Unit 2
Internal control
SA 400 issued by the Institute of Chartered Accountants of India (ICAI) deals with the study and evaluation of Internal Control in connection with an audit. It defines internal Control as “all the policies and procedures adopted by the management of a concern to ensure the orderly and efficient conduct of its business.”
OBJECTIVES
The objective of internal control i.e. accounting Controls and Operational Controls are as follows.
- Accounting controls
- All transactions are duly authorized, properly recorded and recorded promptly.
- The accounting policies adopted by the management in respect of stock valuation, depreciation etc. are implemented.
- The assets of the concern are safeguarded; the assets are not used or sold without proper authorization and are verified regularly.
- Errors and frauds are prevented and detected.
- The books of accounts are complete and accurate.
- The final accounts are reliable and ready in time.
2. Operational or Administrative Controls
Operational Controls aim to ensure that the management policies in respect of the operations and administration of the concern are implemented. This in turn ensures that the business is conducted in an orderly and efficient manner. Examples of operational controls are Quality Control, Budgetary Control, Internal Check, Internal Audit, Quantitative Controls etc.
AUDITORS DUTIES
SA 400 makes the following recommendations in this regard:
- Responsibility of Management
Basically, the management is responsible for establishing and operating the Internal Control system.
2. Auditor’s Duty
The auditor’s duty is to study system, check whether the system was actually in operation during the year and evaluate the system to ascertain how much he can rely upon it.
3. Need for Evaluation
An auditor needs to evaluate internal control system to achieve the objectives.
4. Steps in evaluation
a) Understand the System: In the first stage, the auditor should understand the system of Internal Control. He can understand the system with the help of manuals, discussions with managers or the technique of Flow Charts.
b) Test Application: He should check whether the controls were actually applied in practice. He can check some transactions in depth. Thus he can take up some sales transactions and check all the documents right from the sales order to the receipt from debtors.
c) Evaluate the system: He should judge, on the basis of above tests, whether he can rely on the system and if so to what extent.
5. Communicate Weakness to Management
a) The material weakness in internal controls should be communicated to the management by the auditor. Material weakness means the absence of adequate controls that increase the possibility of errors and frauds in the financial statements.
b) Such communication should be in writing
Key takeaways
Internal control is a process, effected by an entity's board of directors, management and other personnel, designed to provide reasonable assurance
Internal Check is a valuable part of internal control. It is an arrangement of duties of the staff is such a manner that the work performed by one individual is automatically checked by another person is a run time course.
Definition
According to Spiear and Peglar:
A system of internal check is an arrangement of staff duties, whereby no one person is allowed to carry through and to record every aspect of a transaction, so that without collusion between the two or more persons a fraud is prevented and at the same time the possibilities of errors are reduced to a minimum.
Objectives
- To allocate duties and responsibilities to every clerk in such a way that he may be held responsible for a particular error or fraud.
- To minimize the possibilities of errors, fraud or irregularities.
- To detect errors or fraud easily if it is committed, as in an efficient system of internal check, there is provision for independent checking.
- To enhance the efficiency of clerks in a business as the assignment of duties is based on the principle of division of labor.
- To distribute work in such a way that no business transaction is left from being recorded.
- To prepare the final accounts with ease and efficiency, as an efficient system of internal check can make accounts more regular and reliable.
- To exercise moral pressure over a staff.
Advantages
From the Owner’s Point of View
- Good system of Internal Check provides accurate, reliable and genuine accounting record and data to the owner of the business on which he can rely upon.
- Economy in operations and overall efficiency in system due to good Internal Check may result in more profits.
From the Auditors Point of View
- Due to efficient system of Internal Check, the statutory Auditor can avoid deep and detailed checking of transactions. He may rely on test checks, hence Internal Check provides convenience to Auditor.
- Since the Balance Sheet and the Profit and the Loss account is prepared without wasting of time, hence quick preparation of final accounts is possible.
For the Business
- Moral Check − Great check to commission of errors and frauds is possible with knowledge of subsequent checking of work of each employee by others.
- Detection of Errors and Frauds − This helps in early detection of errors and frauds because work of each clerk is checked by another automatically and no one is allowed to do complete work from the beginning to the end.
- Proper Division of Work − According to qualification, experience and area of specialization of work, proper and rational distribution of work among the members of staff is done.
- Increases Efficiency − A good internal control system provides increased efficiency of work coupled with overall economy.
Disadvantages
- Costly for small business: A system of internal check system quite expensive especially for small business houses.
