Audit - I - Yashwantrao Chavan Maharashtra Open Universityycmou.digitaluniversity.ac/WebFiles/MCOM M 17 SEME… · · 2016-01-27... INTRODUCTION OF AUDIT Definition, Objectives

ACG 201

AUDITING - I

SPECIAL GROUP : A - ACCOUNTING GROUP

M. Com (M 17) – Part I

Semester - II

YYYYYASHWASHWASHWASHWASHWANTRAANTRAANTRAANTRAANTRAO CHAO CHAO CHAO CHAO CHAVVVVVAN MAHARASHTRA OPEN UNIVERSITYAN MAHARASHTRA OPEN UNIVERSITYAN MAHARASHTRA OPEN UNIVERSITYAN MAHARASHTRA OPEN UNIVERSITYAN MAHARASHTRA OPEN UNIVERSITYDnyangangotri, Near Gangapur Dam, Nashik 422 222, Maharashtra

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YASHWANTRAO CHAVAN MAHARASHTRA OPEN UNIVERSITY

Vice-Chancellor : Dr. M. M. Salunkhe

Director (I/C), School of Commerce & Management : Dr. Prakash Deshmukh

State Level Advisory Committee

Dr. Pandit Palande Dr. Suhas Mahajan Dr. V. V. Morajkar

Hon. Vice Chancellor Ex-Professor Ex-Professor

Dr. B. R. Ambedkar University Ness Wadia College of Commerce B.Y.K. College, Nashik

Muaaffarpur, Bihar Pune

Dr. Mahesh Kulkarni Dr. J. F. Patil Dr. Ashutosh Raravikar

Ex-Professor Economist Kolhapur Director, EDMU,

B.Y.K. College, Nashik Ministry of Finance, New Delhi

Dr. A. G. Gosavi Dr. Madhuri Sunil Deshpande Dr. Prakash Deshmukh

Professor Professor Director (I/C)

Modern College, Swami Ramanand Teerth Marathwada School of Commerce & Management

Shivaji Nagar, Pune University, Nanded Y.C.M.O.U., Nashik

Dr. Parag Prakash Saraf Dr. S. V. Kuvalekar Dr. Surendra Patole

Director, Institute of Management Associate Professor and Assistant Professor

Science, Pimpri, Pune Associate Dean (Training)(Finance ) School of Commerce & Management

National Institute of Bank Management, Y.C.M.O.U., Nashik

Pune

Dr. Latika Ajitkumar Ajbani

Assistant Professor

School of Commerce & Management

Y.C.M.O.U., Nashik

Authors & Editors

Dr. Parag Prakash Saraf

Director, Institute of Management Science, Pimpri, Pune


Assistant Professor, School of Commerce & Management, Y.C.M.O.U., Nashik

Instructional Technology Editing & Programme Co-ordinator


Assistant Professor, School of Commerce & Management, Y.C.M.O.U., Nashik

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Copyright © Yashwantrao Chavan Maharashtra Open University, Nashik.

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INTRODUCTION

I am very please to placing the first and enlarge edition of this study material

on 'Auditing' to the students and practitioners of this subject. This book is design as

per the revise syllabus prescribed by the YCMOU Nashik from August 2015. It

gives equal importance to the theoretical aspects as well as to the practical case

studies. Hence this edition will be an ideal companion not only to the scholars but

also to the average students. I am sure that this present work a result of my sincere

and dedicated efforts would subserve the genuine interest of all the students concerned

in enriching their knowledge of this ever-growing Auditing discipline.

I have made a sincere attempt to make the subject easy to understand. For

this purpose the theory on each topic is written in a simple and lucid language to

enable the students to grasp the essence of subject. This book is also useful to the

students of CA, CWA and CS course.

It gives me great pleasure to introduce you to the world of Auditing and

Assurance. This book has got knowledge oriented and exam oriented approach. I

am tried to cover all Audit Assurance Standards (AAS) and provisions of amended

Company Act 2013. So let's start this lovely journey of learning in a positive way.

Any suggestions will be appreciated.

I am confident, that students will welcome new edition of this book.

With knowledge, hard work, marvelous success is just around the corner.

All The Best!

- Dr.Parag Prakash Saraf

Index

Unit No. Unit Name Page No.

1 INTRODUCTION OF AUDIT 9

2 TYPES OF AUDIT 18

3 VOUCHER & VOUCHING 26

4 INTERNAL CHECK & ROLE OF INTERNAL

AUDITOR 36

5 DOCUMENTATION 45

6 FRAUDS - THEIR DETECTION & PREVENTION 52

7 VALUATION & VERIFICATION OF ASSETS 63

8 VALUATION & VERIFICATION OF LIABILITIES 73

9 COMPANY AUDIT IN BROAD LINE,

PROFIT AVAILABLE FOR DIVIDEND,

AUDITOR'S DUTIES REGARDING RESERVES 79

10 QUALIFICATION & APPOINTMENT OF

A COMPANY AUDITOR 89

11 RIGHTS, DUTIES AND RESPONSIBILITIES OF

A COMPANY AUDITOR 96

12 MISCELLANOUS MATTERS IN

COMPANY AUDIT 103

SYLLABUS - AUDIT -I

1) INTRODUCTION OF AUDIT

Definition, Objectives of an Audit, Scope of an Audit,

Restriction of scope, Advantages of an Audit, Limitations of an

audit, Audit Programme, Contents of Audit Programme,

Advantages of an Audit Programme, Disadvantages of an Audit

Programme, Audit Working Papers, Commencement of New Audit

2) TYPES OF AUDIT

Kinds of Audit, Statutory / Mandatory Audit, Voluntary /

Independent Audit, Interim Audit, Concurrent Audit, Continuous

Audit, Balance Sheet Audit, Financial Audit, Cost Audit,

Management Audit, Audit Techniques

3) VOUCHER & VOUCHING

Vouching, Purpose of vouching, Objectives of vouching,

Voucher, General Consideration in Audit of Ledger, Audit of

Different Ledgers, Bought Ledger, Sales Ledger, General Ledger,

Kinds of Frauds in relation to Ledgers

4) INTERNAL CHECK & ROLE OF INTERNAL

AUDITOR

Internal Control, Objectives of Internal Control, Essentials

of Good Internal Control System, Inherent Limitations of Internal

Control, Methods for the Proper Review & Evaluation of the

Adequacy of the Internal Control, Internal Check, Objects of

Internal Check, Internal Audit, Basic Principles of Establishing

Internal Auditing, Objectives of Internal Audit, Role of Internal

Auditor, Possible areas of co-operation & co-ordination

5) DOCUMENTATION

Documentation, Importance of Working Papers, Form &

Content of Working Papers, Lien on Working Papers, Classification

of Working Papers, Audit Note Book

6) FRAUDS - THEIR DETECTION & PREVENTION

Frauds, Errors, Reasons & Circumstances of Frauds &

Errors, Auditor's responsibility for non detection of frauds & errors,

Events which increases the risk of fraud or error, Inherent limitation

of an audit in relation to frauds & errors, Types of fraud, Internal

Audit, Internal Control, Elements of internal control, Investigation

for suspected frauds

7) VALUATION & VERIFICATION OF ASSETS

Verification of Assets, General Consideration for Valuation

& Verification of Assets, Valuation of Assets, Valuation of Fixed

Assets, Valuation of Current / Floating Assets, Inventories (Stock

in Trade), Long term Work in Progress, Trade Debtors, Investments,

Loans, Advances, Bank Balance, Cash balance on Hand

8) VALUATION & VERIFICATION OF LIABILITIES

General principles to be followed in verification of liabilities,

Verification of Liabilities, Valuation of Liabilities, Trade Creditors,

Bills Payables, Outstanding Liabilities for expenses, Provision for

Taxation, Contingent Liabilities, Debentures

9) COMPANY AUDIT IN BROAD LINE, PROFIT

AVAILABLE FOR DIVIDEND, AUDITOR'S DUTIES

REGARDING RESERVES

Company Audit, Share Capital Audit, Auditor's duties

regarding to audit of share capital, Shares underwritten placed for

commission, Shares issued at premium, Shares issued at a discount,

Audit of debentures, Preliminary Expenses, Statutory Meeting &

Statutory Report, Dividend, Interim dividend, Auditor's duty with

regard to payment of dividend, Transfer to reserve, Capita profits,

Revaluation reserve

10) QUALIFICATION & APPOINTMENT OF A

COMPANY AUDITOR

Qualification of Auditors, Disqualification of Auditors,

Appointment of Company Auditor, Removal of the auditor, Auditor's

Remuneration

11) RIGHTS, DUTIES AND RESPONSIBILITIES OFA

COMPANY AUDITOR

Rights & Powers of an Auditor, Duties & responsibilities

of the auditor, Scope of duties of an auditor

12) MISCELLANOUS MATTERS IN COMPANY

AUDIT

Statutory report, Audit of branch Accounts, Powers of

accompany auditor in relation to branch, Exemption to Branch

Audit, Special audit on direction of Central Government, Cost audit

Intoduction of AuditUNIT - 1

INTRODUCTION OF AUDIT

Structure

1.0 Introduction

1.1 Objectives

1.2 Definition

1.3 Objectives of an Audit

1.4 Scope of an Audit

1.4.1 Restriction of scope

1.5 Advantages of an Audit

1.6 Limitations of an audit

1.7 Audit Programme

1.7.1 Contents of Audit Programme

1.7.2 Advantages of an Audit Programme

1.7.3 Disadvantages of an Audit Programme

1.8 Audit Working Papers

1.9 Commencement of New Audit

1.10 Key concepts

1.11 Summary

1.12 Exercise & Questions

1.13 Further Reading and References

1.0 Introduction

The industrial revolution and the consequent explosion of technology have

resulted in an enormous increase in the size of all organizations, business

undertakings. So control on various aspects is required. This growth has had far

reaching effects on accounting and auditing. Auditing has now become an analytical

exercise which involves evaluating the effectiveness of internal control procedures

by examining selected samples of transactions and applying analytical procedure.

1.1 Objectives

After this unit you should be able :

1. To understand the concept of audit.

2. To find out scope and limitations of audit.

3. To know in detail the audit program.

4. To understand the importance of audit working papers.

1.2 Definition of an Audit

"An audit is independent examination of financial information of

any entity, whether profit oriented or not, and irrespective of its size or

legal form, when such an examination is conducted with a view to expressing

an opinion thereon."

CHECK YOUR

PROGRESS

Define objectives of

Audit?

AUDITING - I (9)

NOTES

AUDITING - I

(10) AUDITING - I

NOTES

According to general guidelines on internal Auditing issued by ICAI, auditing

is defined as a

"Systematic and independent examination of data, statements,

records, operations and performances (financial or otherwise) of an enterprise

for a stated purpose. In any auditing situation, the auditor receives and

recognizes the propositions before him for examination, collects evidence,

evaluates the same and on this basis, formulates his judgement which is

communicated through his Audit Report".

The above definitions of auditing have certain important elements. They

are:

1. Independence - The auditor has to express an opinion on the financial

statements examined by him. Therefore, auditor should be free from any

interest which might detract his objectivity.

2. Auditor's opinion - The auditor has to express an opinion on the financial

statements examined in the form of an audit report. The audit report is an

expression of opinion rather than a statement of verified facts.

3. Financial statements -. The financial statements comprise of Balance Sheet,

Profit and Loss Account, notes and other statements, which collectively are

intended to give a proper understanding of the financial position. The auditor

has to express an opinion on the financial statements.

These three elements are contained in any kind of audit, whether profit oriented

or not and irrespective of its size or legal form.

1.3 Objectives of an Audit

1. Reporting: The primary objective of auditing is reporting - whether

the Financial Statements present a "true and fair view" of the financial position

(Balance Sheet) and the financial performance (Profit and Loss Account)

during the period.

2. Expression of Opinion: The objective of an audit of Financial Statements,

prepared within a framework of recognized accounting policies and relevant

statutory requirements, is to enable an auditor to express an opinion on such

Financial Statements.

3. True and Fair View: The Auditor's duty is to express an opinion on financial

statements.

(a) Auditor's opinion helps to determine the true and fair view of the operating

results & financial position of an enterprise.

(b) The user, however, should not assume that the Auditor's opinion is an

assurance as to the future viability of the enterprise of the efficiency or

effectiveness.

4. Management Responsibility:

(a) The Management of an enterprise is primarily responsible for the preparation

of Financial Statements

(b) Management's responsibilities include maintenance of adequate accounting

records and internal controls, selection and application of accounting policies

CHECK YOUR

PROGRESS

Define Concept of

Audit?

AUDITING - I (11)

NOTES

Intoduction of Auditand safeguarding the assets of the enterprise.

(c) Hence, the audit of the Financial Statements does not relieve Management

of its responsibilities.

1.4 Scope of an Audit

lllll Scope:

Auditor will be determined the scope of an audit of financial statements with

regards to -

a) The terms of the engagements

b) The pronouncements of ICAI

c) The requirements of relevant legislation

lllll Coverage of work:

The auditor should be organized to cover all operational aspects relevant to

the financial statements. He has to make study & evaluate the accounting

system & internal controls on which auditor wishes to rely.

lllll Disclosure:

Auditor should ensure whether all relevant information is properly disclosed

in financial statements & as per statutory requirement. The disclosure

requirement can be verified by performing-

- Financial statement analysis &

- Evaluation of accounting policies.

lllll Judgment:

Absolute certainty is not attainable in auditing because of the need to exercise

judgment. Auditor is also required to examine the reasonableness of judgment.

lllll Materiality:

Material items are those, which might influence the decision of the users of

financial statements. Auditor should exercise his professional experience &

judgment with material items.

lllll Technical aspects:

Auditor is not expected to perform duties, which fall outside the scope of his

competence. Auditor is not an expert in all fields. So, auditor can take the

advice of an expert for technical work.

1.4.1 Restriction of scopea) The terms of engagement cannot restrict the scope of an audit in relation

to matters,which are prescribed by legislation or by the pronouncement of

the Institute.

b) Where the scope of work impairs the auditors ability to express an

unqualified opinion on such financial statements & he should state the

restriction.

1.5 Advantages of an AuditThe principle advantage of an audit is to get an informed, objectives &

forthright opinion on financial statements of the enterprises. This can be used in

making significant decisions by interested parties like shareholders, creditors, banks

CHECK YOUR

PROGRESS

Give Scope of Audit?

AUDITING - I

(12) AUDITING - I

NOTES

etc. With the help of audit the shareholders of the company are assured that the

funds invested by them are safe & are used for the purpose for which they were

raised.

1) A proprietary concern accounts may be audited to get funds from banks.

2) In case of partnership firm accounts may be audited for the decision making

like valuation of goodwill of firms or settlement of accounts at the time of

admission, retirement or death of partner.

3) There is a separation of ownership & management in case of company.

Shareholders have no direct control on the administration on the company. So

audited accounts may help to shareholders to get complete understanding

about company's affairs.

4) Audit helps in locating the weaknesses, inadequacies in the financial statements.

5) An audit also helps in detection of wastages & losses and suggests ways by

which they might be checked.

6) Sometimes government may require audited & certified statements for giving

assistance or issue a license.

7) An audit helps in setting liability of taxes, negotiating loans, determining purchase

consideration of business, setting trade disputes for higher wages & bonus.

8) An audit also helps to control over inefficiency.

These are some advantages of an audit.

1.6 Limitations of an Audit

Though auditing has its advantages, it has certain limitations too.

1. An auditor has to depend on the books of accounts & other records presented

before him. If these accounts are prepared with malafide intentions, the auditor

may not fully detect them.

2. Auditor is not expected to be an expert in all the fields. He has to depend upon

the opinion of the expert.

3. Auditor has to depend upon the explanations & information given by the client.

But it is possible that such information & explanations may not be correct.

4. Audit evidence persuasive rather than conclusive in nature. Eg. Confirmation

of a debt by a customer is not conclusive that the debt is good & recoverable.

5. The auditor's independence is necessary to serve the purpose of audit. Though

under law shareholders appoint the auditor. In reality, directors appoint the

auditors.

6. Auditor has to make an assessment of internal control system & rely on them

if they are effective. However, there will always some risk of internal control;

it may be ineffective against fraud involving collusion among employees.

1.7 Audit Programme

An audit programme is a predetermined plan of the auditing work to be

performed, specifying the procedure to be followed in verification of each item in

the financial statement, allocation of the audit staff and the time framed to be

followed in conducting audit. Audit programme is the written plan of audit work

CHECK YOUR

PROGRESS

Give advantages of

Audit?

AUDITING - I (13)

NOTES

Intoduction of Auditwhich contains the audit objectives It also specifying what work to be done, when

to be done, & by whom to be done.

1) An Audit programme is detailed plan of work, prepared by the auditor

for carrying out an audit.

2) It constitutes the plan of the work which provides a basis for supervision

& control of work. It is a set techniques & procedures which auditor applies for

forming an opinion on financial statements.

1.7.1 Contents of Audit ProgrammeContents of an audit programme maybe divided as under:

1) A review of the system of internal check.

2) Audit of Balance Sheet accounts.

3) Audit of Profit and Loss account items.

4) Preparation of the audit report and co-ordination of all the

above-mentioned items.

1.7.2 Advantages of an Audit Programme:

1) Instructions: The audit programme specifies the extent & manner of checking

& verification of different aspects of the accounting records.

2) Checklist: It serves as a ready checklist of procedures and techniques to be

applied and minimizes the possibility of overlooking any of the important audit

steps.

3) Phasing work: The work can be planned and phased properly.

4) Selection of Team Members: The audit programme helps in selection of

assistants for jobs on the basis of their capability.

5) Supervision: The work can be supervised and controlled better by periodic

reference to the programme.

6) Work Review: The progress of the work at any point of time can be readily

known by reference to the entries on the audit programme.

7) Future Planning: It serves as a guide for carrying out the current audit and

as a basis for drawing the future audit programmer-

8) Responsibility: Responsibility for an audit examination is fixed on the team

member who has signed after completing a particular procedure under the

programme.

9) Basis for opinion: It serves as evidence of the work performed and provides

a sound basis for the expression of the Auditor's opinion.

10) Record of Work: All work performed by auditor should be recorded. It is

the sufficient proof that the work was carried out with reasonable skill & care

that is of expected a professional.

1.7.3 Disadvantages of Audit Programme.

Following are the disadvantages of Audit Programme -

1) Mechanical work: The audit may be performed mechanically without

reference to the special circumstances of the client or to the development of

any new or unusual features in the client's business.

CHECK YOUR

PROGRESS

Give limitations of

Audit?

AUDITING - I

(14) AUDITING - I

NOTES

2) Rigidity: Additional procedures or techniques may be called for by the special

circumstances.

3) False sense of security: Audit members may feel that everything is taken

care by the audit programme. They may fail to apply their mind in

circumstances that arise during the course of work.

4) Lack of Initiative: Independent judgment and initiative of the staff may be

restricted. It may frustrate talented and efficient audit staff.

5) Lack of Suitability: Procedures may be undertaken which may be

inappropriate to the circumstances of the client's business.

How will you overcome from disadvantages of Audit Programme?

1. Suitability: Audit programme should be suitable to the nature of entity, scale

of operations & volume of transactions & the efficacy of internal controls.

2. Review of the internal controls: Internal controls should be reviewed and

evaluated to obtain knowledge of changes in the controls and systems and

procedures.

3. Changed business operations: The Auditor should obtain information about

new systems to carry on the old business. The audit programme should be

recast or modified to suit the changed business operations and practices.

4. Participative approach: The Auditor should encourage his audit assistants

to keep an open mind and make suggestions for amending the programmes.

5. Flexibility: The audit programme should not become stereotyped. There

should be revision from time to time according to circumstances even though

no material change has taken place in the client's business operations and the

business practice. It means audit programme should be flexible according to

situation.

6. Minimum Requirement: It should be impressed upon the audit assistants

that the programme provides for the minimum tests that should be carried out

and they should undertake tests and surprise checks, considered appropriate,

even though not provided in the programme

1.8 Audit working papers

The audit working paper constitutes the link between the auditor's report

and the client's records.SA 230 on "Documentation" refers to working papers

prepared or obtained by the auditor and retained by him in connection with the

performance of his audit. Working papers should record audit plans. The working

papers should provide for-

a. Means of controlling current audit work.

b. Supervision and review of the audit work.

c. Evidence of audit work performed to support the auditor's opinion.

Working papers should also prove the evidence of work performed in case

of charge of negligence brought against the auditors.

CHECK YOUR

PROGRESS

Define Audit

program, its

advantages and

limitations?

AUDITING - I (15)

NOTES

Intoduction of Audit1.9 Commencement of New Audit

Auditor should prepare himself before the commencement of a new audit;

following points should consider:

lllll Initial Engagement: Initial engagement means appointment of an auditor for

first time by the client. First of all auditor should confirm his appointment

letter that fulfilling all its legal requirements.

lllll Internal Control System: Auditor should evaluate the internal control system

of client's enterprise. The review of internal control system will helps the

auditor to know the weaknesses in system. Accordingly auditor develops the

audit plan.

lllll Books of Accounts: The auditor should obtain the list of all the books of

account and should see that all books have been kept in accordance with

required policies & procedures. Auditor should see that required standards

were followed.

lllll Documentation: The auditor should obtain the copy of the legal documents

and should study carefully before the commencement of audit. Eg.

Memorandum of association, Articles of association, Prospectus and Contract

with vendors etc.

lllll Complexity of Audit: Auditor should know the nature of audit so that he may

prepare himself accordingly. The scope of work & responsibility should be

taken into account in determining the complexity of audit.

lllll Internal Audit: Auditor should also study the internal audit system in the

business concern. He should make detailed inquiries, inspect books of

accounts and observe the actual procedure in operation.

lllll Accounting System: Auditor must know the accounting system adopted by

client concern, before the commencement of new audit. He should thoroughly

investigate the whole system of book keeping and accounting.

lllll Environment in which entity operates: Auditor should understand various

operational aspects of audit. Eg. Extent of computerization, general attitude

of personnel's, etc.

l l l l l Audit Programme: Audit program is predetermined plan of audit. Keeping in

view the nature of audit, nature of business and extent of work, auditor

should work out an audit programme for the commencement of new audit.

lllll List of important persons: Auditor should obtain the list of important persons

along with their powers & responsibilities.

lllll Previous Experience with the client: Auditor should observe the last balance

sheet for the purpose of checking the opening entries for the period under

audit. The previous auditor report should also be inspected. Auditor should

pay particular attention to matters that required special consideration.

These are some points which are necessary to understand before the

commencement of audit. This will help the auditor to determine the nature,

timing & extent of audit.

CHECK YOUR

PROGRESS

Give brief about new

Audit concept?

AUDITING - I

(16) AUDITING - I

NOTES

1.10 Key Concepts

Audit - "An audit is independent examination of financial information of

any entity, whether profit oriented or not, and irrespective of its size or legal form,

when such an examination is conducted with a view to expressing an opinion

thereon."

Audit programme is the written plan of audit work which contains the

audit objectives It also specifying what work to be done, when to be done, & by

whom to be done.

Audit Working Paper constitutes the link between the auditor's report and the

client's records.

1.11 Summary

Systematic and independent examination of data, statements, records,

operations and performances (financial or otherwise) of an enterprise for a stated

purpose is known as audit.

