Auditing Solved Paper May’ 2017 (Semester Exam)
Dibrugarh University B.Com 4th/6th SemCBCS and Non-CBCS Pattern
a) Detection of errors and fraud in audit is
a) Primary object
b) Secondary object
c) Specific object
d) None of the above
b) Management Auditor can be removed by
a) Annual General Meeting.
b) Board of Directors
c) Shareholders
d) Board of Directors and Shareholders
c) A person qualified for appointment as a Company Auditor is
a) a graduate
b) a body corporate
c) officer or employee of company
d) None of them
d) Contingent liability is
a) Trade liability
b) Possible liability
c) Outstanding liability
d) None of the above
e) Undervaluation of stock is
a) Technical error
b) Compensatory error
c) Error of principles
d) None of the above
f) Huge Investment in advertisement shown in financial statements as
a) Revenue expenses
b) Capital expenses
c) Deferred revenue expenses
d) None of the above
g) Provisions regarding redemption of preference shares are in Companies Act, 2013 under
a) Section 180
b) Section 56
c) Section 55
d) None of the above Sec. 90 of the Companies Act, 2013
h) Government may order for cost audit under
a) Section 227
b) Section 233A
c) Section 223B (Old) Section 148 of Companies Act, 2013
d) Section 224
2. (a) Distinguish between any two of the following: 4x2=8
1) Accountants and Auditors.
Ans: Difference between ACCOUNTANTS and AUDITORS: The following points draw a line of demarcation between accountancy and auditing.
1. While Accountancy is mainly concerned with the preparation of summary and analysis of the records prepare by the book-keeper, auditing is the examination of the completed records.
2. While accountant ascertains the trading results of a business during a financial year, auditor certifies as correct the financial statements prepared by the accountant.
3. While an accountant is an employee of the business, an auditor is an independent outsider.
4. As an employee of the business, the accountant draws his monthly salary regularly from the business itself. An auditor, on the other hand, is paid a remuneration agreed upon between him and his client.
5. While an accountant is not expected to have a knowledge of auditing it is very essential for an auditor to possess a thorough knowledge of accountancy.
6. While an accountant is usually a permanent employee of the business, an auditor can be changed from year to year.
7. While an accountant does not submit his report on the financial statements prepared by him, an auditor has to submit his report to his client that the Balance Sheet and Profit and Loss Account give a true and fair view of the state of affairs of the business and are correct to the best of his knowledge and information supplied to him.
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2) Test checking and Routine checking.
Ans: Difference between Routine checking and vouching 2013
| Basis | Routine Checking | Test Checking |
| Meaning | It means checking of common records and books maintained by the business organisation. | It means an act of sampling in which only some transactions are checked to reduced the volume of detailed checking. |
| Scope | Its scope is limited upto the books of accounts. | The auditor has to go beyond the books of account to trace the source of entries in books of accounts. |
| Period | Routine checking is a financial act that is done on a monthly basis to ensure that the numbers in accounting books match the information held by financial institutions. | Test checking is a similar process but only occurs when audit is done at the end of the year. |
| Process | Routine checking is a total process of accounting control which includes examination of totals, balance, verification of entries in ledgers etc. | It is mainly concerned with checking some transactions which represents the whole transactions. |
| Staff | Routine checking of books of accounts are done by the staff appointed by the organisation. | Test checking is mainly done by auditing staff or auditor himself. |
3) Verification and Valuation.
Differences between Verification and Valuation
| Basis | Verification. | Valuation. |
| Objective | Verification is done to prove the existence, ownership and title to assets. | It certifies the correct value of the asset at the date of the BS. |
| Applicability | Verification is done or both assets and liabilities. | Usually only values of assets are certified. |
| Auditor’s involvement | Verification is done by the auditor. | It’s done by the experts and responsible officials. |
| Evidence | Verification is made on the basis of evidence. | Valuation is made based upon the certificate issued by the officials. |
(b) Write short notes on any two of the following:
a) Utility of audit programme.
Ans: Advantages of audit programme
a) Audit programme is prepared to locate exactly the responsibility of every clerk in the auditor’s staff.
b) It promotes division of work in a well organized manner.
c) Since the programme takes into consideration all the details involved in the work to be followed during audit, no portion of the work is left from checking.
d) It helps the auditor to monitor the progress of the work.
e) It will be easier to fix responsibilities for omissions and commissions.
f) It serves as a valuable evidence for the work done.
g) It serves as a guide for future audit.
h) It ensures that audit process in a systematic manner.
i) It eliminates inefficiency and saves time.
j) Incase if any audit assistant goes on leave, his work can be easily continued by others.
k) Before signing the report, it is easily possible for the auditor to have the final review of the work done by him. At this stage, it may be explored whether everything has been completed or not.
l) It avoids duplication of work.
b) Internal control.
Ans: Internal Control: Internal Control is a Systematic measures such as reviews, checks and balances, methods and procedures instituted by an organization to conduct its business in an orderly and efficient manner, safeguard its assets and resources, determine and detect errors, fraud, and theft, ensure accuracy and completeness of its accounting data, produce reliable and timely financial and management information, and ensure adherence to its policies and plans.