- Quality is sacrificed for Promptness: In an internal check system quality of work declines because the clerks of the business attach greater importance to become quick and do not care if in the process their work gets sub-standardised.
- Carelessness among high officials: The possibility of some of the responsible and high officials being complacent increases as they believe, though not always rightly, that under a sound system of internal check nothing can go wrong.
- Disorder in the working of a business: In the absence of a proper organized system of internal check there will be chaos and disorder in the working of business.
- Risky for an auditor: If the auditor does not apply tests and procedure his own and if he relies on the output of the system his work cannot be free from irregularities if the system itself proves to be defective
Auditor’s duties
It is no part of an Auditor’s duty to prescribe the system of internal check for any business, but in case a system of internal check is in operation, he must check its efficiency and find out its weak points. In a large business concern it becomes difficult for an auditor to carry out a detailed checking.
He would prefer to have test checking but he can do this only when he is satisfied about the efficiency and reliability of the system of internal check in force in the business.
Thus, internal check largely determines the nature and extent of the scope of an auditor’s work. It determines to a great extent the examination of details which the auditor may consider necessary to undertake and the extent to which reliance can be placed upon test checking.
A good and effective system Of internal check may relieve him of a large part of detailed checking and he may give his attention to more important matters. Wherever the system is found to be unreliable because of its fundamental weaknesses, the auditor should take up the checking of the whole of the transactions of the business
An auditor must satisfy himself that the internal check is properly conceived and is being satisfactorily carried out before deciding to accept the checking that has already been done by the internal staff of the concern, as adequate, warranting curtailment of the area of checking that he should carry out.
If on examination of the system of internal check, the Auditor finds that there are certain weaknesses, and as a result of those, it would be necessary for him to extend the scope of detailed examination, he must point out this fact to his client so that internal check in that regard maybe strengthened in future.
Key takeaways –
The internal check is an arrangement of the duties of the staff members of the accounting functions in such a way that another automatically checks the work
Internal Check with regard to Cash:
The risk of misappropriation of cash needs no emphasis. The chances of fraud are numerous in cash transactions. For example, receipts may not be entered in the cash-book: records of cash received may be understated by preparing duplicate receipt for amounts less than the original. Cash sales may be treated as credit sales charging the amount to fictitious debtors, etc.
The following are the points that should be taken into consideration while devising a good and proper system of internal checks for cash transactions:
Cash sales
1. Sales at Counter / Counter Sales: The following procedure may be of great use in regard to cash sales:
a) A specific number, name or work may be allotted to every salesman.
b) Every salesman is supplied with a separate book containing blank copies of cash memo.
c) Cash memos should be printed in numerical sequence.
d) Cash memos are printed in different colours for salesman at different counters.
e) When the sales man sells goods to a customer he prepares four copies of the Cash Memo. These copies are checked by the senior clerk.
f) Three copies of the cash memo are handed over to the customer and the fourth is retained by the salesman.
g) The customer should hand over three copies of the cash memos to the cashier, who alters collecting the amounts and recording it in his cash register, returns two copies to the customer duly stamp marked “cash paid”.
h) So the cashier collects the amount and records it in his cash register.
i) The customer should present two copies of the cash memos at the counter where the goods purchased by him are to be delivered.
j) Here the customer will get the goods purchased by him are to be delivered to him.
k) The Clerk, at the delivery counter, checks the sales and delivers the goods to the customer and also keeps one copy of the cash memos.
l) In big business houses, the customer’s copy of the cash memo may be checked by the security staff before the customer is allowed to check out of the place.
m) At the end of the day, each counter salesman, cashier and the delivery counter clerk should prepare summaries of Cash Sales.
n) The cash sales summary prepared by the cashier should be verified with the cash sales summary of each salesman and the delivery counter clerk.
o) The differences if any should be immediately enquired into.
p) If the summaries tally, accounts are certified as correct. Then it is sent to the General Manager and another copy is sent to accounts department.
q) Daily cash receipts should be deposited into the bank on the same day.
r) Where cash recording machines are used, the total cash received as shown by the machine should be checked with the amount actually banked.
