audit-ipcc-CA-Poonam-Madan.pdf

Auditing & Assurance CA: IPCC Volume I Coverage as per Study Material of ICAI

By CA. Poonam Madaan “Shri

Ganeshaya Namah”

“Sat

Jinda Kalyana”

Preface Dear readers, Thanks for holding my notes on Auditing & Assurance. I pray that you find these notes useful for the purpose of achieving your goals, as early as possible. TIPS FOR PREPARATION 1. Familiarize yourself with the syllabus: The broad topics are: Nature and Objectives of Auditing o o Audit Planning, Internal Control, Vouching, Verification of assets and liabilities o Company Audit Miscellaneous Audits o Standards on Auditing. o 2. Read each topic thoroughly at least once: While reading through each topic, take special note of SAs, AS, relevant case laws, legal provisions of the Companies Act or other special legislations, etc. 3. Prepare Notes: Prepare summaries in your own handwriting and as per your understanding of the concept, it helps not only to understand contents but facilitates quick revision as well. 4. Check Your Progress: Go through question papers of previous examinations. Use compiler or scanner. 5. Examination Approach: Question should be read carefully to know its exact requirements. Understand the importance of relevance while answering the questions; write what is relevant and not what you know. Try to divide/sub-divide descriptive questions with distinct paragraph headings. Remember that it will be a test of your writing skills. Attempt all the questions as required, all average answers will fetch you better marks then few best answers. 6. Time Management: Proper time management is the key to success. Always plan your time. If you fail to plan, you plan to fail. Keep in mind the golden principle ‘Always watch your watch’, not only during examination but also during preparations. FEEDBACK Please feel free to give your suggestions at [email protected]

Thanks and Regards CA. Poonam Madaan (Visiting faculty ICAI)

Do it right, the first time SYLLABUS AUDITING AND ASSURANCE

(One Paper- Three hours -100 Marks) Level of knowledge: Working Knowledge Objective:

To understand objective and concept of auditing and gain working knowledge of generally accepted auditing procedures and of techniques and skills needed to apply them in audit and attestation engagements.

What is Auditing?

Chapter 1: Nature & Objective of Audit Chapter 2: Basic concepts of Audit

How to do Auditing?

Chapter 3: Audit Planning & Preparation

Chapter 7: Company Auditor

Chapter 4:

Chapter 8:

Internal Controls

Audit of company

Chapter 5: Vouching Chapter 6: Verification of assets & liabilities

•

• • •

Company Audit

Audit Report: CARO, 2013

Misc. Audits

SAs, AS, etc.

Chapter 9: Government Audit, Audit of Local bodies, NGOs,

Schools, Colleges, Hotels, Hospitals, Clubs, firms, etc.

The Basis for the notes has been the Study Material and other guidelines issued by the Institute of Chartered Accountants of India. The notes have been updated as per Companies Act, 2013 Students can completely rely on these notes for exam preparation. For practice purpose they may refer to the suggested, compliers and Revisionary Test Papers issued by ICAI. Soft copies of all of these are available on website of ICAI. Following link may be helpful for their download http://www.icai.org/post.html?post_id=10114

Chapter Title

Question No.

Page No.

Volume I 1

Nature of Auditing

2

1 - 18

1 - 12

Basic Concepts in Auditing

19 - 24

13 - 16

3

Preparation for an Audit

25 - 37

17 - 25

4

Internal Control

38 - 52

26 - 35

5

Vouching

53 - 67

36 - 44

6

Verification of Assets & Liabilities

68 - 84

45 - 54

7

Company Audit – I & CARO

85 - 104

55 - 80

8

Company Audit – II

105 - 119

81

9

Miscellaneous Audits

120 - 139

95 - 110

– 94

VOLUME II 1

Standards on Auditing

34 SAs

S1

– S37

STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 5 to 10 Marks

I MPORTANCE OF TH E CH APTE R

This chapter lays the foundation of audit for the students.

SAs COVE RE D

SA 200, SA 240

COVE RAGE OF THE CHAPTER

(1) Meaning of Audit and its objectives (2) Auditor and his qualities (3) (4) (5) (6) (7) (8)

E rrors and F rauds: Types of E rror and F rauds Objective, Scope and Types of Audit Limitations of Audit I nvestigation and how it is differentfrom Audit Accounting and how it is different from Audit Relation of audit with different fields

(1) What is Auditing? As per General Guidelines on Internal Auditing issued by ICAI, Auditing is defined as, ► a systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise ► for a stated purpose. ► In any auditing situation, the auditor -

perceives and recognizes the propositions before him for examination, collects evidence,

-

evaluates the same and

-

on this basis formulates his judgment which is communicated through his audit report.

-

(2) What are financial statements? Who are the users of financial statements? Financial Statements

► “Financial statements” is a set of documents which show the result of business operation during a period, how the result was achieved & position of assets & liabilities on a given date. ► They are ordinarily prepared and presented annually. ► Financial Statements mainly includes the following: Profit & Loss Account: It shows the results of the operations of an entity during a period, in form of profit or loss. Balance Sheet: It shows the position of assets & liabilities at a given date. Cash / Fund Flow Statement: It shows the movement of cash/funds during a period. Other statements and explanatory notes: which ordinarily comprise a summary of significant accounting policies and other explanatory information. Users of Financial Statements

Management: To evaluate performances & profitability of business and to make decisions about business. Owners: To get informed about the stewardship of management. Investors: To make decision on investment in a company.

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Credit rating services: To decide about the credit worthiness of entities. Bankers: To determine financial position & strength of entity. Lenders / Creditors: To decide whether to lend money or not & to examine degree of safety of their money. Government: To levy various taxes and regulate the socio-economic state of affairs. Financial analysts: To assess the performance of an entity. Employees: To raise demands for bonus and other performance incentives.

(3) Who is an Auditor? What qualities should an auditor possess? The person conducting audit is known as the auditor; he makes a report to the person appointing him in the form of an opinion on financial statements after due examination of accounting records and statements. Audit has to be conducted by a person having good knowledge of auditing & accounting concepts. In India, as per Companies Act, 2013 only Chartered Accountants can conduct audit of companies. Qualities of an Auditor

► As per SA 200: Integrity: Auditor should be straight forward, honest & sincere in performing his duties. Objectivity: He should be fair & unbiased in his approach. Independence: He should maintain an impartial attitude and be free of any interest. His judgment should not be affected by the wishes or directions of another person. Professional judgment: He should apply relevant training, knowledge & experience in making decisions. Professional skepticism: He should have questioning mind and be alert to conditions indicating doubts. ► He should have a good knowledge of: The general principles of law (Contracts Act, Partnership Act, etc.) The Nature of clients business General economic trends and scenario Specific regulations & provisions (Companies Act, Trust Act, etc.) Accounting & auditing concepts (AS, SAs, Principles, etc.) Data Processing i.e. computers ► He should continuously update his knowledge. ► He should have adequate practical experience under proper supervision.

(4) What are the objectives of audit? PRIMARY OBJECTIVE - EXPRESSION OF OPINION (1) The objective of an audit of financial statements is to enable an auditor to express an opinion on such financial statements. His opinion helps determination of true and fair view of the financial position and operating results of an enterprise. (2) He should obtain reasonable assurance about whether financial statements as a whole are free from material misstatement. Auditor’s opinion is not an absolute assurance due to inherent limitations of audit. (3) The auditor should review and assess the conclusions drawn from audit evidences and on this basis form an overall conclusion as to whether:

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(a) the financial information has been prepared using acceptable accounting policies, which have been consistently applied; (b) the financial information complies with relevant regulations and statutory requirements; (c) there is adequate disclosure of all material matters relevant to the proper presentation of the financial information, subject to statutory requirements, where applicable. (4) The audit report should contain a clear written expression of opinion on the financial information. SECONDARY OBJECTIVE - DETECTION OF FRAUD & ERRORS (1) The auditor has to see that what the statements of account convey is true and not misleading and

such errors & frauds do not exist as to distort what the accounts really should convey. (2) If an auditor has a suspicion of existence of any fraud then he must extend his audit procedures to clear the doubts. His duty is to detect a fraud not to prevent it. (3) An auditor is not bound to be a detective or to approach his work with suspicion. He is a watchdog, but not a bloodhound. Any undetected fraud in accounts, which can’t be observed in normal course of examination of accounts, will not be construed as failure of audit, provided the auditor was not negligent in the carrying out his normal work. Re-Kingston Cotton Mills Co. (4) The ultimate responsibility for control over Frauds & errors is of the management. So, management should install controls to ensure compilation of reliable statements of account. Auditor should review the control systems and may provide management with suggestions for improving controls.

(5) Distinguish between errors & frauds with examples. Basis

Errors

Frauds

Meaning

Error is a mistake, generally done unintentionally. It is an unintentional misstatement in financial statements by way of:

Fraud is an intentional error, with an intention to deceive, to obtain an unjust or illegal advantage. It includes sophisticated and carefully organized schemes designed to conceal truth.

—

clerical mistakes in records

—

mis-interpretation of facts

—

misapplication of A/cing policies

Intention

Generally done unintentionally, intention to conceal.

with

no Done intentionally, with an intention to conceal truth

Alert

May not require a high alert for an auditor

May require an auditor to be very alert as there is implication of dishonesty

Detection

May be easy to detect and can be detected without special efforts

Generally very difficult without special efforts

Reporting

May not be required for errors detected

Should be done for frauds detected & the responses to them

to

detect

(6) Give the various types of errors.

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Errors, on the basis of

Nature

Accounting Incidence

Self-revealing / not self-revealing Intentional / Unintentional Concealed / Unconcealed Affecting TB / Not affecting TB

Errors of Omission Errors of Commission Errors of principle Compensating errors

On the basis of Nature Type of error

Meaning

Example

Self revealing

Errors whose existence becomes apparent in the process of compilation of accounts.

Wrong totaling Omission to post a part of a journal entry to the ledger.

Not self revealing

Errors which do not reveal themselves during preparation of accounts and can be known by detailed analysis.

Capital expenditure shown as revenue expenditure

Intentional

Deliberate mistakes done with some purpose i.e. Fraud.

Misappropriation of assets / goods Forgery

Unintentional An innocent or non-deliberate mistake, due to ignorance.

If cashier forgets to reconcile the bank balance as per books of accounts with bank statement

Errors accompanied by an effort to hide them,

Theft of cash with an effort to do

so that they remain undisclosed. They can be known only after careful checking.

wrong casting in cash book

Unconcealed

Apparent errors, with no efforts to hide them.

Wrong totaling

Affecting Trial Balance

Errors due to which trial balance does not tally, generally one sided errors.

Expense of Rs. 100 entered correctly in the expense account but Rs. 10 in cash book.

Not affecting Trial Balance

Errors which do not affect the trial balance, generally two sided errors.

No provision for bad debt / depreciation

Concealed

On the basis of Accounting Incidence Basis

Errors of Omission

Meaning Errors to not record a

Errors of Commission

Errors of Principle

Compensating Errors

Error to make incorrect or

Error to not observe

Errors

transaction, either wholly or partly in the books

wrong entries in the books of account

fundamental principles of A/cing while making entries

counterbalanced by other errors, not affecting trial balance

Nature

Clerical Error

Clerical Error

Technical Error

Technical Error

Types

1. Partial Omission –

1. Posting Errors – entry

1. Errors affecting

1. Errors

recording only one aspect of a transaction, either

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with wrong account/ amount/ side

2. Casting Errors – wrong

Profits

2. Errors not affecting Profits

affecting profits

2. Errors not 4

Dr. or Cr.

totalling or balancing

affecting profits

2. Complete Omission 3. Duplication errors – – omitting to record both aspects of a transaction

making an entry twice in the books of entry & also posting in the ledger

4. Carry forward errors – C/F with wrong amount/ account/ side

Example ► Sales to A entered in account of A but not in Sales Account.

Effect on Trial Balance

► Partial Omission will affect T/B

► Complete omission will not affect T/B

► Sales to A entered as sales to B

► One sided errors will affect T/B

► Two sided errors may

► Sales of Fixed Assets to A considered as a part of P&L

► Sales to A for Rs. 100 posted correctly in books but with Rs. 10.

► May not affect ► Will not affect the trial balance

the trial balance

not affect T/B

► Duplication error may not affect T/B

► Casting error may affect T/B

(7) Write a note on Procedural Errors. 

An accounting system includes both records and procedures. Any breakdown in the laid down procedures may result in an error. Errors which occur in the implementation of the procedures may be termed as procedural errors.



This type of error cannot be located by any rigorous examination of the books of account.

Eg:It is the normal procedure that goods when received should be inspected for quality by the inspection department staff. If the storekeeper carried out this function it is indeed risky. Similarly, if the procedure requires that the timber godown should have been given periodical insecticide treatment and management has ignored that, a great loss may be caused to the timber by white ants.

(8) What do you mean by the term Fraud and what are the types in which fraud occurs ? As per SA 240 “The Auditor’s Responsibility to Consider Fraud and Error in an Audit of Financial Statements”, Fraud is: 

an intentional act by one or more individuals among management, those charged with governance, employees or third parties,



involving the use of deception



to obtain an unjust or illegal advantage.

Fraud involving one or more members of management or those charged with governance is referred to as ‘management fraud’; fraud involving only employees of the entity is referred to as ‘employee

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fraud’. Risk of management fraud being undetected is higher than risk of employee fraud being undetected. As per SA 240, frauds can occur in two types: (1) Fraudulent Financial Reporting

It involves intentional misstatements in financial statements with an intention to deceive and conceal truth, by way of alteration of accounting records or documents, omission of transactions or information or misapplication of accounting principles (2) Misappropriation of Assets

It involves theft of an entity’s assets accompanied by falsification of records to conceal the fact.

(9)

What do you mean by the term Fraud risk factors? Explain by giving examples.

Events or conditions that indicate an incentive to commit fraud or provide an opportunity to commit fraud are known as Fraud risk factors. Eg: of Fraud risk factors relating to misstatements resulting from Fraudulent Financial Reporting:

Excessive interest by mgt. in maintaining or increasing the entity’s stock price No monitoring of significant controls by mgt. and no timely action on known material weaknesses History of non-compliance of laws & regulations Significant related party transactions which are unusual & unaudited Eg: of Fraud risk factors relating to misstatements resulting from misappropriation of assets:

Large amounts of cash on hand Lack of appropriate management (Eg: inadequate monitoring of remote locations). Lack of an appropriate system of authorization and approval of transactions Poor physical safeguards over cash, investments, inventory or fixed assets.

(10) What are the various aspects to be covered in an audit? The principal aspects to be covered in an audit of final statements of account are: (1)

Internal control: Examination of internal control system to ascertain if it is adequate and reliable.

(2)

Accounting System: Examination of a/cing system to see if it is properly recording all transactions.

(3)

Books of accounts: It includes: Arithmetical Accuracy: Checking of the arithmetical accuracy of the books of account Evidence: Examining the entries in the books of accounts with the relevant supporting documents to ascertain that the entries are true. Completeness: Ascertain that the books contain a complete record of all the transactions of the business and these are recorded in such a manner that their real nature is revealed. Authorisation: Verify that there exists a proper authority in respect of each transaction; that each transaction is correctly recorded. Accounting Principles: Ascertaining that the accounting principles have been followed correctly like by seeing that a proper distinction has been made between items of capital and of revenue nature.

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(4)

Financial Statements Analysis: Ascertaining that the balance sheet and P&L account or other statements are in accordance with the underlying records. Verification of Balance Sheet items True & Fair View: Checking that financial statements depict a true & fair view of the state of affairs and of the profit and loss of the organization. Statutory Compliance: Verifying that final accounts are drawn in the format prescribed by law and all the statutory requirements have been complied with.

(5)

Reporting: Reporting to the appropriate authority whether the financial statements reveal a true and fair view of the state of affairs and of the profit and loss of the organization.

(11) What is the scope of audit as per SA200 on ‘Overall objectives of independent auditor and conduct of audit in accordance with SAs’. The auditor should:

► Give an opinion whether financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework and comply with relevant regulatory requirements. ► Obtain reasonable assurance about whether financial statements as a whole are free from material misstatement. ► Report on financial statements and communicate as required by SAs, as per his findings. Constraints on the scope of audit that impair the auditor’s ability to express an unqualified opinion should be set out in his report, and a qualified opinion or disclaimer of opinion should be expressed as appropriate. ► Due to inherent limitations of an audit, there is an unavoidable risk that some material misstatements may remain undiscovered. However, such discovery is not the main objective of audit, but when there is a doubt of material misstatement, auditor should amend his procedures to confirm or dispel his doubt. ► He must keep the concept of materiality in mind, material items can be judged on the basis of the auditor’s professional experience and judgment. ► The auditor is not expected to perform duties which fall outside the scope of his competence. For example, the professional skill required of an auditor does not include that of a technical expert for determining physical condition of certain assets.

(12) What are responsibilities of management & auditor as per SA200 on ‘Overall objectives of independent auditor and conduct of audit in accordance with

SAs’. ►

Preparation of Financial Statements: The audit of financial statements does not relieve management or those charged with governance of their responsibilities. They have responsibility: 1.

For preparation and presentation of financial statements as per the applicable financial reporting framework including the design, implementation and maintenance of relevant internal control.

2.

To provide auditor with:

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(i)

All information, that are relevant to preparation and presentation of financial statements;

(ii) Any additional information that auditor may request and (iii) Unrestricted access to those within entity from whom auditor wants to obtain audit evidence. ►

Requirements from auditor: Auditor shall: (1) Comply with relevant ethical requirements , including those pertaining to independence, relating to financial statement audit engagements. It ordinarily comprises the Code of Ethics issued by the ICAI. The Code establishes the following as fundamental principles of professional ethics relevant to auditor:

1.

Integrity;

2.

Objectivity;

3.

Professional competence and due care;

4.

Confidentiality; and

5.

Professional behavior.

(2) Plan and perform audit with professional skepticism by being alert in recognising circumstances that may cause financial statements to be materially misstated. Auditor may accept records and documents as genuine unless he has reason to believe the contrary. In case of doubt about the reliability of information he should investigate further and determine the modifications or additions to audit procedures necessary to resolve the matter. (3) Exercise professional judgment in planning and performing an audit. The exercise of professional judgment in any particular case is based on the facts and circumstances that are known by the auditor. (4) Obtain sufficient and appropriate audit evidence to reduce audit risk to an acceptably low level. Sufficiency and appropriateness are interrelated. (5)

Conduct an audit in accordance with SAs: Auditor shall comply with all SAs relevant to audit. He should not report compliance with SAs unless he has complied with requirements of all relevant SAs.

(13) What are the inherent limitations of audit? As per SA 200, Auditor obtains reasonable assurance about whether financial statements as a whole are free from material misstatement. Auditor’s opinion is not an absolute assurance due to inherent limitations of audit. The inherent limitations of an audit arise from the: (1)

Nature of financial reporting: Preparation of financial statements involves judgment by management including subjective decisions, assessments or a degree of uncertainty in estimates made. There are chances of bias in management’s judgments.

(2)

Nature of audit procedures: There are practical and legal limitations on auditor’s ability to obtain audit evidence. As auditor is not inspector so he does not have specific legal powers such as power to search. Certain other audit related limitations are: Exercise of Judgment: Auditor’s work involves exercise of judgment which may not always be correct. Nature of evidence: Audit evidence obtained is generally persuasive in nature rather than conclusive.

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Test Checking: Audit has to be performed on the basis of test checks only and complete review of all transactions is neither possible nor desirable. Dependence on Internal Control:Entire audit process is dependent upon existence of an effective system of internal control. More effective the internal control more reliable will be audit report. (3)

Timeliness of audit and balance between cost & benefit: It is impracticable to audit all existing information or to pursue every matter exhaustively to find a misstatement.

Because of inherent limitations of audit, there is an unavoidable risk that some material misstatements may not be detected, even though audit is properly planned and performed as per SAs.

(14) What are the various types of audit? (1)

Statutory / Mandatory Audit: It is an audit required under law. The organizations which require such audit are: S.No. 1. 2. 3. 4. 5. 6. 7.

(2)

Organization Companies Co-operative Societies Banking companies Electricity supply companies Public and charitable trusts Insurance Companies Specified entities

Governing Statute Companies Act, 2013 Co-operative Societies Act, 1912 Banking Regulation Act, 1949 Electricity Supply Act, 1948 Indian Trusts Act, 1882 Insurance Act & Companies Act Income-tax Act, 1961

Independent/Voluntary Audit: It includes all other audits which are not required under law and performed at the discretion of the governing body. E.g. Audit of accounts of proprietary entities, partnership firms, private trusts, Hindu undivided families, non-profit making institutions like schools clubs and hospitals which are not governed by any statute or specific acts. They may opt for an audit owing to various advantages of an independent audit.

(15) What do you mean by the term “independent audit”? What are the advantages of independent audit? Audit which is not a statutory audit may be termed as an independent audit. It is not compulsory by law and is performed at the discretion of the governing body of the entity. It provides following advantages: 1.

Acts as a moral check on the employees from committing defalcations or embezzlement.

2.

Helps to detect wastage/losses, especially that occurring from inappropriate internal controls.

3. 4.

Ascertains whether the books of accounts and records have been properly kept. Helps in review of internal checks and internal controls.

5.

Provides reliable financial statements to easily understand the state of affairs.

6.

Helps in settlement of accounts at the time of admission or death of partner.

7.

Helps in settling liability for taxes.

8.

Helps in negotiating loans with the banks.

9.

Helps in settling insurance claims in respect of damage suffered by property.

10.

Helps in determining the purchase consideration for a business.

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11.

It is used for settling trade disputes for higher wages or bonus.

12.

Required by Government before it gives assistance or issues a license for a particular trade.

(16) What is the difference between auditing & accounting? Basis

Auditing

Accounting

Meaning

Audit is an independent examination of financial information of an entity with a view to express an opinion.

Accounting is the art of recording, classifying & summarizing financial information & preparation of reports thereon.

Objective

To find thereport accounts show a true &out fairwhether view and thereon.

Recording of transactions & preparation of financial statements

Aspect

It covers examination Financial Statements

It covers recording aspect of Financial Statements

Conducted by

A qualified chartered accountant

Any person having knowledge of accounting

Principles followed

Done as per the standards on auditing (SAs)

Done as per the accounting standards (AS)

Different subjects

It requires good knowledge of various subjects like law, accounting, auditing, economics, statistics, etc.

It requires good knowledge of accounting concepts and accounting standards.

aspect

of

(17) What is the difference between audit & investigation? Basis

Audit

Investigation

Meaning

Audit is an independent examination of financial information of an entity with a view to express an opinion.

Investigation is a critical examination of the accounts with a special purpose.

Objective

To find out whether the accounts show a true & fair view and report thereon.

For some specific purpose to ascertain certain facts

Scope

Scope is wider, to cover all transactions Scope is limited as regard the period or affecting financial statements area to be covered

Frequency

Auditing may be a regular exercise

Investigation is generally done when required

Detection of error/fraud

Secondary objective

Primary objective

Test Checking

Test checking is generally allowed in auditing

Generally Test checking is not advisable & in many cases 100% checking may be required.

Suspicions

Auditor does not plan an audit with Investigator starts his work with suspicion suspicions in his mind about the financial & work towards confirming or dispelling informations it.

Reporting Authority

Owners or shareholders

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as and

Person on whose behalf investigation is undertaken

10

(18) How is auditing related to different fields? Auditing related to

Relation

Auditing starts where accounting ends

Accounting

An auditor has to possess complete knowledge of the accounting concepts as he has to examine the accounts accordingly An auditor has to check if the transactions confirm with the statutory requirements

Law

So, he should have good knowledge of the laws affecting the client He should have knowledge of law of contracts, taxation laws, etc. Auditor should have knowledge of the business of the client & the economic environment in which it operates

Economics

He should be aware of the economic force that affect the firm, relationship of price, role of government and government regulations Language

For effective communication whether oral or written he should have good command over language

Behavioral Science

Audit involves interaction with lot of people involving client, client’s staff, audit staff, legal experts, technicians, etc. He has to see if the persons providing information are acting honestly & competently. He should have the tact of getting along with people

Statistics Mathematics

&

Auditor has to do audit on the basis of sampling, for effective selection of samples, he should have knowledge of the sampling tools For analytical procedures, he should have knowledge of the ratios analysis He have to check the arithmetical accuracy of the books He have to check various calculations, like depreciation, interest, etc.

Data Processing

Nowadays, accounting is getting computerized, so an auditor has to be computer savvy. He have to apply Computer Assisted Audit Techniques (CAATs)

Financial Management

He should have knowledge of various financial techniques like working capital management, funds flow, ratio analysis, capital budgeting, etc. Also, a fair knowledge of the market place, various financial instruments & the institutions affecting market

Business operations

A good auditor is one who understands client and his business well It will help in making effective evaluation of the internal control system He should also understand the cost system in operation

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Practical Questions - Chapter 1: Nature of Auditing Question No. 1: “The audit of Financial Statements relieves the management of its responsibilities”. Question No. 2: “The auditor is only a watchdog, not a bloodhound”. Question No. 3: While doing physical verification of cash the auditor found that the balance shown in books was Rs. 1 lakh and the actual currency in hand amounted to Rs. 40,000. The cashier agreed to pay for the shortage of cash saying that he was in need of cash so he used it and requested for not

reporting for it. Should the auditor consider reporting for it? What if the cashier shows you a complete voucher for cash issued, which he wrongly entered in bank account instead of cash book? Question No. 4: Identify which of the following amounts to a fraud?

(a) Capital expense entered as revenue expense. (b) Capital expense for Rs. 2 Lakhs entered in books as Rs. 3 Lakhs and cash amounting to Rs. 1 Lakh being misappropriated. (c) Cash issued for payment to travel agent for Rs. 40,000 where no such services being used in actual. (d) Giving 20% discount on sales to Tony, where no such policy for discount exists in books. (e) Wrong totalling of cash book. (f) Sales to Tony entered in books as sales to Jonny. Question No. 5: How will you classify the following errors?

(a) Capital expense entered as revenue expense. (b) Goods received not being inspected by the inspector. (c) Sales to Tony entered in books as sales to Jonny. (d) Sales to Tony for Rs. 100 entered in correct accounts but with an amount of Rs. 200. (e) Sales to Tony for Rs. 100 entered twice in books. (f) Opening Stock for Rs. 10 lakhs brought forward with an amount of Rs. 1 Lakh. (g) Sales to Tony for Rs. 100 entered correctly in sales account but no entry made in account of Tony. Question No. 6: Mr. Vyom is a sole proprietor with a medium sized business and is thinking whether to get his books audited or not. How can you convince him to get his books audited? Question No. 7: State whether true or false:

(a) Auditor is not an insurer. (b) Unless an auditor is able to discover all frauds and errors, he has not performed its main function. (c) Procedural errors arise as a result of transactions having been recorded in a fundamentally incorrect manner. (d) Auditor compares entries in books of account with vouchers; and, if the two agree, his work is done. (e) Financial Statements includes only P&L A/c and Balance Sheet. (f) The auditor has to approach everyone with suspicion.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 5 to 10 Marks

I MPORTANCE OF TH E CH APTE R

This chapter clears many concepts of auditing.

SAs COVE RE D

SA 500, SA 520, SA 320

COVE RAGE OF THE CHAPTER

(1) E vidence (2) Audit Audit Procedures (3) Analytical Review Procedures (4) Concept of Materiality

(19) What is “Audit Evidence”? How can auditor determine if the audit evidence is sufficient & appropriate? ► Audit evidence refers to the information used by auditor in arriving at the conclusions on which auditor’s opinion is based. ► Audit evidence includes both information contained in the accounting records underlying the financial statements and other information. TYPES OF AUDIT EVIDENCE On the basis of source External Eg: Bank statement o Internal Eg: Sales invoice o

On the basis of Nature

Documentary Eg: Copy of loan agreement o Oral Eg: discussions with client o Visual Eg: Observing stock taking o

On the basis of impact Persuasive, evidences which are most likely to be true. Eg: management representations o Conclusive, evidences which are only true. Eg: loan contracts. o

► As per SA-200, ‘the auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions there from on which to base his opinion on the financial information’. ► As per SA-200, sufficiency and appropriateness are inter-related. Sufficiency refers to the quantum of audit evidence obtained while appropriateness relates to its quality i.e. relevance and reliability. The quantity of audit evidence needed is affected by the following: 

auditor’s assessment of risks of misstatement (higher the assessed risks, more evidence is required), and



quality of such audit evidence (higher the quality, lesser evidence may be required).

(20) Which factors help in assessing the reliability of audit evidence? The reliability of audit evidence is influenced by its source (internal or external) and by its nature (visual, documentary or oral). Certain generalizations may be useful in assessing the reliability of audit evidence: 1. External evidence is more reliable than internal evidence. 2. Internal evidence is more reliable when related internal control is satisfactory. 3. Evidence obtained by the auditor himself is more reliable than that obtained indirectly.

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4. Documented/written evidence is more reliable than oral representations. 5. Original documents are more reliable than photocopies/facsimiles/scanned documents. In case of suspicious circumstances, the auditor should look for more compelling evidence and should attempt to obtain as much corroborative evidence as may be available.

