UNIT 3
Auditing Standards
All the government and non-government organizations have to keep track of their accounts and audit reports as the financial year approaches. The financial statements of these firms need to be thoroughly analyzed and assessed before submitting them to the authorized departments. This assessment of financial documents is done by an Auditor. In case of any discrepancy in the reports, the auditor is held responsible. Thus, the requirement of an auditor is a must for every organization.
Appointment of Auditor
Within 30 Days:
Every company must appoint its first auditor or an auditing firm within 30 days of registration of the company during the annual general meeting or within 90 days, in an Emergency General Body Meeting by the Board of Directors. The first auditor (or the auditing firm) appointed will hold office from the conclusion of the meeting (in which the appointment of auditor has been made) to the time when the sixth annual general meeting is held (five years). Therein, the auditor appointments are reviewed every sixth year.
Written Consent:
A written consent from the auditor, with sufficient proof to suggest that the person (or firm) qualifies the criteria provided in Section 141 of the Act, needs to be submitted before an appointment.
Appointment Notice:
The company should issue an appointment notice to the auditor, and a Form, ADT- 1 is required to be submitted with the registrar within 15 days of the meeting in which the auditor is appointed.
Section 139:
The companies listed in Section 139 (belonging to the class or classes of companies as mentioned in the section) and Rule 5 of the companies (audit and auditor) rules, 2014, will not:
1. Appoint an individual as auditor for more than one consecutive five-year tenure;
2. Appoint an auditing firm for more than two terms of five consecutive years
Provided, the auditor who has finished his term will not be eligible for reappointment in the same company or the auditing firm who has completed a two-year tenure is not eligible for appointment in the same company for five years.
A three-year transition period is given to comply with this requirement. Although, according to the rules, the five years is calculated with the retrospective effect.
Sections 139 to 148 of the Companies Act, 2013 give a complete and detailed summary of the role of an auditor as well as the other requirements, such as their appointments or removal from the company payroll.
Rights and Powers of auditors
According to Section 227(7) of the Companies Act, a company auditor has the following rights:
1. Right of Access Books of Accounts: As per Section 227(1) of the Companies Act every auditor of the company has the right to access at all times to the books of accounts and vouchers of the company, whether kept at the head office of the company or elsewhere. Under section 209(1) (d), a company auditor has the right to examine the cost records also which are required to be maintained by certain companies relating to production sales, stores etc.
2. Right to Obtain Information and Explanations: An auditor can call for any information or explanation from different officers of the company which he may think necessary for the performance of his duties.
Apart from the auditor’s right to obtain information and explanation it is the duty of every officer of the company to furnish without delay the information to the company auditor. If the directors or officers of the company refuse to supply some information on the ground that in their opinion it is not necessary to furnish it, then the auditor has the right to mention that in his audit report.
3. Right to Receive Notices and Other Communication Relating to General Meetings and to attend them: According to section 231, of the companies act an auditor of a company has the right to receive notices and other communications relating to the general meetings in the same way as that of the members of the company.
Similarly an auditor also has the right to attend any annual general meeting and also to be heard at those meetings which he attends and which concerns him as an auditor.
The auditor also has the right to make a statement or explanation with regard to the accounts he has audited. But he auditor is not expected to answer questions in the general meeting.
4. Right to Visit Branches: According to section 228 of the companies act the auditor of the company has the right to visit the branch office or offices of the company.
He can also audit such accounts of eh offices of the company provided that there is not qualified auditor to audit the accounts of the branch office or offices of the company, in such cases, the auditor has the right to access at all times to the books of accounts and vouchers that the company maintains at branch office or offices.
Moreover section 226 of the companies act provides that in case of the company gets the branch accounts audited by some of the local auditors, even the auditor has access at all times, to the books, accounts an vouchers of the company and he can also visit the branches, if he feels necessary.
5. Right to Correct Any Wrong Statement: The company auditor is required to make a report to the members of the company on the accounts examined by him of the final accounts and the related documents which are laid down before the company in the general meeting.
6. Right to sign the Audit Report: As per section 229 of the companies act only the person appointed as auditor of the company or where a firm is so appointed, only a partner in the firm practicing in India, may sign the audit report or authenticate any other document of the company required by law to be signed.