2. Sales by Travelling Salesmen: In big business houses, generally Travelling salesmen are employed to push sales and to collect debts. These Salesmen collect debts from old customers and accept advances for new ones. Ordinarily debtors will be asked to send the remittances by post and not to hand over the cash to any representative of the enterprise. But in exceptional circumstances travelling Salesmen may be permitted to collect cash from the debtors. For example, where it is necessary for enforcement of the terms of credit or where refusal by travelling salesman to collect cash from a debtor may be regarded as a bad policy. Whatever the case may be, a good system of check over these salesmen is vitally essential. So the following precautions must be taken:
a) Travelling salesmen should be issued with pre-numbered, rough receipt books.
b) Final receipt against receipt of cash by travelling salesman should be issued either from the branch or head office to which the salesman is attached.
c) Customers should be asked to contact the head office or branch office if the final receipt is not mailed to them within a stipulated period.
d) Travelling salesmen should be instructed to remit the entire cash collected by them to the head office or branch office to which they are attached, without making any deduction towards salary or commission payable to them.
e) Head office or branch office should regularly send the statement of accounts to keep them informed of the latest position as to their liability.
f) Special attention should be paid to customer’s accounts that have become overdue.
g) There should be surprise transfers of travelling Salesmen from one area to another. This will increase the efficiency of the agents and will also reduce the chances of fraud.
3. Postal Sales or Value Payable Post (V.P.P) sales: The following points should be
Noted in this regard.
a) There should be a separate register to record sales by post of VALUE PAYABLE POST.
b) When cash is received against V.P.P sales, it should be entered in the V.P.P register and then it should be posted to the cash book.
c) Separate bank pay-in-slips should be used to deposit cash received against post sales.
d) An offer should be deputed to check carefully this register an special attention should be given to those goods that have been returned and those against which payments has not been received .
e) Cash book and orders received should be checked and order received should bed properly filed too.
Internal Check with regard to Cash payments:
(i) Payments by A/c Payee cheques as far as practicable;
(ii) Safe custody of unused cheques;
(iii) ‘Pay Order’ authorisation;
(iv) Payment always by reference to appropriate documentary evidence;
(v) Signing of cheques by the authorised official only;
(vi) Payment for Rs. 2,500/- or more always by ‘A/c Payee’ cheques;
(vii) Use of revenue stamps for cash payments exceeding Rs. 500/-;
(viii) Cash payment of Salaries and wages in presence of a responsible official;
(ix) Preparation of vouchers for all payments;
(x) Continuous serial numbering of all cheque/cash vouchers;
(xi) Obtaining receipts for all payments;
(xii) No payments against I.O.U. And ‘on account’ without the sanction of an appropriate authority;
(xiii) Recording all payments in the cash book; and
(xiv) Preparation of bank reconciliation statement by a person who is not in-charge of writing the cash book.
Internal Check with regard to wages:
The system of internal check for wages should be devised in a careful and planned way, especially in manufacturing concerns, employing large number of workers, possibilities of frauds are always there. Thus efforts should be made to prevent such frauds with the help of some suitable arrangements of internal check which should be revised from time to time in the light of experience gained. System should be actively enforced and supervised by some responsible official. The Objectives are as follows:
a) To avoid inclusions of dummy workers in the list of workers.
b) To avoid incorrect time or piece work records.
c) To avoid fraudulent manipulation of wage-sheet and misappropriation of money etc.
d) To minimize such frauds, the following system of internal check for wages is suggested.
Maintenance of wage records
1. Time Records: Workers are paid their wages normally on the basis of time. Thus the time spent by each worker should be correctly recorded in the time record book and for this purpose the following methods are in practice.
a) The time recording clock: The time recording clock is placed at the gate under the charge of a timekeeper. As soon as worker enters the gate, the time keeper inserts his time into the clock which records the time. It is recorded when the worker leaves the factory.
b) Brass token: The workers are given brass token bearing their numbers. At the gate, a time board is maintained on which each worker hangs his token as soon as he enters in the factory. The time keeper is thus able to record the time of workers entering the factory. He should be vigilant enough to see that no workers hang the token of others who are late or absent.
c) Attendance cards/punching machine: Each worker is provided with a time card with his name, number, department and wages rate mentioned on it. He should punch card at the time of his arrival and departure. The punching or card must be supervised by the time-keeper. Foreman of each department should also be asked to keep the time records of his workers. The time keeper and foreman should separately prepare the time records and the name of absentees at the end of the day.
d) Computers: This method is the most popular method now especially with the multinationals. An identity card is issued to each worker and when the employee enters the factory and leaves the factory, he puts his identity card in the slot of the time recording machine. This machine is controlled by the computer. So the computer records the time the employee spends in the office. Another advantage of this method is that only with a proper identity card, the employee can enter the office. That is only if the identity card is the authorized one, then only the door will open for the employee.