(21) What are the audit procedures to obtain audit evidences? As per SA 500 “Audit Evidences”, audit evidences can be obtained by following audit procedures: 1. Risk assessment Procedures: The audit procedures performed to obtain an understanding of the entity and its environment, including entity’s internal control, to identify and assess the risks of

material misstatement, whether due to fraud or error. 2. Compliance Procedures: Compliance procedures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in effect. Obtaining audit evidence from compliance procedure is intended to reasonably assure auditor in respect of following assertions: a. Existence – that the internal control exists. b. Effectiveness – that the internal control is operating effectively. c. Continuity – that the internal control has so operated throughout the period Compliance tests are carried out to assess the efficiency of internal control system. After the compliance tests auditor determines the nature, timing and extent of substantive procedures. 3. Substantive Procedures Substantive Procedures (Test of completeness, validity & accuracy of accounting data) Test of Details

Analytical Procedures (Ratios & trends analysis)

Test of transactions (Vouching)

Test of Balances (Verification, casting)

Substantive procedures are designed to obtain evidence as to the completeness, accuracy and validity of the data produced by the accounting system. They are of two types: 1. tests of details of transactions and balances; 2. analysis of significant ratios & trends, including enquiry of unusual fluctuations & items.

(22) What are the methods to obtain audit evidence? As per SA 500, auditor obtains evidence by performing one or more of the following methods: Methods to obtain A udit Evidence

Inspection

Observation

Examining records, etc.

Looking at a process or procedure being performed

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External Confirmation

Recalculation

Reperformance

Analytical Review Procedures

Inquiry

Seeking direct written response from a third party

Checking Mathematical accuracy

Independent execution of srcinally performed procedures

Studying significant ratios and trends

Seeking appropriate information

14

1) Inspection: Inspection involves examining records or documents or a physical examination of asset. 2) Observation: Observation consists of looking at a process or procedure being performed by the others. Eg: the auditor may observe the counting of inventories by client personnel. 3) External Confirmation: It represents a direct written response from a third party (confirming party) to the auditor, in paper, electronic or other medium. Eg: debtor’s balance confirmation 4) Recalculation: It consists of checking the mathematical accuracy of documents or records, either manually or electronically. Eg: depreciation calculation 5) Reperformance: It involves the auditor’s independent execution of procedures or controls that were srcinally performed as part of entity’s internal control. Eg: Bank reconciliation 6) Analytical Review: Analytical review consists of studying significant ratios and trends and investigating unusual fluctuation and item. 7) Inquiry: Inquiry consists of seeking appropriate information from knowledgeable person inside or outside the entity. Inquiries may be written or oral, formal or informal. Responses to inquiries may provide the auditor with information which he did not previously possess or may provide him with corroborative evidence.

(23) Write a note on Analytical Review Procedures?  MEANING: As per SA 520, “Analytical procedures” means the analysis of significant ratios and

trends, including investigation of unusual fluctuations and items. On identification of significant fluctuations, the auditor should investigate to obtain adequate explanations and appropriate corroborative evidence.  NATURE procedures OF ANALYTICAL PROCEDURES: include comparisons of entity’s financial information with, for example:  Analytical

1. 2. 3. 4. 



Comparable information for prior periods. Anticipated results of entity, like budgets or forecasts, Expectations of auditor, like an estimation of depreciation, Similar industry information, like comparison of entity’s ratio of Debtor turnover with industry averages. It also include consideration of relationships, for example: 1. Among elements of financial information that conform to a predictable pattern i.e. trend, like gross margin ratio. 2. Between financial and non-financial information, like salary to number of employees. It may be applied to consolidated financial statements, components and individual elements of information.

(24) Explain the concept of Materiality in audit. ► MEANING: AS per SA 320, Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Auditor has to assess materiality right from the stage of audit planning till the final stage of reaching at his opinion ► RELATIONSHIP BETWEEN MATERIALITY AND AUDIT RISK: auditor should consider materiality and its relationship with audit risk when conducting an audit. There is an inverse relation between audit risk & materiality. The more material an item, the lesser is the risk of misstatement.

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► FACTORS TO DETERMINE MATERIALITY: Materiality is a relative term and what may be material in one circumstance may not be material in another. Following factors may be helpful in determining materiality of an item: 1. percentage comparison. 2. the impact that the item has on the profit or loss or on the balance sheet 3. comparison with the corresponding figure of the previous year 4. statutory requirement of disclosure 5. Transaction of abnormal or nonrecurring nature are also considered material ► DISCLOSURE: An auditor has to ensure that a material item is disclosed separately and distinctly or at least clear information about the item is available in the accounting statements. ► MATERIALITY OF SMALL AMOUNTS: Auditor must consider possibility of misstatements of relatively small amounts that, cumulatively, could have a material effect on financial information. Eg: an error during month-end could be an indication of a potential material misstatement if that error is repeated each month. ► REPORTING: An auditor must convey the material misstatements in financial information to the management and should ensure that corrections have been made. In case of presence of material misstatement not intentionally rectified, he should give a qualified opinion. Practical Questions - Chapter 2: Basic Concepts in Auditing Question No. 1: X Ltd holds 4 to 5 board meetings per year. The directors are reimbursed to the extent of actual air fair, and in addition an allowance of Rs. 300 per day is paid for covering hotel bills etc. Auditor of company seeks actual bills/vouchers as evidence in respect of stay charges. The

director contention is that board attendance register containing the signature of director is sufficient evidence. Give your views as a Chartered Accountant. Question No. 2: An assistant of X & Co., chartered accountants detected an error of Rs. 5 per interest payment which recurred number of times. The General Manager (Finance) of T Ltd. advised him not to request for passing any adjustment entry as individually the errors were of small amounts. The company had 2000 deposit accounts and interest was paid quarterly. Give your views on the above. Question No. 3: State whether true or false:

a. Compliance procedures are tests designed to obtain audit evidence as to completeness, accuracy and validity of the data produced by accounting system. b. There is inverse relationship between materiality and audit risk. c. Disclosure of fundamental accounting assumptions is necessary. d. Going concern is a fundamental accounting assumption.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 15 to 20 Marks

I MPORTANCE OF TH E CH APTE R

The Chapter is important not only because it is of good Weightage but also because it helps to know what kind of preparations is required by an auditor before going for an audit.

SAs COVE RE D COVE RAGE OF THE CHAPTER

SA 210, SA 530, SA 230 (1) Terms of Auditor’s Engagement (2) Audit Process (3) Audit Planning / Audit Programme (4) Audit Documentation (5) Audit Sampling (6) Audit Risk

(25) Write a note on Terms of Engagement (SA 210). ► TERMS OF ENGAGEMENT: The engagement letter documents and confirms auditor's acceptance of appointment, objective and scope of audit and extent of auditor's responsibilities to client. Auditor should send an engagement letter, before commencement of engagement, to help avoid any misunderstandings in future. ► PURPOSE: Auditor should accept or continue an audit engagement only when the basis upon which it is to be performed has been agreed, through: a. Establishing whether the preconditions for an audit are present; and b. Confirming that there is a common understanding between auditor and management of the terms of audit engagement. ► PRECONDITIONS FOR AN AUDIT: In order to establish whether the preconditions for an audit are present, auditor shall: a. Determine whether financial reporting framework applied in preparation of financial statements is acceptable; and b. Obtain the agreement of management that it acknowledges and understands its responsibility: i. For preparation of financial statements in accordance with applicable financial reporting framework, ii. For internal control to enable preparation of financial statements that are free from material

misstatement, iii. To provide auditor with: - Access to all information relevant to preparation of financial statements, - Additional information that auditor may request from management for audit purpose; & - Unrestricted access to persons within entity for obtaining audit evidence. ► CONTENTS OF AUDIT ENGAGEMENT LETTER:  Primary Contents 1. Objective and scope of audit; 2. Auditor’s responsibilities;

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

3. Management’s responsibilities; 4. Identification of applicable financial reporting framework for preparation of financial statements; and 5. Expected form and content of any reports to be issued by auditor. Additional Contents: Auditor may also include: 1. Audit Planning 2. Expectation of receiving “Management Representations” 3. Fees and billing arrangements 4. Arrangements w.r.t. involvement of other auditors, experts, internal auditors, client’s staff or predecessor auditor.

► RECURRING AUDIT: In case of a recurring audit, the auditor may decide not to send a new engagement letter each period. However, due to following factors he may send a new letter: - Any indication that the client misunderstands the objective and scope of the audit. - Any revised or special terms of the engagement. - A recent change in senior management, board of directors or ownership. - A significant change in nature or size of the client’s business. - Legal requirements or pronouncements of the ICAI or changes in the existing ones. ► AUDIT OF COMPONENTS: When auditor of a parent entity is also auditor of its subsidiary, branch or division, he should consider certain factors (like, appointing authority, reporting authority, legal requirements, , degree of ownership by parent entity, separate audit report for component, etc.) to decide whether to send a separate engagement letter to the component. ► CHANGES IN TERMS OF ENGAGEMENT: If before completion of engagement, auditor is requested to change the engagement to one which provides a lower level of assurance, then he should consider the appropriateness of doing so. ► If there is reasonable justification for change, then auditor should agree for change. In order to avoid new audit report would not include reference to the srcinal engagement or anyconfusion, proceduresthe performed in the srcinal engagement. ► If there is no reasonable justification for change, then auditor should refuse for the change and if client doesn’t agree then he should withdraw and should consider other obligations.

(26) What are the steps involved in Audit Process? Audit Process refers to the series of activities performed in formulating an opinion on financial statements. It involves the following steps: 1) PRELIMINARY DISCUSSIONS:  Initial discussions with client to determine the scope of audit  Finalize the terms of engagement 2) AUDIT PLANNING  Formulating an audit plan based on the knowledge of client’s business  Preparation of the detailed audit programme to achieve the objective of audit efficiently, effectively and in time 3) AUDITING  Carrying out the audit as per plan with the help of compliance and substantive procedures  Documenting all the material observations and inquiries made in the form of audit working papers  Evaluation of the internal control system with the help of compliance procedures  Checking that the books are giving true & fair view  Vouching of the documents & transactions  Checking arithmetical accuracy by examination of the books of accounts  Verification of assets & liabilities

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

Carrying out analytical review procedures wherever required and ensuring overall accuracy & reliability of the books & financial statements  Ensuring the disclosure requirements has been met. 4) AUDIT REPORT  Forming an opinion on the basis of audit conducted  Drafting an audit report on the true & fair picture of the financial statements  Ensuring that the audit report complies with the statutory requirements  Preparing the report on timely basis  Communicating the report to appropriate authority

(27) Describe Audit Planning. ► AUDIT PLANNING: Auditor should plan his work to conduct audit effectively, efficiently and in time. Plans should be based on knowledge of client’s business and should be further developed and revised as necessary during the course of the audit. ► OBJECTIVE OF AUDIT PLANNING is to:  ensure that appropriate attention is devoted to important areas of the audit  ensure that potential problems are promptly identified  ensure that the work is completed expeditiously  utilise the assistants properly  co-ordinate the work done by other auditors and experts ► KNOWLEDGE OF THE CLIENT’S BUSINESS: The auditor must obtain the knowledge of the client’s business in order to adequately plan the audit. The auditor can obtain such knowledge from:  Discussion with client: It includes such subject as change in management, technology, products, business, accounting procedures and government legislations, etc. & outside entity, Other sources: It includes discussion with client’s staff & other people within client’s annual results, minutes of meeting, previous year’s audit working papers and visits to client’s premises and plant facilities. ► PLANNING INVOLVES developing:  an overall plan for the expected scope and conduct of the audit; and  an audit programme showing nature, timing and extent of audit procedures. ► DOCUMENTATION: Auditor should document his overall plan. 

(28) Describe Audit Programme along with its advantages & disadvantages. ► MEANING: An audit programme is a detailed plan of applying the audit procedures, along with the instructions for appropriate techniques to be adopted to obtain sufficient evidence to enable the auditor to express opinion. ► POINTS TO CONSIDER: Auditor should consider following points in making audit programme: 1. It should meet the objective & cover scope of audit. 2. in writing communicated properly to the It should should be contain audit&objectives for each area and a assistants. set of instructions to the assistants for 3. It proper execution of work to complete audit efficiently, effectively and in time. 4. There should be co-ordination between the procedures to be applied to related items. In assembling procedures & methods, if related items are grouped together, the programme becomes purposeful and easy to coordinate. 5. Audit programme should be reviewed periodically so that inadequacies or redundancies may be removed. 6. Every assistant should follow the instructions as stated in the programme, unless the programme is not officially changed by the principal.

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► ADVANTAGES OF AUDIT PROGRAMME: 1. Set of instructions: It provides clear set of instructions to assistants to carry out the work. 2. Job allocation: It facilitates in selection of assistants on the basis of capability. 3. Systematic Audit: Audit can be carried out systematically covering all important aspects & areas, without the chance of ignorance. 4. Responsibility: The responsibility for the work assigned can be fixed & traced easily. 5. Review: It helps to supervise & control the work of assistants. 6. Future Audits: It serves as a guide for audits to be carried out in the succeeding year. 7. Auditor’s Defense: It serves as evidence in the event of any charge of negligence being brought against the auditor. AUDIT ► DISADVANTAGES work may PROGRAMME: become mechanical and may be carried out without any 1. Mechanical: TheOF understanding of the object. 2. Rigidity: The programme often tends to become rigid and inflexible despite changes in business an old programme may still be carried on. 3. Shelter for inefficient assistants: Inefficient assistants may take shelter behind the programme to defend deficiencies in their work 4. Lack of initiative: A hard and fast audit programme may kill the initiative of efficient and enterprising assistants. ► PRECAUTIONS to avoid disadvantages: 1. Periodic Review: Audit program should be reviewed periodically & updated accordingly.. 2. Participating approach: Suggestions for improvements should be invited from assistants. 3. Explanation to assistants: regarding the objective, scope, etc. of audit in detail.

(29) What is final audit? Give its advantages & disadvantages. MEANING ► closed A accounting final/completed/periodical audit is an audit which begins after the books have at end: of period & thereafter is carried on continuously until completed. ► ADVANTAGES of final audit are: 1. Work can be carried on continuously in a single sitting, without affecting regular work flow of client 2. Possibility of alteration of figures after audit is avoided. 3. Allocation of work for staff becomes easier. 4. It is suitable for small size concerns ► DISADVANTAGES of final audit are: 1. Detailed checking not possible so chances of overlooking material misstatements exists 2. Excessive pressure for timely completion of audit 3. Timely rectification of errors not possible, all rectification entries are passed in year end 4. Not advisable for large size concerns

(30) What is continuous audit? Give its advantages & disadvantages. ► MEANING A continuous audit one in which is engaged continuously in checking the: accounts of client the iswhole year roundthe or auditor’s when staffstaff attends audit at intervals during the financial period. The audit staff is present at client’s premises almost during the entire accounting period. It is also known as detailed audit or running audit. ► ADVANTAGES of continuous audit are: 1. Timely rectification: earlier detection & rectification of errors is possible 2. Moral check: attendance of the audit staff acts as a moral check on client’s staff 3. Up-to-date accounts: the client’s accounts are always kept up-to-date. 4. Detailed checking: auditor has more time for detailed checking of the accounts 5. Early Final Audit: the final accounts can be prepared and reported upon much earlier

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6. Knowledge of client’s affairs: auditor remains constantly in touch with the client’s affairs 7. Less yearend pressure: auditor has to face less pressure at year end 8. Interim reporting: Interim financial reporting is also facilitated to a great extent 9. Beneficial for large sized concerns or entities with weak internal controls ► DISADVANTAGES of continuous audit are: 1. Tampering: audited records may be altered either innocently or fraudulently 2. Time consuming: it may involve waste of time and effort 3. Interruption of work: continuous presence of audit staff may affect regular work flow 4. Small size concerns: it may not be suitable for small size concerns 5. Failure to keep track: audit staff may overlook a matter not examined on last visit

► PRECAUTIONS to avoid disadvantages: visit, important balances should be noted down and the same should be 1. At the end of each compared at the time of the next visit 2. The visits should be at irregular intervals of time including the surprise elements. 3. Special attention should be placed on altered figures, if any. 4. Minimum interference should be done in the client’s regular work flow

(31) Write a note on Audit Working Papers. ► MEANING: As per SA 230, audit working papers refers to the documentation consisting of the record of audit procedures performed, relevant audit evidence obtained and conclusions the auditor reached. It constitutes the link between auditor’s report and client’s records. ► PURPOSE OF AUDIT DOCUMENTATION: 1. To provide Auditor with the basis for conclusion about the audit. 2. To ensure that audit was planned & performed as per SAs and applicable legal & regulatory requirements. 3. To assist the engagement team to plan and perform the audit. 4. To retain records for future audits. ► BASIC REQUIREMENTS OF WORKING PAPERS: 1. Auditor should prepare audit documentation on timely basis. 2. Audit documentation may be recorded on paper or electronic or other media. 3. The documentation is not limited to records prepared by auditor but may include other appropriate records such as minutes of meetings prepared by the entity’s personnel and agreed by the auditor. 4. Assembly of final audit file should be done on timely basis (approx. not more than 60 days after the date of auditor’s report). 5. Working papers should be retained for atleast 7 years from the date of auditor’s report. 6. Ownership of Audit Documentation: Audit documentation is the property of the auditor and he should maintain confidentiality of his working papers. Auditor may, at his discretion, make portions of or extracts from the working papers available to his client. ► CONFIDENTIALITY OF WORKING PAPERS:  The auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose.  As per SA 230 “Working papers are the property of the auditor & he may, at his discretion , make portions of or extracts from his working papers available to his client”. Thus, the client does not have a right to access the working papers of the auditor.  Chartered Accountants Act, 1949, provides that “A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he discloses information acquired in the

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course of his professional engagement to any person other than his client, without the consent of his client or otherwise than as required by any law for the time being in force.”

(32) Explain Permanent Audit Files & give its contents. Permanent audit files refer to audit working papers containing matters which do not change very often and can be referred in future audits. It should be updated from time to time. It includes: • Information relating to the legal & organisational structure of the entity. For e.g.: for a company, this includes the Memorandum and Articles of Association. • Copies of important legal documents, agreements and minutes relevant to the audit. • Copies of audited financial statements for previous years. • Record of communication with the retiring auditor, if any.

(33) Explain Current Audit Files & give its contents. Current audit files refer to audit working papers containing matters primarily relating to audit of a single period. It includes: • Correspondence relating to acceptance of annual reappointment. • Extracts of important matters in the minutes of Board Meetings and General Meetings. • Analysis of transactions and balances. • Record of nature, timing & extent of auditing procedures performed, and there results. • Copies of communication with other auditors, experts and other third parties. • Letters of representation or confirmation received from the client.

(34) What do you mean by Audit Sampling/Test Checking? What are the methods to select sample? As per SA 530, "Audit sampling" means the application of audit procedures to less than 100% of the items within an account balance or class of transactions to enable auditor to obtain and evaluate audit evidence in order to form a conclusion concerning the population. The auditor should select sample items in such a way that the sample can be expected to be representative of the population. There are two major methods which help in determining the size and components of the sample: 1) Judgmental sampling 2) Statistical sampling 1) JUDGMENTAL SAMPLING: Under this method, the sample size and its composition are determined on the basis of the personal experience and knowledge of the auditor. It is a traditional method of sampling. For e.g.: March & June may be selected in year one and different months would be selected in the next year. Advantages of Judgmental Sampling: • It is simple to operate. • Easy to understand. • Auditor’s past experience can help him to make better evaluation of sample. Disadvantages of Judgmental Sampling: • It is neither objective nor scientific • The risk of personal bias in selection of sample items cannot be eliminated. • Sample may not truly represent population. • In case of a new audit the sample selection may be difficult for the auditor. 2) STATISTICAL SAMPLING: An approach to sampling that has the following characteristics: (i) Random selection of the sample items; and (ii) Use of probability theory to evaluate sample results Under this method, the sample size and its composition are determined on the basis of mathematical laws of probability. It has wide application in case of homogenous population.

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Advantages of Statistical Sampling: • It is more scientific. • There is no personal bias. • It is more reliable due to use of mathematical & statistical tools. Disadvantages of Statistical Sampling: • It is complex to operate. • Suitable in case of large organizations, where there is large number of homogenous transactions. • It may be time consuming. • Not suitable when there are variety of transactions without any sequence. •

Audit staff needs to be educated about the statistical techniques first. Statistical Sampling Methods

Random Sampling

Simple Random Sampling

Random selection of samples

Interval/systematic Sampling

Stratified Random Sampling

Stratum

Stratum

Random selection of

Random selection of

samples

samples

Block Sampling

Defined block of consecutive items

Cluster Sampling

Random selection of clusters

► RANDOM SAMPLING Random selection ensures that all items in the population or within each stratum have a known chance of selection. It may involve use of random number tables. It is of two types: 1. Simple Random Sampling: Each unit of the whole population has an equal chance of being selected. Selection may be made by choosing numbers from: • table of random numbers • by computers • picking up numbers randomly from a drum. This method is appropriate in case of homogenous population consisting units falling within a reasonable range. For e.g. debtors balances falling within the range of Rs. 5,000 to Rs. 25,000 and not in the range between Rs. 25 to Rs. 2,50,000. 2. Stratified Random Sampling : This method involves dividing the whole population into different groups called strata. Each stratum is treated as if it was a separate population and sample is selected from each of these stratums. The number of groups into which the whole population has to be divided is determined on the basis of auditor’s judgment. For e.g. in the above case, debtors balances may be divided into four groups as follows:• Group1 : Debtors > Rs. 1,00,000 • Group2 : Rs. 75,000 < Debtors < Rs. 1,00,000 • Group3 : Rs. 25,000 < Debtors < Rs. 75,000 • Group4 : Debtors < Rs. 25,000 From Group1 the auditor may examine all the items; from Group2: 25% of items; from Group3: 10% of items and from Group4: 2% of items may be selected. It helps in focusing attention on more material items. It is useful for heterogeneous or diversified population. ► INTERVAL/SYSTEMATIC SAMPLING:

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Items are selected using a constant interval between selections, the first interval having a random start. The interval might be based on:  Certain number of items (for e.g. every 20th voucher) or  Monetary totals (e.g. every increase of Rs. 1,000 in cumulative value of population). When using systematic selection, the sampling interval should not follow a particular pattern in the population. The multiple random starting points should be taken to minimise the risk of interval sampling pattern with that of the population being sampled. It is of two types: 1. Block Sampling: Selection of a defined block of consecutive items. For e.g. first 200 sales invoices in the month of September. 2. Cluster Sampling: Dividing the population into groups of items known as clusters. A number of clusters are selected For e.g. 500 totables. 540, 2015 2055ofetc. The first item i.e. 2015 is randomly selectedrandomly. from random number The to items selected cluster can500, either be checked completely or a randomly selected proportion of them can be examined.

(35) What are the factors affecting sample size? The auditor should consider the following while determining the sample size: 1) Sampling Risk: Sampling risk arises from the possibility that auditor's conclusion, based on a sample, may be different from conclusion that would be reached if entire population were subjected to the same audit procedure. The lower the sampling risk the auditor is willing to accept, the greater the sample size will need to be. 2) Tolerable Error: Tolerable error is the maximum error in the population which would be acceptable & will not affect the conclusions drawn from sampling. It is considered during the planning stage. The smaller the tolerable error, greater the sample size will need to be. 3) Expected Error: If the error is expected to be present in the population, a larger sample is required. Smaller sample sizes are justified when the population is expected to be error free. In determining thechanges expected error, auditor would & consider matters as other errors identified in previous audits, in the entity's procedures evidencesuch available from procedures. Sampling Risk Tolerable Error Expected Error

The lower the sampling risk the auditor is willing to accept, the greater the sample size will need to be. The smaller the tolerable error, the greater the sample size will need to be If the error is expected to be present in the population, a larger sample is required.

Inverse Inverse Direct

(36) Write a note on audit risk. ► Audit risk means the risk that auditor gives an inappropriate audit opinion when financial statements are materially misstated. It is the possibility of deriving an inappropriate opinion by relying on tampered financial statements. ► Audit risk has three components: inherent risk, control risk and detection risk. Audit Risk Components

Inherent Risk

Control Risk

Risk that material errors will occur

Risk that the client’s system of internal control will not prevent or correct such errors

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Detection Risk Risk that any remaining material errors will not be detected by the auditor 24

Basis Definition

Type of risk

Inherent Risk Inherent risk is the susceptibility of an account balance or class of transactions to misstatement that could be material.

Control Risk Control risk is the risk that misstatement that could occur in an account balance or class of transactions will not be prevented or detected on a timely basis by system of internal control. Risk that material errors Risk that the client’s

Detection Risk Detection risk is the risk that an auditor’s procedures will not detect a misstatement that exists in an account balance or class of transactions.

will occur

material errors by will not be detected the auditor It can be controlled by following adequate audit procedures There is no existence of detection risk if no audit is conducted

system internal will notof prevent or control correct such errors Controllability It will always be present It will always be present in an audit and can’t be in an audit and can’t be controlled by auditor controlled by auditor It exist independently of It exist independently of Existence an audit of financial an audit of financial information information

Risk that any remaining

(37) What is the relationship between various components of audit risk? ► Management minimises inherent risk by designing accounting and internal control systems to prevent/detect and correct misstatements, thus inherent risk and control risk are highly interrelated. Hence, audit risk may be more appropriately determined by making a combined assessment of inherent and control risk. ► The auditor’s combined assessment of control & inherent risk, influences the nature, timing and extent of substantive procedures to be performed to reduce detection risk. ► There is an inverse relationship between detection risk and combined level of inherent and control risks. For example, when inherent and control risks are high, acceptable levels of detection risk need to be low to reduce audit risk to an acceptably low level. On the other hand, when inherent and control risks are low, auditor can accept a higher detection risk and still reduce audit risk to an acceptably low level. Practical Questions - Chapter 3: Preparation for an Audit Question No. 1: Mr. Chintan who was auditor of AB Corp. for the financial year 2009-10 was reappointed as auditor for F.Y. 2010-11. Should he send a new engagement letter for 2010-11? Question No. 2: M/s. Health Zone, a partnership firm running a nursing home have decided to discontinue you as an auditor for the next year and requests you to handover all the relevant working papers of the previous year. Comment on the above situation. Question No. 3: Xavier, the auditor of Sarah Ltd. decided to destroy the audit working papers after the

audit of Sarah Ltd. was complete and the annual report was signed & circulated. Comment, stating why he should carefully preserve the audit working papers? Question No. 4: State whether true or false:

a. b. c. d. e.

When inherent & control risk are low, an auditor can accept a lower detection risk. Audit procedure & audit technique are not one and the same thing. Audit working papers should be kept at least for three years. Audit Planning means developing an overall audit plan to do audit. Audit programme should not be changed.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 10 to 20 Marks

I MPORTANCE OF TH E CH APTE R

The Chapter helps in understanding the environment in which an auditor has to work i.e. theway in which an entity works.

SAs COVE RE D

SA 315, SA 610

COVE RAGE OF THE CHAPTER

(1) (2) (3) (4)

I nternal Control I nternal Check I nternal Audit ComputerisedI nformation System E nvironment

(38) What do you understand by the term ‘internal control’? ► MEANING: As per SA 315 “Identifying and assessing the risk of material misstatement through understanding the entity and its environment”, internal control refers to:  the process designed, implemented and maintained  by those charged with governance, management and other personnel  to provide reasonable assurance about achievement of objectives with regard to

-

reliability of financial reporting, effectiveness and efficiency of operations, safeguarding of assets and compliance with applicable laws and regulations.

(39) Explain internal control environment. ► MEANING: As per SA 315, the control environment includes: - the attitudes, awareness and actions of those charged with governance and management - concerning the entity’s internal control and - its importance in the entity. Management and employees should establish and maintain an environment throughout the organization that sets a positive and supportive attitude toward internal control. ► FACTORS AFFECTING THE CONTROL ENVIRONMENT: 1. Integrity & ethical values communicated and enforced: The effectiveness of controls is influenced by:  the integrity and ethical values of management and staff, and  the way entity’s policies are communicated and reinforced in practice. 2. Commitment to competence: All personnel need to possess and maintain a level of competence to accomplish their assigned duties. Management needs to identify appropriate knowledge and skills needed for various jobs and provide needed training. 3. Participation by those charged with governance: An entity’s controls are influenced significantly by those charged with governance. Some attributes of those charged with governance which may affect controls includes:

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

Their independence from management. Their experience & extent of their involvement.  Their interaction with internal and external auditors. 4. Management’s philosophy and operating style:The attitude and philosophy of management toward information systems, accounting functions, managing business risks, personnel functions and monitoring audits can have a profound effect on internal control. 5. Organizational structure: A good internal control environment requires that the agency’s organizational structure clearly define key areas of authority and responsibility and establish appropriate lines of reporting. 

6. Delegation of authority and responsibility: The delegation of authority and responsibility should be done so as to ensure that all personnel understand the entity’s objectives and know how their individual actions interrelate and contribute to those objectives. 7. Human resource policies and practices:Human resource policies and practices also affect the control environment. This includes establishing appropriate practices for recruiting, training, counseling, promoting, compensating and disciplining personnel. It also includes providing a proper amount of supervision. Promotions based on periodic performance appraisals demonstrate entity’s commitment to advancement of qualified personnel to higher levels.

(40) What are the inherent limitations of internal control? Internal control can provide only reasonable, not absolute, assurance that its objectives are achieved. This is because there are some inherent limitations of internal control, such as: 1. Cost Effectiveness: management’s consideration that a control be cost-effective. 2. Unusual transactions: most controls are not directed at transactions of unusual nature. 3. Human error: the potential for human error. 4. Collusion: the possibility of circumvention of controls through collusion with parties outside the entity or with employees of entity. 5. Override: the possibility that a person responsible for exercising control could abuse that authority, for example, a member of management overriding a control.

(41) What are the methods to review the internal control? The auditor can use one of the following methods to review internal control system: Methods to review internal control

Narrative records Complete & exhaustive description of the system

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Question-naire

Series of instructions and/or questions

Comprehensive series of questions concerning internal control

Flow chart Graphic presentation of each part of internal control

27

1.

