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AUDIT PLANNING
Question 1
Write a short note on - Cut-off Procedures. (4 marks) (Final May 2000)
Answer
Cut-off Procedures: Cut-off procedures mean procedures employed to ensure the separation
of transactions at the end of one year from those in the commencement of the next year.
Usually, the problem of overlapping is found in inventory accounting since quite often goods
are sold but passed on to the buyer only after the year is over or goods are bought but
received only after the close of the year. This situation may create considerable problem for
the proper stock taking of inventory. Therefore, the principal areas of application of cut-off
procedures involve sales, purchases and stock. The auditor should satisfy himself by
examination and test check that these procedures adequately ensure that:
(a) Goods purchased for which property has passed to the client have in fact been included
in inventories and that the liability if any, has been provided for.
(b) Goods sold have been excluded from the inventories and credit has been taken for sales.
The auditor may examine a sample of documents evidencing the movement of stocks into and
out of stores, including documents pertaining to period shortly before and shortly after the cutoff
date, and check whether the stocks represented by those documents were included or
excluded, as appropriate, during the stock-taking.
Question 2
You have been appointed the statutory auditor of a private limited company for the first time.
Apart from adopting the conventional audit procedures such as posting, casting and vouching,
what other auditing techniques would you employ for conducting the statutory audit?
(16 marks) (Final May 2001)
Answer
A statutory auditor conducting audit of a private company for the first time would do well in
case he obtains knowledge of the business of the company to understand and assess the kind
of audit procedures to be employed by him. Knowledge of the business is a frame of
reference within which the auditor exercises professional judgement. Understanding the
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business and using this information appropriately assists the auditor in:
(i) Assessing risks and identifying problems.
(ii) Planning and performing the audit effectively and efficiently.
(iii) Evaluating audit evidence.
Such knowledge would enable the auditor to identify and understand the events, transactions
and practices that, in the auditor's judgement, may have a significant effect on the financial
statements or on the examination or audit report. As far as adoption of conventional audit
procedures is concerned, it would normally involve lot of time without commensurate benefits. In
any case, if size of the business is large, the application of conventional procedure would involve
extraordinary more time resulting into more cost and even then the auditor would not get the
required satisfaction as to the figures contained in the financial statements. There may however,
be some instances, say, where internal control systems are quite weak, it may perhaps be
advisable to stick to conventional audit procedures such as vouching, etc. in detail. In any case,
application of compliance procedure to evaluate the internal control systems in operations would
enable the auditor to determine nature, extent and timing of substantive procedures.
Depending upon various factors including size of the business, it is advisable to reduce the
extent of checking by adopting test check approach. Test-check approach is an accepted
auditing procedure, which aims to test transactions on the basis of selection of samples from the
entire population. Audit sampling means the application of audit procedures to less than 100%
of the items within an account balance or class of transactions to enable the auditor to obtain
and evaluate audit evidence about some characteristic of the items selected in order to form or
assist in forming a conclusion concerning the population. It is important to recognise that certain
testing procedures do not come within the definition of sampling. Tests performed on 100% of
the items within a population do not involve sampling. Likewise, applying audit procedures to all
items within a population which have a particular characteristic (for example, all items over a
certain amount) does not qualify as audit sampling with respect to the portion of the population
examined, nor with regard to the population as a whole, since the items were not selected from
the total population on a basis that was expected to be representative. Such items might imply
some characteristic of the remaining portion of the population. The auditor would also consider
the specific audit objectives to be achieved and the audit procedures which are likely to best
achieve those objectives. In addition, when audit sampling is appropriate, consideration of the
nature of the audit evidence sought and possible error conditions or other characteristics relating
to that audit evidence will assist the auditor in defining what constitutes an error and what
population to use for sampling. For example, when performing tests of control over an entity's
purchasing procedures, the auditor will be concerned with matters such as whether an invoice
was clerically checked and properly approved. On the other hand, when performing substantive
procedures on invoices processed during the period, the auditor will be concerned with matters
such as the proper reflection of the monetary amounts of such invoices in the financial
statements.
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After performing vouching, it is necessary for an auditor to perform verification of balances
contained in the financial statements. Verification and valuation of assets and liabilities
contained in the balance sheet would involve obtaining evidence through methods like
physical observations, confirmation, computation, inspection of documents and analytical
reviews. Direct confirmation procedure provides an independent audit evidence to analyse the
financial information contained in the accounting records. For example, confirmation may be
done for debtors, creditors, investments lying with third parties, bank balances, etc.
Apart from conducting audit procedures like vouching and verification, it is quite useful to
employ analytical review procedures; In fact, analytical review procedures would provide
substantive audit evidence to support various assertions in the financial statements. Over a
period of time, the analytical review as a method of obtaining evidence has emerged as a
significant auditing procedures. As per SA 520, analytical procedures means the analysis of
significant ratios and trends including the resulting investigation of fluctuations and
relationships that are inconsistent with other relevant information or which deviate from
predicted amounts. Analytical procedures in planning the audit use both financial and nonfinancial
information, for example, the relationship between sales and square footage of
selling space or volume of goods sold. The auditor's reliance on substantive procedures to
reduce detection risk relating to specific financial statement assertions may be derived from
tests of details, from analytical procedures, or from a combination of both. The decision about
which procedures to use to achieve a particular audit objective is based on the auditor's
judgement about the expected effectiveness and efficiency of the available procedures in
reducing detection risk for specific financial statement assertions. It further states that when
analytical procedures identify significant fluctuations or relationships that are inconsistent with
other relevant information or that deviate from predicted amounts, the auditor should
investigate and obtain adequate explanations and appropriate corroborative evidence.
Therefore, a statutory auditor who has been appointed for the first time must resort to
evaluation of internal control system through performance of compliance procedures based on
the knowledge of the client's business following by vouching on a selected basis having regard
to sampling. Physical observation and direct confirmation are also useful audit techniques in
the verification of items contained in the financial statements. Ratio analysis or analytical
procedures would also provide audit evidence as to various assertions contained in the
financial statements.
Question 3
“An auditor while analysing the errors in a sample need not consider the qualitative aspects of
errors detected.” Please comment. (8 marks) (Final Nov 2001)
Answer
Characteristics of Sampling Errors: SA 530, “Audit Sampling”, requires that while evaluating
sample results, the auditor should analyse any errors detected in the samples having regard to
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appropriateness of the audit objective. An auditor while evaluating the errors detected in a
sample selected by him from the total audit population, should analyse the nature of the
errors, the projected errors in the total population and the sampling risk attached to it. While
designing an audit sample, the auditor would also need to define the conditions that constitute
the error keeping in view the audit objectives.
Flowing from the above, the auditor, therefore, would also need to consider the qualitative
aspects of the errors detected by him. This will include the nature and reasons for the error
and its possible effect on other phases. In case a repetitive pattern emerges from such
analysis, for example, type of transaction, location, product line or period of time, the auditor
would need to identify all items in the population, which contain such errors, resulting in a total
population. The auditor would then need to carry out a separate analysis based on the
examination carried out by him for each such sub-population. Accordingly, the auditor cannot
be satisfied by detecting errors only but also would need to consider the qualitative aspects of
such errors.
Question 4
Write a short note on - Substantive Procedure. (4 marks) (Final Nov 2001)
Answer
Substantive Procedures: SA 200 on “Basic Principles Governing an Audit”, lists ‘audit
evidence’ as one of the basic principles governing an audit of financial statements. SA 200
requires that an auditor should perform audit procedures, viz., compliance procedures and
substantive procedures to obtain sufficient and appropriate evidence.
As per SA 200, substantive procedures are designed to obtain evidence as to the
completeness, accuracy and validity of the data produced by the accounting system. These
procedures comprise tests of details of transactions and balances and analysis of significant
ratios and trends including the resulting investigation of unusual fluctuations and items.
Obtaining audit evidence from substantive procedures is intended to reasonably assure the
auditor in respect of the following assertions:
Existence - that an asset or a liability exists at a given
date.
Rights and obligations - that an asset is a right of the entity and a
liability is an obligation of the entity at a given
date.
Occurrence - that a transaction or event took place which
pertains to the entity during the relevant
period.
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Completeness - that there are no unrecorded assets, liabilities
or transactions.
Valuation - that an asset or liability is recorded at an
appropriate carrying value.
Measurement - that a transaction is recorded in the proper
amount and revenue or expense is allocated
to the proper period.
Presentation and disclosure - an item is disclosed, classified, and described
in accordance with recognised accounting
polices and practices and relevant statutory
requirements, if any.
The extent and nature of substantive procedures to be performed will vary with respect to
each of the above assertions. Obtaining evidence relevant to one of the above assertions will
not compensate for failure to do so with respect to another matter concerning the same item,
e.g., existence of inventory and its valuation.
Substantive procedures are classified in two categories, viz., tests of detail and analytical
procedures. Tests of details involve vouching which primarily deals with transactions and
verification normally deals with balances contained in the balance sheet. By performing
analytical procedures which aim at calculation of ratios, trends, etc. also aim to provide the
auditor with substantive evidence to validate the items contained in financial statements.
Such procedures are normally conducted after the auditor has conducted compliance
procedures and will be affected by the following factors:
♦ Results of the compliance procedures
♦ Responses to inquiries as to whether the internal system is functioning
♦ Auditors’ evaluation of the internal control environment, especially supervisory controls
♦ Nature and amount of the transactions or balances involved
Question 5
The auditor “should take into account the aggregate of all uncorrected misstatements including
those involving estimates in his assessment of materiality in audit”. (8 marks) (Final May 2002)
Answer
SA 320 on “Audit Materiality” requires that in forming his opinion on the financial information,
the auditor should consider all material aspects, either individual or in aggregate which are
relatively important for true and fair view of financial statements. In this context, the auditor
should consider whether the effect of aggregate uncorrected mis-statements on the financial
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information is material. Qualitative considerations also influence an auditor in reaching a
conclusion as to whether the mis-statements are material. As per SA 320, the aggregate of
uncorrected mis-statements comprises: (a) specific mis-statements identified by the auditor
including the net effect of uncorrected mis-statements identified during the audit of previous
periods; and (b) the auditor’s best estimate of other mis-statements which cannot be
specifically identified (that is, projected errors). The analytical procedures employed by the
auditor may give him some indication about the existence of mis-statements, which can be
further substantiated by him through estimates process.
When an auditor uses audit sampling to test an account balance or class of transactions, he
projects the amount of known mis-statements identified by him in his sample to the items in
the balance or class from which his sample was selected. That projected mis-statement,
along with the results of other substantive tests, contributes to the auditor’s assessment of
aggregate mis-statement in the balance or class.
Impact of Misstatements: If the aggregate of the uncorrected mis-statements that the auditor
has identified approaches the materiality level, or if auditor determines that the aggregate of
uncorrected mis-statements causes the financial information to be materially mis-stated, he
should consider requesting the management to adjust the financial information or extending
his audit procedures. In any event, the management may want to adjust the financial
information for known mis-statements. The adjustment of financial information may involve,
for example, application of appropriate accounting principles, other adjustments in amounts, or
the addition of appropriate disclosure of inadequately disclosed matters. If the management
refuses to adjust the financial information and the results of extended audit procedures do not
enable the auditor to conclude that the aggregate of uncorrected mis-statements is not
material, the auditor should express a qualified or adverse opinion, as appropriate.
Question 6
How does an Auditor apply Statistical Sampling in auditing? (8 marks) (Final Nov 2003)
Answer
Application of Statistical Sampling in Auditing: Statistical Sampling in auditing stands for
the technique of forming an opinion about a group of items on the basis of an examination of a
few of the items. On the basis of audit carried out, an auditor is required to give a report
containing his opinion about the truth and fairness of the accounting statements. Thus, audit
sampling involves the application of audit procedures to less than 100% of the items within an
account balance or class of transactions to enable the auditor to obtain and evaluate audit
evidence about some characteristic of the items selected in order to form or assist in forming a
conclusion concerning the population. Broadly, the following steps are carried out by the
auditor in applying statistical sampling.
In designing an audit sample – the auditor has to consider the specific audit objectives, the
population and the sample size.
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(i) Audit Objectives: The auditor should consider the specific audit objectives to be
achieved to enable him to determine the audit procedure or combinations of procedures
which is likely to achieve these objectives. In addition, when audit sampling is
appropriate, consideration of the nature of the audit evidence sought and possible error
conditions or other characteristics relating to that audit evidence will assist the auditor in
defining what constitutes an error and what population to use for sampling. For example,
when performing series of control over an entity’s purchasing procedures, the auditor will
be concerned with matters such as whether an invoice was clerically checked and
properly approved. On the other hand, when performing substantive procedures on
invoices processed during the period, the auditor will be concerned with matters such as
the proper reflection of the monetary amounts of such invoices in the financial
statements.
(ii) Population: The population is the entire set of data from which the auditor selects the
sample in order to reach a conclusion. The auditor determines that the population from
which he draws the sample is appropriate for the specific audit objective. The total
number of items potentially subject to scrutiny within a defined area, must be sufficiently
large. For example, if the auditor’s objective were to test for overstatement of accounts
receivable, the population could be defined as the accounts receivable listing.
(iii) Confidence Level & Precision: In the mathematical probability, the error rate in the
sample will not differ from the error rate in the population by more than a stated amount.
Confidence level is normally expressed in percentage (90%, 95%, 99%).Precision
involves description of the attributes of a given population. But how precise do we require
this percentage to be? The bigger our sample, clearly the more precise we can be, but
we can never be completely precise for the same reasons as we can never be 100
percent confident. The degree of precision required will depend on the materiality of the
items in question. For example, if Rs. 3,000 of errors in a sales ledger population of Rs.
100,000 would be considered to be just not material, then 3 percent would be our
precision limits.
Finally, the auditor selects sample items in such a way that the sample can be expected
to be representative of the population. This requires that all items in the population have
an opportunity of being selected. Selection methods include random selection,
systematic selection, haphazard selection, etc. When determining the sample size, the
auditor should consider sampling risk, the tolerable error, and the expected error.
‘Sampling risk’ arises from the possibility that the auditor’s conclusion, based on a
sample, may be different from the conclusion that would be reached if the entire
population were subjected to the same audit procedure. Tolerable error is the maximum
error in the population that the auditor would be willing to accept and still conclude that
the result from the sample has achieved the audit objective. If the auditor expects error to
be present in the population, a larger sample than when no error is expected ordinarily
needs to be examined to conclude that the actual error in the population is not greater
than the planned tolerable error. Smaller sample sizes are justified when the population,
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the auditor would consider such matters as error levels identified in previous audits,
changes in the entity’s procedures, and evidence available from other procedures.
The final and last selection in the application of statistical sampling to auditing is the
evaluation of sample results by the auditor. The evaluation of sample results involves
analyses of any errors detected in the sample, projection of the errors found in the
sample to the population, and reassessing the sampling risk.
Question 7
Write a short note on – Enquiry. (4 marks )(Final Nov 2003)
Answer
Enquiry: SA 500 “Audit Evidence” mentions inquiry as one of the methods of collecting audit
evidence by seeking appropriate information from knowledgeable persons inside or outside
the entity. Inquiries may range from formal written inquires addressed to third parties to
informal oral inquiries addressed to persons inside the entity. Responses to enquiries may
provide the auditor with information, which he did not previously possess or may not provide
him with corroborative evidence. The need for inquiry may arise at every stage of auditing.
Wherever any transaction or entry is not readily understandable or its effects are not readily
apparent, the auditor should not hesitate to make enquiry from the appropriate official of the
client. Apart from this, the auditor of a company has to make a statement in his report on
whether he has obtained all the information and explanations that he considered necessary for
his audit. This requirement suggests that inquiry is one of the process of the whole scheme of
auditing and, accordingly, the Companies Act, 1956 has given certain powers to the auditor in
section 227(1) and has cast certain duties on company officials in section 221. Besides,
section 227(1A) requires the auditor to make certain specific enquiries during the course of his
audit. This requirement is without prejudice to his general rights, powers and duties regarding
access to books, etc., and obtaining information and explanations. He is, however, not
required to report on the matters specified in this sub-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 has no further duty to report that he is so satisfied.
Question 8
Answer the following:
As an internal auditor for a large manufacturing concern, you are asked to verify whether there are
adequate records for identification and value of Plant and Machinery, tools and dies and whether
any of these items have become obsolescent and not in use. Draft a suitable audit programme for
the above. (10 marks) ( Final May 2005)
Answer
The Internal Audit Programme in connection with Plant and Machinery and Tools and dies
may be on the following lines:
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(i) Internal Control Aspects: The following may be incorporated in the audit programme to
check the internal control aspects:
(a) Maintaining separate register for hired assets, leased asset and jointly owned
assets.
(b) Maintaining register of fixed asset and reconciling to physical inspection of fixed
asset and to nominal ledger.
(c) All movements of assets are accurately recorded.
(d) Authorisation be obtained for –
(i) a declaring a fixed asset scrapped.
(ii) selling a fixed asset.
(e) Check whether additions to fixed asset register are verified and checked by
authorised person.
(f) Proper recording of all additions and disposal.
(g) Examining procedure for the purchase of new fixed assets, including written
authority, work order, voucher and other relevant evidence.
(h) Regular review of adequate security arrangements.
(i) Periodic inspection of assets is done or not.
(j) Regular review of insurance cover requirements over fixed assets.
(ii) Assets Register: To review the registers and records of plant, machinery, etc. showing
clearly the date of purchase of assets, cost price, location, depreciation charged, etc.
(iii) Cost Report and Journal Register: To review the cost relating to each plant and
machinery and to verify items which have been capitalised.
(iv) Code Register: To see that each item of plant and machinery has been given a distinct
code number to facilitate identification and verify the maintenance of Code Register.
(v) Physical Verification: To see physical verification has been conducted at frequent
intervals.
(vi) Movement Register: To verify (a) whether a Movement Register for movable
equipments and (b) log books in case of vehicles, etc. are being maintained properly.
(vii) Assets Disposal Register: To review whether assets have been disposed off after
proper technical and financial advice and sales/disposal/retirement, etc. of these assets
are governed by authorisation, sales memos or other appropriate documents.
(viii) Spare Parts Register: To examine the maintenance of a separate register of tools,
spare parts for each plant and machinery.
(ix) Review of Maintenance: To scrutinise the programme for an actual periodical servicing
and overhauling of machines and to examine the extent of utilisation of maintenance
department services.
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(x) Review of Obsolescence: To scrutinise whether expert’s opinion have been obtained
from time to time to ensure purchase of technically most useful efficient and advanced
machinery after a thorough study.
(xi) Review of R&D: To review R&D activity and ascertain the extent of its relevance to the
operations of the organisation, maintenance of machinery efficiency and prevention of
early obsolescence.
Question 9
Comment on the following:
Obtaining audit evidence in performing compliance and substantive procedures.
