ACG 202
AUDITING - II
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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best of their knowledge. However, the publisher and its authors
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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
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q Printed by
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q Publisher
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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
AUDIT REPORT AND AUDITOR'S CERTIFICATE
9
2
COMPANIES AUDITOR'S REPORT ORDER 2003
18
3
SPECIAL AUDIT - I
24
4
SPECIAL AUDIT - II
35
5
AUDIT SAMPLING
47
6
INVESTIGATION
55
7
AUDIT OF SHARES
62
8
AUDIT OF INCOME
71
9
AUDIT OF EXPENDITURE
78
10
AUDIT OF TRADING TRANSACTIONS
86
11
INTRODUCTION OF STANDARDS ON AUDITING 95
12
STANDARDS ON AUDITING
101
SYLLABUS - AUDIT -II
1) AUDIT REPORT AND AUDITOR'S CERTIFICATE
Audit Report, Basic elements of the auditor's report,
Company Auditor, Types of Audit Report, Audit Report Under
Companies Act 1956, Opinion other than an unqualified opinion,
Other information issued with audited financial statements, Post
Balance sheet Events, Going Concern, Auditor's Report, Auditor's
Certificate
2) COMPANIES AUDITOR'S REPORT ORDER 2003
Companies (Auditor's Report) Order 2003, Matters to be
covered in the auditor's report, Reasons to be stated for unfavorable
of qualified answers
3) SPECIAL AUDIT - I
Special Audit , Audit of a Sole Trader's Accounts, Audit
of Partnership Firm, Audit of Small Company, Audit of Cinema
Hall, Auditing the Accounts of Hospital
4) SPECIAL AUDIT - II
Special Audit, Audit OF Hotels, Auditing the Books of
Club, Audit of Charitable Institution, Audit of College, Auditing the
Books of Library, Audit of Newspaper Company
5) AUDIT SAMPLING
Surprise check, Test checking, Factors to be consider while
determining the sample size, Methods of selecting samples, Concept
of audit risk, Relationship between materiality & audit risks
6) INVESTIGATION
Investigation into the affairs of the company, Powers of
Inspector, Investigation of ownership of company, Investigation
on behalf of incoming partner, Investigation on behalf of bank
proposing to advance loan to a company, Difference between Audit
& Investigation, Due diligence
7) AUDIT OF SHARES
Verification of Capital Newly Issued, Verification Of
Shares Issued For Cash, Securities issued at premium, Shares issued
at discount, Calls paid in advance, Calls in arrears, Audit of
redemption preference shares, Audit of forfeiture of shares, Buy
back of own securities
8) AUDIT OF INCOME
General procedure of auditing of income, Audit of Cash
receipts, Vouching of cash receipts, Cash sales, Receipts from
customers, Rental receipts, Sale proceeds of junk material, Bills
receivables, Sale of assets, Insurance claims, Commission received
9) AUDIT OF EXPENDITURE
Audit of Payments, Vouching of Payments, Cash
purchases, Payment to creditors, Bills payables, Bills receivable
discounted but dishonored, Travelling expenses, Royalty paid,
Payment of sales tax, Postage, Petty cash, Director's travelling
expenses, Transactions with directors, Salaries & wages
10) AUDIT OF TRADING TRANSACTIONS
Principle matters to be considered while vouching Trading
Transaction, Factors which give rise to discrepancy in the stock,
Factors which increase the gross profit, Factors which decrease
gross profit, Audit of Purchases, Special precautions in the
verification of purchase invoices, Purchase Returns, Audit of sales,
Goods sold on sale or return basis, Returnable containers, Empties
& Packages, Cut-off arrangements
11) INTRODUCTION OF STANDARDS ON AUDITING
Scope of the Auditing & Assurance Standards, Auditing
& Assurance Standards & the Auditor, Functions of the Auditing
& Assurance Standards Board, Composition of the Auditing &
Assurance Standards Board, Various Standards on Auditing, True
& Fair
12) STANDARDS ON AUDITING
Standards on Auditing in detailed
UNIT - 1
AUDIT REPORT AND AUDITOR'S
CERTIFICATE
Audit Report and
Auditors Certificate
NOTES
Structure
1.0
Introduction
1.1
Objectives
1.2
Audit Report
1.3
Basic elements of the auditor's report
1.4
Company Auditor
1.5
Types of Audit Report
1.6
Audit Report Under Companies Act 1956
1.7
Opinion other than an unqualified opinion
1.8
Other information issued with audited financial statements
1.9
Post Balance sheet Events
1.10
Going Concern
1.11
Auditor's Report
1.12
Auditor's Certificate
1.13
Key Concepts
1.14
Summary
1.15
Exercise & Questions
1.16
Further Reading and References
CHECK YOUR
PROGRESS
What is Audit Report?
1.0 Introduction
Main objective of audit is to give report whether statement showing true
or fair effects or not. It never relates to find out fraud . In audit procedure auditor
collects evidences and on that give their report may be qualified or unqualified.
1.1 Objectives
1. To understand the concept and basic elements of the auditor's report.
2. To be familiar with various types of Audit Report.
3. To learn clauses regarding audit report under Companies Act 1956.
4. To learn the specifications regarding Auditor's Certificate.
1.2 Audit Report
These reports form the medium of communication of the auditor's views
to the members of the company.
AUDITING - II (9)
AUDITING - II
1.3 Basic Elements of the Auditor’s Report
The basic elements of the auditor's report are-
NOTES
1.
Title:
The Auditor's Report should have an appropriate title i.e. as "Auditors
Report" distinguished from other Reports, e.g. reports of officers of the entity,
Board of Directors.
2.
Addressee:
The Auditor's Report should be appropriately addressed as required by the
circumstances of the engagement and applicable laws and regulations. Ordinarily,
the Auditor's Report is address appointing the Auditor.
3.
Opening or Introductory Paragraph:
a) The Auditor's Report should identify the Financial Statements of the entity
that have been audited, including the date of and period covered by the
Financial Statements.
CHECK YOUR
PROGRESS
b) The Report should include a Statement that the Financial Statements are
the responsibility of the entity's management and a Statement that the
responsibility of the Auditor is to express an opinion on the Financial
Statements based on the audit.
Describe basic elements of the Auditer’s
Report?
4.
Scope Paragraph:
a) The Auditor's Report should describe the scope of the audit by stating
that the audit was conducted in accordance with auditing standards
generally accepted in India.
b) The Report should include a statement that the audit was planned and
performed to obtain reasonable assurance whether the Financial
Statements are free of material misstatement.
c) The Auditor's Report should described the Audit as includingl Examining, on a test basis, evidence to support the amounts and disclosures
in financial statements.
l Assessing the accounting principles used in the preparation of the Financial
Statements.
l Assessing significant estimates made by management in the preparation
of financial statements.
l Evaluating the overall position of Financial Statements.
d) The Report should include a statement by the Auditor that the audit
provides a reason opinion.
5.
Opinion Paragraph:
The Opinion paragraph of the Report should indicate the Financial Reporting
framework used to prepare the Financial Statements. It should state the Auditor's
opinion as to whether the Financial Statements give a true and fair view in
accordance with the financial reporting framework & where appropriate, whether
the Financial Statements comply with the statutory requirements.
(10) AUDITING - II
6.
Date of the Report:
The date of an Auditor's Report is the date on which the Auditor signs the
report expressing an opinion on the Financial Statements. The Auditor should not
date the Report earlier than the date on which the Financial Statements are signed
or approved by Management.
7.
Audit Report and
Auditors Certificate
NOTES
Place of Signature:
The Report should name the specific location, which is ordinarily the city
where the Audit Report is signed.
8.
Auditor's Signature:
The Report should be signed by the Auditor in his personal name. Where
a firm is appointed as the Auditor, the Report should be signed in the personal name
of the Auditor & in the name of the Audit Firm. The Partner/Proprietor signing the
Report should mention his ICAI Membership number.
1.4 Company Auditor
CHECK YOUR
PROGRESS
Describe types of Audit Report?
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.
1.5 Types of Audit Report
SA 200 states that the audit report should contain a clear written expression
of opinion on the financial statements. In order to express such an opinion, the
auditor should review and assess the conclusions drawn from the audit evidence
obtained by him. On the basis of his assessment, the auditor may issue an unqualified,
qualified, adverse or disclaimer of opinion.
1.
Unqualified Opinion:
The auditor issues a clear report in case he does not have any reservation in
respect of matters contained in the financial statements. In such a case, the audit
report may state that the financial statements give a true and fair view of the state
of affairs and profit and loss account during the period. For issuance of unqualified
report, the auditor should satisfy himself thati.
Reasonable evidence is obtained in support of the transactions recorded
in the books of accounts.
ii. Accounting entries passed in the books of account are in conformity with
the applicable accounting principles and standards followed consistently.
iii. The financial statements prepared represent a true summary of transactions
that took place during the year.
iv. The process of classification and aggregation followed in preparation of
the financial statements is fair and does not hide a material fact. The
form of accounting statement is in the required form, if any.
AUDITING - II (11)
AUDITING - II
v. The accounting statements do not contain any misstatement.
vi. The material transactions recorded in the books are neither illegal nor
beyond the legal power of the client.
vii. All statutory and relevant disclosures have been made.
NOTES
Circumstances that may result in other than unqualified opinion:
i.
Limitation of Scope - The client or circumstances may impose the
limitation of scope on auditor's work.
ii. Disagreement with Management - The disagreement may be as regards
the applicability of accounting policies or the method of their application
including the adequacy of disclosures in the financial statement.
iii. Uncertainty - A significant uncertainty, the result of which will be
dependent upon resolution of future event may cause the auditor to qualify
his report.
2.
Qualified Opinion:
A qualified opinion is issued when the auditor concludes that he cannot
issued an unqualified opinion but that the effect of any disagreement, uncertainty
or limitations on scope is not so material as to require an adverse or a disclaimer of
an opinion. It is given in respect of a part of the information reflected in the financial
statements and that the auditor is not in agreement with that part.
The need for a qualified opinion arises where the auditor is satisfied with
the truth & fairness of the financial statements; yet because of certain transactions
he is not fully satisfied so as to issue a clean or unqualified report. There can be
numerous situations where it would be proper to opt for a qualified opinion.
3.
Adverse Opinion:
An adverse opinion is issued by the auditor when the financial statements
do not show a true and fair view of the state of affairs or of the operating results.
An adverse opinion is given when there is flagrant violation of accounting principle
or evidence is not available for material transactions or where there exists material
misstatement or concealment about financial affairs. The auditor must have
sufficient evidence in favour of his conclusions. Where the audit gives an adverse
opinion, he must disclose all material reasons there for & clearly state that the
financial statements do not reflect a true & fair view.
4.
Disclaimer of Opinion:
Such an opinion has to be necessarily issued when the auditor is unable to
express an opinion on the financial statements because he fails to obtain sufficient
information to form an opinion. For instance, non-availability of records either
because they are destroyed in fire or seized by the government authorities or they
are not accessible for any other reasons. Such an opinion is appropriate when
auditor cannot form an opinion due to absence of the records. The auditor must
also state the reasons whenever disclaimer of opinion is given.
(12) AUDITING - II
l
Signature of the auditor on Audit Report:
Only a person appointed as auditor of the company can sign the Auditor's
Report or sign or authenticate any other document of the company that is required
to be signed by the auditor as required under the Act.
Audit Report and
Auditors Certificate
NOTES
Examplea. Where a person is appointed as the auditor - For P & Co.
Chartered Accountants
P Proprietor
b. Where a firm is appointed as the auditor -
For PV & Co.
Chartered Accountants
P Proprietor
1.6 Audit Report Under Companies Act, 1956
i.
CHECK YOUR
PROGRESS
Report u/s 227(1A):
Section 227(1A) enquires the auditor to make specific enquiries during
the conduct of his audit. This area. 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.
Give in breif provisions
under Company Act
related to Audit Report?
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.
ii.
Report u/s 227(2):
The auditor is required to make a report to the members of the companya. 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.
AUDITING - II (13)
AUDITING - II
iii.
Report u/s 227(3):
The auditor has to state in his report-
NOTES
a. Whether he is obtained all the information & explanations which to the
best of his knowledge & belief were necessary for the purpose of audit.
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.
1.7 Option other than an Unqualified Opinion
SA 720- Whenever the auditor requires an opinion other than unqualified,
a description of all the substantive reasons should be included in the report &
quantification of the possible effects, individually & in aggregate, on the financial
statements should be mentioned in the report.
1.8 Other information issued with Audited Financial
Statement
The objective of the auditor is to respond appropriately when documents
containing audited financial statements & the auditor's report thereon include other
information that could undermine the credibility of those financial statements & the
auditor's report.
a. The auditor shall read the other information to identify material
inconsistencies, if any with the audited financial statements.
b. The auditor shall make appropriate arrangements with management to
obtain the other information prior to the date of the auditor's report.
1.9 Post Balance Sheet Events
i.
(14) AUDITING - II
The auditor shall obtain sufficient appropriate audit evidence that all events
occurring after the balance sheet date, that requires adjustments of, or
disclosure in financial statements have been identified.
ii. Auditor shall- Obtain an understanding of any procedure management has established
to ensure that subsequent events are identified.
- Inquiring of management
Audit Report and
Auditors Certificate
NOTES
- Study the minute & entity's latest subsequent interim financial statements.
iii. If auditor identified the events that require adjustments of, or disclosure
in financial statements, auditor shall determine whether each such event
is appropriately reflected in those financial statements.
1.10 Going Conern
l Under the going concern assumption, an entity is viewed as continuing in
business for the foreseeable future.
l In case the financial statements have not been prepared on a going
concern basis, the fact would need to be appropriately disclosed.
l Auditor's responsibility is to obtain sufficient appropriate audit evidence
about the appropriateness of the going concern assumption.
CHECK YOUR
PROGRESS
Describe different
opinions of Audit
Report?
l He shall consider whether there is material uncertainty about the entity's
ability to continue as a going concern.
l The absence of any reference to going concern uncertainty in an auditor's
report cannot be reviewed as a guarantee as to the entity's ability to
continue as a going concern.
1.11 Auditor’s Report
The offer document should include auditor's report on the profit & loss
statement for the five years immediately preceding the issue of prospectus & on
the assets & liabilities as on the date of issue of prospectus.
1.12 Auditor’s Certificate
The offer document should also include a forecast of estimate profit for
the financial year ending immediately before the date of offer document & for the
financial year ending immediately after the date of the offer document. This should
be supported by an auditor's certificate, which lists the major assumption on which
the forecast is based & gives assurance on the arithmetical calculations derived
from such assumption.
1.13 Key Concepts
The Auditor's Report form the medium of communication of the auditor's
views to the members of the company.
Unqualified Opinion -The auditor issues a clear report in case he does
not have any reservation in respect of matters contained in the financial statements.
Qualified Opinion -The need for a qualified opinion arises where the
auditor is satisfied with the truth & fairness of the financial statements; yet because
AUDITING - II (15)
AUDITING - II
of certain transactions he is not fully satisfied so as to issue a clean or unqualified
report.
An adverse opinion is issued by the auditor when the financial statements
do not show a true and fair view of the state of affairs or of the operating results.
NOTES
Disclaimer of Opinion- Such an opinion has to be necessarily issued
when the auditor is unable to express an opinion on the financial statements because
he fails to obtain sufficient information to form an opinion.
Under the going concern assumption, an entity is viewed as continuing in
business for the foreseeable future.
1.14 Summary
At the end of every audit, the auditor issues his report, which contains
factual information as well as his opinion on the financial statements & other areas.
Basic elements of the auditor's report are -Title, Addressee, Opening or Introductory
Paragraph, Scope Paragraph, Opinion Paragraph, Date of the Report, Place of
Signature. Auditor's Signature.
On the basis of his assessment, the auditor may issue an unqualified,
qualified, adverse or disclaimer of opinion. The auditor is required to make a report
to the members of the company on the accounts examined by him, on the balance
sheet & profit & loss account, on every other document declared by act.
1.15 Exercise & Questions
1. What is Audit Report? Which are the elements of audit report?
2. Explain the various types of audit report in brief?
3. Explain the concept of Going Concern?
l
Fill in the blanks:
1)
The _________________of the Report should indicate the Financial
Reporting framework used to prepare the Financial Statements.
(Date, Opinion paragraph, Scope paragraph, Opening paragraph)
2)
According to ___________of the Companies Act 2013, every company
shall appoint an auditor to audit its books of accounts.
(section 224, section 139(1), section 205, section 226)
3)
______________is issued by the auditor when the financial statements do
not show a true and fair view of the state of affairs or of the operating
results.
(Adverse opinion, Clean opinion, Qualified opinion, Disclaimer of opinion)
4)
The Auditor's Report should have an appropriate __________ i.e. as "Auditors
Report"
(dated, addressed, title, Signed)
5)
(16) AUDITING - II
__________________ has to be necessarily issued when the auditor is
unable to express an opinion on the financial statements because he fails to
obtain sufficient information to form an opinion.
(Adverse opinion, Clean opinion, Qualified opinion, Disclaimer of opinion)
6)
Under the ______________assumption, an entity is viewed as continuing
in business for the foreseeable future.
Audit Report and
Auditors Certificate
(going concern, accrual, consistency, materiality)
7)
The ___________ should include a statement by the Auditor that the audit
provides a reason opinion.
NOTES
(Resolution, Statement, Report, Prospectus)
8)
The Report should name the specific location, which is ordinarily the city
where the ____________________is signed.
(Board report, Audit report, Annual report, Cost audit report)
9)
Auditor's responsibility is to obtain sufficient appropriate
_________________ about the appropriateness of the going concern
assumption.
(Audit evidence, Audit program, Audit plan, Audit report)
10) _______________deals with the auditor's opinion other than unqualified
opinion.
(SA 710, SA 530, SA 720, SA 230)
11) Auditor should enquire that whether personal expenses have been charged
to _________________.
(Revenue account, Capital account, Balance sheet, Trading account)
12) The auditor issues a _____________ in case he does not have any reservation
in respect of matters contained in the financial statements.
(Qualified opinion, Disclaimer of opinion, Adverse report, Clean report)
13) Only a person appointed as _____________of the company can sign the
Auditor's Report.
(Auditor, Director, Manager, Secretary)
14) Director is disqualified from being appointed as director under sec.
___________.
(275, 274(i) (g), 205, 141)
(Answers: 1) Opinion paragraph, 2) section 139(1), 3) Adverse opinion, 4)
title, 5) Disclaimer of opinion, 6) going concern, 7) Report, 8) Audit report, 9)
Audit evidence, 10) SA 720, 11) Revenue account, 12) Clean report, 13)
auditor, 14) 274(i) (g) )
1.16 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 - II (17)
AUDITING - II
UNIT - 2
COMPANIES AUDITOR'S REPORT
ORDER 2003
NOTES
Structure:
2.0
Introduction
2.1
Objectives
2.2
Companies (Auditor's Report) Order 2003
2.2.1
Matters to be covered in the auditor's report
2.2.2
Reasons to be stated for unfavorable of qualified answers
2.3
Summary
2.4
Exercise & Questions
2.5
Further Reading and References
CHECK YOUR
PROGRESS
Describe
2003?
CARO
2.0 Introduction
Every company is required to appoint an auditor. Companies auditor's report
order introduced in the year 2003.
2.1 Objectives
1. To analyze Companies (Auditor's Report) Order 2003
2. To understand the importance of CARO
2.2 Companies (Auditor’s Report) Order 2003
CARO come into force on the 1st day of July, 2003.
CARO shall apply to every company including a foreign company as defined
in section 591 of the Act, except following: l
Banking company as defined in clause (c) of section 5 of the Banking
Regulation Act, 1949;
l
An insurance company as defined in clause (21) of section 2 of the Act;
l
A company licensed to operate under section 25 of the Act; and
l
A private limited company with
i.
A paid up capital and reserves not more than fifty lakh rupees and
ii. Does not have loan outstanding exceeding Rupees Twenty Five lakhs
from any bank or financial institution &
(18) AUDITING - II
iii. Does not have a turnover exceeding five crore rupees at any point of
time during the financial year.
2.2.1 Matters to be covered in the auditor's report:
The auditor's report on the account of a company to which this Orders
applies shall include a statement on the following matters-
Companies Auditor’s
Report Order 2003
NOTES
1.
Fixed Assets:
i. Adequacy of records: Whether or not proper records have been maintained
to show full particulars including quantitative details and details about
situation of Fixed Assets.
ii. Verification: Whether the management has physically verified the fixed
assets & whether material discrepancies observed.
iii. Going concern: Whether the going concern assumption is violated in case
of sale of a substantial part of the fixed assets.
2.
Inventories:
i. Verification: Whether the management has physically verified all
inventories at suitable intervals.
ii. Adequacy of Verification procedures: Whether the procedure for
verification are reasonable & adequate.
iii. Adequacy of records:
- Whether the company is maintaining proper records of inventory.
- Whether any material discrepancies were noticed on physical
verification.
3.
Loans to /from Directors & Interested Parties:
i. Particulars of parties: Details of directors &related parties recorded in
the register maintained u/s 301.
ii. Terms & conditions: Whether the terms & conditions of loan given or
taken by company are prejudicial to the interest of the company.
iii. Repayment: whether the payment of the principal & it's interest amount
are regular.
iv. Steps for recovery: If overdue amount is more than rupees one lakh,
whether reasonable steps have been taken by the company for recovery
of principal & it's interest.
4.
Internal control:
Adequacy: Is there an adequate internal control procedure commensurate
with the size of the company.
Correction of weakness: Whether there is a continuing failure to correct
major weaknesses in internal control.
Transactions covered by section 301:
Records: whether transactions that need to be entered into a register u/s
301 have been so entered.
Reasonability: Whether each of these transactions is reasonable having
regard to the prevailing market prices at the relevant time.
(This information is required only in case of transactions exceeding the
value of five lakh rupees in respect of any party & in any one financial
year)
i.
ii.
5.
i.
ii.
CHECK YOUR
PROGRESS
Give in breif Matters
to be covered in the
Auditer’s Report?
AUDITING - II (19)
AUDITING - II
6.
Deposits from public:
i. If company has accepts deposits from public, whether following are
complied with- Directives issued by the RBI of India.
- Provisions of section 58A & 58AA of Companies Act.
- Orders, if any passed by the Company Law Board.
ii. The nature of contraventions, if any, should be stated in the report.
7.
Internal audit:
Auditor should report whether or not the following companies have an
internal audit systemi. Listed companies, or
ii. Companies having Paid-up Capital and Reserves exceeding Rs.50 lakhs
as at the commencement of the Financial Year concerned, or
iii. Companies having an Average Annual Turnover exceeding Rs.5 crores
for a period of three consecutive Financial Years immediately preceding
the Financial Year concerned.