According to W.W.BIGG: “Internal Control is best regarded as indicating the whole system of controls, financial and otherwise, established by the management in the conduct of a business, including internal check, internal audit and other forms of control.”
Thus, Internal control is the process, affected by an entity's Board of Trustees, management, and other personnel, designed to provide reasonable assurance regarding the achievement of the following objectives:
1. To detect and prevent commission of errors and frauds.
2. To promote accuracy and reliability in accounting and reporting data.
3. To safeguard resources of the organisation against undue wastage or other such inefficiencies.
4. To help in attaining sound company policies and measuring compliance with such policies.
5. To help management in formulation of plans and policies regarding the working of the company.
6. To promote and judge efficiency of all operations in all division of the organisation.
c) Audit evidences.
Ans: Auditor needs evidence to obtain information for arriving at his judgement. AAS 1 “Basic Principles Governing and Audit”, mention audit evidence as one of the basic principles and requires that the auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions there from on which to base his opinion on the financial information.
The evidence may be of varied nature and can assume various forms for example, a signature on the voucher of a designated official, the payee’s receipt, acknowledgement from the stores for goods received, supplier’s invoice, statement of account, minutes’ contracts, etc. Even the information obtained by the auditor by discussing with the officials of the company also constitutes audit evidence. Generally audit evidence, depending on its source, may be classified as internal evidence or external evidence. Internal evidence is one that has been created within the client’s organisation and without its ever going to outside party. External evidence is one which emanates from outside the client’s organisation.
d) Removal of auditor under Companies Act.
Ans: Removal, Resignation of auditor and giving of special notice to the Company Auditor
Provisions relating to removal of auditor before the expiry of term [Sec. 140 (1)]: As per section 140(1), the auditor appointed under sec. 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the central government in that behalf.
Procedure for removal:
a) Holds board meeting to pass the resolution
b) Make an application to the central government along with prescribed fees within 30 days of the board’s resolution.
C) Hold the general meeting to pass the special resolution within 60 days of receipt of approval of the central government.
d) Before taking any action for removal before expiry of terms, the auditor concerned shall be given a reasonable opportunity of being heard.
Resignation by auditor [Sec. 140 (2) and Sec. 140(3)]: When an auditor resigns, he is required to file a statement in the prescribed form with the company and the registrar stating the reasons and other facts which are relevant with regard to his resignation. In case of a government company, the statement shall also be filled with the CAG. The above mentioned statement shall be filled within 30 days form the date of resignation.
Special notice for not appointing the retiring auditor [Sec. 140(4)]: According to Sec. 140:
a) special notice at an AGM shall be required for appointing as auditor a person other than the retiring auditor or providing expressly that the retiring auditor shall not be reappointed. However, special notice shall not be required if the retiring auditor has completed consecutive tenure of 5 years/ 10 years as provided u/s 139(2).
b) On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring auditor.
c) The retiring auditor is entitled to make a representation against his removal. The representation shall be in writing and shall be sent to the company.
d) The company shall send a copy of the representation to every member of the company to whom notice of the meeting is sent.
e) If a copy of the representation is not sent because if was received too late or because of the company’s default, then the auditor may require that the representation shall be read out at the meeting and a copy of representation shall be filed with the registrar.
3. (a) What is vouching? Explain the general and specific considerations which the auditor should keep in mind while checking vouchers of credit sales. 4+10=14
Also Read:
Ans: Vouching: The act of examining vouchers is referred to as vouching. It is the practice followed in an audit, with the objective of establishing the authenticity of the transaction recorded in the primary books of account. It essentially consists of verifying a transaction recorded in the books of account with the relevant documentary evidence and the authority on the basis of which the entry has been made; also confirming that the amount mentioned in the voucher has been posted to an appropriate account which would disclose the nature of transaction on its inclusion in the final statements of account. After examination, each voucher is marked in a manner to ensure that it may not be presented again in support of another entry.
Importance of vouching: Vouching of transactions is the most important audit step in any type of auditing. Voucher is the document which describes any transaction and whole building of accounting stands on vouchers. Such is the importance of voucher and vouching. The importance and objectives of vouching are given below:
1. Back bone of auditing: Vouching is first step in detailed auditing. It gives grounds and reasons for further investigation. It is primary activity to know the worth of any business.
2. Careful vouching helps the auditor to detect fraud, misappropriation of money, errors, falsification etc.
3. Detailed vouching acts as a moral check on employees.
4. Vouching helps in separation of revenue with capital items.
5. Vouching helps in ascertaining whether the transaction is in relation to business or some other activity outside the business.
6. It is the foundation stone for any accounting process.
VOUCHING OF SALES BOOK (Credit Sales): Auditor should examine the following points while vouching the sales book:
1. Internal Checks System: Auditor should check the working of internal control and test the few entries.
2. Checking Of Invoices:
a. Debtor's name.
b. date and amount.
c. The authority.
d. Trade discount.
e. Authority for gaining discount.
3. Duplicate Invoices: Auditor should check the entries in the sales book with the duplicate invoices.
4. Authority Checking: It should also be checked by the auditor that the invoice should be authorized by the responsible officer.
5. Comparison With Order Book: Auditor should compare the sales book with the order received book and goods outward book. It will show that no fictitious sale is made.