(10 marks) (Final May 2005)
Answer
Obtaining Audit Evidence: In performing compliance and substantive procedures, the auditor
may obtain audit evidence by following methods:
(i) Inspection: It consists of examining various records, documents and tangible assets.
Examination of these records and assets provides evidence of varying degree of
reliability depending upon their nature, source and effectiveness of internal control over
their processing. Inspection of tangible assets provides reliable evidence regarding their
existence. Four major categories of documentary evidence, which provide different
degree of reliability are:
(a) documentary evidence originating from and held by third parties;
(b) documentary evidence originating from third party and held by entity;
(c) documentary evidence originating from the entity and held by third parties;
(d) documentary evidence originating from and held by the entity.
Inspection of tangible assets is one of the methods to obtain reliable evidence with
respect to their existence but not necessarily as to their ownership or value.
(ii) Observation: It consists of witnessing a process or procedure being performed by
others. Observation of physical verification of inventories by the auditor will help in
gathering reliable evidence as to their existence, physical condition and control.
(iii) Inquiry and confirmation: Inquiry consists of seeking appropriate information from
knowledgeable persons inside or outside the entity. Inquiries may range from formal
written inquiries addressed to third parties to informal oral inquiries addressed to persons
inside the entity. Responses to inquiries may provide the auditor with information which
he did not previously possess or may provide him with corroborative evidence.
Confirmation consists of the response to an inquiry to corroborate information contained
in the accounting records. For example, the auditor requests confirmation of receivables
by direct communication with debtors.
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(iv) Computation: It consists of checking the arithmetical accuracy of source documents and
accounting records and doing calculation to arrive at facts and figures.
(v) Analytical review: It consists of studying significant ratios and trends and investigating
unusual fluctuations in results.
Question 10
Write short notes on the following:
(a) Walk Through Tests
(b) Factors relevant in evaluation of Inherent Risk (4 x 2 = 8 marks) (Final May 2005)
Answer
(a) Walk Through Tests: A walk through is a procedure in which an auditor traces a
transaction from its initiation through the company’s information systems to the point
when it is reflected in the financial reports. The auditor should perform one walk through,
at a minimum, for each major class of transactions. A walk-through provides evidence to
confirm that the auditor understands (1) the process flow of transactions, (2) the design
of identified controls for internal control components, including those related to
preventing and detecting fraud, and (3) whether all points in the process have been
identified at which misstatements related to relevant financial statement assertion could
occur. Walk through also provide evidence to evaluate the effectiveness of the controls’
design and confirm that the controls have been placed in operation.
When performing a walk-through, the auditor should:
(i) Be sure that the walk-through encompasses the complete process (initiation,
authorization, recording, processing and reporting) for each significant process
identified, including controls intended to address fraud risk.
(ii) Ask the entity’s personnel, at each of key stage in the process, about their
understanding of what the company’s prescribed procedures require.
(iii) Determine whether processing procedures are performed as expected on a timely
basis, and look for any exceptions to prescribed procedures and controls.
(iv) Evaluate the quality of evidence provided and perform procedures that produce a
level of evidence consistent with the auditor’s objectives. The auditor should follow
the whole process, using the same documents and technology that company staff
use, asking questions of different personnel at each significant stage and asking
follow- up questions to identify any abuse of controls or fraud indicators.
Once a walk-through is performed, the auditor may carry forward the
documentation, noting updates, unless significant changes make preparation of new
documentation more efficient. If such significant changes occur in the process flow
of transactions or supporting computer applications, the auditor should evaluate the
nature of changes and the effect on related accounts. The auditor should determine
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whether it is necessary to walk through transactions that were processed both
before and after the change.
(b) Relevant Factors in evaluation of inherent risk: While developing an overall audit
plan, the auditor is required to assess inherent risk at financial statement level and is
then required to relate his assessment to material account balances and the class of
transactions. To assess inherent risk, the auditor would use professional judgement to
evaluate numerous factors, having regard to his experience of the entity from previous
audit engagements of the entity, any controls established by management to compensate
for a high level of inherent risk, and his knowledge of any significant changes which might
have taken place since his last assessment. Normally an auditor evaluates inherent risk
by assessing factors such as integrity of the management, experience and knowledge of
the management, turnover of key management personnel, circumstances which may
motivate the management to misstate the financial statement when its financial
performance is not satisfactory, nature of entity’s business prone to rapid technological
obsolescence, dealing with large number of related parties etc.
Question 11
Designing an Audit Strategy is the backbone of the “Audit Planning” process. Discuss.
(10 marks)(Final May 2006)
Answer
Audit strategy is concerned with designing optimised audit approaches, that seeks to achieve
the necessary audit assurance at the lowest cost within the constraints of the information
available. The formulation of audit strategy as shall be evident from the process as explained
in the following paragraphs in fact shall form the basis of audit planning to achieve the audit
objectives in the most efficient and effective manner. Audit strategy generally involves the
following steps:
(i) Obtaining Knowledge of Business: ( Erstwhile AAS 20 &SA 310 “ Knowledge of the
Business” ) SA 315 & 330 “Identifying and Assessing the Risk of Material Misstatement
Through Understanding the Entity and its Environment” and “The Auditor’s Responses
to Assessed Risks” states that in performing an audit of financial statements, the auditor
should have or obtain knowledge of the business sufficient to enable the auditor to
identify and understand the events, transactions and practices that, in the auditor’s
judgement, may have a significant effect on the financial statements or on the
examination or audit report. Knowledge of the business is a frame of reference within
which the auditor exercises professional judgement. Understanding the business and
using this information appropriately assists the auditor in assessing risks and identifying
problems, planning and performing the audit effectively and efficiently. It also ensures
that the audit staff assigned to an audit engagement obtains sufficient knowledge of the
business to enable them to carry out the audit work delegated to them. This would also
ensure that the audit staff understands the need to be alert for additional information and
the need to share that information with the auditor and the other audit staff.
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(ii) Performing Analytical Procedures: The purpose of analytical procedures at the
planning stage is attention-directing; corroboration is not normally necessary at this
stage. The use of the analytical procedures during the planning stage requires the
extensive use of accounting and business knowledge and experience to assess the
potential for material misstatement in the financial statements as a whole, because the
key aspect of the task is to identify the relevant risk indicators and to interpret them
properly. Furthermore, analytical techniques applied during the planning stage are not
generally as precise as the analytical techniques at the substantive stage.
(iii) Evaluating Inherent Risk: To assess inherent risk, the auditor would use professional
judgement to evaluate numerous factors such as quality of accounting system, unusual
pressure on management, etc. having regard to his experience of the entity from
previous audit engagements of the entity, any controls established by management to
compensate for a high level of inherent risk, and his knowledge of any significant
changes which, might have taken place since his last assessment.
(iv) Evaluating Internal Control: The auditor’s assessment of the control environment is
crucial to the decision on whether to make an extended assessment of controls. This is
because a good control environment is conducive to the maintenance of a reliable
system of accounting and control procedures. For strategy purposes, the auditor should
obtain a sufficient understanding of the control environment. The auditor needs an
understanding of the accounting systems, regardless of whether the audit strategy will
involve an extended assessment of internal accounting controls. This is done by:
(a) considering the results of gathering or updating information about the client; and
(b) making preliminary judgements about materiality, inherent risk and control
effectiveness. These will include identification of the system(s) the auditor
proposes to subject to an extended assessment of controls.
Thus, the audit strategy is evolved after considering the engagement objectives, the results of
the business review, preliminary judgements as to materiality and identified inherent risks.
Audit strategy also considers main points relating to planning and controlling the audit or
comments on adequacy of the existing arrangements. Thus, the overall audit plan involving
determination of timing, manpower, coordination and the directions in which the audit work has
to proceed is dependent upon the audit strategy formulated by the audit firm.
Question 12
As an internal auditor of a Cement Manufacturing Company, draft an audit programme for
verification of transportation charges for despatches from the factory.
(8 marks)(Final May 2006)
Answer
Procedure for Audit of Transportation Charges
(i) Check rates contracted with transporters for carriage of goods.
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(ii) Check whether the rates mentioned as per the contract are correctly taken in the
transporter’s Invoice.
(iii) In case of discrepancy, check whether the same is authorized by the appropriate
sanctioning authority.
(iv) Check that the transporter’s invoice includes a delivery challan which has customers
stamp indicating the receipt of the goods.
(v) In case there is no stamp on the delivery challan, check whether the goods are received
back and there is a corresponding inward note.
(vi) Check whether all the goods to be dispatched have a transport booking order reference.
(vii) Check whether each transporter’s invoice mentions the transport booking order
reference.
(viii) Check whether all the transport booking orders have corresponding transporters names.
(ix) Check whether the transport booking orders are prenumbered.
(x) Check whether all the invoices are correctly booked in the books of accounts.
(xi) In case there is an additional charge by the transporter due to extra carriage, check for
the relevant supporting records (like material Inward Note/Customer Rejection Note)
and necessary authorization by the sanctioning authority.
(xii) Check whether service-tax on the transporters is correctly calculated and accounted.
(xiii) Verify that for there is a mechanism for linking all the Transport Bills to the sale invoices.
Question 13
Write a short note on - Analytical procedures in planning an audit.
(4 marks) (Final May 2007)
Answer
Analytical procedures in planning an audit: In the planning stage, analytical procedures
assist the auditor in understanding the client’s business and in identifying areas of potential
risk by indicating aspects of and developments in the entity’s business of which he was
previously unaware. This information will assist the auditor in determining the nature, timing
and extent of his other audit procedures.
Analytical procedures in planning the audit use both financial data and non-financial
information, such as number of employees, the square feet of selling space, volume of goods
produced and similar information.
Question 14
As a chartered accountants firm draft an engagement letter to the Board of Directors for the
compilation of financial statements of XYZ Ltd. as at 31.3.2007. (16 Marks) (Final May 2007)
Answer
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Engagement letter to the Board of Directors for the compilation of financial statements
of XYZ Ltd. as at 31.3.2007
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To
The Board of Directors
XYZ Ltd.
…………
You have vide your letter dated ………requested that we compile the Balance Sheet of XYZ.
Ltd. as at 31.3.2007 and the related Profit and Loss account for the year ended on that date.
We are pleased to confirm our acceptance and understanding of the engagement by means of
this letter. As no audit or review engagement procedures would be carried out, no opinion on
the financial statements will be expressed. Further, our engagement cannot be relied upon to
disclose whether frauds or defalcations, or illegal acts exist. However, we will inform you of
any such matters which might come to our attention in the course of the engagement.
As Management, you are responsible for :
(a) The accuracy and completeness of the information supplied to us, including maintenance
of adequate accounting records and internal controls and selection and application of
appropriate accounting policies.
(b) Preparation and presentation of the financial statements of the entity, in accordance with
the applicable laws and regulations, if any.
(c) Safeguarding the assets of the entity and also establishing appropriate controls designed
to prevent and detect fraud and other irregularities.
(d) Ensuring that the activities of the entity are carried on in accordance with applicable laws
and regulations and that it institutes appropriate controls to prevent and detect any noncompliance.
You will confirm that events and transactions are recorded in accordance with the applicable
accounting standard(s), issued by the Institute of Chartered Accountants of India and other
recognized accounting principles and practices and inform us of any departures therefrom.
As part of our normal procedures, we may request you to provide written confirmations of any
information or explanations given to us orally during the course of our work.
We understand that the intended use and distribution of the information we have compiled is
………(specify purpose)
We look forward to full co-operation with your staff and we trust that they will make available
to us whatever records, documents and other information requested in connection with our
engagement.
Our fees will be billed as the work progresses.
Please sign and return the attached copy of this letter to indicate that it is in accordance with
your understanding of the arrangements for our compilation of your financial statements.
XYZ & Co.
Chartered Accountants
S/d
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Question 15
M/s PQR & Company, Chartered Accountants have been appointed Statutory Auditors of a
listed Company for the year ended 31st March, 2008. Draft an appropriate engagement letter
to be sent to the Board of Directors for the same. (12 marks)(Final Nov 2007)
Answer
Draft of an Engagement Letter
To the Board of Directors
You have requested that we audit the balance sheet of (Name of the Company) as at 31st
March, 2008 and the related profit and loss account and the cash flow statement for the year
ended on that date. We are pleased to confirm our acceptance and our understanding of this
engagement by means of this letter. Our audit will be conducted with the objective of our
expressing an opinion on the firm statements.
We will conduct our audit in accordance with the auditing standards generally accepted in
India and with the requirements of the Companies Act, 1956. Those Standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
However, having regard to the test nature of an audit, persuasive rather than conclusive
nature of audit evidence together with inherent limitations of any accounting and internal
control system, there is an unavoidable risk that even some material misstatements of
financial statements, resulting from fraud, and to a lesser extent error, if either exists, may
remain undetected.
In addition to our report on the financial statements, we expect to provide you with a separate
letter concerning any material weaknesses in accounting and internal control systems which
might come to our notice.
The responsibility for the preparation of financial statements on a going concern basis is that
of the management. The management is also responsible for selection and consistent
application of appropriate accounting policies, including implementation of applicable
accounting standards along with proper explanation relating to any material departures from
those accounting standards. The management is also responsible for making judgements and
estimates that are reasonable and prudent so as to give a true and fair view of the state of
affairs of the entity at the end of the financial year and of the profit or loss of the entity for that
period.
The responsibility of the management also includes the maintenance of adequate accounting
records and internal controls for safeguarding of the assets of the company and for the
preventing and detecting fraud or other irregularities. As part of our audit process, we will
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request from management written confirmation concerning representations made to us in
connection with the audit.
We also wish to invite your attention to the fact that our audit process is subject to 'peer
review' under the Chartered Accountants Act, 1949. The reviewer may examine our working
papers during the course of the peer review.
We look forward to full cooperation with your staff and we trust that they will make available to
us whatever records; documentation and other information are requested in connection with
our audit.
Our fees will be billed as the work progresses.
This letter will be effective for future years unless it is terminated, amended or superseded.
Please sign and return the attached copy of this letter to indicate that it is in accordance with
your understanding of the arrangements for our audit of the financial statements.
PQR & Co.
Chartered Accountants
…………………………
(Signature)
Date : (Name of the Member)
Place : (Designation)
Acknowledged on behalf of
__________Company by
……………………..
(Signature)
Name and Designation
Date
Question 16
What is an Audit Trail? (4 marks) (Final May 2008)
Answer
Audit Trail: Audit Trail can be defined as those documents, records, journals, ledgers,
master files etc. that enables an auditor to trace the transactions from the source document to
the summarised total in accounting reports or vice-versa.
Audit trail is the visible means whereby the auditor may have a business transactions through
all the stages in which it features in the records of the business. For example, sequentially
numbered sales invoice copies would normally be listed in a register or day book and
subsequently filed either in numerical or chronological sequence. It would then be possible to
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trace a particular invoice from the day book to the original file or vice-versa by reference to the
number or date of the invoice.
In a manual accounting system, it is possible to relate the recoding of a transaction at each
successive stage enabling an auditor to locate and identity all documents from beginning to
end for the purposes of examining documents, totalling and cross-totalling referencing.
However, in an EDP environment, the use of exception reporting by management has
effectively eliminated the audit trail between input and output. Frequently computer generated
totals, analysis and balances are not printed out in detail because the management is not
exercising control through verification of the individual items processed.
Question 17
What is Haphazard Sampling? (6 marks) (Final May 2008)
Answer
Haphazard Sampling: In haphazard selection, the auditor selects the sample without
following a structured technique. Although no structured technique is used, the auditor would
nonetheless avoid any conscious bias or predictability for example, avoiding difficult to locate
items, or always choosing or avoiding the first or last entries on a page and thus attempt to
ensure that all items in the population have a chance of selection. Haphazard selection is not
appropriate when using statistical sampling.
Haphazard selection of sample, may be an acceptable alternative to random selection of
sample, provided the auditor attempts to draw a representative sample from the entire
population with no intention to either include or exclude specific units.
When the auditor uses this method, care needs to be taken to guard against making a
selection that is biased, for example, towards items which are easily located, as they may not
be representative.
Question 18
Explain the concept of Audit risk:
(i) At the level of financial statements
(ii) At the level of account balance and class of transactions.
(4 marks x 2= 8)(Final May 2008)
Answer
(i) Audit risk at the financial statement level: Audit risk is considered at the financial
statement level during the audit planning process. At this time, the auditor should
undertake an overall audit risk assessment based on his knowledge of the client’s
business, industry, management, control environment and operations. Such an
assessment provides preliminary information about the general approach to the
engagement, the auditor’s staffing needs and the framework within which materiality and
audit risk assessment can be made at the individual account balances or class of
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transactions level. For assessing inherent risk, the auditor uses professional judgement
to evaluate numerous factors, examples of which are:
- The integrity of management
- Management experience, knowledge and changes during the period (e.g. the
inexperience of management may affect the preparation of the financial statements
of the entity)
- Unusual pressure on management
- The nature of entity’s business (e.g. its technological obsolescence of products and
services, complex capital structure, significance of related parties and the number of
locations and geographical spread of its production (facilities), factors affecting the
industry in which the entity operates (e.g. economic and competitive conditions,
changes in technology).
(ii) Audit risk at the account balance and class of transactions level: Majority of audit
procedures are directed to, and carried out at the account balance and class of
transactions level. Accordingly, audit risk should be considered by the auditor at this level
taking into account the results of the overall audit risk assessment made at the financial
statement level. To assess inherent risk, the auditor uses professional judgement to
evaluate numerous factors, examples of which are:
(i) The complexity of underlying transactions which might require the use of the work of
an expert;
(ii) Susceptibility of assets to loss or misappropriation;
(iii) The completion of unusual and complex transactions, particularly at or next year
end, and
(iv) Transactions not subjected to the normal processing mode.
Question 19
Write a short note on - Stages in Risk Based Internal Audit. (4 marks) (Final Nov 2008)
Answer
Risk Based Internal Audit - Comprises of 3 stages:
• Assessing Risk Maturity
• Preparing Periodic Audit Plan.
• Conducting individual assurance audit assignments and reporting to appropriate levels.
3
INTERNAL CONTROL
Question 1
Internal Audit said to be an "Independent appraisal activity within an organisation for review of
accounting, financial and other operations as a basis of service to the organisation, it is a
managerial control which functions by measuring and evaluating the effectiveness of other
controls". Explain briefly. (8 marks) (Final May 2000)
Answer
Traditionally, the expression, 'internal audit' refers to an audit conducted on behalf of the
management to ensure that the existing internal controls are adequate and effective; the
financial accounting and other records and reports show results of actual operations
accurately and promptly; and each unit of the organization follows the policies and procedures
as laid down by the top management. Thus, during initial stages, the internal auditor's
significant emphasis was on detection of errors and frauds focused on financial aspects of the
enterprise.
