fraud, and inefficiency;
l Ensuring accuracy and reliability in accounting and operating data;
l Securing compliance with the policies of the organization;
l Evaluating the level of performance in all organizational units of the
organization. Internal controls are simply good business practices.
The system of internal control has been defined as"The plan of organization and all the methods & procedures adopted
by the management of an entity to assist in achieving management's
objective of ensuring, as far as practicable,
i. Orderly & efficient conduct of the business
ii. Adherence to management policies
iii. Safeguarding of assets
iv. Prevention & detection of frauds & errors
v. Ensuring accuracy & completeness of the accounting records
vi. Timely preparation of reliable finance information"
Usually the control is entirely centralized with the owner & there is no
significant delegation of duties. However as the business grows in size, it soon
reaches a stage where the owner can no longer keep himself intimately informed
about the detailed operations of his business in such a case internal control becomes
very important. The reliability of business operations can be judged by the
effectiveness of internal control.
The Internal Auditor role is to examine the adequacy and effectiveness of
the internal controls and make recommendations where control improvements are
needed. Since Internal Auditing is to remain independent, the Internal Auditor does
not have the primary responsibility for establishing or maintaining internal controls.
However, the effectiveness of the internal controls are enhanced through the reviews
performed and recommendations made by Internal Auditing.
6.10.1 Elements of internal control:
(58) AUDITING - I
Internal control systems operate at different levels of effectiveness.
Following are some elements of the internal control system-
i. The Control Environment The control environment relates to the control consciousness of the people
within the organization. The control environment is the basis for all other components
of internal control.
ii. Risk Assessment -
Frauds - Their Detection
& Prevention
NOTES
Risk Assessment refers to the organization's identification, analysis, and
management of the risks that are related to the preparation of financial statement,
in order to ensure that financial statements are presented fairly and in compliance
with generally accepted accounting principles (GAAP).
iii. Control Activities Control Activities of the organization's policies and procedures which help
ensure that necessary actions are taken to address the potential risks involved in
accomplishing the entity's objectives.
iv. Information and Communication Information and Communication focuses "on the nature and quality of
information needed for effective control, the systems used to develop such
information, and reports necessary to communicate it effectively".
v. Monitoring Monitoring involves assessing the quality and effectiveness of the
organizations internal control system. It includes assessing the design and operation
of controls, and assessing compliance with policies and procedures. It also provides
for the implementation of appropriate actions whenever necessary.
6.11 Investigation for Suspected Frauds
1. For the purpose of these procedures, suspected fraudulent or irregular
activities would be where a public servant intentionally uses or abuses
the position for getting benefit the related entity.
2. Management is responsible for detecting improprieties. Each manager
should be familiar with the types of improprieties that might occur in the
area and be alert for any indication that such a defalcation, misappropriation
or irregularity is in existence in the manager's area. As soon as an
impropriety is suspected, it should be promptly reported.
3. During the initial stages of the inquiry into the suspected fraudulent and/
or irregular activities, a determination should be made jointly by staff and
system administration management, as to whether the matters reporting
to the management.
4. Upon review of the suspected frauds by the appropriate management
within system, a determination will be made as to the type of investigation
and by whom the investigation shall be conducted. Generally, appropriate
staff personnel will be involved in all investigation.
AUDITING - I (59)
AUDITING - I
5. Investigations that are conducted by the auditor all proceed as follows:
l During the initial meeting discussions, the suspected fraud and irregularities
should be reviewed and the specific roles of the team representatives
defined. Information regarding the activities should be discussed.
NOTES
l During the course of the investigation, periodic meetings should be
scheduled to discuss the progress of the investigation.
l Preliminary report of the investigation should be prepared and shared
with the investigation team members.
l Finalize the investigation report and submit with appropriate authority.
6. Management should take the appropriate actions relating to such frauds
which are investigated by the auditor & on which report has been
submitted.
6.12 Key Concepts
The fraud refers to intentional misrepresentations regarding financial
information by one or more individuals among management, employees or third
parties.
The term error refers to unintentional mistake in financial information.
Teeming & lading: It means using the funds of the company for personal
purpose without any authority.
Misappropriation means wrongful conversion or fraudulent application
of cash.
Window dressing stands for mis-presentation of accounts with a view to
present a better picture of the state of financial affairs than it's actual.
6.13 Summary
The fraud refers to intentional misrepresentations regarding financial
information by one or more individuals among management, employees or third
parties. The term error refers to unintentional mistake in financial information.
Ignorance of employees, inappropriate account classification, carelessness etc are
some of the reasons of frauds & errors. A financial audit is conducted by the
auditor to obtain reasonable assurance that financial statements are free from
material misstatements caused by fraud or error. Weakness in design of internal
control system & non-compliance with laid down control procedures may increase
the risk of fraud & error. Misappropriation or embezzlement of cash, misappropriation
of goods, fraudulent manipulation of accounts, teeming & lading, window dressing
etc. are various types of fraud. Internal control systems operate at different levels
of effectiveness. The Internal Auditor role is to examine the adequacy and
effectiveness of the internal controls and make recommendations where control
improvements are needed.
6.14 Exercise & Questions
1. What is the Frauds & Errors?
(60) AUDITING - I
2. What is the responsibility of auditor for non detection of frauds & errors?
3. Explain the types of frauds in detailed?
4. State the elements of Internal Control?
Frauds - Their Detection
& Prevention
5. How will you conduct the investigation for suspected frauds?
NOTES
l
Fill in the blanks:
1)
The ________________ refers to intentional misrepresentations regarding
financial information by one or more individuals among management,
employees or third parties.
(Error, Fraud, Misstatement, Misrepresentation)
2)
The term _______________ refers to unintentional mistake in financial
information.
(Error, Misstatement, Fraud, Misrepresentation)
3)
The responsibility of prevention & detection of fraud & error rests with the
______________.
(Auditor, Management, Internal Auditor, Cost Auditor)
4)
------- may be perpetrated by manipulation of accounts. ----------- on the
other hand, may creep in accounts due to omission or clerical errors on the
part of employees.
(Error - Fraud, Fraud - Error, Fraud - Misrepresentation, Error Misrepresentation)
5)
______________________ means wrongful conversion or fraudulent
application of cash.
(Misrepresentation, Misappropriation, Teeming & lading, Window Dressing)
6)
___________________ means any fraudulent application of another's
property by any person to whom it has been entrusted.
(Embezzlement, Teeming & lading, Window Dressing, Misrepresentation)
7)
______________ means using the funds of the company for personal purpose
without any authority.
(Embezzlement, Teeming & lading, Window Dressing, Misrepresentation)
8)
__________________ stands for mis-presentation of accounts with a view
to present a better picture of the state of financial affairs than its actual.
(Window dressing, Teeming & lading, Misrepresentation, Embezzlement)
9)
The auditor shall not delete audit documentation before the end of its
__________ period.
(Audit, Permanent, Retention, Current)
10) ________________ report of the investigation should be prepared and shared
with the investigation team members.
(Final, Preliminary, Interim, Current)
11) ___________ involves assessing the quality and effectiveness of the
organizations internal control system.
(Monitoring, Auditing, Sampling, Testing)
AUDITING - I (61)
AUDITING - I
12) Generally, __________ by manipulation of accounts is committed by person
holding high positions in the business.
(Error, Misstatement, Fraud, Misrepresentation)
NOTES
13) Make _________enquiries of the management to obtain information about
its understanding & assessment of likelihood of fraud occurring within the
entity.
(Enquiry, Observation, Confirmation, Review)
14) Primarily it is the responsibility of _______________ to design & implement
the suitable system of internal control.
(Auditor, Expert, Management, Cost auditor)
15) ___________ deals with frauds & errors.
(SA 230, SA 240, SA 265, SA 260)
(Answers: 1) Fraud, 2) Error, 3) management, 4) Fraud - error, 5)
misappropriation, 6) Embezzlement, 7) Teeming & lading, 8) window dressing,
9) retention, 10) preliminary, 11) monitoring, 12) Fraud, 13) Enquiry, 14)
management, 15) SA 240)
6.15 Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
(62) AUDITING - I
UNIT - 7
VALUATION & VERIFICATION
OF ASSETS
Valuation & Verification
of Assets
NOTES
Structure
7.0
7.1
7.2
7.3
7.4
7.5
7.6
7.7
7.8
Introduction
Objectives
Verification of Assets
General Consideration for Valuation & Verification of Assets
Valuation of Assets
7.4.1 Valuation of Fixed Assets
7.4.2 Valuation of Current / Floating Assets
7.4.3 Inventories (Stock in Trade)
7.4.4 Long term Work in Progress
7.4.5 Trade Debtors
7.4.6 Investments
7.4.7 Loans
7.4.8 Advances
7.4.9 Bank Balance
7.4.10 Cash balance on Hand
Key Concepts
Summary
Exercise & Questions
Readings and References
7.0 Introduction
Balance Sheet is a statement which shows financial position of business
on particular date. Financial position means assets and liabilities. According to
Companies Act 1956, liabilities means sources of funds and assets means application
of those sources. Asset means investments which gives returns in future. Period
of investment classify the assets under two heads i.e. fixed assets and current
assets. For verification of fixed assets auditor follows systematic procedure to find
possession, title, ownership right and utility. This procedure gives auditor assurance
of systematic procurement of funds. Correct valuation of assets used for ascertaining
liquidity and solvency of business.
7.1 Objectives
1. To understand the concept of Verification of Assets.
2. To understand the concept of Valuation of Assets.
3. To be familiar with general principles in valuation & verification of fixed
assets.
4. To learn the process of valuation of different types of assets
AUDITING - I (63)
AUDITING - I
NOTES
7.2 Verification of Assets
Verification of assets is an important audit process; by convention its scope
has been limited to inspection of assets, where it is practicable & collection of
information about them in an examination of documentary & other evidence so as
to confirm that:
a. The assets were in existence on the balance sheet date.
b. The assets have been acquired for the purpose of the business & under
proper authority.
c. The right of ownership of the assets belongs to the undertaking.
d. They were free from any lien or charge not, disclosed in the balance
sheet.
e. They have been correctly valued having regard to their physical condition.
CHECK YOUR
PROGRESS
Describe general
consideration for
valuation
and
verification of Assets?
f. Their values are correctly disclosed in the balance sheet.
Verification of assets is primarily the responsibility of the management
since the proprietor of the entity. The auditors function in these circumstances is
limited only to an appraisal of the evidence, their inspection & reporting on matters
affecting their valuation.
7.3 General Consideration for Valuation &
Verification of Assets
The general principles in valuation & verification of fixed assets that an
auditor should follow are1.
Existence:
To confirm that the assets were in existence on the date of the balance sheet
byi. Physical inspection
ii. Comparison of assets register with general ledger balances
iii. Obtaining confirmation from custodian of asset.
2.
Authority:
To ascertain that the assets have been acquired for the purposes of business
& they are under proper authority.
3.
Ownership:
To confirm that the rights of ownership of assets belonged to the client in
respect of assets appearing in the balance sheet. The fact of joint ownership
must be disclosed.
4.
(64) AUDITING - I
Charge:
To ascertain that no unauthorized charge has been created against any asset
& all the charges are duly registered & disclosed. In case of charge, a
certificate should be obtained from the bank showing the nature of charge.
5.
Cost:
i.
To ascertain the original amount at which the assets was acquired, it
should verify with their invoices. All other expenses incurred to bring the
assets in the present working condition, should have been capitalized.
ii. Verify the invoices, purchase agreement or ownership rights & the sellers
receipt in respect of price paid.
6.
Valuation & Verification
of Assets
NOTES
Carrying amount:
To ensure that the assets have been correctly valued having regard to their
physical conditions, recoverability byi.
Computation cost as per GAAP (Generally Accepted Accounting
Principles)
ii. Charging depreciation on scientific basis.
7.
Disclosure:
To ascertain that the assets have been properly disclosed in the balance sheet
with regard to statutory requirement in accordance with Accounting Standards.