6. Verification Of Year: It should be also checked by the auditor that all the entries made in the sale book belongs to the year under audit.
7. Fixed Assets Sale: Auditor should check that if fixed assets are sold then these are recorded in the sales book. He should also check that these are posted in the sales account in the general ledger or not.
8. Dispatch Of Goods: Auditor should verify the sales invoices with the documentary evidence to ensure the dispatch of goods.
9. Over All Checking: The auditor should check the casts and carry forwards of the sales book.
Or
(b) What are the duties of an auditor with regard to valuation of assets? Discuss the audit procedure for verification of contingent liabilities. 7+7=14
Ans: Valuation of assets means determining the fair value of the assets shown in the Balance Sheet on the basis of generally accepted accounting principles. The valuation of assets is very important because over-statement or under-statement of the value of assets in the Balance sheet not only distorts the true and fair view of the financial position but also gives wrong position of profitability. The valuation of the assets is the primary duty of the officials of the company. The auditor is required to verify whether the value ascertained is fair one or not. For this, he may rely on the technical certificate issued by the experts in the field.
Auditor Duties Regarding Valuation:
An auditor can obtain the certification of valuer and other competent persons. Usually, the assets are valued by responsible officials. An auditor audits many types of companies and he can’t be an expert to value all kinds of assets. An auditor is not a valuer, and can’t be expected to act as such. All that he can do is to verify the original cost price and to ascertain as far as possible the current values are fair and reasonable and are in accordance with accepted principles. It must be borne in mind that the actual valuations are made by officials who have a practical knowledge of such assets and that an auditors duty is confined to testing the valuations as far as he can and in this way satisfy himself with correctness of the balance sheet position. However, he can’t guarantee the accuracy of valuations.
In simple words, in the absence of suspicious circumstances he can rely on the trusted officials of the company but this will not relive him from his responsibilities if assets are incorrectly valued. He should exercise reasonable care and skill, analysis critically all the facts and satisfy himself that generally accepted. Accounting principles are followed. He should not certify what he believes to be incorrect.
CONTINGENT LIABILITIES
Certain liabilities may or may not arise after the preparation of the Balance Sheet. These are called contingent liabilities. In the words of Montgomery, “The term ‘contingent liability’ should be used in the accounting sense to designate a possible liability of presently determinable or indeterminable or indeterminable amount which arise from past circumstances or action which may or may not become a legal obligation in the future, and which, if paid, gives rise to cost or an expenses or an asset of doubtful value” A contingent liability is different from an actual liability.
Types of Contingent Liabilities
1. Liabilities on Bills Receivable Discounted and not Matured.
2. Liability for Calls on Partly Paid Shares
3. Liability under a Guarantee.
4. Liability for Cases against the Company not Acknowledged as Debts.
5. Liability for Penalties under Forward Contracts.
6. Liability in respect of Arrears of Dividend on Cumulative Preference Shares.
Auditor’s Duties
1. Check the various contingent liabilities named above.
2. Some liabilities may have no provision made in the books but merely a note made at the foot of the Balance Sheet, e.g., bills receivable which have been discounted and which have not matured at the date of the balance Sheet, arrears of fixed accumulated dividends, etc. In case for liabilities in respect of which provision has to be made on the Balance Sheet, e.g., liability which may arise in connection with a suit, etc., the auditor should examine such cases and ascertain the amount to be specifically reserved for the purpose.
3. Examine the Directors Minute Book, correspondence made with the legal advisers and the information obtained from the officials of the business. Ensure that proper provision has been made for all such liabilities and if he is not satisfied mention the fact in the report. The requirements of the Companies Act regarding the contingent liability should be complied with in the Balance Sheet on the liabilities side.
4. (a) What are the special considerations involved in the audit of a company? Discuss the duties of an auditor as regards audit of the share capital of a company. 7+7=14
Ans: Special Consideration involved in the audit of a company
Before beginning the audit work, an auditor must review the various arrangements with his client to decide his future course of action. Usually, the following point must be considered in this connection.
1. The Client: An auditor must know about his appointee will in advance.
(a) Whom to report? And
(b) Who will pay his fees?
Some times the client may be a dissatisfied shareholder, member or a banker or the government or some other person and not the person whose accounts he is auditing.
2. Scope of Duties: the auditor should ascertain the scope of his duties and responsibilities from statues, or from the instructions received from those employing his services. If he is appointed under any statue, his duties and responsibilities are enumerated under it and cannot be contracted. However they may be increased by an agreement between the client and the auditor. The auditor’s duties and responsibilities are determined by reference to terms of agreement entered into between him and hic client, who may be partners in a firm or a sole trader. He has no statutory obligation to comply with. He has only to carry out the instructions he receives from his clients. The dividing line between accountancy and audit work is sometimes so uncertain, that it is always proper for the auditor to ascertain what exactly his client requires. He should check that this is formulated in writing especially where accountancy work is also involved. The scope of auditor’s duties is also affected by the purpose for which the audit is to be made.
3. Period to be covered: The auditor should ascertain the period to be covered in the audit. Usually the period is one year, but the period may be more or less than one year if conducted for a specific purposes.
4. Use of client’s staff: The auditor may have his own staff or may take the assistance of his client’s staff where some clerical work is also to be performed. He should know whether he can use the client’s staff as per agreement.
