Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Auditors qualifications, appointment, rights and duties etc. Q. 1 Describe the provisions of Indian Companies Act, 1956 regarding qualifications and disqualifications of a company (Sau. Uni. 2003, 2008, 2009) OR Describe provisions made for the appointment, re-appointment, qualifications, disqualifications, remuneration and removal of auditor according to the Companies Act. (Sau. Uni. 2004, 2005) OR Describe the provisions of companies Act, 1956 for qualification, disqualifications and removal of the auditor. (Sau. Uni. 87, 89, 92, 2000, 2002, B.U.2005) OR Describe the provisions of Companies Act, 1956, concerning the qualifications, disqualifications, appointment and re-appointment of the company auditor. (Sau. Uni. 94, 97, 99, 2007, 2010) OR Write Short Notes : (1) Qualifications of Auditor. (Sau. Uni. 96, 2001) (2) Auditors appointment and re-appointment. (Sau. Uni. 96) Ans. Let us examine the provisions of Companies Act regarding the auditor in following order : 1. Qualifications and disqualifications of auditor 2. Appointment and re-appointment of auditor 3. Auditors remuneration 4. Removal of the auditor I. Qualifications and disqualifications of company auditor : 1. Auditors qualifications : According to section-226 of Companies Act, person or firm having the following qualification can be appointed as an auditor : (1) Person who is the member of Institute of Chartered Accountant. (2) Any firm whose all the partners are serving as chartered accountants in India. (3) A person holding a certificate under the restricted auditors certificate (part B. state) rules, 1956 can be appointed as an auditor. 2. Disqualifications of an auditor : According to section-226(3) of Companies Act, the following person cannot be appointed as an auditor : (1) Any registered institute. e.g. Company; (2) Any salaried officer or employee of the company (3) Officer of the company, partner of an employee or any person who is serving there; (4) A person who is indebted to the company for an amount exceeding Rs.1,000 or who has provided any security in connection with the indebtedness of any thid CHAPTER: 1 COMPANY AUDIT - 1Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ person (party) to the company for an amount exceeding Rs.1000 cannot be appointed as an auditor. (5) According to section-226(4) of Companies Act, if a person is disqualified with relation to either a holding company or its sub - Sidiary Company, he shall be disqualified for being an auditor of the first company. If an auditor becomes the subject to any of the disqualification mentioned above, after his appointment, he shall be deemed to have left his rank (position) as an auditor. Besides provisions of Companies Act, auditor can be disqualified according to the disqualifications shown in section-8 of Charter Accountants Act, 1949. II. Appointment and Re-appointment of auditor : Every company has to appoint an auditor for auditing their accounts. Following provisions have been made regarding appointment of an auditor according to section-224 of the Companies Act in different circumstances. 1. First Appointment : The board of directors appoints the first auditor of the company within one month of the registration of the company, which continues till the end of the first annual general meeting of the company. If the board of directors does not appoint the first auditor of the company in this way, the first auditor of the company is appointed in the annual general meeting of the company. 2. Appointment every year : Every year, Company appoints the auditor in the annual general meeting by share holders. The auditor appointed this way holds office till the completion of next annual general meeting. The auditor has to be intimated about his appointment within seven days after the resolution about the appointment has been passed in the annual general meeting. And after getting this information the auditor has to inform the registrar of companies in writing in a prescribed form whether he has accepted or refused the appointment within thirty days. This provision is also applicable in the case of reappointment of an auditor according to the amendment of 1974 in the Companies Act. 3. Re-appointment : Only the auditor who has been appointed by the company should be reappointed in the annual general meeting. Of course, reappointment is not done under following circumstances : (1) If auditor is not qualified for reappointment. (2) If a resolution has been passed to appoint another person instead of him or resolution has been passed that the same auditor should not be reappointed. (3) If auditor has given a notice in writing to the company about his unwillingness for his own reappointment. (4) If the notice about the resolution of other auditors appointment instead of the current auditor has been received by the company but because of death, insanity, inability or disqualification of such person, the resolution cannot be proceeded with. 4. Appointment by the Central Government : When the appointment of re- appointment of an auditor is not possible at annual general meeting of the company, the Central Government appoints the auditor. In this case, the company has to inform the Central Government withinPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ the seven days of completion of annual general meeting of the company that the auditor is not appointed or re- appointed. 5. Appointment of an auditor of Government Company or Corporation : In the Corporation, government companies which are established by the laws of State Government or Central Government in which the government has the right for more than 50%, the appointment of an auditor of such companies is done by the Central Government on the advice of the Comptroller and Auditor General of India. e.g. Life Insurance Corporation, General Insurance Corporation etc. 6. Appointment by a Special Resolution : According to the amendment in Companies Act of 1974, a new section- 224 (1) (A) is included. As informed in it, the auditor can be appointed or reappointed by the special resolution passed in the annual general meeting of the company in the following circumstances : (1) The company whose 25% or more of subscribed capital is held by public financial institution, the Central Government or the State Government; (2) The company whose 25% or more of Capital is held by such financial or any other institution established under the State Act and 51% of subscribed capital is held by the State Government; (3) The company whose 25% or more subscribed capital is held by nationalized bank or general insurance company. If the auditor has been appointed without passing any special resolution by the company, it will be considered that the auditor has not been appointed at all and later, the Central Government will get the right of appointing the auditor. 