Narrative Records: A complete and exhaustive description of the system as found in operation by the auditor. Actual testing and observation are necessary before such a record can be developed. Advantages 



Disadvantages

Useful where no formal control system is in operation Suitable for small business







It is difficult to understand the system in operation It is difficult to identify weaknesses or gaps in the system It requires constant updation due to reshuffling of manpower, etc.

2.

Check List: A series of instructions and/or questions which a member of the auditing staff must follow and/or answer. On completion, he initials the space against the instruction. Answers to the instructions are usually Yes, No or Not Applicable. The complete check list is studied by the Principal/Manager/Senior to ascertain existence of internal control and evaluate its implementation and efficiency. A few examples of check list instructions are given here under: Are tenders called before placing orders? o Are the purchases made on the basis of a written order? o Is the purchase order form standardised? o Are purchase order forms pre-numbered? o Advantages 

 

3.

Easy to fix responsibility observations in the course of audit

Disadvantages

for

 

Simple to use Evaluation by the principal helps in locating weaknesses

Questionnaire: A comprehensive series of questions concerning internal control. Generally questions are so framed that a ‘Yes’ answer denotes satisfactory position and a ‘No’ answer suggests weakness with a provision for an explanation of ‘No’ answers. The questionnaire is usually issued to the client and the client is requested to get it filled by the concerned executives and employees. Advantages 

4.

Time consuming Requires skill to prepare proper checklist

Chances of minimised

oversight/omission



Can be reviewed on interim basis



More systematic approach



Easy to locate weaknesses

Disadvantages

is



Time consuming



Total dependency on response of client

Flowchart: A graphic presentation of each part of the company’s system of internal control. It is the most concise way of recording the auditor’s review of the system. It minimises the amount of narrative explanation and gives bird’s eye view of the system.

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Advantages 

Most concise way of review



Gives bird’s eye view of the system

Disadvantages 



Difficult to prepare flowchart with details of every aspect of the system Detailed study may also be required in various aspects/areas

(42) What do you understand by internal check? ► MEANING: Internal check refers to:  

existence of checks on the day-to-day transaction. which operate continuously as a part of the routine system.  whereby the work of one person is proved independently or is complementary to the work of another.  the object being the prevention or early detection of errors or fraud. ► It is a part of the overall internal control system. It implies involvement of more than one person for completion of a job or transaction i.e. breaking of the line of responsibility.

(43) What factors should be considered while framing a system of internal check? General considerations in framing a system of internal check are: 1. No independent control: No single person should have an independent control over any important aspect of the business. 2. Job Rotation: Duties of the staff members should be changed from time to time without any previous notice. 3. Leave policy: Staff members should be encouraged to go on leave at least once in a year. 4. Separation of custodial responsibilities : Persons having physical custody of assets must not be permitted to have access to the books of account. 5. Control over assets: Accounting control should exist for each important class of assets; in addition, these should be periodically inspected so as to establish their physical condition. 6. Mechanical devices: To prevent loss or misappropriation of cash, mechanical devices, such as the automatic cash register, should be employed. 7. Budgetary controls: Budgetary controls should be devised and major variances should be observed and reconciled. 8. Stock taking: For stock-taking, at the close of the year, trading activities should, if possible, be suspended. The task of stock-taking and evaluation should be done by staff belonging to several sections of the organisation and not only by stock section staff. 9. Division powers : The officers financial administrative powers should be distributed very judiciouslyofamong different andand be reviewed periodically. 10. Periodic review: There should be periodical verification and testing of different sections of accounting records to ensure that they are accurate. Accounting procedures should be reviewed periodically even if they are well-designed and carefully installed.

(44) What do you understand by internal audit? Explain its objectives. ► MEANING: Internal Audit is  an independent management function,

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

which involves a continuous and critical appraisal of the functioning of an entity with a view to: - suggest improvements thereto and - improve the overall governance mechanism of the entity, - including the entity’s risk management and internal control system. ► OBJECTIVES: The objects of internal audit can be stated as follows: 1. Verification: Verify accuracy & authenticity of accounting & statistical records presented to the management. 2. Authorisation: Ascertain that proper authority exists for every acquisition, retirement and disposal 

3. 4. 5. 6. 7. 8.

of assets. Liabilities: Confirm that liabilities have been incurred only for the legitimate activities of the organisation. Frauds: Facilitate the prevention and detection of frauds. Assets Safety: Examine the protection afforded to assets and the uses to which they are put. Special investigation: Make special investigations for management. Ideas: Provide a channel whereby new ideas can be brought to the attention of management. Internal control review: Review operation of internal control system and bring material weaknesses to management’s notice.

(45) Differentiate internal audit and internal check. Basis

Internal Audit

Internal Check

Meaning

Internal Audit is an independent management function, which involves a continuous and critical appraisal of the functioning of an entity with a view to suggest improvements thereto and improve the overall governance mechanism of the entity, including the entity’s risk management and internal control system.

Internal check refers to existence o checks on the day-to-day transaction which operate continuously as a part of the routine system, whereby the work of one person is proved independently or is complementary to the work of another, the object being the prevention or early detection of errors or fraud.

Objective

Suggest improvements.

Minimise misstatements.

Staff

Specialised function.

staff

is

assigned

such It is performed by the ordinary staf members.

Separation It is a separate function & separate It is a part of internal control system & department is ensured its responsibility. operates as a built in device. Essential

It is not so essential to have a separate It is essential to have internal check internal audit function. over the transactions.

(46) What is the relationship between statutory & internal auditor? (SA 610) Internal audit being an integral part of the system of internal control, it is obligatory for a statutory auditor to examine the scope and effectiveness of work carried out by internal auditor. ► COORDINATION:

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 If after his examination the statutory auditor is satisfied that the internal audit has been efficient and

effective, he may decide to curtail his audit programme by dispensing with some of the detailed checking already carried out by the Internal Audit Department.  He, at times, also decides to entrust certain items of work to the internal auditor.  It is desirable that the external auditor be kept informed of any significant matter that comes to the internal auditor's attention and which he believes may affect the work of the external auditor. Similarly, the external auditor should ordinarily inform the internal auditor of any significant matters which may affect his work.  The report of the external auditor is his sole responsibility, and that responsibility is not by any means reduced because of the reliance he places on the internal auditor’s work.

(47) How should an external auditor evaluate internal audit function? External auditor’s evaluation of internal audit function will assist him in determining the extent of reliance to be placed upon work of internal auditor. The important aspects to be considered in this context are: 1. Organisational Status: Whether internal audit function is outsourced or within the entity itself, if internal auditor reports to the management and is there any constraints or restrictions placed upon his work by management. 2. Scope of Function: Ascertain the nature and depth of coverage of internal audit and the extent of consideration of internal audit recommendations by management. 3. Technical Competence: Review experience & professional qualifications of persons undertaking internal audit, to ascertain if they have adequate technical training & proficiency. 4. Due Professional Care: Ascertain whether internal audit work is properly planned, supervised, reviewed and documented. An example of the exercise of due professional care by the internal auditor is the existence of adequate audit manuals, audit programmes, and working papers.

(48) What are the characteristics of CIS environment? 1) Concentration of functions and knowledge: Certain data processing personnel may be the only ones with a detailed knowledge of data sourcing, processing, distribution and output. 2) Concentration of programs and data: Programs & data are often concentrated in one computer located centrally (common server). 3) Absence of input documents: data may be entered directly into the computer system without supporting documents. (e.g. credit limit approval). 4) Lack of visible transaction trail: certain data may be maintained on computer files only and that too only for a limited period of time. 5) Lack of visible output: certain transactions or results of processing may not be printed and be in form of files readable only by computer. 6) Ease of access to data and computer programs: data and computer programs may be accessed and altered by computers at remote locations. 7) Consistency of performance: Functions are consistently performed in the way they are programmed and are potentially more reliable than manual systems. 8) Programmed control procedures: the internal control procedures may be embedded with the computer programs.(e.g. access by use of passwords only)

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9) Single transaction update of multiple or data base computer files: single input to the accounting system may automatically update all records associated with the transaction. 10) Systems generated transactions: certain transactions may be initiated by system itself (e.g., TDS may be deducted automatically). 11) Vulnerability of data and program storage media: Large volumes of data and computer programs may be stored on portable media, which are prone to theft, or accidental destruction like virus attack.

(49) Write a note on internal control in CIS environment. The internal controls over computer processing include both manual procedures and computerized procedures. These may be classified into: 1. General CIS controls: i.e. the overall controls affecting the CIS environment 2. CIS Application controls: i.e. the specific controls over the accounting applications 1. GENERAL CIS CONTROLS: It establishes overall control over the CIS activities and provides reasonable assurance that overall objectives of internal control are achieved. It may include 1.Organization To establish an organizational framework over CIS activities, including: • Policies and procedures relating to control functions. and management • Appropriate segregation of incompatible functions. controls To provide reasonable assurance that systems are developed and maintained 2.Application in an authorized and efficient manner. They also typically are designed to systems establish control over: development and maintenance controls 3.Computer operation controls

• Implementation and documentation of new or revised systems. • Changes to application systems. • Acquisition of application systems from third parties. To control operation of systems & provide reasonable assurance that: • The systems are used for authorized purposes by authorized personnel only. • Only authorized programs are used.

• To provide reasonable assurance that system software is acquired or developed in an authorized and efficient manner, including restriction of access to systems software and documentation to authorized personnel. 5.Data entry To provide reasonable assurance that: and program • Only authorised transactions are entered in system • Access to data and programs is restricted to authorized personnel. controls 4.Systems software controls

• There is offsite back-up of data and recovery procedures in event of disaster. 2. CIS APPLICATION CONTROLS: It establishes specific control procedures over the accounting applications to provide reasonable assurance that all transactions are authorized, recorded and processed completely, accurately and on a timely basis. CIS application controls include:

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To provide reasonable assurance that: • Transactions are properly authorized before being processed. • Transactions are accurately converted into machine readable form. • Incorrect transactions are rejected, corrected and resubmitted on a timely basis. . Controls over To provide reasonable assurance that: • All transactions are properly processed by the computer. processing and computer • Transactions are not lost, added, duplicated or improperly changed. • Processing errors are identified and corrected on a timely basis. data files

1. Controls over input

. Controls over output

To provide reasonable assurance that: • Results of processing are accurate. • Access to output is restricted to authorized personnel. • Output is provided to appropriate authorized personnel on timely basis.

(50) Write a note on audit trail in CIS environment. ► MEANING: Audit trail refers to tracing the transactions from source document to the summarized total in accounting reports & vice versa. It is the way of relating the srcinal input with the final output on a one-to-one basis. It is the tracing of all the stages through which a particular business transaction passes in the records. ► AUDIT TRAIL IN CIS ENVIRONMENT: In a CIS environment audit trail is generally difficult to maintain, due to following reasons:  Lack of documentary evidence for input data.  

Increase in speed & ease by which data is processed. System generated or automatic transactions with no visible authorization.  Programmed control procedures e.g. checking customer’s credit limit.  Lack of visible output data, due to increased use of on-screen enquiry. ► OVERCOMING LOSS OF AUDIT TRAIL IN CIS ENVIRONMENT:  The auditor may use CAATs to overcome loss of audit trail, by testing: - the logic & controls existing within the system - the record produced by the system Use of CAAT may enhance the effectiveness of the audit.  Arranging for special printouts containing additional information, as required by auditor  Clerical recreation (manually calculating figures which have been generated by system)

(51) What are the benefits of using CAATs? Due to certain limitations of the CIS organizational structure the use of CAATs may be required, to improve the effectiveness and efficiency of audit procedures in following ways: 1. Cost saving: Some transactions may be tested more effectively for a similar level of cost by using the computer to examine all or a greater number of transactions. 2. Time saving: More data can be checked in lesser time by using CAATs 3. Examination in depth: CAATs may permit detailed examination of selected transactions 4. Audit trail: CAATs may effectively help in auditing even in the lack of audit trail. 5. Sampling: It helps in selecting appropriate samples by use of audit softwares.

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(52) What are the various approaches to audit in CIS environment? The auditor must plan whether to use the computer to assist the audit or to audit without using the computer. The two approaches are commonly called: 1) Auditing around the computer and 2) Auditing through the computer 1) AUDITING AROUND THE COMPUTER  Auditing around the computer involves arriving at an audit opinion by examining controls for computer installation and input & output only for application systems.  The computer is viewed as a black box and is used majorly to take printouts.  This approach is useful in either of the following situations: a. The system is simple and batch oriented. b. The system uses generalized software that is well-tested and used widely  Advantages of auditing around the computer: a. The primary advantage of this approach is simplicity. b. Little technical knowledge of computers is required to perform the audit.  Disadvantages of auditing around the computer: a. It is not suitable for large organizations with complex operations. b. The auditor cannot assess if the system is upgraded or not. 2) AUDITING THROUGH THE COMPUTER  Under this approach audit is largely carried on with the assistance of computers.  It can be used in the following circumstances: a. Application system processes large volumes of input & produces large volumes of output. b. Significant parts of internal control system are embodied in the computer system itself. c. The logic of the system is complex. d. There is elimination or reduction of printouts. e. The system uses online real time file updating.  CAATs may be used for auditing through the computer  Advantages of auditing through the computer: a. The auditor has increased power to effectively test a computer system. b. The range and capability of tests that can be performed increases  Disadvantages of auditing through the computer: a. It involves high costs. b. Extensive technical expertise is needed when systems are complex.

Practical Questions - Chapter 4: Internal Control Question No. 1: A senior assistant of X & Co. chartered accountants drew up his audit programme without evaluating internal controls of T Ltd. When the partner asked him for the reason, he stated that the controls were developed by the General Manager (Finance) of T Ltd. who is a chartered accountant and had written a few books on Internal Control and therefore there was no need to review the said area. Question No. 2: State whether true or false: a. Auditor should not communicate the weaknesses in internal control system to the management as he audits only financial statements.

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b. The overall objective and scope of an audit does not change in a CIS environment. c. Statutory auditor should completely rely on work of internal auditor. d. Performing audit in CIS environment is always simpler since the trial balance always tallies.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 10 to 15 Marks

I MPORTANCE OF TH E CH APTE R

This is the most practical oriented chapter and the concepts of this chapter will be used the most in practical life.

SAs COVE RE D

SA 505

COVE RAGE OF THE CHAPTER

(1) (2) (3) (4) (5) (6)

Vouching Audit of Payments Audit of Reciepts Audit of Purchases Audit of Sales Balance Sheet Audit

(53) What do you mean by vouching? The act of examining vouchers is referred to as vouching, where vouchers refers to the documentary evidence in support of a transaction recorded in the books of account. The essential points to be borne in mind while examining a voucher are that: 1. the date of the voucher falls within the accounting period; 2. the voucher is made out in the client’s name; 3. the voucher is duly authorised; 4. the voucher comprised all the relevant documents and is complete in all respects 5. the voucher has been posted to an appropriate account. After examination, each voucher should be either impressed with a rubber stamp or initialed.

(54) What factors should be considered while audit of payments? The factors to be considered are: 1. Authorisation: It is duly authorized by a competent person. 2. Accounting: Appropriate entries have been made in the books of accounts as per applicable accounting principles. 3. Vouching: Payment is made to appropriate person, posting is done under appropriate account & with correct amount, date on voucher agrees with corresponding entry in books. 4. Legality: It should bear a revenue stamp under the Indian Stamp Act, 1899. 5. Audit evidences: All relevant documentary evidences appropriately support the transaction. 6. Disclosures: Adequate disclosures are made in books.

(55) How will an auditor vouch transactions with Related Parties? The main things to be considered are provisions of the Companies Act and resolutions passed at Board Meetings. Some general considerations are: As per Section 188 of Companies Act, 2013 Board’s resolution is required for entering into any contract with the related party [Sec. 2(76)] for:

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sale, purchase or supply of any goods or materials; selling or otherwise disposing of, or buying, property of any kind; leasing of property of any kind; availing or rendering of any services; appointment of any agent for purchase or sale of goods, materials, services or property; such related party's appointment to any office or place of profit in the company, its subsidiary company or associate company [Sec. 2(6)]; and g. underwriting the subscription of any securities or derivatives thereof, of the company. The above provision is subject to the following conditions, namely: a. b. c. d. e. f.

1. The agenda of such Board meeting shall disclose full details of transaction with related party. 2. Prior approval of company by special resolution is required for entering into such contract if: i. a company having a paid-up share capital ≥ Rs. 10 crores ii. sale, purchase or supply of goods directly or through agent exceeding 25% of annual turnover; iii. selling or buying, any property directly or through agent exceeding 10% of net worth; iv. leasing of any property exceeding 10% of net worth or exceeding 10% of turnover; v. availing or rendering of any services directly or through agents exceeding 10% of net worth; vi. appointment to any office or place of profit in company, its subsidiary or associate company at a monthly remuneration exceeding Rs. 2,50,000; vii. remuneration for underwriting subscription of company exceeding 1% of net worth. Turnover or Net Worth referred above shall be as per Audited Financial Statement of last year. 3. Proviso to Section 188(1) provides that no provision to this section shall apply to any transactions entered into by company in its ordinary course of business which are on an arm’s length basis. 4. Board’s report shall refer to all contract entered u/s 188(1). 5. Every interested director, must disclose his interest to company at Board Meeting (Section 184). 6. Interested director is restrained from taking part in such meeting. If he does n’t disclose his interest or, participate in such Board meeting, contract so entered shall be voidable at option of company.

(56) How will an auditor vouch Remuneration paid to Directors? The main things to be considered are provisions of the Companies Act, terms of articles of association and resolution passed at general meeting . In case of vouching director’s remuneration in case of a public company following points must be considered: 1. Examine the Entitlement: The directors are entitled to remuneration either according to: a. the term of articles of association or b. in accordance with a resolution of the general meeting. 2. Examine Adherence to Legal Provisions: Examine compliance of Companies Act, such as: 

Section 197(6) which deals with manner of payment of managerial remuneration.



Section 197(5) which deals with payment of listing fees.



Section 197(1), which has prescribed the overall limit to managerial remuneration.



Schedule V to Act that has laid down conditions for payment of remuneration for companies having no profits or inadequate profits and companies having negative effective capital.

Proviso to Section 197(1) which provides for increase in remuneration with the approval of Central Government. 3. Disclosure: Adequate disclosure should be made in financial statements w.r.t. remuneration. 4. Documents to be vouched includes: 

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a. b. c. d. e. f.

Minutes book: to check terms of appointment Articles of Association: to check authority to pay and mode of payment Register of Directors: to check entry as director for the period under audit Director’s Attendance Register: to check attendance at Board Meetings Payment Voucher: to check computation and proper discharge Financial Statements: to check appropriate disclosure

(57) How are the payments controlled by the Companies Act, 2013 ? There are certain specific provisions relating to payments made as per Companies Act 2013, such as: 1. Reporting of personal expenses charged to company’s revenue a/c as per Sec.143(1)(e) 2. Under Sec. 180, Board of Directors shall require consent of company by special resolution to: i. Sell, lease or dispose of the whole, or substantially the whole of the undertaking of the co. ii. Invest (except in trust securities), compensation received as a result of any merger or amalgamation; iii. Borrow monies, where the total borrowings including proposed borrowings (apart from temporary loans) exceeds the aggregate of paid up capital & free reserves. Provided that the acceptance by a banking company, in ordinary course of its business, of deposits from public, repayable on demand and withdrawable by cheque, draft, etc. shall not be deemed to be a borrowing of monies by banking company within the meaning of this clause. iv. Remit/give time for re-payment of any debt due by directors. 3. Under section 181, Board of Directors can with prior permission of company in general meeting, contribute to bonafide charitable and other funds any amount in any financial year, aggregate of which exceeds 5% of its average net profits for three immediately preceding financial years. 4. As per Section 182, a government company or any other company which has been in existence for less than three financial years cannot contribute any amount directly or indirectly to any political party. In other cases, contribution in any financial year should not exceed 7½ % of average net profits during three immediately preceding financial years. 5. Section 183 permits the Board and other person to make contributions to the National Defence Fund or any other Fund approved by Central Government for the purpose of National Defence to any extent as it thinks fit.

(58) What factors should an auditor c onsider while vouching payment of

following expenses? A. TRAVELLING EXPENSES: The main thing to be considered is Travelling Allowance (T.A.) Rules approved by directors or partners. Some general considerations are: 1. 2. 3. 4. 5. 6.

Authorisation: It should be authorized by the competent person. T.A. Rules: Check if the claim is as per the T.A. Rules approved. Voucher: Voucher for travelling expenses should contain all details such as name & designation of person travelling, location, fare details, boarding/lodging expenses, etc. Director’s travelling expense: Auditor should ensure that it was incurred in the interest of the business and that the directors were entitled to receive the amount from the company. Evidence: For travel by air, counterfoil of air ticket should be inspected. For travel by rail or road, fare claimed should be checked from some independent source. Foreign travel: such expenses should be sanctioned by the Board before being paid.

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Advances: Travelling advance taken, if any should be settled on receipt of final bills. Board Meeting: Directors can charge travelling expenses for attending Board Meetings only if authorised by the articles or by a resolution of shareholders. 9. RBI Approval: Check if RBI approval has been sought for expenditure in foreign currency. 10. Accounting: Check if the entries are correctly reflected in the books of accounts. 11. ARP: Compare current year figures with previous years & inquire into any abnormalities. B. REPAIRS TO ASSETS: The main thing to be considered is that proper distinction should be made between Capital & Revenue expenditure. Some general considerations are: 1. IC system: Examine the Internal Control System related to repairs of assets. 7. 8.

2. AMCs: Examine the contracts if any and note the terms & conditions. 3. Bills: Examine the bills w.r.t. estimate submitted by contractor and the nature of repair. 4. Nature of expense: Check that the repairs which increases the value of asset or enhance its capacity/life should be treated as capital expenditure. In case of any confusion as regards nature of repairs, a certificate from the engineer should be obtained. 5. Accounting: Check if the entries are correctly reflected in the books of accounts. 6. ARP: Compare current year figures with previous years & inquire into any abnormalities. C. ADVERTISEMENT EXPENSES: The advertisement expenses will be vouched as follows: 1. Nature: Ascertain the nature of advertisement expenses to ensure that it has been charged properly and relates to the client’s business. 2. Advertisement schedule: Obtain the complete list of advertisement, media wise (i.e., radio, newspapers, television, etc.) showing dates, exact location, timings, amounts paid, etc. 3. Contract: Ascertain if there is a regular contract with the ad agency and regular statements are obtained. Discounts should be properly adjusted and disclosed in the bills. 4. Receipts: Check the receipts for amounts paid for the advertising expenses incurred. 5. Accounting: Check if the entries are correctly reflected in the books of accounts. 6. Disclosure: Examine if outstanding advertising expenses have been shown as liability and advances paid as assets. D. PAYMENT OF INCOME TAX: The main things to be considered are provisions of Income Tax Act and documents issued by ITO . Some general considerations are: 1. Statement of Total Income: Check that taxable income has been calculated as per the provisions of Income Tax Act. Amount of tax, surcharge and rebates etc. have been properly computed after considering the TDS or advance tax paid. 2. Depreciation Schedule: Check the depreciation calculation as per the provisions of IT Act. 3. Challan: Examine the challan to ascertain the amount, nature & date of tax paid. 4. Bank Statements: Trace the tax payments from bank accounts. 5. External evidences: Refer to the copy of the notice of demand, assessment order, assessment form

and the receipted challan to ascertain payments or advance payments of income tax. 6. Interest: Interest on refunds should be included as income and penal interest charged for nonpayment should be treated as expenditure. 7. CARO provisions: Check if any delay has been made in deposit of tax. 8. Financial Statements: Verify if correct accounting entry is reflected in the books and in the final financial statements. E. PAYMENT OF EXCISE DUTY (CENVAT) Meaning: It is a duty levied upon goods manufactured/produced by an entity and is payable at the time of removal of excisable goods from the factory/godown.

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The main things to be considered are provisions of Central Excise Act, 1944 and the related Rules, Circulars and Notifications. Some general considerations are: 1. Central Excise Act: Refer to the Act to check the rates applied. 2. Challans: Verify payment by examining challans with reference to quantity of goods in respect of which issue permits have been received. 3. Accounting: Ensure that it is correctly reflected in the books. 4. ARP: Test check the accuracy of amount of duty paid by multiplying the rate of excise duty with the value of goods issued as per the client’s stock register. 5. Provisions: For excisable goods manufactured but not released, ensure if the provision for unpaid excise duty has been made. 6. CENVAT credit: Ensure that in every case CENVAT credit has been adjusted and only net excise duty has been paid. 7. Duty Drawback: Duty drawback refers to a scheme under which central excise and customs duties paid for raw-materials and other inputs used in the manufacture of the product prior to its export are refunded to the exporter. Verify that duty drawback has been claimed.

(59) What are the general considerations for Audit of following Receipts? A. INCOME FROM INVESTMENTS 1. In case of voluminous investments, the client generally would have an Investment Register or else an investment schedule should be made. 2. Dividend income is first vouched by reference to the counterfoils of Dividend Warrants and Interest on securities by reference to the tax-deduction certificates. 3. Trace the collection into the investment register and the cash book. 4. Examine the documents to ascertain if any income is unrealized and the reasons thereof. 5. Check if the entries are correctly reflected in the books, as the gross amount should be shown in the P&L A/c and TDS amount debited to income tax account. 6. It should be checked that if investments are sold on ex-dividend basis or when purchase is on cum dividend basis, the dividend has been received subsequently. 7. Ensure that the TDS certificates have been received and kept safely. 8. Check that an entry for accrued income has been appropriately made. B. RENTAL RECEIPTS 1. Check the copies of bills issued to tenants by reference to copies of tenancy agreements and bills of charges paid on behalf of the tenants, i.e., house tax, water tax, electricity bill, etc. 2. Study the terms & conditions in the tenancy agreement and ensure that rent received is as per the agreement. 3. Check Rental Register for rent accrued & collection made by reference to rental bills copies. 4. Trace the entries into the cash book. 5. Scruitinise rental register to find amt. unrecovered & irrecoverable, so as to make provisions. 6. Check if any tax has been deducted at source & TDS certificates been received & kept safely. 7. It should be verified that every available accommodation has been let out and rental income has been duly accounted for. C. BANKRUPTCY DIVIDEND

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The amount received from the estate of an insolvent debtor against settlement of his account is called bankruptcy dividend. Some general considerations in its audit are: 1. Refer to the correspondence with the Official Receiver or Assignee to find particulars of part amounts already collected and the balance outstanding at the beginning of the year. 2. Examine any advice received from the same authority along with the payment. 3. Verify if amount received has been treated as bad debts earlier. 4. Trace the entry in cash book and bank statement. D. ROYALTIES RECEIVED 1. See the relevant contract and examine important provisions relating to conditions of payment of royalty, rate of royalty, mode of calculation and due dates. 2. Check the periodical statements received from the user and calculation of royalty. 3. Trace the entry in cash book and bank statement. 4. In case of any deduction on account of recoupment of royalty for past period, the records for earlier royalty receipts should be seen to ensure that amount of deduction is as per contract. 5. Verify if any tax is deducted at source & TDS certificate has been received & kept safely. 6. Royalties due but not yet received should have been properly accounted for. E. INSURANCE CLAIMS 1. Check if the claim is in respect of fixed assets or current assets. 2. Examine a copy of the insurance claim lodged with the insurance company. 3. Correspondence with the insurance company and the insurance agent should also be seen. 4. Check the counterfoils of receipts issued to the insurance company. 5. Check if appropriate adjustment has been made of the amount received in excess or short of the value of actual loss as per the insurance policy. 6. Verify copy of certificate/report containing full particulars of the amount of loss. 7. Check if appropriate entries are reflected in the books, particularly to ensure that P&L A/c is debited with shortfall of claim admitted against the book value of asset. 8. Trace the entry in cash book and bank statement.

(60) How will an auditor perform Audit of Purchases? ► CLASSIFICATION OF PURCHASES: It is essential that purchases be classified as follows: 1. Purchases of raw material. 2. Purchases of finished goods. 3. Purchases of consumable stores, fuel etc. 4. Purchases of packing materials, etc. 5. Purchases of articles like stationery for office use. 6. Purchases for making additions to assets. ► VOUCHING OF PURCHASE INVOICES 1. the date of invoice falls within the accounting period 2. the invoice is made out in the name of the client 3. the supplier’s a/c is credited with full amount & deduction, if any, is made on a proper basis 4. the goods purchased are regularly dealt in by the concern/ required for manufacture 5. invoice is signed by accountant & store-keeper. A copy of report of a technical person be seen in case of purchase of an item whose price is dependent on its quality. 6. the person competent to sanction payment has authorised its payment.

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appropriate entry is reflected in the books for purchases if an invoice runs into several pages or over several accounts, all amounts so adjusted should be added together to confirm that there has not been error under adjustment. 9. if invoices are received in duplicate/triplicate, it should be confirmed that srcinal invoice has been paid or adjusted separately. 10. if goods are purchased for use of an employee but invoice is made in the name of concern, it should be seen that cost has been charged to person concerned and not to Purchases A/c. 11. check that the statement of accounts has been sent to suppliers and it has been confirmed. 7. 8.