Over a period of time, the participation in non-financial areas increased rapidly since the
business scene was changing very fast. Pressure on the managements was building up due to
enormous growth of organisations in size and operations. The complexity of business activities
and voluminous transactions led to increasing dependence on large number of people. It was
in this context that the management recognised the possibility of utilising the services of
internal audit department in a much more effective manner. And this was possible with only a
little extra expenditure. It was strongly felt that the expertise built by the internal auditor in
financial operations should be equally useful for non-financial operation of the enterprise as
well. This is how in the expression given in the question all three words viz. "accounting",
"financial" and "other operations" stand on equal importance. The Statement of
Responsibilities of Internal Auditor issued in 1971 by the Institute of Internal Auditors, USA cut
the umbilical cord to the books of account and simply defined internal auditing as, Internal
auditing is, "the review of operations as a service to management". With this revision of
definition, it was made clear that accounting activity is also one of the operational areas of the
entity like production, research and development, personnel, marketing, etc. In 1981, the
definition was modified as under:
"Internal auditing is an independent appraisal function established within the organization to
examine and evaluate its activities as a service to the organisation. It is a managerial control
which functions by measuring and evaluating the effectiveness of other controls."
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With this, internal auditing came to be recognised as a management resource- an important
part of the total internal control system for which management is primary responsible. Today,
the total range of services rendered by the internal auditor covers both protective needs and
constructive needs stressing on performance and operations. Specifically, the range of
activities as outlined in the Statement of Responsibilities of Internal Auditors is as follows:
(i) Reviewing and appraising the soundness, adequacy and application of accounting,
financial, and other operating controls, and promoting effective control at reasonable
cost.
(ii) Ascertaining the extent of compliance with established policies, plans and procedures.
(iii) Ascertaining the extent to which company's assets are accounted for and safeguarded
from losses of all kinds.
(iv) Ascertaining the reliability of management data developed within the organisation.
(v) Appraising the quality of performance in carrying out assigned responsibilities.
(vi) Recommending operating improvements.
A close examination of those services help us in identification of primary protective services
viz second, third and fourth, and those that are primarily directed to further improvement in
operations (i.e. the first, fifth, and sixth).
The modern concept of internal auditing suggests that internal auditing need not be confined
to financial transactions and that its scope may be extended to the task of reviewing whether
the resource utilisation of the enterprise is efficient and economically. This would necessitate
a review of all operations of the enterprise as also an evaluation of the effectiveness of
management. In this sense, the internal auditor performs what is known as 'Operational audit'
or 'Management audit'. Thus, the expression makes it clear that the scope of activities of
internal auditor is not restricted to financial areas but extends to non-financial areas as well.
(Note: Recently, the Institute of Internal Auditors itself has revised the definition of Internal
Auditing. The revised definition is:
"Internal auditing is an independent, objective assurance and consulting activity designed to
add value and improve an organisation's operations. It helps an organisation accomplish its
objectives by bringing a systematic, disciplined approach to evaluate and improve the
effectiveness of risk management, control and governance process).
Question 2
Briefly discuss the compliance procedures and their use in evaluation of internal controls.
(8 marks) (Final Nov 2001)
Answer
Compliance Procedures and Evaluation of Internal Controls: SA 200 on “Basic Principles
Governing an Audit” states that, “the auditor should obtain sufficient appropriate audit
evidence through the performance of compliance and substantive procedures to enable him to
draw reasonable conclusions therefrom on which to base his opinion on the financial
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information. According to it, compliance procedures are tests designed to obtain reasonable
assurance that those internal controls on which audit reliance is to be placed are in effect.
Obtaining audit evidence from compliance procedures is intended to reasonably assure the
auditor in respect of the following assertions :
Existence - that the internal control exists.
Effectiveness - that the internal control is operating effectively.
Continuity - that the internal control has so operated throughout the
period of intended reliance.
The auditor formulating his opinion on financial information needs reasonable assurance that
transactions are properly authorised and recorded in the accounting records and that the
transactions have not been omitted. Internal controls, even if fairly simple, may contribute to
the reasonable assurance the auditor seeks. The auditors’ objective in studying and
evaluating internal controls is to establish the reliance he can place thereon in determining the
nature, timing and extent of his substantive auditing procedures.
Compliance procedures are tests designed to obtain reasonable assurance that those internal
controls on which audit reliance is to be placed are in place and are also effective.
Compliance procedures enable the auditor to determine the existence, effectiveness and
continuous operation of the internal control system. These procedures include tests requiring
inspection of documents supporting transactions to gain evidence that controls have operated
properly. For example, the auditor may see that the documents have been properly
authorised. The auditor may also make enquiries about the observation of controls, for
example, determining who actually performs each function not merely who is supposed to
perform it. Compliance procedures are conducted by the auditor to gain evidence that those
internal controls on which he intends to rely operates generally as identified by him and they
function effectively throughout the period of intended reliance. The concept of effective
operation recognises that some deviations from prescribed controls may have occurred.
Based on the results of his compliance procedures, the auditor evaluates whether the internal
controls are adequate for his purpose. If based on the results of the compliance procedures,
the auditor concludes that it is not appropriate to rely on a particular internal control to the
degree previously contemplated, he should ascertain whether there is another control which
would satisfy his purpose and on which he might rely (after applying appropriate compliance
procedures). Alternatively, he may modify the nature, timing or the extent of his substantive
audit procedures.
Question 3
Write a short note on - Audit Risk. (4 marks) (Final May 2002)
Answer
Audit Risks: Audit risk is the risk that an auditor may give an inappropriate opinion on
financial information that is materially misstated. For example, an auditor may give an
unqualified opinion on financial statements without knowing that they are materially misstated.
Such risk may exist at overall level or while verifying various transactions and balance-sheet
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items. Low risk areas are those which require the application of routine “nuts and bolts” audit
procedures in the ordinary course of vouching, casting, checking, etc., at both compliance and
substantive stages, usually occupying up to 80% of all audit effort. High-risk areas are those,
which should be the primary concern of partners and senior managers, and will include such
matters as: adequacy of provisions; full disclosure of liabilities including contingent liabilities;
interpretation of SAs and company legislation; etc. Three components of audit risk are:
♦ Inherent risk (risk that material errors will occur);
♦ Control risk (risk that the client’s system of internal control will not prevent or correct
such errors); and
♦ Detection risk (risk that any remaining material errors will not be detected by the auditor).
The nature of each of these types of risk and their interrelationship is discussed below:
Inherent risk is the susceptibility of an account balance or class of transactions to
misstatement in other balances or classes, assuming that there were no related internal
controls. It is a function of the entity’s business and its environment and the nature of the
account balance or class of transactions. For example, accounts involving a high degree of
management judgement, or that are difficult to compute, such as a complex accounting
estimate, or that involve highly desirable and movable assets, such as jewellery, or that are
particularly susceptible to changes in consumer demand or technology that could affect their
value, will involve more inherent risk than other accounts.
Control risk is the risk that misstatement that could occur in an account balance or class of
transactions and that could be material, individually or when aggregated with mis-statements
in other balances or classes, will not be prevented or detected on a timely basis by the system
of internal control. There will always be some control risk because of the intrinsic limitation of
any control design, as well as test adherence to control procedures. In the absence of such an
assessment, the auditor should assume that control risk is high.
Detection risk is the risk that an auditor’s procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material, individually or
when aggregated with misstatements in other balances or classes. The level of detection risk
relates directly to the auditor’s procedures. Some detection risk would always be present even
if an auditor were to examine 100 percent of the account balance or class of transaction
because, for example, the auditor may select an inappropriate audit procedure, misapply an
appropriate audit procedure or misinterpret the audit results.
Inherent and control risks differ from detection risk in that they exist independently of an
audit of financial information. Inherent and control risks are functions of the entity’s business
and its environment and the nature of the account balances or classes of transactions,
regardless of whether an audit is conducted. Even though inherent and control risks cannot be
controlled by the auditor, the auditor can assess them and design his substantive procedures
to produce an acceptable level of detection risk, thereby reducing audit risk to an acceptably
low level.
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Question 4
“Surprise Checks” help the auditors to ascertain whether the internal control system is operating
effectively in a Company or not. Discuss. (8 marks) (Final May 2003)
Answer
Surprise Checks: The erstwhile AAS 6 & Standard on Auditing 400, “Risk Assessment and
Internal Control”, (hitherto known as SA 315 & SA 330)* prescribes that “the auditor should
obtain an understanding of the accounting and internal control systems sufficient to plan the
audit and develop an effective audit approach. The auditor should use professional judgement
to assess audit risk and to design audit procedures to ensure that it is reduced to an
acceptably low level.” The understanding of the accounting and internal control system can be
obtained in several ways including inspection of documents making inquires of appropriate
management, observation of activities, etc. It is in this context, surprise checks intend to
ascertain whether the system of internal control is operating effectively and whether the
accounting and other records are prepared concurrently and kept up-to-date. Particularly, the
observation of the entity’s activities and operations including observation of the organisation of
computer operations, personnel performing control procedures and the nature of transaction
processing on a surprise visit would reveal the exact manner in which the activities are being
performed in the manner prescribed by the management. It has often been found that
manipulations and frauds are facilitated under a system of book-keeping, which does not give
proper emphasis to the need to keep the books up-to-date. Errors in book-keeping are often
indicative of weaknesses in internal control which may be taken advantage of in order to
perpetrate frauds or manipulations. Surprise checks are a useful method of determining
whether or not such errors exist and where they exist, of bringing the matter promptly to the
attention of the management so that corrective action is taken immediately. Consequently,
surprise visits by the auditor can exercise a good moral check on the client’s staff.
The Guidance Note issued by the Institute on the subject specifies that surprise checks are a
part of the normal audit and the results of such checks are therefore important primarily to the
auditor himself in deciding the scope of his audit and submitting his report thereon. The need
for and frequency of surprise checks is obviously a matter to be decided having regard to the
circumstances of each audit. It would depend upon the extent to which the auditor considers
the internal control system as adequate, the nature of the clients’ transaction, the locations
from which he operates and the relative importance of items like cash, investments, stores etc.
However, wherever feasible a surprise check should be made at least once in the course of an
audit. If this surprise check reveals any weaknesses in the system of internal control or any
fraud or error or the fact that any book or register has not been properly maintained or kept
up-to-date, the auditor should communicate the same to the management and ensure that
action is taken on the matters communicated by him. It does not necessarily follow that all or
any of the matters communicated to the management should form part of the auditor’s report
on the accounts. Thus “surprise checks” help the auditors, during the course of their audit, to
ascertain whether the internal control is operating effectively in a company or not.
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*(NOTE: SA 315 issued in December, 2007. The date this Standard (along with SA 330)
becomes effective, the existing Standard on Auditing (SA) 400, “Risk Assessments and
Internal Control”, SA 310, “Knowledge of the Business”, and SA 401, “Auditing in a
Computer Information Systems Environment”, issued in June 2002, April 2000 and
January 2003, respectively, would stand withdrawn).
Question 5
(a) Underwriting function and its internal control procedures. (4 marks)
(b) Can a statutory auditor act as a book-keeper and as an internal auditor? (4 marks)
(Final May 2003)
Answer
(a) Underwriting function and its internal control procedures: The underwriting function,
which comprises of examination and evaluation of applications for insurance, the rating
of risks and the establishment of premiums, is fundamental to the operations of a general
insurance company. The prime objectives of an internal control system for underwriting
is adherence to guidelines for acceptances of insurance, proper recording of insurance
risk and its evaluation. The following, therefore, may be the internal control procedures
with regard to the underwriting:
(i) Appropriate and clear underwriting guidelines are framed and communicated to the
underwriting department and the intermediaries where such guidelines are executed
with a reasonable certainty without providing substantial flexibility to the
underwriters. The adherence to these guidelines should be monitored by an
appropriate official of the company.
(ii) Firm procedures are instituted to ensure adequate investigation of the risks
assumed (e.g., medical or other investigative reports are duly obtained from the
insured).
(iii) There is an effective communication between claims and underwriting department.
(iv) The relevant information is processed on a timely basis to avoid processing
backlogs.
(v) Suspense/ unreconciled account balances are reviewed and analysed on a timely
basis by responsible officials.
(vi) Guidelines for reinsurance are established and monitored by a responsible officer.
(vii) Adequate systems are developed to identify existence of premium deficiency, if any,
and the calculation in respect thereof is regularly performed and approved by an
appropriate official.
(b) Can a statutory auditor act as a book-keeper and as an internal auditor:
Professional integrity and independence is an essential characteristic of all the learned
professions but is more so in the case of accounting profession. Independence implies
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that the judgement of a person is not subordinate to the wishes or directions of another
person who might have engaged him, or to his own self-interest. In all phases of a
Chartered Accountant’s work, he is expected to be independent, but in particular in his
work as auditor, independence has a special meaning and significance. Not only the
client but in the case of companies, also the shareholders, prospective investors,
bankers and government agencies rely upon the accounts of an enterprise when they are
audited by a Chartered Accountant. As statutory auditor of the accounts of a limited
company, for example, the Chartered Accountant would cease to perform any useful
function if the persons who rely upon the accounts, of the company do not have any faith
in the independence and integrity of the Chartered Accountant. In such cases he is
expected to be objective in his approach, fearless, and capable of expressing an honest
opinion based upon the performance of work such as his training and experience enables
him to do.
In view of the above, a statutory auditor either performing as a book-keeper or an internal
auditor would not be in a position to act in an independent manner on the subject matter
prepared by him. If a person who writes the books of account would not be in a position
to express an opinion on the appropriateness or otherwise of the same. Accordingly, the
Council has clarified that the members are not permitted to write the books of account of
their auditee clients. As back as in 1963, Seventh Annual Report on Working and
Administration of Companies Act, 1956 clarified the acceptance of the book-keeping work
by the statutory auditor is likely to place the statutory auditor in a rather vulnerable
position in the matter of free expression of his professional opinion as an auditor on the
annual accounts of the company.
Regarding the internal auditor, the Code of Ethics also recommend that a statutory
auditor of a company cannot also be its internal auditor, as it will not be possible for him
to give independent and objective report issued under sub-section 4A of section 227 of
the Companies Act, read with the Companies (Auditor’s Report) Order, 2003. Further as
per circular issued by the Department of Company Affairs in case the statutory auditor of
the company is also the internal auditor, it will not be possible for him to give an
independent and objective report under section 227. As such a statutory auditor of a
company cannot also be its internal auditor.
Question 6
Write a short explanatory note on - Flow chart technique for evaluation of internal control.
(4 marks) (Final May 2004)
Answer
Flow-chart technique for evaluation of internal control: A flow-chart is a graphic
presentation of the flow of transactions and documents in an organisation. Evaluation of the
internal controls forms an important part of the auditing process as it enables the auditor to
know the weaknesses and strengths of the accounting system and consequently the general
reliability of the accounting records and data emanating therefrom. Also, it helps the auditor to
decide upon the relative audit thrust needed in the different accounting areas. A properly
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drawn up flow chart can provide a neat visual picture of the whole activities of the section or
department involving flow of documents and activities. More specifically it can show:
(i) at what point a document is raised internally or received from external sources;
(ii) the number of copies in which a document is raised or received;
(iii) the intermediate stages set sequentially through which the document and the activity
pass;
(iv) distribution of the documents to various sections, departments or operations;
(v) checking authorisation and matching at relevant stages;
(vi) filing of the documents; and
(vii) final disposal status.
Different methods are available with the auditor to evaluate the internal controls but the flowcharting
method is, perhaps, the most scientific and advantageous as compared to other
methods. It provides the most concise but comprehensive way of recording the operating
controls along with the flow of transactions and documents. In the flow-chart, a total and
complete visual picture and control system is available and as such its reception in the human
mind is direct. In drawing a flow-chart, organised and concentrated application of mind is
essential to reflect the control system in a rational manner. Even in a large and complex
organisation, the control system could be depicted by few sheets of neatly drawn flow-charts.
However, in drawing the flow chart, the auditor has to take few precautions, e.g., flow-charts
should not be lengthy and cumbersome, should be neat, should portray the flow completely
with final disposal of papers and there should be proper use of symbols and lines. The
auditor will be able to visually correlate the functions and the related controls and assess the
adequacy and effectiveness thereof much quickly than a possibly in any other method.
Question 7
As the Statutory Auditor of a Manufacturing Company, what are the points you will consider to
conclude “Whether the company has an Internal Audit system commensurate with the size of
the company and its operations”? (8 marks)(Final Nov 2007)
Answer
This clause has mandatory application in case of companies having a paid-up capital and
reserves exceeding rupees 50 lacs as at the commencement of the financial year concerned,
or having an average annual turnover exceeding five crores rupees for a period of three
consecutive financial years immediately preceding the financial year concerned. ‘Financial
year concerned’ means the financial year under audit. This clause also mandatory applicable
for the listed companies irrespective of the size of paid-up capital and reserves or turnover.
The auditor has to examine whether the internal audit system is commensurate with the size
of the company and the nature of its business. The following are some of the factors to be
considered in this regard:
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(i) What is the size of the internal audit department? In considering the adequacy of internal
audit staff, it is necessary to consider the nature of the business, the number of operating
points, the extent to which control is decentralised, the effectiveness of other forms of
internal control, etc.
(ii) What are the qualifications of the persons who undertake the internal audit work? Internal
auditing is reasonable to expect that the internal audit department should normally be
headed by a chartered accountant and that, depending upon the size of the department,
it employs other qualified persons.
(iii) To whom does the internal auditor report? In general, the higher the level to which the
internal auditor reports, the greater will be his independence.
(iv) What are the areas covered by the internal audit? Internal audit can cover a large
number of areas including operational auditing, organisation and methods studies,
special investigations and the like.
(v) Has the internal auditor adequate technical assistance? This can be provided either by
having full-time technically qualified persons in the internal audit department or by such
persons being deputed to the internal audit department for specific assignments.
(vi) What are the reports which are submitted by the internal auditor or what other evidence
is there of his work? Auditor should satisfy himself that an internal audit system is
functioning effectively. He can do so by examining the reports submitted by the internal
auditor.
(vii) What is the follow-up? It is necessary that there is an adequate follow-up system to
ensure that the errors pointed out are corrected and remedial action taken on the
deficiencies reported upon.
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NOTE
4
COMPANY AUDIT
Question 1
State your views as an auditor on the following:
(a) T Ltd. purchased goods on credit for Rs.5 crores for export from ABC Ltd. Upon the
export order being cancelled, T Ltd. decided to sell the same in the domestic market at a
discounted price. Accordingly ABC Ltd was requested to offer a price discount of 25%.
ABC Ltd. wants to adjust the sales figure to the extent of discount requested by T Ltd.