8.
Sale of assets:
When the assets are sold, its sale proceeds should be vouched by reference
to the agreement, containing the terms & conditions of sale, counterfoil of the
receipt issued to the purchaser or any other evidence, which may be available.
Resulting profit arising from sale should be transferred to Capital Reserve. In
case of any loss should be transferred to profit & loss account.
7.4 Valuation of Assets
Valuation is not merely the determination of values of the assets as appearing
in the balance sheet but it also the critical examination of these values on the basis
of normally accepted accounting principles. Auditor is not the valuer, but he is
definitely connected intimately with valuation. For the purpose of valuation assets
are classified as followsi. Fixed Assets- Eg. Land, Building, Plant.
ii. Floating or Current or Circulating Assets-Eg. Debtors, Stock.
iii. Wasting Assets -Eg. Mines, Oil wells.
iv. Intangible Assets-Eg. Goodwill, Patent, Copyright.
v. Fictitious Assets-Eg. Preliminary exp., Discount on shares.
7.4.1 Valuation of Fixed Assets:
A fixed asset may be defined as an asset which is held with the intension
that it will be used for the production or long term purpose & not for sale in the
normal course of business. Accordinglya. They are carried over from year to year.
AUDITING - I (65)
AUDITING - I
b. They are relatively higher value.
c. In inflationary market condition, their book value is lower than their
replacement value.
NOTES
Fixed Assets may be classified asAssets which are not subject to depreciation. Eg. Land- land having
infinite life & it's value always appreciate. Since land never depreciated.
i.
ii. Assets which are subject to depreciation. Eg. Building, Plant &
machinery.
iii. Assets which are subject to depletion. Eg. Mines, Oil wells.
iv. Assets which are subject to amortized. Eg. Goodwill.
So,
l Non depreciable assets are valued - at cost price, including purchase
price, broker's commission, registration fees, legal fees & other expenses
on its conditioning.
l Depreciable assets are valued - at cost of purchase or construction, which
includes all incidental payments.
l Any fluctuations in the price are to be ignored because the assets are not
meant for resale & their usefulness to the business is not influenced by
their market price.
7.4.2 Valuation of Current / Floating Assets:
Floating assets are those current assets, which are purchased or created
in normal course of business. They are held temporarily for the purpose of ultimately
converting them into cash. Mainly these assets are two typesi. Stock in trade &
ii. Debtors & receivables
Here,
l Debtors & bill receivables will be valued at their realizable value.
l Whereas stock valued differently- Raw material & work in progress should be normally valued at cost.
- Finished goods are valued at cost or NRV whichever is lower.
(NRV= Net Realizable Value)
l
(66) AUDITING - I
Audit of Current Assets:
-
Auditor's responsibility as to valuation of assets does not end with merely
securing certificate of valuation from expert, including officials of client.
-
He has a duty to take all reasonable steps & exercise due care to ensure
that the value of assets are shown in certificates does indeed represent a
true & fair.
-
He is required to ascertain the valuation has been done in conformity
with legal & professional standards &
-
Principles & practice governing valuation of assets have been consistently
followed.
7.4.3 Inventories ( Stock in Trade ):
Valuation & Verification
of Assets
Inventories constitute the single most important item affecting the results of operation
of an enterprises & its financial condition. Object of verification of inventories is-
l
-
To ascertain that proper care has been taken in determining the physical
quantities & their conditions.
-
To ensure that any lien or pledging of the goods is disclosed in the financial
statements.
-
To assure that the quantities have been fairly & consistently priced in
accordance with accepted accounting principles.
NOTES
Some Important Points as to Inventory Verification:
A large part of inventory verification is done by client staff members.
Auditor should take the following precautions to ensure that inventory verification
is free of errors & frauds.
a) Auditor should examine the system of internal control to ascertain the
effectiveness of work. Proper segregation of responsibilities for custody
& accounting of stock in trade.
b) He should secure a copy of client's physical inventory verification
instruction in advance & see whether these contain adequate safeguards
against possible errors & frauds.
c) He should satisfy himself that proper & adequate records have been
maintained by client, & proper cutoff arrangements made. Any movement
of goods are properly added or deducted as required.
d) He should ensure that the methods regarding counting, weighing &
measuring of inventories are duly adhered to.
e) He should test check the physical existence of at least 5% of the items to
ascertain whether records do correctly represent the stock in hand.
f) He should check the original verification sheet to ascertain whether all
items are covered. Any difference between the physical count & inventory
record should be investigated & suitable adjustments made in records.
g) He should see that inventory lying with third parties, are included in
inventory sheets. It should also ensure that these are not counted twice.
h) He should work out the ratio between gross profit & sales & compare
with previous year. Any material difference between two should be
properly investigated.
i) Auditor should see that inventory is valued "at lower of cost or NRV".
Cost should be further defined as average, FIFO, etc.
l
Valuation of Inventory:
i.
Inventory should be valued in accordance with Accounting Standard 2.
ii. Management determines the basis on which the inventories are valued.
The normal basis is Cost or Net Realizable Value, whichever is lower.
iii. Cost is to be arrived at by taking the aggregate of costs of conversion &
other cost incurred in bringing inventory to the present location &
condition.
iv. The net realizable value is the estimated selling price in ordinary course
of business, less cost incurred in order to make the sale.
AUDITING - I (67)
AUDITING - I
7.4.4 Long term Work in Progress:
i.
NOTES
Auditor should ascertain by reference to appropriate evidence regarding
to the inventory of Work-in-progress (WIP) at the end of the accounting
year. Particularly in a situation where no cost system is in operation or
where a cost system is in operation but is not considered reliable.
ii. The auditor should review the procedure of stocktaking & also allocation
of material & wages to jobs has been done properly should be verified.
iii. Where physical verification is not conducted by the management, the
statement submitted by the management should be reviewed with other
internal records maintained.
iv. Auditor should follow the under mentioned procedure to test the reliability
of costing records,
-
Ascertain that the cost sheets are duly attested by the works engineer &
works manager.
-
Test the correctness of the cost as disclosed by the cost records with
reference to records maintained & original evidence in respect of all
expenditure included in cost sheet.
-
Compare the unit cost or job cost as shown by the cost sheet with the
standard cost or estimates.
-
Compare cost sheet in detail with the previous year's records. If they
vary materially, the causes thereof should be investigated.
v. To ascertain that the WIP is valued either at cost or net realizable value
whichever is lower. The auditor should also see that the mode of valuation.
vi. Certificate from the management should be obtained regarding quantity
& value of WIP.
7.4.5 Trade Debtors:
Following procedure should be adopted for verification of debtorsi.
Obtain a list of debtor balance & agree the total with a control account.
Tests should be performed on individual debtors account with nil balances.
ii. Scrutinize the control account for unusual items & test a selection of
balances.
iii. Agree a selection of receipts after the year end.
iv. Bad debtsThe auditor has to satisfy himself that adequate provision has been made
for all doubtful & bad debts. He must- Obtain a detailed age analysis of debtors & test the analysis.
- Obtain an analysis of the provision for doubtful debts.
- Scrutinize analysis & identify those debts which appear doubtful.
- Discuss with management their reasons, if any of those debts which
are not included in provision for bad debts.
- Perform further testing where any dispute exists.
- Reach the final conclusion regarding the adequacy of bad debts provision.
v. Cutoff Procedures:
(68) AUDITING - I
Auditor will need to perform tests to ensure that-
- The last invoices issued during the year & which have been included in
debtors that the goods have been dispatched & the goods are not included
in stock.
- All goods dispatched prior to the year end have been removed from the
stock record & included in debtors.
Valuation & Verification
of Assets
NOTES
- Goods sold after the year end is not included in year end debtors.
vi. Debtors Confirmation:
The auditor should- Obtain the client's permission.
- Decide the sample required &select the sample including nil balances.
- Control the posting of letters.
- Enclose a stamped addressed envelope & ensure that replies are received
by the auditor himself.
- Send reminders if replies are not received.
- Investigate thoroughly any balances which are not agreed by the
customers. Full explanations should be obtained.
- Where no reply is received the auditor should perform additional testing.
7.4.6 Investments:
The auditor is required to satisfy himself as regards the powers of the
enterprises under audit to make investments, by examining the documents such as
the "Memorandum of Association" in case of company. Investments may be
classified asl
Marketable securities &
l
Long term investments
Marketable securities are readily saleable, but long term investments which
are held with no likely intention to sell, are not so.
All investments should be held in the name of the client. If they are held in
the name of his nominee, the letter confirming the arrangement should be examined.
Investments should be verified by reference to the schedule of investment. The
schedule of investment should give particular as the date of purchase, name of
security, cost, market price, date of receipt or accrual of interest or dividend &
these should be tallied with the investment register.
The object of verification of investments is to ascertain thati.
There is a valid evidence of their ownership & custody.
ii. They are properly classified in financial statement as current & long
term.
iii. There is adequate disclosure of any pledging, hypothecation.
iv. They are valued on a basis in accordance with legal & professional
standards.
Here, Current Investment - shown at cost or NRV, whichever is lower.
Long Term Investment - shown at cost. Except if there is permanent decline
in investment.
AUDITING - I (69)
AUDITING - I
7.4.7 Loans:
The auditor should take following step for verification of balances of loani.
NOTES
Year end scrutiny to ascertain bad & doubtful debts & checking individual
balances in the ledger with the list of loans & advances.
ii. Inspection of loan agreements & the acknowledgements of parties in
respect of receipt.
iii. Examination of the sanction of loans by the board directors, the purpose
of the loans & compliance with the provisions.
iv. Ensuring the loan made by the company are intra-vires of power of the
company.
v. Examination of all the documents relating to the loan & satisfying that the
borrower is competent to receive the loan. The auditor should enquire
whether the lending company has satisfied itself about the loans compliance
by the borrower.
vi. In case of secured loans, inspecting the securities, collateral & other
documents of title & determining the security is adequate & title is clear.
7.4.8 Advances:
Advances include the amounts recoverable either in cash or in kind for value
to be received.
i.
The auditor should obtain the list of advances & compare them with
balances in the ledger.
ii. He should ascertain that advances were made under proper authority &
were being recovered regularly by agreed installments. Where there is
an agreement, the same should be inspected.
iii. Auditor should ensure that adequate provision has been made in respect
of irrecoverable balances.
7.4.9 Bank Balance:
i.
Auditor should compare the entries in cash book with those in the
passbook.
ii. A bank reconciliation statement prepared by the client should be checked.
iii. Auditor should also obtain the certificate from bank confirming the balance
at the yearend as shown in passbook.
iv. If bank account is overdrawn, auditor should obtain from bank particulars
of assets on which the charge has been created to secure the overdraft.
7.4.10 Cash balance on Hand:
i.
The auditor should verify the cash in hand at the close of the business on
the last day of the financial year. If it is not possible then cash in hand
should be checked on some day close to year end.
ii. All cash should be assembled at one place & counted at same time to
avoid frauds.
(70) AUDITING - I
iii. In case of outstation branches, certificate should be obtained from branch
manager. It should be ascertain that cash balance is not large in relation
to client's normal requirements.
iv. A statement should be prepared in duplicate showing the denomination &
number of currency notes, & values of coins & small change, which
have been counted. One copy of statement should be retained by the
auditor's staff & other copy should be given to the cashier.
Valuation & Verification
of Assets
NOTES
7.5 Key Concepts
Verification of assets is an important audit process; by convention its
scope has been limited to inspection of assets.
Valuation of assets is not merely the determination of values of the assets
as appearing in the balance sheet but it also the critical examination of these values
on the basis of normally accepted accounting principles.
A fixed asset may be defined as an asset which is held with the intension
that it will be used for the production or long term purpose & not for sale in the
normal course of business.
Floating assets are those current assets, which are purchased or created
in normal course of business. They are held temporarily for the purpose of ultimately
converting them into cash.