Reporting, expression of auditor's opinion in a fair manner are some of the

objectives of an audit. It is beneficial for getting loan from bank valuation of goodwill.

Audit helps in locating the weaknesses, inadequacies in the financial statements. It

also helps in detection of wastages etc.

There are certain weaknesses of audit such as Auditor has to depend

upon the explanations & information given by the client which may not be correct.

An Audit programme is detailed plan of work, prepared by the auditor for

carrying out an audit. Auditor should prepare himself before the commencement

of a new audit.


1. Define the term Audit & state the advantages of audit?

2. What is mean by Audit Programme? State the disadvantages of Audit

Programme & how will you overcome from disadvantages of Audit

Programme?

3. State the importance of Audit working papers?

4. Which points should considered while commencement of new audit?

lllll Fill in the blanks:

1) The primary objective of auditing is ________________.

(Expression of opinion, Reporting, Vouching, Verification)

2) The Auditor's duty is ___________________on financial statements.

(Reporting, to express an opinion, Vouching,

3) The principle advantage of an audit is to get an informed, _____________

& forthright opinion on financial statements of the enterprises.

(Scope, Objectives, Disadvantages, Audit procedure)

AUDITING - I (17)

NOTES

Intoduction of Audit4) Audit evidence _________________ rather than conclusive in nature.

(True, Persuasive, Fair, Correct)

5) ____________________ is detailed plan of work, prepared by the auditor

for carrying out an audit.

(Audit Programme, Audit Plan, Audit Technique, Audit Working papers)

6) --------------- should also prove the evidence of work performed in case of

charge of negligence brought against the auditors.

(Audit Programme, Internal Control, Working Papers, Internal Audit)

7) Auditor should also study the ________________ in the business concern.

(Environment, Internal audit system, Business policies, Internal control)

8) The -------------- constitutes the link between the auditor's report and the

client's records.

(Audit Working Papers, Audit Programme, Audit Plan, Internal Audit)

9) Audit programme should be ______________ according to situation.

(Fixed, Flexible, Semi Flexible, Classified)

10) All work performed by ____________ should be recorded.

(Director, Auditor, Management, Secretary)

11) There is a separation of ____________ & management in case of company.

(Directorship, Responsibilities, Ownership, Control)

12) Auditor can take the advice of an _______________for technical work.

(Internal auditor, cost auditor, Management, Expert)

13) ________________items are those, which might influence the decision of

the users of financial statements.

(Material, Capital, Revenue, Technical)

14) Auditor should be free from any _____________which might detract his

objectivity.

(Item, Interest, Challenge, None)

15) Reporting is beneficial for getting loan from bank valuation of

________________.

(Goodwill, Fixed assets, Current assets, Share capital)

(Answers: 1) Reporting, 2) to express an opinion, 3) objectives, 4) Persuasive,

5) Audit programme, 6) Working papers, 7) Internal audit system, 8) Audit

working papers, 9) Flexible, 10) Auditor, 11) Ownership, 12) Expert, 13)

Material, 14) Interest, 15) Goodwill)


1. Audit Assurance Standards ( AAS) issued by ICAI

2. N.D.Kapoor's Audit Procedure

3. Dr. Mahesh Kulkarni's Audit practices

AUDITING - I

(18) AUDITING - I

NOTES

UNIT - 2

TYPES OF AUDIT

Structure

2.0 Introduction

2.1 Objectives

2.2 Kinds of Audit

2.2.1 Statutory / Mandatory Audit

2.2.2 Voluntary / Independent Audit

2.2.3 Interim Audit

2.2.4 Concurrent Audit

2.2.5 Continuous Audit

2.2.6 Balance Sheet Audit

2.2.7 Financial Audit

2.2.8 Cost Audit

2.2.9 Management Audit

2.3 Audit Techniques

2.4 Key concepts

2.5 Summary



2.0 Introduction

There are various types of audit. Auditor may choose any audit procedure

for conducting audit of financial statements. Audit procedure may vary from

enterprise to enterprise according to the nature of business, audit period, etc.

2.1 Objectives

After this unit you should be able:

1. To be familiar with various types of audit.

2. To understand new audit techniques.

lllll AUDIT:

"An audit is independent examination of financial information of

any entity, whether profit oriented or not, and irrespective of its size or

legal form, when such an examination is conducted with a view to expressing

an opinion thereon."

AUDITING - I (19)

NOTES

2.2 Kinds of Audit

2.2.1 Statutory / Mandatory Audit:The audit which is prescribed by law i.e. governing by statute or by

regulations is called statutory audit. Where scope is defined by law, it can't be

restricted by the appointing authority. Only a person possessing the prescribed

qualification shall conduct the audit. The matters to be covered in the auditor's

report are generally defined by law.

Examples of Statutory Audit

Enterprise Governing Statute

Companies Companies Act, 1956

Co-operative Multi-state Co-operative Societies Act and

Societies also State enactments

Banking Companies Banking Regulation Act, 1949

Insurance Companies Insurance Act and Companies Act, 1956

Electricity Companies Indian Electricity Act, 1910 and Companies Act, 1956

Corporations Statute by which the Corporation is created

e.g. IDBI Act, LIC, etc.

2.2.2Voluntary / Independent Audit:This audit is purely optional and at discretion of the governing body. The

scope of audit is defined by the letter of engagement between the auditor and the

client. The format of report is prescribed by the scope of work.

Examples: Individuals, Private trusts, Partnership firms etc. which are

not governed by any audit provisions of act.

2.2.3 Interim Audit:An audit which is conducted between two annual audits is called an interim

audit. Such type of audit conducted at a specific date as per client's requirement.

Eg. 30th September, 31st December. Financial statements are prepared for interim

audit period. Assets and liabilities are verified for interim balance sheet purposes.

Advantages of Interim audit

lllll Immediate detection of errors & frauds: Errors & Frauds, if any, easily

detected.

lllll Upto date accounts: The accounting staff of the client is motivated to keep

the books of accounts upto date.

lllll Early final audit: The final audit can be completed in a short span of time.

lllll Interim dividend: It helps the company to publish interim financial statements

for declaration of interim dividend.

lllll Act as deterrent: Frequent attendance by audit staff deters persons from

committing a fraud.

lllll Staff planning: Staff can be sent regularly by proper planning. Work scheduling

can be done effectively.

Types of Audit

CHECK YOUR

PROGRESS

Explain different types

of Audit?

AUDITING - I

(20) AUDITING - I

NOTES

lllll Interim reporting: Interim financial statement can be prepared easily & in

timely manner.

lllll Detailed coverage: All verifications are carried out in detailed than in final

audit.

Disadvantages of Interim audit

lllll Failure to keep track: Since work is carried out in several installments, the

audit staff may fail to keep track of things. As a result some of the transactions

may escape.

lllll Tampering: The staff of the client may alter entries in the books of accounts

after checking thereof.

lllll Uneconomic: The audit is uneconomic for small size concern as a great deal

of time & efforts would be wasted.

lllll Missing links: Continuity in work may be lost when work is executed

lllll Time consuming: Since all transactions are verified. Continuous audit will be

time consuming.

lllll No guarantee for fraud detection: Complete verification of all transactions in

detail, does not guarantee detection of all errors & frauds. Some material

misstatements may still exist.

2.2.4 Concurrent Audit:It implies verification of transactions of a year on a continuous basis. The

period of verification is primarily determined by the auditor. Financial statements

are not prepared. Assets & liabilities are verified only at the time of finalization at

the year end.

2.2.5 Continuous Audit:When the Auditor's staff is engaged continuously in checking the accounts

of the client during the whole year round or when the staff attends audit work at

some intervals, it is called a Continuous Audit.

Advantages of continuous audit

lllll Immediate errors and frauds detection: Management can exercise a stricter

control over the accounts in as much as it is able to check sooner the causes

of any errors or frauds uncovered by such an audit.

lllll Acts as Deterrent: The frequent attendance of the audit staff deters persons

from committing fraud.

lllll Upto date accounts: The accounting staff of the client is motivated to keep

the books of account upto date.

lllll Early Final Audit: The final audit can be completed in short span of time..

lllll Knowledge of clients' affairs: The Auditor can obtain a more detailed

knowledge of the client's affairs, which helps the auditor to discharge his

duties more efficiently.

lllll Detailed Coverage: All aspects of verification are carried out in detail than in

final audit.

CHECK YOUR

PROGRESS

Define interim Audit,

its advantages and

disadvantages?

AUDITING - I (21)

NOTES

Disadvantages of continuous audit

lllll Failure to keep track: Since work is carried out in several installments, the

audit staff may fail to keep track of things. As a result some of the transactions

may escape.

lllll Tampering: The Client's staff may alter entries in the books of account, after

checking thereof.

lllll Uneconomic: The audit is uneconomic for small sized concerns as a great

deal of time and effort would be wasted each time in preparing for the audit.

lllll Interruption of work: The presence of audit staff at regular intervals may

affect the regular work-flow of the client.

lllll Boredom: Routine checking on a continuous basis may become mechanical.

lllll Time consuming: Since all transactions are verified, continuous audit will be

time-consuming.

lllll No guarantee for fraud detection: Complete verification of all transactions in

detail, does not guarantee detection of all errors and frauds. Some material

misstatements may still exist

How will you overcome the disadvantages of Continuous Audit?

Following are some precautions -

lllll Stage-wise completion: The work should be completed upto a definite stage

during the .course of each visit. This will eliminate the possibility of loose

ends.

lllll Documentation: Important balances should be noted down at the end of each

visit and the same should be compared at the time of the next visit. Proper

documentation should be maintained.

lllll Surprise visit: The visits should be conducted at irregular intervals. Client

staff would not know the exact dates of the proposed visit.

lllll Special auditing marks: The client's staff should be instructed not to alter or

correct audited figures. The Auditor should also device a special form of

ticks and places the same, against altered figures. The purpose or the

significance of such special marks should not be disclosed to the client's

staff.

2.2.6 Balance sheet audit:The Balance Sheet Audit means Auditor reviews the Balance Sheet and

works back to the books of original entry and other evidences. In balance sheet

audit it is assumed that there is a reliable system of internal check & internal audit.

Much of the vouching, casting and posting and other routine audit is eliminated

considering the soundness of internal control system. Where internal controls are

considered weak, the Auditor might prefer more elaborate testing procedures to

obtain audit assurance.

Auditor performs analytical review of the items in the Financial Statements and

investigates the followings-

l l l l l Material deviations from budgeted amounts;

l l l l l Items of unusual and non-recurring nature;

l l l l l Items requiring statutory disclosure.

Types of Audit

CHECK YOUR

PROGRESS

Explain continuous

Audit?

AUDITING - I

(22) AUDITING - I

NOTES

Need for Balance sheet audit: The need for Balance Sheet Audit by departing

away from routine "ticking" of vouchers and "post and vouch" audit arises due to -

l l l l l Development of Industries.

l l l l l Adoption of very formal control system by organization.

l l l l l Growth in size of business.

l l l l l Increase in number of transactions of homogeneous nature.

2.2.7 Financial Audit:Financial audit means examination of financial statements to express an

opinion thereon. This audit is mandatory for all enterprises. It covers all the items

which form part of the financial statements. This audit helps to determine the true

& fair view of financial statements. Here propriety aspect is not considered in

detailed.

2.2.8 Cost Audit:Cost audit means review of decisions & actions of management to analyse

performance. This is applicable to those companies specified under law. Cost audit

primarily covers the cost aspects of the enterprise.

2.2.9 Management Audit:Review of decisions & actions of management. Propriety & efficiency of

decisions & managerial actions are studied. It covers all aspects like organizational

objectives, policies, procedures, structure, control & system.

Differentiate between Interim Audit & Concurrent Audit

Particulars Interim audit Concurrent Audit

Meaning An audit which taken up It implies verification of

between two annual audits transactions on a

is called Interim Audit. continuous basis,

at various point of time in a year.

Time period A specific date, as per client's The period of verification

Requirement. is determined by the auditor.

Eg. 30th September, Eg. For a month/ fortnight.

31st December, week etc.

Trial balance Trial balance is drawn & Trial balance may be drawn

verified with a view to with a view to establish

prepare financial Statements. arithmetical Accuracy.

Financial Financial statements are Financial statements are not

Statements prepared for the interim prepared.

audit period.

Assets Assets & liabilities are verified Assets & liabilities are verified

verification for Interim balance sheet only At time of finalization

purpose. at year end.

AUDITING - I (23)

NOTES

Differentiate between statutory audit & Voluntary audit

Particulars Statutory Audit Voluntary Audit

Meaning Audit is prescribed by law i.e. Audit is purely optional &

governing statute or regulations. conducted as per requirement.

Advantages Statutory compliance is the Advantages of independent

chief audit advantage. audit will gain.

Qualifications Only a person possessing the Qualifications for conducting

prescribed qualification shall audit are not prescribed by law.

conduct the audit.

Scope It is defined by law. It is defined by the letter of

engagement.

Rights & Rights & duties of the auditor Rights & duties of the auditor

Duties are prescribed by law & can't defined by client.

be restricted by appointing

authority.

Format of Format of audit report Format of audit report are

report generally defined by law. defined by the scope of work.

2.3 Audit Techniques

It refers to the methods and means adopted by the auditor for collection

and evaluation of audit evidence in different auditing situations.

Techniques refer to the methods employed for carrying out the audit

procedure. Audit techniques are generally interdependent. A combination of

techniques is applied in a particular procedure.

For example,

l l l l l Physical Inspection

l l l l l Confirmation

l l l l l Inquiry

l l l l l Calculations of ratios

Audit techniques may vary from the organization to organization depending

upon the nature of business, number of transactions, etc. However it is important

to remember that the principles of auditing remain constant.

2.4 Key Concepts

The audit which is prescribed by law i.e. governing by statute or by

regulations is called statutory audit.

An audit which is conducted between two annual audits is called an interim

audit.

When the Auditor's staff is engaged continuously in checking the accounts

of the client during the whole year round it is called a Continuous Audit.

The Balance Sheet Audit means Auditor reviews the Balance Sheet and

works back to the books of original entry and other evidences.

Types of Audit

CHECK YOUR

PROGRESS

Differentiate between

Interim Audit &

Concurrent Audit?

AUDITING - I

(24) AUDITING - I

NOTES

Financial audit means examination of financial statements to express an

opinion thereon.

Management Audit - Review of decisions & actions of management.

Audit Techniques refer to the methods adopted by auditor for carrying

out audit procedure.

2.5 Summary

Types of audit includes Statutory / Mandatory Audit, Voluntary / Independent

Audit, Interim Audit, Concurrent Audit, Continuous Audit, Balance sheet audit,

Financial Audit, Cost Audit, Management Audit.


1. How many types of Audit? Explain each one of them.

2. What are the disadvantages of Continuous Audit? How will you overcome

the disadvantages of Continuous audit?

3. Differentiate between statutory audit & Voluntary audit.

4. What is mean by Audit technique?


1) Cost audit primarily covers the ___________aspects of the enterprise.

(Financial, Cost, Human, Behavioral)

2) When the Auditor's staff is engaged continuously in checking the accounts of

the client during the whole year round or when the staff attends audit work at

some intervals, it is called a _______________.

(Concurrent audit, Voluntary audit, Continuous audit, Balance sheet audit)

3) __________________means examination of financial statements to express

an opinion thereon.

(Financial Audit, Cost Audit, Balance Sheet Audit, Concurrent Audit)

4) Propriety & efficiency of decisions & managerial actions are studied in

_______________ Audit.

(Cost, Statutory, Management, Financial)

5) Audit technique refers to the methods and means adopted by the auditor for

collection and evaluation of ____________________.

(Financial Information, Audit Evidence, Cost Data, Audit Procedure)

6) The audit which is prescribed by law i.e. governing by statute or by regulations

is called _____________

(Concurrent Audit, Statutory Audit, Voluntary Audit, Financial Audit)

7) An audit which is conducted between two annual audits is called an

_________________.

(Interim Audit, Balance Sheet Audit, Concurrent Audit, Continuous audit)

8) ________________ implies verification of transactions of a year on a

AUDITING - I (25)

NOTES

continuous basis.

(Concurrent Audit, Continuous audit, Statutory Audit, Cost Audit)

9) The ___________________ means Auditor reviews the Balance Sheet

and works back to the books of original entry and other evidences.

(Balance sheet audit, Continuous audit, Concurrent Audit, Cost Audit)

10) ____________________ helps the company to publish interim financial

statements for declaration of interim dividend.

(Interim audit, Balance sheet audit, Continuous audit, Cost Audit)

11) The scope of Voluntary audit is defined by ________________________.

(Law, Letter of engagement, Pronouncement by ICAI, Prospectus)

12) Auditor performs ______________________ of the items in the Financial

Statements.

(analytical review, compliance procedure, testing, sampling)

13) _______________ refer to the methods employed for carrying out the audit

procedure.

(Sampling, Testing, Techniques, Materiality)

14) ____________________ is purely optional and at discretion of the governing

body.

(Concurrent Audit, Statutory Audit, Voluntary Audit, Financial Audit)

15) In _____________________Assets & liabilities are verified only at time

of finalization at year end.

(Concurrent Audit, Continuous audit, Statutory Audit, Cost Audit)

(Answers: 1) Cost, 2) Continuous audit, 3) Financial audit, 4) Management,

5) Audit evidence, 6) Statutory audit, 7) Interim audit, 8) Concurrent audit, 9)

Balance sheet audit, 10) Interim audit, 11) Letter of engagement, 12) Analytical

review, 13) Techniques, 14) Voluntary audit, 15) Concurrent audit)


1. Audit Assurance Standards (AAS) issued by ICAI



Types of Audit

AUDITING - I

(26) AUDITING - I

NOTES

UNIT - 3

VOUCHER & VOUCHING

Structure

3.0 Introduction

3.1 Objectives

3.2 Vouching

3.3 Purpose of vouching

3.4 Objectives of vouching

3.5 Voucher

3.6 General Consideration in Audit of Ledger

3.7 Audit of Different Ledgers

3.7.1 Bought Ledger

3.7.2 Sales Ledger

3.7.3 General Ledger

3.8 Kinds of Frauds in relation to Ledgers

3.9 Key Concepts

3.10 Summary



3.0 Introduction

Auditing may be viewed as a practical application of the theory of evidence

or the science of proof to financial data. It is not just an inspection of evidence in

support and substantiation of accounting data but it involves and includes a critical

examination of the different business transactions themselves for an accounting

period. An auditor would like to assure himself of the validity, accuracy, adequacy,

authority and accountability.

3.1 Objectives


1. To understand the concept of Vouching.

2. To find out purpose and objectives of Vouching.

3. To be familiar with concept and various types of Voucher.

4. To know in detail about the audit of different ledgers.

5. To understand the nature of frauds in relation to ledgers.

AUDITING - I (27)

NOTES

3.2 Vouching

Vouching means inspection by an auditor of documentary evidence

supporting & substantiating transactions. Vouching is the process of

checking documentary evidence that the transactions are properly recorded

& accounted for.

The main aim of vouching is to inspect all receipts & payments are properly

accounted for & no fraudulent transactions are recorded. Vouching is a substantive

audit procedure to obtain evidence as to completeness, accuracy & validity. With

the help of vouching auditor come to know the genuineness of the transactions.

The duty of auditor is to see substantial accuracy of vouchers & then

make report thereon. Vouching is also the basis for assets & liabilities. Auditor

should be careful while vouching the transactions & entries in the books of accounts.

It is the backbone of auditing process. Thus, vouching may be considered as the

essence of auditing.

3.3 Purpose of Vouching

The purpose of vouching is to determine that-

lllll Classification: Transactions have been classified & disclose in accordance

with accounting policies.

lllll Accurate amount: Accurate amount has been recorded.

lllll Pertains to entity: Transactions are pertains to entity that took place during

the relevant period.

lllll Actual occurred: Transactions which have actually occurred have been

recorded.

lllll Proper Accounts: Transactions is recorded in proper account to proper

period.

3.4 Objectives of Vouching

Following are the objectives of vouching-

lllll To see that transactions & entries are properly recorded in the books of

accounts.

lllll To see that entries & transactions are properly authenticated by reasonable

person.

lllll To see that transactions have been properly classified & disclosed in

accordance with the accounting policies.

lllll To see that no fraudulent transactions are recorded in books of accounts.

lllll To see that all entries & transactions are supported by proper evidence.

3.5 Voucher

A voucher is documentary evidence in support of any transaction in books

of accounts. Voucher can originate within the organization or outside the organization

Voucher & Vouching

CHECK YOUR

PROGRESS

Define objectives of

vouching?

AUDITING - I

(28) AUDITING - I

NOTES

i.e. they can be internal or external. Eg. Internal voucher: invoices for purchase &

sale, receipts, counterfoils, slip of bank, etc. External voucher: consignment stock,

mortgage deed, etc.

Vouchers are of two types:

l l l l l Primary voucher: All written evidences in original are primary vouchers.

l l l l l Secondary voucher: Copies of original vouchers are called collateral vouchers.

Material Defects in Voucher:

Following are the material defect that disqualify the vouchers-

1. Voucher not addressed to the client.

2. Voucher not duly authorized for payment.

3. Voucher concerning purchases & expenses not related to business.

4. Voucher not pertaining to period under audit.

5. Payment not acknowledge against voucher.

6. Voucher in respect of which goods or services have not been received.

7. Date of voucher significantly different from the date on which entry was

made.

8. Amount of voucher not agreed with corresponding entry.

9. Amount altered, erased in voucher without proper authorization.

Care to be taken while Vouching:

1. Voucher must be dated & serially numbered.

2. Information on the voucher should fully explain the transactions.

3. Date of voucher should match with corresponding entry.

4. Auditor should satisfy that transactions are authentic i.e. genion

5. Voucher should be passed by responsible officer.

6. Distinction should be made between capital & revenue expenditure.

7. Amount on voucher should be checked.

8. The period for payment should be noted.

9. Proper care should be taken to see that transaction is not recorded twice.

10. Alteration in voucher must be authorized by proper person.

11. Prepare a list of missing & incomplete vouchers should be prepared.

12. Auditor should stamp the voucher seen.

3.6 General Considerations in Audit of Ledgers

Following steps involves in the audit of ledger-

1. Testing the strength & quality of internal check.

2. Tracing the opening balances from the previous year records.

3. Checking the posting from the subsidiary books.

AUDITING - I (29)

NOTES

4. Checking the closing balances of individual accounts.

5. Checking the totals of ledger accounts, trial balance, schedules.

6. Verifying the balances in personal accounts, either through statement of

accounts or external confirmation.

7. Scrutinizing the accounts generally & examining the composition of final

balances.

8. Ascertaining the clearness of balances brought forward from the previous

year.

9. Tallying the totals of balances in subsidiary ledgers which are kept on self

balancing system.

10. Verifying the balances in impersonal accounts viz. those of fixed assets,

bank balances, etc. with details of assets & liabilities.

Different ledgers:

l l l l l Bought ledger

l l l l l Sales ledger

l l l l l Nominal ledger

3.7 Audit of Different Ledgers

3.7.1 Bought Ledger:

Following are the steps for the audit of bought ledger-

a) Verification of opening balances: Opening balances of the bought ledger

would be verified from audited accounts & schedules. For that purpose auditor

has to know whether audit of that enterprise would actually conduct or not.

b) Internal Control System: Auditor has to check the internal control system.