7. Appointment to fill the casual vacancy : If there is any casual vacancy of an auditor because of death, insanity, insolvency, the board of directors can appoint another auditor, but it the current auditor has resigned and there is any vacancy, the board of directors cannot appoint any other auditor. General meeting possesses tors cannot appoint any other auditor. General meeting possesses the right to fill the casual vancancy that is caused by the resignation of an auditor. Auditor appointed for such casual vacancy will held the office till the completion of next annual general meeting. According to the amendment of 1974, auditor can undertake the audit of 20 companies with pain-up share capital of less than Rs.25 lakhs rupees, including 10 companies with paid-up share capital of more than Rs.25 lakhs. III. Auditors Remuneration : If the auditor has been appointed by the board of directors, his remuneration too will be decided by the board of directors. If the auditor has been appointed by the annual general meeting, his remuneration will be decided by the annual general meeting itself. If auditor has been appointed by the Central Government, the Central Government will decide his remuneration too. In short, one who appoints will decide the remuneration too but the remuneration is paid by the company. The amount given to the auditor as reimbursement of expenses is included in the remuneration of the auditor. According to the provisions of Companies Act, remuneration paid to the auditor should be shown separately and it is to be shown in the profit and loss account of the company. IV. Removal of auditor :Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ The first auditor appointed by the board of directors can be removed by the resolution of general meeting of the company and another auditor can be appointed in his place. The first auditor appointed by the Board of Directors continues to hold his office till the conclusion of the first annual general meeting of the company. But if the auditor is to be removed before the expiry of his term, he can be removed by the resolution of the general meeting of the company and for the appointment of another auditor in his place, any member of the company has to give a notice seven days prior to the date of general meeting. It is not necessary to get the permission of Central Government for this. For the removal of auditor who has been appointed by the other way, means appointed by annual general meeting, Central Government etc., it is necessary to get the permission of Central Government in advance and its resolution has to be passed in the general meeting of the company. According to the provisions of Companies Act, if other auditor is appointed in place of retired auditor, resolution has to be passed in the general meeting of the company. According to the provisions of Companies Act, if other auditor is appointed in place of retired auditor, resolution has to be passed in the general meeting of the company. If such resolution has passed by any share holder, notice regarding this should be sent to the company before 14 days. Company will send this notice to all shareholders and retiring auditors. The auditor has right to show his opinion in writing to the company. If auditor sends his opinion to the written opinion to the company, the company has to send this to all shareholders but if such opinion cannot be sent to the shareholders because of late receiving or because of any other reason, auditor will be given the right to read this opinion in the general meeting. If the company or shareholders feel that such written report is false or auditor makes false representation of his report, the court will not permit to read that statement. Q. 2 According to the provisions of Companies Act, 1956 (1) Describe rights of an auditor (Sau. Uni. 80, 86, 95, 97, 2000, 2002, 2006, 2008) (2) Describe the duties of company auditor (Sau. Uni. 83, 86, 95, 97, 08, 2009, 2011) Ans. With the purpose that auditor can fulfil his duties properly and with the intention of protecting their welfare as the representative of shareholders, company auditor has been given certain rights according to the provisions of Companies Act. Besides this, certain duties have been decided for the Company Auditor which are as follows: Auditors Rights : Auditor has been given some important rights so that he can fulfill his duties honestly and faithfully. These rights can be described as follows : 1. Right to verify books of accounts and documents : According to the provisions of Companies Act, the auditor has the right too check the accounting books during the working hours. Which are kept at the head office of the company or at any other place and their vouchers and account registers which are sent to the head office by the branch at any time. All books of accounts which are kept legally like cost accounting books, accounting registers like legal register, memorandum, articles, minutes, stock register and vouchersPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ like contract, bills, invoices, receipts, etc. can be included in the accounting books. Auditor can check such books of accounts, vouchers, etc. at any time during the working hours of the office. Of course, it is found generally that auditor comes to verify accounts at the previously decided time by the auditor and the client. But it is true that auditor should arrange surprise visit without informing the client and check the securities, cash on hand etc. 2. Right to obtain information Explanation: Auditor has the right to get all the necessary information and explanation which are required for the verification of accounts. He can obtain this explanation from the management of the company, responsible officers and employees of the company. If the auditor is denied this necessary information and explanation, the auditor should make a remark about this clearly in his report. 3. Rights regarding general meeting : If audited accounts are to be presented, auditor has the right to receive a notice of general meeting and remain present in the general meeting. It is not inevitable for auditor to remain present in the general meeting. It is the auditors right, not duty. Of course, if the auditor has criticized the accounts in his reports, it is desirable that he remains present in the meeting and give explanation clearly to the shareholders. Though auditor remains present in the meeting, it is not compulsory for the auditor to give any answer of the question asked by the chairman. When the notice about the appointment of new auditor in place of current auditor is given to each member, the auditor has a right to receive such notice and to present his opinion in writing to the company. But there is a condition that such report should not be reformative. 4. Right to improve the wrong presentation regarding accounts in the meeting : If the auditor feels that the statement of accounts presented by the management is wrong, fraudulent or illusive, auditor has the right to improve (verify) it. But anything that has been left out in the report cannot free the auditor from his responsibility with the help of oral explanation. 