7.6 Summary
Verification of assets is primarily the responsibility of the management
since the proprietor of the entity. The auditors function in these circumstances is
limited only to an appraisal of the evidence, their inspection & reporting on matters
affecting their valuation. The general principles in valuation & verification of fixed
assets that an auditor should follow are- Existence, Cost, Charge, Ownership,
Authority, Carrying amount, Disclosure, Sale of assets.
Valuation is not merely the determination of values of the assets as appearing
in the balance sheet but it also the critical examination of these values on the basis
of normally accepted accounting principles. For the purpose of valuation assets
are classified as Fixed Assets, Floating or Current or Circulating Assets, Wasting
Assets ,Intangible Assets, Fictitious Assets.
7.7 Exercise & Questions
1. Which principles auditor should follow for the valuation & verification of assets?
2. Which precautions auditor should take while verification of Inventory?
3. What is the procedure adopted for verification of debtors?
l
Fill in the blanks:
1)
Verification of assets is primarily the responsibility of the___________ since
the proprietor of the entity.
(Statutory Auditor, Internal Auditor, Management, Cost Auditor)
2)
____________assets are those current assets, which are purchased or
created in normal course of business.
(Fixed assets, Floating assets, Intangible assets, Contingent assets)
AUDITING - I (71)
AUDITING - I
3)
Inventory should be valued in accordance with Accounting Standard
____________.
(6, 1, 2, 10)
NOTES
4)
Current Investment shown at cost or ____________, whichever is lower.
(Market price, Net Realizable Value, Historical Value, Depreciable Value)
5)
Auditor should compare the entries in _________________with those in
the passbook.
(Journal, Cash Book, Voucher, Receipt)
6)
The auditor has to satisfy himself that adequate _____________ has been
made for all doubtful & bad debts.
(Provision, Reserve, Contingency, Provision & reserve)
7)
A ____________ may be defined as an asset which is held with the intension
that it will be used for the production or long term purpose & not for sale in
the normal course of business.
(Fixed assets, Floating assets, Intangible assets, Contingent assets)
8)
A bank reconciliation statement prepared by the _________should be
checked.
(Bank, Auditor, Client, Cost auditor)
9)
____________include the amounts recoverable either in cash or in kind for
value to be received.
(Inventory, Advances, Debtors, Bills receivable)
10) The ___________________ is the estimated selling price in ordinary course
of business, less cost incurred in order to make the sale.
(Net realizable value, Cost price, Market price, Future price)
11) All investments should be held in the name of the _________.
(Auditor, Client, Bank, Manager)
12) _______________________are readily saleable,
(Long term securities, Marketable securities, Current securities, Bank
securities)
13) Auditor is not the ______, but he is definitely connected intimately with
valuation.
(Valuer, Expert, Manager, Director)
(Answers: 1) Management, 2) Floating assets, 3) 2, 4) Net realizable value,
5) cash book, 6) provision, 7) Fixed assets, 8) client, 9) Advances, 10) Net
realizable value, 11) client, 12) Marketable securities, 13) Valuer)
7.8 Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
(72) AUDITING - I
UNIT 8
VALUATION & VERIFICATION OF
LIABILITIES
Valuation & Verification
of Liabilities
NOTES
Structure
8.0
Introduction
8.1
Objectives
8.2
General principles to be followed in verification of liabilities
8.3
Verification of Liabilities
8.4
Valuation of Liabilities
8.4.1
Trade Creditors
8.4.2
Bills Payables
8.4.3
Outstanding Liabilities for expenses
8.4.4
Provision for Taxation
8.4.5
Contingent Liabilities
8.4.6
Debentures
8.5
Key Concepts
8.6
Summary
8.7
Exercise & Questions
8.8
Readings and References
8.0 Introduction
Balance Sheet is a statement which shows financial position of business
on particular date. Financial position means assets and liabilities. According to
Companies Act 1956, liabilities means sources of funds. Valuation of liabilities includes
source, obligation, conditions for repay and verification of it depends upon documents
and rights to create it.
8.1 Objectives
1. To understand the process of Valuation of Liabilities.
2. To be familiar with general principles in verification of liabilities.
3. To learn the process of valuation of different types of liabilities.
8.2 General principles to be followed in verification
of Liabilities
1. The auditor has to report whether the Balance Sheet shows a true & fair
view of the state of affairs of company.
AUDITING - I (73)
AUDITING - I
NOTES
2. If liabilities are not provided for in respect of expenses incurred or in
respect of the income received in advance both the Balance sheet &
Profit & loss A/c would not show true & fair practice.
3. He should verify all the liabilities in the Balance Sheet. Besides, he should
have a certificate from the top management in respect of all the known
liabilities.
4. The auditor should verify the all outstanding liabilities are recorded fully.
An understated liability has the effect of overstating the income & also
the net worth.
5. A liability should not be overstated also. An overstatement of liabilities
may lead to fraudulent disbursement.
6. Auditor should review the internal control system.
CHECK YOUR
PROGRESS
Describe the rules for
verification
of
Liabilities?
7. Auditor should satisfy himself that all liabilities, either actual or contingent,
are adequately disclosed in Balance Sheet. In case of over or
understatement of liability, he should qualify his Audit Report.
8.3 Verification of Liabilities
Verification of liabilities is an important audit process; by convention its
scope has been limited to inspection of liabilities, where it is practicable & collection
of information about them in an examination of documentary & other evidence so
as to confirm that:
a. The liabilities were in existence on the balance sheet date.
b. They have been correctly valued.
c. Their values are correctly disclosed in the balance sheet.
Verification of liabilities is primarily the responsibility of the management
since the proprietor of the entity. The auditors function in these circumstances is
limited only to an appraisal of the evidence, their inspection & reporting on matters
affecting their valuation.
8.4 Valuation of Liabilities
Valuation is not merely the determination of values of the liabilities as
appearing in the balance sheet but it also the critical examination of these values on
the basis of normally accepted accounting principles.
8.4.1 Trade Creditors:
The auditor shouldi.
Evaluate the system of internal control on purchase of goods & services
& payments thereof.
ii. Obtain a list of trade creditors & check with creditors' ledger.
iii. Scan the creditors account & judge nature of balance, nature of supplies
& disputes.
(74) AUDITING - I
iv. Enquire the reasons, if any cheques remaining unpresented for a long
time.
v. Seek confirmations of selected balances by asking the client.
vi. Reconcile the total amount of creditors list with the balance in control
account.
vii. Go though the goods inward book for the two or three weeks before the
close of the year. Similarly, the goods outward book should be seen.
Valuation & Verification
of Liabilities
NOTES
viii. Compare the total amount outstanding at the end of previous year; see
that any material deviation is properly explained.
ix. Ensure that all bills for services rendered to company have been received
& accounted for & that in case where bills have not been received,
appropriate provisions have been created.
x. Check credits raised on account of supplies towards the end of the year
to ensure that they are normal & not for any possible manipulation of
accounts.
8.4.2 Bills Payable:
Where bills payable are large in number a separate register should be
maintained. Auditor should obtain from the client a list of bills payable as on the
close of the year. Bills payable which have been paid already can be verified from
the cash book. Other bills can be verified from other records. The cash book of the
subsequent period can be verified to see whether the bills have been paid. The
auditor may request the client to obtain a certificate from the drawer of the bill
confirming the amount of the bill payable and other conditions.
8.4.3 Outstanding Liabilities For Expenses:
1. Ask for the list of outstanding expenses classified by nature of expenses.
2. Compare the list of this year's outstanding expenses with that of the last
year to see the variations.
3. Verify the basis of estimation, carefully in case outstanding expenses are
provided on an estimated basis.
4. Verify the documentary evidence supporting the outstanding expenses.
5. See the usual outstanding expenses have been paid off.
6. Verify the reference to correspondences, minute book etc. that no
outstanding expenses has been incurred which have not been provided.
7. Ensure that outstanding expenses have been shown under current liabilities
in the Balance Sheet.
8. Examine the service contracts entered into by the client to see that all
outstanding expenses have been provided.
8.4.4 Provision For Taxation:
1. Ascertain tax liability & check the computation of assessable profit by
the client & compare with the profit & loss A/c.
2. Check the amount of tax as per the latest Finance Act.
3. Vouch advance tax paid & verify the calculations.
AUDITING - I (75)
AUDITING - I
4. Examine the copy of Income Tax Return, if already filed.
5. Ensure that the amount of overall provisions on the date of the Balance
Sheet is adequate.
NOTES
6. Obtain a certificate from the practitioner, if other than auditor, regarding
the amount of tax payable.
8.4.5 Contingent Liabilities:
Contingent liability is a possible liability of present determinable amount or
one indeterminable which has aroused from past dealings or actions that may become
a legal obligation in the future. Following are the contingent liabilitiesl Bills discounted.
CHECK YOUR
PROGRESS
l
Legal suits
l
Guarantees given
l Capital commitment
Define Contingent
Liabilities?
l
Investment in partly paid up shares
Following procedure should be adopted in verifying contingent liabilityi.
Inspect the minute book of the company to ascertain all contingent liabilities
known to the company.
ii. Examine the contracts entered by the company & the likelihood of
contingent liability emanating there from.
iii. Scrutinize the lawyer's bills to track unreported contingent liability.
iv. Examine bank letters in respect of bills discounted & not matured.
v. Examine bank letters to ascertain guarantees given.
vi. Discuss with various functional officers of the company about possibility
of contingent liability.
vii. Obtain a certificate from the management that all known contingent
liabilities have been included in the accounts & they have been properly
disclosed.
The contingent liabilities should be disclosed by way of a footnote to the
balance sheet. AS-29 provides guidance in respect of contingent liabilities.
8.4.6 Debentures:
1. Auditor should verify the Trust Deed & examine the securities offered.
2. Auditor should verify the details of securities offered & could see that
the charge, if any is registered with the registrar of companies.
3. Interest is payable on the debentures half yearly in most of the cases.
Provision should be made in respect of the interest accrued but not due.
4. Auditor should verify the Memorandum & Article of Association to
examine whether the company has borrowing powers.
(76) AUDITING - I
8.5 Key Concept
Contingent liability is a possible liability of present determinable amount or
one indeterminable which has aroused from past dealings or actions that may become
a legal obligation in the future.
Valuation & Verification
of Liabilities
NOTES
8.6 Summary
The auditor has to report whether the Balance Sheet shows a true & fair
view of the state of affairs of company. For valuation of liabilities they are classified
into trade creditors and contingent liabilities. The contingent liabilities should be
disclosed by way of a footnote to the balance sheet.
8.7 Exercise & Questions
1. Which principles auditor should follow for the valuation & verification
of liabilities?
2. What is mean by contingent liability? How will auditor verify the
Contingent liabilities?
3. What is the procedure adopted for verification of Trade creditors?
4. What is the procedure adopted for verification of Debentures?
l
Fill in the blanks:
1)
AS-29 provides guidance in respect of _______________.
(Contingent Liability, Contingent Asset, Current Liability, Fixed Asset)
2)
______________ is a possible liability of present determinable amount or
one indeterminable which has aroused from past dealings or actions that may
become a legal obligation in the future.
(Contingent Asset, Contingent Liability, Fixed Asset, Current Liability)
3)
The contingent liabilities should be disclosed by way of a footnote to the
____________.
(Balance Sheet, Trial Balance, Profit & loss A/c, Trading A/c)
4)
Interest is payable on the debentures _____________ in most of the cases.
(Monthly, Quarterly, Half yearly, Yearly)
5)
_________________ is a statement which shows financial position of
business on particular date.
(Balance Sheet, Trial Balance, Profit & loss A/c, Trading A/c)
6)
Obtain a certificate from the ______________ that all known contingent
liabilities have been included in the accounts & they have been properly
disclosed.
(Cost auditor, Internal auditor, Management, Expert)
7)
____________Auditor should review the internal control system.
(Auditor, Manager, Expert, Cost auditor)
AUDITING - I (77)
AUDITING - I
8)
Verification of liabilities is an important ___________ process.