He should verify the system & check whether proper allocation of functional

responsibilities within the organization.

c) Checking of posting: Next step of audit of bought ledger is the checking of

posting into ledger from cash book, purchase register, bills payable book,

journal, & other relevant books of accounts. While checking the posting auditor

should see that correct amounts are posted on the correct side of proper

account.

d) Checking of totals: Auditor should check the totals & casting of each

account. Carry forwards & brought forward should be properly checked.

e ) Checking of summary balances: Auditor should obtain the summary of

balances of the bought ledger. He should see the correct amount is shown

against every party.

f) General checking:

lllll Scanning Accounts: The client should be requested to write in the ledger

also the bill number for which credit is given. Similarly a reference bill while

making the payment should also be made when the party's account is debited.

This will enable both the accountant & the auditor to find out-

Voucher & Vouching

AUDITING - I

(30) AUDITING - I

NOTES

i. Whether there is any dispute in respect of any invoice.

ii. Whether any posting is left out or wrongly done.

iii. Whether goods have been received against advance made.

iv. The composition of the closing balances.

lllll Debit balances in the bought ledger: The auditor may come across

debit balances in some of the suppliers accounts in the bought ledger; this

requires a detailed scrutiny of such accounts. Sometimes, advance given

against the goods turn out to be more than the amount of bill. Here auditor

should find out whether the excess amount paid is received subsequently or

not. The auditor should verify in detailed & find out the reasons of such debit

balances & take all possible precautions.

lllll Confirmation of balances: The client may send the statement of account

to the party to confirm the same & then send it back. The client would be

requested to confirm the balance & write back. All replies should be

investigated independently of the person of in charge.

lllll Summary: Examination of the bought ledgers can be summarized as under-

- Review of the internal control system.

- Check up the opening balances.

- Check up postings, castings, etc.

- Check up the summary of bought ledger & compare with control

accounts.

- Review of confirmation received.

- At the year end examine the cut off procedure, review the transactions

after the balance sheet date,

& secure the certificates.

3.7.2 Sales Ledger:

Sales ledger contains the accounts of customer. So, client's capital blocked

up in debtors & receivables. There must be proper control on all the receivables.

In the absence of such control, the receivables would not be collected in time & as

a result they may become doubtful of recovery & time barred. Following are the

stages for audit of sales ledger-

a) Verification of Internal Control System: Auditor has to check the internal

control system. He should verify the system & check whether proper allocation

of functional responsibilities within the organization.

b) Verification of Opening balances: The auditor will check up the opening

balances of sales ledger. The control accounts should be verified in the general

ledger.

c) Checking of posting: The next stage of the audit of sales ledger is the

checking of posting into the ledger from cash book, Sales register, bills

receivable book, sales return register, & other relevant books of accounts.

While checking the posting, auditor should see that correct amounts are posted

on the correct side of the proper account.

lllll Credit balances in the sales ledger: If the party has sent money in

excess of the invoice value, then there may be a credit balances. If the credit

note is issued to the customer, the customer may send the amount after

deducting the amount of the credit note.

CHECK YOUR

PROGRESS

Define procedure of

sales ledger Audit?

AUDITING - I (31)

NOTES

lllll Confirmation of balances: Confirmation of balances received from

customer is one of the most important evidence in support of balances in

customer's ledgers.

d) Checking of totals & casting: After the checking of posting, auditor should

verify the totals, carry forwards & brought over in each accounts.

e ) Checking of summary of balances: Auditor should obtain the summary of

the balances of sales ledger. The balance in each account would be traced

into the summary. Proper care should be taken to see that correct amount is

shown against the appropriate party.

f) General checking:

lllll Scanning of accounts: The client should be requested to mention in the

sales ledger the reference of the sales invoice while debiting the account of

the customer & also while receiving the amount or while adjusting the credit

note. This will enable the auditor to find out-

i. Whether there is any dispute in respect of any sales invoice.

ii. Whether any posting has been left out or any wrong posting has been

made.

iii. Whether goods have been dispatched against advances received.

The internal auditor or any other responsible officer should periodically see

that all the debtors periodically, at least once in year confirm the balances.

lllll Credit Policy of the Client: Auditor should collect the data regarding all

the customers, credit terms granted to these customers. He should also study

the credit policy granted by competitors.

lllll Classification of Debtors: While obtaining the summary of balances,

auditor also obtains the classification of all such debtors. Credit balances of

customer's ledger should be classified separately. Following points should

considered while verifying the classification of debtors-

i. Debts considered secured.

ii. Debts considered unsecured but good.

iii. Debts considered unsecured but doubtful of recovery.

g) Yearly Examination:

Yearly examination should include-

i. Cut - off procedure.

ii. Review of post Balance sheet transactions.

iii. Comparisons & ratios.

iv. Review of adequacy of the reserve of doubtful debts & reserve for discount.

v. Securing the confirmation of balances.

vi. Securing various classifications of the debtors.

Voucher & Vouching

AUDITING - I

(32) AUDITING - I

NOTES

3.7.3 General Ledger:

General ledger is also called as 'Nominal Ledger' or 'Impersonal Ledger'.

It contains all the balances which are ultimately included in profit & loss account &

balance sheet, it contains:

i. Nominal Accounts

ii. Real or Property Accounts

iii. Capital & Loan Accounts

iv. Control Accounts, etc.

lllll Audit of General Ledger can be divided into following stages:

Following are the stages for the audit of general ledger-

a) Verification of Internal Control System: Auditor has to check the internal

control system. He should verify the system & check whether proper allocation

of functional responsibilities within the organization.

b) Checking of Opening balances: The opening balances of the general ledger

are checked from the audited accounts of the previous year.

c) Checking of posting: Sales Register, Purchase Register, Return Register,

& other appropriate accounts. Entries are posted in general ledger from almost

all the books of accounts. Corresponding control accounts are also posted

from these books. While checking the posting, auditor should see that correct

amounts are posted in correct account & on correct side. He should also see

the item has remained un-posted.

d) Checking of Totals & Casting: After the checking of posting auditor should

check up the totals & casting. He should check up whether figures are properly

& correctly carried over to the next page.

e ) Checking the balances in Trial Balance: The next stage of checking of

the balances of general ledger in trial balances. Because the books are

recorded on the principle of double entry system of book keeping. The total

of debit side must equal to the credit side of the trial balance.

f) Scrutiny & Scanning of ledger accounts: The auditor must scrutinize all

the ledgers one by one & find out whether necessary adjustments are already

recorded. While scrutinizing the partner's capital accounts, auditor should

see whether the conditions laid down by the partnership deed are complied

with. Interest should be allowed on the capital at a rate decided by the

partnership deed.

3.8 Kinds of Frauds in Relation to Ledgers

Ledger keeper may commit some frauds by manipulating the entries in the

ledger. Some of the frauds which may be committed by ledger keeper are as

follows-

1. In the Bought Ledger/ Purchase Ledger/ Creditors Ledger:

Frauds may occurs like-

a. Crediting the supplier's account on the basis of a fictitious invoice.

CHECK YOUR

PROGRESS

Define different kinds

of frauds in relation to

ledger?

AUDITING - I (33)

NOTES

Subsequently misappropriating the payment made against the credit in

the suppliers account.

b. Suppressing a credit note issued by a supplier & misappropriating an

amount equivalent there to out of the payment made to him.

c. Crediting an amount due to a supplier not in his account but under a

fictitious name & misappropriating the amount paid against the credit

balance.

2. In the Sales Ledger / Debtors Ledger:

a. Fraud through Teeming & Lading method.

b. Adjusting a unauthorized credit on fictitious rebate, discount in the account

with a view to reduce the balance.

c. Writing off the amount receivable from a customer's bad debt account &

misappropriating an amount equivalent to credit.

3. In the Nominal Ledger:

a. Allocating an item of income or expenditure wrongly.

b. Understating or overstating the value of stocks, amount of prepaid expenses

or liabilities.

c. Capital expenditure charged as revenue expenditure or vice- versa.

3.9 Key Concepts

Vouching is the process of checking documentary evidence that the

transactions are properly recorded & accounted for.

A voucher is documentary evidence in support of any transaction in

books of accounts.

Primary voucher: All written evidences in original are primary vouchers.

Secondary voucher: Copies of original vouchers are called collateral

vouchers.

General ledger is also called as 'Nominal Ledger' or 'Impersonal

Ledger'. It contains all the balances which are ultimately included in profit

& loss account & balance sheet

3.10 Summary

Vouching means inspection by an auditor of documentary evidence

supporting & substantiating transactions. The main aim of vouching is to inspect all

receipts & payments are properly accounted for & no fraudulent transactions are

recorded. A voucher is documentary evidence in support of any transaction in

books of accounts. There are two types Vouchers i.e. Primary voucher and

Secondary voucher. Voucher must be dated & serially numbered. Voucher should

be passed by responsible officer. Auditor should checked opening and closing

balances, totals, trial balance, subsidiary books etc. while doing the audit of ledgers.

Specific consideration should be given while auditing Bought ledger, Sales ledger,

Nominal ledger.

Voucher & Vouching

AUDITING - I

(34) AUDITING - I

NOTES


1. What is mean by Vouching? What are the objectives of vouching?

2. Which care should be taken while vouching?

3. What is Voucher? State the material defects that disqualify the voucher?

4. How will you conduct the audit of bought ledger?

5. Which stapes will you follow while checking the sales ledger?

6. Explain some kinds of frauds which may occur in bought ledger & nominal

ledger?


1. ________________ is the process of checking documentary evidence that

the transactions are properly recorded & accounted for.

(Auditing, Vouching, Reporting, Verification)

2. _______________ is documentary evidence in support of any transaction

in books of accounts.

(Audit Program, Financial Statements, Voucher, Ledger)

3. Sales ledger contains the accounts of________________.

(Supplier, Customer, Lender, Banker)

4. _________________ is also called as 'Nominal Ledger' or 'Impersonal

Ledger'

(General ledger, Sales ledger, Bought ledger, None)

5. Ledger keeper may commit some ____________ by manipulating the entries

in the ledger.

(Error, Fraud, Plan, Program)

6. With the help of ____________auditor come to know the genuineness of

the transactions.

(Vouching, Reporting, Verification, Auditing)

7. The total of debit side must _______ to the credit side of the trial balance.

(more, lower, equal, more than or equal)

8. There are two types Vouchers i.e. Primary voucher and _____________

voucher.

(Duplicate, Secondary, Multiple, Triplicate)

9. Entries are posted in _____________from almost all the books of accounts.

(Journal, general ledger, trial balance, profit & loss a/c)

10. ____________ balances of customer's ledger should be classified separately.

(Credit, Debit, Both debit & credit, None)

11. ________________of balances received from customer is one of the most

important evidence in support of balances in customer's ledgers.

(Enquiry, Physical verification, Confirmation, Observation)

AUDITING - I (35)

NOTES

12. ______________ may be considered as the essence of auditing.

(Sampling, Vouching, Reporting, Verification)

(Answers: 1)Vouching, 2) Voucher, 3) customer, 4) General ledger, 5) Fraud,

6) Vouching, 7) equal, 8) secondary, 9) general ledger, 10) credit, 11)

Confirmation, 12) Vouching)





Voucher & Vouching

AUDITING - I

(36) AUDITING - I

NOTES

UNIT 4

INTERNAL CHECK & ROLE OF

INTERNAL AUDITOR

Structure

4.0 Introduction

4.1 Objectives

4.2 Internal Control

4.3 Objectives of Internal Control

4.4 Essentials of Good Internal Control System

4.5 Inherent Limitations of Internal Control

4.6 Methods for the Proper Review & Evaluation of the Adequacy

of the Internal Control

4.7 Internal Check

4.7.1 Objects of Internal Check

4.8 Internal Audit

4.8.1 Basic Principles of Establishing Internal Auditing

4.8.2 Objectives of Internal Audit

4.9 Role of Internal Auditor

4.10 Possible areas of co-operation & co-ordination

4.11 Key Concepts

4.12 Summary



4.0 Introduction

In big organization internal audit is a part and parcel of internal control

system. In order to have detailed audit, internal audit is usually conducted in addition

to internal check system. An internal auditing consist of a continuous critical review

of financial and operating activities by a staff of auditors functioning as full time

salaried employees.

4.1 Objectives


1. To understand the concept of internal control.

2. To understand the essentials of Good Internal Control System.

3. To find out objectives and limitations of internal control.

4. To be familiar with the concept of Internal Check and Internal Audit.

5. To understand the role of Internal Auditor.

6. To learn the documentation requirement for Internal Audit.

AUDITING - I (37)

NOTES


The system of internal control has been defined as-

"The plan of organization and all the methods & procedures adopted

by the management of an entity to assist in achieving management's

objective of ensuring, as far as practicable,

i. Orderly & efficient conduct of the business

ii. Adherence to management policies

iii. Safeguarding of assets

iv. Prevention & detection of frauds & errors

v. Ensuring accuracy & completeness of the accounting records

vi. Timely preparation of reliable finance information"

Usually the control is entirely centralized with the owner & there is no

significant delegation of duties. However as the business grows in size, it soon

reaches a stage where the owner can no longer keep himself intimately informed

about the detailed operations of his business in such a case internal control becomes

very important. The reliability of business operations can be judged by the

effectiveness of internal control.

4.3 Objectives of Internal Control

i. Transactions are executed in accordance with management authorization.

ii. All transactions are recorded with appropriate amount & in appropriate

account.

iii. To prevent & detect frauds & errors.

iv. To prevent the assets from unauthorized access, use.

4.4 Essentials of Good Internal Control System

i. Proper allocation of functional responsibilities within the organization.

ii. The quality of personnel is very important. They should be competent &

honest.

iii. Implementation of proper operating & accounting procedures to ensure

the accuracy & reliability.

iv. The review of the work of one individual by another whereby the possibility

of fraud or error in the absence of collusion is minimized.

4.5 Inherent Limitations of Internal Control

Due to some inherent limitations of internal control, objectives of internal

control cannot be absolutely achieved. These limitations are as follows-

1. Many times control does not tend to be directed at transactions of unusual

nature.

Internal Check & Role of

Internal Auditor

CHECK YOUR

PROGRESS

Define concept of

internal control

system?

AUDITING - I

(38) AUDITING - I

NOTES

2. Management's consideration that a control be cost effective.

3. The potential for human errors.

4. The possibility that the person having higher authority may override a

control.

5. The possibility of deception of control through collusion with outside parties

or with employees of the entity.

6. The procedure may not work due to changes in conditions.

7. Manipulation by the management in the preparation of financial

statements.

4.6 Methods for the Proper Review & Evaluation of

the Adequacy of the Internal Control

Auditor can use the following tools to collect information required for the

proper review & evaluation of internal control-

1. Narrative Record:

a) It is complete & exhaustive description of the system as found in operation

by the auditor.

b) Actual testing & observation are necessary before such a record can be

developed. It is suitable for small businesses.

c) But it is difficult to understand the actual system.

d) There is weakness or gap in the internal control system cannot be easily

identified.

2. Check List:

a) This is series of instruction & / or questions which a member of the

auditing staff must follow & / or answer.

b) Answers to the check list instructions are usually Yes, No or Not

Applicable.

c) The auditor should study the complete check list to ascertain existence of

internal control & evaluate its implementation & efficiency.

3. Internal Control Questionnaire (ICQ):

a) Internal Control Questionnaire is a set of questions designed to provide a

thorough view of the state of internal control in an organization.

b) It contents the questions relating to-

- Purchases & Creditors

- Sales & Debtors

- Stocks

- Cash & Bank Receipts & Payments

- Fixed Assets etc.

AUDITING - I (39)

NOTES

c) The purpose of ICQ are-

Identifying Weaknesses:

Weakness in the Internal Control System can be known by examining

answers to the questions in the ICQ.

Extent of checking:

ICQ analysis enables the auditor to decide the extent & depth of checking

required in accounting areas & can pursue his work more objectively.

Proper Sampling:

ICQ analysis helps the auditor to select samples in a rational manner. He

can adopt a more detailed checking in weak control areas.

Audit Planning:

The audit programme can be modified if required. The programme can

be tailor-made to the needs of the specific situations.

4. Flowchart:

a) It is a graphical presentation of each part of the company's system internal

control.

b) It is most concise way of recording the auditor's review of the system.

c) It minimizes the amount of narrative explanation & thereby achieves a

consideration or presentation not possible in any other form.

d) It can be easily spotted & improvements can be suggested.

4.7 Internal Check

The internal check is the part of the whole system of internal control.

Internal check is "the allocation of the authority & work in such a

manner as to enable checks of the routine transactions of day to

day work by means of the work of one person being probed

independently by another, or the work of a person being

complementary to that of another."

4.7.1 Objects of Internal Check:

a) Proper division of work:

Division of work based on each individual's ability, training & specification

leads to overall efficiency & effectiveness.

b) Fixation of Responsibility:

The total work is divided into small units & responsibility for the same

fixed on individual workers. Due to clear determination of responsibility

each member of the staff knows what is expected of him & for any

fraud error originating of going undetected at his end, he alone will be

held responsible.

c) Minimization of errors & frauds :

Work performed by each individual checked by another individual in


Internal Auditor

CHECK YOUR

PROGRESS

Give in brief

objectives of internal

check?

AUDITING - I

(40) AUDITING - I

NOTES

ordinary course. There is considerable reduction in the incidence of errors

& fraud.

d) Reliability of books of accounts:

If an enterprise is operating an effective system of internal check, its

books of accounts & other records are relied upon by interested parties.

Even the statutory auditor confines his examination to selective test

checking, thus avoiding the need to undertake a detailed examination of

each & every transaction.

e ) Early detection of errors & frauds:

Work performed by each individual checked by another individual so, any

errors & fraud committed by an employee is likely to be discovered in

one by another.

f) Early preparation of final accounts:

Accounting data emanating under an effective system of internal check

can safely be used to prepare final accounts of the business in time.

4.8 Internal Audit

Many large organizations have system of internal audit within the

organization as an internal part of the internal control. They have a separate audit

department. The scope & function of this department vary considerably from

organization to organization.

Internal audit is the review of the various operations of the company & of

its records by staff specially appointed for the purpose. This review may be periodical

or may be even continuous.

The Institute of Internal auditors defines internal audit as under-

"Internal auditing is an independent appraisal activity within an

organization for the review of the accounting, financial & other operations

as a basis for protective & constructive services to the management. It is

a type of control which functions by measuring & evaluating the

effectiveness of the other type of control. It deals primarily with accounting

& financial matters but it may also properly deal with matters of an operating

nature."

Internal Audit is an integral part of internal control. It should be understood

that internal control is not merely internal check or internal audit; it is a system of

control as a whole.

4.8.1 Basic Principles of Establishing Internal Auditing:

i. Internal audit should have an independent status in the organization.

ii. Internal audit should be free from executive functions. Internal audit may

help in formulating executive decisions but it does not take part in

formulating the decisions.

iii. It must have unambiguous & clear understanding of the objectives.

iv. It can investigate any phase of the activities of the organization at any

time.

CHECK YOUR

PROGRESS

Define Internal Audit

briefly?

AUDITING - I (41)

NOTES

v. The staff of internal audit department should be adequately qualified so

that is working is success.

4.8.2 Objectives of Internal Audit:

a) Evaluation of accounting & administrative systems & controls:

Internal audit is concerned with ensuring effective & efficient system of

accounting control, standard cost control & other administrative controls.

b) Safeguarding of business assets:

It ascertains the accuracy, the integrity & the reliability of the financial &

other records. It assures the top management that the accounts & the

financial statements show a true view.

c) Compliance with established policies & procedures:

It is concerned with reporting to the management as to compliance with

predetermined policies, procedures & standards of performance.

d) Reliability of management data:

It assures the top management that the accounts & financial statements

show true & fair financial position.

e ) Prevention & detection of fraud:

It facilitates the prevention & detection of fraud & errors.

f) Making special investigations:

It takes up special investigation at the special request of the management.

g) Review of Internal Control System:

It reviews the operation of the overall internal control system & non

compliance to the notice of the appropriate level of management.

h) Suggesting improvements:

If the internal auditor finds any inadequacy & weakness in the working

of internal control in any area, he makes appropriate recommendations to

the management for the improvement of the system.

4.9 Role of Internal Auditor

1) Internal Auditor appointed by the management generally directors.

2) The scope of work is determined by management.

3) Internal auditor is responsible to the management.

4) The scope of work of an internal auditor may extend even beyond the

financial accounting & may include cost investigation, inquiries relating

to losses & wastages, production audit, performance audit etc.

5) He has to submit the audit report to the management.

6) Format of report is not prescribed.


Internal Auditor

AUDITING - I

(42) AUDITING - I

NOTES

4.10 Possible areas of Co-operation & Co-Ordination

1. Reliance on the work of Internal Auditor:

There should be co-ordination between statutory & internal auditor. The

internal auditor's report can provide valuable information on the working,

state of internal controls & specific areas of irregularities in the

organization. These reports help the statutory auditor to decide, whether

& to what extent, consistent with his statutory responsibilities he can rely

on the work of the internal auditor in order to reduce his own examination

of details. Statutory Auditor can rely on the work done by Internal Auditor

according to SA 610.

His decision in this matter will depend upon his judgment on the facts of

each case, having regard in particulars to the following-

i. The extent & efficiency of the internal auditor. Statutory auditor should

examine the internal audit programmes, working papers & reports &

should make test as he think fit.

ii. The experience & qualification of the internal auditor.

iii. Action taken by management on the basis of their report.

iv. Authority vested in the internal auditor & level of management to which

he is directly responsible.

In any event, the Statutory Auditor remains responsible for the

work done & report made by him irrespective of whether he has

put any reliance on the internal audit.

However, reliance on internal audit report does not relieve the

Statutory Auditor from any failure in the discharge of his

professional duty.

2. Usefulness of Internal Audit to the Statutory Auditor:

i. Generally the internal audit work carried out in organization is useful to

the statutory auditor because there are substantial similarities.

ii. He can concentrate on weak areas observed by internal audit or he may

curtail detailed checking when there was satisfactory coverage by internal

auditor.

iii. The degree of reliance on internal audit depends upon individual judgment

of the statutory auditor.

3. CARO Requirement:

Under CARO reporting requirement, the statutory auditor under the

Companies Act 1956, is required to report in case of

lllll Listed Companies or

lllll Companies having a paid up capital & reserves exceeding Rs. 50 lakhs

or

lllll Companies having an average turnover exceeding Rs. 5 crores for the

three financial years immediately preceding the financial years concerned.

Whether the Internal audit is commensurate with the size & nature of its

business.

CHECK YOUR

PROGRESS

Give the role of

Internal Auditor?

AUDITING - I (43)

NOTES

4. Reporting Responsibility:

The report of the External Auditor is his sole responsibility, & that

responsibility cannot by any means be reduced because of the reliance he places

on the Internal Auditor's work. The Internal Audit function cannot have the same

degree of independence as is essential when the external auditor expresses his

opinion on financial information.

Thus, the relationship between internal & statutory auditor is a professional

relationship where in both can benefit from each other.

4.11 Key Concepts

Internal control is a system which judges the reliability of business

operations.