8.
Cost accounting records:
If the central government had prescribed maintenance of cost records u/
s 209(1) (d), whether or not such accounts & records have been prepared
& maintained properly.
9.
Statutory dues:
i. Is the company regular in depositing undisputed statutory dues. Eg.
Provident fund, Income tax, wealth tax, services tax, custom duty, etc.
ii. If not paid regularly the extent of outstanding statutory dues as at the last
day of the financial year for a period of more than 6 months from the
date they became payable, shall be indicated in report.
iii. If such non-payment of dues in on account of any dispute, then the amount
involved & the forum where the dispute is pending should also be
mentioned.
10.
Loss making company:
Company which has been registered for a period not less than five years,
the following should be reportedi. Whether the accumulated losses at the end of the relevant financial year
exceeded 50% of company's net worth.
ii. Whether the company has incurred cash losses in financial year & the
immediately preceding financial year.
11.
Repayment of dues:
i. Has the company paid the principal & interest dues without any default.
ii. In case of default the period & amount should be reported.
12.
Loans against securities:
i. If company has advanced against security by way of pledge. Proper &
adequate documents & records are to be maintained.
NOTES
(20) AUDITING - II
ii. Where there are deficiencies in the maintenance of records, the same
should be reported by the auditor.
13.
Chit / Nidhi / Mutual fund / Societies:
i. Whether or not provisions have been duly complied with.
ii. Whether the net owned fund to deposit liability ratio is more than 1:20.
14.
Companies dealing in securities:
Where the companies dealing in securities, whetheri. Proper records have been maintained of transactions.
ii. Timely entries have been made therein
iii. Securities have been held by the company is its own name except to
extent of exemption, if any granted u/s 49.
15.
Guarantees given:
Where the company has given any guarantee for loans taken whether or
not, the terms & conditions thereof are prejudicial to the interest of the
company.
16.
End use of borrowings:
Whether or not term loans are applied for the purpose for which such
loans were obtained.
Application of funds:
Whether the short term funds have been applied for long term investment.
If such application is made then it should be indicated in the audit report.
Preferential allotment:
Whether company has made any preferential allotment to parties &
companies covered in register maintained u/s 301.
If preferential allotment has been made, whether the issue price of such
shares is prejudicial to the interest of the company.
17.
i.
ii.
18.
i.
ii.
19.
Companies Auditor’s
Report Order 2003
NOTES
Securities for debentures issued:
Whether or not adequate securities have been created in respect of
debentures issued.
20.
End use of issue proceeds
i. Whether the end use of money raised has been adequately disclosed.
ii. Whether such end use & disclosure has been verified.
21.
Fraud:
i. Whether any fraud has been noticed or reported during the year.
ii. Whether the nature & amount involved should be indicated.
2.2.2 Reasons to be stated for unfavorable of
qualified answers:
i.
Where the answer to any the question is unfavorable, the auditor's report
AUDITING - II (21)
AUDITING - II
shall state the reasons for such unfavorable or qualified answers as the
case may be.
ii. Where the auditor is unable to express any opinion, his report shall indicate
such fact together with the reasons why it is not possible for him to give
an answer to such a question.
NOTES
2.3 Summary
Matters to be covered in the auditor's report are Fixed Assets, Inventories,
Loans to /from Directors & Interested Parties, Internal Control, Transactions
covered by section 301, Deposits from public, Internal Audit, Cost accounting
records, Statutory dues, Loss making company, Repayment of dues, Loans against
securities, Chit / Nidhi / Mutual fund / Societies,Companies dealing in securities,
Guarantees Given, End use of borrowings, Application of funds, Preferential
Allotment, Securities for debentures issued, End use of issue proceeds ,Fraud.
2.4 Exercise & Questions
1. Discuss the applicability of CARO 2003?
2. Which matters to be covered in auditor's report under CARO 2003?
l
Fill in the blanks:
1)
CARO shall apply to every company including a __________ company as
defined in section 591 of the Act.
(Banking, Insurance, Foreign, Companies u/s 25)
2)
The _________________has physically verified all inventories at suitable
intervals.
(Auditor, Management, Cost auditor, Director)
3)
Details of directors &related parties recorded in the register maintained
_________.
(u/s 205, u/s 305, u/s301, u/s 25)
4)
If overdue amount of loan is more than rupees ____________, whether
reasonable steps have been taken by the company for recovery of principal
& its interest.
(One lakh, Five lakh, Three lakh, Ten lakh)
5)
Auditor should report whether Companies having Paid-up Capital and
Reserves exceeding Rs.____________ as at the commencement of the
Financial Year concerned have an internal audit system.
(25 lakhs, 50 lakhs, 5 lakhs, 75 lakhs)
6)
The __________________ had prescribed maintenance of cost records u/
s 209(1) (d).
(Management, Auditor, Central Government, State Government)
7)
(22) AUDITING - II
If statutory dues not paid regularly, the extent of outstanding statutory dues
as at the last day of the financial year for a period of more than
_____________from the date they became payable, shall be indicated in
report.
(6 months, 3 months, 12 months, 5 months)
8)
Reporting of loss making companies apply to only those company which has
been registered for a period not less than _____________.
Companies Auditor’s
Report Order 2003
(3 years, 5 years, 8 years, 10 years)
9)
In case of Chit company the net owned fund to deposit liability ratio is more
than ________.
NOTES
(1:10, 2:5, 1:20, 1:5)
10) Where the company has given any ______________for loans taken whether
or not, the terms & conditions thereof are prejudicial to the interest of the
company.
(guarantee, warranty, security, assets)
11) ______Matters to be covered in CARO.
(12, 19, 21, 25)
12) Where the answer to any the question is ____________, the auditor's report
shall state the reasons for the same.
(favorable, unfavorable, true, false)
13) Whether or not adequate securities have been created in respect of
_____________ issued.
(debentures, equity shares, preference shares, bonds)
14) Whether the short term funds have been applied for _____________
investment.
(short term, current, long term, trade)
15) If preferential allotment has been made, whether the ______________ of
such shares is prejudicial to the interest of the company.
(current price, issue price, market price, cost price)
(Answers: 1) Foreign, 2) management, 3) u/s 301, 4) one lakh, 5) 50 lakh, 6)
Central Government, 7) 6 months, 8) 5 years, 9) 1:20, 10) guarantee, 11) 21,
12) unfavorable, 13) debentures, 14) long term, 15) issue price)
2.5 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 - II (23)
AUDITING - II
UNIT - 3
SPECIAL AUDIT - I
NOTES
Structure:
3.0
Introduction
3.1
Objectives
3.2
Special Audit
CHECK YOUR
PROGRESS
Give provissions of
Audit of Sole Traders?
3.2.1
Audit of a Sole Trader's Accounts
3.2.2
Audit of Partnership Firm
3.2.3
Audit of Small Company
3.2.4
Audit of Cinema Hall
3.2.5
Auditing the Accounts of Hospital
3.3
Summary
3.4
Exercise & Questions
3.5
Further Reading and References
3.0 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 conducts audit of financial
statements of business engage in various sectors.
3.1 Objectives
1. To understand the procedure of audit of different sectors.
2. To obtain detail knowledge of special audit.
3.2 Special Audit
3.2.1 Audit of a Sole Trader's Accounts:
The salient features of audit of sole trader's accounts are:
1.
Non - Mandatory Audit:
There is no legal obligation for a sole trader to have his accounts audited,
except when he is covered by certain specific legal provisions.
E.g. Section 44AB of the Income Tax Act, provisions of Local Sales Act
etc.
2.
(24) AUDITING - II
Scope:
l The scope of audit and the conditions, under which it will be carried out,
can be determined by the sole Trader himself.
l The proprietor can also decide whether the audit shall be carried out
continuously or at the year end.
3.
Special Audit - I
Letter of Engagement:
l A written letter of appointment, which clearly defines the scope of the
audit work, should be obtained, in order to prevent misunderstanding.
NOTES
l Alternatively, the auditor should write to his client explaining the scope of
his duties, stating limitations if any, placed by the client. This letter should
be acknowledged by the client before commencement of audit.
4.
Advantages:
Audit of Sole Trader's accounts has the following advantages:
l Moral check: It acts as a moral check on the employees from committing
defalcations / embezzlement.
l Tax Liability: Audited statements of account are helpful in settling liability
for taxes.
l Credit Negotiation: Financiers and Bankers use audited financial
statements in evaluating the credit worthiness of individuals in negotiating
loan. It is also useful for determining the purchase consideration for a
business.
CHECK YOUR
PROGRESS
Give provissions of
Audit of Partnership
Firm?
l Trade Dispute Settlement: Audited statements are also useful for settling
trade disputes for higher wages or bonus as well as claims in respect of
damages suffered by property by due to some other calamity.
l Control over Inefficiency: It also helps in the detection of wastages and
losses and shows the different ways by which these might be checked
especially those that occur due to the absence or inadequacy of internal
checks or internal control measures.
l Arbitration: Audited financial statements are useful is settling disputes by
arbitration.
l Appraisal: Audit reviews the existence and operations of various controls
in the organization & reports inadequacies, weaknesses etc., in them.
The trader can take suitable action based on the reports.
l Assistance to Government: Government may require audited and certified
statements before it gives assistance or issues a license for a particular
trade.
Audit of accounts of a sole proprietor is not compulsory under any statute.
However, the above benefit would accrue to the sole-proprietor when he
gets his accounts audited voluntarily.
3.2.2 Audit of Partnership Firm:
Audit of a partnership firm is not prescribed by law. However, it is in the
interest of all the partners that the accounts of the firm are regularly audited by an
independent auditor. The provision of a regular audit may be made in the partnership
deed itself or by means of a separate agreement.
The terms of appointment of the auditor, the scope of his duties, rights and
liabilities will be determined by the agreement between the firm and the auditor.
The agreement should be in writing. The auditor should preserve the agreement
carefully, to be used in his defense if he is later charged with not having done
AUDITING - II (25)
AUDITING - II
something in accordance with the agreement. In case of any doubt, he should seek
written clarification from the firm.
Before starting the audit, the auditor should carefully study the partnership
deed and note, the provisions as regards the following: -
NOTES
a. Nature of the business of the firm.
b. Amount of capital required to be brought in by each partner.
c. Interest if any, to be paid in respect of capital & the amount advances by
partners in addition to capital.
d. Duration of partnership
e. Extent of drawings allowed to individual partners.
f. Salaries, commission, etc. payable to individual partners
g. Borrowing powers of the firm.
h. Rights and authority of individual partners.
i.
Basis and mode of valuation of goodwill.
j.
Terms and procedures to be followed in the case of admission, retirement
or death of a partner, & upon dissolution of the partnership or the firm.
k. Provision for audit and accounts
l.
Profit and loss sharing ratio.
In the absence of a partnership agreement, some of the provisions of the
act which concern the auditor are the following.
i.
Each partner is required to contribute an equal amount of capital.
ii. The partners shall share equally in profit & losses.
iii. The partners are not entitled to any interest on capital.
iv. When a partner is entitled to interest on capital, such interest will be
payable only out of profits.
v. A partner is entitled to interest on his advances and loans over and above
the capital at 6% per annum.
vi. Every partner can take part in the management of the business. A partner
is, however, not entitled to receive remuneration for taking part in the
conduct of the business.
vii. The property of the firm must be held and used by the partners exclusively
for the purpose of business.
viii. If a partner derives any profit for himself from any transaction of the
firm of from the use of the property of business connections of the firm
or the firm name, he must account for that profit and pay it to the firm;
also the profit from any competing business carried on by a partner without
other partner's consent must also be accounted for and paid to the firm.
ix. In the absence of any usage or customs of trade to the contrary, the
implied authority of partner does not empower him to l Submit a dispute relating to the business of the firm to arbitration;
l Open a bank account on behalf of the firm in his own name;
l Compromise or Relinquish any claim or portion of a claim by the firm;
(26) AUDITING - II
l Withdraw a suit or proceeding filed on behalf of the firm;
Special Audit - I
l Admit any liability in a suit or proceeding against the firm;
l Acquire immovable property on behalf of the firm;
l Transfer immovable property belonging to the firm; or
NOTES
l Enter into partnership on behalf of the firm.
x. A new partner can be admitted to the firm only with the consent of all the
partners.
xi. Any differences arising as to ordinary matters connected with the business
are to be decided by the majority of the partners, but no change can be
made in the nature of business without the consent of all the partners,
xii. lf upon death or retirement of a partner, the remaining partners continue
of carry on business without settlement of accounts between them, the
estate of deceased partner or the retiring partner will be entitled at his
option to the followingl Share in the profits of the firm equal to his share in the property of the
firm, or
l Interest at 6% per annum on his share in the property of the firm
xiii. On dissolution of the partnership, every partner has the right to have the
goodwill of the business sold for the common benefit of all the partners.
xiv. In the event of dissolution of the firm, the assets of the firm will be applied
to meet its losses in the following order.
xv. First, out of profits;
xvi.Next, out of capital,
xvii. Lastly, if necessary, by the partners individually in the proportion in which
they are entitled to share profits.
l
Advantages of audit of a partnership firm:
Although audit of partnership firm is not prescribed in law, there are various
advantages which would accrue to a partnership firm which gets its accounts
audited. Some of the advantages are stated below i.
When anyone of the partners is in charge of the accounts, the audit is
advisable as it will avoid any financial dispute among the partners.
ii. Where there are sleeping or dormant partners, such partners can be
satisfied that there are no frauds if the accounts of the firm are fully
audited.
iii. If the accounts of the firm are audited, the settlement of accounts and
valuation of the goodwill are facilitated when a partner dies or retires of
when one or more new partners are admitted to the firm.
iv. The partners can avail themselves of the benefits of the expertise of
audit for the purposes of taxation or better management, etc.
v. The regular visit by the auditor acts as a moral check on employees. The
books of accounts are maintained up-to-date.
vi. As the work is kept up-to-date; the information that is required by the
management is always available as and when demanded. This facilitates
AUDITING - II (27)
AUDITING - II
in planning the financial affairs.
vii. The audited accounts would also be preferred by insurance companies in
case any claims are lodged with them.
NOTES
viii. Financial institutions and bankers always prefer the audited accounts even
in case of partnership firms. They know that where accounts are audited,
they are authentic and reliable.
ix. Audited accounts are normally preferred by the income tax and the sales
tax authorities. The filling of necessary returns becomes easy.
x. In the case of the sale of a whole concern as a going concern to another
party, the audited accounts will help in finding out the worth of the business.
Assets and liabilities can be valued properly.
xi. The audited accounts are more reliable for the purposes of date of costing
purposes for finding out the cost of a product. This would also help in
fixing-up more realistic price of goods.
CHECK YOUR
PROGRESS
Give provissions of
Audit of Small
Company?
xii. For the purposes of issue of various licenses, the government requires
the audited accounts.
3.2.3 Audit of Small Company:
The duties and responsibilities of auditor and the essential features of audit
remain the same, irrespective of the size of the Company under Audit. The following
points may be noted for a small companyi. Adaptation: Satisfactory accomplishment of the audit work can be
achieved only by skillful adaption and application of the principles of auditing
to the individual case.
ii. Scope Definition: The relationship of the auditor with the directors is
generally informal. Accountancy work may also be undertaken. Hence,
the arrangement and scope of the work should be clearly defined and
recorded.
iii. Accountancy work: Where accountancy work is also undertaken, it is
desirable to separate the accountancy and audit work in order to ensure
the objectivity and independence of the audit. If it is impracticable to
separate the two functions, an audit programme should be maintained.
The final audit review should be made comprehensive.
iv. Letter of Engagement: At the time of engagement, the auditors should
explain to the directors, management's responsibilities for the preparation
of the accounts and establishing a system of internal control appropriate
to the needs of the business. The auditors' need to rely on the internal
control system should be documented in the letter of engagement.
v. Internal Control: For a small company, the internal control system is
not fully operational due tol Substantial domination of accounting and financial functions by one
person, and
(28) AUDITING - II
l Lesser number of employee internal controls in a small company
may be effective for its primary purpose as a check for management
use, but they would be defective as a check on management itself.
vi. Management Representations: Due to inherent limitations of internal
control, it is necessary to perform detailed audit procedures and rely more
on management representation. Before signing the report, a letter of
representation on the company's letterhead addressed to the auditors
should be obtained. The purpose of this representation is to place on
record, representation of the management on significant matters affecting
the account such as the ownership and basis of stating the amount of
assets, and liabilities, contingent liabilities.
vii. Evaluation of Evidence: The auditors must consider whether the
examination of the records of the company, the evidence available to
them and the knowledge of all the circumstances affecting the company
are consistent with & support the representation of management for which
direct confirmatory evidence is not available.
Special Audit - I
NOTES
CHECK YOUR
PROGRESS
Give provissions of
Audit of Cinema Hall?
3.2.4 Audit of Cinema Hall:
i.
Internal control in show collections:
l Verify that entrance to the cinema hall during the show is only through
printed tickets.
l See whether the printed tickets are serially numbered and bond into books.
l Verify whether the printed tickets are endorsed by the Commercial Tax
Authorities.
l Verify that separate series of tickets is used for advance booking.
l See whether the stock of tickets is kept in the custody of a responsible
officer.
l Confirm that at the end of the show, a statement of tickets sold is prepared
& cash collected is agreed with it and a record of the "Free Passes"
issued is maintained.
l Vouch entries in the Cash Book in respect of cash collected on sale of
tickets for different shows on a reference to Daily Statements which
have been test checked as aforementioned.
l Reconcile the amount of entertainment tax collected with the total number
of tickets issued for each class.
ii.
Advertisement Receipts:
l Verify the charges collected for advertisement slides and shots by
reference to the agreements entered into with advertisers.
l Cross verify advertisement income based on the Register of Slides and
Shots exhibited kept at the cinema hall.
AUDITING - II (29)
AUDITING - II
iii.
Refreshments/ Restaurant Income:
l Enquire into the arrangement for collection of share in the restaurant
income. It may either be a fixed sum or a fixed percentage of the takings.
l In case the stalls are run by the cinema hall, verify whether the restaurant
/ refreshment stall incomes have been properly accounted. Ensure that
closing stock of foodstuffs, cold drinks etc. have been duly considered.
NOTES
iv.
Cash Book Verification:
l Examine whether the day's collection is deposited into Bank on the
following day.
l Vouch the entries in the Cashbook in respect of cash collected on sale of
tickets for different shows on a reference to daily statements.
l Trace the deposits made in the Bank Account, along with Counterfoils of
pay-in-slips.
l Conduct Surprise Verification of cash balances and confirm whether the
same agrees with Cash Book.
v.
Expenditure verification:
l Vouch the expenditure incurred on advertisement, repairs and maintenance.
l Verify whether any part of revenue expenditure has been wrongly
capitalized. See that expenditure on extensive redecoration has been
adjusted as deferred revenue expenditure.
l Vouch payments on account of film hire with bills of distributors with
reference to agreements.
l Verify whether depreciation has been charged at the appropriate rates,
which will be higher than those admissible for other business for similar
assets.
vi.
Advances paid to Distributors:
l Examine unadjusted balance out of advances paid to the distributors
against film hire contracts, to see that they are good and recoverable.
l Verify whether all advances in respect of films already run have been
fully adjusted.
l See whether adequate provision has been made in respect of irrecoverable
advances.
vii. General:
l Verify the fixed assets and ensure that adequate depreciation is provided.
l Scrutinize the accounts of Sundry Creditors for Goods, Creditors for
Service & analyze whether there are any abnormal movements.
l Verify the Capital, Secured and Unsecured Loans, and other Liabilities.
(30) AUDITING - II
l Verify whether the form and manner of presentation of financial
information conforms to Accounting Standards and applicable legal
requirements.
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
Special Audit - I
NOTES
3.2.5 Auditing the Accounts of Hospital:
i.
Internal check:
l Examine the internal check as regards the issue & receipts of stares,
linen, apparatus, clothing, instruments, etc.
l Ensure that purchases have been made properly & recorded in the stock
register & that issues have been made only against proper authorization.
ii.
Income from:
l Examine the bill register of patients along with copies of bill issued to
them.
iii.
Services to patients:
l Test Check a few bills with patients' attendance record to see that the
bills have been correctly prepared.
CHECK YOUR
PROGRESS
Give provissions of
Audit of Accounts of
Hospital?
l Verify that bills have been issued to all the patients from whom any amount
was recoverable according to the Rules of the hospital.
l Obtain satisfactory explanations towards unbilled cases and concessional
billing cases, if applicable.
iv.
Cash Collections:
l Verify cash collections entered in the Cash book with the receipt
counterfoils and other evidence. E.g. copies of patient's bills, dividend
warrants, rent bills etc.
l Conduct Surprise Cash Verification at all cash handing locations on the
same day.
l Verify whether there exists a procedure for deposit of all cash collections
on the same day & the same has been followed.
v.
Grants and Donations:
l Verify whether the grants received, if any, have been duly accounted for.
l Ascertain that legacies and donations received for specific purposes have
been so applied.
l Ensure proper classification between Revenue and Capital in respect of
various grants.
vi.
Income from Investments:
l Analyze the Property and Investment registers to see that all the income
by way of rents from properties, dividend and interest on securities etc.
have been properly followed up with the concerned parties.
AUDITING - II (31)
AUDITING - II
vii. Purchase and Expenses:
l Vouch purchases and expenses and obtain satisfactory explanations for
abnormal & non- recurring items, if any.
l Verify whether appointment of staff and increments in their salaries have
been properly authorized by the Trustees or Managing Committee.
NOTES
l Verify whether capital expenditure has been incurred only with the prior
sanction of the trustees or Managing Committee.
l Compare the totals of various items of expenditure and income with the
amounts budgeted for them. Study the variance reports submitted to the
management.
viii. Stock-in-trade:
l Obtain inventories of assets, stocks and stores at the end of the year and
check a % of them physically. Compare their total value with the
respective ledger balances.
ix.
Taxation:
l Verify whether the liability for income tax has been properly determined
and provided for.
l In case the institution is eligible for income-tax exemption; verify whether
refund in respect of taxes deducted at source has been properly claimed.
x.
Property & Investment Register:
l Inspect the bonds, shares, scrip's and Title Deeds of properties and compare
their particulars with those entered in the Property and Investment
Registers.
xi.
General:
l Verify the fixed assets and ensure that adequate depreciation is provided.
l Verify the Share Capital, Reserves and Surplus, Secured and Unsecured
Loans.
l Verify whether the form and manner of presentation of financial
information conforms to Accounting Standards and applicable legal
requirements, Accounting Standards and applicable legal requirements.
