2.1 Vouching | unit 2 audit procedure

UNIT II

Audit Procedure

2.1 Vouching

MEANING

Vouching is an important procedure for obtaining audit evidence. Normally, entries in the books of account are made on the basis of documentary evidence such as bills, receipts, cheque counter-foils, pay-in-slips, pay roll and so on. Such documentary evidence is called a voucher. Vouching means the critical examination of such vouchers. Vouching is the inspection of documents supporting an entry in accounts. It is the act of examining vouchers to establish the authenticity (genuineness) of the transactions recorded.

AIMS, OBJECTIVES AND IMPORTANCE

Auditing is the critical examination of accounts to determine whether they are true and fair and free from errors and frauds. Vouching is said to be the essence of auditing. Vouching is the method of critically examining the documents which support the entries in the accounts. Vouching is important as it achieves the following aims or objectives-

TRUE AND FAIR

Vouching enables the auditor to ascertain whether the entries in the books are true and fair, which is the basic objectives of auditing.

1) Occurrence

Vouching helps the auditor to ascertain whether the transaction actually occurred.

2) Amount

Vouching helps the auditor to check whether the transaction is recorded for the right amount.

3) Relevant Entries

Vouching helps the auditor to ascertain whether the entries recorded in the books are relevant i.e. they relate to concern and to the current accounting year.

4) As per Standards

Vouching enables the auditor to verify whether an item is accounted as per the recognized accounting standards, policies and practices.

5) As per Law

Vouching ensures that the transaction complies with the provisions of Law e.g. the Companies Act, the Income-tax Act etc.

6) Disclosure

Vouching enables the auditor to ensure that an item is properly disclosed in the final accounts as required by Schedule III of the Companies Act, 2013.

ERRORS AND FRAUDS

Vouching helps an auditor to achieve the object also. Thus, vouching helps an auditor to detect errors in recording transaction e.g. errors of commission, errors of omission or errors of principle etc. vouching ensures the arithmetical accuracy of books of accounts. Vouching also enables detection of frauds by manipulation of records.

POINTS TO BE CONSIDERED IN VOUCHING

Checking the Voucher,

Checking the supporting documents and

Checking the entry in the Books.

CHECKING OF VOUCHER

Name of the concern.

Date of the Voucher.

Serial number of Voucher.

Heads of Account Debited and/ or Credited.

Description of transaction and Name of Parties Involved.

Amounts in Figures and Words.

Signature of Authorized Official.

Signature of Person Preparing Voucher.

Signature of Person Making Entry In a Day-book.

Signature of the payee.

CHECKING SUPPORTING DOCUMENTS

PERTAINS TO CLIENT.

PERTAINS TO Current Year.

3 serial Number of Bill.

Details of transaction.

Quantity.

Amount.

Signature of Party.

Approval of Bill.

CHECKING ENTRY IN BOOKS

Client’s Books.

Date of Entry.

Serial number of voucher.

Heads of Account Debited and/or Credited.

Quantity.

Amount.

Vouching of Payments

In vouching, payments shown on cash book, an auditor should see that payment has been made wholly and exclusively for the business of the client and that it is properly authorized by the person who is competent to do so.

An auditor should keep in mind the following special points while vouching payments:-

Name of the concern.

Date of the Voucher.

Serial number of Voucher.

Heads of Account Debited and/ or Credited.

Description of transaction and Name of Parties Involved.

Amounts in Figures and Words.

Signature of Authorized Official.

Signature of Person Preparing Voucher.

Signature of Person Making Entry In a Day-book.

Signature of the payee.

Vouching of Receipts

Cash Receipts is defined as a form of liquid funds given by a consumer to a provider of goods or services as compensation for receiving those products. • In most domestic business transactions, a cash payment will typically be made in the currency of the country where the transaction takes place, either in paper currency, in coins or in an appropriate combination. • Terms used in Vouching of Receipts – Cheque, Cash in hand, Vouchers, Voucher Numbers, Bank Reconciliation, Blank Cheques, Monthly accounts, Discounts, Payment authorities. In vouching, receipts shown on cash book, an auditor should see that receipts have been received wholly and exclusively for the business of the client and that it is properly authorized by the person who is competent to do so.