Internal check is "the allocation of the authority & work in such a manner

as to enable checks of the routine transactions of day to day work by means of the

work of one person being probed independently by another, or the work of a person

being complementary to that of another."


organization for the review of the accounting, financial & other operations as a

basis for protective & constructive services to the management. It is a type of

control which functions by measuring & evaluating the effectiveness of the other

type of control. It deals primarily with accounting & financial matters but it may

also properly deal with matters of an operating nature."

4.12 Summary

The reliability of business operations can be judged by the effectiveness of

internal control. Internal control is required to prevent & detect frauds, errors and

to prevent the assets from unauthorized access, use. Implementation of proper

operating & accounting procedures are essential to ensure the accuracy & reliability

of Internal Control System. Narrative Record, Check List, Internal Control

Questionnaire (ICQ), Flowchart are the methods for the proper review & evaluation

of the adequacy of the Internal Control. The internal check is the part of the whole

system of internal control. Internal audit is the review of the various operations of

the company & of its records by staff specially appointed for the purpose. There

should be co-ordination between statutory & internal auditor. In any event, the

Statutory Auditor remains responsible for the work done & report made by him

irrespective of whether he has put any reliance on the internal audit. However,

reliance on internal audit report does not relieve the Statutory Auditor from any

failure in the discharge of his professional duty.


1. Define the term Internal Control. What are the objectives of Internal

Control?

2. How many methods for evaluation of the adequacy of Internal Control?

Explain in brief.

3. What are the objectives of Internal Check?

4. Define Internal Audit. State the objectives of Internal Audit?


Internal Auditor

AUDITING - I

(44) AUDITING - I

NOTES

l l l l l Fill in the blanks:

1) The reliability of business operations can be judged by the effectiveness of

____________.

(Internal Check, Internal Audit, Internal Control, Internal Policy)

2) _________________ is not merely internal check or internal audit; it is a

system of control as a whole.

(Internal Control, Internal Check, Internal Audit, Business policy)

3) The --------------- can be tailor-made to the needs of the specific situations.

(Checklist, Flowchart, Audit Programme, Internal Control)

4) ________________ is a graphical presentation of each part of the

company's system internal control.

(Checklist, Flowchart, Internal Control Questionnaire, Narrative Record)

5) --------------- is the review of the various operations of the company & of its

records by staff specially appointed for the purpose.

(Internal audit, Internal control, Internal check, Checklist)

6) In any event, the ---------------- remains responsible for the work done &

report made by him irrespective of whether he has put any reliance on the

internal audit.

(Internal Auditor, Management, Statutory Auditor, Cost Auditor)

7) ___________________ is an integral part of internal control.

(Internal Check, Internal Audit, Internal Control, Internal Policy)

8) ______________________ is a set of questions designed to provide a

thorough view of the state of internal control in an organization.


9) CARO applies to the companies having a paid up capital & reserves exceeding

Rs. _____________.

(25 lakhs, 5 crore, 50 lakhs, 70 lakhs)

10) There should be co-ordination between statutory &

_____________________.

(internal auditor, cost auditor, inspector, expert)

11) __________________ analysis helps the auditor to select samples in a

rational manner.


12) ________________ is complete & exhaustive description of the system as

found in operation by the auditor.

(Narrative Record, Checklist, Flowchart, Internal Control Questionnaire)

13) Usually the control is entirely centralized with the _____________.

(Auditor, Owner, Manager, Secretary)

(Answers: 1) Internal control, 2) Internal control, 3) Audit programme, 4)

flowchart, 5) Internal audit, 6) Statutory audit, 7) Internal audit, 8) Internal

control Questionnaire, 9) 50 lakhs, 10) Internal auditor, 11) Internal control

Questionnaire, 12) Narrative record, 13) Owner)





AUDITING - I (45)

NOTES

DocumentationUNIT 5

DOCUMENTATION

Structure

5.0 Introduction

5.1 Objectives

5.2 Documentation

5.2.1 Importance of Working Papers

5.2.2 Form & Content of Working Papers

5.2.3 Lien on Working Papers

5.2.4 Classification of Working Papers

5.3 Audit Note Book

5.4 Key Concepts

5.5 Summary



5.0 Introduction

Auditing has now become an analytical exercise which involves evaluating

the effectiveness of internal control procedures by examining selected samples of

transactions and applying analytical procedure. Auditor should document his overall

audit plan. The documentation will vary depending on the size, nature & complexity

of the audit. The auditor shall assemble the audit documentation in an audit file on

timely basis.

5.1 Objectives


1) To understand the importance of documentation.

2) To understand the concept of audit note book.

3) To know in detailed the lien on working papers.

5.2 Documentation

SA 230 on "Documentation" refers to working papers prepared or obtained

by the auditor & retained by him in connection with the performance of his audit.

The audit working paper constitutes the link between the auditor's report

& the client's records.

Working paper should record the audit plans. The nature, timing & extent

of auditing procedures performed & the conclusions drawn from the evidence

obtained. The working papers should provide for-

AUDITING - I

(46) AUDITING - I

NOTES

a. Means of controlling current audit work.

b. Supervision & review of the audit work.

c. Evidence of audit work performed to support the auditor's opinion.

Working papers should also prove the evidence of work performed

in case of charge of negligence brought against the auditors.

5.2.1 Importance of Working Papers:

The audit working papers are of vital importance whether the audit is statutory,

internal, or the management audit. Audit working papers are tool for accomplishing

the purpose of audit. Audit working papers record evidence gathered by the auditor

which will help him in arriving at his conclusions. Also they act as support for work

accomplished. Working papers are tool for accomplishing the purpose of audit.

The importance of working papers is as follows-

1) Provide the evidence of the audit work performed to support the auditor's

opinion.

2) Aid in planning & performance of audit.

3) Aid in the supervision & review of the audit work.

4) Record & demonstrate the audit work from one tear to another.

5) Plan the timing & extent of audit procedures to be performed.

6) Draw conclusions from the evidence obtained.

7) Standardize the working papers to improve the efficiency of the audit.

8) Facilitate the delegation of work as a means to control its quality.

9) Provide the guidance to the audit staff with regard to the manner of

checking schedules.

10) Fix responsibility on the staff members.

11) Act as evidence in Court of law when a charge of negligence is brought

against the auditor.

5.2.2 Form & Content of Working Papers:

The form & content of audit working papers may vary from one audit to

other. If the auditor identified inconsistent information, the auditor shall document

how the auditor addressed the inconsistency. The form & content of audit working

papers are affected by matters like:

a. Nature of Engagement.

b. Form of auditor's report.

c. Nature & complexity of client's business.

d. Nature & condition of client's records.

e. Degree of reliance on internal control.

CHECK YOUR

PROGRESS

What is working

papers?

AUDITING - I (47)

NOTES

Format of working paper:

Name of client

(----------------------------------)

Date: ----------------

Nature of engagement: -------------------

Nature & complexity of client's business: ------------------------------

Nature & conditions of client's records: -------------------------------

Form of auditor's report: -------------------------------

Signature:

--------------------------

(Name of Auditor)

5.2.3 Lien on Working Papers:

I. Ownership:

The working papers are the property of the Auditor. The Auditor may at

his discretion, make portions of or extracts from his working papers available to his

clients. The ownership of working papers belongs to the auditor. However he may

make copies available to the client.

II. Custody:

The Auditor should take proper measures for custody & confidentiality of

his working papers.

III. Retention Period:

The working papers should be retained for a period of time sufficient to

meet the needs of his practice & satisfy any legal or professional requirement of

record retention. Working papers should be requires to retain at least 7 years (earlier

10 years) from the date of auditor's report.

IV. Lien:

Lien arises only in case of other person's property. Hence, the question of

lien on the working papers does not arise since they belong to the auditor.

5.2.4 Classification of Working Papers:

i. Permanent Audit File

ii. Current Audit File

The auditor shall assemble the audit documentation in an audit file &

completed the administrative process of assembling the final audit file on a timely

basis after the date of auditor's report.

After the assembly, the auditor shall not delete audit documentation before

the end of its retention period.

Documentation

CHECK YOUR

PROGRESS

Describe Lien on

working papers?

AUDITING - I

(48) AUDITING - I

NOTES

i. Permanent Audit File:

They are updated with information regarding legal & organizational structure

of the entity. This file contains all the papers & documents which have a long term

use. They can be referred to on a repetitive engagement from year to year.

lllll Contents of Permanent Audit File:

Following types of working papers are kept & maintained in the permanent

file-

a) Certified copies of the Memorandum of Association, Articles of

Association in case of companies & Partnership Deed in the case of

Partnership Firm.

b) Extracts of minutes from minute book of shareholders, directors.

c) Copies of all the important agreements & contracts & other documents.

d) Information about the company-

I. History of company

II. Location of various offices & factories & nature of business.

III. List of Executives & Officers & their duties.

IV. Different departments & their functions.

e) Details of holding & subsidiary company.

f) A list of directors including-

I. Details of their other directorship

II. Details of other firms & companies in which they are directly or

indirectly interested

III. Details of their membership of other companies or partnership firms

or proprietary business or membership of other public bodies, trusts, etc.

g) Information regarding internal control in the organization.

h) A list of books of accounts & other registers.

i) Compilation of tax returns & tax proceedings.

j) Important details of cases filed by or against the client.

k) Compilation of data of the balance sheet & profit & loss account

&comparative statements.

lllll Advantages of Permanent Audit File:

1. It is very convenient for easy reference. All important data is available in

one file at one place.

2. It enables to auditor to prepare check list of all the important items.

3. It is a guide for the preparation of an audit programme.

4. It acts as reference book to seniors & other assistants who are fresh to

the work.

5. It helps in finalizing the annual accounts & auditor's report. It also helps

to review the work of the client.

CHECK YOUR

PROGRESS

What is Audit file?

AUDITING - I (49)

NOTES

ii. Current Audit File:

They contain information relating primarily to the audit of single period.

All the papers which pertain to the year under audit are filed in current

file.

lllll Contents of Current Audit File:

The current file normally contains all the papers that pertains to the year under

audit. It includes the following-

a) The audit programme for the year.

b) The internal control questionnaire issued to client & replies.

c) Important adjustments or journal entries having a bearing on the final accounts.

d) The working Trial balance.

e) Bank reconciliation statements, all schedules, confirmation letters & replies.

f) Audit notes.

g) Record of work done.

h) Schedule of depreciation, computation of tax liability, computation of dividend.

i) Manuscript copies of current year's final accounts together with all annexure.

j) The manuscript working copy of the auditor's report.

5.3 Audit Note Book

1. Meaning:

An audit notebook is bound book in which a variety of matters observed

during the course of audit are recorded. It is a notebook containing points

or queries that require clarification, explanation & investigation & the

manner in which they are finally settled.

2. Structure:

The Audit notebook is generally divided into two parts-

For keeping a record of general information as regards the audit as whole

&

For regarding special points which have been observed during the course

of audit of the accounts of particular year.

3. Contents:

lllll General information containing -

i. Nature of business carried on

ii. Structure of the financial & administrative organization

iii. A list of books of accounts

iv. Names of principal officers, their duties & responsibilities

Documentation

CHECK YOUR

PROGRESS

Describe in brief Audit

Notebook?

AUDITING - I

(50) AUDITING - I

NOTES

v. Particulars of the accounting & financial policies followed

vi. Important contracts to which the client is a party.

lllll Current information containing-

i. Audit queries not cleared immediately

ii. Mistakes or irregularities observed during the course of audit

iii. Important matters for future reference

iv. Unsatisfactory bookkeeping arrangements, costing method, internal control,

etc.

v. Special points requiring considerations at time of verification of final

accounts

5.4 Key Concepts

"Documentation" refers to working papers prepared or obtained by the

auditor & retained by him in connection with the performance of his audit.

An audit notebook is bound book in which a variety of matters observed

during the course of audit are recorded.

5.5 Summary

Audit working papers record evidence gathered by the auditor which will

help him in arriving at his conclusions. The Auditor may at his discretion, make

portions of or extracts from his working papers available to his clients. The ownership

of working papers belongs to the auditor. Lien arises only in case of other person's

property. Permanent file contains all the papers & documents which have a long

term use. All the papers which pertain to the year under audit are filed in current

file.


1. What is Documentation? State the importance of working papers.

2. Discuss the contents of permanent audit file.

3. What is the lien on working papers?


1) SA 230 on "___________________" refers to working papers prepared or

obtained by the auditor & retained by him in connection with the performance

of his audit.

(Planning, Documentation, Audit Evidence, Materiality)

2) ----------------- is bound book in which a variety of matters observed during

the course of audit are recorded.

(Audit Notebook, Audit File, Audit Programme, Audit Plan)

AUDITING - I (51)

NOTES

3) _____________ arises only in case of other person's property.

(Lease, Pledge, Lien, Mortgage)

4) The audit working paper constitutes the link between the ________________

& the client's records.

(Board's Report, Auditor's Report, Annual Report, Combine Report)

5) ______________________are tool for accomplishing the purpose of audit.

(Working papers, Audit Programme, Audit Report, Annual Report)

6) _____________________provide the evidence of the audit work performed

to support the auditor's opinion.

(Audit program, Audit report, Audit working paper, Annual report)

7) All the papers which pertain to the year under audit are filed in

______________.

(Permanent file, Current file, Folder file, Computer file)

8) ____________file contains all the papers & documents which have a long

term use.

(Permanent file, Current file, Folder file, Computer file)

9) The working papers are the property of the ______________.

(Client, Director, Auditor, Management)

10) The question of lien on the ____________________ does not arise since

they belong to the auditor.

(Working papers, Audit Programme, Audit Report, Annual Report)

11) The Auditor should take proper measures for custody & confidentiality of his

working papers.

(Director, Auditor, Manager, Secretary)

12) The auditor shall not delete audit documentation before the end of its

____________ period.

(Retention, Audit, Lien, Permanent)

(Answers: 1) Documentation, 2) Audit notebook, 3) Lien, 4) Auditor's report,

5) working papers, 6) Audit working papers, 7) Current file, 8) permanent

file, 9) Auditor, 10) Working papers, 11) Auditor, 12) Retention)





Documentation

AUDITING - I

(52) AUDITING - I

NOTES

UNIT - 6

FRAUDS - THEIR DETECTION &

PREVENTION

Structure

6.0 Introduction

6.1 Objectives

6.2 Frauds

6.3 Errors

6.4 Reasons & Circumstances of Frauds & Errors

6.5 Auditor's responsibility for non detection of frauds & errors

6.6 Events which increases the risk of fraud or error

6.7 Inherent limitation of an audit in relation to frauds & errors

6.8 Types of fraud

6.9 Internal Audit


6.10.1 Elements of internal control

6.11 Investigation for suspected frauds

6.12 Key Concepts

6.13 Summary



6.0 Introduction

Audit means systematic examination of records with a view to give opinion

of true and fair view of financial statement .Such opinion is depend upon evidences

which collected in audit procedure. Internal control is important tool in the hands of

management and auditor to prevent fraud and mal practices in business.

6.1 Objectives


1. To understand the concept of fraud and error.

2. To analyze the reasons & circumstances of Frauds & Errors

3. To find out events which increases the risk of fraud or error

4. To be familiar with types of fraud

5. To understand the elements of internal control.

6. To learn the investigation process for suspected frauds

AUDITING - I (53)

NOTES

Frauds - Their Detection

& Prevention6.2 Frauds

According to SA 240 "The fraud refers to intentional misrepresentations

regarding financial information by one or more individuals among management,

employees or third parties."

Fraud may involve:

a. Manipulation, falsification or alteration of records or documents.

b. Misappropriation of assets.

c. Suppression or omission of transactions from records.

d. Recording of transaction without substance.

e. Misapplication of the accounting policies knowingly.

Fraud may be classified as-

i. Misappropriation or embezzlement of cash

ii. Teeming & lading

iii. Misappropriation of goods

iv. Forgery of vouchers

v. Services rendered but not accounted for

vi. Manipulation & falsification of accounts

vii. Window dressing

6.3 Errors

"The term error refers to unintentional mistake in financial information."

Error includes:

a. Mathematical or clerical mistake in the records.

b. Oversight or misinterpretation of facts.

c. Misapplication of accounting policies unknowingly.

Fraud may be perpetrated by manipulation of accounts. Errors on the other

hand, may creep in accounts due to omission or clerical errors on the part of

employees.

Errors may classified as-

i. Errors of omission

ii. Errors of commission

iii. Errors of principle

iv. Errors of duplication

v. Compensating errors

CHECK YOUR

PROGRESS

Difference between

Fraud and Error?

AUDITING - I

(54) AUDITING - I

NOTES

6.4 Reasons & Circumstances of Frauds & Errors

1. Ignorance of employees about accepted accounting principles & policies.

This happens due to not knowing something.

2. Inappropriate account classification by employees during reconciliation

of subsidiary ledgers with the controlling accounts.

3. Carelessness on the part of those involved in the accounting work.

4. A desire to conceal the effect of defalcations or shortages of one kind or

another.

5. A tendency of the management to permit prejudice or bias to influence

the interpretation of transactions or their presentation in the financial

statements.

6. With the purpose of tax evasion.

7. Intentional efforts committed by person-

a. To show up or depress the picture

b. Convert the error to a personal benefit.

6.5 Auditor’s responsibility for non detection of

Frauds & Errors

The responsibility of prevention & detection of fraud & error rests with

the management through the implementation & continued operation of an adequate

system of internal control.

i. A financial audit is conducted by the auditor to obtain reasonable assurance

that financial statements are free from material misstatements caused by

fraud or error.

ii. Due to certain inherent limitations even & audit which is properly planned

& performed in accordance with generally accepted auditing standards,

may fail to detect a cleverly concealed fraud. This particularly happens

in cases of frauds involving forgery or collusion among employees or

management. The auditor thus, cannot be held responsible for the

prevention & detection of frauds & error.

iii. The term reasonable assurance implies that some risk of material

misstatement could be present in financial statements which auditor may

fails to detect. So, he should consider the risk of material misstatement

resulting from fraud during all stages of the audit process.

iv. The auditor should approach his work with a certain degree of professional

skepticism in order to be alert to any signals of misstatement. However,

does not imply that he should approach his work with suspicion. Unless

there is a reasonable ground of doubt the auditor should not question the

authenticity of documents & records.

AUDITING - I (55)

NOTES


& Prevention

v. Auditor should discuss with his audit team about the susceptibility of the

entity's financial statements & design audit procedure accordingly.

vi. To assess the risk of material misstatement resulting from fraud, the auditor

should-considered whether fraud risk factors are present that indicate

the possibility of fraud. Make enquiries of the management to obtain

information about its understanding & assessment of likelihood of fraud

occurring within the entity.

6.6 Events which increases the risk of fraud or Error

SA 240 on fraud & errors lists the following events which may increase

the risk of fraud & error-

i. Weakness in design of internal control system & non-compliance with

laid down control procedures.

ii. Doubts about the integrity or competence of the management.

iii. Unusual pressures within the entity.

iv. Unusual transactions such as transactions with related parties, excessive

payment for certain services.

v. Problems in obtaining sufficient & appropriate audit evidence.

6.7 Inherent limitation of an Audit in relation to

Frauds & Errors

i. Management role:

Primarily it is the responsibility of management to design & implement

the suitable system of internal control to-

lllll Safeguard the assets &

lllll Prevent frauds & defalcations.

ii. Auditor's role:

During the audit auditor should-

lllll Bear in mind the possibility of existence of fraud or other irregularities.

lllll Devise procedures & use techniques to ensure discovery of all frauds &

errors.

lllll Extent his audit procedure to confirm his suspicion on the probable

existence of any fraud or error.

iii. Objective of an audit:

An auditor is not intended & cannot be relied to disclose all defalcations

& other irregularities. However, the auditor does not guarantee that once

he has signed the report on the accounts no fraud exists.

CHECK YOUR

PROGRESS

Describe Inherent

limitation of an Audit

in relation to Frauds

and Errors?

AUDITING - I

(56) AUDITING - I

NOTES

iv. Auditor's responsibility:

The auditor is only requires to conduct the audit by exercising reasonable

care & skill in consonance with professional standards expected of him.

6.8 Types of Fraud

i. Misappropriation or embezzlement of cash:

Misappropriation means wrongful conversion or fraudulent application of cash.

Embezzlement means any fraudulent application of another's property by

any person to whom it has been entrusted.

Misappropriation or embezzlement may be committed by-

lllll Non recording of cash sales.

lllll Making false entries in account of customers.

lllll Showing payments against purchases never made.

lllll Non recording of credit notes for purchase return.

lllll Non recording of cash received against unusual sales.

ii. Misappropriation of goods:

It may be committed by recording wrong purchases. Fraud by way of

misappropriation of goods is easier to commit in case of goods which though

high priced & not bulky. Fraud of such nature can be detected by-

lllll Proper maintenance of accounts as to purchases & sales.

lllll Regular stocktaking.

lllll Strict check on incoming & outgoing goods.

iii. Fraudulent manipulation of accounts:

Such fraud is caused when a person

lllll Make or causes a false entry in the business records.

lllll Altered, erased, removed or destroyed a true entry from records.

lllll Prevents the making of a true entry or causes the omission there of.

Generally, fraud by manipulation of accounts is committed by person holding

high positions in the business.

iv. Teeming & lading:

It is the one of the type of fraud that is committed in connection with the

receipt of cash. It means using the funds of the company for personal purpose

without any authority. If this type of fraud not prevented in time, it may lead

to bigger fraud. This can be prevented by-

lllll The transactions are in cheques.

lllll The work of collecting cash, depositing into bank, recording the same in

cashbook & of issuing receipts shall be allocated that no one person in charge

of all these activities.

CHECK YOUR

PROGRESS

Give different types of

Fraud?

AUDITING - I (57)

NOTES


& Prevention

v. Window dressing:

It means the practice of arranging the disposition of assets & liabilities in

such a way that affairs of business as shown in subsequent balance sheet do

not truly represent the normal financial position.

a. Meaning:

Window dressing stands for mis-presentation of accounts with a view to

present a better picture of the state of financial affairs than it's actual. The

window dressing thus shows an improved financial position than what it really

is.

b. Difficult to detect:

The detection of such manipulation of account is difficult because-

lllll Generally the persons in higher management are associated with this

manipulation &

lllll It is done in methodical manner.

c. Methods:

Window dressing can be done in various ways-

lllll Selecting inappropriate accounting principles. Eg. Method of depreciation

lllll Capitalizing revenue expenses or vice versa.

lllll Grouping items in different manner.

lllll Treating certain items differently on the basis of legal interpretation, etc.

d. Objects of window dressing:

lllll To show more profit & to give managerial personnel more remuneration

where remuneration is linked with profit.

lllll To attract more loans, credits etc. from bankers & financial institutions.

lllll To avoid incidence of income tax or other taxes.

lllll To declare dividends when there are insufficient profits.

lllll To attract potential investors for subscribing the public issues.

6.9 Internal Audit

Many large organizations have system of internal audit within the

organization as an internal part of the internal control. They have a separate audit

department. The scope & function of this department vary considerably from

organization to organization.

Internal audit is the review of the various operations of the company & of

its records by staff specially appointed for the purpose. This review may be periodical

or may be even continuous.

The Institute of Internal auditors defines internal audit as under-


organization for the review of the accounting, financial & other operations

CHECK YOUR

PROGRESS

Define Internal Audit?

AUDITING - I

(58) AUDITING - I

NOTES

as a basis for protective & constructive services to the management. It is

a type of control which functions by measuring & evaluating the

effectiveness of the other type of control. It deals primarily with accounting

& financial matters but it may also properly deal with matters of an operating

nature."