(5 marks)
(b) During the year under audit Z Ltd. credited to the Profit and Loss Account, the entire
profit of Rs.20 lakhs on the sale of land not required for its use. You are informed that the
directors would like to propose dividend out of the above profit. (5 marks)
(c) Y Ltd. provided Rs.25 lakhs for inventory obsolescence in 1998-1999. In the subsequent
years, it was determined that 50% of such stock was usable. The company wants to
adjust the same through prior period adjustment account as the provision was made in
the earlier year. (5 marks)
(d) V V Ltd. had announced a voluntary retirement plan for its employees on January 1,
2000. The scheme is scheduled to close on June 30, 2000. The scheme envisaged an
initial lump sum payment of maximum of Rs. 2 lakhs and monthly payments over the
balance period of service of employees coming under the plan. 200 employees opted for
the scheme as on March 31, 2000. The total lump sum payment for these employees
would be Rs. 250 lakhs and the aggregate of future payments to them would amount to
Rs.1,500 lakhs. However, no payment had been made to the employees under the
scheme up to March 31, 2000. Nor the company made any provision in its accounts
towards any liability under the scheme. (5 marks) (Final May 2000)
Answer
(a) ABC Ltd. had sold goods on credit worth Rs.5 crores to T Ltd. and, therefore, the sale
was complete in all respects. T Ltd' s decision to sell the same in the domestic market at
a discount does not affect the amount booked under sales by ABC Ltd. The price
discount of 25% offered by ABC Ltd. at the request of T Ltd. was not in the nature of
discount given during the ordinary course of trade because otherwise same would have
been given at the time of sale itself. Now as far as ABC Ltd. is concerned, there appears
to be an uncertainty relating to collectability, which has arisen subsequent to the time of
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sale. Therefore, it would be appropriate to make a separate provision to reflect the
uncertainty relating to collectability rather than to adjust the amount of revenue originally
recorded. Therefore such discount should be written off to the profit and loss account and
not shown as deduction from the sales figure.
(b) Profit of Rs. 20 lakhs on the sale of land is a capital profit. It represents the excess of
sale value over the original cost of the asset. The question whether such a profit can be
distributed as dividend has been considered in two legal cases, viz., Lubbock vs The
British Bank of South America Ltd. and Foster vs The New Trinidad Lake Asphalte Co.
Ltd. Based on the Court judgements, it is argued that capital profits can be distributed by
a company only if all the following conditions are fulfilled:
(i) The articles of association should permit distribution of capital profits.
(ii) The capital profit which is sought to be distributed should have actually been
realised.
Unrealised capital profits, e.g., those arising on a revaluation of fixed assets, cannot
be distributed as dividends. However, if the assets so revalued are subsequently
sold, the amount realised over and above the original cost of such assets is a
capital profit available for distribution as dividend (provided the other conditions are
satisfied).
(iii) The capital profit should remain after a proper valuation has been fairly taken of the
whole of the assets and liabilities. In other words, any fall or deficiency in the value
of other assets or appreciation in the amount of liabilities should be deducted from
the amount of capital profits to ascertain the amount which can properly be
regarded as distributable as dividend.
However, Accounting Standard 10 on "Accounting for Fixed Assets" requires that
any gain arising from disposal of a fixed asset should be recognised in the profit and
loss account. Moreover, section 205 of the Companies Act, 1956 does not make
any distinction between capital profit and other profit. Thus, all profits which can
properly be taken to the profit and loss account are 'profits' for the purposes of
section 205 and are, thus, distributable.
(c) As per AS 5 on "Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies", prior period items are income or expenses which arise in the
current period as a result of errors or omissions in the preparation of the financial
statements of one or more prior periods. The write-back of provision made in respect of
inventories in the earlier year does not constitute prior period adjustment since it neither
constitutes error nor omission but it merely involves making estimates based on
prevailing circumstances when financial statements were being prepared. It is a mere
estimate process involving judgement based on the latest information available. An
estimate may have to be revised if changes occur regarding the circumstances on which
the estimate was based, or as a result of new information, more experience or
subsequent developments. The revision of the estimate, by its nature, does not bring the
adjustment within the definitions of an extraordinary item or a prior period item. In this
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case, T Ltd. provided Rs.25 lakhs for inventory obsolescence in 1998-99. In the
subsequent year due to change in circumstances, it was determined that 50% of such
stock was usable. Revision of such an estimate does not bring the resulting amount of
RS.12.5 lakhs within the definition either of a prior period item or of an extraordinary
item. The amount, however, involved is material and requires separate disclosure to
understand the financial position and performance of an enterprise. Accordingly, the
accounting treatment followed by the company is not proper.
(d) Accounting Standard (AS) 4 (Revised) on 'Contingencies and Events Occurring After the
Balance Sheet Date', states that events occurring after the 'balance sheet date are those
significant events, both favourable and unfavourable, that occur between the balance
sheet date and the date on which the financial statements are approved by the Board of
Directors in the case of a company and by the corresponding approving authority in the
case of any other entity.
Two types of events can be identified as:
(a) those which provide further evidence of conditions that existed at the balance sheet
date; and
(b) those which are indicative (of conditions that arose subsequent to the balance sheet
date).
It further states that assets and liabilities should be adjusted for events occurring after
the balance sheet date that provide additional evidence to assist the estimation of
amounts relating to conditions existing at the balance sheet date or that indicate that the
fundamental accounting assumption of going concern (i.e., the continuance of existence
or substratum of the enterprise) is not appropriate.
As per facts of the case, a condition existed on the balance sheet date (31st March,
2000) regarding the liability towards the Voluntary Retirement Plan (VRP) since the
management started the VRP in the month of January, 2000 and 200 employees opted
for the VRP as on March 31, 2000. Since it was probable that future events will confirm
that a liability has been incurred on the balance sheet date and that the amount could be
estimated on reasonable basis, a provision for payments under the VRP would be
required to be made for an appropriate amount for the aforesaid number of employees.
Question 2
You have been appointed a statutory auditor of a limited company engaged in the manufacture
of chemicals. What would be your views on the following?
(a) The management tells you that the work in process is not valued since it is difficult to
ascertain the same in view of the multiple processes involved and in any case the value
of opening and closing work in process would be more or less the same. (5 marks)
(b) The company has a turnover exceeding Rs.5 crores for a period of three consecutive
financial years immediately preceding the financial year concerned, but does not have
any internal audit system. (5 marks)
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(c) The management tells you that there is no need for them to follow accounting standards
specified by the Institute of Chartered Accountants of India as these are for the auditor to
follow. (5 marks)
(d) The company has suffered a net loss for the year. The directors however declared and
paid an interim dividend @ 30% based on the half-yearly performance.
(5 marks) (Final May 2001)
Answer
(a) Valuation of Work-in-Process: As per AS 2 (Revised) on "Valuation of Inventories", the
inventories also include those assets which are in the process of production for sale in
the ordinary course of business apart from finished goods and those materials or
supplies to be consumed in the production process or in the rendering of services. It is,
thus, necessary for a company to ensure that each and every component of inventory is
valued properly. The argument advanced by the company that it is difficult to ascertain
the same in view of the multiple processes involved is not acceptable. Because, the
Guidance Note on "Audit of Inventories" also recognises the likely difficulties in valuation
of work-in-process and states that, "in general , the audit procedures regarding work-inprocess
are similar to those used for raw materials and finished goods. However, the
auditor has to carefully assess the stage of completion of the work-in-process for
assessing the appropriateness of its valuation. For this purpose, the auditor may
examine the production / costing records (for example, cost sheets), hold discussions
with the personnel concerned and obtain expert opinion, where necessary".
The argument that the opening and closing work-in-process would be more or less the
same is also not justified because the omission of those would lead to distortion in true
and fair view. Further, costs incurred for raw materials and the overheads would
normally be different and would give rise to different value of opening and closing stock.
The Guidance Note even requires the auditor to ascertain the system from which the
value of work-in-process is obtained is reliable, and to examine subsequent records of
production / sales.
Therefore, in view of the above, the auditor shall have to qualify the audit report in case
work-in-process is not valued and shown in the financial statements.
(b) Existence of Internal Audit System: Para 4(A)(xv) of the CARO, 2003 issued under
section 227(4A) of the Companies Act, 1956, requires a statutory auditor to comment
whether the auditee company has an internal audit system commensurate with its size
and nature of its business. This is, however, applicable only if the company has a paidup
capital exceeding Rs.50 lakhs as at the commencement of the financial year
concerned or has an average annual turnover exceeding Rs.5 crores for a period of three
consecutive financial years immediately preceding the financial year concerned, whether
the company has an internal audit system commensurate with its size and nature of its
business.
In the instant case, the second condition is met and thus the auditor is required to make
an inquiry whether the company has an internal audit system commensurate with its size
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and nature of its business. Since the internal audit system is not in existence, the auditor
will have to mention the fact of not having such a system in his CARO Report. The fact
that the company does not have an internal audit system commensurate with its size and
nature of its business would also have repercussions on the normal audit procedures
since the efficacy of internal control system would itself be questionable. Under the
circumstances, apart from disclosing the fact of non-existence of the internal audit
system in the report, the auditor should also modify substantive audit procedures as well.
(c) Observance of Accounting Standards: Prior to amendment of section 211 of the
Companies Act, 1956, by the Companies (Amendment) Act, 1999, the contention of the
company was correct that it was not required to follow accounting standards specified by
the ICAI since these were mandatory only for the auditors. However, with the
incorporation of sub-sections (3A), (3B) and (3C) in the section 211 of the Companies
Act, 1956, by the amendment of the Act, every company is required to comply with the
accounting standards as may be prescribed. Sub-section (3A) provides that every profit
and loss account and balance sheet of the company shall comply with the accounting
standards. Sub-section (3C) of section 211 provides that the standard of accounting
specified by the Institute of Chartered Accountants of India shall be deemed to be the
Accounting Standards until the accounting standards are prescribed by the Central
Government under this sub-section.
Thus with the commencement of the Companies (Amendment) Act, 1999, with effect from
October 31, 1998, it is mandatory even for the company to follow the accounting
standards while recording transactions in the books of account and preparing the
financial statements. In fact, sub-section (3B) of section 211 requires that if the said
standards are not complied with, it is obligatory on the part of the company to state
deviations from the accounting standards, reasons for such deviation; and, the financial
effect, if any, arising due to such deviations. The auditor is also required to express his
opinion whether, in his opinion, the profit and loss account and balance sheet complied
with the accounting standards referred to in sub-section (3C) of section 211.
(d) Declaration of Interim Dividend: Interim dividend can be declared by the Board of
Directors only if there is an authorisation in the Articles of Association to do so. Quite
often the advice of the auditor is sought before declaring an interim dividend. When this
is done, he should suggest that an interim accounts should be prepared to ascertain the
amount of profits that has been made. Assuming that interim accounts have been
prepared and they disclose profits sufficient for the declaration of dividend after making
appropriate provisions for depreciation, compulsory transfers to reserves, bad debts and
other contingencies, only then the proportion of profits which have to be distributed as
interim dividend may be decided.
Since the company has suffered a net loss at the end of the year, obviously the directors
have miscalculated the performance of the company about the second half of the year. If
the company had a sufficient balance in the profit and loss account as at the beginning of
the year, the dividend declared could be paid out of the same. The balance had also to
be sufficient to transfer the relevant amounts to reserves. In such a case the auditor
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need not report anything. Moreover, if such balance was not available, the dividend could
also be paid out of reserves. In the situation of dividends to be declared out of reserves,
a maximum of only 10% dividend is allowed. In this case, since the dividend was
declared @ 30%, the said provisions would have been violated and thus the auditor
would have to mention the said fact. If, however, there is no balance in the profit and
loss account nor any reserves were available, the dividend would be clearly paid out of
capital. The auditor would have to qualify his report mentioning the fact of the dividend
having been paid out of capital.
(Note: Students may note that section 205 has been amended by the Companies
(Amendment) Act, 2000. The term "dividend" henceforth includes "interim dividend" also.
The provisions contained in sections 205, 205A, 205C, 206, 206A and 207 have been
made applicable to interim dividend also.)
Question 3
Briefly describe the reporting requirements by a statutory auditor of a company for personal
expenses of directors. (6 marks) (Final May 2001)
Answer
Reporting of Personal Expenses of Directors: Section 227 of the Companies Act, 1956,
specifies the reporting requirements on the part of an auditor.
Under clause (e) of section 227(1A) of the Companies Act, 1956, the auditor has to make a
specific inquiry whether any personal expenses have been charged to revenue account. The
charging to revenue of such personal expenses, either on the basis of the company's contractual
obligations, or in accordance with accepted business practice, is perfectly normal and legitimate
and does not call for any special comment by the auditor. Where, however, personal expenses
not covered by contractual obligations or by accepted business practice are incurred by the
company and charged to revenue account, it would be the duty of the auditor to report thereon.
If no such expenses are found, the auditor has no further duty to report that he is so satisfied.
However, he would have to keep in his working papers adequate documentation that he had
made such inquiries. Further, under para 4(A)(xix) of the MAOCARO, 1988 issued under section
227(4A) of the Companies Act, 1956 the auditor has also to report whether any personal
expenses have been charged to revenue account and, if so, the details thereof have to be
mentioned. Reporting under this clause is mandatory even if there are no personal expenses
which have been charged to revenue. Though the requirement under section 227(1A) involved
making an enquiry but the MAOCARO, 1988 extended this requirement that an auditor would not
only make an enquiry but also report whether or not any personal expenses have been charged
to revenue account. In most cases, however, the report under this clause generally states that
no personal expenses have been charged except those payable under contractual obligations or
in the normal course of business. Where, however, such expenses are not covered by
contractual obligations or generally accepted business practice and are charged to revenue
account, the auditor shall have to report in respect of such expenses.
(Note : The above requirements prescribed in MAOCARO, 1988 have been omitted in CARO,
2003 and has no more relevance).
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Question 4
Comment on the following:
(a) The Accounting Standards issued by the Institute of Chartered Accountants of India need
to be followed only by limited companies and not by partnership firms or proprietorships.
(4 marks)
(b) For Excise Duty on finished goods in stock as at the end of the year, there is an option
available to provide for the same or to show the same as a Contingent liability.
(4 marks) (Final May 2001)
Answer
(a) Applicability of Accounting Standards: The Preface to the Statements of Accounting
Standards clarifies that the Accounting Standards are issued "for use in the presentation of
general purpose financial statements issued to the public by such commercial, industrial or
business enterprises, as may be specified by the Institute from time to time and subject to
the attest function of its members. The term 'General Purpose Financial Statements'
includes balance sheet, statement of profit and loss and other statements and explanatory
notes which form part thereof, issued for use of shareholders/ members, creditors,
employees and public at large". As far as companies, whether limited or unlimited
incorporated under the Companies Act, 1956 are concerned, all such companies are
expected to adhere to specified accounting standards in terms of section 211(3A) of the
said Act. Even otherwise, such a requirement seems to be implicit even in the absence of
specific statutory provisions since the application of accounting standards is an integral
component so as to ensure that the financial statements give a true and fair view.
Accordingly, the compliance with accounting standards has to be examined by the auditors
while auditing general purpose financial statements which are statutorily required to be
audited under any law. Thus, compliance with accounting standards is required to be
examined by an auditor in an audit of financial statements of individuals and non-corporate
enterprises (viz., sole proprietary concerns, partnership firms, societies registered under
the Societies Registration Act, trusts, Hindu Undivided Families, and associations of
persons) only where the financial statements are statutorily required to be audited under
any law. The accounting standards are also applicable to commercial, industrial or
business activities of even charitable or religious organisations. Accounting Standards do
not apply to those organisations whose entire activities are not of commercial, industrial or
business nature, e.g., an organisation collecting donations to finance education of poor
children. However, even if a very small proportion of the activities of an entity is
commercial, industrial or business in nature, the accounting standards will apply to all its
activities. Thus, the Council has made it clear that compliance with accounting standards
required to be examined in an audit of financial statements of non-corporate enterprises
only where the financial statements are required to be audited under any statutory
enactment. For instance, in case there is no statutory requirement for such entities to
prepare accounts on accrual basis, the auditor would not qualify but simply disclose the
basis of accounting followed. Therefore, accounting standards are applicable not only to
limited companies but also to partnership firms or proprietorships.
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(b) Accounting Treatment of Excise Duty: The AS 2 (Revised) on, "Valuation of
Inventories" states that finished goods are to be valued by taking into account the costs
of purchase, costs of conversion and other costs incurred in bringing the inventories to
the present location and condition. The costs of conversion to be included would be all
direct factory overheads related to the said finished goods. Excise duty is a duty which is
payable on the manufacture of the finished goods inside a factory. Though the collection
of the same is deferred till the goods leave the factory, the liability for the same arises
when the manufacture takes place.
The Institute, before the enactment of the revised AS 2, in its Guidance Note on
Accounting Treatment for Excise Duty gave an option to entities to provide the excise
duty payable on finished goods and add the same to the valuation of finished goods or
not to make any provision but only make a disclosure of the said liability. After the
revised AS 2 was issued effective from 1-4-1999, the ICAI revised its earlier guidance
note and removed the alternative of not providing for the excise duty. Thus it is now
mandatory for an entity to provide for liability for excise duty on finished goods lying in
stock at the end of the year and add the same to the to the value of closing stock.
According to Guidance Note on "Accounting Treatment of Excise Duty", excise duty
should be considered as a manufacturing expense and like other manufacturing
expenses be considered as an element of cost for inventory valuation. Where excise
duty is paid on excisable goods and such goods are subsequently utilised in the
manufacturing process, the duty paid on such goods, if the same is not recoverable from
taxing authorities, becomes a manufacturing cost and must be included in the valuation
of work-in-progress or finished goods arising from the subsequent processing of such
goods. Further, where the liability for excise duty has been incurred but its collection is
deferred, provision for the unpaid liability should be made. Excise duty cannot be treated
as a period cost. Accordingly excise duty now cannot be shown as a contingent liability.
Thus, it is now mandatory for an entity to provide for liability for excise duty on finished
goods lying in stock at the end of the year and add the same to the value of closing
stock. If the said provision is not made, the revised Guidance Note on Accounting
Treatment for Excise duty says that the auditor should qualify his report and, if possible,
also mention the quantum of the duty not so provided.
Question 5
As a statutory auditor of a Public Limited Company, how would you deal with the following
situations?