Key Takeaways:

1) Vouching is the inspection of documents supporting an entry in accounts.

2.2 Verification and Valuation of Assets and Liabilities

Spicer and Pegler have defined verification as “it implies an inquiry into the value, ownership and title, existence and possession and the presence of any charge on the assets”. Verification is a process by which an auditor satisfies himself about the accuracy of the assets and liabilities appearing in the Balance Sheet by inspection of the documentary evidence available. Verification means proving the truth, or confirmation of the assets and liabilities appearing in the Balance Sheet.

Thus, verification includes verifying:-

The existence of the assets.

Legal ownership and possession of the assets.

Ascertaining that the asset is free from any charge, and

Correct valuation.

Of course it is not possible for the auditor to verify each and every asset. It was held in Kingston Cotton Mills case that “it is not part of an auditor’s duty to take stock. No one contend that it is. He must rely on other people for the details of stock in trade in hand”.

However, as per the decision given in Mc Kesson and Robins case (1939) the auditor must physically inspect some of the assets. Now the auditor has to report whether the balance sheet shows true and fair view of the state of affairs of the company. Hence, he is required to verify all the assets and liabilities appearing in the balance sheet. In case of failure, the auditor can be held liable for damages.

According to the statement of auditing practices’ issued by ICAI, “the auditor’s object in regard to assets generally is to satisfy that:-

They exist.

They belong to the client.

They are in the possession of the client or the persons authorized by him.

They are not subject to undisclosed encumbrances or lien.

They are stated in the balance sheet at proper amounts in accordance with sound accounting principles, and

They are recorded in the accounts.

POINTS TO BE CONSIDERED

While conducting verification following points should be considered by the auditor:-

Existence: The auditor should confirm that all the assets of the company physically exist on the date of balance sheet.

Possession: The auditor has to verify that the assets are in the possession of the company on the date of balance sheet.

Ownership: The auditor should confirm that the asset is legally owned by the company.

Charge or lien: The auditor has to verify whether the asset is subject to any charge or lien.

Record: The auditor should confirm that all the assets and liabilities are recorded in the books of account and there is no omission of asset or liability.

Audit report: Under CARO the auditor has to report whether the management has conducted physical verification of fixed assets and stock and the difference, if any, between the physical inventory and the inventory as per the book.

Event after balance sheet date: The auditor should find out whether any event after the date of balance sheet has affected any items of assets and liabilities.

SCOPE OF VERIFICATION

Verification includes information on the following:-

That the assets were in existence on the date of the balance sheet.

That the assets had been acquired for the purpose of business only.

That the assets had been acquired under a proper authority.

That the right of ownership of the assets vested in the organization.

That the assets were free from any charge and

That the assets were properly valued and disclosed in the balance sheet.

OBJECTS OF VERIFICATION

Following are the objects of verification of assets and liabilities

To show correct valuation of assets and liabilities.

To know whether the balance sheet exhibits a true and fair view of the state of affairs of the business

To find out the ownership and title of the assets

To find out whether assets were in existence

To detect frauds and errors, if any

To find out whether there is an adequate internal control regarding acquisition, utilisation and disposal of assets.

To verify the arithmetic accuracy of the accounts

To ensure that the assets have been recorded properly.

ADVANTAGES OF VERIFICATION

Advantages of verification are as under:-

It avoids manipulation of accounts

It guards against improper use of assets

It ensures proper recording and valuation of assets

It exhibits true and fair view of the state of affairs of the company.

TECHNIQUES OF VERIFICATION

Inspection: It means physical inspection of the assets i.e. company cash in the cash box, physical inventory, inspection of shares certificates, documents etc.

Observation: The auditor may observe or witness the inspection of assets done by others.

Confirmation: It means obtaining written evidence from outside parties regarding existence of assets.