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
3.3 Summary
Auditor is required to understand the internal control system of business
enterprise. There is no legal obligation for a sole trader to have his accounts audited,
except when he is covered by certain specific legal provisions. The provision of a
regular audit may be made in the partnership deed itself or by means of a separate
agreement. The duties and responsibilities of auditor and the essential features of
audit remain the same, irrespective of the size of the Company under Audit.
(32) AUDITING - II
3.4 Exercise & Questions
Special Audit - I
1. What are the advantages of audit of Partnership Firm?
2. How will you conduct the audit of Cinema Hall?
NOTES
3. What are the steps to be taken for the audit of Hospitals?
l
Fill in the blanks:
1)
This letter of engagement should be acknowledged by the __________before
commencement of audit.
(Auditor, Client, Expert, Member)
2)
Audited statements of account are helpful in settling liability for _________.
(taxes, bills payables, creditors, dividend)
3)
_____________ may require audited and certified statements before it gives
assistance or issues a license for a particular trade.
(Auditor, Member, Government, Director)
4)
Audit of accounts of a sole proprietor is not _____________ under any
statute.
(Optional, Compulsory, Required, Conduct)
5)
The provision of a regular audit of partnership firm may be made in the
________________ itself or by means of a separate agreement.
(Partnership deed, Prospectus, Article of association, Memorandum of
association)
6)
The ______________should preserve the agreement carefully, to be used
in his defense in case of charge of negligence.
(Partner, Firm, Auditor, Member)
7)
A partner is entitled to interest on his advances and loans over and above the
capital at ____ per annum.
(5%, 6%, 7%, 10%)
8)
In the event of dissolution of the firm, the assets of the firm will be applied to
meet its losses firstly out of __________.
(profits, reserves, capital, partner's share)
9)
Due to inherent limitations of ____________________, it is necessary to
perform detailed audit procedures.
(internal audit, internal control, testing, management)
10) The duties and responsibilities of ____________ and the essential features
of audit remain the same, irrespective of the size of the Company under
Audit.
(Government, Director, Member, Auditor)
11) Reconcile the amount of _______________ tax collected with the total
number of tickets issued for each class.
(Income, Entertainment, Wealth, Gift)
AUDITING - II (33)
AUDITING - II
12) Trace the deposits made in the ________________, along with Counterfoils
of pay-in-slips.
(Bank account, Cash account, Creditors account, Loan account)
NOTES
13) Ensure proper classification between _________and ________ in respect
of various grants.
(Current - Capital, Current - Revenue, Revenue - Capital, Revenue - Reserve)
14) Obtain appropriate management _____________ and certificates in respect
of the various aspects covered during the course of audit.
(Report, Representation, Advice, Information)
(Answers: 1) client, 2) taxes, 3) Government, 4) compulsory, 5) Partnership
deed, 6) Auditor, 7) 6%, 8) profits, 9) Internal control, 10) Auditor,
11)Entertainment, 12)Bank account, 13) Revenue & capital 14)
Representation)
3.5 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
(34) AUDITING - II
UNIT - 4
SPECIAL AUDIT - II
Special Audit - II
NOTES
Structure:
4.0
Introduction
4.1
Objectives
4.2
Special Audit
4.2.1
Audit OF Hotels
4.2.2
Auditing the Books of Club
4.2.3
Audit of Charitable Institution
4.2.4
Audit of College
4.2.5
Auditing the Books of Library
4.2.6
Audit of Newspaper Company
4.3
Summary
4.4
Exercise & Questions
4.5
Further Reading and References
CHECK YOUR
PROGRESS
Give provissions of
Audit of Hotels?
4.0 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 conducts audit of financial
statements of business engage in various sectors.
4.1 Objectives
1. To understand the procedure of audit of different sectors.
2. To obtain detail knowledge of special audit.
4.2 Special Audit
4.2.1 Audit of Hotels:
i.
Internal Control - Room Sales:
l Verify the Room Sales Collections from the Guest Register.
l Sometimes, daily occupancy reports and extra bed supply reports are
prepared. In such cases, test checks a few reports with the guest register
and with the individual guest's bills, to ensure proper billing.
l See whether standard room rates have been charged in various guests'
bills. In case of difference, obtain satisfactory explanation and sanction
for the same.
AUDITING - II (35)
AUDITING - II
ii.
Internal Control - Restaurant Billing and Sales:
All sales points in a hotel make both cash and credit sales. The auditor
should examine the internal control system as regards (a) procedure for
room service and sundry services (b) procedure for issue of provisions
and commodities and (c) safe custody of edibles, wines, cigar, cigarettes,
crockery, cutlery, linen, furniture etc. he should-
NOTES
l Perform compliances tests to ensure that the internal control system
operates effectively.
l Reconcile the total sales reported with the total of the bills issued by the
sale point, either in the form of a bill roll or a series of numerically controlled
bills.
iii.
Internal Control -Stocks:
l Examine the documentation procedure in respect of stocks since hotel
stocks are readily (a) portable & (b) saleable e.g. provisions, food,
beverages etc.
l Perform compliance tests to ensure that all such documentation is
accurately processed.
l See whether stocks are kept under safe custody under the supervision of
the department manager.
l Ensure that movement of provisions and goods in or out of the stores
takes place only after proper authorization and recording.
l Supervise the physical stocktaking and test check pricing calculations.
l Verify the basis of valuation adopted for stocks. In case of specialized
professional valuation, examine whether the valuation is done reasonably
and consistently on a systematic basis.
iv.
Casual Labour:
Generally hotels employ casual labour to a very large extent. Hence, the
auditor shouldl Examine the wage payment registers and attendance records to see
whether any manipulation has been made.
l Verify whether adequate records, as required by law, wherever applicable,
have been maintained.
v.
Commission Payments:
Generally, hotels get their bookings through travel agents, hospitality agents,
corporate (for their guests) or other booking agencies. The auditor shouldl Verify that the amounts due are recovered from agents as per the terms
of credit allowed.
l Check the commission, if any, paid to agents by reference to the
agreement.
(36) AUDITING - II
vi.
Fixed Assets:
Special Audit - II
l Obtain a schedule of fixed assets and verify whether adequate depreciation
has been provided at the prescribed rates.
l Verify whether the capitalization and depreciation policies have been
consistently followed.
NOTES
l Conduct physical inspection of fixed assets and obtain management
certificate for periodic inspection thereof.
l Examine the method of recording certain assets e.g. silver cutlery taken
as stock item in other hotels. It is important that comprehensive definition
of stock items exists and the auditor should consider that whether or not
the same have been closely followed in reality.
vii. Statutory Compliance:
l Verify whether the conditions of license for running the hotel have been
complied with.
l See whether all foreign exchange transactions have been properly entered
into & appropriately reported in the accounts.
l See whether all taxes collected on food and occupation have been remitted
to the proper authorities.
viii. Analytical Review:
l Trace the consumption shown in various physical stock accounts, to
customer's bills on a sampling basis wherever practicable or to appropriate
consumption account to ensure that all issues have been billed and
accounted for.
l Work out the occupancy rate and compare the same with other similar
hotels & with the previous year. Investigate material deviations.
l Compare the expenses and receipts with the figures of the previous year
having regard to the average occupancy of visitors and changes in the
rates.
ix.
General:
l Verify whether payments made to foreign collaborator, if any, are in
accordance with the terms of agreement.
l Vouch receipts on account of letting out of the auditorium space and
other spaces for shops & boutiques and for special shows etc. with
reference to respective agreements.
l Examine the customers' ledger on a sample basis but in depth to see that
all charges that should be made to the customers are in fact made.
l Check whether income receivable but not yet billed has been accounted
for in respect of (a) Room Charges and (b) Value of services rendered to
customers still in occupancy on the closing day.
l Check whether costs of re-decoration and renovation of buildings and
facilities have been properly accounted for.
l See whether provision for replacement of current assets like carpets,
AUDITING - II (37)
AUDITING - II
linen etc. is made.
l Verify the Share Capital, Reserves and Surplus, Secured and Unsecured
Loans.
l Verify whether the form and manner of presentation of financial
information conforms to Accounting Standards and applicable legal
requirements.
NOTES
4.2.2 Auditing the Books of Club:
i.
Constitution:
l Examine the constitution of the Club and the powers of governing body.
l Peruse the relevant rules /bye-laws relating to preparation and finalization
of accounts.
l Examine the minute's book of the Governing Body and confirm whether
the powers have been properly exercised.
CHECK YOUR
PROGRESS
Give provissions of
Audit of Club?
ii.
Entrance Fee:
Vouch the receipts on accounts of entrance fees with members'
applications, counterfoils issued and minutes of the Managing Committee.
iii.
Members' subscription:
l Vouch Members subscription with the counterfoils of receipts issued to
members.
l Trace receipts of selected periods to the Register of Members.
l Reconcile the total amount of subscription due with the amount collected
and the amount outstanding.
l Check totals of various columns of Register of Members and tally them
across.
l See the Register of Members to ascertain the dues and arrears and enquire
whether necessary steps are taken for their recovery. The amount
considered irrecoverable, if any should be written off.
l Ensure that arrears of subscription for the previous year have been
brought over correctly and arrears for the year under audit and subscription
received in advance have been correctly adjusted.
iv.
Service Charges from members:
l Verify the internal check as regards members being charged for (i)
foodstuffs and drinks provided (ii) fees chargeable for special services
rendered such as billiards, tennis etc.
l Trace debits for a selected period from subsidiary registers maintained in
respect of supplies and services to members to confirm that the account
of members have been debited with amounts recoverable from them.
v.
(38) AUDITING - II
Purchases:
l Vouch purchase of sports items, furniture, crockery etc. and trace their
entries into respective stock registers.
l Vouch purchase of foodstuffs, wines, cigars etc. and test their sale price
so as to confirm that normal rates of profits have been earned on their
sale.
l Conduct physical verification of closing stock on unsold provisions and
stores & check valuation thereof.
Special Audit - II
NOTES
l Check the stock of furniture, sports materials and other assets physically
with the respective stock registers or inventories prepared at the end of
year.
vi.
Investments:
l Inspect the share scrip's and bonds in respect of investments, check their
current value for disclosure in final accounts, and also ascertain that
arrangements for their safe custody are satisfactory.
l Check the accrual of income there from and provision of income tax
thereon.
CHECK YOUR
PROGRESS
vii. General:
l Verify the fixed assets and ensure that adequate depreciation is provided.
l Scrutinize the accounts of Sundry Creditors for Goods, Creditors for
Services and analyze whether there are any abnormal movements.
Give provissions of
Audit of Trust?
l Verify whether the form and manner of presentation of financial
information conforms to Accounting Standards and applicable legal
requirements.
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
4.2.3 Audit of Charitable Institution:
The following matters deserve the auditors' attention in the curse of audit
of a Charitable Institution:
i.
Constitution:
l Ascertain the constitution of the Charitable Institution.
l Note the financial powers of the executives and the managing committee.
l Examine the relevant bye-laws or trust deed in order to ascertain the
powers & duties of the Managing Committee or Board of Trustees.
ii.
Activities:
l Examine the activities that are being carried on by the institution and
verify whether the same are within the permitted objects of the institution.
l Scrutinize the minute's book of the managing committee as regards various
financial decisions including the decisions on sale or purchase of investment,
fixed assets acquisition or disposal, receipt donations, etc.
AUDITING - II (39)
AUDITING - II
iii.
Donations:
l Vouch all donations received as shown in the cash book, with corresponding
counterfoil receipts.
l In case subscription and donation lists are periodically published, verify
whether all such donations have actually been received.
NOTES
l In case of donation of assets or donation-in-kind, ensure that they are
properly recorded.
iv.
Investments:
l Verify whether purchase and sale of any investment have been properly
authorized.
l Verify Banker's certificate for the lodgment of all securities on the last
day of the accounting year.
v.
Income Verification:
l Vouch all incomes received by way of subscriptions, donation on revenue
account, rent, interest and dividend receipts.
l Verify whether year-end adjustments have been properly carried out in
respect of interest and rents receivable.
vi.
Expenses Verification:
l Verify that all grants and expenses etc. from the funds of the charity are
properly authorized by the managing committee and are intended towards
its objectives.
l Verify whether proper sanction exists in respect of regular administrative
expenditure like salaries, telephone, printing and stationery etc.
l Ensure that the expenses are not incurred to result in the direct or indirect
benefit of any member of the Managing Committee or their relatives.
vii. Taxation:
l Verify whether the institution enjoys income-tax exemption u/s 11 of the
Income Tax Act.
l When tax is deducted at source from rents, interest etc., and see whether
refund claim has been made.
l Examine whether the conditions of exemption are strictly adhered to.
l Verify whether Return of Income u/s 139 (4A) was filed within due date.
viii. General:
l Verify the fixed assets acquired by purchase or by endowment, and ensure
that adequate depreciation is provided.
l Verify the Capital Fund and Other Liabilities if any.
l See whether "Fund Accounts" are represented by earmarked investments.
(40) AUDITING - II
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
Special Audit - II
NOTES
4.2.4 Audit of College:
i.
Constitution:
l Study the Trust Deed or Regulations and ascertain the constitution of the
organization.
l Note the provisions affecting accounts, contained in the regulations.
ii.
Minutes Book:
l Peruse the minutes of the meetings of the Managing Committee or
Governing body, noting resolutions affecting accounts.
l Ensure that the decisions taken have been duly complied with.
iii.
Fees from Students:
CHECK YOUR
PROGRESS
Give provissions of
Audit of College?
l Check the names entered in the Students Fee Register for each month or
term, with the respective Class Registers, showing names of students on
rolls and testing amount or fees charged.
l See that the system of internal check ensures that demands against the
students are properly raised.
l Verify fees received by comparing counterfoils of receipts given with
entries in the Cash Book.
l Trace the collection in the Fee Register to confirm that the revenue from
this source has been duly accounted for.
l Ascertain whether fees paid in advance have been duly considered under
the sanction of an appropriate authority.
l Verify admission fees with admission slips signed by the Principal of the
College & confirming that the amount has been credited to a capital fund
or separate Account if decided so by the Managing Committee.
l Verify whether fines for late payment, absence etc. have either been
collected or remitted under proper authority.
iv.
Other Income:
l Verify rental income from landed property with Rent Receipts and
agreements.
l Vouch the income from endowments and legacies, as well as interest and
dividends from investment; verifying the securities in respect of
investments held.
l Verify any government or local authority grant with the memo of a grant.
Ascertain the reasons if any expenses has been disallowed for purposes
of grant.
AUDITING - II (41)
AUDITING - II
v.
Expenditure:
l Ascertain the operation of internal control system over various heads of
expenditure.
l Vouch various expenditure items, noting abnormal or heavy items, if any.
Obtain suitable explanations for significant items of expenditure.
NOTES
vi.
Taxation:
l Verify whether the institution enjoys tax exemption under the Income-tax
Act.
l In case of tax deducted at source from rents, interest etc., see whether
refund claim has been made.
l Examine whether the conditions subject to which exemption is granted,
have been followed.
CHECK YOUR
PROGRESS
vii. General:
l Verify the fixed assets and ensure that adequate depreciation is provided.
Give provissions of
Audit
of
Sole
Liabrary?
l Verify the Capital Fund and other Liabilities.
l Confirm that caution money and other deposits paid by students on
admission, have been shown as liability in the balance sheet and not
transferred to revenue, unless they are not the refundable.
l Note that the investments representing endowment funds for prizes are
kept separate & any income in excess of the prizes has been accumulated
and invested along with the corpus.
l Ensure that separate statements of accounts have been prepared as
regards Scholarship Fund, Games Fund, Hostel Fund, Staff Provident
Fund etc.
l Verify whether the form and manner of presentation of financial
information conforms to Accounting Standards and applicable legal
requirements.
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
4.2.5 Auditing the Books of Library:
i.
Constitution:
l Verify whether the library is a registered society or public trust.
l Examine the relevant bye-laws or trust deed in order to ascertain the
powers & duties of the management.
ii.
Minutes Book:
l Examine the Minute Books of the Managing Committee to ensure that
resolutions affecting the accounts have been complied with.
l Verify whether expenditure and outgoings are approved by the Managing
Committee or properly delegated to responsible officials.
(42) AUDITING - II
iii.
Internal Control:
Special Audit - II
l Examine the internal check in respect of collection of fees, disbursement
on account of payment of salaries to the staff, purchase of books, and
issue of books to the members, sale of magazines and journals and security
against unauthorized movement of books.
NOTES
iv.
Security Deposit Register:
l Verify whether security deposit received from members / users are
properly recorded.
l Verify the entry with counter foil of the receipt book and trace the same
in the cash book / Bank Statement.
l Trace the receipt entry into the Security Deposit Register.
v.
Assets Register:
l Verify whether there is a proper register for recording various assets like
furniture, books investments etc.
l Inspect the assets and trace the same into the Assets and Investment
Registers.
l Obtain confirmations when investments are held by the Bank for safe
custody.
vi.
CHECK YOUR
PROGRESS
Give provissions of
Audit of Newspaper
Company?
Income Verification:
l Verify whether the following items of income / receipts have been properly
accounted for- Admission fee, Security Deposit and Membership Fees.
l Sale proceeds of magazines and journals.
vii. Grants:
l Verify the receipt of grants from Government or local authorities.
l Ensure whether the same has been properly utilized for the purpose
specified by the authority.
viii. General:
l Verify the fixed assets & ensure that adequate depreciation is provided.
l Verify whether the form and manner of presentation of financial
information conforms to Accounting Standards and applicable legal
requirements.
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
4.2.6 Audit of Newspaper Company:
i.
Preliminary:
l Note the relevant provisions of the Companies Act, 1956 or any legislation,
which are applicable to the Company.
l Examine the Memorandum and Articles of Association. Note the objects
clause, persons who can execute the contracts, delegation, financial
powers, etc.
AUDITING - II (43)
l Note from the Minutes of Board Meetings, the delegation of powers to
various officers, & exercise of powers in pursuance of Articles of
Association.
AUDITING - II
l Obtain a list of books of account, registers, memoranda records and
accounting policies adopted by the Company.
NOTES
ii.
Internal Control:
Examine the Internal Control System operating in the Company regardingl Recording issues and supplies to News Agents.
l Recording direct sales to subscribers.
l Systems of distributing free Copies and sample Copies.
l Purchase of various materials required for printing, and issue thereof for
printing purposes.
l General system of accounting.
iii.
Income Verification:
l Ascertain whether all income by way of sale of issues have been properly
recognized.
l Ensure that the system has sufficient controls to prevent leakage of
revenue. This is because the sale of issues, by individual amounts, may
not be material, but their collective impact will be material, in case of
defalcation or misappropriation.
l Examine the system of checking and giving credit for copies returned
especially those charged out before the year-end and subsequently
returned.
iv.
Advertising Income:
l Verify whether all income by way of advertisements have been recognized
properly.
l Vouch the incomes due based on contracts with authorized advertisement
booking agents.
l Where monthly advertisement revenue statements are prepared, verify
incomes receivable from select advertisements on sample basis.
l Ensure that agents' account balances are properly reflected in the
accounts.
(44) AUDITING - II
v.
Expenditure Verification:
Scrutinize the Nominal Ledger / General Ledger for various expenditure
heads. In case of abnormal debits to expenditure accounts, obtain suitable
explanations.
vi.
Newspaper Competitions:
Verify the existence of any liability in connection with competitions for
which prizes are offered.
vii. Stock Valuation:
Special Audit - II
Verify whether the closing stock of newsprint have been properly valued
in view of fluctuating prices. See whether the basis of valuation is the
same as in the preceding period.
NOTES
viii. Suits against the Company:
l Examine the Advocates Correspondence File and find out the possibility
of legal or other actions outstanding against the newspaper.
l See whether adequate provision has been made in respect of ascertained
liabilities.
ix.
Commitments:
l Verify whether there are any forward commitments with regard to bulk
buying of paper.
l Ensure that the same is adequately reflected in the financial statements.
x.
Going Concern:
Verify whether the going concern assumption would be correct in case
of (i) Plant & machinery becoming non-usable; or (ii) Labour-strike; or
(iii) Supplies of paper becoming unavailable.
xi.
General:
l Verify the fixed assets and ensure that adequate depreciation is provided.
l Scrutinize the accounts of Sundry Creditors for Good, Creditors for
Services and analyze whether there are any abnormal movements.
l Verify the Share Capital Reserves and Surplus, Secured and Unsecured
Loans.
l Obtain appropriate management representations and certificates in respect
of the various aspects covered during the course of audit.
4.3 Summary
Auditor is required to understand the internal control system of business
enterprise. The auditor should examine the internal control system as regards (a)
procedure for room service and sundry services (b) procedure for issue of provisions
and commodities and (c) safe custody. Examine the constitution of the Club and
the powers of governing body.
4.4 Exercise & Questions
1. Which maters covered in the audit of Charitable Institutions?
2. How will you conduct the audit of Books of Library?
AUDITING - II (45)
AUDITING - II
l
Fill in the blanks:
1)
All sales points in a ___________make both cash and credit sales.
(Hospital, Hotel, Library, College)
NOTES
2)
Auditor should verify the basis of ____________ adopted for stocks.
(Valuation, Verification, Documentation, Observation)
3)
Examine the constitution of the Club and the powers of governing body.
(Prospectus, Agreement, Constitution, Memorandum)
4)
Vouch the receipts on accounts of ________________ with members'
applications, counterfoils issued and minutes of the Managing Committee.
(Subscription, Membership fees, Entrance fees, Admission fees)
5)
Obtain ______________ when investments are held by the Bank for safe
custody.
(Confirmation, Enquiry, Observation, Verification)
6)
The Charitable institution enjoys income-tax exemption ______of the Income
Tax Act.
(u/s 10, u/s 11, u/s 12, u/s 13)
7)
Auditor should verify any government or local authority ________ with the
memo of a grant.
(Grant, Help, Subscription, Assurance)
8)
Return of Income u/s 139 (4A) was filed within due date.
(139(2), 139(4A), 139(8), 140)
9)
All income by way of ______________ have been recognized properly.
(Advertisement, Grant, Subscription, Commission)
(Answers: 1) Hotel, 2) Valuation, 3) constitution, 4) entrance fees, 5)
confirmation, 6) u/s 11, 7) grant, 8) 139(4A), 9) Advertisement)
4.5 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
(46) AUDITING - II
UNIT - 5
AUDIT SAMPLING
Structure:
5.0
5.1
5.2
5.3
5.4
5.5
5.6
5.7
5.8
5.9
5.10
5.11
Introduction
Objectives
Surprise check
Test checking
Factors to be consider while determining the sample size
Methods of selecting samples
Concept of audit risk
Relationship between materiality & audit risks
Key concept
Summary
Exercise & Questions
Further Reading and References
5.0 Introduction
Audit Sampling
NOTES
CHECK YOUR
PROGRESS
What is Surprise
Check?