5. Place of Audit Work: The auditor should know the place of his work. This place is where he will open his office with his staff and conduct his enquiries. Regarding working conditions proper arrangement must be made with the client as it is in the interest of effective conduct of his audit work.
6. Review of Business: This includes the review of the following:
(a) Nature of Business.
(b) Organisation of Business.
(c) Basic Documents of the Business.
(d) Accounting Frameworks.
(1) Previous Accounting Records and Balance Sheets.
(2) Additional Accounting work.
(3) Basic Accounting Policies.
(4) Various Control Systems.
7. Clarification: The auditor should clear the following points with the client:
(a) The confirmation of receivable;
(b) The time of starting the examination;
(c) Fees to be charged;
(d) The preparation of tax returns;
(e) Whether or not the client’s records are to be closed prior to the start of the examination.
Note that if the audit is a repeat engagement, work papers and correspondence of prior years should be reviewed.
Share Capital Audit for a New Company / First Issue
Audit involves three stages, namely the application share capital of a new company in the first issue stage, the allotment stage and the call stage. However, the company is required to fulfill a lot of formalities before actually going for public subscription. The auditor should examine compliance of provisions.
Verification of Capital
1. The auditor should confirm that the permission of the Controller of Capital Issues has been obtained in case the issue exceeds Rs. One crore.
2. He should study the terms and conditions of issue contained in the Memorandum and Articles and Prospectus or Statement in lieu of Prospectus and see that these have been fully complied with.
3. He should ensure that the prospectus contains a provision in terms of Sec. 26 A that any person who
a) Makes, in a fictitious name, an application to a company for acquiring or subscribing for, any shares therein, or
b) Otherwise induces a company to allot or register any transfer of shares therein to him, or any other person in a fictitious name, shall be punishable with imprisonment for a term which may extend up to five years.
4. He should verify that preliminary contracts, if any, entered into for the purchase of a property or business, for creating on organisation for management of the company etc., have been carried out strictly as laid down in the prospectus.
5. He should as certain that there exist in internal check on receipts of amount along with the application.
6. He should examine shares issued for cash and shares issued for consideration other than cash, if any.
Auditor’s Duties
1. Application stage: The auditor should undertake the following checks:
1) Checking of the original applications with the application and allotment sheets.
2) Checking and comparing entries in the application and the allotment books as regards deposit of money at the time of application with those in the cash book.
3) Vouching that amounts pertaining to rejected applications, non-allotted application or any excess amount there to have been returned by comparing entries in the cash book with that of application and allotment sheets (books) or letters of regret, if any.
4) Examining that the issue is within the limits authorized by the Memorandum and Articles of Association.
5) Examining that the minimum subscription fee, the amount received on application being not less that 5% of the nominal value of shares, has actually been received before making the allotment.
6) Checking the balance on the application and allotment sheets (book) and verify the total capital issued.
2. Allotment stage: Following steps may be taken in this stage.
1) Examining the Director’s Minute Book to verify approval of allotments which may be in stages as spreading over a number of days. He should note that recording at each stage was properly initialed by at least one director. He should also see that the allotment was legally in order.
2) Comparing copies of letters of allotment / letters of regrets with entries in the application and allotment sheets (book).
3) Vouching money receipt on allotment by comparing the entries in the application and allotment sheets with the cash book or bank statement.
4) Confirming the journal entries regarding allotment money, examining the ledger accounts and comparing the balances in the ledger accounts with the number of shares allotted.
5) Verifying the entries in the Register of Members by comparing these with a separate summary of shares allotted. Verifying that the amounts of the shares allotted do not exceed the authorized or nominal capital of the company.
6) Seeing that returns of allotment have been filed with the Registrar of Companies.
3. Calls stage: The auditor should take the following steps:
1) Examining the Director’s Minute Books regarding decisions about calls.
2) Seeing that the calls as resolved are within the provisions in the Articles of Association and statement in the prospectus issued by the company.
3) Vouching amounts received against calls with the counterfoils of receipts.
4) Checking postings of the amounts received from the calls book (for calls due) and the cash book (for cash money received) into the share register.
5) Comparing the application and allotment books with the schedule of calls in arrears showing the difference between calls due and calls received. He should confirm that the call in arrears figure is correct.
6) Checking the calls received in advance either in the cash book or through the journal and seeing that these are transferred to a separate account not meant up with the share capital of the company.
Or
(b) How will you examine the following items while auditing the accounts of a limited company? 4+5+5=14
a) Preliminary expenses
b) Forfeited shares
c) Shares issued at a discount
Ans: a) Preliminary Expenses
Expenses incurred to the formation of a company are called ‘Preliminary Expenses’. Preliminary expenses include the following:
a) Expenses incurred in order to get the company registered.
b) Expenses incurred for the preparation, printing and issue of prospectus.
c) Cost of preliminary books and Common Seal.
d) Duty payable on Authorized Capital.
e) Underwriting Commission etc.
Preliminary Expenses are to be written off out Securities Premium Account or it may be written off out of the Profit & Loss A/c gradually over some period. The balance left of preliminary expenses is to be shown in the asset side of the balance sheet of the company under the heading of ‘Miscellaneous Expenditure’.