(Testing, Audit, Sampling, Costing)
9)
NOTES
Obtain a list of trade creditors & check with ____________ ledger.
(Debtors, Inventory, Creditors, Bank)
(Answers: 1) Contingent liability, 2) Contingent liability, 3) Balance sheet, 4)
half yearly, 5) Balance sheet, 6) Management, 7) Auditor, 8) Audit, 9) Creditors)
8.8 Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
(78) AUDITING - I
UNIT - 9
COMPANY AUDIT IN BROAD LINE,
PROFIT AVAILABLE FOR DIVIDEND,
AUDITOR'S DUTIES
REGARDING RESERVES
Company Audit in Broad
Line, Profit Available for
Dividend, Auditor’s Duties
Regarding Reserves
NOTES
Structure
9.0
9.1
9.2
9.3
9.4
9.5
9.6
9.7
9.8
9.9
9.10
9.11
9.12
9.13
9.14
Introduction
Objectives
Company Audit
Share Capital Audit
9.3.1 Auditor's duties regarding to audit of share capital
9.3.2 Shares underwritten placed for commission
9.3.3 Shares issued at premium
9.3.4 Shares issued at a discount
Audit of debentures
Preliminary Expenses
Statutory Meeting & Statutory Report
Dividend
9.7.1 Interim dividend
9.7.2 Auditor's duty with regard to payment of dividend
Transfer to reserve
Capita profits
Revaluation reserve
Key Concepts
Summary
Exercise & Questions
Readings and References
9.0 Introduction
Section 221 to 229 of The Company's Act 1956 is related with appointment
of company auditor, their qualification, their rights and duties. Section 202 to 205 of
The Company's Act 1956 related to distribution of profit and dividend. Company
Auditor has to play an important role for keeping specific % of profit as compulsory
reserve and provision.
9.1 Objectives
1. To understand the points which deserve special consideration in case of
company audit.
2. To understand the specifications about Share Capital Audit.
3. To study auditor's duties regarding audit of share capital.
4. To learn the procedure for audit of debentures.
AUDITING - I (79)
AUDITING - I
5. To be familiar with the auditing aspects related with Preliminary Expenses,
Dividend,
Transfer to reserve, Capital profits, and Revaluation reserve.
6. To understand the details about Statutory Meeting & Statutory Report.
NOTES
9.2 Company Audit
CHECK YOUR
PROGRESS
Give in brief concept
of Company Audit?
The following points deserve special consideration in case of company
audit1. Object of audit:
The object of company audit is to examine the books of accounts to report
whether or not the financial statement shows a true & fair view of the state of
company at the end of financial year, & the profit & loss for the financial year
ended on that date.
2. Internal control:
The management is responsible for devising suitable internal control for
safeguarding the assets of the company. However, before placing the reliance on
internal control system of the company, it would be necessary to conduct the
compliance & substantive test procedure to evaluate it from the point of view of its
deficiencies.
3. True & fair:
The financial statement should show a true & fair view of state of the
company & the results of operation of the company during the year.
a. Materiality:
Materiality is a subjective concept. The materiality should be judged in
relation to profit shown by the profit & loss account. What is material in one
circumstance may not be material in other circumstance it depends upon the
professional judgment of the auditor to decide about the materiality of a particular
item.
4. Comparative study:
Auditor should compare the figures of the current year with the previous
year figures. This helps in locating major deviations & he should ascertain reasons
for the same.
9.3 Share Capital Audit
a.
b.
c.
d.
e.
(80) AUDITING - I
The principle objectives of audit of share capital are as follows thatIssues of shares are properly authorized & that there is no over issue
beyond the limits as prescribed in the memorandum.
The cash & other assets acquired through issue of shares have indeed
been received, properly classified, valued & correctly recorded in the
books of accounts.
The distribution of dividends & retention of profits in form of reserves &
provisions are properly authorized.
Provisions relating to rights & privileges of shareholders, creditors, etc.
are duly complied with
Generally accepted accounting principles are followed in the preparation
of financial statements in conformity with legal provisions.
There are three stagesi. Application stage: In this stage application for shares are received along
with application money.
ii. Allotment stage: Allotment of shares takes place allotment letters is
issued & allotment money is received.
iii. Call stage: In this stage calls are made on shares & the amount due is
received.
Company Audit in Broad
Line, Profit Available for
Dividend, Auditor’s Duties
Regarding Reserves
NOTES
9.3.1 Auditor's duties regarding audit of share capital:
i. Auditor should examine the minute book to verify the approval.
ii. He should check the application & allotment book to see the appropriate
journal entry is duly passed.
iii. He should check the copies of letter of allotment & letter of regret with
entries in application & allotment book.
iv. He should examine the resolution passed by the board.
v. He should compare the schedules of calls in arrears with application &
allotment book & see that amount has been correctly calculated.
vi. In case of underwriting, auditor should examine the contract with
underwriters & ascertain that the terms thereof have been complied in
full.
vii. In case of shares issued at premium, auditor should examine the
prospectus & article of association of the company to see whether they
permit the issue of shares at premium.
viii. He should see that whether company has complied with legal provision.
ix. He should also see compliance with SEBI guidelines. In case of premium
he should see section 78 compliance.
x. In case of shares issued at discount, auditor should see that conditions in
section 79 are complied with, & also verify the sanction obtained from
central government.
xi. In case of shares issued at discount, auditor should examine the
prospectus & article of association of the company to see whether they
permit the issue of shares at discount.
xii. Auditor should verify the amount of calls in arrears from the share register.
xiii. He should obtain a statement from the management enlisting the details
of calls received in advance & whether such amount is transferred to a
separate account.
CHECK YOUR
PROGRESS
Describe Auditor’s
duty in relation to
share capital?
9.3.2 Shares underwritten placed for commission:
i.
Many times, the whole or a part of the issue of capital is underwritten.
The underwriters agree to take up the unsubscribed capital in the event
when the capital is not fully subscribed.
ii. The auditor should refer to the underwriting contract to verify the number
of shares if any, which the underwriter were obliged to take up & payment
made by them in respect thereof.
9.3.3 Shares issued at premium:
Section 78 of Companies Act, 1956, deals with the issue of shares at a
premium. A sum equal to the aggregate amount or value of premium received on
AUDITING - I (81)
AUDITING - I
NOTES
the issue of securities at a premium, whether for cash or otherwise, shall be
transferred to a separate account called the "Securities Premium Account". The
securities premium may be applied ini. Paying up unissued securities of the company to be issued to the members
of company as fully paid bonus shares.
ii. Writing off the preliminary expenses of the company.
iii. Writing off the expenses of, or the commission paid or the discount allowed
on, any issue of shares or debentures of the company.
iv. Provide for the premium payable on the redemption of any redeemable
preference shares or any debentures of the company.
9.3.4 Shares issued at a discount:
A company can issue its shares at a discount only if following conditions are fulfilledi. The issue of share at a discount is authorized by a resolution passed by
the company in general meeting & sanctioned by the Central Government.
ii. Resolution should specify the maximum rate of discount at which the
shares are to be issued. Such rate of discount can not be more than 10%
unless the central government is of opinion that a higher % of discount
may be allowed in special circumstances.
iii. Shares can be issued at discount within two months after the date on
which the issue is sanctioned by the Central Government.
iv. Not less than one year has at the date of the issue elapsed since the date
on which company was entitled to commence business.
Every prospectus relating to issue of shares must contain the particulars
of discount allowed on issue of shares or of so much of that discount that has not
been written off at the date of issue of the prospectus.
9.4 Audit of Debentures
Debenture is a written acknowledgement, usually under seal of a debt due
by a company, containing provisions as to payment of interest & repayment of
principal. It may be either a simple or naked debentures carrying no charge or
debenture carrying either a fixed or floating charge on some or all of the assets of
the company.
Auditor should take following steps for verification of debentures:
i.
He should refer to article of association of the company to inquire whether
the company can borrow through debentures.
ii. He should verify the resolution passed by the directors & the shareholders.
iii. If a charge is created, auditor should verify that the charge is registered
with registrar & also entered in the register of charge.
iv. He should see all accounting entries regarding to the issue of debentures
& money received, in the books of accounts & examine them with
reference to bank pass book also.
v. He should verify the entries on the counterfoils of debentures issued with
the debenture register.
vi. He should examine a copy of the Debenture Trust Deed & note the
conditions contained there in as to issue & repayment.
(82) AUDITING - I
vii. He should see that SEBI guidelines are complied with..
9.5 Preliminary Expenses
It is the expenditure incurred incidental to the creation & floating of a
company. It consists of stamp duties, registration fees, legal cost, consultant's fee,
etc. The following should be checkedi.
Company Audit in Broad
Line, Profit Available for
Dividend, Auditor’s Duties
Regarding Reserves
NOTES
Checked the minute book & resolution approving the expenses claimed
by promoters as having been spent in the formation of the company.
ii. Verify whether excess amount, if any, that the amount mentioned in
prospectus, is approved by shareholders.
iii. Note the decisions taken to write off the preliminary expenses over a
period.
iv. Verify the expenses based on relevant documentary evidence.
v. Ensure that the amount not yet written off is shown in the balance sheet
under the head "Miscellaneous expenditure-to the extent not written off
or adjusted".
vi. Check that no expenses other than those what constitute preliminary
expenses is booked under this head.
9.6 Statutory Meeting & Statutory Report
CHECK YOUR
PROGRESS
Describe
the
procedure
of
Preliminary
Expenses?
Under section 165 of the companies act, every Public Company must
hold a statutory meeting within a period of not less than one month & not more
than six months, after the date on which company is entitled to commence business.
The report forwarded to every member at least 21 days before the day of the
meeting is known as the Statutory Report.
Contents of statutory report:
i.
Total number of shares allotted, distinguishing between fully paid or partly
paid up shares. i.e. full details is required of the shares issued.
ii. Total amount of cash received by the company in respect of all shares
allotted.
iii. Abstract of receipts & payments made there out within 7 days of the
report- The receipts from shares, debentures & other sources.
- The payments made there out & particulars concerning the balance
remaining in hand.
iv. An amount or estimate of the preliminary expenses of the company.
v. Particulars of any contracts which, modification or proposed modification
of which, is to be submitted to the meeting for its approval & particulars
of modification or proposed modification.
vi. Extent if any to which each underwriting contract, if any has not been
carried out & reasons for that.
vii. Arrears if any, due on calls from every director & from manager.
viii. Particulars of any commission or brokerage paid or to be paid in connection
with the issue of shares or debentures to any director or manager.
ix. Auditor's certificate.
AUDITING - I (83)
AUDITING - I
NOTES
9.7 Dividend
i. According to section 205(1), dividend can be declared or paid by
the company for any financial year only out ofl It's profit for that year, at after providing for depreciation as per section205
(2).
l Out of money provided by a central or state government for payment of
dividend pursuant to the guarantee given by the government.
ii. Transfer to reserves According to section 205 (2A) dividends shall be paid after the company
has transferred to reserves of the company of such a % of its profits for
that year not exceeding 10%.
CHECK YOUR
PROGRESS
Describe Dividend
Policies?
iii. Payment of dividendFollowing rules have been framedl Dividend once declared becomes the liability of the company & should
be paid within 30 days of the date of declaration. In case dividend have
not been paid or claimed within 30 days, the company should within 7
days from the expiry of 30 days, transferred such amount to separate
bank account titled as "Unpaid Dividend Account".
l
No dividend shall be paid except in cash.
l Dividend should be paid to the registered holder of the shares.
iv. Provision for proposed dividendSchedule VI to the Companies Act, 1956 requires proposed dividend to
be shown under "Current liabilities & provisions". Such event take place
after the balance sheet date but reflects the financial position as on the
date should be included in financial statements.
v. Setting off of brought forward debit balance in profit & loss
accountIn arriving at the divisible profits the provision of section 205 (2) should
be kept in view. Accordingly amount of loss or depreciation (contained in
debit balance of profit & loss account) whichever is less should be set off
against current revenue profits before declaration of dividends.