5. Right to get the advice, service of experts : The auditor has a right to get the advice of experts regarding technical matters of Law and business. But the auditor has to present his own opinion in the report according to the case of London and General Bank Ltd. 6. Right to get remuneration: Generally, authority who appoints the auditor decides the remuneration of the auditor. The auditor has right to receive such remuneration. It has been stated in the case of Homer V/s. Kwitter that auditor is appointed on an annual remuneration and if he is removed during the current year, the auditor has the right to receive the full amount of remuneration. 7. Right to receive legal expenses: According to the provisions of Companies Act, if civil or criminal case have been filed against the auditor, he has the right to receive legal expense for the defence. Not only this, he has a right to recover such legal expense from the assets of the company. (But the condition is that the judgement of the case should be in favour of the auditor and auditor is declared to be innocent or the justice believes that the auditor has behaved honestly.) 8. Right to visit the branch and verify the accounts:Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ When other auditor has been appointed for the audit of accounts in the branch, if the auditor feels necessary, he can visit the branch and verify the accounts. 9. Special Right of an auditor (Lien): If the auditor has worked as an accountant, he gets special right (lien) on books of accounts but if he has worked just as an auditor, he does not get any special right on books of accounts. Duties of an Auditor: Auditor is the protector of the interests of shareholders. Certain duties have been decided to protect the interests of shareholders. Let us discuss such duties from three different view points: I. Duties of an auditor according to Companies Act. II. Duties of an auditor according to judicial decision. III. Professional Ethics. I. Auditors duties according to Companies Act : Auditors duties to shareholders according to Companies Act are as follows: 1. To present Audit report: According to section 227 of the Companies Act, it is the preliminary duty of an auditor that he should present the report before shareholders after verification of accounts of the company. Though the auditor is appointed by any authority, the auditor has to address his report to the shareholders and present it to them. Only in special audit, auditor has to give his report addressing the Central Government. According to the judicial decision, in case of Allen Craig & Co., it is not auditors duty to send audit report to each and every shareholder. Once he submits such a report to the company secretary, his duty is considered to be fulfilled. During his verification of accounts, if the auditor finds any defect, illegal act or breach of the provisions of Companies Act, he has to point it out and guide them about its improvement. Even then, if the error is not corrected or if it is neglected, auditor should clearly mention that matter in his report. According to Section 227 (1) of the Companies Act, it is the auditors duty to verify the following matters: (1) It should be verified that conditions about the loan and security of the company are not harmful to shareholders. And it should be verified that they have received enough security against the loan or not ? (2) It should be verified that the transactions written in the books of company by adjustment entry are not harmful to the interest of the company. (3) If any company except that of investing or banking company has invested in shares, debentures and securities and sold them at lower price than its purchase price, it should be checked in depth and minutely. (4) It should be verified that lended money or loan of the company has not been shown as deposit. (5) It should be verified that any type of personal expenses have not been posted as revenue expenditure. Examining the books of accounts of the company minutely, auditor should find out whether the accounts present true and fair economic condition of the company or not ? Before giving his opinion about it, he should show enough care and skill. As stated in the case of Controller of insurance v/s. H.C. Das, AuditorPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ should not depend only on the certificate of the management and officers of the company. 2. Certification to be given for statutory report : According to section 165 of Companies Act, the company has to hold a statutory meeting within six months after registration of the company in which statutory report is to be presented. The auditor has to give a certificate for the following matters in this statutory report. (1) Number and types of shares issued by the company. (2) Total amount of cash received by the company for allocated shares. (3) Statement of receipts payments of cash till that date. 3. When the prospectus is issued: The company who has been running business and when it is sues the prospectus, the information and detail of profit-loss account of the last five years, amount of dividend distributed every year during the last five years and the auditors report for assets and liabilities of the company should be included in the prospectus. 4. When special auditor is appointed : To verify companys accounts and management, Central Government appoints special auditor. At that time, it is auditors duty to offer necessary and possible help to such auditor-inspector. II. Auditors duties according to judicial decisions : Auditors duties to shareholders according to judicial decision can be shown as under: 1. To exercise reasonable care-skill : According to the statement of the Justice Lipse in the judicial decision of Kingston Cotton mills case, auditor should exercise reasonable care and skill while doing his duty. Of course, what is reasonable care-skill can be decided on the basis of particular circumstances of respective case. 2. To verify important documents : In the judicial decision of Leeds Estate Building and Investment Society Ltd. Vs. Shepherd case, the judge Shri Sterling ruled that the auditor should be familiar with the articles or the company. No excuse regarding auditors ignorance about the existence of articles is accfeptable. 3. To verify the truthfulness of transactions : According to the judicial decision of Registrar of Companies Mumbai V/s. P.M. hedge case, auditor should not check only the accounts from the arithmetical view but he has to inquire into transactions in depth and should verify the truthfulness and authenticity of transactions. 4. To verify the assets : In the judgement of London Oil Storage Co. Vs. Sear Hasluck & Co. the judge Shri Alverstone has ruled that, it was auditors duty to verify the existence of all assets shown in the balance sheet. It the auditor fails to do his duty, auditor is liable to submit the loss suffered by the client. As shown in the case of city Equitable insurance Co. Ltd. Auditor should physically verify the assets and investments. 