Auditor’s Duties regarding Preliminary Expenses
1. To verify the following on the basis of documentary evidence and to see that preliminary expenses do not include these:
a) Loss incurred in the first year of the life of the company;
b) Brokerage, commission etc. for selling or underwriting or for placing shares;
c) Once the company begins to earn revenue, the current expenditure should not be debited to preliminary expenses account (Baidya Nath Biswas v. Emperor).
2. To see that the company is charged only with expenses appropriately payable by it.
3. To examine the contracts relating to these expenses and vouch the mode of payment.
4. To see that expenses of capital nature but unsupported by available assets, be written off as soon as possible out of the revenue. According to Sec. 52 such expenses can be charged against share premium.
5. To see that these are disclosed in the prospectus, statutory report and balance sheet.
6. To see that the preliminary expenses not written off yet have been shown separately under ‘Miscellaneous Expenditure’ in the Balance Sheet.
b) Forfeiture of shares: A company has no inherent power to forfeit shares. The power to forfeit shares must be contained in the articles. Where a share holder fail to pay the amount due on any call, the directors may, if so authorized by the articles, forfeit his shares. Shares can only be forfeited for non-payment of calls. An attempt to forfeit shares for other reasons is illegal. Thus where the shares are declared forfeited for the purpose of reliving a friend from liability, the forfeiture may be set aside.
Auditor’s Duties regarding to Forfeiture and Reissue
1. To examine the Articles to verify authorization and compliance of the Provisions of the Articles. The fact that Articles authorized the company to expel a member is not sufficient to enable the company to deprive the expelled members of the shares also.
2. To examine the Director’s Minute Book to see the resolution forfeiting the shares. The auditor must see that the forfeiture has been correctly accounted for and that necessary adjustments have been made in the Register of Members.
3. To inspect the directors’ resolution about the forfeited shares reissued. To trace the receipt of money and to verify that the amount of discount, if any, does not exceed the amount already received thereon from the defaulter shareholders.
4. To vouch the cancellation by reference to the Directors’ Minute Book and the Register of Members, in case the forfeiture is cancelled by the directors.
5. To see that any premium received on the original issue of the forfeited shares is not transferred to ‘Forfeited Shares Account’ but remains in the ‘Share Premium Account’.
6. To examine that in case some excess money has been realized, it should be transferred to the Capital Reserve Account as it represents capital profit and not divisible profits.
c) Issue of shares at discount:
As per sec. 53 of the Companies Act, 2013, issue of shares at a discount is prohibited. This prohibition applies to all companies, public or private. Any issue of share at a discount shall be void. But a company can issue sweat equity shares to its directors or employees as a reward to them for their contributions. Sweat equity shares are those which are issued by a company at a discount or for consideration other than cash.
According to Section 54 of company act 2013, a company is permitted to issue sweat equity shares provided the following conditions are satisfied:
a) The issue of shares at a discount is authorised by a resolution passed by the company in its general meeting and sanctioned by the Central Government.
b) The resolution must specify the maximum rate of discount at which the shares are to be issued but the rate of discount must not exceed 10 per cent of the nominal value of shares. The rate of discount can be more than 10 per cent if the Government is convinced that a higher rate is called for under special circumstances of a case.
c) At least one year must have elapsed since the company was entitled to commence the business.
d) The shares are of a class, which has already been issued.
e) The shares are issued within two months from the date of sanction received from the Government.
Auditor’s Duties regarding Issue of Shares at a Discount
The auditor must examine compliance with requirements under Sec. 54 and its presentation and disclosure in the Balance Sheet. The auditor must ensure that discount is allowed only in case of sweat equity shares. The auditor must see that at least one year must have been elapsed since the company was entitled to commence the business and rate of discount must not exceed 10%.
5. (a) Explain in brief various types of Audit Report. What are the circumstances under which an auditor considers it necessary to qualify Audit Report? 8+6=14
Ans: TYPES OF AUDIT REPORT: There are four types of audit report which are given below:
a) Clean Report: It is also known as Unqualified Report. It is given by the auditor if he is satisfied with the fairness of Balance Sheet and Profit and Loss account with all the contents of the financial statements and he is satisfied with evidences, documents and explanation given by his clients.
b) Qualified Audit Report: A qualified report means an audit report which is not clean. In case auditor has any reservation in respect of certain methods mentioned in the financial statements he may qualify his report. A qualified opinion shall be expressed as being subject of or except for the effects of the matter to which the qualification matters. If the accounting standards issued by Institute of Chartered Accounts of India is not followed by the company the auditor may qualify his report. The company Act doesn’t lay down any specific requirement regarding the manner in which the auditor should qualify his report. It should not lead any confusion to the reader. Before submitting a qualified report he should discuss the issued with that of the management. He should see that qualified report is free from ambiguity, vague statements etc.
c) Adverse Opinion: The worst type of financial report that can be issued to a business is an adverse opinion. This indicates that the firm’s financial records do not conform to GAAP. In addition, the financial records provided by the business have been grossly misrepresented.
d) Disclaimer of Opinion: On some occasions, an auditor is unable to complete an accurate audit report. This may occur for a variety of reasons, such as an absence of appropriate financial records. When this happens, the auditor issues a disclaimer of opinion, stating that an opinion of the firm’s financial status could not be determined.