The 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. SA 530 deals with Audit sampling.
5.1 Objectives
1. To understand the concept of surprise check.
2. To understand the concept of sampling.
3. To get knowledge of various methods of selecting samples
4. o understand the concept of audit risk.
5.2 Surprise Checks
1)
Meaning:
Audit procedures cannot be routinely and mechanically applied as a set of
rules in all and every situations. There must be flexibility and a sense of surprise in
the certain checks are carried out e.g. cash verification, investments verification
etc.
2)
Significance of Surprise Check:
a) Audit Effectiveness:
The element of surprise verification will improve the effectiveness of an
audit. Wherever practicable, an element of surprise should be incorporated
into the audit program.
AUDITING - II (47)
AUDITING - II
b) Review of internal controls:
Surprise checks are mainly intended to certain whether the system of
internal control is operating effectively & whether the accounting & other
records are prepared concurrently & kept up to date.
NOTES
c) Detection of errors & frauds:
Surprise checks are the useful method of determining whether or not
errors or manipulations exist & where they exist, of bringing the matter
promptly to the attention of the management so that corrective action is
taken immediately.
d) Moral check:
Surprise visits by the auditor can exercise a good moral check on the
client's staff.
e ) Areas:
Surprise checks are relevant for items like cash, investments, stores &
stocks, statutory registers normally require to be examined for the
purposes of audit, etc.
CHECK YOUR
PROGRESS
f) Up to -date- records:
Describe
Checking?
Test
Surprise check seek to ensure that the books of prime entry, for example,
the cash book, sales & purchase journals, etc. have been kept up to date.
g) EDP Audit:
When EDP system is being used, surprise checks through the use of testchecks, etc. are important to ensure that the programs are operating
satisfactorily.
3)
Factors:
The areas where surprise check is required depend upon a) Extent to which the auditor considers the internal control system as
adequate,
b) Nature of the clients transactions,
c) Locations or places from which client operates
d) Relative importance of items like cash, investments, etc.
e) Other special circumstances under which the audit is carried out.
The element of surprise can be both with regard to the time (date) of the
audit & the selection of items audited.
5.3 Test Checking
Test checking is an accepted auditing procedure wherein only a part of it
is check to form an opinion instead of checking all transactions.
l
Advantages of Test checking:
1)
Audit objective:
The auditor is required to form an opinion on the financial statements. Even
after 100% checking, he may not derive absolute satisfaction. Hence, proper
& careful test checking serves the audit objective in obtaining reasonable
audit assurance.
2)
(48) AUDITING - II
Expertise:
Application of test check principles involves the applications of mind &
intelligent judgment. It enables the auditor to use his expertise effectively.
3)
Exception principle:
Test checking adopts the principle of exception in control. If certain aspects
of internal control do not create suspicion, there is no need to verify all those
transactions exhaustively.
4)
Audit Sampling
NOTES
Scientific assessment of risk:
The auditor assesses the risk of material misstatement in the financial
statements in a scientific manner by drawing suitable samples & studying
them in detail
5)
Saving in time:
As fewer transactions are verified, time is saved to a great extent. This time
is available for completing other audit in time.
6)
Reduction in work:
Volume of work is reduced by test checking methods. Audit processes are
not carried out mechanically on all transactions.
l
CHECK YOUR
PROGRESS
Difference between surprise checks & test checks
Particulars Surprise checks
Test checks
Meaning
Surprise check refers to the out Test checking is an accepted
of routine checks that is carried auditing procedure wherein only
out in the normal course of audit. a part of it is check to form an
opinion instead of checking
all transactions.
Areas of
check
Cash verification, investments
verification, stores & stocks &
statutory registers.
Check on the effectiveness of
the internal control system in
operation & other measures for
safeguard of assets.
Timing
There is a surprise element in
such verification. There is no
specific time frame for
conducting surprise check.
Test checks are conducted
during the normal course of audit.
Distinguish between
Surprise Checks &
Test Checks?
Tool used Though there is a presence of
Statistical sampling & auditing
surprise element, usual auditing in depth are effective tools of
procedures are to be followed
test checks.
even in case of surprise checks.
5.4 Factors to be consider while Determining the
Sample size
1.
Sampling risk:
a) It arises from the possibility that the auditors conclusion, based on a sample,
may be different from the conclusion that would be reached if the entire
population were subjected to the same audit procedure.
b) The auditor is faced with sampling risk in both tests of control & substantive
procedures. These risks are-
AUDITING - II (49)
l Tests of controli. Risk of under reliance: The risk that, although the sample result does
not support the auditor's assessment of control risk, the actual compliance
rate would support such an assessment. It affects the audit efficiency;
they would lead to additional work being performed by the auditor.
ii. Risk of over Reliance: The risk that although the sample result supports
the auditor's assessment of control risk, the actual compliance rate would
not support such an assessment. It affects audit effectiveness; they are
likely to lead to an erroneous opinion on financial statements.
l Substantive Proceduresi. Risk of incorrect rejection: The risk that, although the sample result
supports the conclusion that a recorded account balance or class of
transactions is materially misstated, while in fact it is materially misstated.
It affects the audit efficiency; they would lead to additional work being
performed by the auditor.
ii. Risk of incorrect acceptance: The risk that, although the sample result
supports the conclusion that a recorded account balance or class of
transactions is not materially misstated, while in fact it is materially
misstated. It affects audit effectiveness; they are likely to lead to an
erroneous opinion on financial statements.
c) Sample size is affected by the level of sampling risk the auditor is willing
to accept from the results of the sample. When the acceptable risk is low,
the sample size will have to be large & vice versa.
AUDITING - II
NOTES
CHECK YOUR
PROGRESS
What are the Methods
of Selecting Samples?
2.
Tolerable errors:
a) It is the maximum error in the population that the auditor would be willing
to accept & still concludes that the results from sample has achieved
audit objective. It is considered during the planning stage & for substantive
procedures in the auditor's judgment about materiality.
b) The smaller the tolerable errors, the greater will be the sample size.
3.
Expected errors:
a) If the auditor expects error to be present in population, a large sample is
required to conclude that the actual error in the population is not greater
than the planned tolerable error.
b) Smaller sample sizes are justified when the population is expected to be
error free.
c) The auditor would consider matters like error levels identified in previous
audit, changes in entity's procedures.
5.5 Methods of Selecting Samples
1.
(50) AUDITING - II
Random sampling:
i. Simple random samplingEach unit of the population has an equal chance of being selected. It is
appropriate in case of homogeneous population with all items falling within
a reasonable range.
ii. Stratified random samplingThe population is divided into different classes or strata. Each stratum
each treated as if it were a separate population & a sample is taken from
each such class or stratum. It is appropriate for highly diversified population.
2.
Interval / systematic sampling:
i. Block samplingIt involves selections of a defined block of consecutive items. It is similar
to judgmental sampling & has the advantages of simplicity & economy.
ii. Cluster samplingIt involves dividing the population into groups of items known as clusters.
A number of items are randomly selected from all the clusters rather
than individual items of the population.
Audit Sampling
NOTES
5.6 Concept of Audit Risk
1)
MeaningAudit risk is the probability/ chance that an auditor may give an
inappropriate opinion on financial information that is materially misstated.
2)
Components-
CHECK YOUR
PROGRESS
Describe Concept of
Audit Risk?
Audit risk has following 3 componentsa) Risk that errors will occur (Inherent risk)
b) Risk that the clients internal control system may not prevent or correct
such a risk (Control risk)
c) Risk of non-detection of errors (Detection risk)
3) Auditor's responsibilities- to minimize or eliminate the above audit risks.
l
Various components:
a)
Inherent risk:
i.
It is the risk that material errors will occur.
ii. It is a susceptibility of an account balance or class of transactions to
misstatement that could be material, individually or when aggregated with
misstatements in other balances or classes, assuming that there were no
related internal controls.
iii. It is based on factors like the entity's business & its environment & nature
of the account balance of class of transactions.
b)
Control risk:
i.
It represents the risk that the clients system of internal control will not
prevent or correct errors that occur.
ii. It is the risk that any material misstatement that could in an account
balance or class of transaction, individually or when aggregated
misstatement in other balances or classes will not be prevented or detected
on a timely basis by the system of internal control.
iii. Control risk arises due to the intrinsic limitations & imperfections of any
system of internal control.
iv. To assess control risk, the auditor should consider the adequacy of control
design, & test the adherence to control procedures.
AUDITING - II (51)
AUDITING - II
c)
Detection risk:
i.
It is the risk that any remaining material error will not be detected by the
auditor.
ii. It is the risk that an auditors procedures will not detect a material
misstatement the exist in an account balance or class of transactions that
could be material, individually or when aggregated misstatement in other
balances or classes.
NOTES
iii. The level of detection risk relates directly to the auditors procedure.
iv. Detection risk exist even in case of 100% checking due to factors like
selection of an inappropriate audit procedure, or misapplication of an
appropriate audit procedure or misinterpretation of the audit results.
5.7 Relationship Between Materiality & Audit Risks
i.
SA 320 on audit materiality states that the auditor should consider materiality
& its relationship with audit risk when conducting an audit.
ii.
MaterialityAn item is material if its misstatement would affect the decisions of users
taken on the basis of such financial information. It depends on the size &
nature of the item, judged in the particular cases of misstatement.
iii.
Selection of proceduresMateriality helps the auditor to determine the nature, timing, extent of audit
procedures & techniques. The procedures should be designed to support the
audit opinion at an acceptable low degree of audit risk.
iv.
Materiality an audit riskThe inverse relationship between materiality & audit risk is considered in
planning. If there is a change in risk levels at a later date, the auditor mayl Carry out extended or additional test of control; or
l Modify the nature, timing & extent of audit procedures.
v.
Requirement of low audit risk- Audit risk should always be kept as low as
possible.
5.8 Key Concept
Test checking is an accepted auditing procedure wherein only a part of it is
check to form an opinion instead of checking all transactions.
Tolerable error is the maximum error in the population that the auditor
would be willing to accept & still concludes that the results from sample has
achieved audit objective.
Audit risk is the probability/ chance that an auditor may give an inappropriate
opinion on financial information that is materially misstated.
An item is material if its misstatement would affect the decisions of users
taken on the basis of such financial information.
(52) AUDITING - II
5.9 Summary
There must be flexibility and a sense of surprise in the certain checks is
carried out. Sampling risk arises from the possibility that the auditors conclusion,
based on a sample, may be different from the conclusion that would be reached if
the entire population were subjected to the same audit procedure. Detection risk,
control risk, inherent risks are the components of audit risk. SA 320 on audit
materiality states that the auditor should consider materiality & its relationship with
audit risk when conducting an audit.
Audit Sampling
NOTES
5.10 Exercise & Questions
1) What is the significance of surprise check?
2) Which are the components of audit risk?
3) Which factors to be consider while determining the sample size?
l
Fill in the blanks:
1)
_____________ is an accepted auditing procedure wherein only a part of it
is check to form an opinion instead of checking all transactions.
(Audit sampling, Auditing, Test checking, Audit planning)
2)
_______________ refers to the out of routine checks that is carried out in
the normal course of audit.
(Surprise check, Internal audit, Cost audit, Inspection)
3)
The _________ relationship between materiality & audit risk is considered
in planning.
(direct, inverse, equal, greater)
4)
__________________ is the maximum error in the population that the auditor
would be willing to accept & still concludes that the results from sample has
achieved audit objective.
(Expected error, Tolerable error, Sampling error, Planning error)
5)
_______________is the probability/ chance that an auditor may give an
inappropriate opinion on financial information that is materially misstated.
(Sampling risk, Audit risk, Control risk, Detection risk)
6)
SA 320 on audit _______________ states that the auditor should consider
materiality & its relationship with audit risk when conducting an audit.
( planning, sampling, materiality, evidence)
7)
_____________ is the risk that any remaining material error will not be
detected by the auditor.
(Sampling risk, Audit risk, Control risk, Detection risk)
8)
An item is ____________ if its misstatement would affect the decisions of
users taken on the basis of such financial information.
(major, material, negligible, tolerable)
AUDITING - II (53)
AUDITING - II
9)
__________________ represents the risk that the clients system of internal
control will not prevent or correct errors that occur.
(Control risk, Detection risk, Inherent risk, Audit risk)
NOTES
10) _______________ involves selections of a defined block of consecutive
items.
(Cluster sampling, Block sampling, Simple sampling, Stratified sampling)
11) __________________________ is appropriate in case of homogeneous
population with all items falling within a reasonable range.
(Cluster sampling, Block sampling, Simple random sampling, Stratified sampling)
12) _________________ is affected by the level of sampling risk the auditor is
willing to accept from the results of the sample.
(Sample risk, Sample size, Sample audit, Control risk)
13)
___________________involves dividing the population into groups of items
known as clusters.
(Cluster sampling, Block sampling, Simple random sampling, Stratified sampling)
14) _______________ sample sizes are justified when the population is expected
to be error free.
(Greater, Smaller, Equal, judgmental)
15)
The procedures should be designed to support the audit opinion at an
acceptable low degree of _______________.
(Control risk, Detection risk, Inherent risk, Audit risk)
(Answers: 1) Test checking, 2) Surprise check, 3) inverse, 4) Tolerable error,
5) Audit risk, 6) materiality, 7) Detection risk, 8) material, 9) Control risk, 10)
Block sampling, 11) Simple random sampling, 12) Sample size, 13) Cluster
sampling, 14) Smaller, 15) Audit risk)
5.11 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
(54) AUDITING - II
UNIT - 6
INVESTIGATION
Structure:
Investigation
NOTES
6.0
Introduction
6.1
Objectives
6.2
Investigation into the affairs of the company
6.3
Powers of Inspector
6.4
Investigation of ownership of company
6.5
Investigation on behalf of incoming partner
6.6
Investigation on behalf of bank proposing to advance loan to a company
6.7
Difference between Audit & Investigation
6.8
Due diligence
CHECK YOUR
PROGRESS
6.9
Key concept
What is Investigation?
6.10
Summary
6.11
Exercise & Questions
6.12
Further Reading and References
6.0 Introduction
Investigation means systematic & critical examination of books & records
of an entity for specific purpose. Investigation shall be orders by CG.
6.1 Objectives
1. To understand the concept of investigation.
2. To understand the powers of inspector.
3. To understand the various purposes of investigation.
4. To understand the concept of due diligence.
6.2 Investigation into the Affairs of the Company
[Sec. 235 & 237]
1)
Report by registrari.
The registrar is bound to report to CG if the information or explanation
called by him from the company, is not furnished to him or after the
perusal of information or explanation or of the books & papers, the
registrar is of the opinion thatl The state of affairs of the company is unsatisfactory; or
l Full & fair statement of any matter is not disclosed.
AUDITING - II (55)
AUDITING - II
NOTES
ii. On receipt of such report, CG may order an investigation into the affairs
of the company.
2)
Investigation on opinion of CLBi.
CLB forward opinion to CG stating that the business of the company is
being conducted with intent to defraud its creditors, members etc. or for
fraudulent or unlawful purpose; or in a manner oppressive of any of its
members; or
ii. The persons concerned in the formation or management of the company
have been guilty of fraud or misfeasance.
iii. If on the perusal of opinion CLB, CG forms an opinion that the
circumstances stated exist, CG may order an investigation into the affairs
of the company.
CHECK YOUR
PROGRESS
3)
Investigation on declaration by CLB on application of membersi.
What are the Powers
of Inspector?
Members can make an application to CLB. Application must be supported
by evidence as CLB may require to satisfy itself that the applicant have
good reason for requiring the investigation.
ii. On the receipt of application CLB shall give a show cause notice to the
parties. CLB shall consider the allegation made in the application; the
evidence submitted by applicants & the argument of the company.
iii. Then, CLB may declare that an investigation into affairs of the company
is required.
iv. On such declaration of CLB, CG shall order an investigation into affairs
of the company.
v. Before making any appointment of inspector, CG may demand from
applicants, the security for the payment of costs of investigation.
4)
Investigation on order of courti.
Court may require that an investigation into the affairs of the company be
made.
ii. CG shall order investigation if the court declares an in to the affairs of the
company.
5)
Special resolutionA company may pass SR requiring the CG to investigate into the affairs
of the company. Then, CG shall order investigation.
6.3 Powers of Inspector
i.
Inspector can investigate into the affairs of company & related companies.
ii. He may access the books & papers of the company or related companies.
iii. He may retain the books & papers maximum period of 6 months. After
(56) AUDITING - II
the expiry of such period, the inspector can again call the books as &
when required.
iv. The inspector can make an application to the Magistrate of First class or
Presidency Magistrate, if he has reasonable ground to believe that the
books & papers may be destroyed, mutilated, falsified, altered or secreted.
Investigation
NOTES
v. The Magistrate may authorize the inspector to seize such books & papers
as the inspector considers necessary.
vi. Inspector may retain the books & papers till conclusion of investigation.
vii. Inspector shall take notes on examination. Notes shall be in writing. Notes
shall be signed by the person examined.
6.4 Investigation of Ownership of Company
i.
The purpose of investigation is to determine the true persons who are
financially interested in the success or failure of the company; or who
are able to control or materially influence the policy of the company.
ii. Investigation can be ordered byl CG may suo motu order investigation.
l If CLB makes a reference to CG for the investigation, CG shall order
investigation
l If a complaint (supported by evidence) is made to CG, CG may order
investigation
iii. CG is not bound to furnish the report to the company or any other person
ifl CG is of the opinion that there are good reasons for not disclosing the
contents of the report; &
l A copy of the report is kept with the registrar.
iv. The investigation expenses shall be paid by CG. CG may recover these
expenses from the complainants.
6.5 Investigation on behalf of Incoming Partner
i.
Sometimes the incoming partner appoints the investigator to examine the
affairs of the partnership firm.
ii. Here the incoming partner is interested in judging whether the terms &
conditions offered to him are reasonable.
iii. First of all, he should ascertain the reasons for offer of admission to a
new partner.
iv. He should study the history & growth pattern of the firm.
v. He should study the financial statements of previous 3-5 years to determine
its profitability in past years.
vi. He should also examine assets & liability position of the firm.
vii. He should pay proper attention to any hidden liability or overvalued assets.
AUDITING - II (57)
AUDITING - II
viii. Investigator should carefully study the provisions of the partnership deed.
ix. Special attention should be given to some specific point's w.r.t partnerships,
such as profit sharing ratio, interest on capital etc.
NOTES
x. The reputation of the firm as well as that of partners should be properly
ascertained.
xi. He should study the important contracts etc.
xii. He should study the quality i.e. skill & competence of key management
personnel.
xiii. Manner of computation of goodwill on admission & retirement of a partner
should be ascertained.
6.6 Investigation on behalf of Bank Proposing to
Advance Loan to a Company
i. The bank is primarily interested in knowingl The purpose for which a loan is required
l The source from which it would be repaid &
l The security offered by the borrower
ii. Investigator shall obtain the knowledge onl The loan proposal submitted by borrower.
l The purpose for which the loan is required & its repayment schedule
l The creditworthiness & reputation of the board of directors.
l The historical background & growth trend of the company during past
years.
l The growth & profit prospects of the company considering present
economic scenario.
iii. Examination of profitability & state of affairsl The investigating accountant should prepare a condensed income
statement from the p&l account for the previous five years so that it can
be ascertained whether the company has strong past as far as profitability
is concerned.
l He should compute profitability & financial ratios.
l Investigator should also study the cash flow statements of the company.
l Liabilities should be ascertained to ensure the company's present & future
obligation.
l These will help the bank to decide whether to grant loan to the applicant
or not.
l He can devise projected statements so that recoverability of loan can be
judged.
(58) AUDITING - II
6.7 Difference Between Audit & Investigation
Particulars Audit
Investigation
Investigation
Objectives
To judge truthfulness &
To establish a fact.
fairness of financial statement.
Scope
By law & auditing standard
By terms of engagement.
Period
Yearly
It depends on requirement.
Nature
General examination
Detailed examination of some
specific areas.
Inherent
limitations
More
Less (because of
detailed checking)
Evidences
Persuasive
Conclusive.
Reporting
General purpose report, which Confidential report generally
can be used by many
restricted to few parties.
stakeholders.
Standards
SA (Standard on Auditing)
SRS (Standard on related services)
Approach
No doubtful approach.
Doubtful approach is adopted by
the investigator.
By whom
Chartered Accountant.
Expert team.
NOTES
CHECK YOUR
PROGRESS
Difference between
Audit
&
Investigation?
6.8 Due Diligence
This term is used in relation to corporate restructuring. Corporate
restructuring includes internal restructuring, amalgamations, mergers, joint ventures,
etc. Due diligence is review is performed to check whether it is feasible & desirable
to acquire/ merger the unit.
Following are the seven components of the due diligencei.
Operational due diligence
ii.
Financial due diligence
iii.
Tax due diligence
iv.
Information system due diligence
v.
Legal due diligence
vi.
Environment due diligence
vii.
Personnel due diligence
6.9 Key Concept
Investigation means systematic & critical examination of books & records
of an entity for specific purpose.
Corporate restructuring includes internal restructuring, amalgamations,
mergers, joint ventures, etc.
AUDITING - II (59)
AUDITING - II
NOTES
6.10 Summary
CG may order an investigation into the affairs of the company. Audit is the
truthfulness & fairness of financial statements. Investigation may be conducted on
the report of registrar, CLB, court, or company. This term is used in relation to
corporate restructuring.
6.11 Exercise & Questions
1)
What are the important steps involved while conducting investigation on behalf
of an incoming partner?
2)
What are the important steps involved while conducting investigation on behalf
of bank before granting loan?
3)
What is mean by due diligence? Which are components?
l
Fill in the blanks:
1)
____________ means systematic & critical examination of books & records
of an entity for specific purpose.
(Planning, Sampling, Investigation, Cost audit)
2)
Members can make an application to __________.
(Central Government, Court, Company, CLB)
3)
On such declaration of CLB, _______shall order an investigation into affairs
of the company.
(Central Government, Court, Company, CLB)
4)
A company may pass _____________ requiring the CG to investigate into
the affairs of the company.
(general resolution, special resolution, unanimous resolution, resolution)
5)
The ______________ may authorize the inspector to seize such books &
papers as the inspector considers necessary.