Internal Audit is an integral part of internal control. It should be understood

that internal control is not merely internal check or internal audit; it is a system of

control as a whole.


Internal Controls are to be an integral part of any organization's financial

and business policies and procedures. Internal controls consist of all the measures

taken by the organization for the purpose of;

lllll Protecting its resources against waste, fraud, and inefficiency;

lllll Ensuring accuracy and reliability in accounting and operating data;

lllll Securing compliance with the policies of the organization;

lllll Evaluating the level of performance in all organizational units of the

organization. Internal controls are simply good business practices.

The system of internal control has been defined as-

"The plan of organization and all the methods & procedures adopted

by the management of an entity to assist in achieving management's

objective of ensuring, as far as practicable,

i. Orderly & efficient conduct of the business

ii. Adherence to management policies

iii. Safeguarding of assets

iv. Prevention & detection of frauds & errors

v. Ensuring accuracy & completeness of the accounting records

vi. Timely preparation of reliable finance information"

Usually the control is entirely centralized with the owner & there is no

significant delegation of duties. However as the business grows in size, it soon

reaches a stage where the owner can no longer keep himself intimately informed

about the detailed operations of his business in such a case internal control becomes

very important. The reliability of business operations can be judged by the

effectiveness of internal control.

The Internal Auditor role is to examine the adequacy and effectiveness of

the internal controls and make recommendations where control improvements are

needed. Since Internal Auditing is to remain independent, the Internal Auditor does

not have the primary responsibility for establishing or maintaining internal controls.

However, the effectiveness of the internal controls are enhanced through the reviews

performed and recommendations made by Internal Auditing.

6.10.1 Elements of internal control:

Internal control systems operate at different levels of effectiveness.

Following are some elements of the internal control system-

CHECK YOUR

PROGRESS

Define Internal

Control?

AUDITING - I (59)

NOTES


& Prevention

i. The Control Environment -

The control environment relates to the control consciousness of the people

within the organization. The control environment is the basis for all other components

of internal control.

ii. Risk Assessment -

Risk Assessment refers to the organization's identification, analysis, and

management of the risks that are related to the preparation of financial statement,

in order to ensure that financial statements are presented fairly and in compliance

with generally accepted accounting principles (GAAP).

iii. Control Activities -

Control Activities of the organization's policies and procedures which help

ensure that necessary actions are taken to address the potential risks involved in

accomplishing the entity's objectives.

iv. Information and Communication -

Information and Communication focuses "on the nature and quality of

information needed for effective control, the systems used to develop such

information, and reports necessary to communicate it effectively".

v. Monitoring -

Monitoring involves assessing the quality and effectiveness of the

organizations internal control system. It includes assessing the design and operation

of controls, and assessing compliance with policies and procedures. It also provides

for the implementation of appropriate actions whenever necessary.

6.11 Investigation for Suspected Frauds

1. For the purpose of these procedures, suspected fraudulent or irregular

activities would be where a public servant intentionally uses or abuses

the position for getting benefit the related entity.

2. Management is responsible for detecting improprieties. Each manager

should be familiar with the types of improprieties that might occur in the

area and be alert for any indication that such a defalcation, misappropriation

or irregularity is in existence in the manager's area. As soon as an

impropriety is suspected, it should be promptly reported.

3. During the initial stages of the inquiry into the suspected fraudulent and/

or irregular activities, a determination should be made jointly by staff and

system administration management, as to whether the matters reporting

to the management.

4. Upon review of the suspected frauds by the appropriate management

within system, a determination will be made as to the type of investigation

and by whom the investigation shall be conducted. Generally, appropriate

staff personnel will be involved in all investigation.

AUDITING - I

(60) AUDITING - I

NOTES

5. Investigations that are conducted by the auditor all proceed as follows:

lllll During the initial meeting discussions, the suspected fraud and irregularities

should be reviewed and the specific roles of the team representatives

defined. Information regarding the activities should be discussed.

lllll During the course of the investigation, periodic meetings should be

scheduled to discuss the progress of the investigation.

lllll Preliminary report of the investigation should be prepared and shared

with the investigation team members.

lllll Finalize the investigation report and submit with appropriate authority.

6. Management should take the appropriate actions relating to such frauds

which are investigated by the auditor & on which report has been

submitted.

6.12 Key Concepts

The fraud refers to intentional misrepresentations regarding financial

information by one or more individuals among management, employees or third

parties.

The term error refers to unintentional mistake in financial information.

Teeming & lading: It means using the funds of the company for personal

purpose without any authority.

Misappropriation means wrongful conversion or fraudulent application

of cash.

Window dressing stands for mis-presentation of accounts with a view to

present a better picture of the state of financial affairs than it's actual.

6.13 Summary

The fraud refers to intentional misrepresentations regarding financial

information by one or more individuals among management, employees or third

parties. The term error refers to unintentional mistake in financial information.

Ignorance of employees, inappropriate account classification, carelessness etc are

some of the reasons of frauds & errors. A financial audit is conducted by the

auditor to obtain reasonable assurance that financial statements are free from

material misstatements caused by fraud or error. Weakness in design of internal

control system & non-compliance with laid down control procedures may increase

the risk of fraud & error. Misappropriation or embezzlement of cash, misappropriation

of goods, fraudulent manipulation of accounts, teeming & lading, window dressing

etc. are various types of fraud. Internal control systems operate at different levels

of effectiveness. The Internal Auditor role is to examine the adequacy and

effectiveness of the internal controls and make recommendations where control

improvements are needed.


1. What is the Frauds & Errors?

2. What is the responsibility of auditor for non detection of frauds & errors?

AUDITING - I (61)

NOTES


& Prevention

3. Explain the types of frauds in detailed?

4. State the elements of Internal Control?

5. How will you conduct the investigation for suspected frauds?


1) The ________________ refers to intentional misrepresentations regarding

financial information by one or more individuals among management,

employees or third parties.

(Error, Fraud, Misstatement, Misrepresentation)

2) The term _______________ refers to unintentional mistake in financial

information.

(Error, Misstatement, Fraud, Misrepresentation)

3) The responsibility of prevention & detection of fraud & error rests with the

______________.

(Auditor, Management, Internal Auditor, Cost Auditor)

4) ------- may be perpetrated by manipulation of accounts. ----------- on the

other hand, may creep in accounts due to omission or clerical errors on the

part of employees.

(Error - Fraud, Fraud - Error, Fraud - Misrepresentation, Error -

Misrepresentation)

5) ______________________ means wrongful conversion or fraudulent

application of cash.

(Misrepresentation, Misappropriation, Teeming & lading, Window Dressing)

6) ___________________ means any fraudulent application of another's

property by any person to whom it has been entrusted.

(Embezzlement, Teeming & lading, Window Dressing, Misrepresentation)

7) ______________ means using the funds of the company for personal purpose

without any authority.

(Embezzlement, Teeming & lading, Window Dressing, Misrepresentation)

8) __________________ stands for mis-presentation of accounts with a view

to present a better picture of the state of financial affairs than its actual.

(Window dressing, Teeming & lading, Misrepresentation, Embezzlement)

9) The auditor shall not delete audit documentation before the end of its

__________ period.

(Audit, Permanent, Retention, Current)

10) ________________ report of the investigation should be prepared and shared

with the investigation team members.

(Final, Preliminary, Interim, Current)

11) ___________ involves assessing the quality and effectiveness of the

organizations internal control system.

(Monitoring, Auditing, Sampling, Testing)

AUDITING - I

(62) AUDITING - I

NOTES

12) Generally, __________ by manipulation of accounts is committed by person

holding high positions in the business.

(Error, Misstatement, Fraud, Misrepresentation)

13) Make _________enquiries of the management to obtain information about

its understanding & assessment of likelihood of fraud occurring within the

entity.

(Enquiry, Observation, Confirmation, Review)

14) Primarily it is the responsibility of _______________ to design & implement

the suitable system of internal control.

(Auditor, Expert, Management, Cost auditor)

15) ___________ deals with frauds & errors.

(SA 230, SA 240, SA 265, SA 260)

(Answers: 1) Fraud, 2) Error, 3) management, 4) Fraud - error, 5)

misappropriation, 6) Embezzlement, 7) Teeming & lading, 8) window dressing,

9) retention, 10) preliminary, 11) monitoring, 12) Fraud, 13) Enquiry, 14)

management, 15) SA 240)





AUDITING - I (63)

NOTES

Valuation & Verification

of AssetsUNIT - 7

VALUATION & VERIFICATION

OF ASSETS

Structure

7.0 Introduction

7.1 Objectives

7.2 Verification of Assets

7.3 General Consideration for Valuation & Verification of Assets

7.4 Valuation of Assets

7.4.1 Valuation of Fixed Assets

7.4.2 Valuation of Current / Floating Assets

7.4.3 Inventories (Stock in Trade)

7.4.4 Long term Work in Progress

7.4.5 Trade Debtors

7.4.6 Investments

7.4.7 Loans

7.4.8 Advances

7.4.9 Bank Balance

7.4.10 Cash balance on Hand

7.5 Key Concepts

7.6 Summary


7.8 Readings and References

7.0 Introduction

Balance Sheet is a statement which shows financial position of business

on particular date. Financial position means assets and liabilities. According to

Companies Act 1956, liabilities means sources of funds and assets means application

of those sources. Asset means investments which gives returns in future. Period

of investment classify the assets under two heads i.e. fixed assets and current

assets. For verification of fixed assets auditor follows systematic procedure to find

possession, title, ownership right and utility. This procedure gives auditor assurance

of systematic procurement of funds. Correct valuation of assets used for ascertaining

liquidity and solvency of business.

7.1 Objectives

1. To understand the concept of Verification of Assets.

2. To understand the concept of Valuation of Assets.

3. To be familiar with general principles in valuation & verification of fixed

assets.

4. To learn the process of valuation of different types of assets

AUDITING - I

(64) AUDITING - I

NOTES

7.2 Verification of Assets

Verification of assets is an important audit process; by convention its scope

has been limited to inspection of assets, where it is practicable & collection of

information about them in an examination of documentary & other evidence so as

to confirm that:

a. The assets were in existence on the balance sheet date.

b. The assets have been acquired for the purpose of the business & under

proper authority.

c. The right of ownership of the assets belongs to the undertaking.

d. They were free from any lien or charge not, disclosed in the balance

sheet.

e. They have been correctly valued having regard to their physical condition.

f. Their values are correctly disclosed in the balance sheet.

Verification of assets is primarily the responsibility of the management

since the proprietor of the entity. The auditors function in these circumstances is

limited only to an appraisal of the evidence, their inspection & reporting on matters

affecting their valuation.

7.3 General Consideration for Valuation &

Verification of Assets

The general principles in valuation & verification of fixed assets that an

auditor should follow are-

1. Existence:

To confirm that the assets were in existence on the date of the balance sheet

by-

i. Physical inspection

ii. Comparison of assets register with general ledger balances

iii. Obtaining confirmation from custodian of asset.

2. Authority:

To ascertain that the assets have been acquired for the purposes of business

& they are under proper authority.

3. Ownership:

To confirm that the rights of ownership of assets belonged to the client in

respect of assets appearing in the balance sheet. The fact of joint ownership

must be disclosed.

4. Charge:

To ascertain that no unauthorized charge has been created against any asset

& all the charges are duly registered & disclosed. In case of charge, a

certificate should be obtained from the bank showing the nature of charge.

CHECK YOUR

PROGRESS

Describe general

consideration for

valuation and

verification of Assets?

AUDITING - I (65)

NOTES

5. Cost:

i. To ascertain the original amount at which the assets was acquired, it

should verify with their invoices. All other expenses incurred to bring the

assets in the present working condition, should have been capitalized.

ii. Verify the invoices, purchase agreement or ownership rights & the sellers

receipt in respect of price paid.

6. Carrying amount:

To ensure that the assets have been correctly valued having regard to their

physical conditions, recoverability by-

i. Computation cost as per GAAP (Generally Accepted Accounting

Principles)

ii. Charging depreciation on scientific basis.

7. Disclosure:

To ascertain that the assets have been properly disclosed in the balance sheet

with regard to statutory requirement in accordance with Accounting Standards.

8. Sale of assets:

When the assets are sold, its sale proceeds should be vouched by reference

to the agreement, containing the terms & conditions of sale, counterfoil of the

receipt issued to the purchaser or any other evidence, which may be available.

Resulting profit arising from sale should be transferred to Capital Reserve. In

case of any loss should be transferred to profit & loss account.

7.4 Valuation of Assets

Valuation is not merely the determination of values of the assets as appearing

in the balance sheet but it also the critical examination of these values on the basis

of normally accepted accounting principles. Auditor is not the valuer, but he is

definitely connected intimately with valuation. For the purpose of valuation assets

are classified as follows-

i. Fixed Assets- Eg. Land, Building, Plant.

ii. Floating or Current or Circulating Assets-Eg. Debtors, Stock.

iii. Wasting Assets -Eg. Mines, Oil wells.

iv. Intangible Assets-Eg. Goodwill, Patent, Copyright.

v. Fictitious Assets-Eg. Preliminary exp., Discount on shares.

7.4.1 Valuation of Fixed Assets:

A fixed asset may be defined as an asset which is held with the intension

that it will be used for the production or long term purpose & not for sale in the

normal course of business. Accordingly-

a. They are carried over from year to year.


of Assets

AUDITING - I

(66) AUDITING - I

NOTES

b. They are relatively higher value.

c. In inflationary market condition, their book value is lower than their

replacement value.

Fixed Assets may be classified as-

i. Assets which are not subject to depreciation. Eg. Land- land having

infinite life & it's value always appreciate. Since land never depreciated.

ii. Assets which are subject to depreciation. Eg. Building, Plant &

machinery.

iii. Assets which are subject to depletion. Eg. Mines, Oil wells.

iv. Assets which are subject to amortized. Eg. Goodwill.

So,

lllll Non depreciable assets are valued - at cost price, including purchase

price, broker's commission, registration fees, legal fees & other expenses

on its conditioning.

lllll Depreciable assets are valued - at cost of purchase or construction, which

includes all incidental payments.

lllll Any fluctuations in the price are to be ignored because the assets are not

meant for resale & their usefulness to the business is not influenced by

their market price.

7.4.2 Valuation of Current / Floating Assets:

Floating assets are those current assets, which are purchased or created

in normal course of business. They are held temporarily for the purpose of ultimately

converting them into cash. Mainly these assets are two types-

i. Stock in trade &

ii. Debtors & receivables

Here,

lllll Debtors & bill receivables will be valued at their realizable value.

lllll Whereas stock valued differently-

- Raw material & work in progress should be normally valued at cost.

- Finished goods are valued at cost or NRV whichever is lower.

(NRV= Net Realizable Value)

l l l l l Audit of Current Assets:

- Auditor's responsibility as to valuation of assets does not end with merely

securing certificate of valuation from expert, including officials of client.

- He has a duty to take all reasonable steps & exercise due care to ensure

that the value of assets are shown in certificates does indeed represent a

true & fair.

- He is required to ascertain the valuation has been done in conformity

with legal & professional standards &

- Principles & practice governing valuation of assets have been consistently

followed.

AUDITING - I (67)

NOTES

7.4.3 Inventories ( Stock in Trade ):

Inventories constitute the single most important item affecting the results of operation

of an enterprises & its financial condition. Object of verification of inventories is-

- To ascertain that proper care has been taken in determining the physical

quantities & their conditions.

- To ensure that any lien or pledging of the goods is disclosed in the financial

statements.

- To assure that the quantities have been fairly & consistently priced in

accordance with accepted accounting principles.

l l l l l Some Important Points as to Inventory Verification:

A large part of inventory verification is done by client staff members.

Auditor should take the following precautions to ensure that inventory verification

is free of errors & frauds.

a) Auditor should examine the system of internal control to ascertain the

effectiveness of work. Proper segregation of responsibilities for custody

& accounting of stock in trade.

b) He should secure a copy of client's physical inventory verification

instruction in advance & see whether these contain adequate safeguards

against possible errors & frauds.

c) He should satisfy himself that proper & adequate records have been

maintained by client, & proper cutoff arrangements made. Any movement

of goods are properly added or deducted as required.

d) He should ensure that the methods regarding counting, weighing &

measuring of inventories are duly adhered to.

e) He should test check the physical existence of at least 5% of the items to

ascertain whether records do correctly represent the stock in hand.

f) He should check the original verification sheet to ascertain whether all

items are covered. Any difference between the physical count & inventory

record should be investigated & suitable adjustments made in records.

g) He should see that inventory lying with third parties, are included in

inventory sheets. It should also ensure that these are not counted twice.

h) He should work out the ratio between gross profit & sales & compare

with previous year. Any material difference between two should be

properly investigated.

i) Auditor should see that inventory is valued "at lower of cost or NRV".

Cost should be further defined as average, FIFO, etc.

l l l l l Valuation of Inventory:

i. Inventory should be valued in accordance with Accounting Standard 2.

ii. Management determines the basis on which the inventories are valued.

The normal basis is Cost or Net Realizable Value, whichever is lower.

iii. Cost is to be arrived at by taking the aggregate of costs of conversion &

other cost incurred in bringing inventory to the present location &

condition.

iv. The net realizable value is the estimated selling price in ordinary course

of business, less cost incurred in order to make the sale.


of Assets

AUDITING - I

(68) AUDITING - I

NOTES

7.4.4 Long term Work in Progress:

i. Auditor should ascertain by reference to appropriate evidence regarding

to the inventory of Work-in-progress (WIP) at the end of the accounting

year. Particularly in a situation where no cost system is in operation or

where a cost system is in operation but is not considered reliable.

ii. The auditor should review the procedure of stocktaking & also allocation

of material & wages to jobs has been done properly should be verified.

iii. Where physical verification is not conducted by the management, the

statement submitted by the management should be reviewed with other

internal records maintained.

iv. Auditor should follow the under mentioned procedure to test the reliability

of costing records,

- Ascertain that the cost sheets are duly attested by the works engineer &

works manager.

- Test the correctness of the cost as disclosed by the cost records with

reference to records maintained & original evidence in respect of all

expenditure included in cost sheet.

- Compare the unit cost or job cost as shown by the cost sheet with the

standard cost or estimates.

- Compare cost sheet in detail with the previous year's records. If they

vary materially, the causes thereof should be investigated.

v. To ascertain that the WIP is valued either at cost or net realizable value

whichever is lower. The auditor should also see that the mode of valuation.

vi. Certificate from the management should be obtained regarding quantity

& value of WIP.

7.4.5 Trade Debtors:

Following procedure should be adopted for verification of debtors-

i. Obtain a list of debtor balance & agree the total with a control account.

Tests should be performed on individual debtors account with nil balances.

ii. Scrutinize the control account for unusual items & test a selection of

balances.

iii. Agree a selection of receipts after the year end.

iv. Bad debts-

The auditor has to satisfy himself that adequate provision has been made

for all doubtful & bad debts. He must-

- Obtain a detailed age analysis of debtors & test the analysis.

- Obtain an analysis of the provision for doubtful debts.

- Scrutinize analysis & identify those debts which appear doubtful.

- Discuss with management their reasons, if any of those debts which

are not included in provision for bad debts.

- Perform further testing where any dispute exists.

- Reach the final conclusion regarding the adequacy of bad debts provision.

v. Cutoff Procedures:

Auditor will need to perform tests to ensure that-

AUDITING - I (69)

NOTES

- The last invoices issued during the year & which have been included in

debtors that the goods have been dispatched & the goods are not included

in stock.

- All goods dispatched prior to the year end have been removed from the

stock record & included in debtors.

- Goods sold after the year end is not included in year end debtors.

vi. Debtors Confirmation:

The auditor should-

- Obtain the client's permission.

- Decide the sample required &select the sample including nil balances.

- Control the posting of letters.

- Enclose a stamped addressed envelope & ensure that replies are received

by the auditor himself.

- Send reminders if replies are not received.

- Investigate thoroughly any balances which are not agreed by the

customers. Full explanations should be obtained.

- Where no reply is received the auditor should perform additional testing.

7.4.6 Investments:

The auditor is required to satisfy himself as regards the powers of the

enterprises under audit to make investments, by examining the documents such as

the "Memorandum of Association" in case of company. Investments may be

classified as-

l l l l l Marketable securities &

l l l l l Long term investments

Marketable securities are readily saleable, but long term investments which

are held with no likely intention to sell, are not so.

All investments should be held in the name of the client. If they are held in

the name of his nominee, the letter confirming the arrangement should be examined.

Investments should be verified by reference to the schedule of investment. The

schedule of investment should give particular as the date of purchase, name of

security, cost, market price, date of receipt or accrual of interest or dividend &

these should be tallied with the investment register.

The object of verification of investments is to ascertain that-

i. There is a valid evidence of their ownership & custody.

ii. They are properly classified in financial statement as current & long

term.

iii. There is adequate disclosure of any pledging, hypothecation.

iv. They are valued on a basis in accordance with legal & professional

standards.

Here, Current Investment - shown at cost or NRV, whichever is lower.

Long Term Investment - shown at cost. Except if there is permanent decline

in investment.


of Assets

AUDITING - I

(70) AUDITING - I

NOTES

7.4.7 Loans:

The auditor should take following step for verification of balances of loan-

i. Year end scrutiny to ascertain bad & doubtful debts & checking individual

balances in the ledger with the list of loans & advances.

ii. Inspection of loan agreements & the acknowledgements of parties in

respect of receipt.

iii. Examination of the sanction of loans by the board directors, the purpose

of the loans & compliance with the provisions.

iv. Ensuring the loan made by the company are intra-vires of power of the

company.

v. Examination of all the documents relating to the loan & satisfying that the

borrower is competent to receive the loan. The auditor should enquire

whether the lending company has satisfied itself about the loans compliance

by the borrower.

vi. In case of secured loans, inspecting the securities, collateral & other

documents of title & determining the security is adequate & title is clear.

7.4.8 Advances:

Advances include the amounts recoverable either in cash or in kind for value

to be received.

i. The auditor should obtain the list of advances & compare them with

balances in the ledger.

ii. He should ascertain that advances were made under proper authority &

were being recovered regularly by agreed installments. Where there is

an agreement, the same should be inspected.

iii. Auditor should ensure that adequate provision has been made in respect

of irrecoverable balances.

7.4.9 Bank Balance:

i. Auditor should compare the entries in cash book with those in the

passbook.

ii. A bank reconciliation statement prepared by the client should be checked.

iii. Auditor should also obtain the certificate from bank confirming the balance

at the yearend as shown in passbook.

iv. If bank account is overdrawn, auditor should obtain from bank particulars

of assets on which the charge has been created to secure the overdraft.

7.4.10 Cash balance on Hand:

i. The auditor should verify the cash in hand at the close of the business on

the last day of the financial year. If it is not possible then cash in hand

should be checked on some day close to year end.

ii. All cash should be assembled at one place & counted at same time to

avoid frauds.

iii. In case of outstation branches, certificate should be obtained from branch

manager. It should be ascertain that cash balance is not large in relation

to client's normal requirements.

AUDITING - I (71)

NOTES

iv. A statement should be prepared in duplicate showing the denomination &

number of currency notes, & values of coins & small change, which

have been counted. One copy of statement should be retained by the

auditor's staff & other copy should be given to the cashier.