VERIFICATION OF ASSETS

The term ‘verification’ signifies the physical examination of certain class of assets and confirmation regarding certain transactions. Sometimes verification is confused with vouching but they differ from each other on the nature and depth of the examination involved. Vouching goes to prove the arithmetical accuracy and the genuineness of the transactions whereas verification goes to enquire into the value, ownership, existence and possession of assets and also to confirm whether they are free from any mortgage or charge. The fact of the presence of any entry regarding the acquisition of asset does not prove that the particular asset actually exists on the Balance Sheet date, rather it purports to prove that the asset ought to exist; on the other hand, verification through physical examination and confirmation proves whether a particular asset actually exists without having any charge on the date of the balance Sheet.

Verification of assets involves the following steps:

Enquiry into the value placed on assets;

Examination of the ownership and title deeds of assets;

Physical inspection of the tangible assets; and

Confirmations regarding the charge on assets;

Ensuring that the assets are disclosed, classified and presented in accordance with recognized accounting policies and legal requirements.

The scope of verification is wide and consequently verification is an important part of the auditor’s duties. An auditor should put his entire endeavor to satisfy himself whether a particular asset is shown in the Balance Sheet at proper value, whether the concern holds the title to the asset and the asset is in the sole possession of the concern and lastly whether the asset is free from any charge. If the auditor fails to perform his duty, he will be held liable.

Besides the legal importance, verification also plays an important role to guard against improper valuation of assets like stock-in-trade which may inflate or deflate the profit position of the concern. Improper valuation of assets may also conceal the actual position of the business as reflected in the Balance Sheet.

However, it is not possible on the part of the auditor to physically verify each and every asset because time may not permit him to do so, or he may not have sufficient technical knowledge of the assets concerned. It was decided in the case of “Kingston Cotton Mills: that it is not a part of an auditor’s duty to take stock. No one contends that it is. He must rely on other people for the details of the stock-in-trade.

Again, while going through the decision of Mc Kesson and Robins case in 1939, we find that the auditor should physically verify some of the assets. If possible, title documents like negotiable instruments, shares, debentures, securities, etc. are to be thoroughly examined on the last day of the accounting period. He should satisfy himself that the transactions, if any, having bearing on the Balance Sheet date and date of audit are bonfire and are supported with proper evidence. The auditor is also supposed to verify stock-in-trade with reference to the purchase book, the stock records, the gatekeeper’s book, etc. though law does not specially compel him to take stock-in-trade.

Meaning:

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.

Valuation of assets means not only checking value of the assets owned by an organization as on Balance Sheet date, but also critical examination of the value of these assets (comparative analysis of different assets).

The auditor has also to see that the principle of valuation of assets is consistently adopted and is based on established principles of accountancy. For the purpose of convenience, those assets are classified as under to determine their value.

Fixed Assets.

Current Assets or Floating Assets.

Wasting Assets.

Intangible Assets.

Fictitious Assets.

Fixed Assets: Fixed Assets are usually valued at going concern value’ which means cost less depreciation. Cost here means purchase price of the assets plus all incidental manufacturing, buying and installation expenses incurred to bring the assets in use. Depreciation is the provision made for the reduction in the value of the assets on account of their usage, natural wear and tear and obsolescence etc. The depreciation provided should be fair, otherwise the value of fixed assets may not be fair. What is a fixed asset depending on the nature of the business organization.

Current Assets or Floating Assets: These are usually converted into cash at the earliest opportunity in the process of business activity, e.g. stocks, bills receivables, sundry debtors, etc. Based on conservatism principle, usually current asset are valued at original value (cost price) or market value (realizable value) whichever is lower. Because they are intended to be converted into cash at the earliest possible time, hence what value we may realize is important. This method is adopted to strengthen the financial position of a concern by indirectly providing for expected loss by way of fall in the market value of the assets. This principle is held by the conservatism convention of accounting, i.e. do not expect profits but provide for anticipated losses.