7. Right to Being Indemnified: Under Section 633 of the Companies Act, an auditor is considered to be an officer of the company and he has the right to be indemnified out of the assets of the company against any liability incurred by him in defending himself against any civil and criminal proceedings by the company if it is proved that the auditor has acted honestly or the judgment is delivered in his favour.
8. Right to seek Legal and Technical Advice: The company auditor has the full right to seek the opinion of the experts and to take their legal and technical advice so as to discharge his duties efficiently.
9. Right to Receive Remuneration: As per Section 224(8) of the Companies Act, the company auditor has the right to receive remuneration provided he has completed the work which he has undertaken to do so.
Duties and Liabilities of a Company Auditor (Section 227):
Duties towards the shareholders:
1. Report shareholders about true and fair state of affairs of the company
2. State that balance sheet and profit and loss a/c give all information required by law.
3. State that balance sheet and profit and loss a/c agree with the books of account.
4. State that balance sheet and profit and loss a/c agree with accounting standards.
5. State that he has obtained all the necessary information.
6. State whether the company has maintained all books as required by law;
7. State the reasons of qualification in his report.
8. State that he has received the audit report on the branch accounts audited by other auditor and how he has dealt with the same in preparing his report.
9. Auditor shall state in his report whether:
a) The loans taken are properly secured and the terms of loans are not against the interests of the company.
b) Loans given are shown as fixed deposits and the terms of loans are not against the interests of the company.
10. Transactions recorded as book entry are not against the interests of the company.
11. Personal expenses of directors have not been charged to revenue a/c of company;
12. The company fulfills the requirements of CARO 2003.
Duties towards Company:
1. Prospectus: According to Sec 56, the auditor is required to certify profits or losses, assets & Liabilities and dividend paid etc in the prospectus.
2. Statutory Report: Section 165 requires that the auditor has to certify the statutory report.
3. Public Deposits: Section 58AA requires the auditor to report about whether the company has followed all rules and guideline of RBI in regard to public deposits or not.
4. Signature on Audit Report: Section 229: It is duty of auditor to sign on his report.
5. Insolvency (Section 488): If the company wants itself to be declared insolvent, it is duty of auditor to prepare profit and loss a/c for the current period.
Duties towards Government:
1. CARO-2003: The auditor has to report para-wise that the company has fulfilled all the requirements of CARO-2003.
2. Assist the Investigation u/s 237: It is duty of auditor to assist the investigation ordered by the CG u/s 237.
Duties towards General Public:
1. His office is of confidence and faith. He must be reliable in all respects.
2. He should reveal all material information regarding the state of affairs of the company to the company as well as to the general public.
3. While issuing prospectus u/s 56, he should see that the prospectus does not include any misleading information or material.
Key takeaways –
The auditor has a right to access, at all times the books of accounts & vouchers of the company, whether kept at head office or elsewhere. It is an absolute right & is not subject to any restriction, exception or qualification.
Company Audit
A company is said to be an artificial person created by law having a separate legal entity distinct from its members. It cannot be directly managed by its owners because they are very large in number have small holding and also scattered over a wide area. As such the management and control of the affairs of the company is done by directors but an absolute faith put in directors is not considered to be desirable on social and moral grounds. Hence, it becomes essential for a company to appoint an independent and qualified person i.e. an auditor, to verify and certify the truth and fairness of the financial statements.
Further, the companies usually work with a large staff and auditing serves a very useful purpose of locating all errors and irregularities in their work.
In order to achieve the above objectives, The Indian Companies Act 1956 has made it a statutory obligations for joint staff companies, whether public or private, to get their accounts audited by qualified auditor.