(61) How will an auditor audit Purchases Returns? Goods found to be defective or of a poor quality are sometimes returned to the supplier. 1. Ascertain the reasons for return and if the returns are duly authorized. 2. Examine stores record/goods outward bookto ascertain if appropriate entries are made. 3. Examine the debit note to ascertain the calculations by referring to the srcinal invoice. 4. Refer srcinal invoices of purchases to confirm that the nominal account srcinally debited has been subsequently credited on goods having been returned. 5. Special care should be taken if purchase returns are large, either at beginning or at close of the year, as it may be fictitious to cover bogus purchases recorded earlier. 6. Rebates and allowances received should be adjusted on the basis of Credit Notes received from the suppliers and be verified by reference to the srcinal invoices.

(62) Which are the factors which increase the gross profit? 1. 2. 3. 4. 5. 6. 7. 8. 9.

Undervaluation of opening stock. Overvaluation of closing stock. Change in basis of valuation of stock, like where opening stock was valued at cost or market rate whichever was lower, valuing closing stock at market price which is higher than cost. Inclusion of goods sold but not delivered in the closing stock. Sales at close of previous year but invoices raised in current year, taken as current year sales. Inclusion in closing stock of goods received for sale on approval or on a consignment basis. Treatment of goods sent out for sale on consignment basis as regular sales. No provision or under-provision in the expenses accounts included in the Trading Account. Wrong allocations of expenses, e.g., carriage inwards wrongly taken to P&L A/c.

(63) Which are the factors which decrease the gross profit? 1. Over valuation of the opening stock or undervaluation of closing stock. 2. Alteration of the basis of valuation of stock, e.g., closing stock valued at cost, which is below the market price, when the opening stock was valued at market price above cost. 3. Reversal of the fictitious sale entries recorded in the previous year to boost up profit. 4. Entry of sales returns twice/failure to account for purchase returns. 5. Excessive provisions made for wages or direct expenses. 6. Non-inclusion in closing stock of goods sent for sale on approval or on a consignment basis. 7. Inclusion in Trading Account of expenses which should have been included in P&L A/c. 8. Failure to take credit for insurance claim w.r.t. goods lost or destroyed by fire. 9. Failure to account for goods sold or destroyed or given away as samples.

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(64) How will an auditor audit Credit Sales? ► CLASSIFICATION OF SALES: Different types of sales should be classified as follows: 1. Sale of raw materials. 2. Sale of finished goods. 3. Sale of empties and other packing materials. 4. Sale of assets. ► VOUCHING OF SALES INVOICES: Credit sales should be verified by reference to copies of invoices issued to customers and attention should be paid to the following matters: 1. each item of sales relates to the period of account under audit 2. goods are those that are normally dealt in by the concern 3. sale price has been correctly arrived at 4. Check copy of requisition slip issued by Sales Department 5. the invoice has been adjusted in an appropriate account 6. sale has been authorised by a responsible official who has initialed invoice. 7. additional charges recovered along with sale price should be credited to separate accounts. 8. Check if the statement of accounts has been sent to the customers and confirmation received 9. Sales on hire-purchase basis, goods sold on sale or return basis and sales on consignmentbasis should be separately recorded.

(65) What do you understand by cut-off arrangement? 

 



It is an arrangement adopted by management to separate transactions of one period from other, so that results of working of each period can be correctly ascertained. It is a part of the internal check. It is generally applied to accounts of sales, purchases and stock. The main purpose is to ensure that revenue & expenditure of one period are not recorded in the other period. The cut-off procedures should ensure that: 1. goods purchased, property in which has passed to client, have been included in inventories and liability has been provided for in case of credit purchase 2. goods sold have been excluded from inventories and credit has been taken for sales and in case of credit sales the concerned party has been debited. Auditor may examine documents evidencing movement of stocks, including documents pertaining to period shortly before and after the cutoff date and check whether stocks represented by those documents were included or excluded as appropriate during stock taking.

(66) What do you understand by Balance Sheet Audit? 

Due to increase in the size of business units & due to mechanization of accounting, the test checks are applied widely for verification of income & expense accounts as well as assets & liabilities and not only for a few nominal accounts. This has resulted into a form of audit known as Balance Sheet audit.  Balance Sheet audit consists of verification of all Balance Sheet items, together with the examination of expense and income accounts.  It includes the following: 1. Examination of partnership agreement, memorandum & articles of association, minutes of Board Meeting and accounting system in force. CA. Poonam Madaan 43

2. 3. 4. 5. 6. 7. 8.

Establishment of ownership of all assets and proof that all owned assets are included in B/S. Ensuring if asset are included in B/S as per the accepted principles of accounting. Proof that all liabilities are included and at proved amounts. Checking of adjusting & closing or any other entries necessary for preparation of B/S. Evidence that distinction has been made between capital & revenue transactions. Proof that share capital issues have been made as per the law & are correctly recorded. Analysis of charges & credit to revenue a/c & inclusion of the balance in B/S.

(67) What do you understand by Outstanding Assets? 



Outstanding assets may be of two types: 1. Accrued Income: income receivable for services rendered. 2. Prepaid expenses: expense incurred in advance, benefit of which will arise in subsequent years. Following are some of the accounts in which adjustment of outstanding assets could be made: 1. Rent receivable: All rents receivable due or accrued till date of B/S should be calculated and brought into account after making a provision for doubtful/irrecoverable arrears of rent. 2. Interest and dividend: Interest receivable on loans accrued till date of B/S and interest on debentures & other securities receivable on fixed dates accrued and receivable till B/S date should be brought into account and dividend on shares should be accounted for as per the dividend accounting policy followed by the management. 3. Insurance Premium: Insurance premiums are always paid in advance, thus proportion thereof relating to period subsequent to B/S date should be calculated & taken as an outstanding asset. 4. Advertisement: Advances payments may be made under advertising contracts, thus the proportion thereof relating to period subsequent to B/S date be taken as an outstanding asset. Practical Questions - Chapter 5: Vouching

Question No. 1: A loss of Rs. 2,00,000 on account of embezzlement of cash was suffered by the company and it was debited to Salary Account. Comment. Question No. 2: As an auditor comment on the following: a) A sum of Rs. 15,000 p.m. has been paid as remuneration to a Director, who is not in the wholetime employment of the company. b) Travelling expenses of Rs. 2.25 lakhs shown in P&L A/c of X Ltd., including a sum of Rs. 1.10 lakhs spent by Director on his foreign travel for Company’s business accompanied by his mother for her medical treatment. c) The sales proceeds from scrap which did not have a significant value need not be verified if the company had a good accounting and costing system. d) The surplus arising from sale of investments was set-off against a non-recurring loss and was not disclosed separately. e) Insurance claim of Rs. 2 lakhs received stands included under Miscellaneous Income. Question No. 3: While auditing the accounts of a manufacturing company, you discover that the rate of Gross Profit on sales has sharply risen in comparison to the previous year. State eight possible causes of such increase and the steps you would take to satisfy yourself.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 10 to 15 Marks

I MPORTANCE OF TH E CH APTE R

This is the most practical oriented chapter and the concepts of this chapter will be usedthe most in practical life. It also clears various accounting concepts.

COVE RAGE OF THE CHAPTER

(1) (2) (3) (4)

Reserves vs. Provisions Verification of Assets Verification of Liabilities AS 4: Subsequent E vents

(68) What is the difference between Reserve and Provisions? Basis Meaning

Reserve

Provisions

Reserves are amounts appropriated out of Provisions are amounts charged against profits which are not intended to meet any revenue to provide for: liability, contingency, commitment or depreciation, renewal or diminution in diminution in the value of assets known to the value of assets; or exist at the date of the Balance Sheet. a known liability; or 





Nature

It is an appropriation of profits

a claim which is disputed. It is a charge against profits

Source

It is created only out of profits

It can also be created in case of losses

Dividends

It may be used for distribution as dividend. It cannot be used for distribution as dividend

Examples

Capital Redemption Reserve

Provision for tax / depreciation

► DISCLOSURE: Capital and revenue reserves must be shown separately in B/S. - Balance of P&L A/c, if in debit, should be deducted from the revenue reserve. - Additions or withdrawals from reserves, if material, should be disclosed. - When amount of reserve is invested outside business & is represented by readily realised assets, then the term ‘Reserves Fund’ should be used to describe a reserve.

(69) What is the difference between Capital Reserve & Reserve Capital? Basis Capital Reserve Reserve Capital Meaning

Capital reserve represents surplus or profit earned in respect of certain types of transactions and does not include any amount regarded as free for distribution through the P&L A/c.

Disclosure

It is recorded in the books of accounts It is not recorded in the books of

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It is that portion of share capital as determined by the company, which has not been called up and can be called up only in the event of winding up.

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and is disclosed on the liabilities side o the Balance Sheet.

accounts and is not disclosed in the Balance Sheet.

Creation

It is created out of profits of capital Special Resolution is needed to call up nature. this amount in the event of winding up.

Utilisation

It may be used for writing down losses, It can be used only for the purpose of fictitious assets, for issuing bonus shares winding up. or for certain specified purposes as per Sec. 78 & 80.

(70) What is Verification and how does it differ from Vouching? Meaning: Verification is a process by which auditor satisfies himself by inspection or otherwise as to the existence, ownership, valuation and accuracy of items appearing in B/S. Its difference from vouching is stated below: Verification

Vouching

It relates to items appearing in Balance Sheet.

It relates to entries recorded in books.

It is carried out at the end of a period.

It is generally done throughout the year.

It is generally done by experienced people or It is generally done by junior staff. senior staff. It includes valuation.

It does not include valuation.

To confirm existence, ownership, valuation & To verify completeness, accuracy and validity disclosure of B/S items. of transactions.

(71) Write a note on Verification of Assets. Verification of assets is done with an objective to confirm: 1. Existence: that the assets were in existence on the date of the balance sheet 2. Authority: that assets had been acquired for purpose of business & under a proper authority 3. Ownership: that the right of ownership of assets vested in or belonged to the undertaking 4. Charge: that they were free from any lien or charge not disclosed in the balance sheet 5. Valuation: that they had been correctly valued having regard to their physical condition 6. Disclosure: that their values are correctly disclosed in the balance sheet. Verification of assets is primarily the responsibility of management since they are expected to have a much greater intimate knowledge of assets of the entity as compared to an outsider. Auditor is expected only to do appraisal of the evidence, inspection and report on matters affecting their valuation, existence, title & disclosure. His principal function is to verify srcinal cost of assets and confirm that such valuation is fair and reasonable.

(72) Write a note on Valuation of Assets. For the purpose of valuation assets may be classified into: 1. Fixed Assets: Fixed assets are included in the Balance Sheet at their cost less depreciation and impairment loss, where cost includes all expenditure necessary to bring the assets into existence and to put them in working condition. 2. Wasting Assets: It is recommended that provision for depreciation/depletion should be made for every wasting asset like mines, on the basis of estimated physical exhaustion that takes place.

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Provision can be made on the basis of proportion that the quantity of output during the year bears to total quantity that mine is expected to yield during its normal working life. Unit for such a computation should be unit of refined produce. If mine is acquired on a lease, total amount paid for lease should preferably be amortised over the period of lease in proportion to output in each year or on a time basis. 3. Floating/Current Assets: They are valued either at cost or market value whichever is lower. Cost includes cost of purchase, cost of conversion and other costs incurred in the normal course of business in bringing inventories up to the present location and condition. The term market value may either refer to Net realisable value or replacement cost. AS 2 contains the provisions for valuation of Stock-in-trade. The normally accepted accounting principle for valuation of stock-intrade is cost or net realisable value whichever is lower, except for some specified cases. 4. Intangible Assets: These are valued as per the provisions contained in AS 26.

(73) How will an auditor verify Land & Buildings? Sometimes the two assets are shown together in the Balance Sheet but their ledger accounts should always be separate as buildings are subject to depreciation while land in general is not. LAND should be verified as follows: 1. Inspect srcinal title deed and ensure that it covers all lands whose cost is debited in books. 2. Certificate may be obtained from legal adviser of client confirming validity of title to land. 3. Verify that conveyance deed is duly registeredas required under the Registration Act, 1908. 4. In case of mortgaged property, title deed would be in possession of mortgagee or his solicitors. A certificate to this effect should be obtained from them. 5. Examine leases granted and also verify that ground rents which were outstanding for recovery on the date of Balance Sheet have since been recovered. 6. Verify that the amount of profit/loss resulting on sale has been correctly adjusted in accounts. 7. Examine that the charge, if any, against the asset is properly disclosed. 8. Check the basis of valuation and ascertain if it has been revalued. BUILDING should be verified as follows: 1. Examine title deed of the Building. 2. Check if building is stated at its srcinal cost in books by referring to Conveyance Deed. 3. If it is constructed, bills or certificate from contractor or architect be seen. If construction is done by client, verify that the basis of allocation of various costs is reasonable. 4. It should be depreciated at appropriate rates. 5. Ensure that Land & Building are separated for purposes of calculating deprecation. 6. Scrutinise closely the expenditure on repairs and ensure that distinction between capital and revenue expenditure is properly made.

If buildings have been revalued appropriate disclosures in this regard should be made. Examine that the charge, if any, against the asset is properly disclosed. In case of mortgaged property, title deed would be in possession of mortgagee or his solicitors. A certificate to this effect should be obtained from them. 10. Verify that amount of profit/loss resulting on sale has been correctly adjusted in accounts. 7. 8. 9.

(74) How will an auditor verify following fixed assets? A. LEASEHOLD PROPERTY:

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1. Examine lease agreement to understand its terms and conditions and ascertain that the lease has been duly registered. 2. See if all conditions prescribed by lease, whose non-compliance may result in forfeiture or cancellation of lease, are being duly complied with. 3. Examine counterpart of tenant’s agreements, if part of leasehold property has been sublet. 4. Ensure that due provisions for any claim that might arise under dilapidation clause on expiry of lease has been made. 5. Ensure that the accounting and disclosure requirements as per AS 19 have been followed. 6. Where leasehold rights have been revalued that fact should be clearly shown in Balance Sheet till

the account has been completely written off. B. PLANT & MACHINERY: Examine that appropriate internal control exists over plant & machinery. Examine the Plant Register or schedulescontaining the detail of plant & machinery. Verify invoice of machinery supplied & evidence of other incidental expenses for additions made and ascertain if the purchase have been duly authorized. 4. If addition is made by the concern on its own, basis of allocation of costs should be verified. 5. Verify that amount of profit/loss resulting on sale has been correctly adjusted in accounts. 6. Ensure that physical verification of plant & machinery is done periodically for verifying the existence of assets. 7. As a measure of effective internal control, see if assets have been numbered. 8. It should be depreciated at appropriate rates . If an asset has been revalued, depreciation should be provided on revised value. 9. Examine that the charge, if any, against the asset is properly disclosed. 10. Scrutinise closely the expenditure on repairs and ensure that distinction between capital and revenue expenditure is properly made. 11. Ensure that accounting & disclosure requirements as per AS 10 have been complied with. 1. 2. 3.

1. 2. 3. 4. 5. 6. 7.

C. MOTOR LORRIES, VANS, ETC.: Cost of these assets should be verified by reference to invoices of suppliers. Their ownership should be confirmed from permit and Registration Books. Verify that vehicles are covered by a comprehensive policy of insurance. See if adequate depreciation has been provided in respect of each of them. In case of large number of vehicles, there should be a Vehicle Register. In case of second hand purchase, ensure if transfer of ownership has been duly made. See if any charge on them has been properly disclosed.

D. PATENT RIGHTS: 1. If a number of patents are held, a schedule thereof should be obtained. 2. Verify ownership of patent by inspection of certificate of grant of patent or agreement surrendering it in favour of the client. 3. Check if the rights are alive and l egally enforceable and renewal fees have been paid on due dates by charging to revenue and Patent Account.

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4. Ensure that patents are being shown at cost less amortisation charges. Cost includes purchase price and registration cost. If patent has been developed by client in-house, all relevant expenses incurred in creating it should be capitalized. 5. Cost of patent should be written off over the legal term of its validity or over its useful commercial life, whichever is shorter. 6. Provisions of AS-26 should be complied with. E. TRADEMARKS AND COPYRIGHT: 1. Verify ownership of Trademarks and Copyright by inspection of certificate of grant or agreement

surrendering it in favour of the client. 2. It must also be observed that the rights are alive and legally enforceable. 3. Obtain a schedule of trademarks & copyrights. 4. Verify that renewal fees have been paid and charged to revenue. Examine last renewal receipt to ascertain that the trade mark has not lapsed. 5. Ensure that they are being shown at cost less amortisation charges till date. 7. Provisions of AS-26 should be complied with.

(75) How will an auditor verify Investments? Obtain schedule of Investments in form of securities and shares with all details, like opening balance, face value, market value, rate of interest, due date of interest, etc. In separate columns enter amounts of interest and dividend received during the period, interest/dividend accrued/ outstanding at close of period, etc.

1. 2.

Compare closing balance in schedule with the control account in General Ledger. Ensure that the investments made are duly authorised. Verify the brokers’ contract note, bill of costs, etc. Special attention should be paid to investments purchased or sold cum-dividend, ex-dividend, cum-interest/ex-interest, cum rights/ex-rights or cum bonus/ex-bonus. 7. Check the stock exchange quotations if sum paid for purchases/sales are substantial. 8. Physical inspection of investments may be done at the last date of accounting year. 9. If custody of investments is not with the entity, certificate should be obtained from relevant authority to the effect of holding of investments. 10. See that the accounting & disclosure requirements as per AS-13 have been complied with. 11. Examine if expenses like, transfer fees, stamp duty etc. are included in cost of investments. 12. Ensure that dividend or interest has been appropriately accounted for. 3. 4. 5. 6.

(76) How will an auditor verify Stock-in-Trade? 1. Examination of Records : Auditor should examine stock records showing item wise, the receipts, issues and balances. He should refer to the relevant basic documents e.g., goods received notes, inspection reports, material issue notes, bin cards, etc. 

Attendance at Stock-taking: Physical verification of inventories is the responsibility of the management, however, where inventories are material and auditor is placing reliance upon physical count by management, it may be appropriate for him to attend stock-taking. He should consider SA 501 while conducting physical verification.

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2. Confirmations from Third Parties: Where significant stocks of entity are held by third parties, auditor should directly obtain from them written confirmation for stocks held. Arrangements should be made with entity for sending requests for confirmation to such third parties. 3. Examination of Valuation and Disclosure : Ensure that valuation of inventories is in accordance with normally accepted accounting principles and is on consistent basis. 

Observe compliance with provisions of AS 2.



Examine treatment of overhead expenses as part of inventory cost.



 

He may call for reconciliation of total cost of production as per cost records with the financial books and review this reconciliation. If standard rates are used, he may ensure that appropriate adjustment is made. Ensure that inventories have been disclosed properly in financial statements.

(77) How will an auditor verify Work-in-progress? 1. Auditor may involve a technical expert in verification of work-in-progress if necessary. 2. He may advise his client that where possible work-in-progress should be reduced to minimum before closing date. 3. Ascertain that the cost sheets are duly attested by the Works Engineer and Works Manager. 4. Test the correctness of cost as disclosed in cost records by verification of quantities & cost of materials, wages and other charges by reference to records maintained and srcinal evidence in respect of all expenditure included in cost-sheets. 5. Compare the unit cost or job cost as shown by cost sheet with standard cost. 6. Ensure that allocation of overhead expensesis made on reasonable basis. 7. Compare cost-sheet in detail with that of previous year both in regard to composition of cost and value placed on various components. Investigate causes of material variation.

(78) How will an auditor verify the Book debts? 1)

2)

Examination of Records: 1. Evaluate internal control system and examine relevant records about validity, accuracy and recoverability of debtor balances. 2. Check if balances in schedules of debtors agree with those in ledger accounts. 3. Examine whether the age of the debts has been properly determined. 4. Ascertain amounts overdue, having regard to the credit terms of the entity. 5. See if provisions for allowances, discounts, doubtful debts have been properly made. Direct Confirmation Procedure: 1. If management requests auditor not to seek confirmation from certain debtors, he should

whetherthe there are valid for such a request. 2. consider While selecting debtors to begrounds circularized, special attention should be paid to accounts with large balances, old outstanding balances and customer accounts with credit balances. 3. Method of selection of debtors should not be revealed to entity until trial balance of debtors ledger is handed over to auditor. 4. Strict control should be maintained to ensure correctness & proper dispatch of letters. 5. Entity should be asked to reconcile any discrepancies revealed by confirmations received or by additional tests carried out by auditor.

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3)

4)

Analytical Review Procedures: Analytical review procedures may often be helpful for obtaining audit evidence regarding various assertions relating to debtors: 1. comparison of closing balances of debtors with the corresponding figures for the previous year; 2. comparison of actual closing balances of debtors with corresponding budgeted figures, if available 3. comparison of significant ratios relating to debtors with similar ratios for other firms in the same industry, if available; Disclosure: 1. According to Part I of Schedule VI to the Companies Act, 1956, debts outstanding for more

than six months have to be shown separately. 2. All sundry debtors; loans/advances are required to be classified as under: a. Debts considered good in respect of which the company is fully secured. b. Debts considered good but unsecured. c. Debts considered doubtful or bad. 3. Separate disclosure is required for debts due by directors or other officers or any of them either severally or jointly with any other person or debts due by firms or private companies in which any director is partner or a director or a member. 4. Debts due from other companies under same management should be disclosed along with name of the companies.

(79) How will an auditor verify bank balances? 1.

Examine bank reconciliation statement and balance certificates received from banks.

Examine whether cheques issued but not presented for payment and cheques deposited but not credited in bank account, have been duly debited/credited in the subsequent period. 3. Scrutinize items outstanding for an unduly long period in the reconciliation. 4. Disclosures should be made as per recognized accounting policies & practices and relevant statutory requirements. 5. Suitable disclosures be made in relation to balances/deposits with specific charge on them. 6. Examine relevant receipts/certificates and bank advices in case of any deposit with banks. 7. Examine that remittances in transit have been credited in bank in the subsequent period. 8. Adjustments should be made for cheques which have become stale as at year end. 9. Where material amounts are held in bank accounts which are blocked, e.g., in foreign banks with exchange control restrictions examine whether suitable disclosures have been made. 10. If number of bank accounts seems to be disproportionately large in relation to its size, the auditor should exercise greater care to establish the genuineness of transactions & balances. 2.

(80) How will an auditor verify Cash-in-hand? 1. Cash in hand includes petty cash balance, balances of stamps, cash in transit, cash at branches and cash with agents, out of which the first two are verified by actual count. 2. There should be an element of surprise while checking cash. 3. Cashier should be present while cash is being counted and he should sign the statement prepared containing details of the cash balance counted. 4. If cash balance could not be checked on Balance Sheet date, arrangements should be made for all cash balance to be banked.

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5. 6. 7. 8.

Auditor should sign Cash Book to indicate stage at which cash balance was checked. Any slip, chit for temporary advances paid to employees included as part of the cash balance should be initialed by a responsible official & debited to Appropriate Accounts. The quantum of torn or mutilated currency notes should be examined in the context of the size and nature of business of the entity. In case of any material differences between actual cash-in-hand and balance in books, he should seek explanations from senior officials

(81) How will an auditor verify Loans & Borrowings? 1. 2. 3. 4. 5. 6. 7. 8.

Examine if loans obtained are within the borrowing powers of entity. See if book balances agree with statements of lenders in respect of loans and advances from banks, financial institutions and others. Examine reconciliation statements, if any. Examine important terms in loan agreements. Examine whether requirements of applicable statute regarding creation and registration of charges have been complied with. Where entity has accepted deposits, auditor should examine whether directives issued by Reserve Bank of India or other appropriate authority are complied with. If value of security falls below the amount of loan outstanding, auditor should examine whether loan is classified as secured only to the extent of market value of security. Verify if loans have been properly classified as short term and long term loans. Examine hire purchase agreementsand see if adequate disclosures have been made.

(82) How will an auditor verify Provisions? The auditor should examine the reasonableness and adequacy of the amounts provided for. PROVISIONS FOR TAXES AND DUTIES: 1. Adequacy of provision for taxation for the year should be examined by reviewing overall outstanding liability as at B/S date . 2. Examine if suitable adjustments have been made for additional demands or refunds. 3. Examine relevant orders and examine if any short provisions have been made good. 4. Auditor should qualify his report if no provision has been made for a material tax liability. 5. Examine any disputed liability and see if adequate provision or suitable disclosure is made. 6. Check the method of calculating provision. PROVISION FOR GRATUITY: 1. Examine if the entity is required to pay gratuity to its employees by virtue of provisions of the Payment of Gratuity Act, 1972 and/or in terms of agreement with employees. 2. Ascertain if provision for accruing gratuity liability has been made. 3. Examine the adequacy of gratuity provision with reference to actuarial certificate. 4. If no actuarial certificate has been obtained, examine if method followed for calculating the accruing liability for gratuity is rational. PROVISION FOR BONUS: 1. Examine if liability is provided for in accordance with Payment of Bonus Act, 1965 and/or . agreement with employees or award of competent authority

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2. Specifically examine if bonus actually paid is in excess of amount required to be paid as per provisions of applicable law/agreement/award.

(83) How will an auditor verify Contingent Liabilities? As per AS 29, contingent liability is:  possible obligation as a result of past event;  existence of which will be confirmed only by occurrence or non-occurrence of future event &  future event not wholly within the control of the enterprise. Contingent liabilities are continuously assessed and if it becomes probable that an outflow of future economic benefit will be required to settle obligation which is previously assessed as contingent liabilities, a provision is recognized. The following general procedures may be useful in verifying contingent liabilities. 1. Review of minutes of meetings of board of directors, committees of board of directors/other similar body. 2. Review of contracts, agreements and arrangements. 3. Review of list of pending legal cases, correspondence relating to taxes, duties, etc. 4. Review of terms and conditions of grants and subsidies availed under various schemes. 5. Review of records relating to contingent liabilities maintained by the entity. 6. Enquiry of and discussions with, the management and senior officials of the entity. 7. Representations from the management. 8. Verify that proper disclosure as required by AS 29 is made in financial statement.

(84) Write a note on events occurring after the balance sheet date / subsequent events. As per AS 4, events occurring after B/S date are those significant events, both favourable and unfavourable, that occur between B/S date and date on which financial statements are approved by Board of Directors in case of a company and in case of any other entity by the corresponding approving authority. Some of such events may require adjustments to assets and liabilities as at the balance sheet date or may require disclosure. These are classified as under: 1. Adjusting events are those significant events occurring after B/S date that provide additional information materially affecting determination of amounts relating to conditions existing at B/S date, e.g., an adjustment for loss on B/R confirmed by insolvency of customer which occurs after B/S date. 2. Non-adjusting events are those events which do not relate to conditions existing at B/S date, e.g., decline in market value of investments. Disclosure of such events is made if they represent unusual changes affecting existence of enterprise at B/S date. For e.g., destruction of a major production plant by a fire after B/S date will not require any adjustment in B/S, but they may be disclosed in report of approving authority. If disclosure of events occurring after B/S is required, the auditor should see that the following information has been provided: a. the nature of the events; and b. an estimate of the financial effect or a statement that such an estimate cannot be made.

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3. Certain events which take place after B/S date are required to be disclosed in financial statements because of statutory requirements or because of their special nature. E.g., dividend proposed or declared after B/S for period covered by financial statements. Practical Questions - Chapter 6: Verification of Assets & Liabilities Q1. State your opinion/comment on the following: (a) Fixed assets have been revalued and the resulting surplus has been adjusted against the b/f losses.

(b)

B Ltd. acquired a car for Rs. 6.5 lacs on hire Theofinterest payable well as penalty for late payment of installments waspurchase added tobasis. the cost the car. Duringasthe year the company paid Rs. 1.5 lacs as installments for the year and provided depreciation on the said amount paid.

(c)

Inventories of a car manufacturing company include the value of items required for manufacture of a model which was removed from production 5 years back, at cost.

(d)

A machine was purchased by 2 companies jointly. The price was shared equally. It was agreed that they would use the machinery equally and show in their balance sheets, 50% of the value of machinery and charge 50% of depreciation in their books.

(e)

M/s Bonafide Ltd. has taken a Group Gratuity Policy from Insurance Company. During accounting year 2004-05 it received a communication from the said Insurance Company informing that premium amount for the accounting year 2003-04 was less charged by Rs. 75 lacs on account of arithmetical error on the part of Insurance Company. M/s Bonafide Ltd. paid the said sum of Rs. 75 lacs during the accounting year 2004-05 by debiting the same to Prior period expenses.

Q2. State whether the following statements are true or false: (a) Management Certificate obtained by auditor is enough for verification of inventories. (b) The responsibility for properly determining the quantity and value of inventories rests with the management of the entity. (c) Interest accrued but not due on secured loans is required to be shown under appropriate sub-heads under the head secured loans.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 20 to 30 Marks

I MPORTANCE OF TH E CH APTE R

The Chapter is important not only because it is of good Weightage but also because it clears many concepts relating to the company audit and thelaws in relation to company auditor.

SAs COVE RE D COVE RAGE OF THE CHAPTER

SA 299, SA 600, SA 700, SA 705, SA 706 (1) Qualification & disqualification of company auditor (2) Appointment & r emoval of company auditor (3) Power & Duties of company auditor (4) Audit Report (5) Branch Audit (6) Cost Audit

(85) Who can be appointed as a Company Auditor? As per Sec. 141 (1) of Companies Act, 2013 , following persons are qualified to be appointed as company auditor: 1. A chartered accountant, either as:

-

a sole proprietor, appointed in his own name, or a partner, appointed in the name of the firm ( whereof majority of partners practising in India are qualified for appointment as aforesaid). 2. Where a firm including a limited liability partnership is appointed as an auditor of a company, only the partners who are chartered accountants shall be authorised to act and sign on behalf of the firm.