9.7.1 Interim dividend:
Dividend includes any interim dividend. Dividend declared between two
AGMs is called as interim dividend. The board may, from time to time, pay such
interim dividends as may appear to it to be justified by the profits of the company.
i.
Interim dividend can be declared by the Board of Directors if Article of
Association authorizes to do so.
ii. It is the sign of performance of the company.
(84) AUDITING - I
iii. Appropriate provision for depreciation should be made for the whole year
computed in accordance with the section 205 of the companies act.
iv. The distinction between interim & final dividend is that unlike interim
dividend, a final dividend once declared by the company in general meeting
is a debt & creates an enforceable obligation.
v. The interim dividend must be paid within 30 days of its declaration i.e.
within 30 days of date of passing the board resolution declaring dividend.
Company Audit in Broad
Line, Profit Available for
Dividend, Auditor’s Duties
Regarding Reserves
NOTES
vi. The amount of interim dividend is compulsorily deposited in a separate
bank account, within 5 days of passing the board resolution declaring the
interim dividend.
9.7.2 Auditor's duty with regard to payment of dividend:
Auditor should follow the following procedure for the verification of payment
of dividendsi.
He should examine the Memorandum of Association & Article of
Association of the company to determine the rights of the shareholder.
ii. He should ensure that dividend can only be distributed out of profits.
iii. He should ascertain whether profits have been computed in accordance
with requirements of section 205 of the act.
iv. He should ascertain whether rate of dividend has been recommended
properly.
CHECK YOUR
PROGRESS
Define Auditor's duty
with
regard
to
payment of dividend?
v. He should inspect the shareholders minute book to verify the amount of
dividend.
vi. He should verify the amount of unclaimed dividend with dividend account.
vii. He should see that the tax on the distributed profit at the rate of 15 %
(16.995%) is paid within 14 days from the date of declaration, distribution
or payment whichever is earliest.
viii. Auditor should see that the dividend which remains unpaid or unclaimed
within 30 days of declaration of dividend. Such unpaid or unclaimed
dividend has been transfer to special bank account entitled "Unpaid
Dividend Account". The transfer must be made within 7 days from the
date of expiry of 30 days.
ix. If any dividend remains unpaid or unclaimed for a period of 7 years from
the date of transfer, the amount transfer by company to fund called
"Investor Education & Protection Fund".
9.8 Transfer to Reserve
According to section 205 (2A) no company is permitted to declared or pay
dividend without first transferring to reserve profitsl Profit after providing current as well as arrears of depreciation.
l Profit should be after tax.
l Rate of dividend relate to rate of equity dividend & portion of dividend in
excess of fixed rate of dividend in respect of participating preference
shares.
The % of profits required to be transferred to reserves depends on the
amount of dividend proposed for the year & are given here underAUDITING - I (85)
AUDITING - I
NOTES
Rate of dividend
% of profit required to be
transferred to reserve
l Upto 10%
- Nil
l Exceeding 10% but below 12.5 %
- Not less than 2.5 % of current profits
l Exceeding 12.5% but below 15 %
- Not less than 5 % of current profits
l Exceeding 15% but below 20 %
- Not less than 7.5 % of current profits
l Exceeding 20%
- Not exceeding 10 % of current profits
9.9 Capital Profits
Capital profits represent the excess of sale value over the original cost of
assets. Capital profits can be distributed if all the following conditions are fulfilled.
i. Article of Association permit the distribution.
ii. Capital profit which is sought to be distributed should be actually realized.
iii. Capital profit should remains after revaluation of assets of the company,
if there is any capital loss then minus it from capital reserve then remaining
can be allowed to distribute.
9.10 Revaluation Reserve
Revaluation reserve is created from revaluation of profiti. Revaluation reserve should not available for distribution of dividend.
ii. Accumulated losses & depreciation on the acquisition cost (including
arrears of depreciation) should not be adjusted against Revaluation
reserve.
iii. Bonus shares cannot be issued out of revaluation reserve.
9.11 Key Concepts
Debenture is a written acknowledgement, usually under seal of a debt
due by a company.
Preliminary Expenses is the expenditure incurred incidental to the
creation & floating of a company. It consists of stamp duties, registration fees,
legal cost, consultant's fee, etc.
The report forwarded to every member at least 21 days before the day of
the meeting is known as the Statutory Report.
Dividend declared between two AGMs is called as interim dividend.
Capital profits represent the excess of sale value over the original cost
of assets.
9.12 Summary
Auditor should provide special consideration towards Object of audit,
Internal control, Truth & fairness, Materiality, Comparative study etc. while doing
company audit.
(86) AUDITING - I
There are three stages in the audit of share capital Application stage,
Allotment stage, Call stage . There are Auditor's duties regarding audit of share
capital in general and specifically regarding underwritten shares placed for
commission, Shares issued at premium, Shares issued at a discount etc. An auditor
also has a specific role in case of audit of debentures, preliminary expenses ,dividend,
Transfer to reserves, capital profit, revaluation reserves etc. for e.g. According to
section 205 (2A) no company is permitted to declared or pay dividend without first
transferring to reserve profits.
Company Audit in Broad
Line, Profit Available for
Dividend, Auditor’s Duties
Regarding Reserves
NOTES
Under section 165 of the companies act, every Public Company must hold
a statutory meeting within a period of not less than one month & not more than six
months, after the date on which company is entitled to commence business. The
report forwarded to every member at least 21 days before the day of the meeting
is known as the Statutory Report.
9.13 Exercise & Questions
1. What is the duty of auditor regarding to audit of Share Capital?
2. What are the steps to be taken for verification of debentures?
3. What is mean by Statutory Report? Which are the contents of Statutory
Report?
4. What are the duties of auditor regarding to payment of dividend?
5. Explain the relevant provisions regarding to payment of dividend?
6. How much amount required to be transferred to reserves out of profits?
l
Fill in the blanks:
1)
Section _________ of Companies Act, 1956, deals with the issue of shares
at a premium.
(205, 78, 75, 36)
2)
_____________ is a written acknowledgement, usually under seal of a debt
due by a company, containing provisions as to payment of interest & repayment
of principal.
(Debenture, Equity Share, Preference Share, Bond)
3)
________________ is the expenditure incurred incidental to the creation
& floating of a company.
(Prepaid Expenses, Preliminary Expenses, Revenue Expenses, Capital
Expenses)
4)
Under section 165 of the companies act, every Public Company must hold a
statutory meeting within a period of not less than__________ & not more
than _________, after the date on which company is entitled to commence
business.
(2 month-5 month, 6 month-12 month, 1 month- 6 month, 3 month-6 month)
5)
_____________ represent the excess of sale value over the original cost of
assets.
(Revenue profit, Capital profit, Revaluation reserve, General reserve)
6)
The % of profits required to be transferred to reserves depends on the ------------- proposed for the year.
AUDITING - I (87)
AUDITING - I
(Dividend, Revaluation, Tax, Provision)
7)
Dividend declared between two AGMs is called as ---------- dividend.
(Final, Interim, Proposed, Declared)
NOTES
8)
_______________ is created from revaluation of profit.
(Capital Reserve, General Reserve, Revaluation reserve, Profit & loss A/c)
9)
The Companies Act, 1956 requires proposed dividend to be shown under
"________________".
(Current liabilities & provisions, Reserve & surplus, Share Capital, Current
assets)
10) The statutory report forwarded to every member at least __________ before
the day of the meeting.
(7 days, 21 days, 14 days, 30 days)
11) Every __________ relating to issue of shares must contain the particulars
of discount allowed on issue of shares.
(Prospectus, Memorandum of association, Article of association, Certificate)
12) When rate of dividend is exceeding 15% but below 20 % then
minimum_____% of current profit is required to be transferred to reserve.
(2.5, 5, 7.5, 10)
13) Interim dividend can be declared by the __________ if Article of Association
authorizes to do so.
(Board of Directors, Auditor, Members, Secretary)
14) If any dividend remains unpaid or unclaimed for a period of _______ from
the date of transfer, the amount transfer by company to fund called "Investor
Education & Protection Fund".
(30 days, 5 years, 7 years, 8 years)
15) ____________ should specify the maximum rate of discount at which the
shares are to be issued.
(Report, Resolution, Prospectus, Memorandum of association)
(Answers: 1) 78, 2) Debenture, 3) preliminary expenses, 4) one month & six
months, 5) Capital profit, 6) Dividend, 7) Interim, 8) Revaluation reserve, 9)
Current liabilities & provisions, 10) 21 days, 11) prospectus, 12) 7.5%, 13)
Board of directors, 14) 7 years, 15) Resolution)
9.14 Further Reading and References
1. Audit Assurance Standards (AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
(88) AUDITING - I
UNIT - 10
QUALIFICATION & APPOINTMENT OF
A COMPANY AUDITOR
Qualification &
Appointment of A
Company Auditor
NOTES
Structure
10.0
Introduction
10.1
Objectives
10.2
Qualification of Auditors
10.3
Disqualification of Auditors
10.4
Appointment of Company Auditor
10.5
Removal of the auditor
10.6
Auditor's Remuneration
10.7
Key Concepts
10.8
Summary
10.9
Exercise & Questions
10.10
Further Reading and References
10.0 Introduction
According to Sec. 139(1) of the Companies Act 2013, every company
shall appoint an auditor to audit its books of accounts. After the completion of
audit, the auditor has to submit his report to the shareholders of the company. The
position of the auditor is therefore very vital. He reports to the shareholders about
the finances of the company.
10.1 Objectives
1. To understand the qualification and disqualification of auditors.
2. To learn various aspects regarding appointment of Company Auditor.
3. To understand the procedure for removal of the auditor.
4. To study the details about Auditor's remuneration.
10.2 Qualification of Auditors [Section 141 of
Companies Act, 2013]
A person is qualified for the appointment as the auditor of the company
only if he is a Chartered Accountant within the meaning of the chartered
Accountants Act 1949. Nationality is not important. A firm whereof all the partners
practicing in India are qualified for the appointment as auditor, it may be appointed
by its firm name to be auditor of the company.
The holder of certificate under the restricted auditor's certificates rules
1956 shall be entitled to be appointed as an auditor.
AUDITING - I (89)
AUDITING - I
NOTES
10.3 Disqualification of Auditors [Section 141 of
Company Act, 2013]
Following persons are not qualified for the appointment as auditor of a companya) A Body Corporate.
b) An Officer or Employee of the company.
c) A Partner or Employee of an Officer or Employee of the company.
d) A person who, or his relative, or his partner is holding any security in the
company or subsidiary company or holding company or associate company
or subsidiary of such holding company.
(Note - Security means an instrument which carries voting rights.)
e) A person who, or his relative, or his partner is indebted, in excess of such
amount as may be prescribed (the sum prescribed is Rs. 5 lakh) the
company or subsidiary company or holding company or associate company
or subsidiary of such holding company.
CHECK YOUR
PROGRESS
Qulification and
Disqulification of
Company Auditor?
f) A person who, or his relative, or his partner has given a guarantee or
provided any security in connection with the indebtness of any third person,
in excess of prescribed amount (Rs. 1 lakh) the company or subsidiary
company or holding company or associate company or subsidiary of such
holding company.
g) A person or a firm who, whether directly or indirectly, has business
relationship of such nature as may be prescribed with the company or
subsidiary company or holding company or associate company or
subsidiary of such holding company.
h) A person whose relative is a director or is in the employment of the
company as a director or key managerial personnel.
i) A person who is in the employment elsewhere or a person or a partner of
a firm holding appointment as its auditor, if such persons or partner is at
the date of such appointment or reappointment holding appointment as
auditor of more than 20 companies.
j) A person who has been convicted by a court of an offence involving
fraud & a period of 10 years has not been elapsed from the date of such
conviction.
141(4): An auditor, who after his appointment becomes subject to any of above
disqualifications, shall be deemed to have vacated his office as an auditor.