Circumstances for Qualification of Audit Report: In following circumstances the auditor has to qualify his report.
(a) He cannot conduct audit satisfactorily due to non availability of certain books of accounts or records, information or explanations necessary for conduct of his audit.
(b) He finds that the Balance Sheet and Profit & loss Account have not been prepared in accordance with accepted accounting principles.
(c) He detects that provisions for Bad & Doubtful Debts, Depreciation etc. are not adequate.
(d) He detects that the company has created certain secret reserve.
(e) The stock in trade has been valued at market price which is more than cost price.
(f) He finds that the contingent liability for bills discounted has not been disclosed.
Or
(b) What is cost audit? What are the justifications of a cost audit? Discuss the cost audit procedure of a manufacturing unit. 2+5+7=14
Ans: Cost Audit: It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.
As per ICWA London’ “cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.”
The ICWAI defines cost audit as " system of audit introduced by the government of India for the review, examination and appraisal of the cost accounting records and attendant information required to be maintained by specified industries"
From above definition of cost audit, it is clear that cost audit is a sytematic examination of cost accounts to verify correctness of cost accounting records.
Justification of cost audit
Cost audit is needed due its various benefits which are stated below:
To The Management
a) Cost audit helps in detection of errors and frauds.
b) The management gets accurate and reliable data based on which they can make day-to-day decisions like price fixation.
c) It helps in cost control and cost reduction.
d) It facilitates the system of standard costing and budgetary control.
e) It helps the management in inter-unit / firm comparison.
f) It enables the management to identify loss making propositions.
To The Government
a) Cost audit ensures efficient functioning of the industry. This in turn, nurtures a healthy competition among the different companies and paves a path for fast progress.
b) It helps in identification of sick units and enables the Government to make relevant decisions.
c) It helps in fixing prices in the case of essential commodities and checking undue profiteering.
d) It enables to take decisions as to granting of subsidies, incentives and protection to various industries.
e) It helps to take decisions as to levies, duties and taxes.
To the Society
a) Cost audit enables the Government to fix prices of essential commodities. This safeguards the interests of the society.
b) Cost audit enables the Government to keep a check on undue profiteering by the manufacturers and avoids artificial price rise due to monopolistic tendencies.
To the Shareholders
a) Cost audit reveals whether any of the products of the company are making losses. Thus though the company making an overall profit, a loss making line may eating up the company’s profits. This is brought to the notice of the shareholders and the management is forced to take remedial measures, thereby making optimum utilisation of resources.
b) Cost audit ensures that the shareholders get a fair return on their investments.
Procedure of Cost Audit
1. Applicability of Cost Audit
Every company, including foreign companies defined in clause (42) of section 2 of the Act, engaged in the production of the goods or providing services, specified in Tables A and B, having an overall turnover from all its products and services of rupees thirty five crore or more during the immediately preceding financial year, shall be required to maintain cost accounting records.
2. Appointment of Cost Auditor
The cost auditor is to be appointed by the Board of Directors on the recommendation of the Audit Committee, where the company is required to have an Audit Committee. The cost auditor proposed to be appointed is required to give a letter of consent to the Board of Directors (Refer Appendix-2 for Specimen Consent Letter). The company shall inform the cost auditor concerned of his or its appointment as such and file a notice of such appointment with the Central Government within a period of thirty days of the Board meeting in which such appointment is made or within a period of one hundred and eighty days of the commencement of the financial year, whichever is earlier, through electronic mode. Any casual vacancy in the office of a cost auditor, whether due to resignation, death or removal, shall be filled by the Board of Directors within thirty days of occurrence of such vacancy and the company shall inform the Central Government in Form CRA-2 within thirty days of such appointment of cost auditor.
Who can be appointed cost auditor?
Only a Cost Accountant, as defined under section 2(28) of the Companies Act, 2013, can be appointed as a cost auditor. Clause (b) of sub-section (1) of section 2 of the Cost and Works Accountants Act, 1959 defines “Cost Accountant”. It means a Cost Accountant who holds a valid certificate of practice under sub-section (1) of section 6 of the Cost and Works Accountants Act, 1959 and is in whole-time practice. Cost Accountant includes a Firm of Cost Accountants and a LLP of cost accountants.
Who cannot be appointed cost auditor?
According to section 141(3) of the Companies Act, 2013, the following persons shall not be appointed as cost auditors of a company:
a) A body corporate: A company other than a limited liability partnership cannot audit any other company,
b) An officer or employee of the company.
c) A person who is either a partner or employee of an officer or employee of the company.
d) A person who or his relative or his partner has taken debt from the company for amount exceeding Rs. 5,00,000.
e) A person who or his relative or his partner has taken guarantee of another person who has taken a loan exceeding Rs. 1,00,000 from the company.
f) A person who is or his relative or his partner is holding any security in the company or its subsidiary company or its holding company or its associate company or a subsidiary of such holding company.
g) A person whose relative is a director or is in the employment of the company as a director or key managerial personnel.
h) A person who has been convicted by a court of an offence involving fraud and a period of 10 years has not elapsed from the date of such conviction.
i) Any person whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialised services as provided u/s 144.
j) A person, who is disqualified for being appointed as auditor of a company, is automatically disqualified for being auditor of its holding company or its subsidiary company or any other subsidiary of holding company.