(86) Who cannot be appointed as a Company Auditor? ► U/s 141(3) of Companies Act, 2013, following persons are not qualified for appointment as company auditors: a. a body corporate (other than a LLP registered under the Limited Liability Partnership Act, 2008); b. an officer or employee of the company; c. a person who is a partner or employee, of an officer or employee of the company; d. a person who himself, or his relative/partner – i. is holding any security or interest in the company or its subsidiary/holding/associate company or a subsidiary of such holding company. Provided that:

- the relative may hold security/interest of face value not exceeding 1 lakh rupees; - the condition of 1 lakh rupees shall, wherever relevant, be also applicable in case of a company not having share capital or other securities.

- in case the relative acquires any security/interest above 1 lakh rupees, the corrective action to maintain limits shall be taken by auditor within 60 days of such acquisition.

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ii. is indebted to the company or its subsidiary/holding/associate company or a subsidiary of such holding company, in excess of 5 lakh rupees; or iii. has given a guarantee for any third person to the company or its subsidiary/holding/associate company or a subsidiary of such holding company, in excess of 1 lakh rupees; e. a person/firm who, whether directly or indirectly has business relationship with the company or its subsidiary/holding/associate company or a subsidiary of such holding company, of such nature as may be prescribed; where the term “business relationship” shall be construed as any transaction entered into for a commercial purpose, except commercial transactions: i. which are in the nature of professional services permitted to be rendered by an auditor or

f. g. h. i.

audit firm under the Companies Act, 2013 and CAs Act, 1949 ii. which are in the ordinary course of business of the company at arm’s length price. Like sales to auditor as customer, in ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other similar businesses. a person whose relative is a Director or key Managerial Personnel in the company. a person who is in full time employment elsewhere or a person who at the date of appointment or reappointment holds appointment as auditor of more than twenty companies. a person who has been convicted by a Court and 10 years has not elapsed from date of such conviction. any person whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

► U/s 141(4) of Companies Act, 2013,Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned above after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

(87) Specify certain services which cannot be rendered by an auditor. Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor shall provide only such other services as are approved by the BOD or the audit committee, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding/subsidiary company), namely: i. accounting and book keeping services; ii. internal audit; iii. design and implementation of any financial information system; iv. actuarial services; v. investment advisory services; vi. investment banking services;

vii. rendering of outsourced financial services; viii. management services; and ix. any other kind of services as may be prescribed.

(88) How is a Company Auditor appointed? Mode

First Auditor

Subsequent Auditor

Section

139 (6) Board of Directors

139 (1) Members in GM

Appointed by

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Appointment Restrictions

To be appointed within 30 days of date of registration of company.

Tenure

Till conclusion of first AGM

To be appointed at first AGM and appointed/reappointed at every sixth AGM th 1st AGM to 6 AGM subjection to fulfillment of certain conditions

If BOD fails to appoint, members in EGM will appoint auditor within 90 days. Intimation to No intimation is required

No Provisions

Registrar

meeting in which the auditor is appointed. Certificate must be obtained from auditor

Failure appoint

Section 141

to

Certificate auditor

must

be

obtained

from

Intimate within 15 days of the

(89) How is the auditor of Go vernment Company appointed? As per Sec.2(45), “Government company” means any company in which not less than 51% of paid -up share capital is held by Central Govt. / by one or more State Government / partly by Central Govt. and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company. ► Appointment of First Auditor: Under Sec.139 (7), in the case of a Government company or any other company owned or controlled, directly or indirectly, by CG/ one or more SG, or partly by the CG and partly by one or more SG, the first auditor shall be appointed by the Comptroller and Auditor-General of India (CAG) within 60 days from the date of registration of the company. If CAG does not appoint such auditor within the above said period, BOD shall appoint such auditor within the next 30 days. Further, if BOD fails, it shall inform the members who shall appoint such auditor within 60 days at an EGM. Auditors shall hold office till the conclusion of first AGM. ► Appointment of Subsequent Auditor: Under Sec.139 (5), in the case of a Government company or any other company owned or controlled, directly or indirectly, by CG/ one or more SG, or partly by CG and partly by one or more SG, the auditor shall be appointed by CAG within a period of 180 days from the commencement of the financial year, who shall hold office till the conclusion of the annual general meeting.

(90) How is a Company Auditor re-appointed? ► A retiring auditor may be re-appointed at an annual general meeting, ifa. he is not disqualified for re-appointment b. he has not given the company a notice in writing of his unwillingness to be reappointed; and c. a special resolution has not been passed at that meeting appointing some other auditor or providing expressly that he shall not be re-appointed. ► Where at any AGM, no auditor is appointed/re-appointed, the existing auditor shall continue to be the auditor of the company.

(91) What are the provisions regarding filling of a casual vacancy?

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► Casual vacancy may arise due to a variety of reasons which include death, resignation, disqualification, dissolution of the firms of auditors, etc. ► Casual vacancy arises only after a valid appointment of auditor has been made and auditor has accepted appointment. ► As per Section 139(8), any casual vacancy in the office of an auditor shalli. In case of a company other than a company whose accounts are audited by an auditor appointed by CAG, be filled by BOD within 30 days. If casual vacancy is due to resignation, such appointment shall also be approved by company at a general meeting convened within 3 months of the recommendation of Board and he shall hold office till conclusion of next AGM; ii. In case of a company whose accounts are audited by an auditor appointed by CAG, be filled by CAG within 30 days. If CAG fails to fill the vacancy within 30 days, BOD shall fill the vacancy within next 30 days. ► Casual Vacancy by Resignation: As per section 140 (2) auditor who has resigned shall file within a period of 30 days from the date of resignation, a statement in the prescribed form ADT–3 (as per Rule 8 of CAAR) with the company and Registrar, and in case of companies u/s 139(5) i.e. subsequent auditor of Government company, auditor shall also file such statement with CAG, indicating the reasons and other facts as may be relevant with regard to his resignation. In case of failure the auditor shall be punishable with fine which shall range from 50 thousand rupees to 5 lakh rupees as per section 140 (3).

(92) Explain the provisions regarding rotation of Auditor. Section 139(2) Rotation of Auditor : For applicability of section 139(2) the class of companies shall

mean the following classes of companies excluding one person companies and small companies:1. all unlisted public companies having paid up share capital of rupees 10 crore or more; 2. all private limited companies having paid up share capital of rupees 20 crore or more; 3. all companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees 50 crores or more. As per Section 139(2), No listed company or a company as mentioned above, shall appoint/re-appoint: a. an individual as auditor for more than one term of 5 consecutive years; after completion of his term the individual auditor shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of his term; b. an audit firm as auditor for more than two terms of 5 consecutive years; after completion of the term of the audit firm, it shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term. The following points merit consideration in this regard1. As on the date of appointment, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of 5 years. 2. Every company, existing on or before the commencement of this Act which is required to comply with provisions of this sub-section, shall comply with the requirements of this sub-section within 3 years from the date of commencement of this Act.

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3. It has also been provided that right of the company to remove an auditor or the right of the auditor to resign from such office of the company shall not be prejudiced. 4. Subject to the provisions of this Act, members of a company may resolve to provide thata. in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members; or b. the audit shall be conducted by more than one auditor. 5. The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors. Manner of Rotation of Auditors by the Companies on Expiry of their Term: 1. The Audit Committee shall recommend to the Board, the name of an individual auditor or of an audit firm who may replace the incumbent auditor on expiry of his term. 2. Where a company has Audit Committee, Board shall consider recommendation of such committee, and in other cases, Board shall itself consider the matter of rotation of auditors and make its recommendation for appointment of next auditor by members in AGM. 3. For the purpose of rotation of auditors: i. in case of an auditor (whether individual/firm), the period for which the individual or firm has held office as auditor prior to the commencement of the Act shall be taken into account for calculating the period of 5 consecutive years or 10 consecutive years, as the case may be; ii. the incoming auditor or audit firm shall not be eligible if such auditor or audit firm associated with the outgoing auditor or audit firm under the same network of audit firms. Explanation I: For the purposes of these rules the term "same network" includes the firms operating or functioning, hitherto or in future, under the same brand name, trade name or common control. Explanation II: For the purpose of rotation of auditors,a. a break in the term for a continuous period of five years shall be considered as fulfilling the requirement of rotation; b. if a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years. 4. Where a company has appointed two or more individuals or firms or a combination thereof as joint auditors, the company may follow the rotation of auditors in such a manner that both or all of the joint auditors, as the case may be, do not complete their term in the same year.

(93) What are the provisions relating to Audit Committee? U/s Section 177, where a company is required to constitute an Audit Committee, all appointments, including filling of a casual vacancy of auditor shall be made on recommendations of such committee. Following classes of companies shall constitute an Audit Committee: a. All listed companies, b. all public companies with a paid up capital of 10 crore rupees or more c. all public companies having turnover of 100 crore rupees or more; d. all public companies, having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding 50 crore rupees or more. Explanation: Paid up share capital/turnover/outstanding loans/borrowings/debentures/deposits, as existing on date of last audited Financial Statements shall be taken into account.

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(94) What is the manner for selection and appointment of auditors? 1. In case of companies having Audit Committee u/s 177, the committee, and in other cases, the Board, shall consider the qualifications and experience of the individual or firm proposed to be appointed as auditor and whether such qualifications & experience are commensurate with the size and requirements of the company: Provided that while considering appointment, the Audit Committee or Board, shall have regard to any order or pending proceeding relating to professional matters of conduct against the proposed auditor before ICAI or any competent authority or any Court. 2. They may call for such other information from proposed auditor as it may deem fit. 3. Where a company is having Audit Committee, committee shall recommend name of auditor to the Board, and in other cases, Board shall recommend auditor to members in AGM for appointment. 4. If Board agrees with recommendation of Audit Committee, it shall further recommend the appointment of auditor to the members in AGM. 5. If Board disagrees with recommendation of Audit Committee, it shall refer back the recommendation to committee for reconsideration citing reasons for such disagreement. 6. If Audit Committee, after considering reasons given by Board, decides not to reconsider its srcinal recommendation, Board shall record reasons for its disagreement and send its own recommendation for consideration of members in AGM; and if Board agrees with Audit Committee, it shall place the matter for consideration by members in AGM. 7. Auditor appointed in AGM shall hold office from conclusion of that meeting till the conclusion of sixth AGM, with the meeting wherein appointment was made being counted as the first meeting: Provided that such appointment shall be subject to ratification in every AGM till the sixth such meeting by way of passing of an ordinary resolution. Explanation: For the purposes of this rule, it is hereby clarified that, if the appointment is not ratified by the members of the company, the BOD shall appoint another auditor.

(95) What are the provisions regarding Auditor’s Remuneration? ► U/s 142 remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as may be determined therein. However, board may fix remuneration of first auditor appointed by it. ► Further, the remuneration, in addition to the fee payable to an auditor, include the expenses, if any, incurred by the auditor in connection with the audit of the company and any facility extended to him but does not include any remuneration paid to him for any other service rendered by him at the request of the company. Therefore, it has been clarified that the remuneration to Auditor shall also include any facility provided to him.

(96) What are the provisions regarding Auditor’s Removal? REMOVAL OF AUDITOR BEFORE EXPIRY OF TERM [Sec. 140 (1)] ► According to Section 140 (1) the auditor appointed under section 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the Central Government in that behalf as per Rule 7 of CAAR, 2014: ► The application to the Central Government for removal of auditor shall be made in Form ADT-2 and shall be accompanied with fees as provided for this purpose under the Companies (Registration Offices and Fees) Rules, 2014.

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► The application shall be made to the Central Government within thirty days of the resolution passed by the Board. ► The company shall hold the general meeting within sixty days of receipt of approval of the Central Government for passing the special resolution. ► It is important to note that before taking any action for removal before expiry of terms, the auditor concerned shall be given a reasonable opportunity of being heard. REMOVAL OF AUDITOR AFTER EXPIRY OF TERMi.e. conclusion of sixth AGM. [Sec. 140] ► Section 140 lays down procedure to appoint an auditor other than retiring auditor who was removed:

1. Special notice shall be required for a resolution at an annual general meeting appointing as auditor a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be reappointed, except where the retiring auditor has completed a consecutive tenure of five years or as the case may be, ten years, as provided under subsection (2) of section 139. 2. On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring auditor. 3. Where notice is given of such a resolution and the retiring auditor makes with respect thereto representation in writing to the company (not exceeding a reasonable length) and requests its notification to members of the company, the company shall, unless the representation is received by it too late for it to do so,a. in any notice of the resolution given to members of the company, state the fact of the representation having been made; and b. send a copy of the representation to every member of the company to whom notice of the meeting is sent, whether before or after the receipt of the representation by the company. and if a copy of the representation is not sent as aforesaid because it was received too late or because of the company's default, the auditor may (without prejudice to his right to be heard orally) require that the representation shall be read out at the meeting. ► Provided that if a copy of representation is not sent as aforesaid, a copy thereof shall be filed with the Registrar.

(97) What are the provisions regarding Ceiling on number of Audits? ► CEILING: The specified number of audits which an auditor can undertake as per Section 141(3)(g) should not be more than 20 companies. This limit of 20 company audits is per person. o The number of audit assignments a person is holding at the date of appointment/ reappointment has to be considered. o In the case of an audit firm, 'specified number of companies' shall be construed as the number

o

o

of companies specified for every partner of the firm who is not in full time employment elsewhere. Council of ICAI specifies that a CA shall be deemed to be guilty of professional misconduct, if he holds at any time appointment of more than the prescribed limit u/s 141(3) (g). If a CA is a partner in a number of firms, all firms in which he is partner or proprietor will be together entitled to the specified number of audits on his account. In computing the specified number of audit assignments. a. the number of such assignments, which he or any partner of his firm has accepted whether singly or in combination with any other CA, shall be taken into account.

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o

o

o

b. number of partners of firm on date of acceptance of audit assignmentshall be taken. c. a chartered accountant in full time employment elsewhere shall not be taken into account. RECORDS: A CA in practice as well as firm of CAs in practice shall maintain a record of the audit assignments accepted by him or by the firm of chartered accountants, or by any of the partner of the firm in his individual name or as a partner of any other firm as far as possible, in the prescribed manner. CEILING ON TAX AUDIT ASSIGNMENTS: The specified number of tax audit assignments u/s 44AB of Income Tax Act, 1961 that an auditor, as an individual or as a partner of a firm, can accept is 60 numbers. CERTIFICATE: Before accepting appointment, auditor should give a written certificate to the company stating that such appointment, if made, will be as per the limits specified u/s 141(3) (g).

(98) What are the powers / rights of auditor? 1. Right of access to books of accounts & vouchers:The auditor of a company, at all times, shall have a right of access to the books of account and vouchers of the company, whether kept at the registered office or elsewhere. [Section 143(1)]. The right also extends to branch records and records of all subsidiaries in so far as it relates to the consolidation of its financial statements. 2. Right to obtain information and explanation from officers: Every auditor has, at all times, the right to obtain from officers of the company such information and explanations as he thinks necessary, for performance of his duties as auditor. The term ‘officer’ includes any director, manager or secretary or any person in accordance with whose directions or instructions Board of

Directors or any one or more of the directors are accustomed to act. 3. Right to receive notices and to attend general meeting: (section 146) In relation to general meeting auditors has the right to:  

Attend any general meeting of the company Receive all notices and other communications relating to general meetings, which members are entitled to receive

To be heard at any general meeting on any part of business which concerns him as auditor It is not his duty to attend or take part in the discussion, further such a right extends only to meeting of the members and not to the meeting of directors. 4. Right to report to members on accounts examined by him: The auditor shall make a report to the members of the company on the accounts examined by him and on every financial statements which are required under this Act to be laid before the company in general meeting. 5. Right to Lien: Auditor can exercise lien on books and documents placed at his possession by the 

client for non-payment of fees, for work done on the books and documents. 6. Powers / Rights of CAG: In case of a Government company, CAG shall appoint the auditor and direct him the manner in which accounts are required to be audited. Auditor shall submit a copy of audit report to CAG which, among other things, include directions issued by CAG, action taken thereon and its impact on accounts and financial statement of company. CAG shall within 60 days from the date of receipt of audit report have a right to: a. conduct a supplementary audit of financial statement by such person/s as he may authorize;

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b. comment upon or supplement such audit report. Such comments shall be sent to every person entitled to copies of audited financial statements and also be placed before the annual general meeting of the company at the same time and in the same manner as the audit report. Test Audit: CAG may, if he considers necessary, by an order, cause test audit to be conducted of the accounts of such company.

(99) Write a note on Auditor’s Lien. ► MEANING OF LIEN: Any person having lawful possession of somebody else’s property, on which he has worked, may retain the property for nonpayment of his dues on account of the work done on the property. ► AUDITOR’S LIEN: Auditor can exercise lien on books and documents placed at his possession by the client for non-payment of fees, for work done on the books and documents. Thus, Auditor’s lien is not unconditional. ► CONDITIONS TO EXERCISE LIEN : As per Institute of Chartered Accountants in England and Wales: 1. Documents retained must belong to the client who owes money. 2. Documents must have come into possession of auditor on authority of client. They must not have been received through irregular or illegal means. In case of a company, they must be received on the authority of the Board of Directors. 3. Auditor can retain documents only if he has done work on documents assigned to him. 4. Documents which are connected with work on which fees have not been paid can be retained. ► AUDITOR’S LIEN WHETHER EXERCISABLE : U/s 128, books of account of a company must be kept at the registered office, which makes it impracticable for auditor to have possession of the books and documents. o If Board passes a resolution under which books of account could be kept at a different place and hands them over to auditor, auditor may in such circumstances, exercise right of lien for nonpayment of fees. o However, as per section 128 he must provide reasonable facility for inspection of books of account by directors and others authorised to inspect under the Act. o Thus, it seems that though legally, auditor may exercise right of lien in cases of companies, it is mostly impracticable for legal and practicable constraints. ► LIEN ON AUDIT WORKING PAPERS: As per SA 230, working papers are property of auditor, thus question of lien on them does not arise. He may at his discretion make portions of or extracts from his working papers available to his clients. He should retain them for a period of time sufficient to meet needs of his practice and satisfy any legal requirements of record retention.

(100) What are the duties of auditor? As per Section 143 of the Companies Act, 2013 the duties of an auditor of a company include: 1. Duty to Inquire on certain matters:It is the duty of auditor to inquire into the following matters: a. whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members; b. whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company;

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c. where the company not being an investment company or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company; d. whether loans and advances made by the company have been shown as deposits; e. whether personal expenses have been charged to revenue account; f. where it is stated in the books and documents of the company that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading.

The auditor is not required to report on above matters unless he has any special comments to make on any of the items referred to therein. 2. Duty to Sign the Audit Report: The person appointed as an auditor of the company shall sign the auditor's report or sign or certify any other document of the company, as per provisions of Section 141(2) and the qualifications or observations on financial transactions or matters, which have any adverse effect on the functioning of the company mentioned in the auditor's report shall be read before the company in general meeting and shall be open to inspection by any member. 3. Duty to comply with Auditing Standards: As per section 143(9), every auditor shall comply with the auditing standards. U/s 143(10), Central Government may prescribe standards of auditing or any addendum thereto. Provided that until any auditing standards are notified, any standard, or standards of auditing specified by the ICAI shall be deemed to be the auditing standards. 4. Duty to audit report: As per section 143(3), the auditor's report shall also state: a. whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements; b. whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him; c. whether the report on the accounts of any branch office of the company audited by a person other than company's auditors has been sent to him and the manner in which he has dealt with it in preparing his report; d. whether the company's balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns; e. whether, in his opinion, the financial statements comply with the accounting standards; f. the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company; g. whether any director is disqualified from being appointed as a director u/s 164(2); h. any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith; i. whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls; j. such other matters as may be prescribed. Rule 11 of the Companies (Audit and Auditors) Rules, 2014 prescribes the other matters to be included in auditor’s report. The auditor's report shall also include their views and comments on the following matters, namely:i. whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement;

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ii. whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long term contracts including derivative contracts; iii. whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company. 5. Duty to report on frauds: As per section 143(12), if an auditor while conducting audit, identifies a fraud committed by officers or employees of the company, he shall immediately report the matter to the Central Government within such time and in such manner prescribed in rule 13. Rules 13 of the Companies (Audit and Auditors) Rules, 2014, prescribes that in case auditor has sufficient reason to believe that fraud has been committed against the company by its officers or employees, he shall report the matter to Central Government immediately but not later than 60 days of his knowledge and after following the procedure indicated herein below: i. auditor shall forward his report to Board or Audit Committee, immediately after he comes to knowledge of the fraud, seeking their reply or observations within 45 days; ii. on receipt of such reply auditor shall forward his report and reply of Board or Audit Committee alongwith his comments to Central Government within 15 days of receipt of such reply; iii. in case auditor fails to get any reply within the stipulated period of 45 days, he shall forward his report to Central Government alongwith a note containing details of his report that was forwarded to Board or Audit Committee. Further, the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post or by Speed post followed by an e-mail in confirmation of the same. This report shall be on the letter-head of the auditor. These provisions shall also apply, to a cost auditor and a secretarial auditor u/s 148 and 204 respectively. 6. Duty to report on any other matter specified by Central Government:Central Government may, in consultation with the National Financial Reporting Authority, by general or special order, direct, in respect of such class or description of companies, as may be specified in the order, that auditor's report shall also include a statement on such matters as may be specified therein. 7. Duties in regard to Branch Audit 8. Duty to state the reason for qualification or negative report:As per section 143(4), where any of the matters required to be included in the audit report is answered in the negative or with a qualification, report shall state the reasons there for.

(101) What are the elements of the Audit Report? (SA 700) Auditor’s report should contain a clear written expression of opinion on financial statements taken as a whole. Components of Auditor’s Report are as under: 1. Title: The auditor’s report shall have a title that clearly indicates that it is the report of an independent auditor. 2. Addressee: Law or regulation applicable to entity often specifies the addressee; normally auditor’s report is addressed to those for whom it is prepared, often either to shareholders or to those charged with governance. 3. Introductory paragraph: The introductory paragraph in the auditor’s report shall:  Identify the entity whose financial statements have been audited;  State that the financial statements have been audited;

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

Identify the title of each statement that comprises the financial statements; Refer to the summary of significant accounting policies and other explanatory information; and  Specify the date or period covered by each financial statement comprising the financial statements. 4. Management’s responsibility for financial statements : Auditor’s report shall include a section with the heading “Management’s [or other appropriate term] Responsibility for Financial Statements”, describing management’s responsibility as per terms of engagement. It shall state that management is responsible for preparation of financial statements in accordance with applicable financial reporting framework; it also includes the design, implementation and maintenance of 

internal control relevant to preparation of financial statements. 5. Auditor’s Responsibility: Auditor’s report shall include a section with heading ‘Auditor’s Responsibility’, stating that:  responsibility of auditor is to express an opinion on financial statements based on audit  audit was conducted as per SA issued by ICAI  audit involves performing procedures to obtain audit evidence about amounts & disclosures in financial statements  procedures selected depend on auditor’s judgment, including assessment of risks of material misstatement  auditor considers internal control for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on effectiveness of entity’s internal control.  audit also includes evaluating appropriateness of accounting policies used and reasonableness of accounting estimates made by management, as well as the overall presentation of financial statements. 6. Auditor’s opinion: The auditor’s report shall include a section with the heading “Opinion”. ► When expressing an unmodified opinion on financial statements prepared as per fair presentation framework, the auditor’s opinion shall use one of the following phrases: a. financial statements present fairly, in all material respects, as per the applicable financial reporting framework; b. financial statements give a true and fair view as per the applicable financial reporting framework. ► When giving unmodified opinion on financial statements prepared as per compliance framework, opinion shall be that financial statements are prepared, in all material respects, as per the applicable financial reporting framework. 7. Other reporting responsibilities: If auditor also addresses other reporting responsibilities, it shall be addressed in a separate section in auditor’s report sub-titled ‘Report on other legal and regulatory requirements’. 8. Signature of auditor: Where firm is appointed, report is signed in personal name of auditor and in name of audit firm. Partner/proprietor signing report also needs to mention his membership number assigned by ICAI and registration number of firm, wherever applicable, as allotted by ICAI. 9. Date: It shall be dated no earlier than the date on which auditor has obtained sufficient appropriate audit evidence on which to base his opinion on financial statements. 10. Place of signature: It shall name specific location, which is ordinarily the city where audit report is signed.

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ILLUSTRATION OF AUDITOR’S REPORT: “AUDITOR’S REPORT To,……….. (Appropriate Addressee) st

We have audited the attached Balance Sheet of…. (Name of the entity) as at 31 March 2XXX and also the Profit and Loss Account for the year ended on that date annexed thereto. These financial statements are the responsibility of the entity’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted in accordance with standards generally accepted in India. Those Standards requireour thataudit we plan and perform the auditing audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion and to the best of our information and according to the explanations given to us, the financial statements give a true and fair view in conformity with the accounting principles generally accepted in India: a) in the case of the Balance Sheet, of the state of affairs of…..(Name of the entity) as at 31st March 2XXX; and b) in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date. For ABC and Co., Chartered Accountants (Firm’s Registration Number) Auditor’s Signature (Name of Member signing the Audit Report) Place: (Designation) Date: Number)

(Membership

(102) What are different types of Audit Report? (SA 700, 705, 706) The audit report may be classified as follows on the basis of the type of opinion of auditor: Types of Audit Report

Unqualified

Modified

Reports

Reports

Affecting Auditor’s opinion

Not affecting Auditor’s opinion

Emphasis of matter

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Other matter

Qualified Report

Disclaimer of Opinion

Adverse opinion 67

1. UNQUALIFIED OR CLEAN AUDIT REPORT: (SA 700) An unqualified opinion is expressed when auditor have no reservations in respect of matters contained in the financial statements and thus concludes that financial statements give a true & fair view. An unqualified opinion also indicates that: ► Financial statements have been prepared using generally accepted accounting principles, which have been consistently applied. ► Financial statements comply with relevant statutory requirements and regulations. ► There is adequate disclosure of all material matters, adhering to statutory requirements. 2. MODIFIED AUDIT REPORTS: An auditor’s report is considered to be modified when it

includes: a. Matters That Do Not Affect Auditor’s Opinion: (SA 706) 1. Emphasis of matter: An auditor may modify his report by adding an emphasis of matter paragraph to highlight a matter affecting the financial statements. ► The addition of such an emphasis of matter paragraph does not affect auditor’s opinion. It would refer to the fact that auditor’s opinion is not qualified in this respect. ► It is included immediately after the Opinion paragraph in the auditor’s report. ► The paragraph may highlight a material matter regarding: - a going concern problem if going concern question is not resolved. - a significant uncertainty, whose resolution is dependent upon future events and which may affect financial statements. 2. Other matter: A paragraph included in auditor’s report that refers to a matter other than those presented or disclosed in financial statements that, in auditor’s judgment, is relevant to users’ understanding of audit, auditor’s responsibilities or auditor’s report. This paragraph shall be included immediately after Opinion paragraph and Emphasis of Matter paragraph. Eg: Restriction on distribution or use of auditor’s report. b. Matters That Affect the Auditor’s Opinion: (SA 705) An auditor may not be able to express an unqualified opinion in either of the following circumstances: ► there is a limitation on the scope of auditor’s work or ► there is any disagreement with management. 1. Qualified Opinion should be expressed when auditor concludes that an unqualified opinion cannot be expressed, and items which are subject matter of qualification are not so material, that it will affect the truth and fairness of financial statements. It should be expressed as being ‘subject to’ or ‘except for’ the effects of matter to which qualification relates. 2. Disclaimer of opinion should be expressed when the effect of a limitation on scope is so material and pervasive that auditor has not been able to obtain sufficient appropriate audit evidence and is unable to express an opinion on financial statements. Like when books of accounts of company are seized by IT authorities. 3. Adverse opinion should be expressed when effect of disagreement with management is so material and pervasive to financial statements that a qualification of report is inadequate to disclose the misleading or incomplete nature of financial statements. ► In all cases where auditor expresses an opinion other than unqualified, the reasons and possible effect on financial statements should be included in report.

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(103) What are the provisions regarding audit of Branch Office Accounts? ► ELIGIBILITY TO BE BRANCH AUDITOR : Audit of branch office accounts can be done by: a. company’s auditor appointed under section 139 or b. a person qualified for appointment as contemplated by section 141 or c. in case of a foreign branch, either by any one of above two or by any person duly qualified to act as an auditor in accordance with laws of that foreign country. ► BOOKS OF ACCOUNTS OF BRANCH: As per section 128(2), proper books of account relating to the transactions effected at the branch office shall be kept at that office and proper summarised returns periodically shall be sent by the branch office to the company at its registered office. ► DUTIES OF BRANCH AUDITOR: To prepare a report on the accounts of the branch examined by him and send it to the company auditor, who shall deal with it in his report in such manner as he considers necessary. Reporting of fraud by company auditor shall also extend to such branch auditor to the extent it relates to the concerned branch. ► USING THE WORK OF ANOTHER AUDITOR: As per SA 600, when branch audit is done by a person other than company's auditor, there should be clear understanding of the role of branch auditor and company's auditor. Where another auditor has been appointed for branch, principal auditor should rely upon the work of such auditor unless there are special circumstances to make it essential for him to visit branch and to examine books of accounts of the branch. Principal auditor should ensure that work of other auditor is adequate for his purposes. When using work of another auditor, principal auditor should ordinarily perform the following procedures: a. advise other auditor of the use that is to be made of other auditor's work and report; b. make sufficient arrangements for co-ordination of their efforts at planning stage of audit; c. advise the other auditor of the significant accounting, auditing and reporting requirements and obtain representation as to compliance with them. d. discuss with other auditor the audit procedures applied. e. visit the other auditor.