The list of disqualifications makes the position of an auditor as independent as
possible.
10.4 Appointment of Company Auditor
1.
Appointment of first auditor[ Section 139(6) of Companies Act,
2013]:
i.
As per section 139(6), first auditor will be appointment.
ii. The first auditor shall appointed by the board of directors within one
month of the date of registration of the company.
(90) AUDITING - I
iii. The first auditor so appointed shall hold office until the conclusion of the
first Annual General Meeting.
iv. Appointment of first auditor should be by valid resolution at the board
meeting. Merely naming in the Article of Association will not be recognized
as appointment under the act.
Qualification &
Appointment of A
Company Auditor
NOTES
v. In case the board does not exercise its power in this regard, the board
shall inform members of the company who shall appoint the first auditor
within 90 days at an extraordinary general meeting.
2.
Appointment of First Auditor in case of Government Company [
Section 139(7) of Companies Act, 2013]:
i.
Where the company is the Government Company or any other company
owned or controlled, directly or indirectly, by CG, or by one or more State
Government, or partly by CG & partly by one or more State Government,
the first auditor shall be appointed by CAG within 60 days of registration
of the company.
ii. In case CAG does not appoint the first auditor within the said period of
60 days, the Board shall appoint the first auditor within next 30 days.
iii. In case of failure of the Board to appoint the first auditor within the said
period of 30 days, the Board shall inform the members of the company
who shall appoint the first auditor within 60 days at an extraordinary
general meeting.
CHECK YOUR
PROGRESS
Rules
for
Appointment of
Company Auditor?
iv. The first auditor shall hold office till the conclusion of the first AGM.
v. Government company means any company in which not less than 51%
of the paid up share capital is held bya. CG
b. SG(s)
c. Partly by CG & partly by SG(s)
Government Company includes a company which is a subsidiary company of
Government Company
3.
Appointment in case of Casual Vacancy[ Section 139(8) of
Companies Act, 2013]:
i.
Casual vacancy means vacancy in office of auditor resulting from
accidental circumstances such as death, incapacity or disqualification of
the auditor.
ii. Casual vacancy shall be filled within 30 days by the Board of Directors.
iii. Where a vacancy is caused by the resignation of an auditor, the vacancy
shall be filled within 30 days by the Board of Directors, & the appointment
made by the board shall be approved in a general meeting convened
within 3 months of the recommendation of the Board.
iv. Where casual vacancy arises in a company whose accounts are subject
to audit by an auditor appointed by CAG, such casual vacancy shall be
filled within 30 days by CAG.
AUDITING - I (91)
AUDITING - I
v. In case CAG does not fill the casual vacancy within prescribe time, the
board shall fill the casual vacancy within next 30 days.
vi. Any auditor appointed in a casual vacancy shall hold office until the
conclusion of the next Annual General Meeting.
NOTES
4.
Appointment of Subsequent Auditor in case of a Government
Company[ Section 139(5) of the Companies Act 2013]:
i.
This section applies toa. Government Company
b. Any other company owned or controlled, directly or indirectly, by- CG; or
- One or more State Government; or
CHECK YOUR
PROGRESS
- Partly by CG & partly by one or more SG
ii. In case of aforesaid companies, CAG shall appoint an auditor duly qualified
to be appointed as an auditor of companies under this act, within 180
days from the commencement of the financial year.
Rules for the Removal
of Auditor?
iii. The auditor shall hold office till the conclusion of the AGM.
10.5 Removal of the Auditor [Section 140 of the
Companies Act, 2013]
(92) AUDITING - I
i.
Removal of auditor before the expiry of his term:
l Previous approval of Central Government must be obtained within 30
days of passing of the Board resolution.
l The company shall hold the general meeting within 60 days of receipt of
approval of CG for passing the special resolution.
l Before taking any action for removal, the auditor shall be given a
reasonable opportunity of being heard.
ii.
Resignation by Auditor:
When an auditor resigns, he is required to file a statement in the prescribe
form. The statement shall indicate the reasons & other facts as may be
relevant with regard to his resignation. The statement shall be filed with
l the company
l the Registrar
l CAG in case of a Government Company.
The statement shall be filed within 30 days from the date of resignation.
l
Requirement of Special Notice:
1. At an AGM, special notice shall be required forl Appointing as auditor a person other than the retiring auditor, or
l Providing expressly that the retiring auditor shall not be reappointed.
2. On the receipt of notice of such a resolution, the company shall forthwith
send a copy thereof to the retiring auditor.
3. Retiring auditor is entitled to make a representation against his removal.
The representation shall be in writing & shall be sent to the company.
4. He may request the company to circulate the representation to the
members of the company.
5. If copy of the representation is not sent because it was received too late
or because of the company's default, then the auditor may require that
the representation shall be read out at the meeting. A copy of
representation shall be filed with the registrar.
Qualification &
Appointment of A
Company Auditor
NOTES
10.6 Auditor’s Remuneration [Section 142 of
Companies Act, 2013]
i.
Where appointment by the Board of Directors:
When an auditor is appointed by the Board of Directors, remuneration is also
fixed by them. The resolution appointing the auditor should also prescribe the
remuneration.
ii.
Where appointed by Shareholders:
In this case the remuneration is determined by the shareholders at the AGM.
Sometimes, shareholders may delegate the power of fixing remunerations to
the Board of Directors or the Chairman.
iii.
Where appointed by the Comptroller & Auditor General of India:
The remuneration shall be fixed by the company in general meeting or in
such manner as the company in general meeting may determine.
iv.
Remuneration other than audit fees:
Where an auditor renders services other than those as an auditor, he is entitled
to get extra remuneration. Such remuneration may not be fixed in advance
by the appointing authority while appointing him as an auditor & while fixing
his remuneration.
CHECK YOUR
PROGRESS
Rules for the
Remuneration of
Auditor?
10.7 Key Concepts
The first auditor of the company appointed by the board of directors
prior to the annual general meeting may be removed by the members in general
meeting.
10.8 Summary
The first auditor of the company appointed by the board of directors prior
to the annual general meeting may be removed by the members in general meeting.
According to Sec. 139(1) of the Companies Act 2013, every company
shall appoint an auditor to audit its books of accounts. Every company shall at each
Annual General Meeting appoint an auditor who holds office as an auditor from
the conclusion of that meeting until the conclusion of next Annual General Meeting.
After the completion of audit, the auditor has to submit his report to the shareholders
of the company. A person is qualified as auditor if he is a Chartered Accountant.
AUDITING - I (93)
AUDITING - I
10.9 Exercise & Questions
1. How Sec.141 of the act deals with the qualification & disqualifications
of an auditor?
NOTES
2. Discuss the appointment of an auditor by CAG?
3. How the act deals with removal of auditor?
l
Fill in the blanks:
1)
A person is qualified for the appointment as the auditor of the company only
if he is a ___________________ within the meaning of the chartered
Accountants Act 1949.
(Lawyer, Chartered Accountant, Company Secretary, Cost Accountant)
2)
Appointment of auditor of the Government companies will be as per section
__________
(139(6), 139(7), 139(8), 141)
3)
The first auditor shall be appointed by CAG within ________days of
registration of the company.
(30, 60, 90, 45)
4)
As per section __________ first auditor will be appointment.
(139(6), 139(7), 139(8), 141)
5)
Auditor will be disqualified if such persons or partner is at the date of such
appointment or reappointment holding appointment as auditor of more than
________ companies.
(40, 20, 45, 35)
6)
The first auditor shall appointed by the board of directors within _________
month of the date of registration of the company.
(One, Three, Six, Twelve)
7)
Retiring auditor is entitled to make a ______________ against his removal.
(Report, Representation, Enquiry, Investigation)
8)
The statement of resignation shall be filed within _____days from the date
of resignation.
(30, 60, 90, 45)
9)
Removal of auditor before the expiry of his term requires the ___________
resolution.
(Ordinary, Unanimous, Special, General)
10) Government Company includes a company which is a _____________
company of Government Company
(Subsidiary, Holding, Associate, Investment)
11) The remuneration is determined by the ______________ at the AGM.
(94) AUDITING - I
(Shareholders, Board of Directors, CAG, Secretary)
12) After the completion of audit, the auditor has to submit his report to the
______________ of the company.
(Shareholders, Board of Directors, CAG, Secretary)
13) Appointment of Subsequent Auditor in case of a Government Company shall
be made by CAG within ________days from the commencement of the
financial year.
Qualification &
Appointment of A
Company Auditor
NOTES
(30, 60, 90, 180)
14) The appointment made by the board to fill the casual vacancy shall be approved
in a general meeting convened within ___________ of the recommendation
of the Board.
(30 days, 60 days, 1 month, 3 months)
(Answer: 1) Chartered Accountant, 2) 139(7), 3) 60 days, 4) 139(6), 5)20, 6)
one, 7) representation, 8) 30 days, 9) special, 10) subsidiary, 11) shareholders,
12) shareholders, 13) 180 days, 14) 3 months)
10.10
Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
AUDITING - I (95)
AUDITING - I
UNIT - 11
RIGHTS, DUTIES AND
RESPONSIBILITIES OF
A COMPANY AUDITOR
NOTES
Structure
CHECK YOUR
PROGRESS
Describe the Rights &
Powers of an
Auditor?
11.0
11.1
11.2
11.3
11.4
11.5
11.6
11.7
11.8
Introduction
Objectives
Rights & Powers of an Auditor
Duties & responsibilities of the auditor
Scope of duties of an auditor
Key Concepts
Summary
Exercise & Questions
Further Reading and References
11.0 Introduction
According to Sec. 139(1) of the Companies Act 2013, every company
shall appoint an auditor to audit its books of accounts. The position of the
auditor is therefore very vital. He reports to the shareholders about the finances of
the company.
11.1 Objectives
1) To be familiar with the rights & duties of an auditor.
2) To understand the scope of an auditor.
11.2 Rights & Powers of an Auditor [Sec. 143]
1.
Right of access to Books of account & Vouchers [Sec. 143(1)]:
The auditor has a right to access, at all times the books of accounts &
vouchers of the company, whether kept at head office or elsewhere. It is an absolute
right & is not subject to any restriction, exception or qualification.
The term book includes all types of books such as financial statutory or
statistical books. The right of access at all times implies that an auditor can inspect
the books, accounts & vouchers of the company during the normal business hours
of the audit.
2.
Right to obtain information & explanation [Sec. 143(1)]:
An auditor of the company is entitled to required from the officers, of the
company such information & explanation as he may think necessary for the
performance of his duties as an auditor. The auditor is bound to state in his report
whether he has obtained all the information & explanations which to the best of his
knowledge & belief were necessary for the purpose of the audit.
(96) AUDITING - I
3.
Right to visit branch offices & access to branch account:
Where the accounts of any branch office are audited by a person other
than the company's auditor, the company's auditor is entitled to visit the branches,
if he deemed it necessary to do so for the performance of his duties as an auditor.
However, the auditor does not have right to visit foreign branches of a
banking company & it will be adequate if he is allowed access to such copies of
extracts from the books or accounts of the branch as have been sent to the principal
office in India.
Rights, Duties and
Responsibilities of
A Company Auditor
NOTES
4.
Right to receive notice & attend general meeting:
The auditor has the right of receiving all the notices & other communications
relating to any general meeting of a company which any member of the company
is entitled to have. He is entitled to attend any general meeting & to be heard at
any general meeting which he attend on any part of the business which concerns
him as an auditor.
However, the auditor has no obligation to attend such meetings. Also, this
right does not extend to board meeting.
5.
Right to make representation:
The retiring auditor is entitled to receive a copy of the special notice intending
to remove him or proposing to appoint any other person as auditor. The retiring
auditor has a right to make his representation in writing & request that the same is
circulated among the members. In case the same could not be circulated, the
auditor may require that the representation shall be read out at the general meeting.
6.
Right to report to members:
The auditor has right as well as duty to make a report to the members on
the accounts examined by him & to state whether in his opinion & to the best of his
information & explanation given to him. Auditor has to state whether the financial
statements give a true & fair view of the state of affairs of the business of the
company.