3. Piece-work records: Where the workers are paid on the basis of the wages system, proper hooks for actual work done by workers should may be maintained. Each worker should be provided with a job card or piece work return form bearing his name, hob number, nature of worker should be recorded on this card which should be countersigned by the foreman of the department. Store-keeper to whom the goods manufactured are handed over, should sign this card. It should be finally checked by piece work reviewer along with quality of goods.
4. Overtime records: Ordinarily overtime work should not be encouraged. No worker should be allowed to work overtime unless he is authorized to do so by the authorized official of the organization. Strict check must be kept on loiterers at the place of work. Overtime slips should be sanctioned in advance. Such slips should bear the name and number of worker, overtime put in the job or the department in which he is engaged. At the weekend such slips should be sent to the department in and the job or the department in which he is engaged. At the weekend such slips should be sent to the time-keeper who will forward them to the wage office.
5. Pass-out records: The workers should not be allowed to leave the factory before the scheduled time. But if sometimes, a worker wants to go out of the factory on his personal work during working hours he should not be allowed to go out of the factory premises without obtaining permission from authorized official who should issue passout slips. Such slips are handed over to gatekeeper wage office should also be given copy of such slips. In case a worker leaves the factory before time on his own account, it should be properly accounted.
6. Preparation of wage sheets: The preparation of wage sheets should be done by a separate department. This work should be done by five clerks to minimize the irregularities. Information regarding attendance can be had from the attendance register, job cards, piece work register, overtime slips, pass out slips etc,. For time workers and piece rage workers, separate wage sheet should be used. In big factories loose wage sheet should be used so that the work may be distributed amongst various clerks easily. All the essential particulars should be entered in the wage slips which should have columns for:
a) Name
b) Number/code number allotted to him and his address
c) Total time worked
d) Details of word
e) Rate
f) Total amount of wages
g) Bonus
h) Overtime, if any
i) Deductions
j) Net amount payable
The whole work is to be divided in various parts to be done by separate clerks in the wage department.
i. Two clerks should examine the time and piece wage records, over time records and other statements received from the foreman.
Ii. The third clerk is to prepare individual employee statement i.e., name of the worker, code number allotted to him and his address, total time worked and rate of wages.
Iii. The fourth clerk is to check the calculations and deduct the permissible amount i.e. rent, provident fund, income tax, installment of loans and other permissible deductions under the PAYMENT OF WAGES ACT, 1936. From the gross wages to arrive at the net amount to be paid to the workers.
Iv. The fifth clerk is to check the whole work thoroughly.
v. All these clerks should initial the wage slips before these are signed by some responsible officer, such as director or works manager.
Internal Check with regard to sales and purchase:
1. Cash Sales:
(a) Sales at the counter:
(i) Preparation of cash memo in triplicate by Salesmen, the original and duplicate copies being handed over to the customer and the triplicate retained in the book;
(ii) Payment of cash by the customer along with cash memo (2 copies) to the cashier;
(iii) Marking cash memos as ‘Paid’ by rubber stamp by the cashier who should hand over them to the customer and record the amount as a receipt in Cash Register Machine;
(iv) Verifying the total cash sales for the day as per cash register statement with the cash memos retained by the salesmen and the gatekeeper.
This system is followed in a big departmental retail stores:
(b) Sales by travelling Salesmen/Agents:
For ‘direct sales’ promotion and collection by them, the-system should be:
(i) Authorising them to issue money receipt;
(ii) Specifically instructing them to deposit the entire cash collection daily to the cashier or to company’s bank account;
(iii) Asking them to submit daily report of sales and collection for bank deposits;
(iv) Strictly advising them neither to keep any collection with them nor to allow any collection to remain outstanding.
(c) Sales through post:
For this, the system should be:
(i) Maintenance of separate registers for VPP sales, postal sales, and sales returns for non-acceptance by customers;
(ii) Recording in respect of goods dispatched/received from stores/ returned to stores, cash received against sales, expenses on postage for dispatches, etc.;
(iii) The person dispatching goods should not receive cash;
(iv) Accounting of cash in the Cash Book and deposit thereof in the bank;
(v) Accounting and adjustment of advances to avoid double dispatches.
(d) General Checks:
(i) Verification and accounting of outstation cheques by reference to the sales bills;
(ii) Verification of cash or cheque receipts with the Order Receipt Book to find out un-realised amounts, if any; and
(iii) Preparation of Bank Reconciliation Statement by the cashier to confirm bank balance.