(CLB, CG, Magistrate, Company)
6)
Inspector may retain the books & papers till conclusion
of________________.
(cost audit, internal audit, special audit, investigation)
7)
The investigation expenses shall be paid by _______. Then may recover
these expenses from the complainants.
(CLB, CG, Magistrate, Company)
8)
The ____________ partner appoints the investigator to examine the affairs
of the partnership firm.
(incoming, retiring, sleeping, nominee)
9)
Investigator should carefully study the provisions of the _______________.
(agreement, partnership deed, partnership act, regulation)
(60) AUDITING - II
10) The __________ is primarily interested in knowing the purpose for which a
loan is required.
Investigation
(bank, company, auditor, CLB)
11) Inspector may retain the books & papers maximum period of ___________.
NOTES
(3 months, 6 months, 12 months, 5 months)
12) ____________ is the truthfulness & fairness of financial statements.
(Audit, Investigation, Planning, Sampling)
13) ____________ term is used in relation to corporate restructuring.
(financial due diligence, Due diligence, personnel due diligence, tax due
diligence)
14) There are _________components of the due diligence.
(five, six, seven, eight)
15) The scope of investigation is _______________________.
(terms of engagement, law, agreement, contract)
16) The purpose of _________________ of ownership is to determine the true
persons who are financially interested in the success or failure of the company.
(cost audit, internal audit, special audit, investigation)
(Answers: 1) Investigation, 2) CLB, 3) CG, 4) special resolution, 5) Magistrate,
6) investigation, 7) CG, 8) incoming, 9) partnership deed, 10) bank, 11) 6
months, 12) Audit, 13) Due diligence, 14) seven, 15) terms of engagement,
16) investigation)
6.12 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 - II (61)
AUDITING - II
NOTES
UNIT - 7
AUDIT OF SHARES
Structure:
7.0
Introduction
7.1
Objectives
7.2
Verification of Capital Newly Issued
7.3
Verification Of Shares Issued For Cash
7.4
Securities issued at premium
7.5
Shares issued at discount
7.6
Calls paid in advance
7.7
Calls in arrears
7.8
Audit of redemption preference shares
7.9
Audit of forfeiture of shares
7.10
Buy back of own securities
7.11
Key concept
7.12
Summary
7.13
Exercise & Questions
7.14
Further Reading and References
7.0 Introduction
The shares are issued both at the time of incorporation and afterwards
whenever the company needs more capital. The audit of share capital is an important
function of the auditor. Share capitals are mainly in two types-1) Equity shares 2)
Preference shares.
7.1 Objectives
1. To understand the procedure for issue of shares.
2. To understand how to conduct the audit of shares.
3. To understand th concept of transmission of shares.
4. To get knowledge of buy back of shares.
l
The principle objectives of audit of share capital are as follows:
i.
(62) AUDITING - II
That various issues of shares are properly authorized and that there is no
over-issue beyond the limits as prescribed in the memorandum;
ii. That cash and other assets acquired through issue of shares have indeed
been received, properly classified, valued and correctly recorded in the
books of account;
iii. That distribution of dividend and retention of profits in the form of reserves
and provisions are properly authorized.
Audit of Shares
iv. That provision relating to rights and privileges of shareholders, creditors,
etc. are duly complied with; and
v. That generally accepted accounting principles are followed in stating the
account balances and these are disclosed in the balance sheet in conformity
with legal provisions.
NOTES
7.2 Verification of Capital Newly Issued
1) The auditor should study the conditions relating to issue of share capital
in the memorandum and articles of association, as well as prospectus or
statement in lieu of prospectus, and see that these have been duly complied
with.
2) The auditor should see that the first allotment of shares confirms to the
guidelines issued by Securities and Exchange board of India (SEBI). Also
he should verify that the first allotment was not made until the amount of
minimum subscription stated in the prospectus had been subscribed and
until then the amount received was kept deposited in a scheduled bank as
required by Section 69 of the Act.
3) He should ensure that the company intending to offer shares to the public
for subscription by the issue of a prospectus has, before such issue, made
an application to one or more stock exchange for permission for the shares
intending to be so offered within the stock exchange or each stock
exchange as required by companies (amendment) Act, 1988.
CHECK YOUR
PROGRESS
What
are
the
Provisions
for
Varification of Capital
Newly Issued?
4) He should ascertain that there exists an internal check on receipt of
amounts along with application and that the same throughout has continued
to function satisfactorily.
7.3 Verification of Shares Issued for Cash
a.
There are three distinct stages in the case of shares issued for cash.
These are a. Application stage - In this stage, applications for shares are received
along with application money.
b. Allotment stage - Here allotment of shares takes place, allotment letters
are issued and allotment money is received.
c. Call stage - In this stage, calls are made on shares and the amount due
is received.
Audit procedure at application stage:
i. The auditor should examine original applications for shares and check
the entries in the Application and Allotment Book (or Sheets) with the
help of these applications.
ii. He should check the entries in the Application and Allotment Book with
regard to money received on application and check these with
corresponding entries in the Cash Book.
iii. He should vouch the sum refunded to unsuccessful applicants with the
copies of letters of regret.
AUDITING - II (63)
AUDITING - II
NOTES
iv. He should check the totals in application and allotment book and see that
an appropriate journal entry debiting Share Application Account and
crediting share capital is duly passed.
b.
Audit procedure at allotment stage:
i. The auditor should examine the Director's Minute Book to verify approval
of allotments.
ii. He should check the copies of letters of allotment and letters of regret
with entries in the Application and Allotment Book;
iii. He should check the amount received on allotment, by comparing entries
in the Cash Book with those in the Application and Allotment Book.
iv. He should check the postings in the Share Register of the amount received
on application and allotment with the totals in the Application and Allotment
Book.
v. He should see that the totals have been correctly made and that an
appropriate journal entry debiting Share Allotment and crediting Share
Capital Account has been duly made.
c.
Audit procedures at calls stage:
i. The auditor should examine the resolution passed by board as to making
the calls from the director's minute book.
ii. He should check the entries in the calls book from the copies of the call
letters copies,
iii. The amount received against calls should be checked with the counterfoils
the money receipts.
iv. He should check postings into the share register from calls book (for
calls due) and cash book (for money received against calls).
v. He should compare the schedules of calls in arrears with the application
and allotment book, and see that the amount has been correctly calculated.
vi. He should check the journal entries debiting calls account and crediting
share capital account.
d.
Other general audit duties:
The auditor should see that the nominal value of shares issued does not
exceed the authorized and issued capital and that allotment has been
made in conformity with the conditions stipulated in the prospectus and
guidelines issued by the SEBI.
i. He should compare the balance in the shareholder's account with that in
the share capital account.
ii. He should see that the returns of allotment have been filed with the registrar
of the companies.
iii. He should examine the contract with the underwriters and ascertain that
the terms thereof have been complied in full.
iv. He should verify payments on account of underwriting contract and stamps
of brokers on application forms.
l
Shares issued for consideration other than cash:
Shares may be issued for consideration other than cash. Such shares are
issued by the company to vendors towards payment of purchase
CHECK YOUR
PROGRESS
What
are
the
Provisions
for
Varification of Share
issued for Cash?
(64) AUDITING - II
1.
2.
3.
4.
5.
l
consideration, to promoters by way of preliminary expenses incurred by
them for bringing the company into legal existence; to underwriters for
payment of underwriting commission or underwriting shares or
debentures. The auditor should adopt the following audit procedure in
regard to issue of shares for considerations other than cash.
Examination of contractsThe auditor should examine the contract under which the shares have
been allotted for consideration other than cash. This will help in determining
how many shares are agreed to be issued for what value and the nature
and the other details of the consideration.
Examination of prospectusThe auditor should examine the prospectus for details as to the amount
payable to vendors, underwriters and promoters, and the mode of payment.
Directors minute bookHe should examine director's minute book to ensure that proper board
resolution is passed for allotment of shares for consideration other than
cash.
Journal entryHe should check the journal entry concerning the issue of shares for
consideration other than cash, and see that it is in order.
Compliance with legal provisionsUnder Section 75(1) (b) of the Companies Act, if shares are allotted for
consideration other than cash, the original a contract together with a copy
thereof, duly verified by an affidavit, should give the number and nominal
amount of shares allotted, the extent to which these will be treated as
paid up and consideration for which those have been issued. The document
should be filed within 30 days of the date of allotment of shares with the
registrar of companies. The auditor should see that these provisions have
been duly complied with.
Audit of Shares
NOTES
CHECK YOUR
PROGRESS
What
are
the
Provisions
for
Varification
of
Securities Issued at
Premium?
Shares underwritten placed for commission:
Many a 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. The auditor should refer to the
underwriting contract to verify the number of shares, if any, which the
underwriter were obliged to take up and payment made by them in respect
thereof.
7.4 Securities Issued at Premium
Section 78 of the Companies Act, 1956, deals with the issue of securities
at a premium. A sum Equal to the aggregate amount or value of premium
received on the issue of securities at a premium, whether for cash or
otherwise, shall be transferred to a separate account called the" securities
premium account".
l
Application of the securities premium amount - [Sec. 78 (2)1
The securities premium may be applied in1. Paying up unissued securities of the company to be issued to the members
AUDITING - II (65)
AUDITING - II
of company as fully paid bonus securities;
2. Writing off the preliminary expenses of the company;
3. Writing off the expenses of, or the commission paid or the discount allowed
on, any issue of securities or debentures of the company, or
NOTES
4. Providing for the premium payable on redemption of any redeemable
preference securities or any debentures of the company.
l
Auditor's duty when shares are issued at premium
1. He should examine the prospectus.
2. He should verify the article of association of the company to see whether
they permit the issue of shares at premium.
3. He should examine the minute of board meeting.
CHECK YOUR
PROGRESS
7.5 Shares Issued at a Discount [Sec. 79]
A company can issue its shares at a discount only if the following conditions
are fulfilled:
What
are
the
Provisions for Shares
Issued at a Discount?
1. Shares can be issued at a discount within two months after the date on
which the issue is sanctioned by the Central Government or within such
extended time as the Central Government may allow.
2. Not less than one year has at the date of the issue elapsed since the date
on which company was entitled to commence business.
3. The issue of shares at discount is authorized by a resolution passed by
the company in a general meeting & sanctioned by the CG.
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 the issue of the prospectus.
l
Auditor's duty when shares are issued at discount
1) The auditor should see that the conditions laid down in Section 79 are
complied with.
2) He should see the resolution passed at the general meeting of the
shareholders.
3) He should verify the sanctions obtained from Central Government.
4) He should see that the rate of discount does not exceed 10% or a higher
rate as sanctioned by the Central Government.
5) He should examine the articles of association to find out whether the
company is authorized to issue shares at discount.
6) He should verify the prospectus to see that the necessary information as
required under the Act has been disclosed therein.
7) The discount on the issue of shares should be shown in the balance sheet
under the head "miscellaneous expenditure" until it is written off.
(66) AUDITING - II
7.6 Calls Paid in Advance
A company, if authorized by its articles of association, accepts from any
member the whole or a part of the amount remaining unpaid on any
shares held by him, although no part of that amount has yet been called
up. However the amount so received cannot be treated as part of the
capital for purposes of any voting rights. According to Section 93, the
company may, if so authorized by its articles, pay dividend in proportion
to the amount paid up on each share where a large amount is paid up on
some shares than on others.
Audit of Shares
NOTES
7.7 Calls in Arrears
1) The auditor should verify the amount of calls in arrear from the share
register.
2) He should see that the amount of calls in arrear is properly shown on the
liabilities side of the balance sheet by deducting it from the amount of
called up capital.
3) The amount of calls due from directors should be separately shown in the
balance sheet.
4) He should verify the articles of association for interest chargeable on
such arrears.
CHECK YOUR
PROGRESS
What
are
the
Provisions for Audit of
R e d e m p t i o n
Preference Shares?
7.8 Audit of Redemption Preference Shares
Under Section 80, a company limited by shares may, subject to authorization
by its articles, issue preference shares which are (at the option of the
company) liable to be redeemed. However, according to Section 80A, no
company limited by shares shall issue any preference shares, which is
irredeemable or is redeemable after the expiry of a period of 20 years
from the date of its issue. Redemption of preference shares will be subject
to following conditions
1) Only fully paid, preference shares can be redeemed.
2) The shares can be redeemed only out of profits available for distribution
as dividend, or out of proceeds of a fresh issue of shares made for the
purpose of such redemption.
3) In case shares are redeemed out of profits which would otherwise be
available for dividend, an amount equal to the nominal amount of the
shares redeemed should be transferred to the capital redemption reserve
account.
7.9 Audit Offorfeiture of Shares
If a member fails to pay any call or installment of a call on the days
appointed for payment, the board may at any time thereafter during such
time as such amount remains unpaid, serve a notice on him requiring
payment of such unpaid calls or installment with accrued interest. If,
AUDITING - II (67)
AUDITING - II
however, the member fails to pay the same within the specified time, the
company may forfeit his shares.
l
NOTES
Auditor's duty in case of forfeiture of shares
1. The auditor should verify the provisions of the articles of association of
the company in respect of the forfeiture of shares. If the articles are
silent in this regard, regulations 29 to 35 of Table A of the Companies Act,
1956 would apply.
2. He should see that forfeiture of shares is strictly in accordance with
these provisions.
3. He should examine the minute books of the board of directors to see
whether a resolution forfeiting the shares is duly passed.
4. He should see that proper notice was given to the defaulting shareholder.
5. He should examine the entries of forfeiture in the books of the company.
7.10 Buy Back of Shares [Sec. 77A]
1.
2.
3.
4.
5.
6.
Buy back of shares means company purchase its own shares.
Section 77A of the Companies Act deals with buy back of shares.
The auditor should ensure the compliance of all the provisions relating to
buy back & also see that proper accounting entries have been made.
Buy back of shares should be authorized by the articles of association
&sanctioned by special resolution in a general meeting of the company.
Special resolution is not necessary ifl Buy back is less than 10% of the total paid up capital & free reserve.
l Buy back is authorized by a board resolution.
l At least 365 bays have elapsed from the date of previous offer of
buy back, if any.
The buy back is or less than 25% of the total paid up capital & free
reserves of the company.
The Debt-Equity ratio should not be more than 2:1 after such buy back.
7.11 Key Concept
A sum Equal to the aggregate amount or value of premium received on the
issue of securities at a premium, whether for cash or otherwise, shall be transferred
to a separate account called the" securities premium account".
Buy back of shares means company purchase its own shares.
7.12 Summary
(68) AUDITING - II
Share capitals are mainly in two types-1) Equity shares 2) Preference
shares. The auditor should study the conditions relating to issue of share capital in
the memorandum and articles of association, as well as prospectus or statement in
lieu of prospectus, and see that these have been duly complied with. Section 78 of
the Companies Act, 1956, deals with the issue of securities at a premium. The buy
back is or less than 25% of the total paid up capital & free reserves of the company.
7.13 Exercise & Questions
1) What is the audit procedure at allotment stage?
2) Short note on "shares issued for consideration other than cash".
3) Short note on "buy back of shares".
4) What are duties of auditors when shares are issued at discount?
l
Fill in the blanks:
1)
The auditor should see that the first allotment of shares confirms to the
guidelines issued by_______________.
Audit of Shares
NOTES
(Government, Company, SEBI, ICAI)
2)
In _______________ stage, applications for shares are received along with
application money.
(Allotment, Application, Call, Initial)
3)
In ____________ stage, calls are made on shares and the amount due is
received.
(Allotment, Application, Call, Initial)
4)
The auditor should examine the __________________ to verify approval
of allotments.
(Report, Representation, Director's Minute Book, Agreement)
5)
An appropriate journal entry debiting Share Allotment and crediting
______________ has been duly made.
(Share Capital A/c, Reserve & surplus A/c, Share application A/c, Current
A/c)
6)
The buy back is or less than ____of the total paid up capital & free reserves
of the company.
(15%, 20%, 25%, 30%)
7)
If the member fails to pay the call or installment within the specified time, the
company may ___________ his shares.
(forfeit, issue, cancel, reject)
8)
No company limited by shares shall issue any preference shares, which is
irredeemable or is redeemable after the expiry of a period of _________from
the date of its issue.
(10 years, 20 years, 15 years, 5 years)
9)
A sum Equal to the aggregate amount or value of premium received on the
issue of securities at a premium, whether for cash or otherwise, shall be
transferred
to
a
separate
account
called
the"
____________________________".
(Securities premium A/c, Reserve & surplus A/c, Share capital A/c, Current
A/c)
10) The discount on the issue of shares should be shown in the balance sheet
under the head "__________________________" until it is written off.
(current assets, intangible assets, miscellaneous expenditure, Fixed assets)
AUDITING - II (69)
AUDITING - II
11)
Shares can be issued at a discount within ___________after the date on
which the issue is sanctioned by the Central Government.
(five months, two months, one month, six months)
NOTES
12) The rate of discount does not exceed _____or a higher rate as sanctioned by
the Central Government.
(5%, 15%, 10%, 20%)
13) The Debt-Equity ratio should not be more than __________after such buy
back.
(1:2, 2:1, 2:5, 3:1)
14) Only fully paid, preference shares can be ______________.
(forfeit, redeemed, reject, reissue)
15) Section _______of the Companies Act, 1956, deals with the issue of securities
at a premium.
(77, 77A, 78, 79)
16) _______________ of shares means company purchases its own shares.
(Buy back, Equity, Forfeiture, Redemption)
(Answers: 1) SEBI, 2) Application, 3) Call, 4) Director's Minute Book, 5)
Share Capital A/c, 6) 25%, 7) forfeit, 8) 20 years, 9) Securities premium A/c,
10) miscellaneous expenditure, 11) two months, 12) 10%, 13) 2:1, 14) redeemed,
15) 78, 16) Buy back)
7.14 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
(70) AUDITING - II
UNIT - 8
AUDIT OF INCOME
Structure:
8.0
8.1
8.2
8.3
8.4
8.5
8.6
8.7
8.8
Introduction
Objectives
General procedure of auditing of income
Audit of Cash receipts
Vouching of cash receipts
8.4.1 Cash sales
8.4.2 Receipts from customers
8.4.3 Rental receipts
8.4.4 Sale proceeds of junk material
8.4.5 Bills receivables
8.4.6 Sale of assets
8.4.7 Insurance claims
8.4.8 Commission received
Key concept
Summary
Exercise & Questions
Further Reading and References
Audit of Income
NOTES
CHECK YOUR
PROGRESS
What is the General
Procedure of Auditing
of Income?
8.0 Introduction
The auditor has to be extra cautious while verifying cash transactions. He
should understand the accounting and internal control operating in the organization
in relation to cash. He should see that there is proper documentary evidence in
respect of each transaction, and the transactions are authorized by competent
person, in particulars, the auditor should keep, following important points in mind
while auditing cash transactions.
8.1 Objectives
1. To understand the procedure of audit of income
2. To get the detailed knowledge of audit of various items of income
3. To get the detailed knowledge of conducting audit of cash receipts
8.2 General Procedure of Auditing of Income
1)
Study of internal control system:
The Internal control system in relation to cash transactions should be
studied so as to place reliance on the efficacy of the internal control. It
would also help the auditor in determining the nature, timing and extent of
audit procedures.
AUDITING - II (71)
AUDITING - II
2)
Correctness of book- keeping Records:
The auditor should check the recording of each transaction. This would
help in verifying that entries have been, made in the books of accounts in
accordance with the accounting system followed by the entries and books
of accounts reflect correct balance.
NOTES
3)
Observance of Accounting principles:
The auditor should see that transactions are recorded in accordance with
well-known and accepted accounting, principles, e.g. there should be
distinction between capital receipts and revenue receipts, the expenses
or cost, should be matched to the income or receipt, the expenditure and
income should be treated on accrual basis, the fixed assets should be
depreciated on a consistent basis etc.
4)
Evidence of Transactions:
The auditor should see that the transactions are supported by some kind
of documentary evidence. The evidence can be in the form of payee's
receipts, supplier's invoices, statement of account of parties, minutes of
meeting of directors or the shareholders etc. The documentary evidence
can be internal or external. External evidence are more reliable than
internal evidence and the auditor should try to get as much external
evidence as possible because the likelihood of its being duplicated or
fabricated is much less.
5)
Validity of Transactions:
The auditor should also look into the validity of the Transaction. It is the
function of the auditor to establish that payments have been made validly
to persons who are shown to be the recipients. He should refer to the
documentary evidence to check the validity of Transactions. The
documentary evidence can be in the form of legal provision, Articles of
Association, partnership deed.
6)
Disclosure in Final Accounts:
The auditor is required to certify the financial statements i.e. Balance
Sheet and Profit and loss Account presenting a true and fair view of the
financial position of the entity. The auditor should see that Final accounts
are prepared in accordance with applicable statute and necessary
disclosures as required under statute are made. He should see that items
of income and expenditure and that of assets and liabilities are properly
classified and disclosed.
8.3 Audit of Cash Receipts
1. Before Starting the audit of cash receipts, it is essential that the auditor
should evaluate the adequacy of the internal control system. This would
bring to light any weakness in the internal control system.
2. The chances of manipulation or frauds in case of cash receipts are not
less than cash payments. There are chances that some of the entries of
the receipts are fully omitted. The auditor should be very careful while
auditing the cash receipts.
(72) AUDITING - II
3. Where a rough cash book or diary is maintained, the auditor should
compare the receipts in cash books with those appearing in the rough
cash book or diary. Cash receipts are usually checked with counterfoils
of the receipts issued.
4. The auditor should see whether the client issues receipts for all the
payments he receives. He should also see that all receipts with counterfoils
or carbon copies are serially numbered and they are in bound books.
Audit of Income
NOTES
5. The unused receipts should be in custody of a responsible person.
8.4 Vouching of Cash Receipts
8.4.1 Cash Sales:
1.
2.
3.
4.
5.
6.
The auditor should fully examine the system of internal control with the
object of finding out loophole therein. The following point should be taken
care of while vouching cash sales:
The cash sales register should be fully checked with the carbon copies of
the cash memos.
A summary of daily cash should be checked.
The summary should then be tallied with the receipts recorded in the
cashbook.
The auditor should also verify the daily deposit of cash received in the
bank. Pay-in-Slips should also be verified.
The auditor should be more careful where cash memos are issued even
where cash is not received.
Cash sales summary book posting should be checked with the cash book.
CHECK YOUR
PROGRESS
Describe in breif
Vouching of Cash
Receipts?
8.4.2 Receipts from customers:
1. Receipts of cash from the customers against price of goods sold are
checked with the counter foils of receipt issued to them. At the same
time, it is also verified that there is a system of internal check in operation
which acts as a safeguard against amounts collected being
misappropriated.