5. Disclose true economic condition : In the case of London and General Bank Ltd., the judge Shri Lindle has stated that it was not the auditors duty to give advice to the trader but to disclose the true economic condition of the company. III. Auditors duties according to professional ethics (duites towards institute):Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ According to the Chartered Accountants Act, the auditors duties to his profession ethics are as below: 1. Regarding the acceptance of appointment or re-appointment: If he is appointed in place of retiring auditor, auditor should inform the retiring auditor in writing before he accepts the appointment. Moreover, he should accept the appointment or re-appointment after following the provisions of sections 224 and 225 of Companies Act. 2. Regarding the rejection of less fees : Appointment cannot be accepted on lower fees in place of any other Chartered Accountant. 3. Regarding signing the report : A person who is the member or a partner of Institute of Chartered Accountant of India can sign the annual accounts. Any other person should not be allowed to sign on the annual report. 4. Regarding not getting work through advertisement : Through advertisements or circulars auditors work cannot be obtained. 5. Regarding not getting work by giving commission : He cannot pay commission, brokerage or pay fees out of profit of business to get any work of audit. Of course, there is nothing wrong if he gives the share of profit to the partner of the firm after his retirement or death as per agreement. Liabilities of Auditor Q. 3 Discuss auditors liabilities to negligence according to the Companies Act. (Sau. Uni. 81, 84 , 86 , 92 , 94 , 99 , 2001, 2004, 2005, 2007, 2010, 2011) Discuss auditors Civil liabilities according to the Companies Act. (Sau. Uni. 81 , 84 , 86 , 92 , 94) Write Short Notes : Auditors liability to negligence (Sau. Uni. 89) Discuss in brief : Auditors liability to misfeasance (Sau. Uni. 89) Ans. Auditors Liability : Auditor of a private institute is not appointed under any Law. He is appointed by an agreement with the client. So, his liabilities are decided on the basis of instructions given by the client. It is advisable for the auditor of private institute to get instructions of the client in writing so that there will be no confusion regarding the work done by him in future. Company auditing is different from this. He is appointed according to the Indian Companies Act of 1956 and his liabilities are showed in the law. His liabilities can be described under two heads : 1. Civil Liability : (A) Liability arising from negligence (B) Liability arising from misfeasance (A) Auditors civil liability regarding negligence : As auditor is appointed by the company, it becomes auditors duty to protect the interest of the company. Moreover, as auditor represents shareholders, it becomes prime and sacred duty of an auditor to maintain the trust of shareholders. In order to fulfil his duty faithfully auditor should use care skill. Of course, it is difficult to define fair care skill and it is again difficult to define it or measure it. It can be decided on the basis of form, type of the case or condition.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ If the auditor fails to do his duties, he should be ready to suffer its results. It means, he should pay for the losses suffered by the client. Here, it should be remembered that auditor has to pay for the losses of the client only if the loss occurs because of his negligence to his duties. But if he owner has not suffered any losses because of auditors negligence or auditor had not been negligent and yet the client had suffered, in that case the auditor is not liable to pay for it. This can be easily understood with the help of following manner. Loss without negligence An auditor is not liable for Negligence without loss Moreover, if the client has really suffered losses because of the negligence of the auditor, only the company has the right to file a suit for the recovery of damages, individual shareholders cannot claim. Of course, if the company is making losses, its liquidator can file such suit. Following cases regarding this are famous : (1) Leeds Estate Building and Investment Co. vs. Shaepherds (1887) (2) The Irish woolen Co. vs. Tyson and Brothers (1900) (3) London Oil storage Co. vs. Seer Hasluck and Co. (1904) (4) Registrar of Companies (Mumbai) vs. Hedge (1954) Q.4 Discuss auditors liabilities to misfeasance as per Companies Act. (Sau. Uni. 81, 84 , 86 , 92 , 94 , South G.U. 2001, 2004, B.U.2004) Ans . As Auditor is considered liable for negligence, in the same way, he can be found liable for misfeasance also. As the representative of shareholders, auditor should protect the interests of shareholders and for this auditor should take proper care and use his skill and expertise. Even then, if auditor does not follow his duty properly, means if he commits misfeasance, auditor is liable for this. If company has suffered any loss because, of auditors misfeasance or breach of trust, auditor should pay the damages. When company becomes insolvent as per the provisions of Companys Act, court feels that founders of the company, management or officers (including auditor) have misused the money of the Company or kept it in unauthorized manner with them or they have committed misfeasance or breach of trust. In that case the court can order such founders, management or officers to pay for the loss company has suffer because of their breach of trust and misfeasance by holding them liable. Even then, if the suit is filed in the court against any officer of the company (including auditor) for negligence, misfeasance etc. and if the court feels during the hearing of the case that (1) He may be liable or not; or (2) They had acted fairly an honestly; or (3) On overall consideration of all the circumstances of case and circumstances under which he was appointed, if he is found worth absolving from the allegations, the court gives total or partial freedom under certain conditions. When auditor gets the idea that a case is going to be filed against him for negligence, breach of trust or misfeasance, before the case is filed, auditor can make himself free from such liability by sending an application to the court and if the court finds it proper, it can make the auditor free from such responsibility.