2. Credit Sales:
(i) Separation of sales department from the dispatch department;
(ii) Functional sub-divisions, e.g., receiving orders, accounting of goods supplied, invoice preparation, etc. within the dept.;
(iii) Recording of all customers’ orders serially in the book;
(iv) Endorsement of customers’ orders to the dispatch dept.;
(v) Authorisation by a competent official as regards terms of sale, discount allowed, bad debts write-offs;
(vi) Verification of invoices against orders executed with the orders received prior to dispatch;
(vii) Preparation of invoices in triplicate and matching the third copy with the duplicate received from the customer duly signed for the goods received;
(viii) Daily verification of the Goods Outward Book (containing entries for goods supplied to customers) with the Order Book and the Invoice Book;
(ix) Maintenance and checking of the Sales register written up from invoice copies; and
(x) Periodical follow-up measures on the collection of customers’ accounts.
3. Cash Purchases:
(i) Preparation of purchase orders based on the purchase requisitions duly authorised by a competent official;
(ii) Deciding the terms of purchase based on the comparative tenders and quotations;
(iii) Verification of purchased materials as to quantity and quality by a dept. Independent of purchase and stores dept.;
(iv) Verification and accounting of purchase invoices with the purchase order, goods receipts and the prevailing market prices to prevent/detect manipulation or fraud;
(v) Authorisation of payment against invoices by a responsible official; and
(vi) Recording of all details in the purchases register.
4. Credit Purchases:
In addition to the internal checks outlined at:
(3) Above, the system should include
(i) Separation of records between cash purchases and credit purchases;
(ii) Functional separation of the main items of work, e.g., purchase ordering, tender committee, tenders and quotations, contracts, acceptance of purchases, etc.;
(iii) Record of approved suppliers;
(iv) Pre-numbered purchase orders and their distribution to the concerned depts.;
(v) Pre- numbered goods receipt notes and their distribution;
(vi) Recording of advances paid and adjustments before final payment; and
(vii) Checking of credit terms and discount receivable.
As regards Purchases Returns (Returns Outward), the system should be:
(i) Maintenance of Purchase Returns Book for goods returned to suppliers on account of rejections;
(ii) Preparation of Goods Returned Notes and their distribution to Stores and Accounts dept. And to Suppliers;
(iii) Obtaining Suppliers’ credit notes for accounting adjustments and entries in purchase returns book;
(iv) Matching Invoices (not paid-off) and the credit notes, or filing credit notes with the current invoices awaiting payment.
Meaning and Definition
Vouching is concerned with examining documentary evidence to ascertain the authenticity of entries in the books of accounts. In other words it is an inspection by the auditor of evidence supporting the transactions made in the books. Vouching is a technique used by an auditor to judge the truth of entries appearing in the books of accounts. Some important definitions of vouching are:
“Vouching means testing the truth of items appearing in the books of original
Entry.” – J.R. Batliboi
“Vouching is an act of comparing entries in the books of accounts with
Documentary evidence in support thereof.” - Dicksee
From the above definitions we can conclude that vouching is a technique in which an auditor verifies authenticity and authority of transactions recorded in the books and on the basis of which he submits a report, indicating that accounts are correct, free from errors or fraud and complete.
Objectives of Vouching:
1. All the transactions which are connected with the business have been recorded in the books
Of accounts properly.
2. To verify that all transactions recorded in the books of accounts are supported by documentary evidence.
3. The vouchers which support the entries are legally valid from the view point that they are authentic, addressed to the business and properly dated.
4. To verify that no fraud or error has been committed while recording the transaction in books of accounts.
5. The vouchers have been processed carefully through various stages of internal check system.
6. While recording the transaction whether distinction has been made between capital and revenue items.
7. Whether accuracy has been observed while totaling, carrying forward and recording an amount in the account.
Importance
1. Vouching Is The Backbone Of Auditing
Main aim of auditing is to detect errors and frauds for proving the true and fairness of results presented by income statement and balance sheet. Vouching is only the way of detecting all sorts of errors and planned frauds. So, it is the backbone of auditing.
2. Vouching Is The Essence Of Auditing
Auditing not only checks the accuracy of books of accounts but also checks whether the transactions are related to business or not. All the transactions are performed after the prior approval of concerned authority or not, transactions are real or not because an accountant may include fictitious transactions to commit frauds. All these facts can be found with the help of vouching. So, vouching is essential for auditing.
3. Vouching Is Important To See Whether Evidences Are Correct Or Not
An auditor checks the books of accounts to detect errors and frauds. Frauds may be committed presenting duplicate vouchers. All the small and big amounts of frauds can be detected with the help of vouching. So, all the evidential documents and records are to be checked carefully and in detail by an auditor which is the scope of vouching.