7.
Right to sign audit report:
The auditor has right as well as duty to sign the audit report & the balance
sheet & the profit & loss account including all the documents attached or annexed
therewith.
8.
Right of seeking opinion of an expert:
In respect of any special technical matters, the auditor is entitled to consult
& take the opinion of an expert. He is also entitled to take legal advice so as to
discharge his duties efficiently.
9.
Right to receive remuneration:
The auditor has an inherent right to receive remunerations for auditing the
accounts of the company, though such rights accrue only after he has completed
the work.
AUDITING - I (97)
AUDITING - I
11.3 Duties & Responsibilites of the Auditor
1.
Report to members [Sec.143(2)]:
The auditor is required to make a report to the members of the company-
NOTES
a. On the accounts examined by him.
b. On the balance sheet & profit & loss account.
c. On every other document declared by act.
His report must state whether in his opinion & to the best of his information
& according to the explanations given to him the said accounts give a true & fair
view in case of balance sheet, of the state of company's affairs as at end of the
financial year, & in the case of the profit & loss account for its financial year.
2.
CHECK YOUR
PROGRESS
Examination of accounts:
The auditor has to state in his reporta. Whether he is obtained all the information & explanations which to the
best of his knowledge & belief were necessary for the purpose of audit.
Describe the Duties
and Responsibilities of
the Auditor?
b. Whether in his opinion proper book of accounts as required by law has
been kept by the company & proper returns adequate for the purpose of
audit have been received from the branches not visited by him.
c. Whether any branch audit report under section 228 forwarded to him &
how he has dealt with the same in preparing auditors report.
d. Whether the company's balance sheet & profit & loss account dealt with
the report are in agreement with the book of account & returns.
e. Whether in his opinion the balance sheet & Profit & loss account comply
with the accounting standards.
f. If any adverse effect on the functioning of the company is observed it
needs to be comment in bold & italic font.
g. Whether any director is disqualified from being appointed as director
under sec. 274 (i) (g).
h. Whether cess payable under sec. 441A has been paid & if not the details
of the amount of cess.
3.
Reporting on true & fair view:
The primary duty of the auditor is to express his opinion whether the balance
sheet shows true & fair view of the state of company's affair as at the end of the
financial year.
Scheduled VI refers only to the minimum disclosure requirement, if certain
information has a material bearing on the representation made in the financial
statements, it must be disclosed even if there is no legal requirement for its disclosure
under schedule VI. Before expressing his opinion on the truth & fairness of the
financial statement, the auditor must ensure a. They are drawn up according to exact legal requirements.
b. They show the financial position & profit & loss with out any distortion.
c. They do not contain any misstatement as to income or expenses.
(98) AUDITING - I
d. They are generally accepted principles of accounting have consistently
been followed in drawing up financial statements.
e. All necessary information is made available to shareholders as to the true
financial position of the company.
4.
Duty as to Enquiry [Sec.143(1)]:
Rights, Duties and
Responsibilities of
A Company Auditor
NOTES
It is the duty of the auditor to enquirea. Whether loans & advances made by the company on the basis of security
have been properly secured & whether the terms on which they have
been made are not prejudicial to the interest of the company.
b. Whether the transactions are represented merely by book entries are not
prejudicial to the interest of the company.
c. Whether the company is not an investment company or a banking company,
whether so many of the assets of the company have been sold at a price
less than at which they were purchased by the company.
d. Whether loans & advances made by the company have been shown as
deposits.
e. Whether personal expenses have been charged to revenue account.
f. Whether the position is stated in books of accounts & balance sheet is
correct, regular & misleading.
The auditor is not required to report on the matters specified under this
section unless he has any special comments to make on any of the items referred
to therein. If he is satisfied as a result of the enquiries, he is not required to report
that he is so satisfied.
5.
Report as to additional matters:
In exercise of this power, the Central Government has issued Companies
( Auditor's Report ) Order CARO,2003. The auditor has to make a statement on
each of the matters specified in the order.
6.
Duty to sign report:
It is the duty of the auditor to sign the auditor's report or sign or authenticate
any other document of the company required by law to be signed or authenticated
by the auditor. In case of a firm, only a partner of the firm practicing in India can
sign the report.
7.
Duty as to statutory report:
It is the duty of the auditor to certify as correct that part of the statutory
report that relates toa. The shares allotted by the company.
b. Cash received in respect of such share &
c. Receipt & payments of the company.
8.
Duty as to prospectus [Sec.56]:
Section 56 deals with matters to be stated & the reports that is to be set
out in the prospectus. It is the duty of the auditor to certify this report for the
purposes of the prospectus.
AUDITING - I (99)
AUDITING - I
9.
Duty to assist investigation:
Where any investigation has conducted, it is the duty of auditora.
To preserve & to produce all books & papers relating to the company
to inspector.
b.
Give to the inspector all assistance in the connection with investigation.
NOTES
It may be noted that no limitation can be placed upon the duties of the
auditor under section 227, either by the articles of the company or by any resolution
of the members.
11.4 Scope of Duties of an Auditor
CHECK YOUR
PROGRESS
Scope of Duties of an
Auditor?
The scope of duties of an auditor depends upon the nature of the business
carried on by the concern. The duties & the responsibilities can be briefly
summarized as followsa. To verify that the statements of account are drawn up on the basis of the
books of the business. However, the auditor is not liable for facts which
are concealed & kept out of books which he can not verify in the ordinary
course of exercise of reasonable care & diligence.
b. To verify that the statements of the account exhibit a true & fair state of
affairs of the business.
c. To confirm that the management has not exceeded the financial
administrative power vested in it by the articles or by any specific resolution
of shareholders passed at general meeting.
d. To investigate matters in regard to which his suspicion is aroused as to
the result of a certain action on the part of the servants of the company.
e. To perform his duties by exercising reasonable skill & care. He should
not rely on the certificate of the management for those items which he
can verify directly.
11.5 Key Concepts
The term book includes all types of books such as financial statutory or
statistical books.
Section 56 deals with matters to be stated & the reports that is to be set
out in the prospectus.
11.6 Summary
An auditor has various rights & duties such as - right of access to Books
of account & Vouchers ,right to obtain information & explanation ,right to visit
branch offices & access to branch account ,right to receive notice & attend general
meeting, right to make representation ,right to report to members ,right to sign audit
report , right of seeking opinion of an expert, right to receive remuneration etc.
(100) AUDITING - I
11.7 Exercise & Questions
1. What are the rights & powers of an auditor?
2. What are the duties & responsibilities of an auditor?
3. What is the duty of auditor regarding enquiry?
l
Fill in the blanks:
1)
The auditor does not have right to visit foreign branches of a _____________
company & it will be adequate if he is allowed access to such copies of
extracts from the books or accounts of the branch as have been sent to the
principal office in India.
Rights, Duties and
Responsibilities of
A Company Auditor
NOTES
(Insurance, Banking, Infrastructure, Private)
2)
________________ is entitled to attend any general meeting & to be heard
at any general meeting which he attend on any part of the business which
concerns him.
(Auditor, Broker, Manager, Director)
3)
_______________ deals with matters to be stated & the reports that is to
be set out in the prospectus.
(Section 65, Section 45, Section56, Section 54)
4)
Auditor reports to the _________________ about the finances of the
company.
(Directors, Management, Government, Shareholder)
5)
It is the duty of the _____________ to certify the statutory report.
(Auditor, Director, Shareholder, Management)
6)
He should not rely on the certificate of the ____________ for those items
which he can verify directly.
(Directors, Management, Government, Shareholder)
7)
The scope of duties of an auditor depends upon the __________of the
business carried on by the concern.
(Nature, Environment, Scope, Management)
8)
Give to the ___________ all assistance in the connection with investigation.
(Management, Director, Auditor, Inspector)
9)
It is the duty of the auditor to sign the __________________.
(Board' report, Auditor's report, Annual report, Cost report)
10) Scheduled ________ refers only to the minimum disclosure requirement.
(VI, IV, IX, VIII)
11) _____________ is disqualified from being appointed as director under sec.
274 (i) (g).
(Auditor, Director, Manager, Cost auditor)
12) In respect of any special technical matters, the auditor is entitled to consult &
take the opinion of ___________________.
(An expert, Internal auditor, Cost auditor, Management)
AUDITING - I (101)
AUDITING - I
13) The auditor has no ____________ to attend general meetings.
(Right, Duty, Obligation, Power)
NOTES
14) The retiring auditor is entitled to receive a copy of the ______________
intending to remove him or proposing to appoint any other person as auditor..
(Special notice, General notice, Prospectus, Cost audit report)
(Answers: 1) Banking company, 2) Auditor, 3) Section 56, 4) shareholder, 5)
Auditor, 6) Management, 7) nature, 8) Inspector, 9) Auditor's report, 10) VI,
11) Director, 12) an expert, 13) obligation, 14) special notice)
11.8 Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
(102) AUDITING - I
UNIT - 12
MISCELLANOUS MATTERS IN
COMPANY AUDIT
Miscellanous Matters in
Company Audit
NOTES
Structure:
12.0
Introduction
12.1
Objectives
12.2
Statutory report
12.3
Audit of branch Accounts
12.4
Powers of accompany auditor in relation to branch
12.5
Exemption to Branch Audit
12.6
Special audit on direction of Central Government
12.7
Cost audit
12.8
Key concepts
12.9
Summary
12.10
Exercise & Questions
12.11
Further Reading and References
CHECK YOUR
PROGRESS
Define Statutory
Report?
12.0 Introduction
Every company shall require to appoint the auditor for conducting the audit
of financial statements. The position of the auditor is therefore very vital. He reports
to the shareholders about the finances of the company. Auditor should consider
some miscellaneous matters in the company audit.
12.1 Objectives
1. To understand the concept of branch audit.
2. To get knowledge about special audit
3. To get detailed knowledge about cost audit
12.2 Statutory Report
Under section 165 of Companies Act, every public company must hold a
statutory meeting within a period of not less than one month & not more than six
months, after the date on which company is entitled to commence business. The
report forwarded by the directors to every member for this meeting at least 21
days before the day of the meeting is known as the Statutory report.
l
Contents of a Statutory report:
1. Total number of shares allotted, distinguishing between shares allotted as
fully paid or partly paid-up otherwise than in cash & in case of partly paid
up shares, the extent to which they are so paid up, in either case, the
consideration for which they have been allotted.
AUDITING - I (103)
AUDITING - I
2. The amount of cash received by the company in respect of all shares
allotted.
3. An abstracts of receipts of the company & of the payments made there
out within 7 days of report.
NOTES
4. An amount or estimate of the preliminary expenses of the company
showing separately any commission or discount paid or to be paid on the
issue or sale of shares or debentures.
5. Extent if any, to which each underwriting contract, if any, has not been
carried out & reasons for that.
6. Arrears if any, due on calls from every director & from the manager.
7. Particulars of any commission or brokerage paid or to be paid in connection
with the issue of sale of shares or dentures to any director or to the
manager.
8. Auditor's certificate.
CHECK YOUR
PROGRESS
Define Audit of
Branch Account?
12.3 Audit of Branch Account
The accounts of the branch office should be audited by company's auditor
appointed u/s 139(1) or a person who is qualified for appointment as an auditor of
the company. Where a Branch office is situated outside India, the books of that
branch shall be audited by the company's auditor or by any person qualified or by
an accountant duly qualified to act as the auditor of that branch in accordance with
the laws of that country.
l
Appointment of Branch Auditor:
i.
The branch auditor may be appointed by the company in its general
meeting.
ii. The general meeting may authorize the board of directors to appoint such
persons in consultation with the company's auditor.
iii. The branch auditor shall have the same powers & duties in respect of the
audit of accounts of that branch office as the company's auditor has in
respect of the same.
iv. He shall prepare a report on the accounts of the branch office examined
by him.
v. He shall then forward the report to company's auditor. The company's
auditor will deal with the report of the branch auditor in such a manner, as
he consider necessary.
vi. The branch auditor shall receive remuneration & shall hold his appointment
as per such terms & conditions as may be fixed either by the company in
the general meeting or by the board of directors if so authorized in general
meeting.