2. The receipts should be serially numbered. Unutilized receipt books should
be in the safe custody of a responsible person.
3. In large business houses, the entries of receipts from debtors may be
more in number. The auditor may test check the receipts. But this will
depend upon the adequacy of the system of internal check within the
organization.
4. The auditor should test-check the entries in the bank statements to see
that the amounts are received and the cheques are realized also.
5. When cheques are returned unpaid, entry for dishonor of cheques should
be passed.
8.4.3 Rental Receipts:
1. Test check point of bills issued to tenants by reference to tenancy
agreements and charges paid by the company on behalf of tenants i.e.
house tax, water tax, electricity consumed; etc. Register, if any, maintained
for the tenants may also be checked.
2. Examine the rent received with the counter foils or the carbon copies of
AUDITING - II (73)
AUDITING - II
3.
NOTES
4.
5.
6.
7.
rent receipts. The receipts normally refer to the months for which rents
are received.
Scrutinize the amount of the collecting agent, where the rent is collected
by such agents.
Verify the rent received statement prepared tenant-wise or propertywise or combination of both in case where tenants or properties are more
than one.
Vouch the entries for rent received in advance. See that proper adjustment
entries are passed for the rent receivable during the year. Adjustment
against deposit, if any, should be seen.
Reconcile the rent received with the amount of rent receivable and enquire
into the difference, if any.
Investigate into abnormal rent outstanding.
8.4.4 Sale proceeds of junk materials:
The auditor should:
1. Ascertain whether the organization is maintaining reasonable records for
the sale and disposal of junk materials.
2. Review the production and cost records for the determination of the extent
of junk material that may arise in a given period.
3. Compare the income from the sale of junk materials with the corresponding
figures of the preceding few years.
4. Check the rates at which different types of junk material have been sold
and compare the same with the rates that prevailed in the preceding
year.
5. See that all junk materials sold have been billed and check the calculations
on the invoices.
6. Ensure that there exist-a proper procedure to identify the junk material
and good quality material is not mixed up with it.
7. Make an overall assessment of the value of the realization from the sale
of junk materials as to its reasonableness.
8.4.5 Bills Receivables:
1.
2.
3.
4.
5.
The company keeps a separate Bills Receivable Book where the numbers
of bills are large. The audit procedures are as under:
The entry for receipt of money in the cash book should be compared with
the simultaneous recording in the bills Receivable Books.
The amount should be verified in the bank statement or bank pass books.
The auditor should verify the Bills Receivable book in order to trace out
the bills which have became due and for which amounts have not been
received.
The auditor should verify the entries for the dishonor of bills and the
reference of such bills dishonored in the Bills Receivable Book also.
The contingent liability in respect of bills receivable discounted with the
bank should also be determined.
8.4.6 Sale of Assets:
(74) AUDITING - II
The auditor should verify the proceeds from the sale of assets of capital
1.
2.
3.
4.
5.
6.
7.
nature such as land, building, plant and machinery etc. in the following
manner:
Check whether the sale of assets has been authorized by proper authority,
e.g. Board of Directors.
Check the proceeds of sale through correspondence, agreement etc.
entered between client and purchaser of assets.
Check whether quotation invited through newspaper advertisement and
whether proceeds are at reasonable market value.
Check that the amount shown as received is the actual sale price of the
asset less any expenditure incurred has been deducted.
Ensure that the amount has been credited to asset account and not included
in sales account.
Ensure that proper bifurcation as to capital profit and revenue profit arising
from transaction has been done.
In case asset is sold in an auction, auctioneer's account supporting the
transaction should be checked.
Audit of Income
NOTES
8.4.7 Insurance Claims:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Such claims may be in respect of fixed assets or current assets. While
vouching receipts of insurance claim, the auditor should examine: Copy of the insurance claim lodged with the insurance company.
Correspondence with the insurance company.
Correspondence with the insurance agent, if any.
Counterfoils or carbon copies of the receipts issued to the insurance
company. Many a time, advance receipts are sent to the insurance
company. In such a case, see that the amount has actually been received
at a subsequent date.
Entries in the book of accounts.
Adjustments of the amount received in excess or short of the value of the
actual loss.
The insurance policy to determine the rights and sum assured.
The copy of survey report containing full particulars of the amount of
loss.
The accounting treatment of the amount received should be seen
particularly to ensure that revenue is credited with the appropriate amount
and that, in respect of claim against an asset, the Profit and Loss account
is debited with the short fall of the claim admitted against the book value.
8.4.8 Commission Received:
1.
2.
3.
4.
The auditor should note the names of the parties from whom commission
is receivable & the rate of commission in each case.
The auditor should verify the agreement in each case.
The auditor should vouch the commission received the counterfoils of the
receipt issued.
The auditor should check calculation to see that no item is left out while
calculating such a commission.
The auditor should vouch the adjustment in respect of commission
receivable but not received.
AUDITING - II (75)
AUDITING - II
NOTES
5. When commission is received from abroad, the auditor should verify bank
advice and see that the provisions of foreign exchange laws are also
complied with.
8.5 Key Concept
The auditor should see that the transactions are supported by some kind of
documentary evidence.
8.6 Summary
The auditor has to be extra cautious while verifying cash transactions. He
should understand the accounting and internal control operating in the organization
in relation to cash. The auditor should also look into the validity of the Transaction.
The auditor should see that the transactions are supported by some kind of
documentary evidence. External evidence are more reliable than internal evidence.
The auditor is required to certify the financial statements i.e. Balance Sheet and
Profit and loss Account presenting a true and fair view of the financial position of
the entity.
8.7 Exercise & Questions
1) What is the general procedure for conducting audit of income?
2) Short note on Rental Receipts.
3) What is the procedure for the audit of cash sales?
l
1)
2)
3)
4)
5)
6)
7)
(76) AUDITING - II
Fill in the blanks:
The auditor has to be extra cautious while verifying _________ transactions.
(cash, credit, capital, revenue)
The auditor should see that the transactions are supported by some kind of
documentary ________________.
(representation, evidence, papers, report)
___________________ evidence are more reliable than internal evidence
and the auditor should try to get as much external evidence as possible.
(Internal, Written, documentary, External)
Before Starting the audit of cash receipts, it is essential that the auditor should
evaluate the adequacy of the _____________________________.
(internal control system, audit system, valuation procedure, accounting system)
Cash sales summary book posting should be checked with the
______________.
(pass book, cash book, daily book, ledger)
The auditor may ________________ the receipts.
(test check, sample, detailed check, check)
When commission is received from abroad, the auditor should verify bank
advice and see that the provisions of _____________________ laws are
also complied with.
(company, foreign exchange, SEBI, Miscellaneous)
8)
9)
10)
11)
12)
13)
14)
15)
The auditor should check calculation to see that no item is left out while
calculating such a _________________.
(dividend, brokerage, fees, commission)
The copy of ____________ containing full particulars of the amount of loss
should examine by the auditor.
(survey report, audit report, annual report, summary report)
The amount shown as received is the actual _____________ of the asset
less any expenditure incurred has been deducted should be examined.
(sale price, purchase price, market price, historical cost)
The auditor should verify the ____________________ in order to trace
out the bills which have became due and for which amounts have not been
received.
(Bills payable book, Cash book, Bills Receivable book, Pass book)
The _______________in respect of bills receivable discounted with the
bank should also be determined.
(current liability, contingent liability, current assets, fixed liability)
Review the production and _______________ for the determination of the
extent of junk material that may arise in a given period.
(accounting records, other records, cost records, manufacturing records)
The auditor should also look into the validity of the________________.
(Transaction, records, reports, statements)
Make an overall assessment of the value of the _______________ from
the sale of junk materials as to its reasonableness.
(realization, sale, cost, market price)
Audit of Income
NOTES
(Answers: 1) cash, 2) evidence, 3) External, 4) internal control system, 5)
cash book, 6) test check, 7) foreign exchange, 8) commission, 9) survey
report, 10) sale price, 11) Bills Receivable book, 12) contingent liability, 13)
cost records, 14) Transaction, 15) realization)
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
AUDITING - II (77)
AUDITING - II
NOTES
UNIT - 9
AUDIT OF EXPENDITURE
Structure:
9.0
9.1
9.2
9.3
CHECK YOUR
PROGRESS
What is Audit of
Payment?
9.4
9.5
9.6
9.7
Introduction
Objectives
Audit of Payments
Vouching of Payments
9.3.1 Cash purchases
9.3.2 Payment to creditors
9.3.3 Bills payables
9.3.4 Bills receivable discounted but dishonored
9.3.5 Travelling expenses
9.3.6 Royalty paid
9.3.7 Payment of sales tax
9.3.8 Postage
9.3.9 Petty cash
9.3.10 Director's travelling expenses
9.3.11 Transactions with directors
9.3.12 Salaries & wages
Key concept
Summary
Exercise & Questions
Further Reading and References
9.0 Introduction
Before the auditor proceeds to audit payments, he should evaluate the
system of internal control operating in the organization. This would help him in
understanding the weakness, if any, which he should report to the management.
9.1 Objectives
1) To understand the audit procedure of payments
2) To understand the various modes of payments.
3) To get detailed knowledge of payments.
9.2 Audit of Payments
In case of audit of payments, the auditor should see that:
1. The payments are for the business itself.
2. The payments are made to the right persons.
(78) AUDITING - II
3. The amounts are properly recorded both in voucher and cash book / bank
book.
Audit of Expenditure
4. Payments are debited to appropriate accounts.
5. Payments are duly authorized by the proper person.
NOTES
The auditor should also see whether provisions of various acts in force are
complied with.
The auditor should see that the receipts produced in evidence of payments
are properly stamped i.e. they bear a revenue stamp. He should also see that
adequate precautions to prevent payments being made to wrong persons are being
taken by client's office.
The auditor should inquire whether a daily or rough cash book is maintained.
The auditor should compare the entries in the cash book with those appearing in
diary or rough cash book. The auditor should inquire where the amounts recorded
are same but are under different accounts in these two different records. He
should also see that all vouchers are serially numbered and are serially arranged in
convenient files.
9.3 Vouching of Payments
9.3.1 Cash purchases:
CHECK YOUR
PROGRESS
What is Vouching of
Payments?
Urgent purchases may have to be made in cash. For want of such goods,
the production may close down. In such cases, cash has to be given against goods.
In most of the cases, such purchases are petty purchases of items of stores. They
may also be the items of purchase of stationery, etc. The system of internal control
should be evaluated. The auditor should see that in all such cases, the internal
control system is adequate. The auditor while vouching should see that:
1. The cash memo for a purchase or receipted bill is attached to the voucher
as supporting evidence.
2. The purchase is authorized by a responsible officer.
3. The voucher is also authorized by a responsible person who is not the
person authorizing the purchase.
4. The amount is debited to the appropriate account.
5. The net amount, after an allowance for discount, should be recorded, as
this is the amount paid.
9.3.2 Payment to creditors:
1. The payments to creditors should be vouched with the receipts issued by
the creditor. The receipt is the acknowledgement of the receipt of money.
2. See that, as far as possible, vouchers have references of bills against
which the payment is made.
3. Where the payment is 'on account', there must be such a reference.
4. Where the amounts of invoice from the party differ from the amount of
the payment, the difference should be inquired into. If a short payment is
made in full and final settlement, the difference should be adjusted.
5. Where the payment is in excess of the bill or where the same bill is paid
twice; the fact should be inquired into. The auditor should also verify
AUDITING - II (79)
AUDITING - II
whether the excess amount paid to the creditor has been received back
or has been deducted from the subsequent bill.
6. The auditor should verify the periodical statement of account.
7. Wherever, necessary, the auditor, should refer to the minutes of directors.
NOTES
9.3.3 Bills payables:
1.
2.
3.
4.
CHECK YOUR
PROGRESS
Describe provisions of
Vouching of Travelling
Expenses?
5.
6.
It represents an acknowledgement of debt payable. The following may
be adopted by the auditor:
Verify the bills pending on the last day of accounting period by excluding
the bills paid out of those issued during a year and opening balance therein
is added to arrive at correct quantum of liability outstanding on this front
and properly disclosed.
Ensure that in case of bills paid during the year the correct amount has
been paid.
Reconcile the closing balance of bills payable schedule / list with the
balances in bills payable account at the year end.
Verify that the charge, if any, created on any asset for due payment of
the bills has been appropriately disclosed.
Obtain conformation from the drawers or holders of the bills regarding
amounts due thereon.
Check out in case of bills pertaining to a party, whether payment has
been made in respect of a bill or is made on account.
9.3.4 Bills receivable discounted but dishonored:
1. A bill receivable may be discounted with the bank. Sometimes, the bill
may be dishonored. In such a case, the bank will return the bill and the
amount will have to be paid to the bank. Instead of receiving the money
separately the bank may debit the account, if maintained with that bank.
In such cases, there will not be a separate payment.
2. The auditor should see that the bank's advice is attached to the voucher.
3. The bill, which should also be returned by the bank, should be verified by
the auditor.
4. The auditor should see that the amount has been credited to the bank
account. He should also see that the account of the drawee or the debtor
is also debited.
5. Where bankers have charged a commission, the same should be recovered
from the party. The auditor should see that such an amount has been
debited to the party concerned.
6. The auditor should also see the relevant correspondence.
9.3.5 Travelling expenses:
1. The auditor should first go through the rules framed by the company in
respect of the travelling expenses to be reimbursed to the staff of the
company. If there are no such rules, he should go through the conventions
or past practices.
2. The auditor should see that the voucher is supported by the full details of
travelling expenses and is supported by evidences and also by receipt.
3. The head of the department should normally authorize the payment of
(80) AUDITING - II
4.
5.
6.
7.
8.
the travelling expenses incurred by his subordinate staff.
Reimbursement of expenses may be on the actual basis or per some
fixed allowances per day. The auditor should verify the vouchers
accordingly.
Where an advance for the travelling expenses is given to the employee,
the auditor should see that the same is adjusted simultaneously.
Where a travelling allowance is given in place of travelling expenses, the
auditor should see the calculations accordingly.
In respect of foreign travelling expenses, the auditor should see the
authorization by the board or the partner. He should see the vouchers,
along with the supporting document like the bill from the traveling agents,
the permissions of the Reserve Bank of India, the documents regarding
foreign exchange, etc.
Similarly, whenever, there is an extraordinary type of travelling, a
responsible person should authorize the voucher.
9.3.6 Royalty paid:
1. The auditor should verify the royalty agreement and study the relevant
clauses for calculations and the payment of royalty.
2. He should see that the vouchers are supported by the statement showing
calculations of royalty payable. He should check the calculations of royalty
payable. He should check the calculation and see that it is as per the
royalty agreement.
3. The auditor should also see the receipt for the payment.
4. He should also mark the date or the period up to which royalty is payable.
He should see that no royalty is paid after the period of expiry.
Audit of Expenditure
NOTES
CHECK YOUR
PROGRESS
Describe provisions of
Vouching of Payment
of Sales Tax?
9.3.7 Payment of sales tax:
1.
2.
3.
4.
5.
Sales tax is payable every quarter or every month, as the case may be,
together with the quarterly or monthly return. The balance sales tax, if
any, is paid at the time of the final assessment.
The auditor should see the receipted challan in support of the payment
voucher.
The sales tax payment for each year should be properly recorded.
Auditor should verify the assessment order where assessment has been
completed.
The sales tax payment may be in respect of VAT or the Central sales
Tax. The auditor should see that both are separately recorded.
He should see the returns and calculations to verify the correctness of
the amount paid.
9.3.8 Postage:
1. The auditor should verify the postage register, whenever maintained.
2. He should see that monthly expenses are debited to the postage account
through the cash book or other records. In such cases, as and when
payment is made for the purchase of stamps, the advance account is
debited. The monthly expenses are then debited to the postage account
by crediting the advance account. Where an advance is made, the entry
AUDITING - II (81)
AUDITING - II
NOTES
for the payment from the cash book should be traced into the postage
register.
3. The voucher in respect of the advance should be signed by the postage
or dispatch clerk also.
4. Where the franking machine is used by the client, a similar method should
be followed. For the payment of the postage authority, the auditor should
verify the pass - book issued by them.
5. The closing balance of the stamp on hand should be counted and verified
by the auditor.
9.3.9 Petty cash:
CHECK YOUR
PROGRESS
Describe provisions of
Vouching of Petty
Cash?
1. The vouchers duly authorized by a responsible person are serially
numbered and filed in the same serial number
2. All the vouchers are serially recorded daily.
3. Expenses are debited to appropriate accounts.
4. 'Receipts in petty cash are recorded on the same day as given by the
main cashier.
5. The petty cash book is maintained on the imprest system and there is a
proper control by the main cashier.
6. The auditor should examine all the petty cash vouchers and there supporting
evidences. All the vouchers and their supporting evidences must be
stamped or initialled by the auditor to ensure that no voucher is recorded,
and presented twice for audit.
7. The voucher must be signed by the receiver of amount.
The amount in the petty cash voucher must be written both in words and
figures.
9.3.10 Director's travelling expenses:
1. For attending Board Meetings, the auditor should verify whether the Articles
of Association permit the payment of such travelling expenses and if yes,
whether the director was present in the Board meeting. The auditor should
verify the attendance register.
2. The auditor should see the resolution fixing the travelling expenses of
director per meeting.
3. The auditor should see that personal expenses of the directors are not
entered as the company's expenses.
4. He should see that voucher is supported by the necessary resolution,
details of expenses and the receipt for the payment.
5. In respect of foreign travelling expenses, the auditor should see the
resolution of Board of director, the permission of Reserve Bank of India,
the bill from company's travelling agent, documents in respect of foreign
exchange, the voucher with all the details and receipt from the director
concerned.
9.3.11 Transactions with directors:
1. In case of transaction with directors, the relevant Provisions of Companies
Act, 1956 should be complied with.
2. According to section 297, a director of a company or his relative, a firm
(82) AUDITING - II
in which a director or his relative is a partner or a private company of
which the director is a member, cannot enter into any contract with the
company for sale, or purchase of supply of goods and materials or for
underwriting subscriptions to shares or debentures except with the consent
of the Board. In case of companies having a paid- up capital of Rs 1
crore or more, in addition to Boards consent, prior approval of Central
Government would be necessary. Section 297(2) provides exception to
this rule. A contract in contravention of this provision is voidable at the
option of the Board.
3. According to sec 299, every director of a company who is in any way,
whether directly or indirectly, concerned or interested in a contract or
agreement entered into or one proposed to be entered into by the company,
must disclose his interest in the Board Meeting. An interested director is
not allowed to participate in discussion. He is also not allowed to vote in
any contract or agreement in which he is interested. His presence is not
counted for quorum required for considering such contract or for voting
thereat. If he does so, his vote would be invalid. However subsection (2)
and (3) of section 300 provides exceptions to these provisions.
9.3.12 Salaries & wages:
The auditor should verify the internal control for the following matters:
1. Mechanically recording of attendance of workmen by time recording
clock installed at the factory gate, as well as in each department and the
reconciliation of the total labour force with the total of workmen different
departments.
2. Preparation of wages and salary bills in case of newly appointed persons
by reference to orders for appointment, promotion or transfer made during
each month and of those payable to old employees by reference to old
records and on reference to the record of attendance.
3. Preparation of wages and salary bills of members of the staff, who are
not connected with maintaining a record of engagement of workers,
recording of their attendance and fixation of their wages.
4. Rotation of duties of different clerks employed for payment of wages
and salaries.
5. Verification of total wages paid with the amount adjusted in the costing
records.
6. Checking and authorization of overtime and piece - work payment by
officers who are not associated with the department.
l
After study and evaluation of internal control, the auditor should check
the payment of wages and salaries as follows:
1. Check the bill in detail by reference to record of attendance, schedule of
rates, sanctioned by management for different classes of workers and
employees and the sanction for their payment.
2. Check the computation of wages and salaries on taking into account the
deduction and other factors like absence, leave with pay, loans and
advances, increments, fines and penalties, deduction on account of
Provident Fund and Income - Tax, deduction on account of contribution
towards Employee's State Insurance etc.
3. In case of increments, the auditor should verify the records and see that
all increments are as per appointments in the letter.
Audit of Expenditure
NOTES
CHECK YOUR
PROGRESS
Describe provisions of
Vouching of Salaries
& Wages?
AUDITING - II (83)
AUDITING - II
4. Confirm that all payments to workers and other employees have been
acknowledged.
5. Check that amount remaining undisbursed have been deposited back in
the bank and credited to the unpaid wages and salaries accounts. Also,
check disbursement of unpaid wages salaries during the month.
6. Test the correctness of the amount paid by the reference to Annual Return
of Salaries etc. submitted to the Income Tax authorities and that of wages
with Employee's State Insurance cards.
7. Trace recoveries of loans and advance, outstanding against employees
Loans and Advance Register.
8. The auditor should see that the names of same persons do not always
appear on the list of unpaid wages if their wages are not from, time to
time, adjusted against their loans and advances to prevent their absence
being noticed at the time wages are paid. It may provide a clue that the
workmen are dummies
NOTES
l
Preliminary expenses:
It is the expenditure incurred incidental to the creation and floating of a
company. It consists of stamp duties, registration fees, legal costs, consultant's
fees, expenses of printing of memorandum and articles, etc.
9.4 Key Concept
Preliminary expenses are the expenditure incurred incidental to the
creation and floating of a company.
In Cash Purchases, cash has to be given against goods.
9.5 Summary
Before the auditor proceeds to audit payments, he should evaluate the
system of internal control operating in the organization. Urgent purchases may
have to be made in cash. For want of such goods, the production may close down.
In such cases, cash has to be given against goods. Sales tax is payable every
quarter or every month, as the case may be, together with the quarterly or monthly
return.
9.6 Exercise & Questions
1) What is the audit procedure of travelling expenses?
2) Short note on Petty cash.
3) How to conduct the audit of salaries & wages?
l
1)
2)
(84) AUDITING - II
Fill in the blanks:
Before the auditor proceeds to audit payments, he should evaluate the system
of __________________ operating in the organization.
(internal control, internal audit, audit sampling, environment)
The _____________ should inquire whether a daily or rough cash book is
maintained.
(management, members, auditor, government)
3)
4)
5)
6)
7)
8)
9)
10)
11)
12)
13)
14)
15)
In _____________________, cash has to be given against goods.
(credit purchases, cash purchases, investment, payment of salaries)
The payments to ____________ should be vouched with the receipts issued
by the creditor.