3. Remuneration of Cost Auditor
The remuneration recommended by the Audit Committee under shall be considered and approved by the Board of Directors and ratified subsequently by the shareholders.
4. Obligation to report offence of fraud
As per sub-section (12) of section 143 of the Companies Act 2013, extract of which is given above, it is obligatory on the part of cost auditor to report offence of fraud which is being or has been committed in the company by its officers or employees, to the Central Government as per the prescribed procedure under the Rules.
5. Form for filing Cost Audit Report with the Central Government
Every company to whom cost auditor submits his or its report shall, within a period of thirty days from the date of receipt of a copy of the cost audit report, furnish the Central Government with such report along with full information and explanation on every reservation or qualification contained therein, in form CRA-4 along with fees.
6. (a) What steps would you taken before commencing the actual work of audit, if you are being appointed as an auditor? Explain the auditor’s duties in relation to the detection and prevention of errors and fraud. 6+8=14
Ans: Before beginning the audit work, an auditor must review the various arrangements with his client to decide his future course of action. Usually, the following point must be considered in this connection.
1. The Client: An auditor must know about his appointee will in advance.
a) Whom to report? And
b) Who will pay his fees?
Some times the client may be a dissatisfied shareholder, member or a banker or the government or some other person and not the person whose accounts he is auditing.
2. Scope of Duties: the auditor should ascertain the scope of his duties and responsibilities from statues, or from the instructions received from those employing his services. If he is appointed under any statue, his duties and responsibilities are enumerated under it and cannot be contracted. However they may be increased by an agreement between the client and the auditor. The auditor’s duties and responsibilities are determined by reference to terms of agreement entered into between him and hic client, who may be partners in a firm or a sole trader. He has no statutory obligation to comply with. He has only to carry out the instructions he receives from his clients. The dividing line between accountancy and audit work is sometimes so uncertain, that it is always proper for the auditor to ascertain what exactly his client requires. He should check that this is formulated in writing especially where accountancy work is also involved. The scope of auditor’s duties is also affected by the purpose for which the audit is to be made.
3. Period to be covered: The auditor should ascertain the period to be covered in the audit. Usually the period is one year, but the period may be more or less than one year if conducted for a specific purposes.
4. Use of client’s staff: The auditor may have his own staff or may take the assistance of his client’s staff where some clerical work is also to be performed. He should know whether he can use the client’s staff as per agreement.
5. Place of Audit Work: The auditor should know the place of his work. This place is where he will open his office with his staff and conduct his enquiries. Regarding working conditions proper arrangement must be made with the client as it is in the interest of effective conduct of his audit work.
6. Review of Business: This includes the review of the following:
a) Nature of Business.
b) Organisation of Business.
c) Basic Documents of the Business.
d) Accounting Frameworks.
e) Previous Accounting Records and Balance Sheets.
f) Additional Accounting work.
g) Basic Accounting Policies.
h) Various Control Systems.
7. Clarification: The auditor should clear the following points with the client:
a) The confirmation of receivable;
b) The time of starting the examination;
c) Fees to be charged;
d) The preparation of tax returns;
e) Whether or not the client’s records are to be closed prior to the start of the examination.
Note that if the audit is a repeat engagement, work papers and correspondence of prior years should be reviewed.
Auditor’s duties in regard to detection and prevention of errors and frauds
A) Detection and prevention of errors: errors are mistakes committed unintentionally because of ignorance, carelessness. Errors are of many types:
a. Errors of Omission: These are the errors which arise on account of transaction into being recorded in the books of accounts either wholly partially. If a transaction has been totally omitted it will not affect trial balance and hence it is more difficult to detect. On the other hand if a transaction is partially recorded, the trial balance will not agree and hence it can be easily detected.
b. Errors of Commission: When incorrect entries are made in the books of accounts either wholly, partially such errors are known as errors of commission. E.g.: wrong entries, wrong Calculations, postings, carry forwards etc such errors can be located while verifying.
c. Compensating Errors: when two/more mistakes are committed which counter balances each other. Such an error is known as Compensating Error. E.g.: if the amount is wrongly debited by Rs 100 less and Wrongly Credited by Rs 100 such a mistake is known as compensating error.
d. Errors of Principles (2015): These are the errors committed by not properly following the accounting principles. These arise mainly due to the lack of knowledge of accounting. E.g.: Revenue expenditure may be treated as Capital Expenditure.
e. Clerical Errors; A clerical error is one which arises on account of ignorance, carelessness, negligence etc.
f. Location of Errors: It is not the duty of the auditor to identify the errors but in the process of verifying accounts, he may discover the errors in the accounts. The auditor should follow the following procedure in this regard:
i. Check the trial balance.
ii. Compare list of debtors and creditors with the trial balance.
iii. Compare the names of account appearing in the ledger with the names of accounting in the trial balance.
iv. Check the totals and balances of all accounts and see that they have been properly shown in the trial balance.
v. Check the posting of entries from various books into ledger.