7.5 Key Concepts

Verification of assets is an important audit process; by convention its

scope has been limited to inspection of assets.

Valuation of assets is not merely the determination of values of the assets

as appearing in the balance sheet but it also the critical examination of these values

on the basis of normally accepted accounting principles.

A fixed asset may be defined as an asset which is held with the intension

that it will be used for the production or long term purpose & not for sale in the

normal course of business.

Floating assets are those current assets, which are purchased or created

in normal course of business. They are held temporarily for the purpose of ultimately

converting them into cash.

7.6 Summary

Verification of assets is primarily the responsibility of the management



affecting their valuation. The general principles in valuation & verification of fixed

assets that an auditor should follow are- Existence, Cost, Charge, Ownership,

Authority, Carrying amount, Disclosure, Sale of assets.

Valuation is not merely the determination of values of the assets as appearing

in the balance sheet but it also the critical examination of these values on the basis

of normally accepted accounting principles. For the purpose of valuation assets

are classified as Fixed Assets, Floating or Current or Circulating Assets, Wasting

Assets ,Intangible Assets, Fictitious Assets.


1. Which principles auditor should follow for the valuation & verification of assets?

2. Which precautions auditor should take while verification of Inventory?

3. What is the procedure adopted for verification of debtors?


1) Verification of assets is primarily the responsibility of the___________ since

the proprietor of the entity.

(Statutory Auditor, Internal Auditor, Management, Cost Auditor)

2) ____________assets are those current assets, which are purchased or

created in normal course of business.

(Fixed assets, Floating assets, Intangible assets, Contingent assets)


of Assets

AUDITING - I

(72) AUDITING - I

NOTES

3) Inventory should be valued in accordance with Accounting Standard

____________.

(6, 1, 2, 10)

4) Current Investment shown at cost or ____________, whichever is lower.

(Market price, Net Realizable Value, Historical Value, Depreciable Value)

5) Auditor should compare the entries in _________________with those in

the passbook.

(Journal, Cash Book, Voucher, Receipt)

6) The auditor has to satisfy himself that adequate _____________ has been

made for all doubtful & bad debts.

(Provision, Reserve, Contingency, Provision & reserve)

7) A ____________ may be defined as an asset which is held with the intension

that it will be used for the production or long term purpose & not for sale in

the normal course of business.

(Fixed assets, Floating assets, Intangible assets, Contingent assets)

8) A bank reconciliation statement prepared by the _________should be

checked.

(Bank, Auditor, Client, Cost auditor)

9) ____________include the amounts recoverable either in cash or in kind for

value to be received.

(Inventory, Advances, Debtors, Bills receivable)

10) The ___________________ is the estimated selling price in ordinary course

of business, less cost incurred in order to make the sale.

(Net realizable value, Cost price, Market price, Future price)

11) All investments should be held in the name of the _________.

(Auditor, Client, Bank, Manager)

12) _______________________are readily saleable,

(Long term securities, Marketable securities, Current securities, Bank

securities)

13) Auditor is not the ______, but he is definitely connected intimately with

valuation.

(Valuer, Expert, Manager, Director)

(Answers: 1) Management, 2) Floating assets, 3) 2, 4) Net realizable value,

5) cash book, 6) provision, 7) Fixed assets, 8) client, 9) Advances, 10) Net

realizable value, 11) client, 12) Marketable securities, 13) Valuer)





AUDITING - I (73)

NOTES

UNIT 8

VALUATION & VERIFICATION OF

LIABILITIES

Structure

8.0 Introduction

8.1 Objectives

8.2 General principles to be followed in verification of liabilities

8.3 Verification of Liabilities

8.4 Valuation of Liabilities

8.4.1 Trade Creditors

8.4.2 Bills Payables

8.4.3 Outstanding Liabilities for expenses

8.4.4 Provision for Taxation

8.4.5 Contingent Liabilities

8.4.6 Debentures

8.5 Key Concepts

8.6 Summary



8.0 Introduction

Balance Sheet is a statement which shows financial position of business

on particular date. Financial position means assets and liabilities. According to

Companies Act 1956, liabilities means sources of funds. Valuation of liabilities includes

source, obligation, conditions for repay and verification of it depends upon documents

and rights to create it.

8.1 Objectives

1. To understand the process of Valuation of Liabilities.

2. To be familiar with general principles in verification of liabilities.

3. To learn the process of valuation of different types of liabilities.

8.2 General principles to be followed in verification

of Liabilities

1. The auditor has to report whether the Balance Sheet shows a true & fair

view of the state of affairs of company.


of Liabilities

AUDITING - I

(74) AUDITING - I

NOTES

2. If liabilities are not provided for in respect of expenses incurred or in

respect of the income received in advance both the Balance sheet &

Profit & loss A/c would not show true & fair practice.

3. He should verify all the liabilities in the Balance Sheet. Besides, he should

have a certificate from the top management in respect of all the known

liabilities.

4. The auditor should verify the all outstanding liabilities are recorded fully.

An understated liability has the effect of overstating the income & also

the net worth.

5. A liability should not be overstated also. An overstatement of liabilities

may lead to fraudulent disbursement.

6. Auditor should review the internal control system.

7. Auditor should satisfy himself that all liabilities, either actual or contingent,

are adequately disclosed in Balance Sheet. In case of over or

understatement of liability, he should qualify his Audit Report.

8.3 Verification of Liabilities

Verification of liabilities is an important audit process; by convention its

scope has been limited to inspection of liabilities, where it is practicable & collection

of information about them in an examination of documentary & other evidence so

as to confirm that:

a. The liabilities were in existence on the balance sheet date.

b. They have been correctly valued.

c. Their values are correctly disclosed in the balance sheet.

Verification of liabilities is primarily the responsibility of the management



affecting their valuation.

8.4 Valuation of Liabilities

Valuation is not merely the determination of values of the liabilities as

appearing in the balance sheet but it also the critical examination of these values on

the basis of normally accepted accounting principles.

8.4.1 Trade Creditors:

The auditor should-

i. Evaluate the system of internal control on purchase of goods & services

& payments thereof.

ii. Obtain a list of trade creditors & check with creditors' ledger.

iii. Scan the creditors account & judge nature of balance, nature of supplies

& disputes.

iv. Enquire the reasons, if any cheques remaining unpresented for a long

time.

CHECK YOUR

PROGRESS

Describe the rules for

verification of

Liabilities?

AUDITING - I (75)

NOTES

v. Seek confirmations of selected balances by asking the client.

vi. Reconcile the total amount of creditors list with the balance in control

account.

vii. Go though the goods inward book for the two or three weeks before the

close of the year. Similarly, the goods outward book should be seen.

viii. Compare the total amount outstanding at the end of previous year; see

that any material deviation is properly explained.

ix. Ensure that all bills for services rendered to company have been received

& accounted for & that in case where bills have not been received,

appropriate provisions have been created.

x. Check credits raised on account of supplies towards the end of the year

to ensure that they are normal & not for any possible manipulation of

accounts.

8.4.2 Bills Payable:

Where bills payable are large in number a separate register should be

maintained. Auditor should obtain from the client a list of bills payable as on the

close of the year. Bills payable which have been paid already can be verified from

the cash book. Other bills can be verified from other records. The cash book of the

subsequent period can be verified to see whether the bills have been paid. The

auditor may request the client to obtain a certificate from the drawer of the bill

confirming the amount of the bill payable and other conditions.

8.4.3 Outstanding Liabilities For Expenses:

1. Ask for the list of outstanding expenses classified by nature of expenses.

2. Compare the list of this year's outstanding expenses with that of the last

year to see the variations.

3. Verify the basis of estimation, carefully in case outstanding expenses are

provided on an estimated basis.

4. Verify the documentary evidence supporting the outstanding expenses.

5. See the usual outstanding expenses have been paid off.

6. Verify the reference to correspondences, minute book etc. that no

outstanding expenses has been incurred which have not been provided.

7. Ensure that outstanding expenses have been shown under current liabilities

in the Balance Sheet.

8. Examine the service contracts entered into by the client to see that all

outstanding expenses have been provided.

8.4.4 Provision For Taxation:

1. Ascertain tax liability & check the computation of assessable profit by

the client & compare with the profit & loss A/c.

2. Check the amount of tax as per the latest Finance Act.

3. Vouch advance tax paid & verify the calculations.


of Liabilities

AUDITING - I

(76) AUDITING - I

NOTES

4. Examine the copy of Income Tax Return, if already filed.

5. Ensure that the amount of overall provisions on the date of the Balance

Sheet is adequate.

6. Obtain a certificate from the practitioner, if other than auditor, regarding

the amount of tax payable.

8.4.5 Contingent Liabilities:

Contingent liability is a possible liability of present determinable amount or

one indeterminable which has aroused from past dealings or actions that may become

a legal obligation in the future. Following are the contingent liabilities-

l l l l l Bills discounted.

l l l l l Legal suits

l l l l l Guarantees given

l l l l l Capital commitment

l l l l l Investment in partly paid up shares

Following procedure should be adopted in verifying contingent liability-

i. Inspect the minute book of the company to ascertain all contingent liabilities

known to the company.

ii. Examine the contracts entered by the company & the likelihood of

contingent liability emanating there from.

iii. Scrutinize the lawyer's bills to track unreported contingent liability.

iv. Examine bank letters in respect of bills discounted & not matured.

v. Examine bank letters to ascertain guarantees given.

vi. Discuss with various functional officers of the company about possibility

of contingent liability.

vii. Obtain a certificate from the management that all known contingent

liabilities have been included in the accounts & they have been properly

disclosed.

The contingent liabilities should be disclosed by way of a footnote to the

balance sheet. AS-29 provides guidance in respect of contingent liabilities.

8.4.6 Debentures:

1. Auditor should verify the Trust Deed & examine the securities offered.

2. Auditor should verify the details of securities offered & could see that

the charge, if any is registered with the registrar of companies.

3. Interest is payable on the debentures half yearly in most of the cases.

Provision should be made in respect of the interest accrued but not due.

4. Auditor should verify the Memorandum & Article of Association to

examine whether the company has borrowing powers.

CHECK YOUR

PROGRESS

Define Contingent

Liabilities?

AUDITING - I (77)

NOTES

8.5 Key Concept

Contingent liability is a possible liability of present determinable amount or

one indeterminable which has aroused from past dealings or actions that may become

a legal obligation in the future.

8.6 Summary

The auditor has to report whether the Balance Sheet shows a true & fair

view of the state of affairs of company. For valuation of liabilities they are classified

into trade creditors and contingent liabilities. The contingent liabilities should be

disclosed by way of a footnote to the balance sheet.


1. Which principles auditor should follow for the valuation & verification

of liabilities?

2. What is mean by contingent liability? How will auditor verify the

Contingent liabilities?

3. What is the procedure adopted for verification of Trade creditors?

4. What is the procedure adopted for verification of Debentures?


1) AS-29 provides guidance in respect of _______________.

(Contingent Liability, Contingent Asset, Current Liability, Fixed Asset)

2) ______________ is a possible liability of present determinable amount or

one indeterminable which has aroused from past dealings or actions that may

become a legal obligation in the future.

(Contingent Asset, Contingent Liability, Fixed Asset, Current Liability)

3) The contingent liabilities should be disclosed by way of a footnote to the

____________.

(Balance Sheet, Trial Balance, Profit & loss A/c, Trading A/c)

4) Interest is payable on the debentures _____________ in most of the cases.

(Monthly, Quarterly, Half yearly, Yearly)

5) _________________ is a statement which shows financial position of

business on particular date.

(Balance Sheet, Trial Balance, Profit & loss A/c, Trading A/c)

6) Obtain a certificate from the ______________ that all known contingent

liabilities have been included in the accounts & they have been properly

disclosed.

(Cost auditor, Internal auditor, Management, Expert)

7) ____________Auditor should review the internal control system.

(Auditor, Manager, Expert, Cost auditor)


of Liabilities

AUDITING - I

(78) AUDITING - I

NOTES

8) Verification of liabilities is an important ___________ process.

(Testing, Audit, Sampling, Costing)

9) Obtain a list of trade creditors & check with ____________ ledger.

(Debtors, Inventory, Creditors, Bank)

(Answers: 1) Contingent liability, 2) Contingent liability, 3) Balance sheet, 4)

half yearly, 5) Balance sheet, 6) Management, 7) Auditor, 8) Audit, 9) Creditors)





AUDITING - I (79)

NOTES

UNIT - 9

COMPANY AUDIT IN BROAD LINE,

PROFIT AVAILABLE FOR DIVIDEND,

AUDITOR'S DUTIES

REGARDING RESERVES

Structure

9.0 Introduction

9.1 Objectives

9.2 Company Audit

9.3 Share Capital Audit

9.3.1 Auditor's duties regarding to audit of share capital

9.3.2 Shares underwritten placed for commission

9.3.3 Shares issued at premium

9.3.4 Shares issued at a discount

9.4 Audit of debentures

9.5 Preliminary Expenses

9.6 Statutory Meeting & Statutory Report

9.7 Dividend

9.7.1 Interim dividend

9.7.2 Auditor's duty with regard to payment of dividend

9.8 Transfer to reserve

9.9 Capita profits

9.10 Revaluation reserve

9.11 Key Concepts

9.12 Summary



9.0 Introduction

Section 221 to 229 of The Company's Act 1956 is related with appointment

of company auditor, their qualification, their rights and duties. Section 202 to 205 of

The Company's Act 1956 related to distribution of profit and dividend. Company

Auditor has to play an important role for keeping specific % of profit as compulsory

reserve and provision.

9.1 Objectives

1. To understand the points which deserve special consideration in case of

company audit.

2. To understand the specifications about Share Capital Audit.

3. To study auditor's duties regarding audit of share capital.

4. To learn the procedure for audit of debentures.

Company Audit in Broad

Line, Profit Available for

Dividend, Auditor’s Duties

Regarding Reserves

AUDITING - I

(80) AUDITING - I

NOTES

5. To be familiar with the auditing aspects related with Preliminary Expenses,

Dividend,

Transfer to reserve, Capital profits, and Revaluation reserve.

6. To understand the details about Statutory Meeting & Statutory Report.

9.2 Company Audit

The following points deserve special consideration in case of company

audit-

1. Object of audit:

The object of company audit is to examine the books of accounts to report

whether or not the financial statement shows a true & fair view of the state of

company at the end of financial year, & the profit & loss for the financial year

ended on that date.

2. Internal control:

The management is responsible for devising suitable internal control for

safeguarding the assets of the company. However, before placing the reliance on

internal control system of the company, it would be necessary to conduct the

compliance & substantive test procedure to evaluate it from the point of view of its

deficiencies.

3. True & fair:

The financial statement should show a true & fair view of state of the

company & the results of operation of the company during the year.

a. Materiality:

Materiality is a subjective concept. The materiality should be judged in

relation to profit shown by the profit & loss account. What is material in one

circumstance may not be material in other circumstance it depends upon the

professional judgment of the auditor to decide about the materiality of a particular

item.

4. Comparative study:

Auditor should compare the figures of the current year with the previous

year figures. This helps in locating major deviations & he should ascertain reasons

for the same.

9.3 Share Capital Audit

The principle objectives of audit of share capital are as follows that-

a. Issues of shares are properly authorized & that there is no over issue

beyond the limits as prescribed in the memorandum.

b. The cash & other assets acquired through issue of shares have indeed

been received, properly classified, valued & correctly recorded in the

books of accounts.

c. The distribution of dividends & retention of profits in form of reserves &

provisions are properly authorized.

d. Provisions relating to rights & privileges of shareholders, creditors, etc.

are duly complied with

e. Generally accepted accounting principles are followed in the preparation

of financial statements in conformity with legal provisions.

CHECK YOUR

PROGRESS

Give in brief concept

of Company Audit?

AUDITING - I (81)

NOTES

There are three stages-

i. Application stage: In this stage application for shares are received along

with application money.

ii. Allotment stage: Allotment of shares takes place allotment letters is

issued & allotment money is received.

iii. Call stage: In this stage calls are made on shares & the amount due is

received.

9.3.1 Auditor's duties regarding audit of share capital:

i. Auditor should examine the minute book to verify the approval.

ii. He should check the application & allotment book to see the appropriate

journal entry is duly passed.

iii. He should check the copies of letter of allotment & letter of regret with

entries in application & allotment book.

iv. He should examine the resolution passed by the board.

v. He should compare the schedules of calls in arrears with application &

allotment book & see that amount has been correctly calculated.

vi. In case of underwriting, auditor should examine the contract with

underwriters & ascertain that the terms thereof have been complied in

full.

vii. In case of shares issued at premium, auditor should examine the

prospectus & article of association of the company to see whether they

permit the issue of shares at premium.

viii. He should see that whether company has complied with legal provision.

ix. He should also see compliance with SEBI guidelines. In case of premium

he should see section 78 compliance.

x. In case of shares issued at discount, auditor should see that conditions in

section 79 are complied with, & also verify the sanction obtained from

central government.

xi. In case of shares issued at discount, auditor should examine the

prospectus & article of association of the company to see whether they

permit the issue of shares at discount.

xii. Auditor should verify the amount of calls in arrears from the share register.

xiii. He should obtain a statement from the management enlisting the details

of calls received in advance & whether such amount is transferred to a

separate account.

9.3.2 Shares underwritten placed for commission:

i. Many times, the whole or a part of the issue of capital is underwritten.

The underwriters agree to take up the unsubscribed capital in the event

when the capital is not fully subscribed.

ii. The auditor should refer to the underwriting contract to verify the number

of shares if any, which the underwriter were obliged to take up & payment

made by them in respect thereof.

9.3.3 Shares issued at premium:

Section 78 of Companies Act, 1956, deals with the issue of shares at a

premium. A sum equal to the aggregate amount or value of premium received on




Regarding Reserves

CHECK YOUR

PROGRESS

Describe Auditor’s

duty in relation to

share capital?

AUDITING - I

(82) AUDITING - I

NOTES

the issue of securities at a premium, whether for cash or otherwise, shall be

transferred to a separate account called the "Securities Premium Account". The

securities premium may be applied in-

i. Paying up unissued securities of the company to be issued to the members

of company as fully paid bonus shares.

ii. Writing off the preliminary expenses of the company.

iii. Writing off the expenses of, or the commission paid or the discount allowed

on, any issue of shares or debentures of the company.

iv. Provide for the premium payable on the redemption of any redeemable

preference shares or any debentures of the company.

9.3.4 Shares issued at a discount:

A company can issue its shares at a discount only if following conditions are fulfilled-

i. The issue of share at a discount is authorized by a resolution passed by

the company in general meeting & sanctioned by the Central Government.

ii. Resolution should specify the maximum rate of discount at which the

shares are to be issued. Such rate of discount can not be more than 10%

unless the central government is of opinion that a higher % of discount

may be allowed in special circumstances.

iii. Shares can be issued at discount within two months after the date on

which the issue is sanctioned by the Central Government.

iv. Not less than one year has at the date of the issue elapsed since the date

on which company was entitled to commence business.

Every prospectus relating to issue of shares must contain the particulars

of discount allowed on issue of shares or of so much of that discount that has not

been written off at the date of issue of the prospectus.

9.4 Audit of Debentures

Debenture is a written acknowledgement, usually under seal of a debt due

by a company, containing provisions as to payment of interest & repayment of

principal. It may be either a simple or naked debentures carrying no charge or

debenture carrying either a fixed or floating charge on some or all of the assets of

the company.

Auditor should take following steps for verification of debentures:

i. He should refer to article of association of the company to inquire whether

the company can borrow through debentures.

ii. He should verify the resolution passed by the directors & the shareholders.

iii. If a charge is created, auditor should verify that the charge is registered

with registrar & also entered in the register of charge.

iv. He should see all accounting entries regarding to the issue of debentures

& money received, in the books of accounts & examine them with

reference to bank pass book also.

v. He should verify the entries on the counterfoils of debentures issued with

the debenture register.

vi. He should examine a copy of the Debenture Trust Deed & note the

conditions contained there in as to issue & repayment.

vii. He should see that SEBI guidelines are complied with..

AUDITING - I (83)

NOTES

9.5 Preliminary Expenses

It is the expenditure incurred incidental to the creation & floating of a

company. It consists of stamp duties, registration fees, legal cost, consultant's fee,

etc. The following should be checked-

i. Checked the minute book & resolution approving the expenses claimed

by promoters as having been spent in the formation of the company.

ii. Verify whether excess amount, if any, that the amount mentioned in

prospectus, is approved by shareholders.

iii. Note the decisions taken to write off the preliminary expenses over a

period.

iv. Verify the expenses based on relevant documentary evidence.

v. Ensure that the amount not yet written off is shown in the balance sheet

under the head "Miscellaneous expenditure-to the extent not written off

or adjusted".

vi. Check that no expenses other than those what constitute preliminary

expenses is booked under this head.

9.6 Statutory Meeting & Statutory Report

Under section 165 of the companies act, every Public Company must

hold a statutory meeting within a period of not less than one month & not more

than six months, after the date on which company is entitled to commence business.

The report forwarded to every member at least 21 days before the day of the

meeting is known as the Statutory Report.

Contents of statutory report:

i. Total number of shares allotted, distinguishing between fully paid or partly

paid up shares. i.e. full details is required of the shares issued.

ii. Total amount of cash received by the company in respect of all shares

allotted.

iii. Abstract of receipts & payments made there out within 7 days of the

report-

- The receipts from shares, debentures & other sources.

- The payments made there out & particulars concerning the balance

remaining in hand.

iv. An amount or estimate of the preliminary expenses of the company.

v. Particulars of any contracts which, modification or proposed modification

of which, is to be submitted to the meeting for its approval & particulars

of modification or proposed modification.

vi. Extent if any to which each underwriting contract, if any has not been

carried out & reasons for that.

vii. Arrears if any, due on calls from every director & from manager.

viii. Particulars of any commission or brokerage paid or to be paid in connection

with the issue of shares or debentures to any director or manager.

ix. Auditor's certificate.




Regarding Reserves

CHECK YOUR

PROGRESS

Describe the

procedure of

P r e l i m i n a r y

Expenses?

AUDITING - I

(84) AUDITING - I

NOTES

9.7 Dividend

i. According to section 205(1), dividend can be declared or paid by

the company for any financial year only out of-

lllll It's profit for that year, at after providing for depreciation as per section205

(2).

lllll Out of money provided by a central or state government for payment of

dividend pursuant to the guarantee given by the government.

ii. Transfer to reserves -

According to section 205 (2A) dividends shall be paid after the company

has transferred to reserves of the company of such a % of its profits for

that year not exceeding 10%.

iii. Payment of dividend-

Following rules have been framed-

lllll Dividend once declared becomes the liability of the company & should

be paid within 30 days of the date of declaration. In case dividend have

not been paid or claimed within 30 days, the company should within 7

days from the expiry of 30 days, transferred such amount to separate

bank account titled as "Unpaid Dividend Account".

lllll No dividend shall be paid except in cash.

lllll Dividend should be paid to the registered holder of the shares.

iv. Provision for proposed dividend-

Schedule VI to the Companies Act, 1956 requires proposed dividend to

be shown under "Current liabilities & provisions". Such event take place

after the balance sheet date but reflects the financial position as on the

date should be included in financial statements.

v. Setting off of brought forward debit balance in profit & loss

account-

In arriving at the divisible profits the provision of section 205 (2) should

be kept in view. Accordingly amount of loss or depreciation (contained in

debit balance of profit & loss account) whichever is less should be set off

against current revenue profits before declaration of dividends.