(debtors, investors, creditors, members)
________________ represents an acknowledgement of debt payable.
(Bills payable, Creditors, Bills receivable, Debtors)
______________ is payable every quarter or every month, as the case
may be, together with the quarterly or monthly return.
(Income tax, Gift tax, Wealth tax, Sales tax)
_______________________ are the expenditure incurred incidental to the
creation and floating of a company.
(Travelling expenses, Preliminary expenses, Salary expenses, Postage
expenses)
The auditor should verify the royalty ____________ and study the relevant
clauses for calculations and the payment of royalty.
(agreement, report, document, contract)
The head of the department should normally authorize the payment of the
__________________ incurred by his subordinate staff.
(Travelling expenses, Preliminary expenses, Salary expenses, Postage
expenses)
The _________________ of the stamp on hand should be counted and
verified by the auditor.
(opening balance, closing balance, account balance, class balance)
_________________ of different clerks employed for payment of wages
and salaries.
(Rotation of duties, Separation of duties, Segregation of duties, Responsibilities
& duties)
'Receipts in __________ are recorded on the same day as given by the
main cashier.
(sales, petty cash, cash book, pass book)
Verification of total wages paid with the amount adjusted in the
____________.
(accounting records, financial records, costing records, auditing records)
A contract in contravention of provision of sec. 297 is voidable at the option
of the___________.
(Board, Auditor, Members, CG)
The auditor should see that ________________of the directors are not
entered as the company's expenses.
(Professional expenses, personal expenses, travelling expenses, remuneration
expenses)
Audit of Expenditure
NOTES
(Answers: 1) internal control, 2) auditor, 3) cash purchases, 4) creditors, 5)
Bills payable, 6) Sales tax, 7) Preliminary expenses, 8) agreement, 9) Travelling
expenses, 10) closing balance, 11) Rotation of duties, 12) petty cash, 13)
costing records, 14) Board, 15) personal expenses)
9.7 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 - II (85)
AUDITING - II
NOTES
CHECK YOUR
PROGRESS
What are the principle
matters
to
be
considered while
vouching Trading
Transaction?
UNIT - 10
AUDIT OF TRADING TRANSACTIONS
Structure:
10.0
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
Introduction
Objectives
Principle matters to be considered while vouching Trading Transaction
Factors which give rise to discrepancy in the stock
Factors which increase the gross profit
Factors which decrease gross profit
Audit of Purchases
Special precautions in the verification of purchase invoices
Purchase Returns
Audit of sales
Goods sold on sale or return basis
Returnable containers, Empties & Packages
Cut-off arrangements
Key concept
Summary
Exercise & Questions
Further Reading and References
10.0 Introduction
In case of large concerns, as the volume and variety is very large, the
auditor should understand the internal control system and only test check some of
stock entries.
10.1 Objectives
1. To understand the principle matters consider while vouching trading
transactions.
2. To understand the audit procedure of purchase & sales.
3. To understand the concept of cut-off arrangements.
10.2 Principle matters to be considered while
Vouching Trading Transaction
1. Correctness of Book - Keeping record: The auditor should verify that
the profitability statement show true profit i.e. the profits are neither
understated nor overstated.
(86) AUDITING - II
2. Observation of Accounting Principles - The auditor should see that
the transactions are recorded in accordance with the well - known and
accepted accounting principles, e.g. there should be a distinction between
capital and revenue expenditure. If the distinction between capital and
revenue expenditure is not made, the profit or loss would be wrongly
stated. As a result, the final accounts would not disclose the true and fair
view of state of affairs of the business.
Audit of Trading
Transactions
NOTES
3. Checking of stock and Record - The stock accounts are an integral
part of the financial accounts.
Therefore, any inaccuracy in one affects the other. It is, therefore,
necessary that while checking entries of purchases and sales in the
financial books, corresponding entries in the stock accounts should also
be checked. He must, however, reconcile the quantities of goods purchased
and sold with the balance at the close of the year.
10.3 Factors which give rise to Discrepancy in the Stock
1. Inclusion in the closing stock of goods that should have been returned to
suppliers.
CHECK YOUR
PROGRESS
2. Non - inclusion of goods returned by customers.
3. Inclusion of goods received for sale on approval or on a consignment
basis.
Describe the Factors
which increase the
Gross Profit?
4. Non - inclusion in the closing stock of goods sent out for sale on approval
or on consignment basis.
5. Failure to adjust any sales, the proceeds were of have been
misappropriated, or purchases, the bills in respect of which had not been
received from the suppliers.
6. Failure to include goods purchased that were in transit.
7. Failure to exclude goods which had been sold but not delivered.
8. Non-adjustment of the losses in weight of material in the process.
10.4 Factors which Increase the Gross Profit
1. Under valuation of opening stock, it may be either the effect of non inclusion of certain items of stocks or that of valuation of the stock at a
rate lower than that warranted by the basis of valuation adopted or
miscalculation of the value of one or more items of stock.
2. Overvaluation of closing stock, either by. the inclusion therein of fictitious
items of stock or over statement or values Of some of them
3. Inclusion in the closing stock of goods returned awaiting dispatch to
supplier, the cost of which has been debited to them or goods returned by
the customers, the cost where of has not been credited to parties.
4. The Inclusion in the closing stock of goods received for the sale on approval
or on a consignment basis.
5. Treatment of goods sent out for sale on consignment basis as regular
sales.
6. No provision or under - provision in the expenses accounts included in
AUDITING - II (87)
AUDITING - II
the Trading Account. For example, purchase may be understated; provision
for outstanding wages or carriages inward may not have been made.
7. Wrong allocation of expenses e.g. carriage inward either in whole or in
part may be wrongly taken to the Profit and Loss Account.
NOTES
10.5 Factors which Decrease Gross Profit
1. Overvaluation of the opening stock or under valuation of closing stock
either due to mistake made in taking stock or in its valuation.
2. Alteration of the basis of valuation of stock e. g. closing stock having
been valued at cost, which is below the market price, when the opening
stock was valued at market price above cost.
3. Inclusion in the year of the amount of goods purchased in the previous
year, which were received and were taken in the same year.
CHECK YOUR
PROGRESS
What
are
the
provisions of Audit of
Purchases?
4. Reversal of the fictitious sales entries recorded in the previous year to
boost up profit.
5. Entry of sales returns twice or failure to account for purchase return
when the goods in question have been sent back.
6. Excessive provision has been made for wages or direct expenses.
7. Failure to include in closing stock goods sent out for sale on approval or
on a consignment basis.
8. Omission to adjust the value of unused stock of consumable stores, such
as fuel and packing material or inclusion in the Trading Account expenses
which should have been included in the Profit and loss Account.
9. Failure to take credit for the amount of an insurance claim in respect of
consignment of goods lost in transit or destroyed by fire.
10. Failure to account for goods sold or destroyed or given away as samples.
10.6 Audit of Purchases
The auditor should adopt following steps while audit of purchase transactions:
1. Before starting the vouching of credit purchases, the auditor should evaluate
the system of internal control existing in the organization.
2. He should see that only credit purchases are entered in the purchase
book.
3. The auditor should see that the duplicate invoices are not entered again.
Where duplicate invoices are entered, he should see that original invoices
are not available; the duplicate invoice may be entered.
4. The auditor should see that costs of purchases are debited to an appropriate
nominal account or accounts.
5. The auditor should call statements from the suppliers. This will enable
him to see whether any invoices are left out. He should also get
confirmation of balances from the suppliers.
6. Auditor should verify the following books & documents(88) AUDITING - II
l
Purchase book
l
Copies of purchase order
l
Purchase invoices
l Goods inward book
l
Audit of Trading
Transactions
NOTES
Copies of challan received at the time of receipt of goods
7. While vouching purchase invoice, the auditor should seel
The name of client
l
The capital goods are not recorded in the purchase book
l
The price charged in the invoices are as per order placed
l
Quantities mentioned in the order & invoice arte same
10.7 Special Precautions in the Verification of
Purchase Invoices
1. When an invoice runs into several pages, the auditor should be more
careful while checking calculations and totals; Where the amount of an
invoice has been distributed over several accounts it should be confirmed
that the amounts relating to different parts of the invoice have been adjusted
in separate accounts, all the amounts so adjusted should be added together
to confirm that there has not been any error under adjustment.
2. At times, invoices are received in duplicate or triplicate. The auditor should
see that duplicate invoices are not entered again. Duplicate invoices may
be entered only when original invoice is not available. Payment should be
made only on the basis of original invoice. It should be confirmed that
original has not also been paid or adjusted separately.
3. The auditor should see that terms and conditions are mentioned in invoice
is same as were agreed of at the time of placing order, e. g. price and
quantity mentioned in invoice are same 'as per the order placed.
4. If the amount of an invoice was payable only after the lapse of some
time, it should be seen that it has not been paid earlier and the benefit of
cash discount, if any, has been obtained.
5. Where a trade discount has been deducted from the amount of the invoice,
it should be seen that only net amount has been credited to the supplier.
6. When partners or the officials of the company have made purchases in
the name of the client, the auditor should see that the personal accounts
are debited and not purchase Account.
7. Purchases of goods from the allied and associated concerns can be made
only under on appropriate sanction.
8. In case of an invoice addressed to an individual, special care should be
taken while vouching such an item, since the individual may have attempted
to procure goods for his own use and allowing the company to pay for
them.
9. If materials are brought for direct delivery to a customer, the exact
circumstances of the transaction should be ascertained and the reason
AUDITING - II (89)
AUDITING - II
NOTES
for the goods having been delivered direct to the customer. The auditor
should see that the transaction was authorized by a responsible official. A
copy of the delivery note signed by the customer on delivery of the goods
should be examined.
10. The auditor should be more careful while vouching the invoices of the
first month and the last month of the year. He should see that invoices of
the previous year are not entered in the current year.
11. He should see whether there exists a system of internal control which
would prevent payment being made for any goods not received in stock.
10.8 Purchase Returns
CHECK YOUR
PROGRESS
What
are
the
provitions of Audit of
Sales?
1. If a part or whole of a consignment of goods is found to be defective or
of a poor quality, the goods sometimes are returned to the supplier and his
account is debited. The debit is raised in the Purchase Returns Books, on
the basis of Debit Note. The suppliers on receiving the debit note, issue a
credit note indicating his acceptance of the debit: Thus a receipt is attached
to the Debit note. All these entries should be verified by references to the
record kept in the goods outward book or the stores record.
2. The original invoices through which purchases were made also should be
referred to for confirming that the nominal account, which was originally
debited on the purchases being made, has been subsequently credited on
a part or whole of the goods contained in the consignment having been
returned.
3. Where the purchase returns are large, either at the beginning or at the
close of the year, these might be fictitious, entered to cover bogus purchases
recorded earlier. On such a consideration, the nature there of should be
ascertained.
4. The rebate in price and allowances granted by the suppliers should be
adjusted through the journal on the basis of Credit Note received from
the suppliers.
10.9 Audit of Sales
1. The auditor should first evaluate the system of internal check in existence.
The adequacy of internal check would help him to determine whether to
apply test check or not.
2. While vouching sales invoices, the auditor should compare the copies of
the sales invoice with the sales register. He should verify the dates of the
sale invoices, names of the customers, quantities of various goods, amount
of taxes, duties etc., total gross amount to be collected from the customers.
3. He should test check the totals and castings of sales register and test
check the calculation of the invoices.
4. He should see that goods are those that are normally dealt in by the
concern. The sale of fixed assets should not be entered in the sales register
but should be recorded separately through the journal.
5. He should see that each item of sales relates to the period of account
(90) AUDITING - II
under audit.
6. He should see that invoices are prepared in respect of all the challans.
He should further see that all invoices are entered in the sales register.
Once the entry is made in sales register, the same should be posted
accordingly.
Audit of Trading
Transactions
NOTES
7. The auditor should see that sale has been authorized by a responsible
official and in token thereof he has initialed the invoice. Any alteration in
the invoice has been attested by the same person.
8. The auditor should verify that the sales have been made at a uniform
rate, and on identical terms as regards payment of freight, sales-tax,
packing, forwarding charges etc.
9. Sometimes during the period under audit, goods are dumped with the
customers and sales invoices are prepared. But in the subsequent period,
the credit notes are issued as the goods are returned. The auditor should
verify this in detail. There may be entries of fictitious sales also which
will be reversed in the next year. He should verify the credit notes issued
in the subsequent period.
10. It is difficult to locate a fraud where the sales invoice is not prepared and
hence not entered in the sales register. The auditor should go through the
goods outward register and other records as a test check to see that
entries are passed in respect of goods delivered.
11. The sale of goods on hire purchase basis or the goods sent out on sale or
return basis or on consignment basis should be separately recorded.
CHECK YOUR
PROGRESS
What
are
the
provitions of Audit of
Goods sold on Sale of
Return Basis?
12. Where invoices are cancelled, the auditor should see that all the copies
are bunched together and kept properly.
10.10 Goods Sold on Sale or Return Basis
1. Goods sold on sale or return basis or on approval basis cannot be considered
sold unless the other party has approved the sale or has opted for the
purchase of the goods. Goods are delivered to the party on the condition
that if he does not approve of the goods the same can be returned within
a stipulated period.
2. If the party informs the sender of the goods before the stipulated date
about the non approval, the sender will make the arrangements for getting
the goods back. On the other hand, if the party approves the goods would
be considered as sold and the sender would send him the sales invoices.
3. If on the date of the balance sheet the stipulated date is not over, and the
party has neither approved nor returned the goods, the transaction would
not be considered as a sale. The goods lying with the other party would
be included in the closing stock.
4. The auditor should take a letter from the client that on the date of the
balance sheet the party held the stock on his behalf.
5. A separate record should be maintained for the goods sent on an approval
basis or a sale or return basis. The auditor should vouch this register with
the documentary evidence like correspondence, or invoice on the sale or
return basis etc. Unapproved goods should be taken on the closing stock.
AUDITING - II (91)
AUDITING - II
NOTES
10.11 Returnable Containers, Empties & Packages
1. Some goods can be dispatched to the customers in containers or packages
only. These containers are returnable and are not sold. Hence, certain
suppliers like gas companies maintain separate accounts for each customer
for containers. The amounts of such deposits are credited to these separate
accounts.
2. When a container is damaged, the customer is separately billed. When
the customer retains the container for a period more than the stipulated
period, he is invoiced for the rental charged. Invoices of rentals are
recorded separately.
3. The dispatch of returnable containers and empties with the goods is not
sale. Likewise, the return of containers and empties is not a sale return.
Separate accounts should be maintained. Rental charges recovered and
charges for damages are also not sales. They are separately accounted.
CHECK YOUR
PROGRESS
What
are
the
provitions of Audit of
R e t u r n a b l e
Containers, Empties &
Packages?
4. The receipt of the deposit received from the customer should be vouched
with the duplicate or counterfoil of the receipt issued to the party. For
rental charges, the auditor should check the invoices raised for that
purpose.
10.12 Cut-off Arrangements
1. Accounting is a continuous process because business never comes to an
end. It is, therefore, necessary that the transaction of one period would
be separate from those in the working of each period can be correctly
ascertained. The arrangement that is made for the purpose is technically
known as cut-off arrangement.
2. It essentially forms part of the internal check of the organization. Accounts
other than sales, purchases and stock are not usually affected by the
continuity of the business and, therefore this arrangement is generally
applied only to the aforesaid accounts. The auditor satisfies by examination
and test check that the cut - off procedures adequately ensure that:
l Goods purchased, property which has passed to the client, have in fact
been included in the inventories and that the liability has been provided
for in case of credit purchases and
l Goods sold have been excluded from the inventories and credit has been
taken for the sales; if the value of sales is to be received the concerned
party has been debited.
3. The auditor may examine a sample of documents evidence of the
movement of stocks into and out of stores, including documents pertaining
to period shortly before and after the cut-off date and check whether
stocks represented by those documents were included or excluded as
appropriate during stock taking.
10.13 Key Concept
(92) AUDITING - II
The transaction of one period would be separate from those in the working
of each period can be correctly ascertained. The arrangement that is made for the
purpose is technically known as cut-off arrangement.
10.14 Summary
The auditor should see that the transactions are recorded in accordance
with the well - known and accepted accounting principles. The auditor should first
evaluate the system of internal check in existence. The auditor should vouch this
register with the documentary evidence like correspondence, or invoice on the sale
or return basis.
Audit of Trading
Transactions
NOTES
10.15 Exercise & Questions
1) Which factors increase the gross profit?
2) What is the audit procedure of purchases?
3) What is mean by cut-off arrangements?
4) What is the audit procedure of sales returns?
5) Which precautions should be taken in verification of purchase invoice?
l
Fill in the blanks:
1)
The ________________ should see that the transactions are recorded in
accordance with the well - known and accepted accounting principles.
(government, director, auditor, member)
2)
If the distinction between __________ and revenue expenditure is not made,
the profit or loss would be wrongly stated.
(capital, personal, current, fixed)
3)
Discrepancy in the stock due to inclusion in the closing stock of goods that
should have been returned to ___________.
(auditor, suppliers, manager, member)
4)
Overvaluation of closing stock, either by the inclusion therein of ___________
items of stock or over statement or values Of some of them
(current, fixed, fictitious, intangible)
5)
The auditor should see that ________________are debited to an appropriate
nominal account or accounts.
(costs of purchases, cost of sales, cost of labour, other cost)
6)
Auditor should also get confirmation of balances from the _______________.
(government, suppliers, manager, member)
7)
The debit is raised in the Purchase Returns Books, on the basis of
_____________.
(Debit Note, Credit note, Order note, Delivery note)
8)
A copy of the ______________ signed by the customer on delivery of the
goods should be examined.
(Debit Note, Credit note, Order note, Delivery note)
9)
Auditor should see that only _____________are entered in the purchase
book.
(credit purchases, cash purchases, credit sales, cash sales)
AUDITING - II (93)
AUDITING - II
NOTES
10) The transaction of one period would be separate from those in the working of
each period can be correctly ascertained. The arrangement that is made for
the purpose is technically known as __________________.
(audit procedure, cut-off arrangement, substantive procedure, compliance
procedure)
11) When the customer retains the container for a period more than the stipulated
period, he is invoiced for the __________ charged.
(brokerage, commission, rental, discount)
12) ______________ recovered and charges for damages are also not sales.
(Rental charges, brokerage, commission, discount)
13) The goods lying with the other party would be included in
the___________________.
(opening stock, closing stock, debtors balance, creditors balance)
(Answers: 1) auditor, 2) capital, 3) suppliers, 4) fictitious, 5) costs of purchases,
6) supplier, 7) Debit Note, 8) delivery note, 9) credit purchases, 10) cut-off
arrangement, 11) rental, 12) Rental charges, 13) closing stock)
10.16 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
(94) AUDITING - II
UNIT - 11
INTRODUCTION OF STANDARDS ON
AUDITING
Introduction of Standards
on Auditing
NOTES
Structure:
11.0
11.1
11.2
11.3
11.4
11.5
11.6
11.7
11.8
11.9
11.10
11.11
Introduction
Objectives
Scope of the Auditing & Assurance Standards
Auditing & Assurance Standards & the Auditor
Functions of the Auditing & Assurance Standards Board
Composition of the Auditing & Assurance Standards Board
Various Standards on Auditing
True & Fair
Key Concept
Summary
Exercise & Questions
Further Reading and References
11.0 Introduction
CHECK YOUR
PROGRESS
Describe Scope of
Auditing
and
Assurance Standards?
In the changing environment, it is obvious that a professional accountant
should to adhere to standards & procedures laid down by the professional
accountancy bodies of which he is a member while discharging his duties in a
responsible manner.
The Institute of Chartered Accountants of India has, from time to time,
issued statements of "Standards on Auditing". The SAs have been issued by the
Institute with a view to securing compliance by the members on matters, which on
the opinion of the institute are critical for the proper discharge of audit work.
Standards on Auditing are benchmarks by which the quality of audit performance
can be measured & the achievement of objectives can be documented.
11.1 Objectives
1. To understand the concept of Auditing Standards.
2. To understand the importance of Auditing Standards.
3. To get knowledge of functions of AASB.
4. To obtain the knowledge of various SAs.
5. To obtain an understanding of true & fair view.
11.2 Scope of the Auditing & Assurance Standards
Where an independent audit is carried with a view to express an opinion
on financial statements of any entity whether profit oriented or not, the AAS apply
in all cases. If any AAS is not applicable in a particular kind of audit or particular
situation, it is mentioned in that particular AAS. By using standards an auditor can
AUDITING - II (95)
AUDITING - II
NOTES
determine the professional qualities necessary for effective audit performance. In
simple words SA are Auditing Standards, which prescribe the way auditing should
be conducted.
11.3 Auditing & Assurance Standards & the Auditor
The role of a professional accountancy body is to lay down such standards
& procedures with the aim of providing guidance to members.
It is the duty of auditor (who the member of ICAI) to ensure that the audit
is conducted in accordance with these AAS & disclose the material departure
there from wherever necessary. The auditor becomes liable to the disciplinary
proceedings of the Institute of Chartered Accountants of India.
Auditor in his audit report has to mention that he conducted the audit in
accordance with 'generally accepted auditing standards'. The generally accepted
auditing standards in Indian context mean the AAS as issued by the Institute of
Chartered Accountants of India (ICAI).
CHECK YOUR
PROGRESS
What
are
the
Functions of Auditing
&
Assurance
Standards Board?
11.4 Functions of the Auditing & Assurance
Standards Board
Auditing & Assurance Standards Board (AASB) of the Institute of
Chartered Accountants of India (ICAI) determines the specific area in which the
AAS need to be formulated. The main function of the AASB is to review the
existing auditing practices in India & to develop statements on Standards on Auditing
(SAs) so that these may be issued by council of the Institute.
i.
To review the existing & emerging auditing practices worldwide.
ii. To formulate Engagement Standards, Standards on Quality Control &
Statements on Auditing.
iii. To review & revise the existing standards & statements auditing.
iv. To develop Guidance Notes on issue arising out of any standards, auditing
issues pertaining to any specific industry & revise.
v. To review & revise the existing Guidance notes.
vi. To formulate General Clarifications, where necessary, on issue arising
from standards.
vii. To formulate & issue practice manuals, studies.
11.5 Composition of the Auditing & Assurance
Standards Board
Auditing practices committee has been converted into an Auditing &
Assurance Standards Board by the council of the Institute. A significant step has
been taken aimed at bringing in the desired transparency in the working of Auditing
& Assurance Standards Board, through participation of representatives of various
segments of the society.
(96) AUDITING - II
Apart from amongst the elected members of the Council of the ICAI the
following are also represented on AASB-
i.