(104) Write a note on Cost Audit. ► MEANING: It is an audit process for verifying cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. ► COST AUDIT: Cost Audit is covered by Section 148, cost audit shall be in addition to the audit conducted under section 143. U/s 148 Central Government may by order specify audit of items of cost in respect of certain companies.

-

Central Government may, by order, direct that particulars relating to utilisation of material or labour or other items of cost as may be prescribed shall also be included in the books of account.

-

If Central Government considers it necessary, it may, by order, direct that audit of cost records of companies, which are covered under sub-section (1) and which have a net worth of such amount as may be prescribed or a turnover of such amount as may be prescribed, shall be conducted in the manner specified in the order. ► COST AUDITOR: The audit shall be conducted by a Cost Accountant in Practice who shall be appointed by the Board of such remuneration as may be determined by the members in such manner as may be prescribed:

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-

No person appointed u/s 139 as auditor of the company shall perform cost audit.

Auditor conducting cost audit shall comply with the cost auditing standards issued by the Institute of Cost and Works Accountants of India. ► APPOINTMENT OF COST AUDITOR : As per rule 14 of the Companies (Audit and Auditors) Rules, 2014 a. in the case of companies which are required to constitute an audit committeei. Board shall appoint an individual, who is a cost accountant in practice, or a firm of cost accountants in practice, as cost auditor on recommendations of Audit committee, which shall also recommend remuneration for such cost auditor; ii.

The remuneration recommended by Audit Committee shall be considered and approved by the Board of Directors and ratified subsequently by the shareholders; b. in case of other companies which are not required to constitute audit committee, Board shall appoint an individual who is a cost accountant in practice or a firm of cost accountants in practice as cost auditor and the remuneration of such cost auditor shall be ratified by shareholders subsequently. ► QUALIFICATION, DISQUALIFICATION, RIGHTS, DUTIES AND OBLIGATIONS OF COST AUDITOR: The qualifications, disqualifications, rights, duties and obligations applicable to auditors under this Chapter shall, so far as may be applicable, apply to a cost auditor appointed under this section and it shall be the duty of the company to give all assistance and facilities to the cost auditor appointed under this section for auditing the cost records of the company. However, the cost audit report shall be submitted to the Board of Directors of the company. ► SUBMISSION OF COST AUDIT REPORT: Company shall within 30 days from date of receipt of of cost audit report, furnish to Central Government report with full information andcopy explanation on every reservation/qualification containedsuch therein. If, along after considering cost audit report and information and explanation furnished by company as above, Central Government is of the opinion, that any further information/explanation is necessary, it may call for such further information/explanation and the company shall furnish it within such time as may be specified by that Government.

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SUMMARY OF SECTIONS Section 139 139 139 139 139 139 139 139 140 140 140 140 141

Subsection 1 2 5 6 7 8 10 1 2 4

141 141 141 141 142 143 143

1 3 3 (g) 4

143 143 143 143 143 143 143 143 143 143 144 145 146 148

2 3 4 5 6 7 8 9 11 12

177 128 2

1

2 45

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Detail Appointment of Auditor (Old Section 224) Appointment of Subsequent Auditor Rotation of Auditors Appointment of Subsequent Auditor of government company Appointment of First Auditor Appointment of First Auditor of government company Filing of Casual Vacancy When no auditor appointed in AGM Removal, resignation of auditor (Old Section 225) Removal before expiry by special resolution with CG approval Casual Vacancy by resignation Procedure for removal of auditor Qualifications & disqualifications of an Auditor (Old Section 224, 226) Only CA qualified to be appointed as auditor Disqualification of an Auditor Ceiling on number of Audits Deemed vacation of office on acquiring any disqualification Remuneration of auditors (Old Section 224) Powers & Duties of auditors (Old Section 227, 228, 619) Right of access to books & duty to inquire (clause a to f) Duty to report on financial statements Specific reporting requirements ( clause a to j) Reasons to be stated for qualifications or negative answers CAG to give directions for audit of government company Right of CAG to conduct supplementary audit Right of CAG to conduct test audit Audit of branch & reporting Duty to comply with Auditing Standards Reporting requirements by CG Duty to report frauds Auditor not to render certain services (New Provision) Signature on audit report (Old Section 229, 230) Right of auditor to attend general meeting (Old Section 231) Audit of cost accounts in certain companies as directed by CG (Old Section 233B) Forming of Audit Committee Books of accounts of branch office (Old Section 228) Definition of a Government Company

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COMPANIES (AUDITOR’S REPORT) ORDER, 2015 (in comparison to CARO, 2003. Highlighting the additions in CARO, 2003 and showing deletions striked through)

In exercise of the powers conferred by section 143 (11) of the Companies Act, 2013, the Central Government, after consultation with the ICAI, hereby makes the following Order:

APPLICABILITY OF THE ORDER ► The Order applies to all companies including foreign companies [Sec 2(42)] except the following: 1. a banking company 2. an insurance company 3. a company licensed to operate under section 8 of the Companies Act, 2013 4. a One Person Company as defined u/s 2(62) and asmall company as defined u/s 2(8;5)and 5. private limited company if at any point of time during the financial year its: a. paid-up capital and reserves are not more than Rs. 50 lakh; b. loan outstanding from any bank/financial institution does not exceed Rs. 25 lakh; and c. turnover does not exceed Rs. 5 crore

CARO 2015, PARA 3: Matters to be included in the auditor's report: CLAUSE (i): (FI XED ASS E TS) a) whether the company is maintaining proper quantitative details and situation of fixed assets;

records showing full particulars, including

b) whether these fixed assets have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of account; c) if a substantial part of fixed assets have been disposed off during the year, whether it has affected the going concern; CLAUSE (ii): (INVENTORY) a) whether physical verification of inventory has been conducted at reasonable intervals by the management; b) are the procedures of physical verification of inventory followed by the management reasonable and adequate in relation to the size of the company and the nature of its business. If not, the inadequacies in such procedures should be reported; c) whether the company is maintaining proper records of inventory and whether any material discrepancies were noticed on physical verification and if so, whether the same have been properly dealt with in the books of account; CLAUSE (iii): (LOANS GR ANTE D & TAK E N U/S 189) a) has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 189 of the Act. If so, give the number of parties and amount involved in the transactions; and b) whether the rate of interest and other terms and conditions of loans given by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and c) whether receipt of the principal amount and interest are also regular; and d) if overdue amount is more than rupees one lakh, whether reasonable steps have been taken by the company for recovery of the principal and interest; CA. Poonam Madaan 72

e) has the company taken any loans, secured or unsecured from companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and the amount involved in the transactions; and f) whether the rate of interest and other terms and conditions of loans taken by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and g) whether payment of the principal amount and interest are also regular CLAUSE (iv): (ADEQU ACY O F I NTER NAL CO NTRO L SYST E M) is there an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and

services. Whether there is a continuing failure to correct major weaknesses in internal control system; CLAUSE (v): (TRANSACTI ONS CO VE RE D B Y SE C. 301) a) whether transactions that need to be entered into a register in pursuance of section 301 of the Act have been so entered; b) whether each of these transactions have been made at prices which are 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 and in any one financial year). CLAUSE (vi): (PUBLI C DEPOS I TS) in case the company has accepted deposits from the public, whether the directives issued by the Reserve Bank of India and the provisions of sections 73 to 76 of the Act and the rules framed there under, where applicable, have been complied with. If not, the nature of contraventions should be stated; If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any court or any other tribunal, whether the same has been complied with or not? CLAUSE (vii): (ADEQU ACY O F I NTER NAL AU DI T SYST E M) in the case of listed companies and/or other companies having a paid-up capital and reserves exceeding Rs.50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crore rupees for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business; CLAUSE (viii): (MAI NTENANCE OF COST RE CORDS) where maintenance of cost records has been prescribed by the Central Government under section 148(1) of the Act, whether such accounts and records have been made and maintained; CLAUSE (ix): (STATUTO RY DUE S ) a) is the company regular in depositing undisputed statutory dues including Provident Fund, Investor Education and Protection Fund, Employees' State Insurance, Income-tax, Sales-tax, Wealth Tax, Service tax , Custom Duty, Excise Duty, Value added tax, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated by the auditor. b) in case dues of sales tax or income tax or service tax or wealth tax or excise duty or custom duty or value added tax or cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending may please be mentioned. (A mere representation to the Department shall not constitute the dispute).

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c) whether the amount required to be transferred to investor education and protection fund in accordance with the relevant provisions of the Companies Act, 1956 and rules made thereunder has been transferred to such fund within time. CLAUSE (x): (NET WORTH E ROS I ON) whether in case of a company which has been registered for a period not less than five years, its accumulated losses at the end of the financial year are not less than fifty per cent of its net worth and whether it has incurred cash losses in such financial year and in the financial year immediately preceding such financial year also; CLAUSE (xi): (DEF AULT I N RE PAYM ENT O F DUE S) whether the company has defaulted in repayment of dues to a financial institution or bank or debenture holders? If yes, the period and amount of default to be reported; CLAUSE (xii): (RE CORDS F OR LOAN S & ADVANCE S GRANTED) whether adequate documents and records are maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities; If not, the deficiencies to be pointed out. CLAUSE (xiii): (CHI T FUN D) whether the provisions of any special statute applicable to chit fund have been duly complied with? In respect of nidhi/ mutual benefit fund/societies; a) whether the net-owned funds to deposit liability ratio is more than 1:20 as on the date of balance sheet; b) whether the company has complied with the prudential norms on income recognition and provisioning against sub-standard/default/loss assets; c) whether the company has adequate procedures for appraisal of credit proposals/requests, assessment of credit needs and repayment capacity of the borrowers; d) whether the repayment schedule of various loans granted by the nidhi is based on the repayment capacity of the borrower and would be conducive to recovery of the loan amount; CLAUSE (xiv): (SHARE S, SECU RI TIE S, DEBE NTU RE S AN D OTHER I NVESTMENTS ) if the company is dealing or trading in shares, securities, debentures and other investments, whether proper records have been maintained of the transactions and contracts and whether timely entries have been made therein; also whether the shares, securities, debentures and other securities have been held by the company, in its own name except to the extent of the exemption, if any, granted under section 49 of the Act; CLAUSE (xv): (GU ARANT EE GI VEN) whether the company has given any guarantee for loans taken by others from bank or financial institutions, the terms and conditions whereof are prejudicial to the interest of the company; CLAUSE (xvi): (APP LI CATION O F TER M LOA NS) whether term loans were applied for the purpose for which the loans were obtained; CLAUSE (xvii): (APP LI CATI ON OF SHORT- TER M L OANS) whether the funds raised on short-term basis have been used for long term investment and vice versa; If yes, the nature and amount is to be indicated; CLAUSE (xviii): (PRE F E RE NTIAL ALLO TME NT) whether the company has made any preferential allotment of shares to parties and companies covered in the Register maintained under section 301 of the Act and if so whether the price at which shares have been issued is prejudicial to the interest of the company; CLAUSE (xix): (SECURITI ES CRE AT ED)

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whether securities have been created in respect of debentures issued? CLAUSE (xx): (END US E OF MONEY R AI SED BY PUBLI C I SSUES) whether the management has disclosed on the end use of money raised by public issues and the same has been verified; CLAUSE (xxi): (FRAUDS) whether any fraud on or by the company has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated. : Where, in the auditor's report, the Reasons to be stated for unfavourable or qualified answers answer to any of the questions referred to in paragraph 4 is unfavourable or qualified, the auditor's report shall also state the reasons for such unfavourable or qualified answer, as the case may be. Where the auditor is unable to express any opinion in answer to a particular question, his report shall indicate such fact together with the reasons why it is not possible for him to give an answer to such question.

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COMPANIES (AUDITOR’S REPORT) ORDER, 2015 In exercise of the powers conferred by section 143 (11) of the Companies Act, 2013, the Central Government, after consultation with the ICAI, hereby makes the following Order:

APPLICABILITY OF THE ORDER ► The Order applies to all companies including foreign companies [Sec 2(42)] except the following: 1. a banking company 2. an insurance company 3. a company licensed to operate under section 8 of the Companies Act, 2013 4. a One Person Company as defined u/s 2(62) and a small company as defined u/s 2(85); and 5. private limited company if at any point of time during the financial year its: a. paid-up capital and reserves are not more than Rs. 50 lakh; b. loan outstanding from any bank/financial institution does not exceed Rs. 25 lakh; and c. turnover does not exceed Rs. 5 crore

CARO 2015, PARA 3: Matters to be included in the auditor's report: CLAUSE (i): (FI XED ASS E TS) a) whether the company is maintaining proper records showing full particulars, including quantitative details and situation of fixed assets; b) whether these fixed assets have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so,

whether the same have been properly dealt with in the books of account; CLAUSE (ii): (INVENTORY) a) whether physical verification of inventory has been conducted at reasonable intervals by the management; b) are the procedures of physical verification of inventory followed by the management reasonable and adequate in relation to the size of the company and the nature of its business. If not, the inadequacies in such procedures should be reported; c) whether the company is maintaining proper records of inventory and whether any material discrepancies were noticed on physical verification and if so, whether the same have been properly dealt with in the books of account; CLAUSE (iii): (LOANS GR ANTE D & TAK E N U/S 189) a) has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 189 of the Act. b) whether receipt of the principal amount and interest are also regular; and c) if overdue amount is more than rupees one lakh, whether reasonable steps have been taken by the company for recovery of the principal and interest; CLAUSE (iv): (ADEQU ACY O F I NTER NAL CO NTRO L SYST E M) is there an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control system; CLAUSE (v): (PUBLI C DEPO SI TS)

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in case the company has accepted deposits from the public, whether the directives issued by the Reserve Bank of India and the provisions of sections 73 to 76 of the Act and the rules framed there under, where applicable, have been complied with. If not, the nature of contraventions should be stated; If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any court or any other tribunal, whether the same has been complied with or not? CLAUSE (vi): (MAI NTENANCE OF COST RE CORDS) where maintenance of cost records has been prescribed by the Central Government under section 148(1) of the Act, whether such accounts and records have been made and maintained; CLAUSE (vii): (STATU TORY DUE S ) a) is the company regular in depositing undisputed statutory dues including Provident Fund, Employees' State Insurance, Income-tax, Sales-tax, Wealth Tax, Service tax, Custom Duty, Excise Duty, Value added tax, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated by the auditor. b) in case dues of sales tax or income tax or service tax or wealth tax or excise duty or custom duty or value added tax or cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending may please be mentioned. (A mere representation to the Department shall not constitute the dispute). c) whether the amount required to be transferred to investor education and protection fund in accordance with the relevant provisions of the Act and rules made thereunder has been transferred to such fund within time. CLAUSE (viii): (NE T WORTH E ROSI ON) whether in case of a company which has been registered for a period not less than five years, its accumulated losses at the end of the financial year are not less than fifty per cent of its net worth and whether it has incurred cash losses in such financial year and in the financial year immediately preceding such financial year also; CLAUSE (ix): (DEF AULT I N RE PAYM ENT O F DUE S) whether the company has defaulted in repayment of dues to a financial institution or bank or debenture holders? If yes, the period and amount of default to be reported; CLAUSE (x): (GU ARAN TEE GI VEN) whether the company has given any guarantee for loans taken by others from bank or financial institutions, the terms and conditions whereof are prejudicial to the interest of the company; CLAUSE (xi): (APP LI CATI ON OF TER M LOANS ) whether term loans were applied for the purpose for which the loans were obtained; CLAUSE (xii): (FRAUDS) whether any fraud on or by the company has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.

: Where, in the auditor's report, the Reasons to be stated for unfavourable or qualified answers answer to any of the questions referred to in paragraph 3 is unfavourable or qualified, the auditor's report shall also state the reasons for such unfavourable or qualified answer, as the case may be. Where the auditor is unable to express any opinion in answer to a particular question, his report shall indicate such fact together with the reasons why it is not possible for him to give an answer to such question.

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SUMMARY OF CARO, 2015 Para1: Non-applicability: 1. Banking Companies 2. Insurance Companies 3. Companies registered u/s 8 4. One person company & small company 5. Private Limited Company if at any point during the year its: a) Paid–up capital + Reserves b) Loan o/s



Rs. 25 lakh

c) Turnover



Rs. 5 crs



Rs. 50 lakh

PARA 3: MATTERS TO BE INCLUDED IN AUDITOR’S REPORT: CLAUSES (i to xii) :

i.

Fixed Assets

a. Proper Records b. Physical verification, Material Discrepancies

ii .

Inventory

a. Physical Verification b. Adequacy of procedures for verification c. Proper records, discrepancies in physical verification For Loans Granted a. Whether loans granted to parties u/s 189

iii.

Loans Granted U/S 189

iv.

Adequacy Of Internal Controls

► Failure to rectify major weaknesses ► For purchase of inventory & fixed assets ► For sale of goods & services

v.

Public Deposits

► Non- compliance if any with provisions of RBI, Companies Act and order of CLB

vi.

Maintenance Of Cost Records

► If prescribed maintained.

b. Receipt of principal & interest if regular c. For overdue amount > Rs. 1 lacs, recovery steps

u/s

148(1),

whether

made

&

a. Undisputed dues paid regularly; if not amount o/s > 6 months

vii.

Statutory Dues

viii.

Net Worth Erosion

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b. Disputed taxes due, with amount and forum where pending c. Amounts transferred to investor education and protection fund within stipulated time

► Applicability: Companies registered >= 5 years ► Accumulated losses if > 50% of net worth ► Cash losses in current or previous year

78

► Dues of bank/financial institutions/debenture holders ► State period & amount of dues.

ix.

Default In Repayment Of Dues:

x.

Guarantee Given To Banks/Financial Institutions

► Terms & conditions, if prejudicial.

xi.

Application Of Terms Loans

► used for the purpose for which obtained

Frauds

► on or by company noticed or reported, if yes, its nature & amount.

xii.

Practical Questions - Chapter 7: Company Audit – I & CARO.  TRUE OR FALSE

Q1.State with reasons (in short) whether the following statements are True or False: (a) If the auditor appointed at the AGM refuses to accept the same, the Company can appoint another person by holding General Meeting. (b) The first auditor appointed by the board of directors can be removed by the board at its subsequent meeting. (c) The Auditors of a company is entitled to attend any General meeting of the company as his duty.  QUALIFICATION & DISQUALIFICATION OF AUDITOR Q2.An Stateauditor your comments the following: (a) purchasedon goods worth Rs.1,500 on credit from a company being audited by him. The Company allowed him one month’s credit, which it normally allowed to all known customers. (b) Ram and Hanuman Associates, C.A. in practice have been appointed as Statutory Auditor of Krishna Ltd. for the accounting year 2002-03. Mr. Hanuman holds 100 equity shares of Shiva Ltd. a subsidiary company of Krishna Ltd.  APPOINTMENT OF AUDITOR Q3.State your comments on the following: (a) Due to resignation of the existing auditor(s) the Board of Directors of X Ltd. appointed Mr. Hari as the auditor. Is the appointment of Hari as auditor valid? (b) No AGM was held for the year ended 31st March, 05 in XYZ Ltd. Ninu is the auditor for previous year, whether she is continuing to hold office for current year or not.  REMOVAL OF AUDITOR Q4.State your comments on the following: (a) X and Co. C.A. who were appointed as the first auditors of the company, were removed without the prior approval of the Central Government before the expiry of their term, by calling an Extra-ordinary General meeting. (b) The Board of Directors removed first auditor before expiry of the term and appointed another auditor in his place.  CEILING ON AUDITS Q5.State your comments on the following: (a) PSB & Associates, a C.A. firm has three partners P, B and S. The firm is already having audit of 60 companies which includes 2 branch audits of a company. The firm was offered 3 company audits out of which one is a private company other is a foreign company and the third one is a public company. Decide and advise whether PSB & Associates will

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exceed the ceiling prescribed by companies act?  AUDIT REPORT

Q6.State your comments on the following: (a) Mr. Rajendra a fellow member of ICAI, working as manager of Srivastava & Co. a chartered accountant firm, signed the audit report of OMB Ltd. on behalf of Srivastava & Co.

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STATI STI CS OF TH E C H APTE R I MPORTANC E OF THE CHAPTER COVER AGE OF THE CHAPT ER

Tentative Weightage of Chapter: 10 to 20 Marks This chapter covers the audit related issues specific to companies. (1) Books of Accounts (2) Board’s Report (3) Audit of Share Capital (4) Alteration of Share Capital (5) Audit of Debentures (6) Audit of dividends

(105) What are the specific provisions regarding books of accounts in the Act? U/s 128, the provisions in the matter of books of account are briefly summarised below: ► Contents of books: Books of accounts should include records maintained in respect of: a. all receipts and expenditure by company; b. all sales and purchases of goods and services by the company; c. the assets and liabilities of the company; and d. the items of cost as mayunder be prescribed u/s 148 in case of a company which belongs to any class of companies specified that section; Such books of Accounts shall be kept on accrual basis and according to the double entry system of accounting. ► Place of books [Section 128(1)]:The books of account and other relevant papers are required to be kept at the registered office of the company. a. Books of account for transactions effected at branch offices shall be kept at that branch office. b. Proper summarised returns periodically must be sent by branch office to the company at its registered office or other place as decided by Board of directors. ► Change in location of books: Board of directors may decide to keep books at any other place in India. Company shall, within 7 days of decision, file with Registrar a notice in writing giving full address of that other place. ► Electronic form of Books of accounts: a. The company may keep its books of account or other relevant papers in electronic mode. b. The books of account and other relevant books and papers maintained in electronic mode shall: 1. remain accessible in India. 2. be retained completely in the srcinal format and information contained in electronic records shall remain complete and unaltered. 3. information received from branches shall not be altered and be kept in srcinal format. 4. There shall be a proper system for storage, retrieval, display or printout of electronic records and such records shall not be disposed of unless permitted by law. 5. back-up of books of account in electronic mode shall be kept in servers physically located in india on a periodic basis.

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c. Company shall intimate to Registrar on an annual basis during filing of financial statement: 1. The name of the service provider; 2. The internet protocol address of service provider; 3. The location of the service provider (wherever applicable); 4. Where books are maintained on cloud, such address as given by service provider. ► Persons who can inspect [Section 128(3) and (4)]: a. Books of account maintained within India shall be open for inspection by any director during business hours. b. For financial information maintained outside India, copies of such financial information shall be maintained and produced for inspection by any director subject to following conditions: 1. Summarised returns of books kept outside India shall be sent to registered office at quarterly intervals, it shall be kept at registered office and be open for inspection to directors. 2. Where any other financial information maintained outside India is required by a director, he shall furnish a request giving full details of such information sought. 3. Such information shall be given to director within 15 days of receipt of written request. 4. Such information shall be sought for by director himself. c. Inspection in respect of any subsidiary shall be done only by a person authorised by a resolution of Board of Directors. d. Officers and other employees of company shall assist the person making such inspection. ► Period of Maintenance [Section 128(5)]: The books of account together with relevant vouchers shall be kept in order by company for a minimum period of 8 financial years immediately preceding a financial year. ► Persons responsible for Maintenance & Penalty [Section 128(6)]: The following persons are responsible for maintenance of proper books of account: 1. Managing director, whole-time director in charge of finance, CFO; or 2. any other person of a company charged by Board.

(106) What are the provisions regarding Financial Statements in the Act? ► Meaning: As per section 2 (40), “Financial statement” in relation to a company, includes— a. a balance sheet as at the end of the financial year; b. a profit & loss account, for non-profit company, income & expenditure account for financial year; c. cash flow statement for the financial year; d. a statement of changes in equity, if applicable; and e. any explanatory note annexed to or forming part of such financial statement Provided that financial statement, of One Person Company, small company and dormant company, may not include cash flow statement; ► Form of Financial statements [Section 129(1)]: a. The financial statements shall: 1. give a true and fair view of the state of affairs of the company or companies, 2. comply with the accounting standards notified under section 133 and 3. shall be in the form as provided in Schedule III 4. the items contained in financial statements shall be as per accounting standards. b. The above provisions shall not apply to following companies:

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1. Insurance Companies 2. Banking companies 3. Company engaged in the generation or supply of electricity 4. Any other class of company for which a form of financial statement has been specified ► Presentation of financial statements [Section 129(2)]: At every annual general meeting, Board of directors shall lay before the company the financial statements for the financial year. ► Consolidated Financial Statements [Section 129(3) & (4)]: a. A company shall prepare a consolidated financial statement including all the subsidiaries in the same form and manner as that of its own. b. Consolidated financial statements shall also be laid before AGM. c. Company shall also attach with its financial statement, a separate statement containing salient features of financial statement of its subsidiaries in Form AOC-1. Subsidiary shall include associate company and joint venture. d. Consolidation of financial statements shall be made as per the provisions of Schedule III and applicable accounting standards. e. Provisions applicable to preparation, adoption and audit of financial statements of a holding company shall, also apply to consolidated financial statements. ► Deviations from Accounting Standards [Section 129(5)]:If financial statements do not comply with accounting standards, company shall disclose in its financial statements the following namely: a. the deviation from the accounting standards, b. the reasons for such deviation and c. the financial effects, if any, arising out of such deviation ► Authentication of Financial statements [Section 134(1), (2) & (7)]: a. The financial statements, including consolidated financial statement, if any, shall be approved by the board of directors and signed by the following: 1. Chairperson of the company where he is authorised by the Board or by 2 directors out of which one shall be managing director, 2. Chief Executive Officer and 3. Company secretary, wherever he is appointed. b. For a one person company, financial statement shall be signed by only one director. c. The auditors’ report shall be attached to every financial statement. d. A signed copy of every financial statement shall be issued along with a copy each of — 1. Any notes annexed to or forming part of such financial statement; 2. The auditor’s report; and 3. The Board’s report.

(107) Write a note on Board’s Report. ► Board’s report [Section 134(3) & (4)]: a. Board’s report shall be prepared based on standalone financial statements of the company and it shall contain a separate section wherein a report on performance and financial position of each subsidiaries, associates and joint venture companies is presented. b. It shall be attached to statements laid before company in general meeting. It shall include: 1. The extract of the annual return as provided u/s 92 (3); 2. Number of meetings of the Board;

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3. Directors’ Responsibility Statement; 4. a statement on declaration given by independent directors u/s 149 (6); 5. in case of a company covered u/s 178 (1), company’s policy on directors’ appointment and remuneration including criteria for determining qualifications, positive attributes, independence of a director and other matters provided u/s 178 (3); 6. explanations or comments by Board on every qualification made by auditor in his report and by company secretary in his secretarial audit report; 7. particulars of loans, guarantees or investments under section 186; 8. particulars of contracts or arrangements with related parties referred u/s 188 (1); 9. the state of the company’s affairs; 10. the amounts, if any, which it proposes to carry to any reserves; 11. the amount, if any, which it recommends should be paid by way of dividend; 12. material changes and commitments, if any, affecting financial position of company which have occurred between end of financial year and date of report; 13. the conservation of energy, technology absorption, foreign exchange earnings and outgo; 14. A statement indicating development and implementation of a risk management policy including risk, which in opinion of Board may threaten the existence of company; 15. policy developed and implemented on corporate social responsibility initiatives; 16. Every listed company and every other public company having a paid up share capital of 25 crore rupees or more calculated at the end of the preceding financial year shall include, a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and individual directors. 17. The report of the Board shall also contain: i. financial summary or highlights; ii. change in the nature of business, if any; iii. details of directors or key managerial personnel who were appointed or have resigned during the year; iv. names of companies which have become or ceased to be its subsidiaries, joint ventures or associate companies during the year; v. details relating to deposits like deposits accepted, unpaid at the end of the year and any default in repayment of deposits or interest thereon vi. details of deposits which are not in compliance with the requirements of Chapter V of the Act; vii. details of significant and material orders passed by the regulators or courts or tribunals impacting the going concern status and company’s operations in future; viii. details in respect of adequacy of internal financial controls. c. Board’s report in case of OPC [section 134(4)]: in case of a one person company, board’s report shall mean a report containing explanations or comments by the board on every qualification made by auditor in his report. ► Directors’ Responsibility Statement [Section 134(5)]: It shall state that: 1. in preparation of annual accounts, applicable accounting standards had been followed along with proper explanation relating to material departures; 2. the directors had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of

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3. 4. 5. 6.

the state of affairs of the company at the end of the financial year and of the profit and loss of the company for that period; directors had taken proper and sufficient care for maintenance of adequate accounting records as per the provisions of this Act for safeguarding assets and preventing and detecting fraud; directors had prepared the annual accounts on a going concern basis; and directors, in the case of a listed company, had laid down internal financial controls to be followed by company and such controls are adequate and were operating effectively. directors had devised proper systems to ensure compliance with the provisions of all applicable laws and that such systems were adequate and operating effectively.

► Signing of Board’s Report [Section 134(6)]: The Board’s report and any annexures thereto shall be signed by its chairperson if he is authorised by Board and where he is not so authorised, shall be signed by at least two directors, one of whom shall be a managing director, or by the director where there is one director.

(108) What are the provisions regarding powers of Board of Directors? U/s 179, Board of Directors is entitled to exercise all such powers as the company is authorised to do. However, Board shall not exercise any power which is directed by any legislation or memorandum or articles of the company, to be exercised by company, in general meeting. Various decisions that can be taken by way of resolution by Board of Directors only in Board’s meetings are as follows: 1. to make calls on shareholders in respect of money unpaid on their shares; 2. to authorise buy-back of securities under section 68; 3. to issue securities, including debentures, whether in or outside India; 4. to borrow monies; 5. to invest the funds of the company; 6. to grant loans or give guarantee or provide security in respect of loans; 7. to approve financial statement and the Board’s report; 8. to diversify the business of the company; 9. to approve amalgamation, merger or reconstruction; 10. to take over a company or acquire a controlling or substantial stake in another company; 11. any other matter which may be prescribed, like: a. Adopting of accounts before submitting to auditor for their report- Section 134 b. Appointment of the first auditors and filling of casual vacancy - Section 139. c. Investment in shares of companies within the limits specified in Section 186. d. Entering into contracts with persons who are directors of the company or related to or associated with the directors as are specified in Section 188 of the Act.