9.7.1 Interim dividend:

Dividend includes any interim dividend. Dividend declared between two

AGMs is called as interim dividend. The board may, from time to time, pay such

interim dividends as may appear to it to be justified by the profits of the company.

i. Interim dividend can be declared by the Board of Directors if Article of

Association authorizes to do so.

ii. It is the sign of performance of the company.

iii. Appropriate provision for depreciation should be made for the whole year

computed in accordance with the section 205 of the companies act.

CHECK YOUR

PROGRESS

Describe Dividend

Policies?

AUDITING - I (85)

NOTES

iv. The distinction between interim & final dividend is that unlike interim

dividend, a final dividend once declared by the company in general meeting

is a debt & creates an enforceable obligation.

v. The interim dividend must be paid within 30 days of its declaration i.e.

within 30 days of date of passing the board resolution declaring dividend.

vi. The amount of interim dividend is compulsorily deposited in a separate

bank account, within 5 days of passing the board resolution declaring the

interim dividend.

9.7.2 Auditor's duty with regard to payment of dividend:

Auditor should follow the following procedure for the verification of payment

of dividends-

i. He should examine the Memorandum of Association & Article of

Association of the company to determine the rights of the shareholder.

ii. He should ensure that dividend can only be distributed out of profits.

iii. He should ascertain whether profits have been computed in accordance

with requirements of section 205 of the act.

iv. He should ascertain whether rate of dividend has been recommended

properly.

v. He should inspect the shareholders minute book to verify the amount of

dividend.

vi. He should verify the amount of unclaimed dividend with dividend account.

vii. He should see that the tax on the distributed profit at the rate of 15 %

(16.995%) is paid within 14 days from the date of declaration, distribution

or payment whichever is earliest.

viii. Auditor should see that the dividend which remains unpaid or unclaimed

within 30 days of declaration of dividend. Such unpaid or unclaimed

dividend has been transfer to special bank account entitled "Unpaid

Dividend Account". The transfer must be made within 7 days from the

date of expiry of 30 days.

ix. If any dividend remains unpaid or unclaimed for a period of 7 years from

the date of transfer, the amount transfer by company to fund called

"Investor Education & Protection Fund".

9.8 Transfer to Reserve

According to section 205 (2A) no company is permitted to declared or pay

dividend without first transferring to reserve profits-

lllll Profit after providing current as well as arrears of depreciation.

lllll Profit should be after tax.

lllll Rate of dividend relate to rate of equity dividend & portion of dividend in

excess of fixed rate of dividend in respect of participating preference

shares.

The % of profits required to be transferred to reserves depends on the

amount of dividend proposed for the year & are given here under-




Regarding Reserves

CHECK YOUR

PROGRESS

Define Auditor's duty

with regard to

payment of dividend?

AUDITING - I

(86) AUDITING - I

NOTES

Rate of dividend % of profit required to be

transferred to reserve

lllll Upto 10% - Nil

lllll Exceeding 10% but below 12.5 % - Not less than 2.5 % of current profits

lllll Exceeding 12.5% but below 15 % - Not less than 5 % of current profits

lllll Exceeding 15% but below 20 % - Not less than 7.5 % of current profits

lllll Exceeding 20% - Not exceeding 10 % of current profits

9.9 Capital Profits

Capital profits represent the excess of sale value over the original cost of

assets. Capital profits can be distributed if all the following conditions are fulfilled.

i. Article of Association permit the distribution.

ii. Capital profit which is sought to be distributed should be actually realized.

iii. Capital profit should remains after revaluation of assets of the company,

if there is any capital loss then minus it from capital reserve then remaining

can be allowed to distribute.

9.10 Revaluation Reserve

Revaluation reserve is created from revaluation of profit-

i. Revaluation reserve should not available for distribution of dividend.

ii. Accumulated losses & depreciation on the acquisition cost (including

arrears of depreciation) should not be adjusted against Revaluation

reserve.

iii. Bonus shares cannot be issued out of revaluation reserve.

9.11 Key Concepts

Debenture is a written acknowledgement, usually under seal of a debt

due by a company.

Preliminary Expenses is the expenditure incurred incidental to the

creation & floating of a company. It consists of stamp duties, registration fees,

legal cost, consultant's fee, etc.

The report forwarded to every member at least 21 days before the day of

the meeting is known as the Statutory Report.

Dividend declared between two AGMs is called as interim dividend.

Capital profits represent the excess of sale value over the original cost

of assets.

9.12 Summary

Auditor should provide special consideration towards Object of audit,

Internal control, Truth & fairness, Materiality, Comparative study etc. while doing

company audit.

AUDITING - I (87)

NOTES

There are three stages in the audit of share capital Application stage,

Allotment stage, Call stage . There are Auditor's duties regarding audit of share

capital in general and specifically regarding underwritten shares placed for

commission, Shares issued at premium, Shares issued at a discount etc. An auditor

also has a specific role in case of audit of debentures, preliminary expenses ,dividend,

Transfer to reserves, capital profit, revaluation reserves etc. for e.g. According to

section 205 (2A) no company is permitted to declared or pay dividend without first

transferring to reserve profits.

Under section 165 of the companies act, every Public Company must hold

a statutory meeting within a period of not less than one month & not more than six

months, after the date on which company is entitled to commence business. The

report forwarded to every member at least 21 days before the day of the meeting

is known as the Statutory Report.


1. What is the duty of auditor regarding to audit of Share Capital?

2. What are the steps to be taken for verification of debentures?

3. What is mean by Statutory Report? Which are the contents of Statutory

Report?

4. What are the duties of auditor regarding to payment of dividend?

5. Explain the relevant provisions regarding to payment of dividend?

6. How much amount required to be transferred to reserves out of profits?


1) Section _________ of Companies Act, 1956, deals with the issue of shares

at a premium.

(205, 78, 75, 36)

2) _____________ is a written acknowledgement, usually under seal of a debt

due by a company, containing provisions as to payment of interest & repayment

of principal.

(Debenture, Equity Share, Preference Share, Bond)

3) ________________ is the expenditure incurred incidental to the creation

& floating of a company.

(Prepaid Expenses, Preliminary Expenses, Revenue Expenses, Capital

Expenses)

4) Under section 165 of the companies act, every Public Company must hold a

statutory meeting within a period of not less than__________ & not more

than _________, after the date on which company is entitled to commence

business.

(2 month-5 month, 6 month-12 month, 1 month- 6 month, 3 month-6 month)

5) _____________ represent the excess of sale value over the original cost of

assets.

(Revenue profit, Capital profit, Revaluation reserve, General reserve)

6) The % of profits required to be transferred to reserves depends on the -----

--------- proposed for the year.




Regarding Reserves

AUDITING - I

(88) AUDITING - I

NOTES

(Dividend, Revaluation, Tax, Provision)

7) Dividend declared between two AGMs is called as ---------- dividend.

(Final, Interim, Proposed, Declared)

8) _______________ is created from revaluation of profit.

(Capital Reserve, General Reserve, Revaluation reserve, Profit & loss A/c)

9) The Companies Act, 1956 requires proposed dividend to be shown under

"________________".

(Current liabilities & provisions, Reserve & surplus, Share Capital, Current

assets)

10) The statutory report forwarded to every member at least __________ before

the day of the meeting.

(7 days, 21 days, 14 days, 30 days)

11) Every __________ relating to issue of shares must contain the particulars

of discount allowed on issue of shares.

(Prospectus, Memorandum of association, Article of association, Certificate)

12) When rate of dividend is exceeding 15% but below 20 % then

minimum_____% of current profit is required to be transferred to reserve.

(2.5, 5, 7.5, 10)

13) Interim dividend can be declared by the __________ if Article of Association

authorizes to do so.

(Board of Directors, Auditor, Members, Secretary)

14) If any dividend remains unpaid or unclaimed for a period of _______ from

the date of transfer, the amount transfer by company to fund called "Investor

Education & Protection Fund".

(30 days, 5 years, 7 years, 8 years)

15) ____________ should specify the maximum rate of discount at which the

shares are to be issued.

(Report, Resolution, Prospectus, Memorandum of association)

(Answers: 1) 78, 2) Debenture, 3) preliminary expenses, 4) one month & six

months, 5) Capital profit, 6) Dividend, 7) Interim, 8) Revaluation reserve, 9)

Current liabilities & provisions, 10) 21 days, 11) prospectus, 12) 7.5%, 13)

Board of directors, 14) 7 years, 15) Resolution)





AUDITING - I (89)

NOTES

Qualification &

Appointment of A

Company Auditor

UNIT - 10

QUALIFICATION & APPOINTMENT OF

A COMPANY AUDITOR

Structure

10.0 Introduction

10.1 Objectives

10.2 Qualification of Auditors

10.3 Disqualification of Auditors

10.4 Appointment of Company Auditor

10.5 Removal of the auditor

10.6 Auditor's Remuneration

10.7 Key Concepts

10.8 Summary



10.0 Introduction

According to Sec. 139(1) of the Companies Act 2013, every company

shall appoint an auditor to audit its books of accounts. After the completion of

audit, the auditor has to submit his report to the shareholders of the company. The

position of the auditor is therefore very vital. He reports to the shareholders about

the finances of the company.

10.1 Objectives

1. To understand the qualification and disqualification of auditors.

2. To learn various aspects regarding appointment of Company Auditor.

3. To understand the procedure for removal of the auditor.

4. To study the details about Auditor's remuneration.

10.2 Qualification of Auditors [Section 141 of

Companies Act, 2013]

A person is qualified for the appointment as the auditor of the company

only if he is a Chartered Accountant within the meaning of the chartered

Accountants Act 1949. Nationality is not important. A firm whereof all the partners

practicing in India are qualified for the appointment as auditor, it may be appointed

by its firm name to be auditor of the company.

The holder of certificate under the restricted auditor's certificates rules

1956 shall be entitled to be appointed as an auditor.

AUDITING - I

(90) AUDITING - I

NOTES

10.3 Disqualification of Auditors [Section 141 of

Company Act, 2013]

Following persons are not qualified for the appointment as auditor of a company-

a) A Body Corporate.

b) An Officer or Employee of the company.

c) A Partner or Employee of an Officer or Employee of the company.

d) A person who, or his relative, or his partner is holding any security in the

company or subsidiary company or holding company or associate company

or subsidiary of such holding company.

(Note - Security means an instrument which carries voting rights.)

e) A person who, or his relative, or his partner is indebted, in excess of such

amount as may be prescribed (the sum prescribed is Rs. 5 lakh) the

company or subsidiary company or holding company or associate company

or subsidiary of such holding company.

f) A person who, or his relative, or his partner has given a guarantee or

provided any security in connection with the indebtness of any third person,

in excess of prescribed amount (Rs. 1 lakh) the company or subsidiary

company or holding company or associate company or subsidiary of such

holding company.

g) A person or a firm who, whether directly or indirectly, has business

relationship of such nature as may be prescribed with the company or

subsidiary company or holding company or associate company or

subsidiary of such holding company.

h) A person whose relative is a director or is in the employment of the

company as a director or key managerial personnel.

i) A person who is in the employment elsewhere or a person or a partner of

a firm holding appointment as its auditor, if such persons or partner is at

the date of such appointment or reappointment holding appointment as

auditor of more than 20 companies.

j) A person who has been convicted by a court of an offence involving

fraud & a period of 10 years has not been elapsed from the date of such

conviction.

141(4): An auditor, who after his appointment becomes subject to any of above

disqualifications, shall be deemed to have vacated his office as an auditor.

The list of disqualifications makes the position of an auditor as independent as

possible.

10.4 Appointment of Company Auditor

1. Appointment of first auditor[ Section 139(6) of Companies Act,

2013]:

i. As per section 139(6), first auditor will be appointment.

ii. The first auditor shall appointed by the board of directors within one

month of the date of registration of the company.

CHECK YOUR

PROGRESS

Qulification and

Disqulification of

Company Auditor?

AUDITING - I (91)

NOTES

Qualification &

Appointment of A

Company Auditor

iii. The first auditor so appointed shall hold office until the conclusion of the

first Annual General Meeting.

iv. Appointment of first auditor should be by valid resolution at the board

meeting. Merely naming in the Article of Association will not be recognized

as appointment under the act.

v. In case the board does not exercise its power in this regard, the board

shall inform members of the company who shall appoint the first auditor

within 90 days at an extraordinary general meeting.

2. Appointment of First Auditor in case of Government Company [

Section 139(7) of Companies Act, 2013]:

i. Where the company is the Government Company or any other company

owned or controlled, directly or indirectly, by CG, or by one or more State

Government, or partly by CG & partly by one or more State Government,

the first auditor shall be appointed by CAG within 60 days of registration

of the company.

ii. In case CAG does not appoint the first auditor within the said period of

60 days, the Board shall appoint the first auditor within next 30 days.

iii. In case of failure of the Board to appoint the first auditor within the said

period of 30 days, the Board shall inform the members of the company

who shall appoint the first auditor within 60 days at an extraordinary

general meeting.

iv. The first auditor shall hold office till the conclusion of the first AGM.

v. Government company means any company in which not less than 51%

of the paid up share capital is held by-

a. CG

b. SG(s)

c. Partly by CG & partly by SG(s)

Government Company includes a company which is a subsidiary company of

Government Company

3. Appointment in case of Casual Vacancy[ Section 139(8) of

Companies Act, 2013]:

i. Casual vacancy means vacancy in office of auditor resulting from

accidental circumstances such as death, incapacity or disqualification of

the auditor.

ii. Casual vacancy shall be filled within 30 days by the Board of Directors.

iii. Where a vacancy is caused by the resignation of an auditor, the vacancy

shall be filled within 30 days by the Board of Directors, & the appointment

made by the board shall be approved in a general meeting convened

within 3 months of the recommendation of the Board.

iv. Where casual vacancy arises in a company whose accounts are subject

to audit by an auditor appointed by CAG, such casual vacancy shall be

filled within 30 days by CAG.

CHECK YOUR

PROGRESS

Rules for

Appointment of

Company Auditor?

AUDITING - I

(92) AUDITING - I

NOTES

v. In case CAG does not fill the casual vacancy within prescribe time, the

board shall fill the casual vacancy within next 30 days.

vi. Any auditor appointed in a casual vacancy shall hold office until the

conclusion of the next Annual General Meeting.

4. Appointment of Subsequent Auditor in case of a Government

Company[ Section 139(5) of the Companies Act 2013]:

i. This section applies to-

a. Government Company

b. Any other company owned or controlled, directly or indirectly, by-

- CG; or

- One or more State Government; or

- Partly by CG & partly by one or more SG

ii. In case of aforesaid companies, CAG shall appoint an auditor duly qualified

to be appointed as an auditor of companies under this act, within 180

days from the commencement of the financial year.

iii. The auditor shall hold office till the conclusion of the AGM.

10.5 Removal of the Auditor [Section 140 of the


i. Removal of auditor before the expiry of his term:

lllll Previous approval of Central Government must be obtained within 30

days of passing of the Board resolution.

lllll The company shall hold the general meeting within 60 days of receipt of

approval of CG for passing the special resolution.

lllll Before taking any action for removal, the auditor shall be given a

reasonable opportunity of being heard.

ii. Resignation by Auditor:

When an auditor resigns, he is required to file a statement in the prescribe

form. The statement shall indicate the reasons & other facts as may be

relevant with regard to his resignation. The statement shall be filed with

l l l l l the company

l l l l l the Registrar

l l l l l CAG in case of a Government Company.

The statement shall be filed within 30 days from the date of resignation.

lllll Requirement of Special Notice:

1. At an AGM, special notice shall be required for-

lllll Appointing as auditor a person other than the retiring auditor, or

lllll Providing expressly that the retiring auditor shall not be reappointed.

2. On the receipt of notice of such a resolution, the company shall forthwith

send a copy thereof to the retiring auditor.

CHECK YOUR

PROGRESS

Rules for the Removal

of Auditor?

AUDITING - I (93)

NOTES

Qualification &

Appointment of A

Company Auditor

3. Retiring auditor is entitled to make a representation against his removal.

The representation shall be in writing & shall be sent to the company.

4. He may request the company to circulate the representation to the

members of the company.

5. If copy of the representation is not sent because it was received too late

or because of the company's default, then the auditor may require that

the representation shall be read out at the meeting. A copy of

representation shall be filed with the registrar.

10.6 Auditor’s Remuneration [Section 142 of


i. Where appointment by the Board of Directors:

When an auditor is appointed by the Board of Directors, remuneration is also

fixed by them. The resolution appointing the auditor should also prescribe the

remuneration.

ii. Where appointed by Shareholders:

In this case the remuneration is determined by the shareholders at the AGM.

Sometimes, shareholders may delegate the power of fixing remunerations to

the Board of Directors or the Chairman.

iii. Where appointed by the Comptroller & Auditor General of India:

The remuneration shall be fixed by the company in general meeting or in

such manner as the company in general meeting may determine.

iv. Remuneration other than audit fees:

Where an auditor renders services other than those as an auditor, he is entitled

to get extra remuneration. Such remuneration may not be fixed in advance

by the appointing authority while appointing him as an auditor & while fixing

his remuneration.

10.7 Key Concepts

The first auditor of the company appointed by the board of directors

prior to the annual general meeting may be removed by the members in general

meeting.

10.8 Summary

The first auditor of the company appointed by the board of directors prior

to the annual general meeting may be removed by the members in general meeting.


shall appoint an auditor to audit its books of accounts. Every company shall at each

Annual General Meeting appoint an auditor who holds office as an auditor from

the conclusion of that meeting until the conclusion of next Annual General Meeting.

After the completion of audit, the auditor has to submit his report to the shareholders

of the company. A person is qualified as auditor if he is a Chartered Accountant.

CHECK YOUR

PROGRESS

Rules for the

Remuneration of

Auditor?

AUDITING - I

(94) AUDITING - I

NOTES


1. How Sec.141 of the act deals with the qualification & disqualifications

of an auditor?

2. Discuss the appointment of an auditor by CAG?

3. How the act deals with removal of auditor?


1) A person is qualified for the appointment as the auditor of the company only

if he is a ___________________ within the meaning of the chartered

Accountants Act 1949.

(Lawyer, Chartered Accountant, Company Secretary, Cost Accountant)

2) Appointment of auditor of the Government companies will be as per section

__________

(139(6), 139(7), 139(8), 141)

3) The first auditor shall be appointed by CAG within ________days of

registration of the company.

(30, 60, 90, 45)

4) As per section __________ first auditor will be appointment.

(139(6), 139(7), 139(8), 141)

5) Auditor will be disqualified if such persons or partner is at the date of such

appointment or reappointment holding appointment as auditor of more than

________ companies.

(40, 20, 45, 35)

6) The first auditor shall appointed by the board of directors within _________

month of the date of registration of the company.

(One, Three, Six, Twelve)

7) Retiring auditor is entitled to make a ______________ against his removal.

(Report, Representation, Enquiry, Investigation)

8) The statement of resignation shall be filed within _____days from the date

of resignation.

(30, 60, 90, 45)

9) Removal of auditor before the expiry of his term requires the ___________

resolution.

(Ordinary, Unanimous, Special, General)

10) Government Company includes a company which is a _____________

company of Government Company

(Subsidiary, Holding, Associate, Investment)

11) The remuneration is determined by the ______________ at the AGM.

(Shareholders, Board of Directors, CAG, Secretary)

AUDITING - I (95)

NOTES

Qualification &

Appointment of A

Company Auditor

12) After the completion of audit, the auditor has to submit his report to the

______________ of the company.

(Shareholders, Board of Directors, CAG, Secretary)

13) Appointment of Subsequent Auditor in case of a Government Company shall

be made by CAG within ________days from the commencement of the

financial year.

(30, 60, 90, 180)

14) The appointment made by the board to fill the casual vacancy shall be approved

in a general meeting convened within ___________ of the recommendation

of the Board.

(30 days, 60 days, 1 month, 3 months)

(Answer: 1) Chartered Accountant, 2) 139(7), 3) 60 days, 4) 139(6), 5)20, 6)

one, 7) representation, 8) 30 days, 9) special, 10) subsidiary, 11) shareholders,

12) shareholders, 13) 180 days, 14) 3 months)





AUDITING - I

(96) AUDITING - I

NOTES

UNIT - 11

RIGHTS, DUTIES AND

RESPONSIBILITIES OF

A COMPANY AUDITOR

Structure

11.0 Introduction

11.1 Objectives

11.2 Rights & Powers of an Auditor

11.3 Duties & responsibilities of the auditor

11.4 Scope of duties of an auditor

11.5 Key Concepts

11.6 Summary



11.0 Introduction


shall appoint an auditor to audit its books of accounts. The position of the

auditor is therefore very vital. He reports to the shareholders about the finances of

the company.

11.1 Objectives

1) To be familiar with the rights & duties of an auditor.

2) To understand the scope of an auditor.

11.2 Rights & Powers of an Auditor [Sec. 143]

1. Right of access to Books of account & Vouchers [Sec. 143(1)]:

The auditor has a right to access, at all times the books of accounts &

vouchers of the company, whether kept at head office or elsewhere. It is an absolute

right & is not subject to any restriction, exception or qualification.

The term book includes all types of books such as financial statutory or

statistical books. The right of access at all times implies that an auditor can inspect

the books, accounts & vouchers of the company during the normal business hours

of the audit.

2. Right to obtain information & explanation [Sec. 143(1)]:

An auditor of the company is entitled to required from the officers, of the

company such information & explanation as he may think necessary for the

performance of his duties as an auditor. The auditor is bound to state in his report

whether he has obtained all the information & explanations which to the best of his

knowledge & belief were necessary for the purpose of the audit.

CHECK YOUR

PROGRESS

Describe the Rights &

Powers of an

Auditor?

AUDITING - I (97)

NOTES

Rights, Duties and

Responsibilities of

A Company Auditor

3. Right to visit branch offices & access to branch account:

Where the accounts of any branch office are audited by a person other

than the company's auditor, the company's auditor is entitled to visit the branches,

if he deemed it necessary to do so for the performance of his duties as an auditor.

However, the auditor does not have right to visit foreign branches of a

banking company & it will be adequate if he is allowed access to such copies of

extracts from the books or accounts of the branch as have been sent to the principal

office in India.

4. Right to receive notice & attend general meeting:

The auditor has the right of receiving all the notices & other communications

relating to any general meeting of a company which any member of the company

is entitled to have. He is entitled to attend any general meeting & to be heard at

any general meeting which he attend on any part of the business which concerns

him as an auditor.

However, the auditor has no obligation to attend such meetings. Also, this

right does not extend to board meeting.

5. Right to make representation:

The retiring auditor is entitled to receive a copy of the special notice intending

to remove him or proposing to appoint any other person as auditor. The retiring

auditor has a right to make his representation in writing & request that the same is

circulated among the members. In case the same could not be circulated, the

auditor may require that the representation shall be read out at the general meeting.

6. Right to report to members:

The auditor has right as well as duty to make a report to the members on

the accounts examined by him & to state whether in his opinion & to the best of his

information & explanation given to him. Auditor has to state whether the financial

statements give a true & fair view of the state of affairs of the business of the

company.