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ According to the provisions of Companies Act, any company cannot keep the auditor free from liability of negligence, breach of trust or misfeasance by its articles or agreement. If there has been any provision or agreement has been made, as it is against Companies Act, it is considered null and void. Yet, in certain circumstances civil or criminal liability of auditor is created, company can give relief to the auditor under the following conditions : (1) Judgement should be in favour of the auditor; or (2) Auditor should have been declared innocent; or (3) The court must have given relief the auditor according to the provisions of Section-633 of Companies Act. If auditor has made any false statements in the prospectus inviting the public to invest in shares or debentures, as an expert, auditor is considered liable for it. Moreover, if any person has purchased share, debenture on the basis of such false statements and if he has suffered loss, auditor is liable to pay for it. But if auditor withdraws his statements before the issue of prospectus is out, he becomes free from the liability. Famous cases regarding this are given bellow : (1) London and General Bank Ltd. (2) Kingston Cotton Mills Company Ltd. (3) The City Equitable Fire Insurance Company Ltd. (4) The Westminster Road Construction and Engineering Company Ltd. Q.5 Discuss adutiors criminal liabilities under the Indian Companies Act. (Sau. Uni. 81, 83 , 89 , 92 , 93 , 96 , 98, 2006) Write Short Notes : Auditors Criminal liability. (Sau. Uni. 96) Ans. Criminal liabilities : Auditor is an officer of the company and if he breaks the provisions of law. It is known as criminal liability of the auditor. For this, auditor is liable to fine or punishment. Regarding auditors criminal liability, various provisions of Companies Act are as follows: According to Section-63 of Companies Act, if a prospectus is issued by the company containing false statement, every person including auditor who authorized the issue of such provisions in section 68 of the Companies Act, to punish him. Contrary to the provisions of Section-233 of Companies Act, if any auditor gives report or certifies documents of the company, auditor or any other person who has signed the report or any one who was certified documents does this intentionally, he is liable for fine upto Rs.1000. According to Section-240 of Companies Act, the auditor should help the inspector appointed by the Central Government. If auditor does not help him, he is liable to be punished with imprisonment of six months and or with fine of Rs.2000. According to Section-242 of Companies Act, the Central Government take necessary steps on the basis of the report by the inspector and if the suit has been filed against the person related to the company, if the auditor does not help, it is treated similar to contempt of court and the auditor will be held liable to punishment. According to Section-477 of Companies Act, a Private Court can examine the auditor when the company is making loss and the important documents which are with the auditor should be submitted to the court if necessary. If the auditor does not remain present in the court, he can be arrested.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ According to Section-478 of Companies Act, the auditor of the company can be investigated by the High Court on the basis of official liquidators application. Its remark will be made and the auditor should sign on it. In the civil or criminal procedure of an auditor, such entry can be used as an evidence. According to Section-539 of Companies Act, if the auditor makes any false or fraudulent entry in the account books of the company, register or tears, destroys, alters or tampers with it, the auditor is liable for the punishment upto seven years imprisonment and or fine. Q.6 Discuss auditors liability to the third party. Describe judicial decisions of any two cases related to it. (Sau. Uni. 83, 93 , 95 , 96) Discuss auditors liability under the titles shown below : (1) Liability to the third party Write Short Notes : Auditors liability to the third party (Sau. Uni. 93, 95) Ans. Auditors Liability to the third party : Generally, the auditor is appointed by the company. So, the relationship between the company and auditor is established according to the agreement. Therefore, auditor is aware of the fact, that if he fails to do his duty, he is liable to pay for the loss suffered by the client; but the question arises here is that, whether other persons of the society connected with the financial interest of the company like creditors, debenture holders etc. can consider the auditor liable for his work or not ? If any third party takes any decision keeping in mind the accounts certified by the auditor, trusting his report and if the annual accounts prove to be wrong and as there is no reference to the wrong accounts in the report of the auditor, if the third party incurs any loss, can the auditor be considered liable to pay for the losses ? In binary circumstances, the answers to these questions are into negative because auditors appointment, remuneration, removal etc. are not decided by the third party. Generally, an agreement is made between the company and the auditor. Company appoints the auditor. It pays remuneration. Therefore, uditor is accountable to the company and not the third party. Yet it is not totally true. In certain situations, auditor is liable to even the third party. Let us clarify this matter by referring to various judgements. It was decided in the case of Lelievere & Dennes vs. Gold that auditor had nothing to do with the third party because he is never appointed by the auditor. In case of Calender vs. Crane Christmas and Co. Ltd., the justice had stated in his judgement that auditor is not responsible for any loss suffered by third parties through reliance on accounts already audited by him even if the negligence is proved. This is because there is not relation of any kind between the auditor and the third party through agreement. But in case of Hedley Byrne and Co. vs. Heller and Partners, giving judgement, House of Lords of England informed that auditor cannot escape from his liability if the third party suffers any loss by relying on the report of the auditor and takes any important decision based on it. Based on this judgement, Institution of Accountants of England published one statement Auditors liability to the third party. Following recommendations have been mode :Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ (1) If the auditor has prepared accounts, registers, reports with negligence and if they are prepared keeping in view certain transactions with the third party and if actions are to be taken on the basis of it by the third party, then the third party can get the compensation for the losses shown by the auditor. (2) If any shareholder decides individually to invest in the company on the basis of certified accounts or auditors reports, auditor is not liable to that shareholder individually. (3) If the accountant knows that his accounts will be based for the estimatin of taxes and yet if any negligence is showed, the auditor is not liable for it. Of course, in the case of Commissioner of Income Tax (Madras) Vs. G. M. Dandekar in India, Justice Shri Ayyar stated that auditor is not responsible to income-tax department for the correctness of the accounts. In case of Ultramares Corporation Bank Vs. Touche, Niven & Co. (U.S.A.) Ultramres Corporation Bank had granted loan to Touche, Niven & Co. relying on the audited accounts of the company. In fact, accounts did not present the true and fair condition of the company, as a result, Ultramares Corporation Bank was not in a position to recover the money