Wasting Assets: Wasting Assets means those which lose their value gradually upon their use, e.g. a mine, a quarry etc. To value these assets firstly we should determine the usefulness of the assets in terms of units of production etc. and as per their actual use the value is to be reduced on proportionate basis. If in a particular period this type of asset is not used then the value may not diminish also. Thus, these assets are to be reduced on the basis of consumption. But sometimes it may be difficult to adopt this method, then the cost less depreciation’ principle may have to be applied.

Intangible Assets: Usually intangible assets like goodwill, patent rights, know how, etc. are valued on cost basis. But if the same are acquired by a non-cash transaction, then the fair market value is to be taken as the value of intangible assets. Auditor should also see the period of time and till it is fully written off, they are shown as assets because they do not have any realizable value. They are to be valued at actual cost less amount written off as depreciation upto Balance Sheet date.

Fictitious Assets: Certain lump sum expenses giving benefit for more than one year when incurred are written off over a period of time, and till it is fully written off, it is shown as an asset in the Balance Sheet e.g. preliminary expenses, discount on issue of shares etc. These are all fictitious assets because they do not have any realizable value. They are to be valued at actual cost less amount written off upto the Balance Sheet date.

Methods of Valuation

The following are the various principles of valuation of assets-

Cost Price (Going Concern Value): Under this method actual cost of assets are reduced by the depreciation provided. Usually this method is applied to value fixed assets.

Market Value: This refers to the market value of the asset i.e. the price at which the asset is being transacted in the market. This is applied to value the current assets only when this is lower than cost of the asset. Usually market value is adopted to value items having perishable nature.

Scrap Value: Assets which are useless for the enterprise may be sold as scrap in the market. The value for which such assets can be disposed of as scrap, is called as scrap value of assets.

Replacement Value: This represents the value at which the existing assets can be replaced. That means the price to be paid to acquire such type of assets in the market on the date of the balance Sheet.

Realizable Value: The value that can be obtained if the asset is sold in the market i.e. anticipated selling price. Usually, expenses such as commission, brokerage etc. are deducted from it.

Distinction between verification and valuation:

Meaning: verification establishes existence, ownership and acquisition of assets whereas valuation certifies correctness of the value of assets and liabilities.

Time: Verification is done at the end of the year whereas valuation is done during the year.

Personnel: Verification is done by auditor whereas valuation is done by the proprietor himself.

Evidence: The title deeds, receipts of payments constitute documentary evidence for verification where as certificate given by the proprietor is the documentary evidence for valuation.

VERIFICATION OF LIABILITIES verification of

Meaning: The liabilities imply an enquiry into the nature, extent and existence of liabilities.

It involves ensuring the following:

That all the liabilities have been clearly stated on the liability side of the Balance Sheet.

That all the liabilities relate to the business itself.

That they are correct and authorized.

That they are shown in the Balance sheet at their actual figures.

It is an important duty of an auditor to verify the liabilities appearing in the Balance Sheet of the company. The object of verification of liabilities is to ascertain whether there is any improper inflation or deflation of values or improper creation of an imaginary liability in the books. This form of manipulation is done in most cases to inflate or deflate the profits of the concern and thus make the position of the business appear stronger than what actually is, to create a secret reserve. As a result of such manipulation, the Profit and Loss Account and the Balance Sheet prove to be incorrect and thus the Balance Sheet does not exhibit a true and fair view of the state of affairs of the concern. So, the auditor must take all possible steps to ensure that all liabilities are recorded properly in the books of accounts of the business. It is advisable that the auditor should, besides verifying the liabilities as shown in the Balance Sheet, get a certificate from the management that all liabilities of any nature have been included in the books of accounts and the contingent liabilities have been shown by way of a foot-note to the Balance Sheet or have been provided for.

Key Takeaways:

1) Verification means proving the truth, or confirmation of the assets and liabilities appearing in the Balance Sheet.

2) Valuation of assets means determining the fair value of the assets shown in the Balance Sheet on the basis of generally accepted accounting principles.

3) The liabilities imply an enquiry into the nature, extent and existence of liabilities.

References:

‘Auditing and Assurance services’ by Alvin A. Arens and Randal J. Elder.

‘The Why and How of Auditing’ by Charles B. Hall.

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