Eminent members of the profession.
ii. One special invitee from each three regulatory bodies SEBI, RBI, IRDA
Introduction of Standards
on Auditing
iii. One special invitee from the Indian Institute(s) of Management
iv. One special invitee from a prominent Industry association
NOTES
v. One special invitee representing public interest.
11.6 Various Standards on Auditing
l
SA 200 - Basic principles & objectives governing an audit.
l
SA 210 - Agreeing the terms of audit engagements (Revised)
l
SA 220 - Quality control for audit work
l
SA 230 - Audit documentation (Revised)
l
SA 240 - The auditor's responsibilities frauds in an audit of financial statements
(Revised)
l
SA 250 - Consideration of laws & regulations in an audit of financial
statements (Revised)
l
SA 260 - Communication with those charged with governance (Revised)
l
SA 265 - Communicating deficiencies in internal control to those charged
with governance & management
l
SA 299 - Responsibility of joint auditors
l
SA 300 - Planning an audit of financial statements (Revised)
l
SA 315 - Identifying & assessing the risk of material misstatement through
understanding the entity & its environment
l
SA 320 - Materiality in planning & performing an audit (Revised)
l
SA 330 - Auditors response to assessed risks
l
SA 402 - Audit consideration relating to an entity using service organization
(Revised)
l
SA 450 - Evaluation of misstatements identified during the audit
l
SA 500 - Audit evidence (Revised)
l
SA 501 - Audit evidence - additional consideration for specific items
l
SA 505 - External confirmation
l
SA 510 - Initial audit engagements - opening balances (Revised)
l
SA 520 - Analytical procedures
l
SA 530 - Audit sampling (Revised)
l
SA 540 - Auditing accounting estimates, including fair value accounting
estimates, & related disclosures (Revised)
l
SA 550 - Related parties (Revised)
l
SA 560 - Subsequent events (Revised)
l
SA 570 - Going concerns (Revised)
l
SA 580 - Written representation (Revised)
l
SA 600 - Using the work of another auditor
l
SA 610 - Using the work of internal auditor
l
SA 620 - Using the work of an expert
AUDITING - II (97)
AUDITING - II
NOTES
l
SA 700 - Auditor's report on financial statements
l
SA 710 - Comparatives
l
SA 720 - The auditor's responsibility in relation to other information in
documents containing audited financial statements
11.7 True & Fair
The Auditor's duty is to express an opinion on true & fair view of 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.
CHECK YOUR
PROGRESS
What is True & Fair
Concept?
Auditor should ascertain whether financial statements are prepared
according to Financial Reporting Framework. He should also ascertain whether
financial statements comply with the relevant Accounting Standards. ICAI issue
the statements on Accounting Standards.
"Accounting Standards are the rules framed by an expert committee in
relation to recognition, measurement & disclosure of financial information in
preparation of financial statements"
The basic objective of accounting standards is to standardize the accounting
principles & policies with a view to bring a common approach in preparation of
financial statements. Following are the Accounting Standards1. Disclosure of accounting policies
2. Valuation of inventories
3. Cash flow statements
4. Contingencies & events occurring after the Balance sheet date
5. Net profit or loss for the period, prior period items & changes in accounting
policies
6. Depreciation accounting
7. Construction contracts
9. Revenue recognition
10. Accounting for fixed assets
11. Effects of changes in Foreign Exchange Rates
12. Accounting for Government grants
13. Accounting for Investments
14. Accounting for Amalgamation
15. Employee benefits
16. Borrowing costs
17. Segment reporting
18. Related party disclosure
19. Accounting for leases
20. Earning per share
21. Consolidated financial statements
(98) AUDITING - II
22. Accounting for taxes on income
23. Accounting for investments in Associate in CFS
24. Discontinuing operations
25. Interim financial reporting
26. Intangible assets
27. Financial reporting of interest in joint venture
28. Impairment of assets
29. Provisions, contingent liabilities & contingent assets
30. 31. 32. Accounting for financial instruments
Introduction of Standards
on Auditing
NOTES
11.8 Key Concepts
The Institute of Chartered Accountants of India has, from time to time,
issued statements of "Standards on Auditing".
The 'generally accepted auditing standards' in Indian context mean
the AAS as issued by the Institute of Chartered Accountants of India (ICAI).
"Accounting Standards are the rules framed by an expert committee in
relation to recognition, measurement & disclosure of financial information in
preparation of financial statements"
11.9 Summary
The Institute of Chartered Accountants of India has, from time to time,
issued statements of "Standards on Auditing". Auditor in his audit report has to
mention that he conducted the audit in accordance with 'generally accepted auditing
standards'. It is the duty of auditor to ensure that the audit is conducted in accordance
with these AAS & disclose the material departure there from wherever necessary.
The Auditor's duty is to express an opinion on true & fair view of financial statements.
11.10 Exercise & Questions
1) What are the functions of the Auditing & Assurance Standards Board?
2) What is the scope of AAS?
l
1)
2)
3)
Fill in the blanks:
The Institute of ______________________ of India has, from time to time,
issued statements of "Standards on Auditing".
(Company Secretary, Cost & Works Accountants, Chartered Accountants,
Accountants)
It is the duty of ______________ to ensure that the audit is conducted in
accordance with these AAS & disclose the material departure there from
wherever necessary.
( Director, Auditor, Government, Management)
___________________ are benchmarks by which the quality of audit
performance can be measured & the achievement of objectives can be
documented.
(Standards of Accounting, Standards on Auditing, Documentation, Vouching)
AUDITING - II (99)
AUDITING - II
4)
5)
NOTES
6)
7)
8)
9)
10)
11)
12)
13)
14)
15)
________ deals with communicating deficiencies in internal control to those
charged with governance & management.
(SA 260, SA 265, SA 220, SA 299)
An independent audit is carried with a view to express an opinion on
___________________of any entity.
(Balance sheet, Board's report, Financial statements, Profit & loss A/c)
By using standards an auditor can determine the professional qualities
necessary for effective ___________________.
(Audit procedure, Audit performance, Audit documentation, Management)
________deals with materiality in planning & performing an audit.
(SA 320, SA 300, SA 500, SA 315)
SA 550 deals with __________________________.
(Written representation, Going concern, Related parties, Comparatives)
________ deals with using the work of another auditor.
(SA 600, SA 610, SA 620, SA 700)
Auditor in his ________________ has to mention that he conducted the
audit in accordance with 'generally accepted auditing standards'.
(Board report, Audit report, Annual report, Summary report)
One special invitee from the Indian Institute(s) of ______________ also
represented on AASB
(Science, Engineering, Management, Commerce)
The Auditor's duty is to express an opinion on true & fair view of
__________________.
(Balance sheet, Financial statements, Profit & loss A/c, Board's report)
The basic objective of ____________________ is to standardize the
accounting principles & policies with a view to bring a common approach in
preparation of financial statements.
(Accounting Standards, Accounting procedure, Auditing, Sampling)
_____deals with Net profit or loss for the period, prior period items & changes
in accounting policies.
(AS 6, AS 4, AS 5, AS 10)
____________ should ascertain whether financial statements are prepared
according to Financial Reporting Framework.
(Management, Auditor, Director, Government)
(Answers: 1) Chartered Accountant, 2) Auditor, 3) Standards on auditing, 4)
SA 265, 5) financial statements, 6) Audit performance, 7) SA 320, 8) related
parties, 9) SA 600, 10) Audit report, 11) Management, 12) financial statements,
13) Accounting standards, 14) AS 5, 15) Auditor)
11.10 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
(100) AUDITING - II
UNIT - 12
STANDARDS ON AUDITING
Structure:
12.0
12.1
12.2
12.3
12.4
12.5
Standards on Auditing
NOTES
Introduction
Objectives
Standards on Auditing in detailed
Summary
Exercise & Questions
Further reading & references
12.0 Introduction
The Institute of Chartered Accountants of India has, from time to time,
issued statements of "Standards on Auditing". The SAs have been issued by the
Institute with a view to securing compliance by the members on matters, which on
the opinion of the institute are critical for the proper discharge of audit work.
12.1 Objectives
1. To understand the importance of Auditing Standards.
2. To get detailed knowledge of Auditing Standards.
CHECK YOUR
PROGRESS
Describe in breif
Standards on Auditing
in Detailed?
12.2 Standards on Auditing in Detailed
l
SA 200 - Basic principles & objectives governing an audit:
It establishes the independent auditor's overall responsibilities when conducting
an audit of financial statements in accordance with SAs. Specifically, it sets
out the overall objectives of the independent auditor & explains the nature &
scope of an audit designed to enable the independent auditor to meet those
objectives. This SA requires that the auditor to obtain reasonable assurance
about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error.
l
SA 210 - Agreeing the terms of audit engagements (Revised):
The revised standard deals with the auditor's responsibilities in agreeing the
terms of audit of audit engagement with management &, where appropriate
those charged with governance. SA 210 also deals with the requirement relating
to preconditions for an audit, agreement on audit engagement terms, recurring
audits, acceptance of change in the terms of the audit engagement & additional
considerations in engagement acceptance.
l
SA 220 - Quality control for audit work:
The revised standard deals with the specific responsibilities of the auditor
regarding quality control procedures for an audit of financial statements. It
also addresses, where applicable, the responsibilities of engagement quality
control reviewer. Revised SA 220 also deals with the aspects relating to
leadership responsibilities for quality on audits.
AUDITING - II (101)
AUDITING - II
l
SA 230 - Audit documentation (Revised):
The standard deals with the auditor's responsibility to prepare audit
documentation for an audit of financial statements. SA 230 also deals with
the requirement of timely preparation of audit documentation; documentation
of the audit procedures performed & audit evidence obtained & assembly of
the final audit file. SA 230 also outlines about vesting of property of working
papers with the auditor.
NOTES
l
SA 240 - The auditor's responsibilities frauds in an audit of financial
statements (Revised):
The standard adopts a risk- based approach to auditor's responsibility relating
to fraud in an audit of financial statements. An auditor is responsible for
obtaining reasonable assurance that the financial statements taken as whole
are free from material misstatement. An auditor is responsible for maintaining
an attitude of professional skepticism throughout the audit.
l
SA 250 - Consideration of laws & regulations in an audit of financial
statements (Revised):
The revised standard deals with the auditor's responsibility to laws & regulations
when performing an audit of financial statement. Revised SA 250 also deals
with the effects of laws & regulations, responsibility of management for
compliance with laws & regulations, responsibility of the auditor, audit
procedures & reporting of identified or suspected non compliance &
documentation requirements.
l
SA 260 - Communication with those charged with governance
(Revised):
This standard deals with the auditor's responsibility to communicate with those
charged with governance in relation to an audit of financial statements. SA
260 also describes the requirements regarding communication with those
charged with governance & regarding matter to be communicated &
documentation required. This standard also spells out the distinction between
Management & Those Charged with Governance.
l
SA 265 - Communicating deficiencies in internal control to those
charged with governance & management:
This standard deals with the auditor's responsibility to communicate
appropriately to those charged with governance & management deficiencies
in internal control that the auditor has identified in an audit of financial
statements. SA 265 defines the terms "Deficiency in internal control" &
"significant deficiency in internal control". This standard somehow supplements
the concept of "Letter of Weakness".
l
(102) AUDITING - II
SA 299 - Responsibility of joint auditors:
This SA deals with the professional responsibilities which the auditors
undertake in accepting appointments as joint auditors. The division of work
among joint auditors as also the areas of work to be covered by all of them
should be adequately documented & preferably communicated to the entity.
The SA also states that each joint auditor is responsible only for the work
allotted to him, whether or not he has prepared a separate report on the work
performed by him. The SA describes the areas for which joint auditors are
jointly & severally responsible.
l
SA 300 - Planning an audit of financial statements (Revised):
Standards on Auditing
NOTES
This standard on auditing deals with the auditor's responsibility to plan an
audit of financial statements. As per this SA the objective of auditor is to plan
the audit so that it will be performed in an effective manner.
l
SA 315 - Identifying & assessing the risk of material misstatement
through understanding the entity & its environment:
The standard deals with auditor's responsibility to obtain an understanding of
the entity & its environment & using that understanding to identify & assess
the risks of material misstatement at the financial statement level & assertion
level.
l
SA 320 - Materiality in planning & performing an audit (Revised):
The revised standard deals with the auditor's responsibility to apply the concept
of materiality in planning & performing an audit an audit of financial
statements. This SA also deals with the requirement of determining materiality
& performance materiality when planning the audit, revision as the audit
progresses & documentation requirements.
l
SA 330 - Auditors response to assessed risks:
SA 330 is a new standard on auditing which deals with the auditor's
responsibility to design & implement responses to the risks of material
misstatement identified & assessed by the auditor in accordance with SA
315 at the financial statement level & assertion level. This SA also deals with
aspects relating to overall responses to assessed risks, audit procedures
responsive to the assessed risks of material misstatement at the assertion
level, adequacy of presentation & disclosure, evaluating the sufficiency &
appropriateness of audit evidence & documentation requirements.
l
SA 402 - Audit consideration relating to an entity using service
organization (Revised):
The revised standard deals with the auditor's responsibility to obtain sufficient
appropriate audit evidence when a user entity uses the services of one or
more service organizations. SA 402 also deals with the aspects like obtaining
an understanding of the services provided by a service organization, including
internal control, responding to the assessed risks of material misstatement.
l
SA 450 - Evaluation of misstatements identified during the audit:
This standard deals with the auditor's responsibility to evaluate the effect of
identified misstatement on the audit & of uncorrected misstatements, if any,
on the financial statements. This SA also deals with the aspects like
accumulation of identified misstatements, consideration of identified
misstatements as the audit progresses, communication & correction of
misstatements, evaluating the effect of uncorrected misstatements, written
representation & documentation.
AUDITING - II (103)
AUDITING - II
l
SA 500 - Audit evidence (Revised):
The revised standard is quite detailed in terms of audit evidence in an audit of
financial statements, & deals with the auditor's responsibility to design &
perform audit procedures to obtain sufficient appropriate audit evidence to
be able to draw reasonable conclusion on which to base the auditor's opinion.
This SA also deals with the requirements of obtaining sufficient appropriate
audit evidence, how information to be used as audit evidence, how to select
items for testing to obtain audit evidence & procedures in case of inconsistency
in, or doubts over reliability of, audit evidence.
NOTES
l
SA 501 - Audit evidence - additional consideration for specific items:
The revised standard deals with specific consideration by the auditor in
obtaining sufficient appropriate audit evidence in accordance with SA 330.
Revised SA 501 also deals with the requirements & application of the aspects
relating to inventory, litigation & claims & segment information.
l
SA 505 - External confirmation:
The revised standard deals with the auditor's use of External confirmation
procedures to obtain audit evidence in accordance with the requirements of
SA 330. Revised SA 505 also deals with the requirements & application of
the aspects relating to external confirmation procedures, management's refusal
to allow the auditor to send a confirmation request, results of the external
confirmation procedures, negative confirmations & evaluating the evidence
obtained.
l
SA 510 - Initial audit engagements - opening balances (Revised):
The revised standard establishes the principles regarding audit of opening
balances in case of initial engagements, i.e., when the financial statements
are audited for the first time or when the financial statements for the preceding
period were audited by another auditor. This SA also deals with the audit
procedures & audit conclusions & reporting requirements in case of initial
audit engagements.
l
SA 520 - Analytical procedures:
The revised standard deals with the auditor's use of analytical procedures as
substantive procedures & as procedures near the end of the audit that assist
the auditor when forming an overall conclusion on the financial statements.
Revised SA 520also deals with the requirements & application of aspects
relating to substantive analytical procedures, analytical procedures that assist
when forming an overall conclusion & investigating results of analytical
procedures.
l
(104) AUDITING - II
SA 530 - Audit sampling (Revised):
The revised standard applies when the auditor has decided to use audit sampling
in performing audit procedures. It also deals with the auditor's use of statistical
& non-statistical sampling when designing & selecting audit sample, performing
tests of controls & & test of details, & evaluating the results from the sample.
This SA also deals with the requirements relating to sample design, size &
selection of items for testing, performing audit procedures, nature & cause of
deviations & misstatements, projecting misstatements & evaluating results
of audit sampling.
l
SA 540 - Auditing accounting estimates, including fair value accounting
estimates, & related disclosures (Revised):
Standards on Auditing
NOTES
The revised standard deals with the auditor's responsibilities regarding
accounting estimates, including fair value accounting estimates, & related
disclosures in an audit of financial statements. It also includes requirements
& guidance on misstatements of individual accounting estimates, & indicators
of possible management bias.
l
SA 550 - Related parties (Revised):
The revised standard deals with the auditor's responsibilities regarding related
party relationship & transactions when performing an audit of financial
statements. This standard also deals with the Risk Assessment procedure &
related activities, identification & assessment of the risk of material
misstatement associated with related party relationships & transactions,
responses to the risks of material misstatement associated with related party
relationships.
l
SA 560 - Subsequent events (Revised):
The revised standard deals with the auditor's responsibilities relating to
subsequent events in an audit of financial statements. SA 560 also deals with
the events occurring between the date of the financial statements & the date
of the auditor's report, facts which become known to the auditor after the
date of the auditor's report but before the date the financial statements are
issued & facts which become known to the auditor after the financial statements
have been issued.
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SA 570 - Going concerns (Revised):
The revised standard is quite detailed in terms of auditor's responsibility in the
audit of financial statements with respect to management's use of the going
concern assumption in the preparation & presentation of the financial
statements. SA 570 requires the auditor to inquire of management as to its
knowledge of events or conditions beyond the period of management's
assessment that may cast significant doubt on the entity's ability to continue
as a going concern.
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SA 580 - Written representation (Revised):
The revised standard is quite detailed in terms of the duties & objectives of
the auditors regarding the acknowledgment by the management that it is
fulfilling its responsibility relating to preparation & presentation of financial
statements & internal controls, the various forms of management
representations, situation where management representations are unreliable
or where the management refuses to provide requested representation.
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SA 600 - Using the work of another auditor:
This SA discusses the procedures to be applied in situations where an
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independent auditor reporting on the financial statements of an entity, uses
the work of an independent auditor with respect to the financial statements.
The statement also discusses the principal auditor's responsibility in relation
to his use of the work of other auditor.
NOTES
When the principal auditor uses the work of another auditor, the principal
auditor should determine how the work of the other auditor will affect the
audit.
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SA 610 - Using the work of internal auditor:
The revised standard deals with the External auditor's responsibilities regarding
the work of internal auditors. This SA also defines the terms "Internal audit
function" & "Internal auditor". SA 610 also deals with the aspects like
determining whether & to what extent to use the work of the internal auditors,
using specific work of the internal auditors & documentation.
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SA 620 - Using the work of an expert:
The revised standard deals with the auditor's responsibilities regarding the
use of an individual or organization's work in a field of expertise other than
accounting or auditing, when that work is used to assist the auditor in obtaining
sufficient appropriate audit evidence.
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SA 700 - Auditor's report on financial statements:
The revised standard deals with the auditor's responsibilities to form an opinion
on the financial statements & the form & contents of the auditor's report
issued as a result of an audit of financial statements. Revised SA 700 also
deals with the requirements relating to forming an opinion on the financial
statements, form of opinion, auditor's report, supplementary information
presented with the financial statements & the application guidance of these
aspects.
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SA 710 - Comparatives:
The revised standard deals with the auditor's responsibilities regarding
comparative information in an audit of financial statements. This SA defines
the terms 'Corresponding figures', 'Comparative information' & 'Comparative
financial statement'. Revised SA 710 also deals with the requirements &
application of the aspects relating to the audit procedures & audit reporting
relating to Corresponding figures & Comparative financial statements.
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SA 720 - The auditor's responsibility in relation to other information
in documents containing audited financial statements:
This standard on auditing deals with the auditor's responsibility regarding other
information in documents containing audited financial statements & the auditor's
report thereon. As per SA 720 the objective of auditor is to respond
appropriately when documents containing audited financial statements & the
auditor's report thereon include other information that could undermine the
credibility of those financial statements & the auditor's report.
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12.3 Summary
The Institute of Chartered Accountants of India has, from time to time,
issued statements of "Standards on Auditing". These auditing standards deal with
the auditor's responsibilities regarding the audit procedure.
Standards on Auditing
NOTES
12.4 Exercise & Questions
1) Explain SA 300 in detailed?
2) What are the responsibilities of auditor under SA 500?
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Fill in the blanks:
1)
SA_____ requires that the auditor to obtain reasonable assurance about
whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error.
(250,240,265,315)
2)
The revised standard 220 deals with the specific responsibilities of the auditor
regarding ____________ control procedures for an audit of financial
statements.
(Quality, Quantity, Preventive, Corrective)
3)
SA 230 also outlines about vesting of property of working papers with the
___________.
(Director, Management, Auditor, Government)
4)
SA 260 spells out the distinction between _______________ & Those
Charged with Governance.
(Director, Management, Auditor, Government)
5)
Standard on Auditing 265 somehow supplements the concept of
"__________________".
(Letter of communication, Letter of appointment, Letter of weakness, Quality
control)
6)
SA 299 describes the areas for which joint auditors are _________ &
severally responsible.
(jointly, individually, personally, separately)
7)
Standard on auditing ____deals with the auditor's responsibility to plan an
audit of financial statements.
(315, 320, 330, 300)
8)
The revised standard deals with the auditor's responsibility to apply the concept
of _____________ in planning & performing an audit an audit of financial
statements.
(testing, materiality, sampling, documentation)
9)
_____ deals with Audit consideration relating to an entity using service
organization.
(SA 300, SA 450, SA 402, SA 320)
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10) SA 500 deals with the requirements of obtaining sufficient appropriate
_____________.
(Audit evidence, Audit procedure, Audit technique, Audit sampling)
NOTES
11) The revised standard 510 establishes the principles regarding audit of
_____________ balances in case of initial engagements.
(Closing, opening, bank, cash)
12) The revised standard 520 deals with the auditor's use of analytical procedures
as _______________ procedures.
(substantive, compliance, audit, sampling)
13) The revised standard____ applies when the auditor has decided to use audit
sampling in performing audit procedures.
(550, 530, 570, 560)
14) The revised standard 550 deals with the auditor's responsibilities regarding
related party.
(subsequent event, analytical procedure, going concern, related party)
15) _____deals with using the work of another auditor.
(SA 610, SA 620, SA 600, SA 570)
(Answers: 1) 240, 2) Quality, 3) Auditor, 4) Management, 5) Letter of
weakness, 6) jointly, 7) 300, 8) Materiality, 9) SA 402, 10) Audit evidence, 11)
Opening, 12) Substantive, 13) 530, 14) related party, 15) SA 600)
12.5 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
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