B) Detection and Prevention of Fraud: A fraud is an Error committed intentionally to deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.
a. Misappropriation of Cash: This is one of the majored frauds in any organisation it normally occurs in the cash department. This kind of fraud is either by showing more payments/ less receipt. The cashier may show more expenses than what is actually incurred and misuse the extra cash. E.g.: showing wages to dummy workers. Cash can also be misappropriated by showing less receipts E.g.: not recording cash sales. Not allowing discounts to customers. The cashier may also misappropriate the cash when it is received. Cash received from 1st customer is misused when the 2nd customer pays it is transferred to the 1st customer’s account. When the 3rd customer pays it goes forever. Such a fraud is known as “Teaming and Lading”. To prevent such frauds the auditor must check in detail all books and documents, vouchers, invoices etc.
b. Misappropriation of Goods: Here records may be made for the goods not purchase not issued to production department, goods may be used for personal purpose. Such a fraud can be deducted by checking stock records and physical verification of goods.
c. Manipulation of Accounts: this is finalizing accounts with the intention of misleading others. This is also known as “WINDOWS DRESSING”. It is very difficult to locate because it is usually committed by higher level management such as directors. The objective of WD may be to evade tax, to borrow money from bank, to increase the share price etc.
To conclude it can be said that, it is not the main objective of the auditor to discover frauds and irregularities. He is not an insurance against frauds and errors. But if he finds anything of a suspicious nature, he should probe it to the full.
Or
(b) Explain the advantages of continuous audit. How would you compare continuous audit and internal audit? 6+8=14
Ans: Continuous audit: Continuous audit is a system of audit where the auditor and his staff Examines all the transactions and books of accounts in details continuously throughout the year at regular intervals i.e. weekly or fortnightly or monthly etc.
According to Spicer and Pegler, “a continuous audit is one where the auditor’s staff is occupied continuously on the accounts the whole year round, or where the auditor attends at intervals, fixed or otherwise, during the currency of the financial year and performs an interim audit; such audits are adopted where the work involved is considerable and have many points in their favour although they are subject to certain disadvantages.”
Advantages of continuous audit: Following are the advantage of continuous audit in an organization. These are discussed below:
(i) Extensive checking: As the auditor regularly visits the client’s office, he should get time for extensive checking of small transactions and the audit work can ne smoothly conducted.
(ii) Early detection of errors and frauds: As continuous audit is conducted throughout the whole year, errors and frauds can be quickly detected. The accounting staff should not get sufficient time to manipulate accounts.
(iii) Early Preparation of Final accounts: AS this audit is conducted throughout the whole year, it is possible to prepare final accounts i.e. Profit and Loss account and Balance Sheet just at the end of the financial year. The management and the owners can know the financial results without delay.
(iv) Deceleration of interim dividend: Those companies who want to declare interim dividend at the middle of the year is to prepare interim accounts. Continuous audit helps to get interim account in time.
(v) More reliability on audited accounts: If continuous audit is done throughout the year, all the interested parties can rely much on the audited accounts.
(vi) Moral check: As a result of continuous audit employees should feel a moral pressure and the chances of errors and frauds are minimized.
(vii) Early declaration of dividend: With the help of continuous audit final accounts are prepared just at the end of the financial year and the shareholder get dividend without delay.
(viii) Early submission of report: As continuous audit is conducted throughout the year the auditor can complete final accounts audited just at the end of the financial year and can submit his audit report to the shareholders as early as possible.
(ix) Increase in efficiency: As audit is conducted on continuous basis, all the transactions are correctly recorded in the books of accounts and overall efficiency in according work can be made.
Disadvantage of continuous audit: The following are the disadvantages of continuous audit:
(i) High Cost: As continuous audit is conducted throughout the year the organization has to give huge remuneration to the auditor. Therefore, a small concern cannot afford the high cost of conducting such audit.
(ii) Difficulties in accounting work. As a result of frequent visits of the auditor often it is seen that the books of accounts are checked by the audit staff and for this audit work is hampered.
(iii) Change of figures: It may so happen that the portion of accounts which have already examined by the auditor may alter the figures by the dishonest employees to achieve some personal interest.
(iv) Loss of continuity of work: As continuous audit is conducted at regular intervals, the auditor may left unchecked same audit work which was pending during his last audit work.
(v) Adverse effect on employees morale:
(vi) monotony in Work
(vii) Chances of collusion between organization’s staff and auditor’s staff
Difference between Continuous Audit and Internal Audit
1. Nature: Continuous audit is one which is concerned and carried on before the close of the financial period to which it relates.
2. Objective: While the object of continuous audit is to present the correct and fair final statement of the concern to the shareholders, the main object of internal audit is carried on continuously throughout year.
3. Administration: While continuous audit is an independent administrative work, internal audit is an integral part of existing administration system of the concern.
4. Status: While continuous audit is done by an independent and professional auditor, internal audit is done by the internal auditor who is an employee of the concern itself.
5. Auditor’s Qualification: While is continuous audit, the auditor must be a Chartered Accountant, is internal audit, the auditor need not possess professional qualification.
6. Auditor’s Responsibility: While in continuous audit, the auditor is responsible to shareholders, in internal audit, the auditor is responsible to managers.
7. Report: While in continuous audit the auditor’s report is submitted at the end of the financial year, in interim audit there is no question of submitting the report.
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