(a) The company has sold some old machinery for Rs. one crore. The details of the cost of
such machinery are not available since the entire records relating to fixed assets have
been destroyed in an earthquake. (5 marks)
(b) The company had subscribed to shares of associate companies amounting to Rs.5
crores. These associate companies have incurred substantial losses and have been
referred to BIFR for being declared as sick companies. The company does not want to
make any provision for the fall in the value of the investments. (5 marks)
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(c) As at the beginning of the year, the company has a capital of Rs.2.50 crores, free
reserves of Rs.0.50 crore and Revaluation Reserve of Rs.4.50 crores. In the relevant
year under audit the company has incurred a loss of Rs.4 crores. The company
proposes to adjust the loss with the Revaluation Reserve. (6 marks) (Final May 2001)
Answer
(a) Sale of Machinery: AS 10 on "Accounting for Fixed Assets", gains or losses arising on
disposal are generally recognised in the profit and loss statement. Therefore, when the
company sells old machinery, profit/loss on sale thereof has to be determined. Such profit or
loss can be determined provided the cost and written down value of the said machinery is
available. In the instant case, since the entire records of fixed assets have been destroyed,
the cost and the WDV of the machinery sold could not be arrived at. The company may
therefore, have to determine the same on some estimated basis provided all reasonable
efforts to determine the cost/WDVs of the machinery do not yield any better result. An all out
attempt should be made by the management to reconstruct the old records. Such records
may be constructed by obtaining old copies of annual reports distributed amongst
shareholders, annual accounts filed with ROC, etc. In fact, through this process, the
company shall be able to determine the WDV of the asset because the machinery sold seems
to be quite big and must have been recorded on stand alone basis.
The auditor will have to see whether the estimate of cost and WDV arrived at in the above
manner by the company is reasonable and whether the profit/loss is determined
accordingly. A note to that effect would also have to be given by the management in the
accounts. If the auditor is of the opinion that the said estimates are satisfactory based on
available records and the note given by management explains the said fact, he may not
qualify his report. If he is not so satisfied, he would have to give disclaimer in the audit
report that in the absence of proper records, the said profit/loss has been arrived on an
estimated basis and in that view he has been unable to form an opinion. As far as the
report under the CARO, 2003 order is concerned, the auditor would have to point out that
proper records of fixed assets showing full particulars as required by that clause are not
available.
(b) Valuation of Investments: AS 13 on "Accounting for Investments" requires investments
to be classified as long term and current investments distinctly in its financial statements.
The investments in shares of associate companies can very well be considered as trade
investments since they would not be intended to be liquidated within a period of one year
from its acquisition. Hence they would be classified as long term investments.
AS 13 states, "long-term investments should be carried in the financial statements at
cost. However, provision for diminution shall be made to recognise a decline, other than
temporary, in the value of the investments, such reduction being determined and made
for each investment individually". In the instant case, these associate companies have
incurred substantial losses and have been referred to BIFR for being declared as sick
companies. The net worth of these companies would have been wiped out resulting in a
fall in the value of the investments. Therefore, such fall cannot be merely temporary as
the companies could take a long time to turn around (if at all) and again have a positive
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net worth. The auditor would therefore have to qualify his report by saying that no
provision for diminution for fall in the value of investments as required by AS 13 has been
made and to that extent the profits and reserves have been overstated.
(c) Adjustment of Loss against Revaluation Reserve: AS 10 on "Accounting for Fixed
Assets" states that an increase in net book value of fixed assets is normally credited to
owner's interest and under the heading Revaluation Reserves except that, to the extent
that such increase is related to and not greater than a decrease arising on revaluation
previously recorded as a charge to the profit and loss statement, it may be credited to the
profit and loss statement. A decrease in net book value arising on revaluation of fixed
asset should be charged directly to the profit and loss statement except that to the extent
that such a decrease is related to an increase which was previously recorded as, credit
to revaluation reserve and which has not been subsequently reversed or utilised, it may
be charged directly to that account. The Guidance Note on Treatment of Reserve
created on Revaluation of Fixed Assets states that where the value of fixed assets is
written up in the books of account of a company, the corresponding credit appearing as
revaluation reserve does not represent a realised gain and is, therefore, not available for
distribution as dividend. Similarly, accumulated losses and the depreciation on the
acquisition cost (including arrears of depreciation) should not be adjusted against
revaluation reserve since this would amount to setting off actual losses against
unrealised gains.
The auditor should explain to the management that accumulated losses cannot be
adjusted against the revaluation reserve created on revaluation of the fixed assets. In
case the company in question does so, the balance sheet of the company will not reflect
a true and fair view of the state of affairs of the company keeping in view the magnitude
of the amounts involved, i.e., accumulated losses amount to Rs.4 crores and share
capital and reserves amount to Rs.3 crores (excluding revaluation reserve). If the
management does not agree with the opinion of the auditor, the auditor may even issue
an adverse report.
Question 6
As an auditor state your views on the following situations:
(a) Included under Current Assets of XYZ Ltd. is inventory aggregating to Rs.20 crores. A part of
the said inventory manufactured for export had to be sold earlier at a discounted price offshore
due to moisture content present at the time of delivery. A part of similar inventory is
included in Rs.20 crores. (5 marks)
(b) A construction company accounted for a contract entered into with a Government Department
on completed contract method and that with a Private Sector Company on percentage of
completion method. Both the contracts were for development of a township. (5 marks)
(c) X Ltd. entered into a contract with Y Ltd. to despatch goods valuing Rs. One lakh every
month for six months upon receipt of entire payment. Y Ltd. accordingly made the payment.
In 3rd month due to a natural calamity, Y Ltd. requested X Ltd. not to despatch until further
notice.
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X Ltd. accounted Rs. two lakhs as sales and transferred the balance to Advance Receipt
against sales. (5 marks)
(d) XYZ Ltd. entered into a collaboration agreement with a U.S. based company to acquire
knowhow for both manufacturing process and design, drawing of the factory at a total
cost of Rs.10 crores. 75% of the knowhow cost was for design and drawings. XYZ Ltd.
capitalised the cost of drawings, etc., with factory building and cost for manufacturing
process with the cost of machinery. (5 marks) (Final Nov 2001)
Answer
(a) Valuation of Damaged Inventory: A part of the inventory exported earlier had to be sold
at a discounted price off shore due to moisture content present at the time of delivery.
The auditor will therefore have to examine what part of the inventory is included in the
inventory valued at Rs.20 crores, a part of which had been exported at a discounted
price. He will also have to satisfy himself that whether such part left with the company
has also been damaged on account of moisture content. If required, the auditor may
obtain a certificate from an expert about the condition of the inventory. Thereafter, it
should be verified whether the principle of valuation enunciated in AS 2 (Revised)
“Valuation of Inventories” have been followed in such a case. The standard requires that
the inventories should be valued at the lower of cost or net realisable value. AS 2
(Revised) defines the net realisable value as the estimated selling price in the ordinary
course of business less the estimated costs of completion and the estimated costs
necessary to make the sale. Accordingly, such part of inventory which is damaged
should be valued at estimated realisable value if the same is lower than the cost. It may
however, be noted that inventories are usually written down to net realisable value on an
item-by-item basis. In some circumstances, however, it may be appropriate to group
similar or related items. This may be the case with items of inventory relating to the
same product line that have similar purposes or end uses and are produced and
marketed in the same geographical area and cannot be practicably evaluated separately
from other items in that product line. It is not appropriate to write down inventories based
on a classification of inventory, for example, finished goods, or all the inventories in a
particular business segment. Thus, the auditor should ensure that such damaged
inventories have been valued accordingly.
(b) Method of Accounting in case of Construction Contracts: AS 7 on “Accounting for
Construction Contracts”, recommends, as on date, two methods of accounting for
contracts, viz., the percentage of completion method and the completed contract method.
As per the facts given, the construction company has entered into two separate contracts
for the development of township, one with the Government Department and other, with a
private sector company. Regarding accounting treatment, the construction company had
accounted for the contracts differently since the contract entered into with the
government department was accounted for on Completed Contract Method and that with
a private sector company on Percentage of Completion Method. AS 7 stipulates that, “it
may be necessary for accounting purposes to combine contracts made with a single
customer or to combine contracts made with several customers if the contracts are
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negotiated as a package or if the contracts are for a single project. Conversely, if a
contract covers a number of projects and if the costs and revenues of such individual
projects can be identified within the terms of the overall contract, each such project may
be treated as equivalent to a separate contract”. This, in accordance with Accounting
Standard 7, a contractor may use different methods simultaneously for different contracts
depending upon circumstances. However, AS 7 requires that when a contractor uses a
particular method of accounting for a contract, then in that case for all other contracts
that meet similar criteria, the same method is required to be used.
(c) Treatment of Advance Received Against Sales: AS 9 on “Revenue Recognition”
specifies that revenue from sales should be recognised when the following conditions
have been fulfilled:
(i) the seller of the goods has transferred to the buyer the property in the goods for a
price or all significant risks and rewards of ownership have been transferred to the
buyer and the seller retains no effective control of the goods transferred to a degree
usually associated with ownership; and
(ii) no significant uncertainty exists regarding the amount of consideration that will be
derived from the sale of the goods.
In this case, X Ltd. had transferred the property in the goods at an agreed price and all
significant risks and rewards. As such sale has been fully completed because upon
receipt of the entire payment, X Ltd. was required to despatch goods valuing Rs.100,000
for six months out of its inventory. However, in the third month, Y Ltd requested to stop
despatch until further intimation due to a natural calamity. X Ltd. recognised revenue to
the extent the goods were despatched and transferred the balance payment received to
Advance Receipt against Sales. X Ltd. had transferred the property in the goods at an
agreed price and all significant risks and rewards. The delivery was to be effected as per
the schedule indicated by Y Ltd. As per AS 9, “Revenue Recognition”, mere
postponement of delivery at buyer’s request does not alter the period in which revenue
should be recognised. Accordingly, X Ltd. should recognise the entire Rs.6,00,000 as
Sales and pass necessary corrective entries.
(d) Treatment of Know-How Expenditure: AS 10, “Accounting for Fixed Assets” requires
that know-how in general is recorded in the books only when some consideration in
money or money’s worth has been paid for it. Know-how is generally of two types:
(i) relating to manufacturing processes; and
(ii) relating to plans, designs and drawings of buildings or plant and machinery.
Know-how related to plans, designs and drawings of buildings or plant and machinery is
capitalised under the relevant asset heads. In such cases, depreciation is calculated on
the total cost of those assets, including the cost of the know-how capitalised. Know-how
related to manufacturing processes is usually expenses in the year in which it is incurred.
In accordance with AS 10, Accounting for Fixed Assets, XYZ Ltd. should have capitalised
knowhow related to plans, design and drawings of buildings or plant and machinery,
under the respective asset heads. It should be ensured that such cost has been
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capitalised under the relevant asset head only. Depreciation should have been
calculated on the total cost of those assets, including cost of knowhow capitalised.
Furthermore, knowhow expenses relating to manufacturing process should have been
treated as an expense in the year in which it was incurred. Therefore, capitalising cost of
manufacturing process with the cost of machinery is not proper.
Question 7
Y Ltd. Has accumulated losses of Rs.12 crores. The Reserves and Surplus of the said company
also include “Share Premium Account” of Rs. 15 crores. The company intends to adjust the
accumulated losses against the “Share Premium Account”. Is the company permitted to do so
under the provisions of the Companies Act, 1956? (6 marks) (Final Nov 2001)
Answer
Section 78 of the Companies Act, 1956 deals with the application of premium received an
issue of securities (The word “securities” was substituted for the word “Share” by the
Companies (Amendment) Act, 1999 w.e.f. October 31, 1998). Sub-section (1) of the said
section provides that where a company issues shares at a premium, whether for cash or
otherwise, the amount received as premium on such shares shall be transferred to an account
called “Securities Premium Account” and the provisions of the Companies Act, 1956 relating to
reduction of the securities capital of a company except as provided in the section shall apply
as if the securities premium accounts were paid up securities capital of the company. Subsection
(2) of the said section provides that notwithstanding anything contained in sub-section
(1), Securities Premium Account may be applied by the company for:
(a) Issue of fully paid bonus securities.
(b) Writing off of the preliminary expenses of the company.
(c) Writing off of expenses of the commission paid or the discount allowed on any issue of
securities or of any debentures of the company.
(d) Providing the premium payable on the redemption of any redeemable preference
securities or of any debentures of the company.
In view of the above provisions of the Companies Act, 1956, the company is not permitted to
adjust its accumulated loss against the Share Premium Account.
Question 8
Write a short note on - Capital Reserves. (4 marks) (Final Nov 2001)
Answer
Capital Reserves: The expression ‘reserve’ has been defined in Part III of Schedule VI to the
Act as not including “any amount written off or retained by way of providing for depreciation,
renewals or diminution in the value of assets or retained by way of providing for any known
liability”. A reserve may be ‘capital reserve’ or ‘revenue reserve’. The term “capital reserve”
has not been defined in the Companies Act, 1956 except in a negative way in Part-III of
Schedule VI to the Act. The expression “capital reserve” shall not include any amount
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regarded as free for distribution as dividend through the Profit and Loss Account. Capital
reserve is created out of profits of a capital nature. Premiums issued on the issue of shares
and debentures, profit made on redemption of debentures and the balance standing to the
credit of forfeited shares account after re-issue of forfeited shares are some of the examples
of capital reserve. In fact, capital reserves are in the nature of capital receipts which also
cannot be distributed as dividends at all. AS 12, “Accounting for Government Grants” provides
that where the grant relates to a non-depreciable asset, e.g., freehold land, and it has been
decided that gross value of fixed asset should not be touched it should be generally be
credited to capital reserve.
Question 9
As an auditor, state your view on the following:
(a) M Ltd. manufactures machinery used in Steel Plants. It quotes prices in various tenders
issued by Steel Plants. As per terms of contract, full price of machinery is not released
by the steel plants, but 10% thereof is retained and paid after one year if there is
satisfactory performance of the machinery supplied. The company accounts for only
90% of the invoice value as sales income and the balance amount in the year of receipt
to the extent of actual receipts only. (5 marks)
(b) A company had imported raw materials worth US dollars 2,50,000 on 15th January, 2002
when the exchange rate was Rs.46 per US dollar. The company had recorded the
transaction at that rate. The payment for the imports was made only 15th April, 2002
when the exchange rate was Rs.49 per US dollar. However, on 31st March, 2002 the rate
of exchange was Rs.50 per US dollar. The company passed an entry on 31st March,
2002 adjusting the cost of raw materials consumed for the difference between Rs.49 and
Rs.46 per US dollar. (5 marks)
(c) A Public Company defaulted in the repayment of deposits together with interest on the
due date for more than a year and the Chief Accountant contends that the auditor need
not report on the default committed by the company (5 marks) (Final May 2002)
Answer
(a) Recognition of Revenue: AS 9 on ‘Revenue Recognition’, states that revenue from
sale of goods should be recognised when the seller of goods has transferred to the buyer
the property in the goods for a price or all significant risks and rewards of ownership
have been transferred to the buyer and the seller retains no effective control of the goods
transferred to a degree usually associated with ownership and no significant uncertainty
exists regarding the amount of consideration. In the case of M Ltd., the goods, as well as
the risks and rewards of ownership have been transferred to the steel plants. The
invoice raised by M Ltd. is for the full price, but 10% less is received as the same is kept
as ‘Retention Money’. In this case, therefore, revenue has to be recognised at the full
invoice price, i.e., 100% has to be accounted as Sales Income. Depending on the past
experience of recovering the balance 10% from the steel plants, M Ltd. can, however,
make a provision for sales income which is not likely to realised . In the absence of the
above, the auditor will have to qualify his report.
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(b) Changes in Exchange Rates: As per AS 11, “Accounting for the Effects of Changes in
Foreign Exchange rates”, Monetary items denominated in a foreign currency (e.g.,
foreign currency notes, balances in bank accounts denominated in a foreign currency,
and receivables, payables and loans denominated in a foreign currency) should be
reported using the closing rate. However, in certain circumstances, the closing rate may
not reflect with reasonable accuracy the amount in reporting currency that is likely to be
realised from, or required to disburse, a foreign currency monetary item at the balance
sheet date, e.g., where there are restrictions on remittances or where the closing rate is
unrealistic and it is not possible to effect an exchange of currencies at that rate at the
balance sheet date. In such circumstances, the relevant monetary item should be
reported in the reporting currency at the amount which is likely to be realised from, or
required to disburse, such item at the balance sheet date. Sundry creditors are monetary
items. The AS requires that on every balance sheet date, monetary items denominated in
foreign currency should be reported using the closing rate. In the instant case, having
regard to the fact that the amount payable for the raw materials is a monetary item, the
same would have to be shown in the balance sheet at the rate on the closing date of 31st
March, 2002 i.e. Rs.50, irrespective of the payment for the same subsequently at a lower
rate.
Hence the treatment given by the company is wrong and if the same is not rectified the
auditor would have to qualify his report stating that AS 11 requirements were not
followed.
(c) Default in Repayment of Deposits and Auditor’s duties: The auditor’s reporting
requirements are contained in section 227 of the Companies Act, 1956. As far as
requirements relating to de posits are concerned: CARO 2003, issued under section 227
of the Companies Act, 1956; and, clause (f) of Section 227(3) read with section 274 (1)
(g) require auditor to specifically report on this aspect. Hence, The contention of the chief
accountant is not correct. Under Clause (f) of section 227(3) of Companies Act, 1956 the
auditor has to report whether any director is disqualified from being appointed as a
director under clause (g) of sub-section (1) of section 274.
The relevant extracts of section 274(1) (g) referred to in clause (f) of section 227 (3) of
the Companies Act, 1956 are as follows :
“A person shall not be capable of being appointed director of the company, if
(g) such person is already a director of public company which:
(A)------------------------------------------------------------------------------------------
(B) has failed to repay its deposits or interest thereon on due date or redeem its
debentures on due date or pay dividend and such failure continues for one
year or more; provided that such person shall not be eligible to be appointed
as director of any other public company for a period of five years from the date
on which such public company in which he is a director ………….has failed to
repay its deposits or interest or redeem its debentures on due date or pay
dividend referred to in Clause B”.
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On a perusal of section 227(3)(f) it is apparent that the auditor has to report upon
whether any of the directors of the public company, are disqualified from being appointed
as a director in terms of clause (g) of sub-section (1) of section 274.
In addition, the CARO under section 227(4A) of the Companies Act, 1956 under Para
(vi) has to state whether in case the company has accepted deposits from the public,
whether the directives issued and the provisions of sections 58A, 58AA or any other
relevant provisions of the Act and the rules framed there under, where applicable, have
been compiled with. If contraventions should be stated; If an order has been passed by
Company Law Tribunal or Reserve Bank of India or any Court or any other Tribunal
whether the same has been complied with or not ?
In view of the above two situation, the auditor is required to make a report on defects
committed by the company.
Question 10
(a) Following is the data regarding six segments of Z Ltd.:
(Rs. in ‘000s)
Particulars A B C D E F
Segment Revenue (Rs.) 150 310 40 30 40 3
0
Segment Result (Rs.) 25 (95) 5 5 (5) 1
5
Segment Assets (Rs.) 20 40 15 10 10 5
The Finance Director is of the view that it is sufficient that segments A and B alone be
reported. Advise (4 marks)
(b) Y Ltd. wishes to obtain a machine tool costing Rs.20 lakhs by way of lease. The
effective life of the machine tool is 12 years but the company requires it only for the first
five years. It enters into an agreement with R Ltd. for a lease rental of Rs.2 lakhs p.a.