Key takeaways –
Vouching is concerned with examining documentary evidence to ascertain the authenticity of entries in the books of accounts.
Vouching of cash Transactions:
How to vouch various cash receipts (Receipt side)
- Cash sales: In vouching cash sales, cash register should be fully checked with carbon copies of cash memos. Then, the auditor should verify the daily deposits of cash received in the bank dates of the cash and the date on which the receipts are recorded in cash book must be same. Where the cash memos are cancelled, all copies including the original copy duly cancelled should be kept in the book. Where a company has a discount policy, if more discount is allowed in a transaction it must be approved by a responsible officer.
2. Cash received from the debtors: The auditor should verify amount received from debtors from the counterfoils or carbon copies of the receipt issued to the customers. All these receipts should be serially numbered. Amount should be entered in the cash book on the day when received. Discount allowed to customers should be authorized by a responsible officer. Sometimes correspondence made with customer can also be verified.
3. Loans: While vouching the loans received, the terms and the conditions contained in the agreement should be verified. If the loan is secured what security has been offered, whether the fact has been disclosed in the balance sheet.
4. Bills receivable: Bills receivable book maybe verified because the various details regarding the bills matured and discounted are available in it. Auditor should check the amount received with the bank statement. Some bills might have become due but no amount has been received. Whether the entry for the dishonor of such bill has been made. A verification of the bills discounted should be made. Whether, entry for discount has been made. Such bills should appear as contingent liability in the balance sheet; if the date of maturity is after the date of balance sheet.
5. Sale of Investment: If the sales have been affected through a bank, the auditor should examine the bank advice to know the various details. Sometimes the investment is sold through the broker. Broker’s sold note or commission should be examined to verify the sale proceeds and commission charged by the broker. If the investments are sold at cum-dividend price, auditor should see that proper apportionment has been made between capital receipts and revenue receipts. Sometimes the investments are made against specified funds. Profit or loss on sale of such investments must be transferred to such funds account.
6. Sale of Fixed Assets: Sale of fixed assets may be vouched with minute book of board of directors, correspondence, agents’ sale account and sale contract. It should be seen that proper account has been credited. Any profit arising on the sale of asset shall be credited to revenue account which is not available for distribution of dividends. If any expense on the sale of assets is paid, the sale proceeds of the asset should be reduced by such amount and the balance should be credited to asset account. It must be seen that sale of fixed assets has been sanctioned by the authorized person or committee.
Vouching of cash payments (payment side):
- Cash Purchases: good purchased are actually received by store keeper. Cash memos can be compared with goods inward book to verify the goods received. Only the net amount (after trade discount) should be entered in the books.
- Payment to creditors: Should be examined with the receipts issued by the creditors. The receipts should indicate the purpose for which the payment has been made. If the payment is made in full and final settlement of account, the balance should be accounted for as discount received. Where the payment is made in excess of the bill, either the excess payment is in advance or the payment is made by mistake, which should be recovered back from the creditor.
- Bills payable: Bills payable honored on the date of maturity and is returned by the payee after receiving the payment. These bills should be cancelled after being paid. Bills payable paid can be vouched with bills book. If the payment is made by the bank, bank statement or pass book can be examined to verify the payment of bill
- Wages: wages paid and calculated for various months should be compared. If the wages of particular month differ from the preceding month, the auditor should look into the reasons for difference. Random checking of wages calculations should be made. The auditor should see the proper record is maintained for unpaid wages, deductions for any advance taken by the worker should also be verified, and deductions made from the wages should also be entered in the proper account. Special attention should be given to the payments made to casual workers.
- Payment Of Salaries: in vouching the payment of salaries following points are important a. Auditor should check salary register with the entries made in the cash book b. He should examine carefully alterations in the amount of deductions on account of fines, funds, loans, insurance etc.
- Purchase of Investment: the auditor should compare the investment purchased with Broker’s Bought Note. If the possible, physical verification of investments should be made. Investments must be in the name of the company. Where the investments are purchased at cum-interested price, interest included in the purchase price should be debited in the interest account and the balance in investment account. Later on when the interest is received on the investment, it should be credited in the interest account.
- Rent paid: the auditor should verify the payment of rent from the agreement. The ret voucher should be supported by rent receipt from the landlord. It should be seen that payment of rent is sanctioned by responsible officer.