of loan. So, the bank filed a suit against the auditor of the company for the compensation of damages. Of course, the settlement was done outside the court before the court announced judicial decision. According to the opinions presented in the magazine Accountant published in England, as there is no relation between be held liable otherwise difficult situation may arise. If the readers of the newspapers, magazines act on the basis of the information published in it and incur losses, the owner of the newspapers and magazines cannot be held liable. In order to consider auditor liable, it should be proved that following four conditions showed in case Derry Vs. Peek have been followed: (1) The third party depends on the statement which was signed by an auditor was in fact false. (2) One who made statement knew that statement was wrong or he had showed total negligence to know the truthfulness or he had remained ignorant intentionally. (3) The statement was with the knowledge and intention that the third party would act upon it, trusting its correctness. (4) The third party had acted on the basis of such statement and they had incurred losses. If the conditions shown above are applicable, auditor is liable to compensate, the losses incurred by the third party. It should be remembered that towards the third party, auditor has a moral liability. They will act depending on his reports so, if auditor has made false or misguiding statements and the third party suffers loss, it is auditors moral liability. According to Indian Companies Act, if there is any misguiding statement in the magazine and auditor has given his permission, auditor is liable to pay for the gamage suffered by the person who has invested money depending on it. But it should be remembered that the auditor should be honest. While auditing, he should use fair skill, vigilance and expertise. It is necessary that auditor is honest and gives his report after proper verification of accounts. Auditor has moral liability too. The third party deals with the company thinking that accounts which have been verified by the qualified auditor are correct. In this situation, auditor should take care of the interest of third parties.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Report of Auditor Q. 1 Explain the importance of audit report. (Sau. Uni. 91, 2008, 2009) Explain the importance of company audit and describe the types of reports. (Sau. Uni. 90, 91, 95, 2006) Write Short Notes : (1) Types of Audit Reports (Sau. Uni. 90, 95) (2) Auditors Qualified Report (Sau. Uni. 2000, 2001) Ans. Audit report is the presentation of collected and considered facts. It is prepared in such a way that those people who do not have information about the matter of the report can be informed clearly in brief. According to Section 227 (2) of Companies Act, it is auditors duty to verify the accounts of the company carefully and give a report about whether the accounts present true and fair condition of the Company or not ? Auditor is the representative of shareholders; therefore it is his moral duty to take care of shareholders interest. Generally, shareholders do not know the real condition of the company. They are not capable for it. So, auditor should verify whether the money of shareholders is properly managed ? that money is not used illegally or for personal purpose, the management is done according this. He should minutely verify the accounts of that company. Finally, he has to present in his report before shareholders whether the profit-loss account and balance sheet of the company gives true and fair economic condition of the company. Let the auditor not add any new information in the presented accounts but the real importance lies in giving the report after verifying the truthfulness and clarity. In the case of London and General Bank, justice had stated the auditor was liable for not giving proper report to the shareholders. Auditors report proves very useful to those who have lent money to the company, banks who have sanctioned loans for short or long term and finance company. CHAPTER: 2 COMPANY AUDIT - 2Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ It helps shareholders, debenture holders, depositors to know the true financial condition of the company before deciding their financial investments. While assessing Sales Tax, duty, custom, income tax etc., audited accounts help income tax officers by providing faith and trust and truth. As a result assessment of tax takes place easily and quickly. Auditor report is useful to know that the public money is not misused and wasted. Thus, auditors report is very important from various points of view to shareholders, debenture holders, depositors, bank, other investors, creditors, bankers, income tax officer, public, government etc. Types of audit reports: There are two types of reports : 1. Clean Report 2. Qualified Report 1. Clean Report: If no defect, illegal act, frauds are detected during the verification of the accounts of the company and if profit and loss account in the annual account of the company presents true and fair profit or loss and balance sheet shows true and fair economic condition as of the date and auditor presents whatever report are called clean report. Clean report is also called report without defect or routine report or regular report. 2. Qualified Audit Report: During the verification of the accounts of the company, any defect, illegal act, frauds, breach of provision of law is detected and the profit loss account does not show true and reasonable profit or loss of the concluding year and balance sheet does not show the true and fair economic condition as of that date, when auditor gives report about it is called qualified audit report. This type of audit is also called improved report or limited report. In the following circumstances, the auditor should give qualified report: (1) When accounts, financial registers etc. are not prepared according to the accepted principles of Accounting. (2) When it is not possible to verify accounts according to accepted principles of auditing. (3) Where the auditor is not given enough books of accounts, certificates, vouchers and necessary information and explanations. (4) When Account books are not maintained as per the provisions of Companies Act. (5) When profit-loss account and balance sheet, profit-loss allocation accounts have not been prepared as per Companies Act. (6) Including management, if any person has committed breach of provisions of articles, memorandum, provision of Companies Act, qualified report should be given. If auditor ascertains that companys balance sheet does not present true and fair economic condition of company and profit-loss account does not present true and fair financial picture, in circumstances like (i) More or insufficient provision of depreciation on fixed assets. (ii) If there is an adverse effect on profit-loss account because of change in the method of depreciation. (iii) More or insufficient provision for bad debts, bad-debt reserve has been made. (iv) Assets shown in the balance sheet are assessed at low price or more price etc. Auditor should present qualified report.