The Finance Director of Y Ltd. is not sure about the treatment of these lease rentals and
hence requests your assistance in proper disclosure of the same. For calculation
purposes, the implicit rate of interest may be taken at 15%. Discount factors : 0.87, 0.76,
0.66, 0.57 and 0.50. (4 marks) (Final May 2002)
Answer
(a) As per AS 17 on ‘Segment Reporting’, “a business segment of geographical segment
should be identified as a reportable segment if:
(i) its revenue from sales to external customers and from transactions with other
segments is 10% or more of the total revenue, external and internal of all segments,
or
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(ii) its segment result, whether profit or loss, is 10% or more of:
(a) the combined result of all segments in profit ; or
(b) the combined result of all segments in loss, whichever is greater in absolute
amount; or
(iii) its segment assets are 10% or more of the total assets of all segments.
AS 17 also requires that if total external revenues attributable to reporting segments
constitute less than 75% of the total enterprise revenue, additional segments should be
identified even if they do not meet 10% criteria.
On the basis of the above the following conclusions emerge:
♦ Segmental Revenue – A and B will be reportable segments since both these
segments 10% or more of total revenue i.e., Rs. 6,00,000
♦ Segmental Results – A, B and F will be reportable segments since the result of
these segments is 10% or more than (Rs. 1,00,000) the combined results of
segments in loss.
♦ Segment assets – A,B,C, D and E will be the reportable segments since there are
10% or more if total segmental assets i.e. Rs. 1,00,000. Hence all the segments
have to be reported.
(b) The fair value of asset is Rs.20 lacs and the present value of lease rentals is 6.72 lacs.
The machine is required for five years only which is less than 50% of the economic life.
In view of having regard to substance of the transaction on both were courts, as per AS
19 on Leases, the lease will be classified as an operating lease. As per AS 19, the
following may be disclosed:
Future minimum lease payments – Not later than 1 year Rs. 2 lacs
Future minimum lease payments – Later than 1 year and
not later than 5 years Rs.4.98 lacs
Question 11
Write a short note on - Divisible profits. (4 marks) (Final May 2002)
Answer
Divisible Profits: Divisible profits are profits available for distribution to shareholders as
dividends. It is different from book profit or economist’s concept of profit. It represents those
profits which are legally available for distribution as dividends. In the earlier years there were
disputes whether depreciation should be provided before declaration of dividend or not; there
were disputes whether capital profits or profits on revaluation of assets are available for
distribution. Now these controversies stand resolved through the provisions of Companies
Act, 1956 and also the judicial pronouncements over the years.
Section 205 prohibits a company from declaring dividends out of its profits before providing for
depreciation in the manner laid down in the section. Depreciation should be provided as per
rates/methods prescribed in Schedule XIV of the Act; not only for the year for which dividend
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is declared but also in respect of preceding financial year or years [since the commencement
of Companies (Amendment) Act, 1960] for which adequate depreciation had not been
provided in the books. If a loss has been incurred in the past which remains debited in the
accounts then the amount of loss or the amount of depreciation whichever is less should be
provided in the books before any dividend is declared. Under section 205(2A), the central
government has the power to make rules regarding transfer of profits by a company to its
reserves before any dividend can be declared.
Dividends may be declared out of the profits of the company for the current year after
providing for depreciation. However, a company is required to transfer a prescribed
percentage of its profits to reserves before declaring dividends. According to the rules framed
by the central government in this regard, no dividend can be declared or paid by a company
for any financial year out of its profits for that year unless it transfers a percentage of its profits
for that year to reserve. The second source of dividends are the reserves created out of the
undistributed profits of any previous financial years after providing for depreciation. Section
205A(3) of the Act provides that dividends can be declared out of the reserves only in
accordance with the rules framed by the central government in this behalf. A declaration which
is not in accordance with such rules can be made only with the previous approval of the
central government. A company can also declare dividends out of the moneys provided by the
central government or a State government for payment of such dividend in pursuance of a
guarantee given by that government.
An auditor should be fully acquainted with all legal implications of dividends. Not only should
be take into account the provisions of the Companies Act (specially Sections 205-208), but he
should also consider the contractual and other legal obligations which determine the divisibility
of profits. It cannot be over-emphasised that a dividend beyond what is legally permissible can
give rise to legal action, since it would be construed as a payment out of capital. Hence, the
first task of the auditor is to ensure that the dividends payable are within the legally
permissible limits.
In ascertaining divisible profits, in the following circumstances, capital profits are included
provided:
(i) the capital profits remain after a revaluation of all assets and liabilities;
(ii) the capital profit is realised in cash; and
(iii) the articles of association permits of such distribution.
Question 12
As a statutory auditor for the year ended 31st March 2002, how would you deal with the
following:
P Ltd. has filed a petition in the High Court for adjustment of product development expenses of
Rs.50 crores against the balance in Securities Premium account. While finalizing the
accounts, the directors carried out the said adjustment since they were certain that the High
Court approval would be received. The said petition has not come up for hearing till the date
of signing of the accounts by the auditor. (5 marks) (Final Nov 2002)
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Answer
Adjustment of Product Development Expenses Against Balance in the Securities
Premium Account: Product development expenses are normally classified as revenue
expenditure. They can in some cases also be classified as Deferred Revenue Expenditure. If
it is classified as Deferred Revenue Expenditure, the same have to be written off to the profit
and loss account over a reasonable period of time. In the instant case, the company adjusted
the said expenses with the balance standing in the Securities Premium Account. Such an
accounting treatment is not possible having regard to the normally acceptable accounting
principles. However, any adjustment that is approved by the High Court will override the
normally acceptable accounting principles. In the instant case, though the company has filed
a petition in the High Court for carrying out the above adjustment, and though the directors are
certain that the High Court would approve the adjustment, the said petition has not been
finalised or approved by the High Court till the date of signing of accounts. In view of the
same, the company cannot carry out the said adjustment. The statutory auditor, therefore, will
have to qualify his report by stating that the product development expenses have been
adjusted against the Securities Premium Account rather than treating them as the revenue
expenditure and writing it off to the Profit and Loss Account. The statutory auditor would also
have to mention the amount by which the profit for the year has been overstated.
[Students may refer Section 78 of the Companies Act, 1956 to specify the areas where the
Securities Premium can be used]
Question 13
As a statutory auditor, how would you deal with the following:
(a) ABC Ltd., is a company engaged in the business of construction of roads and bridges. It
follows completed contract method for all its projects and therefore revenue is recognised
only when the contract is completed or substantially completed. For the year ended 31st
March, 2001, the ABC Ltd., has earned a sum or Rs. 25 lakhs as interest on short-term
deposits with their bank. These deposits are made out of advances received from the
customers towards the projects that they are executing. ABC Ltd. while filing their Return
of Income for the year 31st March, 2001 with the tax authority declared NIL income for
that year. While calculating progress payments at the year-end, the interest of Rs.25
lakhs earned was considered as part of the funds received for the project. Is the
treatment given by ABC Ltd. with regard to the interest earned on short-term deposit
correct? (6 marks)
(b) XYZ Ltd., as part of overall cost cutting measure announced voluntary retirement scheme
(VRS) to its employees, to reduce the employee strength. During the first half year
ended 30.9.2002 the company paid a compensation of Rs.72 lakhs to those who availed
the scheme. The Chief Accountant has reflected this payment as part of regular salaries
and wages paid by the company. Is this correct? (6 marks)
(c) During the course of statutory audit of an investment company dealing in shares and
securities, in spite of repeated reminders by the statutory auditor, the company officials
did not provide the investments held by the company at the Balance Sheet date for
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verification and also did not provide the details for valuation of unlisted shares as on the
Balance Sheet date. The statutory auditor, in his final audit report to the shareholders,
reported as follows:
“Subject to the verification of the existence and value of the investments, the Balance
Sheet shows a true and fair view.”
Is the report made by the Statutory auditor correct? (6 marks) (Final May 2003)
Answer
(a) Accounting Treatment of Interest on Short-term Deposits: As per AS 7, “Accounting
for Construction Contracts” ABC Ltd. is free to use either Percentage of Completion
Method or Completed Contract Method. Normally contractors who build highways,
buildings, bridges and other structures, use the Percentage of Completion method since
the projects they execute are completed over a long period of time. However, there is
nothing wrong in adopting the Completed Contract Method by ABC Ltd. as per the
accounting treatment permitted by the existing standard. Under the Completed Contract
method, the costs and progress payments received are accumulated during the course of
the contract but revenue is not recognised until the contract activity is fully or
substantially completed. The interest of Rs. 25 lakhs earned by ABC Ltd., for the year
ended 31st March 2001 is to be treated as ‘income from other sources’ and ABC Ltd.
should declare that as income earned in their Return of Income for they ended 31st March
2001. Also as per AS 9, “Revenue Recognition” the interest earned on short term
deposits cannot be treated as progress payments received for the contracts that are
under progress and the interest earned should be recognised as revenue in the year in
which it is earned.
(Note I: Alternatively, in case there exists a specific contract between ABC Ltd. and their
customers that interest received on deposits made by them shall be adjusted towards the
progress payments then the treatment accorded by the company is correct.
Note II: Candidates may note that the above answer is based on old AS 7 “Accounting for
Construction Contracts”, issued in 1985. The revised AS 7 comes into force in respect of
all contracts entered during accounting periods commencing on or after 1.4.2003.)
(b) Accounting Treatment of Payment on account of VRS: As per AS 5, “Net Profit or
Loss for the Period, Prior Period Items and Changes in Accounting Policies” the payment
made to its employees on account of VRS as an overall cost cutting measure would fall
in the ambit of ordinary activities connected with the business of the enterprise. AS 5
requires that when items of income and expense within profit or loss from ordinary
activities are of such size, nature or incidence that their disclosure is relevant to explain
the performance of the enterprise for the period, the nature and amount of such items
should be disclosed separately. In fact an activity like VRS can very well be treated as
restructuring exercise carried by the enterprise. Though this is not an extraordinary item,
AS 5 requires that items of income and expense which are not extraordinary items, the
nature and amount of such items may be relevant to users of financial statements in
understanding the financial position and performance of an enterprise and in making
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projections about financial position and performance. Disclosure of such information is
sometimes made in the notes to the financial statements.
Considering the above, the compensation of Rs. 72 Lakhs paid towards VRS availed by
employees should be shown separately in the profit and loss account of XYZ Ltd., so that
the effect of it on the operating results of the Company during the previous year can be
perceived. Therefore, clubbing of Rs. 72 lakhs with the regular salaries and wages of the
company by the Chief Accountant is not appropriate and, thus, the separate disclosure is
necessary.
(c) Failure to Obtain Information and Explanation: The statutory auditor is required to
express his opinion on the truth and fairness of financial statement audited by him only
after examining the authenticity with reference to the information and explanations given
to him. He must determine the extent of information which should be obtained by him
before he expresses his opinion on the financial statement submitted to him for report.
He should not express an opinion before obtaining the required data and information. In
the given case, since the statutory auditor did not see the existence and also valuation of
the investments held by the investment company the auditor, should not say “Subject to
the verification of the existence and value of the investments, the balance sheet shows a
true and fair view.” In fact, as per facts given in the question, the auditor has not been
able to obtain information and might not be able to satisfy himself by adopting other audit
procedure and accordingly may have to appropriately modify the report. The auditor may
state that because of these circumstances, he has been unable to form an opinion. But,
reporting by the auditor that, “subject to verification of the existence and value of the
investments, the balance sheet shows a true and fair view”, the auditor is not providing
information but only means to information. The situation in this case is analogous to
London and General Bank’s case. By reporting in the above manner auditor is not
conveying any information. Rather, the auditor is arousing the suspicion of users of
financial statements. Section 227(3) requires the auditor to specifically, state whether or
not he has obtained all such information and explanation. If the auditor has not been
able to obtain relevant information or explanations, he may have to qualify his opinion on
the truth and fairness of the financial statements or express his inability to give an
opinion in the matter. Thus the auditor has failed to perform his responsibilities
Question 14
As a Statutory Auditor, how would you deal with the following cases?
(a) During the course of audit of ABC Ltd. it is noticed that out of Rs. 12 lakhs of provident
fund contribution accounted in the books, only Rs. 2 lakhs has been remitted to the
authorities during the year. On enquiry the Chief Accountant informed that due to
financial problems they have not remitted but will remit the same as and when the
position improves. (4 marks)
(b) National Tourism Ltd., a wholly owned Government Company approaches you to give a
revised report on the revised accounts, as the original accounts has undergone changes
consequent to the audit of Comptroller and Auditor General of India. (4 marks)
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(c) M/s LNK’s group gratuity scheme’s valuation by actuary shows wide variation compared
to the previous year’s figures. (4 marks)
(d) In the books of accounts of M/s OPQ Ltd. huge differences are noticed between the
control accounts and subsidiary records. The Chief Accountant informs that this is
common due to huge volume of business done by the company during the year.
(4 marks) (Final May 2004)
Answer
(a) Depositing Provident Fund Dues: The Companies Audit Report’s Order, 2003
required the auditor to state whether the dues of provident fund have been regularly
deposited with the appropriate authorities and, if not, the extent of arrears shall have to
be indicated by the auditor. A company is required to deposit provident fund dues to
appropriate authorities with in the period prescribed under the Rules governing it. In the
case of fund constituted by the company, the company is required to follow provisions of
section 418 of the Act. In this case there is a default in not depositing the provident fund
contribution to the extent of Rs. 10 lakhs which is a lapse on the part of the company.
The reason put forward by the Chief Accountant that the amount has not been deposited
due to financial problems faced by the Company is no excuse for not remitting the
provident fund. In fact, the company has not at all been regular in depositing the amount.
Thus, the auditor shall include this in his report indicating the extent of arrears.
(Note: The Companies (Auditor’s Report) Order, 2003 (now applicable) requires the
auditor to comment upon the regularity aspects as also the extent of arrears in case the
same has been outstanding for a period of more than six months. In the given case, it
may be noted that M/s ABC Ltd. has failed to deposit the provident funds regularly and
the major part of it has been outstanding for more than six months.)
(b) Auditor’s Report on Revised Accounts: The Guidance Note on Auditor’s Report on
Revised Accounts of Companies Before Circulation to Shareholders deals with those
situations wherein the statutory auditor is required to give report on the revised accounts.
The auditors of National Tourism Ltd. have been asked to give revised report on the
revised accounts as the original accounts have undergone changes consequent to audit
of the C&AG. The Guidance Note requires that the statutory auditor must observe the
following steps while issuing the revised report:
(i) All copies of the original accounts and reports thereon are returned to the auditor.
(ii) The adequate disclosure has to be made that the accounts which were earlier
approved by the Board of Directors and reported by the auditors have been revised
and re-approved by the Board of Directors as a specific note on the amended
accounts.
(iii) In case the notes to accounts do not contain any note on revision or such a note is
not considered adequate or comprehensive, the statutory auditor shall have to
indicate that accounts have been revised based on the audit report of C&AG. The
auditors at the time of issue of revised report has to bring these facts in his report if
not included as a note in the revised accounts.
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(v) Finally, the auditor’s report (revised) should clearly draw the attention to their earlier
audit report.
(c) Valuation by Actuary: SA 620, “Using the Work of an Expert” states that the auditor has to
evaluate the work of an expert, say, actuary, before adopting the same. This becomes more
crucial since M/s LNK’s group gratuity scheme’s valuation by actuary shows wide variation
compared to previous year figures. There is no doubt that appropriateness, reasonableness
of assumptions and methods used are the responsibility of the expert, but the auditor has to
determine whether they are reasonable based on the auditor’s knowledge of the client’s
business and result of his audit procedures. In the present case, the auditor must verify the
reasonableness of assumptions made and methods adopted by the actuary in the evaluation
particularly with reference to factors such as rate of return on investments, retirement age,
number and salary of employees, etc. Accordingly, the auditor has to satisfy himself whether
valuation done by the actuary can be adopted, otherwise he may report on his findings for
wide variation.
(d) Difference Between Control Accounts and Subsidiary Records: The huge differences
found between control accounts and subsidiary records in the books of M/s OPQ Ltd.
indicate that there may be material misstatements requiring detailed examination by the
auditor to ascertain the cause. The contention of Chief Accountant cannot be accepted
simply because the company has done huge volume of business. Such a phenomenon
indicates that recording of transactions is not being done properly or the accounting
system in the company which might have several branches spread over the country fails
to capture all transactions in time. It would also be interesting to see whether it is a
recurring phenomenon or such reconciliation could not be done at a subsequent date.
Having regard to all these circumstances, it appears from the facts of the case that these
difference indicate the possibility of some kind of material misstatements. As per SA
240, “The Auditor’s Responsibility to Consider Fraud and Error in an Audit of Financial
Statements” when the auditor encounters circumstances that there is material
misstatement, the auditor should perform procedures to determine whether the financial
statements are materially misstated. If as a result of such examination the auditor comes
across any material information involving fraud or gross irregularity the same shall be
reported by him appropriately.
Question 15
State the salient features of Investor’s Education and Protection Fund. (8 marks) (Final May 2004)
Answer
Salient features of Investors Education and Protection Fund: Section 205(C) of the Act
empowers the Central Government to establish a fund to be called the Investor Education and
Protection Fund to be utilized for the promotion of investor awareness and protection of the
interest of the investors. The following amounts shall be credited to the fund, namely,
(a) amounts in unpaid dividends accounts of companies;
(b) matured deposits with companies;
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(c) application moneys received by companies for allotment of any securities and due for
refund;
(d) matured debentures with companies;
(e) interest, if any, accrued on the above items, i.e. (a) to (d);
(f) grants and donations given to the Fund by the Government or any other institutions, etc.
(g) the interest or other incomes received out of the investments made from the fund.
It may be noted that in respect of four items, i.e., unpaid dividends, application moneys,
matured deposits and debentures shall be transferred to Fund only if such amounts shall
remained unclaimed and unpaid for seven years from the date they became due for payment.
In fact, after lapses of seven years, no claims are tenable against the company or the Fund.
Question 16
Miranda Spinning Mills Ltd. is a sick company and has accumulated losses of Rs. 10 crores. The
company has Rs. 12 crores in its share Premium Account. The Management desires to adjust the
accumulated losses against the share premium balance. Advise the company giving your reasons.
(8 marks) (Final Nov 2004)
Answer
Application of Share Premium Account: Section 78 of the Companies Act, 1956 deals with
the application of premium received on issue of shares. Sub-section (1) of the said section
provides that where a company issues shares at a premium, whether for cash or otherwise,
the amount received as premium on such shares shall be transferred to an account called
“Share Premium Account” and the provisions of the Companies Act, 1956 relating to reduction
of share capital of a company except as provided in the section shall apply as if the share
premium account was paid up share capital of the company. Sub-section (2) of the said
section provides that notwithstanding anything contained in sub-section(1), share premium
account may be applied by the company for issue of bonus shares, writing off of preliminary
expenses of the commission paid or discount allowed on any issue of shares or debentures of
the company or for paying the premium on redemption of preference shares or debentures of
the company. In view of these provisions of the Companies Act, 1956, it is not permitted to
adjust its accumulated losses against the share premium account.