- Loans: Auditor should be that the loan voucher should be supported by the receipt given by the party. Further details regarding terms and condition of the loan can be verified from the loan agreement. It should be seen that installment of loan along with interest are received in time. Mortgage Deeds and other documents should also be examined.
- Interest on Loan: Auditor should verify that rate of interest on loan does not differ from the terms and conditions of loan agreement. Debenture interest can be verified from debenture interest book. All the payments of interest must be supported by vouchers and receipts.
Vouching of Trading Transactions
Vouching of purchase book:
The main aim vouching of purchases book is to see that all purchase invoices are entered in purchases book and the goods entered in the purchases book are entered are actually received by the business.
While vouching credit purchases the auditor should examine and see the following points.
i. There should be proper record for all purchase orders. A duplicate copy of the order is kept in office for record.
Ii. A copy of purchase order shall be send to the Accounts Department.
Iii. All goods received should be recorded on goods received note; a copy of it should be sent to Accounts Department.
1. The auditor should see that only credit purchases of the goods are recorded in
Purchase book.
2. The purchases book can be verified from purchase invoices, copies of orders placed, goods received note, goods inward book, copies of challans from suppliers.
3. The quantity mentioned in the invoice must be same as is shown in the purchase order.
4. The price charged by the supplier must be as per quotation/pricelist of the
Supplier.
5. The supplier bill must be in the name of business and for the period under audit.
6. While vouching the purchase vouchers, each voucher should be stamped or
Initialed after examination, so that it could not be produced again.
7. Any purchase, made not for the purpose of business of the client, must not be
Debited to purchase account.
8. Duplicate invoices must not be entered in the purchase book if original invoices have already been recorded.
9. The auditor should be more careful while vouching the purchase made in the first and last month of the accounting period, because sometimes the purchase of last year may be included in the purchases of first month of current year or purchases of the last month of current year may be recorded in the next.
Vouching of Purchase Returns
While vouching the purchase returns the following points should be taken into consideration by the auditor.
1. He should see that a Debit note has been sent to the supplier or Credit note has
Been received from the supplier.
2. The quantity returned as per the return note must correspond with storekeeper’s record, return outward register and gatekeeper’s outward register.
3. The amount showed in the credit note should be verified.
4. He should be careful about the recordings of purchases return in the current year.
Sometimes the profits of current year may be manipulated by recording current
Year’s purchases return in the subsequent year.
5. The purchases return of the first month and last month of the Accounting year
Should be vouched carefully, to detect any manipulation of amounts.
Vouching of Credit Sales
1. The sales register should be examined with copies of sales invoices. The sale of
Capital items should not be recorded in the sales book, otherwise the profits will be inflated.
2. Test check should be applied on the calculations made in sale invoices.
3. The totaling and the castings of sales book should be verified.
4. Sales Tax, duties collected thorough sales invoices must be recorded under separate accounts.
5. It should be verified that all sales invoices are prepared on the basis of challans and then sales invoices are entered in sales book and from there, posted to their respected accounts.
6. Sales made in the current year must be recorded under that year and shall not be treated as sales of subsequent year.
7. All cancelled sales invoices must be kept together for verification by auditor, Who should see that cancelled invoices are properly treated in the books.
8. The statement of accounts should be verified by getting confirmations from the customers.
Vouching of Sales Return
The Auditor should pay special attention to the following while vouching the sales return
1. Date on which the goods are actually retuned.
2. Credit note or Debit note of sales return.
3. Gatekeeper’s receipt book.
4. Return inward register.
5. Stores records.
6. Corresponding entry for the return of goods in customer’s account.
7. Goods returned should form the part of closing stock at cost price or market price whichever is less.
Vouching of Goods sent on consignment basis
The goods sent on consignment basis by principal to his agent should not be considered as sale. Only when the goods are sold by the consignee, the entry for sale should be made in the books. The goods sent on consignment still lying with the consignee should be taken into closing stock. A separate
Book should be maintained to show the record of goods sent on consignment basis. At the end of the year an account sale is received by the consignee, indicating the goods sold by him and balance of closing stock of goods sen on consignment basis. The auditor should verify the goods sent on the consignment basis from proforma invoices, goods outward register correspondence with consignee and account sales.
Verification is the process of substantiation involved in proving that a statement account or item is accurate and stated properly. It is an enquiry into the value, ownership & title, existence and possession, and presence of any charge on the assets as stated in the balance sheet.
Objects of Verification –
- Picture of true position.
- Correct valuation.
- Not exceeding the actual.
- Not less than actual.
- Existence and possession.
- Ownership and title.
- Without fraud or irregularity.