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Q. 2 Explain the works true and fair used in the audit report. (Sau. Uni. 88, 93 , 95 , 96, South G.U.2003) Write Short Notes : Concept of True and Fairness. (Sau. Uni. 91, 94 , 97 , 98 , 99, 2001, 2003, 2005, 2007, 2010) Ans. After verifying accounts of the company, he has to give a report whether the accounts of the company present true and fair economic condition of the company or not ? In that case, it is necessary to understand what the meaning of words is true and fair. It can be said that the accounts of the company show true and fair economic condition of the company only when accounts have been prepared according to the accounting principles and accounting methods, capital and revenue transactions have been allocated properly, information is given according to the second part of residual-6 of Companies Act, total information is given as per provisions of law and shown in law. All the assets and liabilities of the company shown in the balance sheet of the annual accounts are presented properly, means no assets or liabilities of the company have been left, or have not been shown were wrongly, its valuation has been done according to the accepted principles, there is provision for depreciation on fixed assets, contingent liability is shown with provision regarding it. Thus, if the real condition of assets and liabilities is shown in the balance sheet, it is called true and fair condition. We can say that fair and true profit is shown in profit-loss account only when profit has been calculated after adjusting in necessary from according to Companies Act and Profit-Loss account has been prepared according to the principles of accounting and provision of Companies Act. Account of allocation of profit-loss should have been prepared properly; necessary amount should have been carried to the reserve account, provision for depreciation, bad debt reserve, reserve discount, tax reserve etc. should have been properly arranged. If profit and loss account has been affected due to change in the methods of depreciation, along with above, it is to be seen whether the entries related to pre-paid expenses, bill receivable, bills payable or income received have been properly posted or not. The presentation done through accounts on the circumstances discussed above is true, transparent and fair and at that time auditors certificate regarding accounts will present true and fair economic condition in its real sense. The use of words true and fair started with the implementation of Companies Act in 1956. Before that, words true and correct were used. These words were used since the implementation of Companies Act of 1913. The meaning of true and correct is that the basis on which the annual accounts have been prepared matches with the books of accounts. In this sense. Annual accounts show true and correct condition of the company. True and fair words are used in this extensive sense. The meaning of true and fair is extensive. Annual accounts are true only with reference to books of accounts. Not only are these accounting books also truly transparent. Transactions in it are regarding business. They are authentic, true and written truly. In this sense, fairness of transactions is presented by words true and fair. Q. 3 Explain words True and Fair used in the audit report of auditor to be presented with the balance sheet. (with changes Sau. Uni. 96, 2007, 2011)Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Ans. In Ans 12(B), we have already discussed the meaning of words True and Fair. So, now let us prepare a clean report. Clean report of the auditor To Shareholders of maha gujarat Co.Ltd., We have verified the attached balance sheet of Maha Gujarat Co. Ltd. Dated 31-3-2009 and the profit and loss account for the year ended on that date and report that : 1. We have obtained all the information and explanations which to the best of our knowledge and belief where necessary for the purpose of out audit. 2. In our opinion proper books of accounts as required by law have been maintained by the company so far as seen from our verification of the books. 3. The balance sheet and Profit-Loss Account of the company showed in the report are in agreement with the books of account. 4. In our opinion and to the best of our information and according to the explanations given to us, the accounts, including remarks thereon give the information required by the Companies Act, 1956 in the manner required and (1) The balance sheet of the company shows true and fair economic condition as on 31-3-2011; and (2) Profit and Loss Account shows true and fair profit for the year ended on the date. Signature : Naresh Narayan Modi (Partner) Karnavati Modi & Co. Date : 15-6-2011 Chartered Accountants Q. 4 Prepare a report of a company by an auditor having three defects. ( Sau. Uni. 93, 97 , 99 , 02 , 03 , 04 , 05 , 2010) Ans. Here is the specimen of a qualified audit report: Auditors qualified report : Specimen To The Shareholders of Gyayak Company Ltd. We have verified the attached balance sheet of Gyayak Company Ltd. As on 31-3-2010 and also the profit and loss account of the company, for the year ended on that date annyexed there to and present the report that: 1. We have been provided all the necessary information and explanations required for the purpose of our audit. 2. In our opinion proper books of accounts as required by law have been maintained by the company which is so found out from our verification. 3. The profit and loss account and balance sheet are in agreement with the books of accounts. 4. In our opinion and to the best of our information and explanations given to us, the accounts, including remarks on it, are as per the Companies Act, 1956 in the manner as it is required and (1) The balance sheet of the company presents true and fair state of companys affairs on 31-3-2011.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ (2) Profit and Loss Account gives true and fair profit for the year ended on that date. (i) In our opinion, the provision for depreiation on Fixed assets is as less as Rs.1,80,000. (ii) There has been change in the method of valuation of closing stock, due to which the profit of the company is calculated more by Rs.1,75,000. (iii) The loan granted to the management worth Rs.1,80,000 is contrary to the section-295 of Companies Act. (iv) Sales Tax has been assessed Rs.1,60,000 regarding which there is no provision in the accounts. Signature : P.P.Parmatma Prakash (Partner) Rajkot Atma & Company Date : 10-6-2011 Chartered Accountants Divisible profit and dividend Q.1 Discuss the factors affecting divisible profit. (Sau. Uni. 2007, 2008, 2009, 2011) Discuss in brief the factors affecting true profit. (Sau. Uni. 93, 2003) What is divisible profit? Which points should be kept in mind while determining it ? (Sau. Uni. 86, 87, 99, 2002, 2004) What is divisible profit? Which points will you keep in mind while