Question 17
(a) Section 274 of the Companies Act, 1956 is applicable to appointment of Directors.
Briefly explain your duty as a statutory auditor in this connection. (8 marks)
(b) A company has paid interim dividend at 10% based on its half-yearly performance while
at the end of the year suffered a net loss. How you will deal with the matter in your audit
report as a statutory auditor? (4 marks) (Final Nov 2004)
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Answer
(a) Appointment of Directors – Auditor’s Duty: As per section 274(1)(g) of the Companies
Act, 1956, a person is disqualified to be appointed as a director in case such person is a
director of a public company which has not filed the annual accounts for any continuous
period of three years; or such company has failed to repay its deposits or interest thereon
on due date or pay dividend and such failure continues for one year or more.
Section 227(3)(f) of the Companies Act, 1956 requires the statutory auditor to state
whether any director is disqualified from being appointed as director under clause (g) of
sub-section (1) of section 274. Further, the Department (now Ministry of Company
Affairs) has also issued the Companies (Disqualification of Directors under section
274(1)(g) of the Companies Act, 1956) Rules, 2003. Rule 4 requires that the statutory
auditors of both the appointing as well as the disqualifying company to:
(i) report under section 227(3)(f) of the Act to the members of the respective
companies as to whether any director is disqualified from being appointed as a
director under clause (g) of section 274(1) of the Companies Act, 1956; and
(ii) furnish a certificate every year as to whether on the basis of his examination of the
books and records of the company, any director of the company is disqualified as a
director or not.
The auditor is required to obtain written representation as to names of directors,
particulars of appointment, default by the company, etc. As a part of audit procedures,
the auditor is required to obtain the necessary information before giving his report. The
auditor is required to obtain evidence in the form of written representation from a director
in respect of each such company has not defaulted in terms of the section 274(1)(g).
The written representation should also be noted and taken on record by the Board. The
auditor should also verify the information provided by the management and direction from
the information contained in the register mentioned u/s 303(1) of the Act. Accordingly, the
auditor is required to report appropriately.
(b) Declaration of Interim Dividend: Section 205 of the Companies Act, 1956 permits
declaration of interim dividend. Ordinarily based on the performance of the company and
taking a conservative view, the Board of Directors of the company declare the interim
dividends. Quite often the advice of the auditor is sought before declaring an interim
dividend. When this is done, he should suggest that an interim accounts should be
prepared to ascertain the amount of profits that has been made. Assuming that interim
accounts have been prepared and they disclose profits sufficient for the declaration of
dividend after making appropriate provisions for depreciation, compulsory transfers to
reserves, bad debts and other contingencies, only then the proportion of profits which
have to be distributed as interim dividend may be decided.
Since the company has suffered a net loss at the end of the year, obviously the directors
have miscalculated the performance of the company about the second half of the year. If
the company had a sufficient balance in the profit and loss account as at the beginning of
the year, the dividend declared could be paid out of the same. The balance had also to
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be sufficient to transfer the relevant amounts to reserves. In such a case the auditor
need not report anything. Moreover, if such balance was not available, the dividend could
also be paid out of reserves. In the situation of dividends to be declared out of reserves,
a maximum of only 10% dividend is allowed. If, however, there is no balance in the profit
and loss account nor any reserves were available, the dividend would be clearly paid out
of capital. The auditor would have to qualify his report mentioning the fact of the
dividend having been paid out of capital.
Question 18
As a Statutory Auditor, how would you deal with the following?
The accountant of C Ltd. has requested you, not to send balance confirmations to a particular
group of debtors since the said balances are under dispute and the matter is pending in the Court.
(4 marks) (Final May 2005)
Answer
External Confirmation Requests: SA 505, “External Confirmations”, establishes standards
on the auditor’s use of external confirmation as a means of obtaining audit evidence. It
requires that the auditor should employ external confirmation procedures in consultation with
the management. The auditor may come across certain situations in which the management
may request him not to seek external confirmation from certain parties because of dispute with
the debtors, etc. The management, for example, might make such a request on the grounds
that due to a dispute with the particular debtor, the request for confirmation might aggravate
the sensitive negotiations between the entity and the debtor. In such cases, when an auditor
agrees to management’s request not to seek external confirmation regarding a particular
debtor, the auditor should consider validity of grounds for such a request and assess
management’s integrity and obtain evidence to support the same. The auditor should also ask
the management to submit its request in a written form, detailing therein the reasons for such
a request. The auditor agrees to management’s request not to seek external confirmation
regarding a particular matter, the auditor should document the reasons for acceding to the
management’s request and should apply alternative procedures to obtain sufficient
appropriate evidence regarding that matter. While considering the validity of request, in case
the auditor reaches at a conclusion that the same was not valid, he may appropriately modify
the report.
Question 19
Answer the following:
When can a company be said to have ‘Not maintained’ proper books of account? What is the role
of the statutory auditor for the same? (6 marks) (Final May 2005)
Answer
Section 209(1) of the Companies Act, 1956 requires that every company shall keep proper books
of account with respect to the following items:
(i) all sums of money received and expended by the company and the matters in respect of
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which the receipts and expenditure take place;
(ii) all sales and purchases of goods by the company;
(iii) the assets and liabilities of the company; and
(iv) in the case of a company pertaining to any class of companies engaged in production,
processing, manufacturing or mining activities, such particulars relating to utilisation of
material or labour or to other items of cost as may be prescribed, if such class of
companies is required by the Central Government to include such particulars in the
books of account.
Proper books of account shall not be deemed to be kept if such books of accounts are not
kept on accrual basis of accounting and according to double entry system of accounting.
In case proper books of account are not kept, the auditor is required to specifically refer to
violation of the Companies Act, 1956 in the auditor’s report and shall also state that in his
opinion proper books of account as required by law have not been kept by the company so far
as appears from his examination of those books and, he has to further give either qualified
opinion or disclaimer of opinion.
Further, the books also have to be maintained under accrual system. If the statutory auditor
finds the books not maintained are not maintained accordingly, he will have to modify his
report.
Question 20
Briefly describe the Auditor’s responsibilities regarding disqualification of Directors.
(8 marks) (Final Nov 2001)
Answer
Auditor’s Responsibilities regarding Disqualification of Directors: Section 227(3) of the
Companies Act, 1956 has recently been amended by the Companies (Amendment) Act, 2000
whereby clauses (e) and (f) have been inserted. Clause (f) now inserted requires an auditor to
comment ‘whether any director is disqualified from being appointed as director under clause
(g) of sub-section (1) of section 274. The relevant extracts of section 274(1)(g) referred to in
clause (f) of section 227 (3), are reproduced below:
“274(1) A person shall not be capable of being appointed director of a company, if–
.................................................................................................
.................................................................................................
(g) such person is already a director of a public company which –
(A) has not filed the annual accounts and annual returns for any continuous three financial
years commencing on and after the first day of April, 1999; or
(B) has filed to repay its deposit or interest thereon on due date or redeem its debentures on
due date or pay dividend and such failure continues for one year or more;
Provided that such person shall not be eligible to be appointed as a director of any other public
company for a period of five years from the date on which such public company in which he is a
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director failed to file annual accounts and annual returns under sub-clause (a) or has failed to
repay its deposit or interest or redeem its debentures on due date or pay dividend referred to in
clause (B).”
Section 274(1)(g) is applicable to appointment of directors both in public and private companies
but the reporting will be limited to those directors of a company who are also directors of any
public company. It may be further noted that a person who was a director of a public company
which had defaulted in terms of clause (g) of section 274(1) and ceased to be a director of that
public company would not be disqualified from being appointed as a director of a private
company since on the date of appointment, he is not director of such public company and
moreover proviso to section 274(1)(g) is only applicable to appointment of such director in
another public company.
A person is disqualified from being appointed as a director of a company, where any public
company of which also he is a director, has not filed annual accounts and annual returns for any
continuous three financial years commencing on and after 1.4.1999 or has failed to repay its
deposit or interest thereon on due date or redeem its debentures on due date or pay dividend
and such failure continues for one year or more. In case of a disqualification by virtue of subclause
(A) of clause (g) of section 274(1), the period of five years would be reckoned from the
date as specified in sub-clause (A), on which the public company failed to file its annual
accounts and annual returns. Where the disqualification arises on account of sub-clause (B) of
clause (g) of section 274(1), the period of five years will be reckoned from the relevant due date
as specified in sub-clause (B) for repayment of deposit or interest thereon or redemption of
debentures or payment of dividend, as the case may be.
Section 303(1) of the Companies Act, 1956 requires every company to keep a register of
directors, etc. at its registered office. The said register contains various particulars relating to all
the directors of the company including particulars in respect of the office of director, managing
director, etc. held in any other body corporate(s) by each director.
In case an auditee company happens to be a public company which has not filed the annual
accounts and annual returns for any continuous three financial years commencing on and after
1st April, 1999; or has failed to repay its deposit or interest thereon on due date or redeem its
debentures on due date or pay dividend and such failure continues for one year or more; then
the auditor must report that all the directors are disqualified from being appointed as director in
terms of clause (g) of sub-section (1) of section 274 of the Act.
Question 21
Write short notes on the following:
(i) Consolidated Financial Statements (Final- Nov 2000)
(ii) Audit Committee (Final- Nov 2000, Nov 2002)
(iii) Remuneration to Statutory Auditors under the Companies Act, 1956.
(Final May 2006) (4 × 3=12 marks)
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Answer
(i) Consolidated Financial Statements
Consolidated financial statements are the financial statements of a group presented as
those of a single enterprise. The consolidated financial statements provide the users of
financial statements an overall picture of the holding company and its subsidiaries.
Consolidated Profit and Loss Account gives the overall profitability of the group after
adjustment of unrealised profit involved in mutual transactions and decomposition of
profit of the subsidiaries into capital and revenue. Similarly, Consolidated Balance Sheet
shows the unified state of affairs of the group after adjustment of mutual indebtedness
and putting separately the minority interest. Thus the overall financial health of the
holding company can be judged using Consolidated Financial Statements. Those who
want to invest in the shares of the holding company or acquire it need such consolidated
statement for evaluation. Thus, in many developed countries like USA, UK, Germany,
France etc., the consolidation of financial statements is compulsory. At present in India
preparation of consolidated financial statements is a legal necessity. The ASB of the
Institute has issued “Accounting Standard on Consolidated Financial Statements” SA
250, which came into effect in respect of accounting periods commencing on or after 1st
April, 2001 and mandatory in nature. The objective of this Statement is to require parent
(also known as holding) enterprises to provide financial information about the economic
activities of their groups by preparing consolidated financial statements. These
statements are intended to present financial information about a parent enterprise and its
subsidiary enterprises as a single economic entity to show the economic resources
controlled by the group, the obligations of the group and results the group achieves with
its resources. Accounting Standard - 22 lays down in detail the consolidation procedures
and disclosure requirements.
(ii) Audit Committee
An audit committee is a committee of the board of directors of a company entrusted with
the task of overseeing the financial process of the company. This committee will consider
various issues relating to the audit functions and review the company’s financial and risk
management policies. Audit committees have received wide publicity and there is a
growing awareness of the benefits of these committees. That an effective audit
committee can make a significant contribution to the financial reporting process of a
company has been well recognised. Though an audit committee may be considered as
an extended arm to assist in accomplishing board’s objectives, it has very strong impact
on all major groups related to the financial reporting process, viz., the board of directors,
the managerial personnel and the independent auditor.
Primarily, an effective audit committee is a positive step as it strives to enhance the
credibility and integrity of financial statements. In this process, the following related
benefits accrue as well:
(i) It helps board of directors to discharge their ever-increasing responsibilities in an
efficient and effective manner with due care and diligence. Thereby, it reduces the
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burden of top management.
(ii) It facilitates greater personal involvement by directors’ especially non-executive
directors in financial and audit aspects of the company.
(iii) An effective committee is also concerned to determine whether or not to appoint
statutory auditor for non-audit services as well. Thus, it reinforces the auditor’s
independence in general.
(iv) By monitoring and evaluating the results of internal audit, it can suggest overall
improvement in the internal controls.
(v) By an objective review of management’s financial policies including accounting
policies and operations, it provides a stimulus for optimal performance by the
management.
The formation of an audit committee is a relatively simple matter, but rendering it
effective is more complex. A single most important factor is the attitude of the top
management towards such committees. The success of a committee depends upon the
selection of members who are not only competent enough to deal with technical matters
but should also have enough time to devote in order to fulfil their role. This may also
lead to increase in costs.
Note:[Not a part of the Answer]
Section 292A of the Companies (Amendment) Act, 2000 applicable w.e.f. 13-12-2000
provides for constitution of audit committees is reproduced below for the information of
students.
(i) Every public company having paid-up capital of not less than five crores of rupees
shall constitute a committee of the Board known as “Audit Committee” which shall
consist of not less than three directors and such number of other directors as the
Board may determine of which two-thirds of the total number of members shall be
directors, other than managing or whole-time directors.
(ii) Every Audit Committee constituted under sub-section (1) shall act in accordance
with terms of reference to be specified in writing by the Board.
(iii) The members of the Audit Committee shall elect a chairman from amongst
themselves.
(iv) The annual report of the company shall disclose the composition of the Audit
Committee.
(v) The auditors, the internal auditor, if any, and the director-in-charge of finance shall
attend and participate at meetings of the Audit Committee but shall not have the
right to vote.
(vi) The Audit Committee should have discussions with the auditors periodically about
internal control systems, the scope of audit including the observations of the
auditors and review the half-yearly and annual financial statements before
submission to the Board and also ensure compliance of internal control systems.
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(vii) The Audit Committee shall have authority to investigate into any matter in relation to
the items specified in this section or referred to it by the Board and for this purpose,
shall have full access to information contained in the records of the company and
external professional advice, if necessary.
(viii) The recommendations of the Audit Committee on any matter relating to financial
management, including the audit report, shall be binding on the Board.
(ix) If the Board does not accept the recommendations of the Audit Committee, it shall
record the reasons therefor and communicate such reasons to the shareholders.
(x) The Chairman of the Audit Committee shall attend the annual general meetings of
the company to provide any clarification on matters relating to audit.
(xi) If a default is made in complying with the provisions of this section, the company,
and every officer who is in default, shall be punishable with imprisonment for a term
which may extend to one year, or with fine which may extend to fifty thousand
rupees, or with both.
(iii) Remuneration to Statutory Auditors under the Companies Act, 1956: The company
auditor’s remuneration is fixed by:
(i) directors when the first auditors are appointed or to fill a casual vacancy (other than
the one caused by resignation of the auditor);
(ii) Central Government when the appointment is made by it; and
(iii) company in general meeting or in such other manner as the company in General
meeting may determine (including those wherein the auditor is appointed by the
C&AG of India u/s 619 of the Act.)
It is further provided that any sums paid by the company in respect of the auditor’s
expenses shall be deemed to be included in the expression ‘remuneration’. This implies
that where a fixed sum is approved as remuneration of the auditor, it includes his
expenses. However, it is not necessary that the amount of remuneration is specified by
the company in its general meeting. It would be enough if the manner in which the
remuneration is to be fixed is laid down in the general meeting. It is also not essential
that the remuneration is fixed in the same general meeting in which the auditor is
appointed.
Disclosure Requirements Under Companies Act, 1956: As per the Profit and Loss
Account under Schedule VI to the Companies Act, 1956, the remuneration may be
disclosed to the auditors in the following manner:
(a) As auditor
(b) As adviser or in any other capacity in respect of:
(i) taxation matters
(ii) Company Law Matters, and
(iii) Management Services
(c) The amounts paid in any other manner.
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Question 22
Write a short note on - Personal Expenses of Directors. (4 marks) (Final May 2003)
Answer
Personal Expenses Of Directors: Payments to directors by way of remuneration and perquisites
are required to be authorised in accordance with sections 198 and 309 of the Companies Act,
1956. Depending upon the requirements of Articles of Association of the company, the
remuneration may require sanction of the shareholders either by special resolution or ordinary
resolution or only approval of the Board. If terms of appointment include payment of expenses of
personal nature then the company can incur such expenses. If there is no provision to incur
personal expenses and if such expenses are incurred, then it is the duty of the auditor to point out
such expenses in the report. Reporting requirements “the requirement of identifying and reposting
on personal expenses” has been dispensed with in CARO, 2003.
Question 23
Answer the following:
You have been appointed the sole statutory auditor of a company where you were one of the joint
auditors in the immediately preceding year. The concerned joint auditor has not been reappointed.
What are the various steps you would take to ascertain the compliance of the requirements of the
Companies Act, 1956 before accepting the audit? (5 marks) (Final May 2005)
Answer
Compliance with Requirements of Companies Act, 1956: When one of the joint auditors of
the previous year is appointed as the sole auditor for the next year, it is similar to new reappointment
of one of the retiring joint auditors. The provisions of section 225 of the
Companies Act, 1956, relating to non-reappointment of the other person also need to be
considered. The following points should be taken into account:
(i) Special notice u/s 225(1) was duly received by the company from a member at least 14
days before AGM containing a proposal for appointing a sole auditor expressly.
(ii) Verify notice sent to all the members at least 7 days before the AGM. [u/s 190(2)]
(iii) Verify that special notice has been sent to retiring auditor forthwith. [u/s 225(2)]
(iii) Any representation received from the retiring auditor was sent to the members [u/s
225(3)].
(iv) Verify from the minutes whether the representation received from the retiring joint auditor
was considered at the AGM.
(v) Examine that proposed resolution was properly passed.
(vi) Ensure that provisions of section 224(2) are complied fully.
(vii) Ascertain special resolution u/s 224A, if any, is passed accordingly.
(viii) Obtain a certified copy of the relevant minutes of AGM and a written communication of
the appointment within 7 days.
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Question 24
Comment on the following:
A company has a branch office, which recorded a turnover of Rs. 1,90,000 in the financial year
2004-05. No audit of the branch has been carried out. The statutory auditor of the company has
made no reference of the above branch in his report. The total turnover of the company is Rs.10
crores for the year 2004-05. (6 marks) (Final May 2005)
Answer
Section 228 of the Companies Act, 1956 requires that the accounts of a branch office of a
company are required to be audited either by the company’s auditor or by any other person
qualified for appointment as auditor of the company. So, normally speaking, the audit of
branch office has to be carried out unless the company has obtained exemption under the
Companies (Branch Audit Exemptions) Rules, 1961 formulated u/s 228(4), having regard to
quantum of activity. The Rules provide for the exemption of a branch office of a company
carrying on manufacturing, processing or trading activity from the provisions of section 228, if
the average quantum of activity of the branch does not exceed rupees two lakh or two per cent
of the average of the total turnover and the earnings from other sources of the company as a
whole, whichever is higher. Since in the instance case, no such exemption has been obtained
and accordingly, the company is liable. The auditor is also required to mention this fact in the
audit report and deal appropriately.