(109) How will an auditor examine the following documents? ► Memorandum of Association: It is a charter containing particulars of business activities that the company can undertake and the powers it can exercise. On examining MOA auditor will be able to determine whether a transaction entered into by company is intra vires. If a company enters into ultra vires transaction, shareholders, though entitled to claim profit arising on such a transaction, may restrain management from charging loss. If auditor fails to detect and report ultra vires transactions, he would be guilty of negligence.

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► Articles of Association: These are rules and regulations for internal management of company. Auditor should, therefore, study Articles and include extracts from them in his permanent audit file. Auditor, who fails to take note of provisions in Articles in verification of statements of accounts, would be guilty of professional negligence. He must acquaint himself with provision of Articles and should apply this knowledge in verification of transactions of company. ► Prospectus: It is a formal document which a public company must issue before it makes allotment of shares. It must contain all the terms and conditions on which subscription to shares is sought to be obtained from public. In case the company fails to carry out any of these undertakings or if any statement made by it ultimately is proven to be false, the shareholder has the option to claim refund of the amount paid by him. So, auditor should study carefully all stipulations made in the prospectus and, in case any of them has not been carried out, to draw the attention of shareholders thereto. Right to claim refund is restricted to such shareholders who subscribed for shares on the basis of prospectus.

(110) How will an auditor audit Share Capital? Audit of share capital is necessary both on incorporation and afterwards whenever the directors decide to increase subscribed share capital. Auditor may follow following procedure: a. Authorised capital: may be verified with reference to amount shown in the Memorandum of Associations. Previous year audited balance sheet may also be seen. b. Issued & subscribed capital: may be verified with reference to last year audited balance sheet. c. Further issue of capital: The general points are given as under 1. Study conditions of issue from MOA, AOA, Prospectus etc. and see that all of them have fully been complied with. 2. Verify that first allotment was made on receiving amount of minimum subscription stated in Prospectus and until then amount received was deposited in a Scheduled bank as required by Section 39. 3. Confirm that brokerage and underwriting commission was paid only at the rates authorised by Prospectus or AOA, having regard to the provisions contained in Section 40. 4. Ensure that legal requirements u/s 62 (dealing with right shares) have been complied with. 5. Verify that preliminary contracts, if any, entered into for purchase of a property, etc. have been carried out strictly as per terms stated in Prospectus. 6. Ensure that company intending to offer shares to public by issue of Prospectus has, before such issue, made an application to one or more recognised stock exchanges for permission to offer shares through each stock exchange. 7. Confirm that guidelines issued by SEBI have been followed. 8. Ascertain that there exists an internal check on receipt of money. 9. Verify compliance with legal provision relating to issue of shares at premium (section 52), issue of shares at discount (section 53) and issue of sweat equity shares (section 54) A. SHARES ISSUED FOR CASH 1. Applications: It can be verified in the following manner : a. Check entries in Application and Allotment Book with the srcinal applications. b. Trace entries for money received in Application & Allotment Book and Cash Book. c. Vouch amounts refunded to the unsuccessful applicants with copies of Letters of Regret.

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d. Check totals in Application & Allotment Book and confirm the journal entry debiting Share Application Account and crediting Share Capital Account. e. Examine underwriting contract to ensure that all obligations have been fully satisfied. f. Vouch payment of commission and brokerage. 2. Allotment a. Examine Director’s Minutes Book to verify approval of allotments. b. Ascertain that nominal value of shares allotted does not exceed authorized and issued capital and allotments were made as per the conditions contained in the Prospectus. c. Compare copies of letters of allotment with entries in Application and Allotment Book. d. Trace entries for amounts collected in Cash book and Application and Allotment Book. e. Trace amount collected on application & allotment into Share Register. f. Check the arithmetical accuracy and accounting entry for allotment of shares. g. See the returns of allotment have been filed with the Registrar of Companies. h. Check that amount payable on application on every security is not less than 5% of the nominal amount of security or such other percentage or amount as may be prescribed by SEBI. i. If the stated minimum amount has not been subscribed and sum payable on subscription is not received within a period of 30 days from date of issue of prospectus or such period as my be specified by SEBI, check that the amount received above is returned within a period of 15 days from closure of issue and in case of default to repay, directors in default shall jointly and severally be liable to repay that amount with interest at the rate of 15% p.a. j. See that company has delivered share certificates within 3 months after allotment of any of its shares in accordance with the procedure laid down u/s 53. k. Signatories to MOA being the first shareholder, it is usual to make allotment in their favour. 3. Calls a. Examine the Director’s resolution for making the call. b. c. d. e. f.

Vouch amounts received with counterfoils of receipts. Trace amounts received from Calls Book and Cash Book into the Share Register. Verify the accounting entry for calls due and money received. Note the calls in arrears. Extract balances of shareholders’ accounts contained in Share Register and tally their total with balance in Share Capital Account.

B. SHARES ISSUED FOR CONSIDERATION OTHER THAN CASH :  Refer the contract on the basis of which shares have been allotted  Confirm the allotment by reference to Minutes of the Board of Directors.  Verify that a copy of contract has been filed with ROC within 1 month of the date of allotment.  Ensure that appropriate accounting entry has been passed.  See if it is separately disclosed in the Balance Sheet.  If allotment is made in adjustment of a bonafide debt payable in money at once, allotment should

be considered as against cash. C. SHARES ISSUED AT A PREMIUM (Section 52):  Sum equal to amount of premium collected should be transferred to Securities Premium A/c.  Securities premium account may be applied only for the following purposes:

-

issue of fully paid bonus shares writing off preliminary expenses of the company writing off any expenses relating to issue of shares or debentures of the company

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-

paying premium on redemption of any= redeemable preference shares or debentures for the purchase of its own shares or other securities under section 68.  See that appropriate disclosures have been made in the Balance Sheet. D. SHARES ISSUED AT A DISCOUNT (Section 53) :  As per section 53 a company cannot issue shares at discount, except in case of issue of sweat equity

shares given under section 54.  Any share issued by a company at a discounted price shall be void.  If a company contravenes the provisions of this section, it shall be punishable with fine ranging

from 1 lakh to 5 lakh rupees and every officer in default shall be punishable with imprisonment for a term extending to 6 months or with fine ranging from 1 lakh to 5 lakh rupees, or with both. E. ISSUE OF SWEAT EQUITY SHARES (Section 54): “Sweat Equity Shares” means equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing know-how or making available right in the nature of intellectual property rights or value additions, by whatever name called.  Auditor should see that sweat equity shares issued are of a class of shares already issued.  Issue of sweat equity shares should be authorised by a special resolution in general meeting.  Resolution should specify the number of shares, current market price, consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued.  Check that at the date of issue at least 1 year has elapsed since the date on which the company was entitled to commence business.  Sweat equity shares of a company whose equity shares are listed on a recognized stock exchange are issued as per the regulations of SEBI in this behalf. However, if equity shares of a company are not listed, issue will be in accordance with guidelines as may be prescribed. F. CALLS PAID IN ADVANCE:  Auditor should study AOA to ascertain the powers of company to accept from members the amount

remaining unpaid on any shares held by him as calls in advance.  Amount so received cannot be treated as a part of capital for the purpose of any voting rights.  A company, if so authorised by its Articles, may pay dividend in proportion to amount paid upon

each share, where a larger amount is paid up on some shares than that on other.  Unless the company decides to pay dividend, the shareholders who have paid calls in advance

would be entitled to receive interest at the rate specified in the Articles.  Interest can also be paid out of capital when profits are not available for such a payment.  In the event of winding up, calls in advance is paid with interest accrued thereon before any part of

capital is returned to shareholders. G. CALLS IN ARREARS:  Amount due from shareholders for calls in arrears should be verified by reference to Share register.  If any calls are due from Directors, they should be shown separately in the balance sheet.  If AOA provides to charge interest on calls in arrears then interest in such a case should be verified.

(111) What are the provisions regarding buy back of shares?

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1. As per section 68 (1) a company may buy-back its own shares and other specified securities out of: a. its free reserves; or b. the securities premium account; or c. the proceeds of the issue of any shares or other specified securities. (No buy-back shall be made out of the proceeds of an earlier issue of same kind of shares or securities.) 2. Section 68(2) states that no company shall purchase its own shares or securities unless: a. the buy-back is authorised by its articles; b. a special resolution has been passed in general meeting authorising the buy-back; However, in case buy back is upto 10% of paid up equity + free reserves, it may be done only with authorization of Board Resolution. c. buy-back is not more than 25% of total paid-up capital and free reserves of the company: d. ratio of debt owed by company after such buyback is not more than twice the total of its paid up capital and its free reserves: e. all the shares or other specified securities for buy-back are fully paid-up; f. buy-back of shares or securities listed on any recognised stock exchange is as per the regulations of SEBI in this behalf; 3. There cannot be more than one buy back in one year. 4. Every buy-back shall be completed within 12 months from date of passing special resolution, or resolution passed by board of directors. 5. Notice of meeting at which special resolution is proposed to be passed shall contain full details of the buyback. 6. The buy-back may be: a. from existing security holders on a proportionate basis; or b. from open market; or c. by purchasing securities issued to employees under scheme of stock option or sweat equity. 7. Company shall, before making buy-back, file with Registrar and SEBI a declaration of solvency stating that it is capable of meeting its liabilities and will not be rendered insolvent within a period of 1 year of the date of declaration. 8. Company shall physically destroy securities bought-back within 7 days of last date of completion of buy-back. 9. Company shall not make further issue of same kind of shares within a period of 6 months except by way of bonus issue or in discharge of subsisting obligations. 10. If company purchases its own shares out of free reserves or securities premium account, a sum equal to nominal value of shares so purchased shall be transferred to Capital Redemption Reserve Account and details of such account shall be disclosed in Balance Sheet. 11. CRR A/c may be applied by company in issue of bonus shares to members. 12. After buyback the company shall maintain a register of securities so bought, consideration paid for them, date of cancellation of securities, date of physically destroying of securities and such other particulars as may be prescribed. 13. After buyback the company shall, file with Registrar and SEBI (for listed companies), a return containing such particulars relating to buy-back within 30 days of such completion, 14. Auditor should ensure that proper accounting entries have been passed immediately after buyback. ► Prohibition for buy back in certain circumstances: As per provisions of Section 70: 1. No company shall directly or indirectly purchase its own shares or other specified securities: a. through any subsidiary company including its own subsidiary companies; or

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b. through any investment company or group of investment companies; or c. if a default, by the company, in repayment of deposit or interest payable thereon, redemption of debentures or preference shares or payment of dividend to any shareholder or repayment of any term loan or interest payable thereon to any financial institutions or bank, is subsisting. Provided that the buy – back is not prohibited if the default is remedied and a period of three years has elapsed since the cessation of the default. 2. No company shall directly or indirectly purchase its own shares or other specified securities in case such company has not complied with provisions of Sections 92,123, 127 and 129. Section 92 relates to the filing of Annual Return, Section 123 and 127 to declaration and payment of dividend and Section 129 to the financial statement of the company.

(112) What are the provisions regarding Issue & Redemption of preference shares? ► Issue of Preference shares: 1. The explanatory statement annexed to notice of general meeting pursuant to section 102 shall, provide complete details of issue of preference shares. 2. Register of Members shall contain particulars in respect of such preference share holder(s). 3. A company intending to list its preference shares on a recognized stock exchange shall issue such shares as per the regulations made by SEBI. 4. A company may issue preference shares for a period exceeding 20 years for infrastructure projects, subject to the redemption of such percentage of shares as may be prescribed on an annual basis at the option of such preferential shareholders. ► Redemption of Preference Shares: 1. Preference shares may be redeemed:a. at a fixed time or on the happening of a particular event; b. any time at the company’s option; or c. any time at the shareholder’s option. 2. They shall be redeemed out of profits which are available for dividend or out of proceeds of a fresh issue of shares made for the purposes of such redemption; 3. Such shares shall be fully paid; 4. Where such shares are redeemed out of profits, a sum equal to nominal amount of shares to be redeemed shall be transferred to Capital Redemption Reserve Account. 5. Premium payable on redemption shall be provided for out of profits. 6. Where a company is not able to redeem any preference shares or to pay dividend on such th shares, it may, with consent of holders of 3/4 in value of such preference shares and with approval of Tribunal on a petition made by it, issue further redeemable preference shares equal to amount due including dividend and on issue of such further redeemable preference shares, unredeemed preference shares shall be deemed to have been redeemed. Such issue shall not be deemed to be an increase or reduction in share capital.

(113) How will an auditor audit Alteration of Share Capital?  Alteration As per section 61 a limited company having share capital may, if authorised by its AOA,

alter its capital part of the memorandum in its general meeting.

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 Within 30 days of the shares having been consolidated, converted, sub-divided, redeemed, or

cancelled or the stock having been reconverted, notice should be given to Registrar along with an altered memorandum [Section 64].  The auditor’s duties in the circumstances shall be: a. to verify that the alteration of capital is authorised by the Articles b. to inspect the minutes of the shareholdersauthorising the alteration c. to obtain Allotment Lists containing details of new holdings by each member and verify it with the entries d. to inspect the directors’ resolution in regard to allotment, consolidation, conversion or subdivision passed pursuant to the resolution of the members e. to see that the procedure, prescribed by the Articles in this regard, has been complied with f. to verify that the share capital account is correctly shown in the Balance Sheet g. to see that the necessary intimation to Registrar has been sent. ► REDUCTION OF CAPITAL (SECTION 66) (this section is not yet notified) The duties of the auditor in this regard are following: a. Check if special resolution was duly passed. b. Confirm that the AOA authorise reduction of capital. c. Examine the order of Tribunal confirming reduction. d. See that a copy of order and minutes have been registered and filed with ROC. e. Inspect the Registrar’s Certificateas regards reduction of capital. f. Vouch the journal entries recorded to reduce capital and to write down assets. g. Confirm that revaluation of assets have been properly disclosed in the Balance Sheet. h. Verify the adjustment made in members’ accounts in Register of Members. i. Confirm that the words “and reduced”, if required by order of Tribunal, have been added to the name of the company in the Balance Sheet. j. Verify that the MOA of the company has been suitably altered.

(114) How will an auditor verify Forfeiture of shares? ► Verification of Forfeiture of Shares: 1. Ascertain that Articles authorise BODs to forfeit shares and the power has been exercised by Board in the best interest of the company. 2. Verify amount of calls which was outstanding for each forfeited share. 3. Ascertain that procedure as given in Articles has been followed. 4. See that proper resolution is passed by Directors for issue of notice & forfeiture of shares. 5. Verify accounting entries and confirm that premium, if any, received on issue of shares has not been transferred to Forfeited Shares Account. 6. See that appropriate entries have been made in the Members Register.

(115) What do you mean by option on share capital? An option on shares arises when a person has acquired a right under an agreement with the company to subscribe for share in the company if he so chooses. Such options generally arise under the following circumstances: a. Under the promoter’s agreements, subsequently ratified by the company; b. Collaboration agreement; c. Loan agreements, debenture deeds; d. Agreements to convert preference shares into equity shares; and e. Other contracts, such as for supply of capital goods and/or merchandise. Schedule III, Part I, requires disclosure of particulars of any option on unissued share capital.

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(116) How will an auditor verify issue of bonus shares? A company may issue fully paid-up bonus shares to its members out of its free reserves, securities premium account or capital redemption reserve account. No issue of bonus shares shall be made out of reserves created by revaluation of assets. Auditor should ensure compliance of following conditions for issuing fully paid-up bonus shares like: 1. it is authorised by AOA; 2. it has been recommended by Board and then authorised in general meeting of company; 3. company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it; 4. company has not defaulted in payment of statutory dues of employees like PF, gratuity and bonus; 5. partly paid-up shares, if any outstanding on the date of allotment, are made fully paid-up; 6. company which has once announced the decision of its Board recommending a bonus issue, shall not subsequently withdraw the same. 7. bonus shares shall not be issued in lieu of dividend.

(117) How will an auditor perform Audit of Debentures? 1. Prepare a schedule of debenture holders with reference to Register of debenture holders. 2. Ascertain borrowing powers & limitations from Memorandum and Articles of company. 3. Inspect a copy of debenture bonds to ascertain terms of repayment and particulars of assets charged as security for repayment. 4. Confirm that necessary information has been duly communicated to the ROC, like particulars of charges created over assets of the company, etc. 5. Company should make an application to one or more recognised stock exchanges for permission to offer debentures through stock exchange. 6. Appropriate disclosures should be made as required by law. 7. Debenture Trust Deed: Section 71 has now made it compulsory for filing of Debenture Trust Deed and creation of Debenture Redemption Reserve. It is specified that Debenture Trust Deed shall be open for inspection and can be made available on payment. Section 71 has also made it compulsory appointment of debenture trustees and specified their duties. 8. Debenture Redemption Reserve Account: When debentures are issued, company shall create a debenture redemption reserve a/c by observing following conditions: a. Debenture Redemption Reserve shall be created out of profits available for payment of dividend; b. company shall create DRR equivalent to notified rate i.e at least 25% of the amount raised through debenture issue before debenture redemption commences. c. every company required to create DRR shall on or before 30th day of April in each year, invest or deposit, a sum which shall not be less than 15%, of the amount of its debentures maturing during the year ending on 31st March of next year, in any specified method; d. in case of partly convertible debentures, DRR shall be created for non-convertible portion; e. amount credited to DRR shall not be utilised except for purpose of redemption of debentures. ► Allotment of Debentures:Normally the auditor should take following steps for such verification: 1. Verify that Prospectus had been duly filed with Registrar before the date of allotment. 2. Verify that allotment was made as per the terms and conditions contained in prospectus. 3. Check Application and Allotment Book to verify that name, address of the applicants and number of debentures applied for are correctly recorded. 4. Verify the allotment of debentures by reference to the Directors’ Minute Book.

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5. Vouch the amounts collected as entered in Cash Book and Application & Allotment Book. 6. Check postings from Application and Allotment Book into the Debentures Register. 7. Examine a copy of Debenture Trust Deed and note conditions for creation of DRR. 8. Ensure that the charge, if any, is clearly disclosed in the Balance Sheet. 9. Compliance with SEBI Guidelines should also be seen. 10. Confirm the compliance of terms and conditions for issuance of Secured debentures. 11. Where debentures have been issued as fully paid up to vendors as part of purchase consideration, the contract in this regard should be referred to. 12. Issue of debentures with an option to convert them into shares at time of redemption, should be approved by a special resolution passed at a general meeting. 13. No company shall issue any debentures carrying any voting rights. ► INTEREST ON DEBENTURES 1. Interest paid should be vouched with acknowledgment of debenture holders. 2. Total amount paid should be reconciled with total amount due and payable and the amount of interest outstanding for payment. 3. A provision must be made for interest payable unless the debenture holders have agreed that in case of loss interest would be waived by them. 4. It must be disclosed as a separate item in the Profit and Loss Account.

(118) What are the provisions regarding issue of secured debentures? 1. An issue of secured debentures may be made, provided the date of its redemption shall not exceed 10 years from the date of issue. A company engaged in setting up of infrastructure projects may issue secured debentures for a period exceeding 10 years but not exceeding 30 years; 2. such an issue of debentures shall be secured by creation of a charge, on properties of the company, having a value which is sufficient for due repayment of amount of debentures and interest thereon; 3. the company shall appoint a debenture trustee before issue of prospectus and not later than 60 days after allotment of debentures and execute a debenture trust deed; 4. the security for debentures by way of a charge or mortgage shall be created in favour of the debenture trustee.

(119) How will an auditor perform Audit of Dividends? ► 1. 2. 3. 4. 5.

VERIFICATION OF DIVIDENDS: Examine MOA and AOA to ascertain dividend rights of different classes of shares. Confirm that profits appropriated for payment of dividend are distributable profits. Inspect the shareholders’ Minute Book to verify amount of dividend declared. Confirm that the amount of dividend is recommended by directors. If a separate bank account was opened for payment of dividends, check the transfer of the total amount of dividends payable from the Dividends Accounts. 6. Check particulars of members entered in Dividend Register by reference to Register of Members, test check calculation of gross amount of dividend payable to each shareholder on the basis of the number of shares held and amount of CDT, if applicable. 7. Check the amount of dividend paid with the dividend warrants surrendered.

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8. Ensure that as per section 123, total amount of dividend which remains unpaid or unclaimed has been transferred, within 30 days of declaration of dividend to a special bank account entitled “Unpaid Dividend Account of .... Company Limited/Company (Pvt.) Limited”. Such an account is to be opened only in a scheduled bank. Transfer must be made within 7 days from date of expiry of 30 days. 9. Any money remaining unpaid for 7 years from the date of transfer to bank account shall be transferred to Investor Education and Protection Fund established u/s 125. 10. Ensure the compliance, if dividend is paid in case of inadequate profits. 11. Board may declare interim dividend and amount of dividend including interim dividend shall be deposited in a separate bank account within 5 days from date of declaration of such dividend. 12. The provisions contained in sections 123, 124, 125, 126 and 127 shall, as far as may be, also apply to any interim dividend.

Practical Questions - Chapter 8: Company Audit – II Q1. State your comments on the following: (a) A portion of share premium utilized to declare 40% dividend. (b) Directors of Speedway Ltd. declared a final dividend of 30% for 2002-03 in their meeting held on 11.8.2003. Q2. What will be position of the Auditor in the following cases? (a) Y is the auditor of X Ltd. in which there are four shareholders only, who are also the directors of the Co. On account of bad trade and for reducing the expenses in all directions,

the directors asked Y to accept a reduced fee and for that he has been offered not to carry out such full audit as he has done in the past. Y accepted the suggestions of the directors. Q3. Interest on share capital was paid to shareholders as the company had a long gestation period before it could become operational. Comment.

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STA TI STI CS OF TH E CH APTE R

Tentative Weightage of Chapter: 10 to20 Marks

I MPORTANCE OF TH E CH APTE R

The Chapter covers the audits of miscellaneous organizations having different legal forms.

COVER AGE OF THE CHAPT ER

(1) (2) (3) (4) (5) (6) (7) (8)

Government Audit Audit of Local Bodies Audit of NGOs Audit of Partnership F irm Compilation Engagement Audit of Chari table I nstitutions Audit of Educational I nstitutions Audit of Hi re Purchase & Leasing Companies

(120) What do you mean by Government Audit? Who conducts Government Audit? ► Government auditing is: - the objective, systematic, professional and independent examination of

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financial, administrative and other operations of a public entity for the purpose of evaluating and verifying them, presenting a report on audit findings along with recommendations for future actions and expressing opinion on fairness of the financial statements. ► It aims to ensure accountability of the executive in respect of public revenue and expenditure ► In India government audit is performed by the Comptroller and Auditor General through the agency of Indian Audit and Accounts Department. C&AG watch that in regard to financial matters various authorities act in accordance with Constitution and laws made by Parliament.

(121) What is the legal framework regarding Comptroller & Auditor General? ► Appointment: He shall be appointed by the President of India. ► Salary: He shall be paid salary equivalent to that of a Judge of Supreme Court. The Parliament can make laws to determine salary and other conditions of service. ► Tenure: He shall hold office for 6 years or up to the age of 65 years, whichever is earlier. ► Removal: He shall not be removed from office except on the ground of proven misbehavior or incapacity. He can be removed only when each House of Parliament decides to do so by a majority of not less than 2/3rd of the members of the House present and voting. ► Resignation: He can resign at any time through a resignation letter addressed to the President.

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► Powers & duties: C & AG shall perform such duties and exercise such powers as may be prescribed by the Parliament. The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 defines these functions and powers in detail. ► Accounts: Article 150 of the Constitution provides that accounts of the Union/States shall be kept in such form as the President may on the advice of C & AG prescribed. ► Reports: Reports of C & AG relating to accounts of the Union/State /Union Territory having legislative assembly shall be submitted to the President/Governor/ Administrator who shall cause them to be laid before House of Parliament/State Legislature/Legislative Assembly.

(122) What are the duties and powers of Comptroller and Auditor General? The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 defines functions and powers in detail. The relevant provisions are discussed hereunder: — DUTIES OF THE C & AG : 1. Compile and submit Accounts of Union and States : CAG shall be responsible for compiling accounts of the Union/State/Union Territory having a Legislative Assembly, and shall submit those accounts to President/Governor of State/Administrator of the Union Territory, on or before such dates as he may determine with concurrence of the Government concerned. 2. Audit of Receipts and Expenditure: He shall audit all receipts and expenditure of any body which has been substantially financed by grants or loans from Consolidated Fund of India/State/Union Territory. A body/authority shall be deemed to be substantially financed if: - such grant/loan in a FY is not less than Rs. 25 lakhs, and - amount of such grant/loan is not less than 75% of total expenditure of that authority/body. 3. Audit of Grants or Loans : Where any grant/loan is given for any specific purpose from the Consolidated Fund of India/any State/any Union Territory to any authority/body other than a foreign State or international organisation, he shall scrutinise the procedures by which the sanctioning authority satisfies itself as to the fulfillment of conditions for giving such grants or loans and may access books & accounts of that authority/body, after giving reasonable previous notice. 4. Audit of Receipts of Union or States : He shall audit all receipts payable into the Consolidated Fund of India/each State/each Union Territory and ensure existence of an effective check on assessment, collection and proper allocation of revenue. 5. Audit of Accounts of Stores and Stock: He shall audit and report on the accounts of stores and stock kept in any office or department of the Union or of a State. 6. Audit of Government Companies and Corporations : Duties and powers of CAG in relation to the audit of government companies & corporations shall be performed and exercised by him in

with the provisions the Companies 7. accordance General Provisions Relating toofAudit : It shall beAct, the 1956. duty of the CAG to audit and report: — a. on all expenditure from the Consolidated Fund of India/each State/each Union Territory and to ascertain whether sum disbursed was appropriately applied for the designated purpose and whether expenditure conforms to the authority which governs it; b. all transactions of the Union/States relating to Contingency Funds and Public Accounts; c. on all trading, manufacturing P&L A/c, B/S and other subsidiary accounts kept in any department of the Union or of a State.

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POWERS OF C & AG 1. Inspect any office of accounts under the control of the Union or State Government. 2. Require that any accounts, books, papers and other documents relevant to the transactions under audit, be sent to specified places. 3. Ask such questions or make such observations as he may consider necessary to the person in charge of the office. 4. Call for such information as he may require for the preparation of any account or report. 5. Some powers are granted u/s 619(3) of The Companies Act, 1956.

(123) How does an auditor audit Government Expenditure? Audit of government expenditure is one of the major components of government audit. It involves the following: 1. AUDIT AGAINST RULES & ORDERS / REGULARITY AUDIT: It aims to ensure that the expenditure conforms to the relevant provisions of the Constitution, laws and rules made there under and is as per the financial rules, regulations and orders issued by a competent authority. ► It involves interpretation of the Constitution, statutes, rules, regulations and orders. ► These rules, regulations and orders are mainly made in relation to the following: a. Powers to incur and sanction expenditure from Consolidated Fund/Contingency Fund of India or of a State. b. The mode of presentation of claims against government; c. withdrawing moneys from the Consolidated Fund, Contingency Fund & Public Accounts of Government of India/States. d. The conditions of service, pay and allowances, and pensions of government servants. ► Auditor should see that the rules, regulations and orders issued by executive authorities are applied properly by the subordinate authorities and see that: - are consistent with the provisions of Constitution or any laws made there under. - are consistent with essential requirements of audit & accounts as determined by C & AG. - are not in conflict with the orders or rules made by any higher authority. - have been approved by the competent authority or an authorized person. 2. AUDIT OF SANCTIONS: It aims at ensuring that: ► the expenditure is properly covered by a sanction, either general or special ► the authority sanctioning it is competent for the purpose by virtue of - powers vested in it by provisions of Constitution and law, rules/ orders made thereto, or - by the rules of delegation of financial powers. 3. AUDIT AGAINST PROVISION OF FUNDS : It aims at ascertaining that: - the expenditure is incurred on the purpose for which grant/appropriation had been provided

- the amount of such expenditure does not exceed the appropriation made. 4. PROPRIETY AUDIT: While conducting propriety audit, auditors identify cases of improper or avoidable expenditure even though the expenditure has been incurred in conformity with the existing rules and regulations. ► A transaction may satisfy all the requirements of regularity audit insofar as the various formalities regarding rules and regulations are concerned, but may still be highly wasteful. ► For e.g., a school building may be constructed but used after 5 years of its completion a case of avoidable expenditure. ► Propriety audit seeks to ensure that expenditure conforms to the following principles: CA. Poonam Madaan

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a. The expenditure should not be prima facie more than the occasion demands. b. Every public officer should exercise the same vigilance for incurring expenditure from public moneys as a person of ordinary prudence would exercise for spending his own money. c. No authority should sanction expenditure, directly/indirectly to its own advantage. d. Public moneys is not utilised for the benefit of a particular person/section of community. ► It is the responsibility of executive departments to enforce economy in public expenditure and auditor is only required to bring to the notice of the proper authorities of wastefulness in public administration and cases of improper, avoidable & infructuous expenditure. 5. PERFORMANCE AUDIT: Performance audit involves 3E’s efficiency, economy and effectiveness audit. It is an objective examination of financial and operational performance oriented towards identifying opportunities for greater economy, and effectiveness. ► Efficiency audit aims at examining relationship between goods & services produced and resources used to produce them. Thus, it looks into whether:

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various schemes/projects are executed their operations are conducted in a way to yield the expected results. ► Economy audit looks into whether:

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government has acquired all resources in an economical manner, and the sanctioning and spending authorities have observed economy. ► Effectiveness audit is an appraisal of - the performance of programmes, schemes & projects, and - the achievement of overall targeted objectives.