7. Right to sign audit report:

The auditor has right as well as duty to sign the audit report & the balance

sheet & the profit & loss account including all the documents attached or annexed

therewith.

8. Right of seeking opinion of an expert:

In respect of any special technical matters, the auditor is entitled to consult

& take the opinion of an expert. He is also entitled to take legal advice so as to

discharge his duties efficiently.

9. Right to receive remuneration:

The auditor has an inherent right to receive remunerations for auditing the

accounts of the company, though such rights accrue only after he has completed

the work.

AUDITING - I

(98) AUDITING - I

NOTES

11.3 Duties & Responsibilites of the Auditor

1. Report to members [Sec.143(2)]:

The auditor is required to make a report to the members of the company-

a. On the accounts examined by him.

b. On the balance sheet & profit & loss account.

c. On every other document declared by act.

His report must state whether in his opinion & to the best of his information

& according to the explanations given to him the said accounts give a true & fair

view in case of balance sheet, of the state of company's affairs as at end of the

financial year, & in the case of the profit & loss account for its financial year.

2. Examination of accounts:

The auditor has to state in his report-

a. Whether he is obtained all the information & explanations which to the

best of his knowledge & belief were necessary for the purpose of audit.

b. Whether in his opinion proper book of accounts as required by law has

been kept by the company & proper returns adequate for the purpose of

audit have been received from the branches not visited by him.

c. Whether any branch audit report under section 228 forwarded to him &

how he has dealt with the same in preparing auditors report.

d. Whether the company's balance sheet & profit & loss account dealt with

the report are in agreement with the book of account & returns.

e. Whether in his opinion the balance sheet & Profit & loss account comply

with the accounting standards.

f. If any adverse effect on the functioning of the company is observed it

needs to be comment in bold & italic font.

g. Whether any director is disqualified from being appointed as director

under sec. 274 (i) (g).

h. Whether cess payable under sec. 441A has been paid & if not the details

of the amount of cess.

3. Reporting on true & fair view:

The primary duty of the auditor is to express his opinion whether the balance

sheet shows true & fair view of the state of company's affair as at the end of the

financial year.

Scheduled VI refers only to the minimum disclosure requirement, if certain

information has a material bearing on the representation made in the financial

statements, it must be disclosed even if there is no legal requirement for its disclosure

under schedule VI. Before expressing his opinion on the truth & fairness of the

financial statement, the auditor must ensure -

a. They are drawn up according to exact legal requirements.

b. They show the financial position & profit & loss with out any distortion.

c. They do not contain any misstatement as to income or expenses.

d. They are generally accepted principles of accounting have consistently

been followed in drawing up financial statements.

CHECK YOUR

PROGRESS

Describe the Duties

and Responsibilities of

the Auditor?

AUDITING - I (99)

NOTES

Rights, Duties and

Responsibilities of

A Company Auditor

e. All necessary information is made available to shareholders as to the true

financial position of the company.

4. Duty as to Enquiry [Sec.143(1)]:

It is the duty of the auditor to enquire-

a. Whether loans & advances made by the company on the basis of security

have been properly secured & whether the terms on which they have

been made are not prejudicial to the interest of the company.

b. Whether the transactions are represented merely by book entries are not

prejudicial to the interest of the company.

c. Whether the company is not an investment company or a banking company,

whether so many of the assets of the company have been sold at a price

less than at which they were purchased by the company.

d. Whether loans & advances made by the company have been shown as

deposits.

e. Whether personal expenses have been charged to revenue account.

f. Whether the position is stated in books of accounts & balance sheet is

correct, regular & misleading.

The auditor is not required to report on the matters specified under this

section unless he has any special comments to make on any of the items referred

to therein. If he is satisfied as a result of the enquiries, he is not required to report

that he is so satisfied.

5. Report as to additional matters:

In exercise of this power, the Central Government has issued Companies

( Auditor's Report ) Order CARO,2003. The auditor has to make a statement on

each of the matters specified in the order.

6. Duty to sign report:

It is the duty of the auditor to sign the auditor's report or sign or authenticate

any other document of the company required by law to be signed or authenticated

by the auditor. In case of a firm, only a partner of the firm practicing in India can

sign the report.

7. Duty as to statutory report:

It is the duty of the auditor to certify as correct that part of the statutory

report that relates to-

a. The shares allotted by the company.

b. Cash received in respect of such share &

c. Receipt & payments of the company.

8. Duty as to prospectus [Sec.56]:

Section 56 deals with matters to be stated & the reports that is to be set

out in the prospectus. It is the duty of the auditor to certify this report for the

purposes of the prospectus.

AUDITING - I

(100) AUDITING - I

NOTES

9. Duty to assist investigation:

Where any investigation has conducted, it is the duty of auditor-

a. To preserve & to produce all books & papers relating to the company

to inspector.

b. Give to the inspector all assistance in the connection with investigation.

It may be noted that no limitation can be placed upon the duties of the

auditor under section 227, either by the articles of the company or by any resolution

of the members.

11.4 Scope of Duties of an Auditor

The scope of duties of an auditor depends upon the nature of the business

carried on by the concern. The duties & the responsibilities can be briefly

summarized as follows-

a. To verify that the statements of account are drawn up on the basis of the

books of the business. However, the auditor is not liable for facts which

are concealed & kept out of books which he can not verify in the ordinary

course of exercise of reasonable care & diligence.

b. To verify that the statements of the account exhibit a true & fair state of

affairs of the business.

c. To confirm that the management has not exceeded the financial

administrative power vested in it by the articles or by any specific resolution

of shareholders passed at general meeting.

d. To investigate matters in regard to which his suspicion is aroused as to

the result of a certain action on the part of the servants of the company.

e. To perform his duties by exercising reasonable skill & care. He should

not rely on the certificate of the management for those items which he

can verify directly.

11.5 Key Concepts

The term book includes all types of books such as financial statutory or

statistical books.

Section 56 deals with matters to be stated & the reports that is to be set

out in the prospectus.

11.6 Summary

An auditor has various rights & duties such as - right of access to Books

of account & Vouchers ,right to obtain information & explanation ,right to visit

branch offices & access to branch account ,right to receive notice & attend general

meeting, right to make representation ,right to report to members ,right to sign audit

report , right of seeking opinion of an expert, right to receive remuneration etc.

CHECK YOUR

PROGRESS

Scope of Duties of an

Auditor?

AUDITING - I (101)

NOTES

Rights, Duties and

Responsibilities of

A Company Auditor


1. What are the rights & powers of an auditor?

2. What are the duties & responsibilities of an auditor?

3. What is the duty of auditor regarding enquiry?


1) The auditor does not have right to visit foreign branches of a _____________

company & it will be adequate if he is allowed access to such copies of

extracts from the books or accounts of the branch as have been sent to the

principal office in India.

(Insurance, Banking, Infrastructure, Private)

2) ________________ is entitled to attend any general meeting & to be heard

at any general meeting which he attend on any part of the business which

concerns him.

(Auditor, Broker, Manager, Director)

3) _______________ deals with matters to be stated & the reports that is to

be set out in the prospectus.

(Section 65, Section 45, Section56, Section 54)

4) Auditor reports to the _________________ about the finances of the

company.

(Directors, Management, Government, Shareholder)

5) It is the duty of the _____________ to certify the statutory report.

(Auditor, Director, Shareholder, Management)

6) He should not rely on the certificate of the ____________ for those items

which he can verify directly.

(Directors, Management, Government, Shareholder)

7) The scope of duties of an auditor depends upon the __________of the

business carried on by the concern.

(Nature, Environment, Scope, Management)

8) Give to the ___________ all assistance in the connection with investigation.

(Management, Director, Auditor, Inspector)

9) It is the duty of the auditor to sign the __________________.

(Board' report, Auditor's report, Annual report, Cost report)

10) Scheduled ________ refers only to the minimum disclosure requirement.

(VI, IV, IX, VIII)

11) _____________ is disqualified from being appointed as director under sec.

274 (i) (g).

(Auditor, Director, Manager, Cost auditor)

12) In respect of any special technical matters, the auditor is entitled to consult &

take the opinion of ___________________.

(An expert, Internal auditor, Cost auditor, Management)

AUDITING - I

(102) AUDITING - I

NOTES

13) The auditor has no ____________ to attend general meetings.

(Right, Duty, Obligation, Power)

14) The retiring auditor is entitled to receive a copy of the ______________

intending to remove him or proposing to appoint any other person as auditor..

(Special notice, General notice, Prospectus, Cost audit report)

(Answers: 1) Banking company, 2) Auditor, 3) Section 56, 4) shareholder, 5)

Auditor, 6) Management, 7) nature, 8) Inspector, 9) Auditor's report, 10) VI,

11) Director, 12) an expert, 13) obligation, 14) special notice)





AUDITING - I (103)

NOTES

Miscellanous Matters in

Company AuditUNIT - 12

MISCELLANOUS MATTERS IN

COMPANY AUDIT

Structure:

12.0 Introduction

12.1 Objectives

12.2 Statutory report

12.3 Audit of branch Accounts

12.4 Powers of accompany auditor in relation to branch

12.5 Exemption to Branch Audit

12.6 Special audit on direction of Central Government

12.7 Cost audit

12.8 Key concepts

12.9 Summary



12.0 Introduction

Every company shall require to appoint the auditor for conducting the audit

of financial statements. The position of the auditor is therefore very vital. He reports

to the shareholders about the finances of the company. Auditor should consider

some miscellaneous matters in the company audit.

12.1 Objectives

1. To understand the concept of branch audit.

2. To get knowledge about special audit

3. To get detailed knowledge about cost audit

12.2 Statutory Report

Under section 165 of Companies Act, every public company must hold a

statutory meeting within a period of not less than one month & not more than six

months, after the date on which company is entitled to commence business. The

report forwarded by the directors to every member for this meeting at least 21

days before the day of the meeting is known as the Statutory report.

lllll Contents of a Statutory report:

1. Total number of shares allotted, distinguishing between shares allotted as

fully paid or partly paid-up otherwise than in cash & in case of partly paid

up shares, the extent to which they are so paid up, in either case, the

consideration for which they have been allotted.

CHECK YOUR

PROGRESS

Define Statutory

Report?

AUDITING - I

(104) AUDITING - I

NOTES

2. The amount of cash received by the company in respect of all shares

allotted.

3. An abstracts of receipts of the company & of the payments made there

out within 7 days of report.

4. An amount or estimate of the preliminary expenses of the company

showing separately any commission or discount paid or to be paid on the

issue or sale of shares or debentures.

5. Extent if any, to which each underwriting contract, if any, has not been

carried out & reasons for that.

6. Arrears if any, due on calls from every director & from the manager.

7. Particulars of any commission or brokerage paid or to be paid in connection

with the issue of sale of shares or dentures to any director or to the

manager.

8. Auditor's certificate.

12.3 Audit of Branch Account

The accounts of the branch office should be audited by company's auditor

appointed u/s 139(1) or a person who is qualified for appointment as an auditor of

the company. Where a Branch office is situated outside India, the books of that

branch shall be audited by the company's auditor or by any person qualified or by

an accountant duly qualified to act as the auditor of that branch in accordance with

the laws of that country.

lllll Appointment of Branch Auditor:

i. The branch auditor may be appointed by the company in its general

meeting.

ii. The general meeting may authorize the board of directors to appoint such

persons in consultation with the company's auditor.

iii. The branch auditor shall have the same powers & duties in respect of the

audit of accounts of that branch office as the company's auditor has in

respect of the same.

iv. He shall prepare a report on the accounts of the branch office examined

by him.

v. He shall then forward the report to company's auditor. The company's

auditor will deal with the report of the branch auditor in such a manner, as

he consider necessary.

vi. The branch auditor shall receive remuneration & shall hold his appointment

as per such terms & conditions as may be fixed either by the company in

the general meeting or by the board of directors if so authorized in general

meeting.

12.4 Powers of Accompany Auditor in Relation to

Branch

Where the accounts of any branch are audited by a person other than

company's auditor, the company's auditor-

CHECK YOUR

PROGRESS

Define Audit of

Branch Account?

AUDITING - I (105)

NOTES


Company Audit

a. Shall be entitled to visit the branch office, it he deems it necessary to do

so, for the performance of his duties as an auditor &

b. Shall have the right of access at all times to the books & accounts &

vouchers of the company maintained at the branch office.

It means he can call for such books, etc. at the company's registered

office also.

12.5 Exemption to Branch Audit

Central Government has the power to make rules for providing exemption

to any branch from to the extent specified in such rules. The Central Government

shall have regard to the arrangements made by the company for the audit of branch

accounts & the nature & extent of activities carried on at that branch for the

previous three years.

lllll Exemption based on quantum of activity conditions:

a. Any manufacturing, processing or trading activity is carried on at the

branch office.

b. The exemption is available only if the amount calculated in step 2 is not

more than amount calculated in step 3

Step 1: Calculate 'quantum of activity'. The quantum of activity means

the highest of the following-

i. Aggregate value of goods produced or manufactured or processed at the

branch office.

ii. Aggregate value of goods sold & services rendered by the branch office.

iii. Aggregate value of expenditure, whether of revenue or capital nature,

incurred by the branch office.

Step 2: Calculate average of 'quantum of activity' by taking average of

the 'quantum of activity' during three financial years immediately preceding

the relevant FY.

Step 3: Calculate the higher of the following two limits:

i. Rs. 2 lakhs; &

ii. 2% of the total turnover of the company including all its branch offices,

earning from services rendered & earning from any other source.

But the auditor of the company shall have the right to visit the branch if he

feels necessary. He has the right of access at all times to the books & accounts &

vouchers of the company maintained at the branch office. The Central Government,

on an application made by the company, may grant exemption in other cases if the

conditions are fulfilled. They are-

a. The company should have made satisfactory arrangements for the scrutiny

& check at regular intervals of the accounts of the branch by a responsible

person.

b. The company should have made arrangements for the audit of branch

accounts by a person otherwise qualified for appointment as a branch

auditor, even though such a person is an employee of the company.

CHECK YOUR

PROGRESS

Define Exemption to

Branch Audit?

AUDITING - I

(106) AUDITING - I

NOTES

c. Having regard nature & quantum of activity carried on at branch office,

or for any other reason, a branch auditor is not likely to be available at

reasonable cost.

d. For any other reason, the Central Government is satisfied that the

exemption may be granted.

The Central Government may, after giving the company a reasonable

opportunity to make its objections, revoke an exemption granted.

12.6 Special Audit on Direction of Central Government

[Sec. 233 A]

1. Circumstances warranting special audit:

Section 233A of the companies act provides the power to the Central

Government to direct that special audit of accounts of a company be

conducted for specified period, if in its opinion, any of the following

circumstances exist-

a. The affairs of the company are not being managed in accordance with

sound business principles or prudent commercial practices; or

b. The company is being managed in a manner likely to cause serious injury

or damage to the interests of the trade, industry or business to which it

pertains; or

c. The financial position of the company is such as to endanger its solvency.

2. Appointment:

The Central Government may appoint any of the following persons to conduct

the special audit-

a. A Chartered Accountant, whether or not in practice, or

b. The company auditor himself.

Such person appointed shall be called as the Special Auditor.

3. Remuneration:

Remuneration of the special auditor shall be determined by the Central

Government & paid by the company.

4. Powers & duties:

The special auditor shall have the same powers & duties in relation to

special audit, which company auditor enjoys. The special auditor shall

report to the Central Government instead of the shareholders. The Central

Government may take some action on such report.

5. Copy to company:

If Central Government does not take any action on the report within four

months from the date of its receipt, that government shall send to the

company either a copy of, or relevant extracts from the report with its

comment thereon & require the company either to circulate that copy or

those extracts to the members or to have such copy or extracts read

brfore the company at its next general meeting.

CHECK YOUR

PROGRESS

Define Special Audit

on Direction of

Central Government?

AUDITING - I (107)

NOTES


Company Audit12.7 Cost Audit

Section 233B of companies act deals with cost audit. Cost Auditor is a

person who appoint for conducting the cost audit of cost accounting records. The

Central Government may, if it considers it necessary, direct that the audit of cost

accounts kept by the company shall be conducted by cost accountant.

i. The auditor verifies the correctness of cost records of the company.

ii. Cost audit is an audit process for verification of the cost of manufacture

or production of any article on the basis of accounts relating to utilization

of material, labour & other items of cost as maintained by the enterprise

in cost records.

iii. The person to be appointed as cost auditor of a company is required -

l l l l l To be a cost accountant within the meaning of Cost & Works

Accountants act, 1959 &

l l l l l To hold a certificate of practice issued by ICWAI.

iv. The cost auditor may be an individual or a firm of cost accountants.

v. The cost auditor shall have the same powers & duties in relation to the

audit conducted by him as the cost auditor.

vi. Cost auditor shall make his report in triplicate to Central Government in

the prescribed form. A copy of report shall be forwarded by him to the

company.

lllll Cost Audit Report:

Cost auditor shall make his report to Central Government in the prescribed

form. A copy of report shall be forwarded by him to the company.

i. The cost auditor must forward the Cost audit report to the Central

Government & to the company within 180 days of the closing of the year

to which the audit relates.

ii. Cost audit report must be given in prescribed form.

iii. The cost auditor must further report on the adequacy of cost accounting

records maintained by company to confirm that they give a true & fair

view of the cost of production, processing, manufacturing or mining

activities, as the case may be.

iv. Additional information may be included in the annexure in the report.

v. The company shall within 30 days from the date of the receipt of the

copy of report furnished the Central Government with full information &

explanation on every reservation or qualification contained in such report.

vi. The Central Government may seek further information from the company

if it so needs after consideration of the report & information & explanation

given by the company.

vii. The Central Government may direct the company concerned to circulate

to its members along with the notice of annual general meeting to bt held

for the first time after submitting of the relevant cost audit report the

whole or part if the report as it may specify, it should be noted that cost

AUDITING - I

(108) AUDITING - I

NOTES

audit will not be required annually but only for financial year(s) specified

in the order.

l l l l l Difference between Special Audit & Cost Audit:

Particulars Special audit Cost Audit

Governing 233A 233B

section

Circumstances a. Affairs of the company are The company should be one

not being managed in for which maintenance of

accordance with sound cost records u/s 209(1) (d)

business principles or prudent have been prescribed.

commercial practices; or

b. Co. is being managed in a

manner likely to cause serious

injury or damage to the

interests of the trade, industry

or business to which it

pertains; or

c. The financial position of

the co. is such as to endanger

its solvency.

Appointing By Central Government By the Board of directors

Authority directly. with the previous approval

of Central Government.

Auditor a. A Chartered Accountant A cost accountant as per the

u/s 2(1) (b) of the Cost & Works Accountants

Chartered Accountants Act, 1959. It is specifically

Act, 1949 whether or not he provided that the company

is in practice, or auditor shall not be appointed

b.The auditor himself. as cost auditor.

Audit report Directly send to the Central To Central Government with

Government. a copy to the company.

Auditor's Determined by the Central It shall be decided by the

remuneration Government. Board of directors.

12.8 Key Concepts

The report forwarded by the directors to every member for this meeting at

least 21 days before the day of the meeting is known as the Statutory report.

The Central Government may appoint any of the following persons to

conduct the special audit -A Chartered Accountant, whether or not in practice, or

the company auditor himself, such person appointed shall be called as the Special

Auditor.

Cost Auditor is a person who appoint for conducting the cost audit of

cost accounting records.

CHECK YOUR

PROGRESS

Difference between

Special Audit & Cost

Audit?

AUDITING - I (109)

NOTES


Company Audit12.9 Summary

Under section 165 of Companies Act, every public company must hold a

statutory meeting within a period of not less than one month & not more than six

months, after the date on which company is entitled to commence business. Section

233A of the companies act provides the power to the Central Government to direct

that special audit of accounts of a company be conducted for specified period.

Remuneration of the special auditor shall be determined by the Central Government

& paid by the company. The special auditor shall report to the Central Government

instead of the shareholders. Section 233B of companies act deals with cost audit.

Cost auditor shall make his report to Central Government in the prescribed form. A

copy of report shall be forwarded by him to the company.


1) What is mean by statutory report & what are the contents?

2) Write short note on exemption of branch audit?

3) Short note on cost audit.


1) Under section 165 of Companies Act, every public company must hold a

statutory meeting within a period of not less than one month & not more than

_______ months, after the date on which company is entitled to commence

business.

(five, six, seven, eight)

2) The report forwarded by the directors to every member for this meeting at

least 21 days before the day of the meeting is known as the

____________________.

(statutory report, audit report, board report, summary report)

3) The accounts of the branch office should be audited by company's auditor

appointed u/s _______ or a person who is qualified for appointment as an

auditor of the company.

(139(8), 139(7), 139(1), 139(6) )

4) The general meeting may authorize the _________________ to appoint

such persons in consultation with the company's auditor.

(board of directors, internal auditor, cost auditor, government)

5) ______________________ has the power to make rules for providing

exemption to any branch office from audit.

(State Government, Central Government, Board of directors, Company auditor)

6) Average of the 'quantum of activity' during _________financial years

immediately preceding the relevant FY should be taken.

(one, two, three, four)

7) Higher of Rs. 2 lakhs; & ______ of the total turnover of the company including

all its branch offices, earning from services rendered & earning from any

other source will be taken.

(5%, 3%, 2%, 7%)

AUDITING - I

(110) AUDITING - I

NOTES

8) Section 233A of the companies act provides the power to the Central

Government to direct that ________________of accounts of a company.

(internal audit, statutory audit, cost audit, special audit)

9) Remuneration of the special auditor shall be determined by the

________________ & paid by the company.

(Board of directors, Central Government, members, internal auditor)

10) The Central Government may appoint any of the following persons to conduct

the special audit -a Chartered Accountant, whether or not in practice, or the

company auditor himself, such person appointed shall be called as the

___________________.

(Special auditor, cost auditor, internal auditor, statutory auditor)

11) The special auditor shall report to the __________________ instead of the

shareholders.

(Board of directors, Central Government, members, internal auditor)

12) If Central Government does not take any action on the report within

_______months from the date of its receipt, that government shall send

copy of report to the company.

(one, two, three, four)

13) The cost auditor must forward the Cost audit report to the Central Government

& to the company within ____________ of the closing of the year to which

the audit relates.

(60 days, 180 days, 3 months, 30 days)

14) The company shall within _________from the date of the receipt of the

copy of report furnished the Central Government with full information &

explanation on every reservation or qualification contained in such report.

(50 days, 60 days, 30 days, 90 days)

15) The governing section of cost audit _______.

(233B, 233A, 44A, 44B)

16) _______________ is a person who appoint for conducting the cost audit of

cost accounting records.

(Special auditor, cost auditor, internal auditor, statutory auditor)

(Answers: 1) six, 2) statutory report, 3) 139(1), 4) board of directors, 5)

Central Government, 6) three, 7) 2%, 8) special audit, 9) Central Government,

10) Special auditor, 11) Central Government, 12) four, 13) 180 days, 14) 30

days, 15) 233B, 16) cost auditor)

12.11Further Reading and References




Documents

Audit - I - Yashwantrao Chavan Maharashtra Open Universityycmou.digitaluniversity.ac/WebFiles/MCOM M 17 SEME… · · 2016-01-27... INTRODUCTION OF AUDIT Definition, Objectives