Question 25
As a Statutory Auditor, how would you deal with the following?
(a) P Ltd. of whom you are the Statutory Auditor appoints M/s XYZ as Branch Auditors for
one of its branches. M/s XYZ conducted the audit of the branch without visiting the
branch and instead getting the books at the H.O. M/s XYZ has submitted their Branch
Audit Report to you. (5 marks)(Final Nov 2005)
Answer
(a) Branch Auditor’s Report: As per provisions of the Companies Act, 1956, the accounts
of a branch office of a company are required to be audited either by the company’s
auditor or by any other person qualified for appointment as auditor of the company. It is
not necessary for branch auditor M/s XYZ to visit the branch and conduct the audit only
at branch’s premises. It is a matter of professional judgement for the branch auditor to
decide as to whether he needs to visit the branch. At the same time, the statutory auditor
has the right to visit branch offices and to have access to the books of accounts and
vouchers maintained at the branch office in this case.
In any case, the principal auditor i.e. the statutory auditor of Head Office P Ltd. Is entitled
to rely on the work of branch auditor unless there are special circumstances to make it
essential for him to visit the branch and examine the books of account and voucher
records. As per basic principles governing an audit, the principal auditor is entitled to
rely upon the work performed by others provided he exercises adequate skill and care
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and is not aware of any reason to believe that he should not have so relied. As per SA
600, “Using the work of another auditor”, the principal auditor is not required to evaluate
professional competence because branch auditor happens to be member of ICAI. The
statutory auditor is also required to deal with the Branch Auditor’s report in the manner,
he considers necessary. Therefore, the statutory auditor is required to deal with M/s
XYZ’s report in the manner it considers fit under the circumstances.
Question 26
As a statutory auditor, how would you deal with the following:
ABC Ltd. having a paid up capital of Rs. 1 crore earned as total net profit of Rs. 1 crore for the
years 2001-02 to 2003-04. The Company did not declare any dividend nor transferred any
amount to Reserves for these years. The entire profit was retained in the Profit & Loss
Account. In 2004-05, the company made a profit of Rs. 20 lacs. The company also proposed
in 2004-05 to declare dividend @25% out of accumulated profits. (4 marks)(Final May 2006)
Answer
Declaration of Dividends: ABC Ltd. earned a total net profit of Rs.1 crore for three years
2001-02 to 2003-04 but it did not declare any dividend nor transferred any amount to
Reserves for these three years. Since it did not declare any dividend, there was no
compulsion to transfer any amount to Reserves. It appears that the company has retained the
profit of previous years as “surplus” under the heading of “Reserves & Surplus”. ABC Ltd.
wants to declare dividend of Rs. 25 lacs for the financial year 2004-05, which works out to
25% of its paid up capital. However, since this rate of dividend exceeds 20% of the paid up
share capital, as per the requirements of Companies (Transfer of Profit to Reserves) Rules,
1975, the company should transfer at least 10% of its current profit that is Rs.2 lacs to
reserves resulting into deficiency of Rs. 7 lacs in the amount of current profit which could be
available for the purpose of distribution of dividend.
The company, however, is well within its power to cover the said deficiency of profit out of its
accumulated profit in spite of restrictions laid down in the rules prescribed under section 205A
(3) of the Act, viz., Companies (Declaration of Dividend out of Reserves) Rules, 1975, since
the company had not transferred any of its profit for the years 2001-2002 to 2002-04 to
reserves. Thus, the company is well within its powers and right to declare the dividend of
Rs.25 lacs for the year 2004-05.
Question 27
As a Statutory Auditor, how would you deal with the following?
(a) Mr.Rajesh is appointed as the auditor of NOIDA Travels Ltd. with audit fees of Rs.
35,000. He purchased air ticket from Delhi to Kolkata and back for Rs. 18,000 from the
client for his personal work and the amount remains unpaid at the end of the year as it is
a general practice of the client to give credit to all. Mr. Rajesh claims that he does not
incur any disqualification as contained in Section 226(3)(d) of the Companies Act.
(5 marks)
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(b) Apex Ltd., a well reputed manufacturing public limited company has made a contribution
of Rs. 2.5 lacs during the financial year ended 31.3.06 to a political party for running a
school, situated in the village, where most of the workers of the company reside. It is
admitted that the benefit of the school is mostly for the children of the workers of the
company. The company has not made any profits in the last four years.
(4 marks)(Final Nov 2006)
Answer
(a) Disqualification of auditors: The guidance note on “Independence of Auditors” issued
by the ICAI in this context recommends that “a question of indebtedness may also be
raised where an auditor of a company purchases goods or services from the company
audited by him. In such a case, if the amount outstanding exceeds Rs. 1000, irrespective
of the nature of the purchase or period of credit allowed to other customers, the
provisions concerning disqualification of auditor as contained in sec 226 (3) (d) will be
attracted. This is applicable in the case of purchase of air tickets for personal work by the
auditor of a company on normal terms and conditions of the business of the company as
the amount outstanding at the end of the year exceeded Rs. 1000. Therefore, the
contention of Mr. Rajesh that he does not incur disqualification is not correct as he has
purchased a ticket of the value of Rs. 18,000. The provisions concerning disqualifications
of auditor as contained in Sec 226 (3) (d) will be attracted.
(b) Restrictions regarding political contribution: Section 293-A of the Companies Act
1956 deals with prohibitions and restrictions regarding political contribution. A non-
Government company which has been in existence for not less than three years may
contribute any amount or amounts directly or indirectly to any political party or for any
political purpose to any person provided that the aggregate of the amounts which may be
so contributed by a company in any financial year shall not exceed 5% of its average net
profits determined in accordance with the provisions of Sections 349 and 350 during the
three immediately preceding financial years. The company in question has not made any
profit in last four years and contributed Rs. 2.5 lacs during the year to a political party for
running a school. This is violation of the provisions of Section 293-A of the Companies
Act although the children of its workers are benefited. The auditor would have to qualify
his report stating the contravention of the provisions of the Companies Act.
Question 28
As an auditor, how would you deal with the following?
(a) In the audit of ABC Private Limited, auditor came across cases of payments to Directors,
whereby, expenses of a personal nature were reimbursed. (5 Marks)
(b) The management of a limited company states that proposed dividend does not represent
a liability and hence no provision need to be made-Comment. (4 Marks)
(4 Marks) (Final May 2007)
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Answer
(a) Reimbursement of personal expense of Director: All payments to Directors as
remuneration or perquisites whether in the case of a public or private company are
required to be authorised both in accordance with the Companies Act and Articles of
Association of the company. Articles may provide that such remuneration require
sanction of the shareholders either by ordinary or special resolution while in some cases
it may require only approval of Directors. If the terms of appointment of a Director include
payment of expenses of a personal nature, then such expenses can be incurred by the
company; otherwise, no such expense can be incurred or reimbursed by the company. In
the instant case the auditor has to ensure that the above is complied with, without which,
if such expenses are paid, he has to disclose the fact in his report, as also in the
accounts. In this regard attention is invited to section 227 (1A) (e) of the Companies Act
wherein auditor has to inquire into whether personal expenses have been charged to
revenue. However, reporting requirements “the requirement of identifying and reposting
on personal expenses” has been dispensed with in CARO, 2003.
(b) Provision for proposed dividend: As per the ICAI’s Guidance Note, proposed dividend
does not represent a liability, nor does it amount to a provision, pending the approval of
the share holders in the general meeting.
Though the format given in schedule VI requires proposed dividend to be shown under
‘Current Liabilities and Provisions’, it does not mean in fact that the proposed dividend
becomes a liability or is necessarily a provision. Part 1 of Schedule VI that prescribes the
form of balance sheet requires “ proposed dividend’ to be shown under ‘Provisions’ and
paragraph 3(xiv) of Part II of the same Schedule requires specific disclosure of the
proposed dividend.
It is recommended, that if no appropriation is made, shareholders’ attention should be
drawn to such fact and the amount should be quantified. The fact that provision for
proposed dividend has not been made should be disclosed by means of a note in the
accounts. The auditor should refer to the note in his report and make his report subject
thereto.
Question 29
A company wants to amend its accounts after the completion of the audit and adoption of the
Accounts by the Board, but before circulation to the shareholders. It requires its statutory
auditor to report on the amended accounts. State the steps the statutory audit should adopt in
such a situation. (8 marks) (Final May 2007)
Answer
(a) Amendment of accounts after the completion of the audit and adoption of the
Accounts by the Board before circulation to the shareholders: This pertains to the
manner in which the statutory auditor should report upon amended accounts. The
Companies Act does not contemplate the revision of accounts and a further report by the
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statutory auditor on the amended accounts. At the same time, it is entirely within the
competence of the Board of Directors to amend the accounts and resubmit the same to
statutory auditors for report before the accounts are placed before the annual General
Meeting. The report issued by the statutory auditor on such amended accounts will be in
substitution of the report issued before the amendment. Unless all copies of the original
accounts and reports are returned to the auditor, such substitution is not possible.
The guidance on Auditor’s report on revised accounts of companies before circulation to
shareholders recommends that members, when called upon to issue a report on
amended accounts for the same period due to amendments to the accounts, should
ensure all copies of the original accounts and reports are returned to him, adequate
disclosure about the revision of accounts already reported, appears as a specific note on
the amended accounts. If the Statutory auditor is satisfied about the adequacy of
disclosure, there may not be any need for him to refer to the revision of balance sheet
and/or the profit and loss account in his report otherwise he has to refer to the revision in
his report.
Question 30
(a) What are the important aspects to be looked into a due diligence review of Cash flow?
(8 marks) (Final Nov 2007)
(b) What is the meaning of “Small and Medium sized Company” as per the Companies
(Accounting Standards) Rules, 2006? (8 marks) (Final Nov 2007)
Answer
(a) Due Diligence review of cash flow
(i) Review the historical pattern of cash flows of the organization and look for change
in trends.
(ii) See whether the company is able to meet its cash requirements from internal
generations/accruals or does it seek outside sources from time to time.
(iii) Check whether the company honours its commitments to creditors, Government and
other stock holders.
(iv) Verify the ability of the company to turn its stock into Debtors i.e. sale ability of its
products.
(v) Ensure that the company follows up with Debtors and that the Debtors collection
period is not very large.
(vi) Check the ability of the company to deploy its funds in profitable investment
opportunities.
(vii) Look into the investment pattern of the company, whether they give maximum
benefits to the company and are easily realizable.
(b) In exercise of the powers conferred by clause (a) of sub-section (1) of section 642 of the
Companies Act, 1956 (1 of 1956), read with sub-section (3C) of section 211 and subsection
(1) of section 210A of the said Act, the Central Government, in consultation with
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National Advisory Committee on Accounting Standards, made the Companies
(Accounting Standards) Rules, 2006. As per these rules “Small and Medium Sized
Company” (SMC) means, a company-
(i) whose equity or debt securities are not listed or are not in the process of listing on
any stock exchange, whether in India or outside India;
(ii) which is not a bank, financial institution or an insurance company;
(iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the
immediately preceding accounting year;
(iv) which does not have borrowings (including public deposits) in excess of rupees ten
crore at any time during the immediately preceding accounting year; and
(v) which is not a holding or subsidiary company of a company which is not a small and
medium-sized company.
Explanation: For the purposes of this a company shall qualify as a Small and Medium
Sized Company, if the conditions mentioned therein are satisfied as at the end of the
relevant accounting period.
Question 31
Write a short note on - Supplementary Audit u/s 619(4) of the Companies Act, 1956.
(4 marks) (Final Nov 2007)
Answer
Supplementary Audit u/s 619(4) of the Companies Act, 1956: The auditor of a Government
company shall be appointed or re-appointed by the Comptroller and Auditor-General of India .
The auditor aforesaid shall submit a copy of his audit report to the Comptroller and Auditor-
General of India who shall have the right to comment upon, or supplement, the audit report in
such manner as he may think fit. Any such comments upon, or supplement to, the audit report
shall be placed before the annual general meeting of the company at the same time and in the
same manner as the audit report.
Question 32
Elaborate under Clause 49 of the Listing Agreement, who is an Independent Director.
(6 marks) (Final May 2008)
Answer
Clause 49 of the listing agreement on Independent Director: As per Clause 49 of the
listing agreement, an Independent Director shall mean a non-executive director of the
company who:
(i) apart from receiving director’s remuneration, does not have any material pecuniary
relationship or transactions with the company, its promoters, its directors, its senior
management or its holding company, its subsidiary(s) and associates which may affect
independence of the director;
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(ii) is not related to promoters or persons occupying management positions at the board
level or at one level below the Board;
(iii) has not been an executive of the company in the immediately preceding three financial
years;
(iv) is not a partner or an executive or was not partner or an executive during the preceding
three years, of any of the following:
(a) The statutory audit firm or the internal audit firm that is associated with the
company, and
(b) The legal firm(s) and consulting firm(s) that have a material association with the
company.
(v) is not a material supplier, service provider or customer or a lessor or lessee of the
company which may affect independence of the director and
(vi) is not a substantial shareholder of the company i.e. owning two per cent or more of the
block of voting shares.
Question 33
As a Statutory Auditor, how would you verify advances against Goods?
(8 marks) (Final May 2008)
Answer
Verification of advances against goods(Banking Companies):
(i) Sanction: Examine the sanction letter, letter of hypothecation and note the important
terms and conditions of the advances.
(ii) Stock statements: Verify the quantity and value of goods hypothecated based on the
stock statements received from the borrower. Test check the Godown Register and
examine the valuation of goods to ascertain the reasonableness of the same.
(iii) Inspection: Ascertain as to whether the premises of the borrowers are periodically visited
by the bank officials to verify the quantity as per the periodic stock statements.
(iv) Stock Audit: See whether the bank has got a system of obtaining stock and receivables
audit report in respect of such advances. If so, review the stock audit report and identify
adverse comments, if any.
(v) Hypothecation/Pledge: Examine the letter of hypothecation and certificate of registration
of charge, in respect of goods pledged with the bank.
(vi) Insurance: Examine the insurance policies for their validity, adequacy etc. and see that
policies are in favour of the bank.
(vii) Documents of title: Inspect the documents of title to goods like bill of lading, dock
warrant, railway receipts etc to ensure that they are endorsed registered in favour of the
bank.
(viii) Third party certificate: Where the hypothecated goods are in possession of third parties,
such as clearing and forwarding agents, transporters, bankers, etc. undertaking has been
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obtained by the bank that they will handover the goods or sale proceeds thereof to the
bank only. In such cases, certificate should be obtained by the bank from such third
parties regarding quantities on hand, on balance sheet date. The valuation of such goods
should be checked by the auditor.
Question 34
What are the steps to be taken by a firm of Chartered Accountant to ensure that its
appointment as Statutory Auditor of a Company is valid? (6 marks)(Final May 2008)
Answer
Validity of appointment as a statutory auditor: To ensure that the appointment is valid, the
incoming auditor should take the following steps before accepting his appointment:
1. Ceiling limit: Ensure that a certificate has been issued u/s 224 of the Companies Act, so
that the total number of company audits held by the firm (including the new appointment)
will not exceed the specified number.
2. Resolution at AGM: Verify that at AGM of the Company, a proper resolution is passed.
Inspect general meeting minutes book to see that the appointment is duly recorded.
3. Compliance with law: Satisfy that the legal procedure contemplated in Sections 224 and
225 of the Companies Act, dealing with removal of existing auditor, if required, has been
followed. Also see whether Section 224A (provision of special resolution in case of
companies in which not less than 25% of the subscribed capital of the Company is held
by public financial institutions or Government Companies) and Section 619B (in case of a
company in which not less than 51 % of the paid up share capital is held by Central /
State Government - C&AG appointment) are attracted and complied with.
4. Code of conduct: Communicate with the previous auditor, if any, to ascertain if there are
any professional reasons for not accepting the appointment.
Question 35
What are the duties of an auditor regarding disqualification of directors under Section
274(1)(g) of the Companies Act, 1956? (8 marks) (Final Nov 2008)
Answer
Clause (g): of sub section (1) of section 274 of Companies Act, 1956 states:
A person shall not be capable of being appointed as director of company if:
Such person is already a director of a public company which -
(A) has not filed annual accounts and annual returns for any continuous three financial years
commencing on and after first day of April, 1999 or
(B) has failed to repay its deposits or interest thereon on due date or redeem its debentures on
due date or pay dividend and such failure continues for one year or more.
Provided such a person shall not be appointed as director of any other public company for a
period of five years from date on which such public company where he is director has failed to
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file annual accounts or returns or has failed to repay deposits or redeem debentures on due
date or pay dividend.
Auditor is required to report under section 227 (3) (f) of the Companies Act,1956 to members
of respective companies whether any director is disqualified from being appointed as director
under clause (g) of section 274 (1) of the Companies Act, 1956 and
Furnish certificate every year as to whether on the basis of his examination of the books and
records of the company any director of the company is disqualified as a director or not.
Auditor to comply with section 227 (3) (f) should obtain a written representation as to:
(a) Names of directors of company during period covered by auditor’s report
(b) particulars of appointment /resignation of such directors
(c) Submission of form DD-A, required to be submitted by such director.
(d) Information of directors contained in register maintained under section 303(1) of Company’s
Act as update up to date of balance sheet.
(e) Details of default committed by company under section 274(1).
(f) If company has committed any default, whether form DD-B submitted by company on the
basis of such examination, auditor is required to furnish certificate every year stating whether
any director is disqualified for appointment as director.
Question 36
You have been asked by a company to compile financial statements for the purpose of
obtaining loan from a Bank. Draft a report to be given to the Management for the same.
(8 marks) (Final Nov 2008)
Answer
Draft of a Report of an Engagement to Compile Financial Statements - SRS 4410
To…………
On the basis of the accounting records and other information and explanations provided to us by
the Management, we have compiled the unaudited Balance Sheet of_______ (Name) as
at______(date) and the related Profit & Loss Account for the period then ended.
The management of the__________ (Name) is responsible for:
(a) Completeness and accuracy of the underlying data and complete disclosure of all
material and relevant information to the accountant;
(b) Maintaining adequate accounting and other records and internal controls and selecting
appropriate accounting policies;
(c) Preparation and presentation of financial statements in accordance with applicable laws.
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(d)………………….
(e)…………………….
The compilation engagement was carried out in accordance with SRS 4410 issued by ICAI.
The Balance sheet and the Profit & Loss Account are in agreement with the books of accounts.
We have not audited or reviewed these financial statements and accordingly express no opinion
thereon.
For_______________
Chartered Accountants.