Statutory requirements governing the Company Auditors
Before commencing the audit work of company, the auditor should go through the following
2. Inspection of Statutory Books and Documents: Before the auditor commences the work of audit, he should examine the following documents
a. Memorandum of Association.
b. Articles of Association.
c. Prospectus.
d. Certificate of in cooperation and certificate to commence business He should also examine the following statutory books and registers-
a. Register of Members. (Sec 88)
b. Index of Members. (Sec 88)
c. Register and Index of Debenture holders. (Sec 88)
d. Register to Mortgages and charges (Sec 85)
e. Register of Investment [sec 187(3)]
f. Foreign Register ( Sec 88)
g. Register of Contracts (Sec 188, 184 and 189)
h. Register of Directors, managing Director , Manager and Secretary (170)
i. Register of Director’s Shareholdings (170)
j. Register of Deposits (73)
k. Register of Loans (Sec [186(9)]
l. Minute books (118)
3. Inspection of Contracts: The auditor should inspect and examine the contracts which have been entered into by a company with other e.g.
a. Contracts with the vendors of any property.
b. Contracts with brokers and under writers for their commission.
c. Contract with the promoters for the preliminary expenses, etc.
If any statement regarding these contracts has been made by the company in the prospectus, the auditor should see that such statement is correct and that entries relating to such contracts are correctly recorded in the books of account.
4. Study of Previous year’s balance Sheet and Auditor’s report: The auditor should inspect the previous year’s balance sheet to verify the opening balances of the current year. Moreover, according to Companies Act, the corresponding figures of the previous year have to be given in the balance sheet.
The last audit report is inspected by the auditor mainly for two purposes.
a. To formulate a rough idea about the company and its working.
b. To see whether the recommendations made there in have been carried out or not.
5. Study of the Internal Control System in Operation: The study and evaluation of the internal control system in operation is important it serves as a basis there on. It helps the auditor in determining the extent of the tests to which auditing procedures can be restricted.
Audit Report /Auditor’s Report
An auditor’s Report is the format of result of all the effort that goes into the audit. Communicating the Auditor’s findings to interested users is part of all audits. Thus, the Final phase of an Audit involves preparing that communication, which is known as auditor’s report.
According to Lancaster, “Audit report is statement of collected and considered facts, so drawn up as to give clear and concise information to persons who are not already in possession of full facts of subject matter of the report.”
Contents of Audit Report
Under section 227 (2) every auditor is required to make report to the shareholders on the accountants examined by him and every balance sheet and profit and loss A/c and every document declared by law to be part of or annexed to the balance sheet and profit or loss A/C which are placed before the shareholders of the company at the general meeting during tenure of his office. The report has to state whether, in his opinion and to the best of his information and according to the explanations given to him, the said accountants give the information required by the Companies Act in manner so required and give a true and fair view.
i. In the case of the balance sheet, of the state of the company’s affairs as at the end of its financial year; and
ii. In the case of profit and loss account, of the profit or loss account for its financial year.
Sub-section (iii) of the section 227 required that the auditor’s report shall also state.
a. Whether he has obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit;
b. Whether in his opinion, proper books of account as required by law have been kept by the company so far as appears from hiss examination of these books, and proper returns adequate for the purposes of his audits have been received from the branches not visited by him .
c. Whether the report on the accounts of any branch office audited under section 228 by a person other than the company’s auditor has been forwarded to him and how he has dealt with the same in preparing the auditor’s report.
d. Whether the company’s balance sheet and profit and loss A/C dealt with by the report are in agreement with the books of accounts and returns.
If any of the matters as referred to in section 227 (2) and (3) is answered in the negative or with the qualification the auditor has to state in his report the reasons for such answer.
The Auditor’s report shall also include a statement on such additional matters as specified by the Central Government under section 227 (4-A) of the Companies Act, This section empowers the Central Government to order the inclusion of certain matters in the auditor’s report.
The Institute of Chartered Accountants of India requires the auditor’s to ensure that the accounting standards are implemented in the presentation of financial statements covered by their audit reports. The deviation should be reported in the report.
Key Takeaways-
A company is said to be an artificial person created by law having a separate legal entity distinct from its members.
Special Audit of a Bank
Auditor will begin his work by carrying out a thorough verification of the assets and liabilities of the banking company. Points to which he must pay his special attention in the performance of this work with regard to each individual asset and liability are discussed below:
1- Cash in hand / with other banks – Auditor will attend on the last date of the period under audit and will verify cash in hand or bullion by actual counting or weighing. He will compare and tally the balance with the Cash Book, the Day Book. Balances with the State Bank or other banks shall be verified.
2- Investments – Auditor shall obtain a list of the investments of the bank. He shall verify these investments at the close of the year by carrying out an actual inspection of the scripts or other documentary evidence available with the bank. He must take utmost care to see that the same investments are not shown to him twice.