12.4 Powers of Accompany Auditor in Relation to
Branch
(104) AUDITING - I
Where the accounts of any branch are audited by a person other than
company's auditor, the company's auditor-
a. Shall be entitled to visit the branch office, it he deems it necessary to do
so, for the performance of his duties as an auditor &
Miscellanous Matters in
Company Audit
b. Shall have the right of access at all times to the books & accounts &
vouchers of the company maintained at the branch office.
It means he can call for such books, etc. at the company's registered
office also.
NOTES
12.5 Exemption to Branch Audit
Central Government has the power to make rules for providing exemption
to any branch from to the extent specified in such rules. The Central Government
shall have regard to the arrangements made by the company for the audit of branch
accounts & the nature & extent of activities carried on at that branch for the
previous three years.
l
Exemption based on quantum of activity conditions:
a. Any manufacturing, processing or trading activity is carried on at the
branch office.
CHECK YOUR
PROGRESS
Define Exemption to
Branch Audit?
b. The exemption is available only if the amount calculated in step 2 is not
more than amount calculated in step 3
Step 1: Calculate 'quantum of activity'. The quantum of activity means
the highest of the followingi.
Aggregate value of goods produced or manufactured or processed at the
branch office.
ii. Aggregate value of goods sold & services rendered by the branch office.
iii. Aggregate value of expenditure, whether of revenue or capital nature,
incurred by the branch office.
Step 2: Calculate average of 'quantum of activity' by taking average of
the 'quantum of activity' during three financial years immediately preceding
the relevant FY.
Step 3: Calculate the higher of the following two limits:
i.
Rs. 2 lakhs; &
ii. 2% of the total turnover of the company including all its branch offices,
earning from services rendered & earning from any other source.
But the auditor of the company shall have the right to visit the branch if he
feels necessary. He has the right of access at all times to the books & accounts &
vouchers of the company maintained at the branch office. The Central Government,
on an application made by the company, may grant exemption in other cases if the
conditions are fulfilled. They area. The company should have made satisfactory arrangements for the scrutiny
& check at regular intervals of the accounts of the branch by a responsible
person.
b.
The company should have made arrangements for the audit of branch
accounts by a person otherwise qualified for appointment as a branch
auditor, even though such a person is an employee of the company.
AUDITING - I (105)
AUDITING - I
c. Having regard nature & quantum of activity carried on at branch office,
or for any other reason, a branch auditor is not likely to be available at
reasonable cost.
d. For any other reason, the Central Government is satisfied that the
exemption may be granted.
NOTES
The Central Government may, after giving the company a reasonable
opportunity to make its objections, revoke an exemption granted.
12.6 Special Audit on Direction of Central Government
[Sec. 233 A]
1.
Circumstances warranting special audit:
Section 233A of the companies act provides the power to the Central
Government to direct that special audit of accounts of a company be
conducted for specified period, if in its opinion, any of the following
circumstances exista. The affairs of the company are not being managed in accordance with
sound business principles or prudent commercial practices; or
b. The company is being managed in a manner likely to cause serious injury
or damage to the interests of the trade, industry or business to which it
pertains; or
c. The financial position of the company is such as to endanger its solvency.
2.
Appointment:
The Central Government may appoint any of the following persons to conduct
the special audita. A Chartered Accountant, whether or not in practice, or
b. The company auditor himself.
Such person appointed shall be called as the Special Auditor.
3. Remuneration:
Remuneration of the special auditor shall be determined by the Central
Government & paid by the company.
Powers & duties:
The special auditor shall have the same powers & duties in relation to
special audit, which company auditor enjoys. The special auditor shall
report to the Central Government instead of the shareholders. The Central
Government may take some action on such report.
CHECK YOUR
PROGRESS
Define Special Audit
on Direction of
Central Government?
4.
5.
(106) AUDITING - I
Copy to company:
If Central Government does not take any action on the report within four
months from the date of its receipt, that government shall send to the
company either a copy of, or relevant extracts from the report with its
comment thereon & require the company either to circulate that copy or
those extracts to the members or to have such copy or extracts read
brfore the company at its next general meeting.
12.7 Cost Audit
Section 233B of companies act deals with cost audit. Cost Auditor is a
person who appoint for conducting the cost audit of cost accounting records. The
Central Government may, if it considers it necessary, direct that the audit of cost
accounts kept by the company shall be conducted by cost accountant.
i.
Miscellanous Matters in
Company Audit
NOTES
The auditor verifies the correctness of cost records of the company.
ii. Cost audit is an audit process for verification of the cost of manufacture
or production of any article on the basis of accounts relating to utilization
of material, labour & other items of cost as maintained by the enterprise
in cost records.
iii. The person to be appointed as cost auditor of a company is required l
To be a cost accountant within the meaning of Cost & Works
Accountants act, 1959 &
l
To hold a certificate of practice issued by ICWAI.
iv. The cost auditor may be an individual or a firm of cost accountants.
v. The cost auditor shall have the same powers & duties in relation to the
audit conducted by him as the cost auditor.
vi. Cost auditor shall make his report in triplicate to Central Government in
the prescribed form. A copy of report shall be forwarded by him to the
company.
l
Cost Audit Report:
Cost auditor shall make his report to Central Government in the prescribed
form. A copy of report shall be forwarded by him to the company.
i.
The cost auditor must forward the Cost audit report to the Central
Government & to the company within 180 days of the closing of the year
to which the audit relates.
ii. Cost audit report must be given in prescribed form.
iii. The cost auditor must further report on the adequacy of cost accounting
records maintained by company to confirm that they give a true & fair
view of the cost of production, processing, manufacturing or mining
activities, as the case may be.
iv. Additional information may be included in the annexure in the report.
v. The company shall within 30 days from the date of the receipt of the
copy of report furnished the Central Government with full information &
explanation on every reservation or qualification contained in such report.
vi. The Central Government may seek further information from the company
if it so needs after consideration of the report & information & explanation
given by the company.
vii. The Central Government may direct the company concerned to circulate
to its members along with the notice of annual general meeting to bt held
for the first time after submitting of the relevant cost audit report the
whole or part if the report as it may specify, it should be noted that cost
AUDITING - I (107)
AUDITING - I
audit will not be required annually but only for financial year(s) specified
in the order.
l
NOTES
CHECK YOUR
PROGRESS
Difference between
Special Audit & Cost
Audit?
Difference between Special Audit & Cost Audit:
Particulars
Special audit
Cost Audit
Governing
section
233A
233B
Circumstances a. Affairs of the company are
not being managed in
accordance with sound
business principles or prudent
commercial practices; or
b. Co. is being managed in a
manner likely to cause serious
injury or damage to the
interests of the trade, industry
or business to which it
pertains; or
c. The financial position of
the co. is such as to endanger
its solvency.
The company should be one
for which maintenance of
cost records u/s 209(1) (d)
have been prescribed.
Appointing
Authority
By Central Government
directly.
By the Board of directors
with the previous approval
of Central Government.
Auditor
a. A Chartered Accountant
u/s 2(1) (b) of the
Chartered Accountants
Act, 1949 whether or not he
is in practice, or
b.The auditor himself.
A cost accountant as per the
Cost & Works Accountants
Act, 1959. It is specifically
provided that the company
auditor shall not be appointed
as cost auditor.
Audit report
Directly send to the Central
Government.
To Central Government with
a copy to the company.
Auditor's
remuneration
Determined by the Central
Government.
It shall be decided by the
Board of directors.
12.8 Key Concepts
The report forwarded by the directors to every member for this meeting at
least 21 days before the day of the meeting is known as the Statutory report.
The Central Government may appoint any of the following persons to
conduct the special audit -A Chartered Accountant, whether or not in practice, or
the company auditor himself, such person appointed shall be called as the Special
Auditor.
Cost Auditor is a person who appoint for conducting the cost audit of
cost accounting records.
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12.9 Summary
Under section 165 of Companies Act, every public company must hold a
statutory meeting within a period of not less than one month & not more than six
months, after the date on which company is entitled to commence business. Section
233A of the companies act provides the power to the Central Government to direct
that special audit of accounts of a company be conducted for specified period.
Remuneration of the special auditor shall be determined by the Central Government
& paid by the company. The special auditor shall report to the Central Government
instead of the shareholders. Section 233B of companies act deals with cost audit.
Cost auditor shall make his report to Central Government in the prescribed form. A
copy of report shall be forwarded by him to the company.
12.10
Miscellanous Matters in
Company Audit
NOTES
Exercise & Questions
1) What is mean by statutory report & what are the contents?
2) Write short note on exemption of branch audit?
3) Short note on cost audit.
l
Fill in the blanks:
1)
Under section 165 of Companies Act, every public company must hold a
statutory meeting within a period of not less than one month & not more than
_______ months, after the date on which company is entitled to commence
business.
(five, six, seven, eight)
2)
The report forwarded by the directors to every member for this meeting at
least 21 days before the day of the meeting is known as the
____________________.
(statutory report, audit report, board report, summary report)
3)
The accounts of the branch office should be audited by company's auditor
appointed u/s _______ or a person who is qualified for appointment as an
auditor of the company.
(139(8), 139(7), 139(1), 139(6) )
4)
The general meeting may authorize the _________________ to appoint
such persons in consultation with the company's auditor.
(board of directors, internal auditor, cost auditor, government)
5)
______________________ has the power to make rules for providing
exemption to any branch office from audit.
(State Government, Central Government, Board of directors, Company auditor)
6)
Average of the 'quantum of activity' during _________financial years
immediately preceding the relevant FY should be taken.
(one, two, three, four)
7)
Higher of Rs. 2 lakhs; & ______ of the total turnover of the company including
all its branch offices, earning from services rendered & earning from any
other source will be taken.
(5%, 3%, 2%, 7%)
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AUDITING - I
8)
Section 233A of the companies act provides the power to the Central
Government to direct that ________________of accounts of a company.
(internal audit, statutory audit, cost audit, special audit)
NOTES
9)
Remuneration of the special auditor shall be determined by the
________________ & paid by the company.
(Board of directors, Central Government, members, internal auditor)
10) The Central Government may appoint any of the following persons to conduct
the special audit -a Chartered Accountant, whether or not in practice, or the
company auditor himself, such person appointed shall be called as the
___________________.
(Special auditor, cost auditor, internal auditor, statutory auditor)
11) The special auditor shall report to the __________________ instead of the
shareholders.
(Board of directors, Central Government, members, internal auditor)
12) If Central Government does not take any action on the report within
_______months from the date of its receipt, that government shall send
copy of report to the company.
(one, two, three, four)
13) The cost auditor must forward the Cost audit report to the Central Government
& to the company within ____________ of the closing of the year to which
the audit relates.
(60 days, 180 days, 3 months, 30 days)
14) The company shall within _________from the date of the receipt of the
copy of report furnished the Central Government with full information &
explanation on every reservation or qualification contained in such report.
(50 days, 60 days, 30 days, 90 days)
15) The governing section of cost audit _______.
(233B, 233A, 44A, 44B)
16) _______________ is a person who appoint for conducting the cost audit of
cost accounting records.
(Special auditor, cost auditor, internal auditor, statutory auditor)
(Answers: 1) six, 2) statutory report, 3) 139(1), 4) board of directors, 5)
Central Government, 6) three, 7) 2%, 8) special audit, 9) Central Government,
10) Special auditor, 11) Central Government, 12) four, 13) 180 days, 14) 30
days, 15) 233B, 16) cost auditor)
12.11Further Reading and References
1. Audit Assurance Standards ( AAS) issued by ICAI
2. N.D.Kapoor's Audit Procedure
3. Dr. Mahesh Kulkarni's Audit practices
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