(124) How does an auditor audit Government Receipts? While auditing government receipts the auditor checks whether: a. All revenues have been correctly assessed and credited to government account. b. Adequate regulations have been framed & carried on to secure an effective check on assessment, collection and proper allocation of cases. c. Adequate checks exist for prompt detection & investigation of irregularities, double refunds, fraudulent refund and other modes of leakages of revenue. d. Internal procedures ensure correct and regular accounting of demands collection, refunds & other dues and to suggest improvement.

(125) How does a Government auditor perform audit of stores & stocks? ► Audit of the accounts of stores and stocks involves : - Ascertaining whether Regulations governing purchase, receipt, issue, custody, sale and stock taking of stores are well devised & properly carried out. - Bringing to the notice of government any deficiencies in quantities of stores held or any defects in the system of control. ► Audit of purchase of stores is conducted to ensure that:

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these are properly sanctioned, made economical and as per the Rules laid down the prices paid are reasonable and as per the contract for supply of stores the certificates of quality and quantity are furnished by the inspecting and receiving units.

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► Cases of uneconomical purchase and losses due to inferior quality are specifically examined. ► Any excess or idle stock is specifically mentioned in the report. ► Periodical verification of stock is conducted to ensure their existence. ► Valuation of stocks is examined.

(126) What do you mean by audit of Commercial Accounts w.r.t. to Government Audit? ► Government may carry out commercial activities and be required to maintain commercial accounts for such public enterprises. Such enterprises are generally classified as follows: a. departmental enterprises engaged in commercial and trading operations, which are subject to the same laws, financial and other regulations as other government departments and agencies; b. statutory bodies, corporations, created by specific statutes mostly financed by government in the form of loans, grants, etc. and c. government companies set up under the Companies Act, 1956. ► The audit of departmental concerns is undertaken in the same manner as any department of government where commercial accounts are kept. ► Audit of statutory bodies or corporations depends on the nature and type of the statute governing the bodies or corporations. Its audit is conducted by the C&AG. ► In the case of a government company, audit is conducted by professional auditors appointed on the advice of the C&AG and the C&AG is authorized u/s 619(4) of the Companies Act, 1956 to conduct supplementary or test audit.

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The C&A G shall have following powers u/s 619(3): a. to direct the manner in which company’s accounts shall be audited and to give such auditor instructions in regard to any matter relating to the performance of his functions. b. to conduct a supplementary or test audit of the company’s accounts by such person or persons as he may authorise in this behalf. c. to require information or additional information to be furnished to person conducting supplementary audit, on such matters and in such form, as C&A G may direct.

Auditor aforesaid shall submit a copy of his audit report to the C&A G who shall have the right to comment upon or supplement, the audit report in such manner as he may think fit.

(127) What do you mean by Local bodies? ► A municipality can be defined as a unit of local self-government in an urban area. ► Local self-government refers to:  administration of a locality, a village, a town, a city or any other area smaller than a state  by a body representing the local inhabitants, possessing fairly large autonomy,  raising at least a part of its revenue through local taxation and  spending its income on services regarded as local and distinct from state & central services. ► Municipal government in India covers 5 distinct types of urban local authorities, viz., the municipal corporations, the municipal councils, the notified area committees, the town area committees and the cantonment committees. ► Municipal authorities are endowed with specific local functions covering regulatory, maintenance and development activities.

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► Expenditure incurred by the municipalities and corporations can be broadly classified as general administration and revenue collection, public health, public safety, education, public works, and others such as interest payments, etc. ► Property taxes and octroi are the major sources of income of the municipal authorities; other municipal taxes are profession tax, tax on advertisement, tolls, etc. ► Local bodies may receive different types of grants from state administration as well. Broadly, the revenue grants are of three categories: a. General purpose grants: These are primarily intended to substantially bridge the gap between the needs and resources of the local bodies. b. Specific purpose grants: These grants which are tied to the provision of certain services or performance of certain tasks. c. Statutory and compensatory grants: These grants are given to local bodies as compensation on account of loss of any revenue on taking over a tax by state govt. from local govt. ► Accounting System: Municipal accounting system is usually kept as per the cash basis.

(128) How will an auditor perform audit of Local bodies? ► The important objectives of audit are: a. reporting on the fairness of the content and presentation of financial statements b. reporting upon the strengths and weaknesses of systems of financial control c. reporting on the adherence to legal and/or administrative requirements d. reporting upon whether value is being fully received on money spent e. detection and prevention of error, fraud and misuse of resources. ► Auditor should obtain an understanding of the financial administration of the body including the knowledge of budgets, accounting systems and internal controls. ► He should vouch the income and expenditure in the usual manner. ► He should examine transactions which are ultra vires and beyond legal authority of local body.

(129) What do you mean by Non-Governmental Organisations (NGO’s)? ► MEANING: NGOs can be defined as - non-profit making organisations - which raise funds from members, donors or contributors - also receive donation of time, energy and skills - for achieving their social objectives like imparting education, providing medical facilities, economic assistance to poor, managing disasters and emergent situations. ► EXAMPLES: Some examples of NGOs operating in India include Child Relief and You (CRY), UNICEF, Godhuli, Vidya, Concern India Foundation., etc. ► LEGAL FORM: NGO’s can be incorporated in either of the following ways: - societies under the Societies Registration Act, 1860 - a trust under the India Trust Act, 1882 - a company u/s 25 of the Companies Act, 1956. ► SOURCES OF FUNDS: The main sources of funds include grants and donations, fund raising programmes, advertisements, fees from the members, fee for services rendered, subscriptions, gifts, sale of produce or publications, etc.

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Contribution made towards the capital/corpus of an NGO is known as corpus contribution. Donations and grants may also be received for acquisition of specific fixed assets. Contributions may also be received in kind including assets e.g. land and articles related to programmes/projects e.g. food, books, and raw material for training purposes, e.g. Wool. ► APPLICATION OF FUNDS: The areas of application of funds for an NGO include Establishment Costs, Office and Administrative Expenses, Maintenance Expenses, Programme / Project Expenses, Charity, Donations and Contributions given, etc.

(130) How will an auditor perform audit of Non-Governmental Organisations? 1. PRELIMINARY WORK: While planning audit, the auditor may concentrate on the following: a. Knowledge of NGO’s work, mission, vision and areas of operations. b. Updating knowledge of relevant statutes. c. Reviewing legal form of Organisation, its MOA, AOA, Rules and Regulations. d. Reviewing NGO’s Organisation chart, Manuals, Project and Programme Guidelines, Funding Agencies Requirements and formats, budgetary policies if any. e. Examination of minutes of Board/Managing Committee/Governing Body/Management, etc. f. Study the accounting system, internal controls and checks and verify their applicability. g. Review the previous year’s Audit Report. 2. AUDIT OF RECEIPTS: Income of NGO may be checked on the following lines: : Check agreements with donors and a. Contributions and Grants for projects & programmes grants letters to ensure that funds received have been accounted for. Check that all foreign contribution receipts are deposited in the foreign contribution bank account. b. Receipts from fund raising programmes : Verify in detail the internal control system and ascertain the persons responsible for collection of funds and mode of receipt. Ensure that collections are counted and deposited in the bank daily. c. Membership Fees: Check fees received with Membership Register. Reconcile fees received with fees to be received during the year. Ensure proper classification is made between entrance fees, annual fees and life membership fees. d. Subscriptions: Check with subscription register and receipts issued. Check the receipts with subscription rate schedule. e. Interest and Dividends: Check interest and dividends received and receivable with investments held during the year. 3. AUDIT OF EXPENDITURE: a. Programme & Project Expenses: Verify agreement with donor/contributor(s) for particular programme / project and for contracts ensure that income tax is deducted, deposited and returns

filed and verify the terms of the contract. b. Establishment Expenses: Verify that PF, life insurance premium, ESI and other administrative charges are properly accounted for and deposited within prescribed time. Also check other office & administrative expenses such as postage, stationery, etc. 4. AUDIT OF BALANCE SHEET ITEMS: a. Corpus Fund: Vouch with reference to the letters from the donor(s). The interest income be checked with Investment Register and Physical Investments in hand. b. Reserves: Vouch with reference to donor’s letters and board resolutions. Also check transfers from capital reserve to general reserve and adjustments during the year.

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c. Loans: Vouch loans with loan agreements, receipt counter-foil issued. d. Fixed Assets: Vouch all acquisitions, sale or disposal of assets including depreciation in the usual way. Also check donor’s letters/agreements for the grant. e. Investments: Check Investment Register and physically verify investments to ensure that investments are in the name of NGO. Verify approval by appropriate authority and refer to bank accounts for the principal amount and interest. f. Cash in Hand: Physically verify the cash in hand and imprest balances. g. Bank Balance: Check bank reconciliation statements and ascertain old outstanding. h. Stock in Hand: Obtain certificate from management for quantities & valuation of the same.

(131) How will an auditor perform audit of a Firm? ► APPOINTMENT OF AUDITOR: The auditor is appointed by the partners and his remuneration is also fixed by them. The letter of appointment should clearly state the nature and scope of audit to be carried out and limitations, if any, under which he would have to function. ► The Indian Partnership Act, 1932 does not prescribe audit of a partnership firm. The auditor should have knowledge of the provisions of the Partnership Act. ► Before starting audit, he should examine partnership agreement and note the provisions as regards the following matters : a. The duration of the partnership, if any, that has been agreed upon. b. The amount of capital to be contributed by each partner, whether it will be fixed or not. c. Accounting period and ratio for sharing profit/losses among partners. d. Provisions for maintenance of books of account and basis of calculation of profits for division among partners e.g., creation of reserves, provision for depreciation, etc. e. Borrowing capacity of the partnership. f. The rate at which interest will be allowed on capital and loans provided by partners and the rate at which it will be charged on their drawings and current accounts. g. Provisions relating to salaries or withdrawals. h. Provisions regarding operation of bank account of the firm & investment of surplus funds. ► In the absence of a partnership agreement the auditor should refer to the provisions of the Partnership Act. ► Matters which should be specially considered in the audit of accounts of a partnership: - Confirming that appointment letter is signed by a partner duly authorized and clearly specifies the nature and scope of audit and limitation, if any. - Studying the Minute Book and examining matters which are not in routine nature. - Verifying that the business carried on is authorized by the partnership deed. - Examining if proper books of accounts are being maintained.

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Confirming that provision for tax payable has been made before arriving at the amount of profit divisible among the partners. Verifying that profits/losses are divided among partners as per agreed profit-sharing ratio.

(132) Write a note on compilation engagement? (SRS 4410)  In the compilation engagement the member has to use accounting expertise and not auditing

expertise, to collect, classify and summarise financial information. The procedures employed are not designed and do not enable member to express any opinion on financial information.

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 A compilation engagement would ordinarily include preparation of financial statements but may

also include the collection, classification and summarisation of other financial information.  When an engagement to compile financial statementsis undertaken, the form and content of

report issued in connection with such a compilation should be such that the association of the name of member with financial statements is not misconstrued by a user of the statements as the same having been audited by him.  Engagements to provide limited assistance to a client in preparation of financial statements like selection of appropriate accounting policy, do not constitute a compilation engagement.  The member should clearly bring out the nature of association with the financial statements and the work performed by him. The following recommendations are made in this regard a. The title of the report should be ‘ACCOUNTANT’S REPORT ON UNAUDITED FINANCIAL STATEMENTS’ and not ‘AN AUDITOR’S REPORT’. b. The report should be addressed to the appointing authority. c. The report should identify the financial information compiled; also stating that it is based on the information provided by the management. d. The report should clearly state that the financial statements are not audited. e. In describing the engagement, ambiguous terms such as ‘review’, ‘general review’, ‘check’ etc., should not be used. f. Date of the report should be mentioned. g. Name and address of firm of member appointed for carrying out compilation engagement should be mentioned. h. Signatures, designation and membership number should appear in the report. An example of the report is given below: Accountant’s Report on Unaudited Financial Statements To....... On the basis of information provided by management we have compiled the balance sheet of......... (Name of the entity) as of March 31, XXXX and the statement of profit and loss for the period then ended. The balance sheet and the statement of profit and loss are in agreement with the books of account. We have not audited or reviewed these financial statements and accordingly express no opinion thereon. Date: For A & Co. Signature (Name of the partner and membership number) Partner Chartered Accountants

(133) How will an auditor perform audit of Charitable Institutions? 1. PRELIMINARY WORK: a. Study the constitution under which the charitable institution has been set up. It may be registered as a society, company limited by guarantee or trust. b. Verify whether it is being managed as per the law under which it has been set up. c. Examine internal control system, especially as regards accounting of amounts collected. d. Verify in detail the income and confirm that amounts received are regularly deposited in bank. 2. AUDIT OF RECEIPTS: 1. Subscriptions and donations a. Ascertain changes, if any, made in amount of annual/life membership subscription. b. Confirm that adequate control is imposed over unused receipt books.

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c. Test check the counterfoils of receipts issued with the cash book. d. Obtain list of subscriptions and donations and tally them with total collections. e. Verify total subscriptions and donations received with any figures published in reports, etc. issued by the charity. 2. Legacies: Verify amounts received with correspondences and other available information. 3. Grants a. Vouch amount received with the relevant correspondence, receipts and minute books. b. Obtain a certificate from a responsible official showing the amount of grants received. 4. Investments Income a. Vouch the amounts received with the dividend and interest counterfoils. b. Check the calculations of interest received on securities bearing fixed rates of interest. c. Compare amounts of dividend received with schedule of investments. 5. Rents: a. Examine rent roll and tenancy agreements noting amounts of rents and due dates. b. Vouch rents on to the rent roll from counterfoils of receipt books and check totals of cash book. 6. Special function, etc.: Vouch gross receipts and outgoings for special functions like concerts, held in aid of charity with such vouchers and cash statements as are necessary. Verify that proceeds of all tickets issued have been accounted for. 7. Income Tax Refunds: Where income-tax has been deducted from the Investment income, it should be seen that a refund thereof has been obtained since charitable institutions are exempt from payment of Income-tax. Income Tax Refund may be vouched with correspondence with Income-tax Department. 3. AUDIT OF EXPENDITURE a. Vouch payment of grants, also verify that grants have been paid only for a charitable purpose or for purposes for which charitable institution has been set up and that no trustee, director or member of the Managing Committee has benefited there from. b. Verify schedules of securities held and inventories. c. Carry physical verification of inventories, securities and other movable properties. d. Verify the cash and bank balances. e. Ascertain that funds contributed for a special purpose have been utilised for the purpose.

(134) How will an auditor perform audit of Educational Institutions (School, College or University)? 1.

2.

PRELIMINARY WORK: a. Constitution : Examine Trust Deed/Regulations for school/college and note all provisions affecting accounts. For university, refer to Act of Legislature and Regulation framed. b. Minutes: Examine minutes of meetings of Managing Committee/Governing Body, note the resolutions affecting accounts and ensure their compliance, as regards the operation of bank accounts and sanctioning of expenditure. AUDIT OF RECEIPTS: a. Fees from Students:

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i.

ii. iii.

iv.

3.

4.

Check names entered in Students Fee Register for each month/term, with respective Class Registers, test amount of fees charged and verify that there operates a system of internal check which ensures that demands against the students are properly raised. Check fees received by comparing counterfoils of receipts with entries in Cash Book and trace collections in Fee Register. Examine Fees Register for each month/term to calculate fees paid in advance which have been carried forward and ensure that arrears that are irrecoverable have been written off under the sanction of an appropriate authority. Check admission fees with admission slips signed by head of institution and confirm that

amount has been credited to a Capital fund, unless the Managing Committee has taken a decision to the contrary. v. See that free studentship and concessions have been granted by a person authorised to do so, having regard to the Rules prepared by the Managing Committee. b. Other Incomes: i. Confirm that fines have been either collected or exempted under proper authority. ii. Confirm that hostel dues were recovered before student’s accounts were closed and their deposits of caution money refunded. iii. Verify rental income from landed property with the rent receipts, etc. iv. Vouch income from endowments and legacies, as well as interest and dividends from investment; also inspect the securities in respect of investments held. v. Verify any Government or local authority grant with the memo of grant. vi. Report old heavy arrears for fees, dormitory rents, etc. to the Managing Committee. vii. Vouch donations with the list published with annual report. Ensure that donations for any specific purpose have been utilised for the purpose only. viii. Confirm that refund of taxes deducted from income from investment, etc. has been claimed and recovered as institutions are generally exempted from income-tax. AUDIT OF EXPENDITURE: a. Vouch all capital expenditure in the usual way and verify it with the sanction of the Managing Committee as contained in the minute book. b. Vouch all establishment expenses in usual manner and enquire into any unduly heavy expenditure. In case of annual budget, see that any excess over amount budgeted was duly sanctioned by Managing Committee. c. See that increase in salaries of staff have been sanctioned and minuted by Committee. d. See if there is effective check over receipt and issue of provisions, foodstuffs, clothing and other equipment and all bills are duly authorised and passed before payment. AUDIT OF BALANCE SHEET ITEMS: a. Confirm that caution money and other deposits paid by students on admission, have been shown as liability in B/S and not transferred to revenue, unless they are not refundable. b. See that investments representing endowment funds for prizes are kept separate and any income in excess of the prizes has been accumulated and invested along with the corpus. c. Verify that Provident Fund money of staff has been invested in appropriate securities. d. Verify inventories of furniture, stationery, clothing, provision and all equipment etc. by reference to Stock Register or corresponding inventories of previous year and values applied to various items should be test checked.

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(135) How will an auditor perform audit of Hospitals? 1.

2.

3.

4.

PRELIMINARY WORK: a. Constitution: Examine the legal form of the Hospital, whether it is a society, partnership, company, etc. and study the applicable rules & regulations in relation thereto. b. Internal Check: Examine internal check on receipt and issue of stores, medicines, linen, apparatus, clothing, instruments, etc. and ensure that purchases have been properly recorded in Stock Register and issues made only against proper authorisation. AUDIT OF RECEIPTS: a. Collections from patients: i. Vouch Register of patients with copies of bills issued to them. ii. Verify bills for a selected period with patients’ attendance record to see that the bills have been correctly prepared and issued to all patients as per rules of the hospital. iii. See if timely settlements have been made in case of mediclaim policies. iv. Trace cash collections in Cash Book with receipts and copies of patient’s bills. b. Other Incomes: i. Examine property and Investment Register to see that all income receivable by way of rent on properties, dividends and interest on securities has been collected. ii. Ascertain that legacies and donations received for a specific purpose have been applied in the manner agreed upon. iii. Trace all collections of subscription and donations from Cash Book to respective Registers. Reconcile the total subscriptions due from Subscription Register. iv. Verify that grants received from Government/local authority has been duly accounted for

and utilised in the manner agreed upon. v. See that refund in respect of taxes deducted at source has been claimed. AUDIT OF EXPENDITURE: a. Vouch all purchases and expenses in usual manner, pay special attention to purchase of high value items like injections, medicines, etc. b. Verify that capital expenditure was incurred only with due sanction of authorised person. c. Ensure that appointments and increments to staff have been duly authorised. d. Compare various items of expenditure and income with amount budgeted for them and report significant variations to the Trustees or the Managing Committee. AUDIT OF BALANCE SHEET ITEMS: a. See that depreciation has been written off against all the assets at the appropriate rates. b. Inspect bonds, share scrips, title deeds of properties and compare their particulars with those entered in the property and Investment Registers. c. Obtain inventories, especially of stocks and stores as at the end of the year and check a percentage of items physically and compare total values with respective ledger balances.

(136) How will an auditor perform audit of Club? 1.

PRELIMINARY WORK: a. Constitution: Study the legal form of the club, generally club is constituted as company limited by guarantee. Ensure compliance with rules & regulations of applicable statute.

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2.

b. Internal Check: Verify internal check as regards members being charged with the price of foodstuffs and drinks provided to them and their guests, as well as, with the fees chargeable for the special services rendered, such as billiards, tennis, etc. c. Powers: Examine financial powers of the secretary and report to the Managing Committee if powers have been exceeded. AUDIT OF RECEIPTS: a. Entrance Fees: Vouch entrance fees received with members’ applications, counterfoils issued to them, as well as on a reference to minutes of the Managing Committee. b. Subscriptions:

Vouch member’s subscriptions with counterfoils of receipt issued to them. Trace receipts for a selected period in Register of Members. Reconcile total subscriptions due with the amount collected and that outstanding. Ensure that appropriate adjustments have been made for arrears of subscriptions and subscriptions received in advance. v. Check totals of various columns of the Register of members and tally them across. vi. Ascertain member’s dues in arrear and enquire if necessary steps have been taken for their recovery and report amount considered irrecoverable. c. Charges recovered from members: i. Examine the criteria on the basis of which different services are charged to members. ii. Trace debits for a selected period from subsidiary registers in respect of supplies and services to members and confirm that account of every member has been debited with amounts recoverable from him. AUDIT OF EXPENDITURE: a. Vouch purchase of sports items, furniture, crockery, etc. and trace their entries into the respective stock registers. b. Vouch purchases of foodstuffs, cigars, wines, etc., and test their sale price so as to confirm that normal rates of gross profit have been earned on their sales. c. Compare various expenses with that of previous year and carry out audit in usual way. AUDIT OF BALANCE SHEET ITEMS: a. Stock of unsold provisions and stores at year end should be verified physically and its valuation checked. b. Check the stock of furniture, sports material and other assets physically with the respective stock registers or inventories prepared at the end of the year. c. Inspect share scrips and bonds in respect of investments, check their current values for disclosure in final accounts; also ascertain that satisfactory arrangements are made for their safe custody. i. ii. iii. iv.

3.

4.

(137) How will an auditor perform audit of Cinema? 1. PRELIMINARY WORK: a. Constitution: Study the legal form of cinema hall and the applicable rules & regulations. Study the minutes of meetings of the governing body/trustee to gain knowledge of important policy decisions concerning the accounts. b. Internal control: Evaluate the system of internal control. 2. AUDIT OF RECEIPTS:

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a. Revenue from tickets: i. Verify that entrance to the cinema-hall during show is only through printed tickets. ii. Tickets should be serially numbered and bound into books. iii. See that for advance booking a separate series of tickets is issued. iv. Stock of tickets should be kept in the custody of a responsible official. v. Confirm that at the end of show, a statement of tickets sold is prepared and cash collected is agreed with it. vi. Vouch entries in Cash Book for cash collected on sale of tickets by reference to Daily Statements for the different shows held. vii. Verify that a record is kept of free passes and they are issued under proper authority. b. Tax collected: Reconcile the amount of Entertainment Tax collected with the total number of tickets issued for each class. c. Advertisements: Verify charges collected for advertisement slides and shorts from the Register of Slides and Shorts Exhibited and the agreements with advertisers in this regard. d. Restaurant income: Examine the arrangement for collection of share in the restaurant income; either a fixed sum or a fixed percentage of the taking may be receivable annually. If restaurant is run by Cinema, its accounts should be checked. The audit should cover sale of various items of foodstuffs, purchase of foodstuffs, cold drink, cigarettes, etc. 3. AUDIT OF EXPENDITURE: a. Vouch expenditure incurred on advertisement, repairs and maintenance. b. See that expenditure is properly classified between capital and revenue. c. Vouch payments on account of film hire with bills of distributors and the agreements concerned should be referred to. 4. AUDIT OF BALANCE SHEET ITEMS: a. Confirm that depreciation on machinery & furniture has been charged at appropriate rates. b. Examine unadjusted balance out of advance paid to distributors against film hire contracts to see that they are good and recoverable. If any film in respect of which an advance was paid has already run, it should be enquired as to why the advance has not been adjusted. c. Management should be asked to make a provision in respect of irrecoverable advances.

(138) How will an auditor perform audit of Hotels? 1. PRELIMINARY WORK: a. Constitution: Study the legal form of hotel and applicable rules & regulations including the condition of licence for running the hotel. Study the minutes of meetings of the governing body/trustee to gain knowledge of important policy decisions concerning the accounts. b. Internal Control: i. Evaluate internal control over sales made through various sales point in hotel. ii. See that adequate controls exist to minimise pilfering/leakage as far as possible. iii. Regular (weekly) trading accounts should be prepared for each sales point and a detailed scrutiny of resulting profit percentages be done. The auditor should review these regular trading accounts and obtain explanations for any apparent deviations. 2. AUDIT OF RECEIPTS: a. Sales:

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i. Almost all sales points in a hotel make both cash and credit sales. The auditor should reconcile total sales reported with total of bills issued by sales point. ii. Check cash sales with the cash records and credit sales with the guest’s bills. iii. The charge for room sales is normally posted to guest bills by the receptionist or in case of large hotels by night auditor. Any difference between rates charged on guests’ bills and standard room rate should be investigated. iv. Study the daily occupancy report and exit report, if prepared, and test check with the guest register or individual guest’s bill. v. In many hotels, housekeeper prepares a daily report of rooms which were occupied the

previous night and the number of beds kept in each room. This report tends not to be permanently retained and the auditor should ensure that a sufficient number of reports are available for him to test both with guest register and with individual guest’s bill. b. Booking of halls: The auditor should ensure that proper records are maintained for booking of halls and other premises for special parties and recovered on the basis of the tariff. c. Restaurant income: The auditor should verify a few restaurant bills by reference to K.O.T.s (Kitchen Order Tickets)/basic record to ensure that controls on revenue cycle are in order. d. Forex Conversion booth: In case of a booth to facilitate conversion of foreign currencies, auditor should ensure compliance with various applicable provisions of Foreign Exchange Regulation Act, 1973 and the rules framed by Foreign Exchange Dealer’s Association. e. Travel agents: Auditor should see that money are recovered from the travel agents or booking agencies as per the terms of credit allowed. 3. AUDIT OF EXPENDITURE: a. Auditor should ensure that adequate records are maintained for wages paid to casual labour and proper controls exist over the wages paid. b. Check commission paid to travel agents/booking agents with the agreement on that behalf. c. See that expenses are properly classified as revenue & capital. d. See that all taxes collected from occupants on food, etc. have been paid to proper authority. 4. AUDIT OF BALANCE SHEET ITEMS: a. Stocks: i. Ensure that effective internal control exists over receipt and issue of stocks of each individual stores areas and sales point as hotel stock are readily portable and saleable. ii. Areas where large quantities of stock are held should be kept locked, the key being retained by the departmental manager and issued only to trusted personnel. iii. The auditor should consider attending the physical stock taking. iv. Verify the basis of valuation adopted for stock. b. Fixed Assets: Examine the accounting policies for fixed assets and see that appropriate classification is made between fixed assets and quasi-fixed assets like silver and cutlery. In such cases see if very detailed definitions of stock items exist and ensure that definitions have been closely followed. c. Occupancy-in-Progress: The auditor should ensure that proper valuation of occupancy-inprogress at the balance sheet date is made and included in the accounts.

(139) How will an auditor perform audit of Hire Purchase and Leasing Companies?

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HIRE PURCHASE: 1. Auditor should examine the hire purchase agreement and see if it is signed by all parties. 2. Hire purchase agreement should specify clearly: a. The hire-purchase price of goods to which the agreement relates. b. The cash price of goods i.e., the price at which goods may be purchased by hirer for cash. c. The date on which the agreement shall be deemed to have commenced. d. Number of installments to be paid for hire- purchase price, amount of each installment, due date for payment and the person to whom it is payable. e. The goods covered by such agreement, in a manner sufficient to identify them. 3. Ensure that payments are being received regularly as per the agreement. LEASE: 1. Auditor should study object clause of leasing company to ascertain goods & activities in respect of which the company can undertake leasing activities. 2. See if proper procedure exists to perform credit analysis of lessee like lessee’s ability to meet the commitment under lease, past credit record, availability of collateral security, etc. 3. The lease agreement should be examined and the following points may be noted: a. the description of lessor, lessee, equipment and location where equipment is to be installed. b. agreement has been signed by the authorized persons. c. the amount & tenure of lease, dates of payment, late charges, deposits or advances etc. d. whether the equipment shall be returned to lessor on termination of agreement and cost shall be borne by the lessee. e. conditions in relation to subletting of property. 4. Examine the lease proposal form submitted by lessee requesting lessor to provide him the equipment on lease. 5. Ensure that the invoice is retained safely as lease is a long-term contract. 6. Examine the acceptance letter obtained from lessee indicating that equipment has been received in order and is acceptable to him. 7. See that the copies of the insurance policies have been obtained by lessor for his records.

Practical Questions - Chapter 9: Special Audits Q1. Discuss the provision of the Constitution of India to safeguard the independence of the Comptroller and Auditor general of India. Q2. Mention the special points to be examined by the auditor in the audit of a charitable institution running hostel for students pursuing chartered accountancy course and which Q3. (a) (b) (c) (d) (e) (f)

charges only Rs. 500 p.m. from a student for his lodging/boarding. State with reasons whether true or false: CAG may be removed by President. A partnership firm must have a duly registered partnership agreement. Regularity audit refers to audit against rules & regulations. In a compilation engagement, member has to use auditing expertise. In a hotel sale is made through various sales points. Hire Purchase and Lease is one and the same thing.

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