3- Advances, Overdrafts, Loans and Cash Credits – Auditor shall obtain a schedule of all loans, advances, cash credits and overdrafts etc from the bank and will then proceed to verify them with the balances of respective leaders. The totals will be compared and checked up with the respective total accounts maintained in the general ledger.
The responsibilities of the auditor with regard to the verification of loans and advances etc are very heavy. He will have to pay special attention with regard to the different kinds of advances such as:
a) Advances against government securities;
b) Advances against stock in trade;
c) Advances against properties;
d) Advances against Life policies;
e) Advances against fixed deposits;
f) Advances against bullion.
4- Bills Discounted and Purchased – Auditor will verify bills discounted and purchased as recorded in the books with those which are in the actual possession of the bank. He shall see that the limits fixed by the Board of Directors have not been exceeded and that the total of the Bills Discounted Ledger agrees with the balance of the control account in the General Ledger. He will examine the date of maturity of each bill in order to verify the amount of overdue bills.
5- Contra Accounts – Usually they relate to the following types of accounts (a) Bills for collection (b) acceptances, guarantees, letters of credit etc, opened on behalf of the customers. These items appear on both sides of the balance sheet as they constitute both the assets and liabilities of the bank.
6- Branch adjustments – This item discloses the combined effect of the differences in the inter-branch balances. Auditor shall verify this item from the certificates of balances received from branches preparing reconciliation statements.
7- Other Assets – Other assets of the bank shall include premises, furniture and fixtures, stock of stationary, interest accrued on investments etc. Auditor shall examine the title deeds or any other type of documentary evidence in order to ascertain that the assets of the bank, on the date of the Balance Sheet, do exist in the name of the bank and that they have been properly valued.
8- Liabilities – Important items which usually appear on the liabilities side of the Balance Sheet of a bank are the customer’s deposits, borrowings from other banks or agents etc, bills payable, branch adjustments, liabilities for outstanding expenses and contingent liabilities etc. Auditor will try to check up the understatement or overstatement of liabilities.
Audit of Educational Institutions
Audit of books of educational institutions like school, college, universities etc. or other such institutions which are engaged in the educational field is known as audit of educational institutions. Auditor should check income and expenditure account and balance sheet of such institutes in order to verify and report the true and fairness of results presented by income statements and financial position presented by the balance sheet. Generally, the methods and procedures for vouching and auditing is same even though an auditor of educational institution should perform following tasks:
Audit of Non –Profit Institution:
Audit of Insurance Companies:
Investigation
It implies an enquiry into the accounts and records of a business undertaking. It is a sort of special audit with a particular object in view.
Investigation involves inquiry into facts behind the books and accounts, into the technical, financial and the economic position of the business or organisation.
Investigation is an examination of books and records preliminary of financing or for any specified purpose, sometimes differing in scope from the ordinary audit.
Investigation implies an examination of and record for some special purpose.
Nature of Investigation
Investigation is an enquiry into the financial statements of a number of past years with a view to know the real financial position or earning capacity. It is in fact a kind of special audit with predetermined scope depending upon the purpose to be achieved. Investigation is neither accounting nor auditing. Investigation is carried out not in substitution of audit, but in addition to audit. The investigating auditor may even have to investigate the audited accounts.
Scope of investigation
No general principle can be laid down with regard to the scope of every type of investigation. Scope of investigation, in each case, would be limited to the period or area to be covered by the investigator. An investigation on behalf of a person intending to purchase running business of a sole trader will be restricted to the determination of value of assets, liabilities, reserves, existing potential and future prospects. An investigation to settle suspected irregularities in cash or stock would normally cover a period from three to six months.
Objectives of Investigation
The real objective of conducting an investigation by an auditor on behalf of his client is to provide him the desired information in the form of a report about the matter specified. Normally the objective of investigation is to collect, analyze and evaluate facts in respect of desired field of activity with a view on some special purpose as determined by the person on whose behalf the investigation is undertaken. In short investigation is to ascertain the financial position and earning capacity of a business on behalf of a certain person
The common objectives of investigation are listed below:
1) Proposed purchase of business.
2) Proposed sale of business.