- Arithmetical correctness.
- Correct presentation in the balance sheet.
Position of Auditor as regards valuation of assets –
An auditor is not a valuer or a technical expert. So he has to rely upon the valuation made by directors, partners, technical experts, surveyors, etc. However he must ensure that the valuation is fair and reasonable and based upon some accepted principles.
Verification of fixed assets -
(i) Goodwill -
(a) Existence : Whether purchased or acquired. Self generated goodwill is not said to be in existence.
(b) Records : Check the fixed asset register.
(c) Right of Ownership : Check purchase agreement, purchase consideration and MOU between the parties.
(d) Valuation and proper amortization as per AS-14, i.e. 5 years.
(e) Proper presentation and disclosure.
(ii) Freehold Properly: Which is in the name and title of owner.
(f) Ownership: Check the sale deed.
(g) Mortgage: Check the mortgage deed.
(h) Change in asset due to sale, purchase or construction work should be enquired and duly recorded.
(i) Revenue expenses regarding repairs and maintenance should be written off in P & L Account.
(j) The auditor must enquire into the existence, valuation and presentation in balance sheet.
(iii) Leasehold Property : It has two owners and both have qualified rights over it. The following points to be considered :
(k) Ownership : Lease deed should be examined.
(l) Mortgage : Relevant deed should be perused.
(m) Revenue expenses : To be charged to P & L.
(n) Existence, valuation and presentation B/S to be checked.
Iv) Plant & Machinery :
(a) Existence : Physical verification to be conducted, additions and deductions to be checked.
(b) Records : Check the fixed asset register.
(c) Ownership : Invoice receipt and purchase order to be checked.
(d) Revenue and capital expenditure should be properly accounted for.
(e) Proper presentation and disclosure under the schedule of fixed assets.
(v) Furniture, fixture and fittings:
The auditor has to verify the existence, records, changes, ownership, valuation, presentation and disclosure in the balance sheet, along with depreciation.
(vi) Motor Vehicles:
The auditor has to verify the existence, fixed asset register, log books, invoices, registration book, incidental charges like insurance and road tax, depreciation, licenses etc.
(vii) Copyrights, patents, trademarks, loose tools
Check the existence ownership, valuation, presentation in balance sheet, respective registers, write off etc.
(viii) Investments:
b) Ownership: name of client, pledge or lien of investments, Classification: trade or non trade, long term, short term, stock in trade.
c) Physical verification: obtain relevant certificates, etc.
d) Changes: broker’s purchase note or sale note should be checked.
e) Valuation and disclosure :Current investments should be valued at lower of cost or fair market value. Long term investments should be valued at historical cost of acquisition.
(ix)Inventory:
f) Classification of inventory : Stores and spare parts, loose tools, raw materials, material in process, finished goods, waste or by products.
g) Existence and records in the stock register to be verified.
h) Right of ownership : Invoices, documentary evidence to be checked.
i) Valuation : According to AS-2, valuation is done on cost or NRV whichever is lower. Method is FIFO or weighted average and method is not changed, unless required.
j) Presentation and disclosure in Balance Sheet.
(x)Debtors, Loans and Advances:
k) List of debtors to be obtained.
l) Correspondence with debtors.
m) Inquiry into discount and bad debts, provision for bad debts.
n) Securities.
o) Presentation and disclosure in Balance Sheet.
p) Classification of debtors according to age, security and reliability, bad and doubtful.
Loans and Advances.:
q) Names & Amounts involved.
r) Terms and Conditions of loan.
s) Regularity of repayment.
t) Steps for recovery/repayment of overdues.
Verification of Liabilities
Steps for verification
- Examination of records.
- Direct confirmation procedure.
- Examination of disclosure.
- Analytical review procedure.
- Obtaining Management Representations.
The nature, timing and extent of substantive procedures to be performed is a matter of professional judgement of the auditor which is based on the auditor’s evaluation of the effectiveness of the related internal controls.
Key takeaways –
- Verification means to validate the resemblance of facts regarding the assets and liabilities, with those appearing in the Balance Sheet.
- Vouching is done on the basis of documentary evidence i.e. vouchers, invoices, bills or statements.
References:
1. Attowood, Frank A. & Stein, Neil D.: Depaul’s Auditing
2. Choudhari, Roy A.B.: Modern Internal Auditing
3. Chatlia, S.V.: Spicer and Pegler’s Practical Auditing
4. Dinkar, Pagare: Principles and Practices of Auditing
5. Gupta, Kamal: Contemporary Auditing