3) Reasons for low profitability.
4) Cause of high employee turnover.
5) Reliability of business data.
6) Proposed investment in particular securities.
7) Suspected fraud.
8) Joining in existing partnership business.
9) Borrowing funds.
10) Lending funds.
11) Proposed purchase of controlling shares in a company.
12) Suspected misfeasance against directors.
13) Detection of undisclosed income for tax purposes.
14) Suspected misappropriation by trustees.
Process of Investigation
Divisible profits and dividends
Divisible Profit is that profit for the disbursement of which as dividend a company has legal right. Direct interest of shareholders of a company is in dividend, therefore, the management of the company always endeavours to disburse dividend to the shareholders but it cannot do so in such style as may result into the bankruptcy of the company, e.g. out of capital.
Divisible Profits under the Indian Companies Act 1956:
Section 205 lays down law on the following points :
It would be useful to elaborate the provisions:
(i) Sources of Dividend: As per Section 205(1), a company can disburse dividend for a certain year from the following sources:
(a) Profits of the year;
(b) Profits of the previous year;
(c) The two (a) and (b) together, that is, total thereof;
(d) Amount received for disbursement of dividend from the Central Government or any State Government for the payment of dividend in pursuance of a guarantee given by that government.
Dividend can be disbursed from the sources after making the following deductions from the profits of the company:
(a) Current Deprecation [Section 205(2)]
(b) Transfer to Reserves [Section 205(2A)]
(c) Arrears of Deprecation [Section 205(1)(a)]
(d) Past Losses [Section 205(b)]
The following points need consideration in respect of divisible profits :
(1) Section 205 of the Companies’ Act must be abided by:
(2) The rules as provided in the Articles of Association must be kept in mind.
(3) The excess of income over the current expenditure may, after deducting depreciation on current assets, as required under sections 205 and 350 of the Companies Act, and creating adequate funds for payment of liabilities, be divided as dividend among the shareholders.
(4) The capital profit can be disbursed as dividend if (i) they have been realised in cash, (ii) there is surplus after writing off capital losses, and realised in cash, (ii) there is surplus after writing off capital losses, and (iii) the company is authorised to divide it as dividend by its Articles.
(5) It is compulsory to write off revenue losses before distribution of revenue profits as dividend and, similarly, it is also required to write off capital losses before disbursement of capital profit as dividend but it is not compulsory to write off capital losses before disbursement of revenue profits as dividend.
(6) It is not obligatory to write off the existing loss of paid up capital of the company or the past debit balance of P & L. Account (before deprecation) prior to distribution of dividend, if the company has adequate funds to discharge liabilities.
Preliminaries before starting Audit-
1. Appointment of Auditor.
2. Nature of Business of the Company.
3. Accounting Year.
4. Board of Director
5. Acquaintance with Management.
6. Knowledge of the byelaws regarding Memorandum of Association and Articles of Association.
7. Study of prospectus.
8. To receive the List of Books.
9. Obtaining the List of Employees and job description.
10. Knowledge of Internal Control.
11. Acquisition of Previous Final Accounts and Audit Report
Audit of Share-Issue
Audit of Share Transfer -
1. Under the Companies’ Act.
2. Under agreement:
(i) Checking the Articles.
(ii) Checking the Transfer Registrar.
(iii) Checking the Transfer Deed.
(iv) Checking the intimation to Transferee.
(v) Action by Directors’ Meeting.
(vi) Checking the Share Certificates.
(vii) Checking the Register of Membership.
Audit of Debentures -
(i) Cash Consideration.
(ii) Other consideration.
(iii) Commission and Discount.
(iv) Application forms and Allotment.
(v) Premium.
(vi) Collateral security.
(vii) Entries of interest.
Key takeaways –
Divisible Profit is that profit for the disbursement of which as dividend a company has legal right.
Sources-
1. Gupta, Kamal : Contemporary Auditing, Tata McGraw Hill, New Delhi.
4. Pagare, Dinkar : Principles and Practice of Auditing, Sultan Chand, New Delhi.
5. Sharma, T.R. : Auditing Principles and Problems, Sahitya Bhawan, Agra.
7. Tandon, B.N. : Principles of Auditing, S.Chand & Co., New Delhi.