determining it? Explain in regard to the judgement. (Sau. Uni. 2005) Explain the guideline principles for calculating divisible profit. (Sau. Uni. 90, 94) Write Short Notes : Divisible Profit (Sau. Uni. 89, 90, 95, 2001, 2003) Ans. What is divisible profit ? Divisible profit means the profit that can be legally allocated among shareholders in the form of dividend. In section 205 of Companies Act, clarification regarding the meaning of divisible profit has been made. According to section 205 of Companies Act. (1) Company cannot announce or allocate dividend for any financial year except, (a) Out of the profits of the company are from the current year or out of the accumulated balance of profits of the earlier years remaining undistributed after provision for depreciation is made or (b) out of the money provided by the Central or Sate Government for the payment of dividend by the Central of State Government for the payment of dividend in pursuance of guarantee given by such Governments. In cases other than guaranty of the government, company cannot allocate dividend from any other funds except profit. Dividend can be distributed CHAPTER: 3 COMPANY AUDIT - 3Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ out of profit only. Of course, there is no binding of law that interest should be paid out of the profit earned from business. It can be from capital profit or revenue profit. There is one exception to this principle and it has been described in section-208 of Companies Act. According to the provisions of this section, if capital has been accumulated by issuing shares and if this capital is used in the activity of such construction in which a lot of time passes for this construction activity to become more profitable, company can allocate interest from the capital even if it doesnt have profit. Of course, for this, permission of the Central Government should be taken and the conditions enforced by this section has to be followed. To decide the divisible profit of the company, following principles should be kept in mind : 1. Accepted principles of Accounting: According to the accounting principles, while deciding divisible profit, difference between the beginning of the accounting year and closing assets and credit and capital and liabilities should be worked out. It there are more assets, profit is calculated but if there are less assets, it is considered as loss. According to the accounting principles, it is not at all proper (fair) to allocate dividend from capital profit. Even in the current year, before distributing dividend from the profit if there is any loss of the last year, it should be adjusted and it would be proper and advisable to distribute dividend from the remaining profit. Not only this, it is advisable to allocate dividend only after taking a certain amount of profit to the reserve account. 2. Provisions of Memorandum and articles: For the allocation of divisible profit, management has to obey the provisions of Memorandum and articles that allocation of profit also affects third parties. Therefore, if in the distribution of dividend, capital is returned, it is contrary to principles of law, so, according to the provisions of memorandum and articles, management can recommend the allocation of dividend from divisible profit after deducting reserve and provisions. But if dividend is distributed form capital, it is called breach of trust, so, management has to return it. (K. Madhav Vs. Popular Bank, 1970) It has been said in various judgments that provisions of articles should be followed completely. Any work contrary to it will be considered illegal. 3. Provisions of Law: In order to decide divisible profit, it is inevitable to abide by law. After the amendments of 1960 and 1974 in the Companies Act of 1956, legal condition became absolutely clear. According to sections 205 and 350 of Companies Act, after deciding divisible profit, dividend can be allocated from it. 4. Judgements: Jugements can prove a guideline to decide divisible profit and distributing dividend from it : Practical points to be considered while deciding divisible profit: It is necessary to keep in mind certain practical points given below while deciding divisible profit. (1) Depreciation: While deciding divisible profit, it is necessary to have provision of depreciation of assets according to section 205 of Companies Act. If there is no provision for depreciation, accounts will not show true and fair economic condition and once the life of assets is over, in order to get new asset in Place of that, replacing the asset is not possible because of lack of financial funds. Of course,Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Central Government can permit any public company to distribute a dividend without having provision for depreciation in public interest. Here is the example of one judgement regarding this: Lee Vs. New Chatel Asphalt Co. Ltd. (2) Capital profit: In business, capital profit is different from current profit. The profit earned from regular activities is common or revenue profit. Dividend can be allocated from it, but dividend cannot be allocated out of capital profit. Received premium while issuing shares debentures, amount of forfeiture, profit received from the sale of fixed assets, profit before the registration of the company etc. are examples of capital profit. Generally, dividend cant be distributed from capital profit but if such profit has been really received, and if there is provision for articles on assets and if any such profit remains after re-valuation of liability, dividend can be allocated from capital profit. Here is the example of a judgement regarding this: Foster Vs. New Trinided Lake Asphalt Co. Ltd. (3) Capital Loss: Capital loss is different from the ordinary or revenue loss in business. Discount on share-debenture, premium loss in the sale of fixed assets etc. are examples of capital loss. On the basis of certain judgments, it can be said that even without adjusting capital loss, company can allocate dividend from the current profit but without adjusting capital loss, dividend cannot be distributed from capital profit. Here is the reference to a judgment regarding it : Bolton Vs. Natal Land and Colonization Co. Ltd. (4) Past Loss, Past Profit: According to principles, before allocating dividend to shareholders, past loss should be adjusted. It has been informed in section-205 of Companies Act that without adjusting past loss, dividend cannot be distributed. But certain judgments have been given contrary to these provisions of Companies Act. Foreign judgments which are contrary to the provision of Indian Companies Act are not binding in India. Like past loss, if there is profit of the past year and if the company has suffered loss in the current year, before distributing dividend from the profit of the past year current loss should be adjusted. Here is the example of such judgment regarding this: Stapley Vs. Reid Bros. Ltd. (5) Transfer to reserves: According to Table A, Management can transfer any amount of profit to reserves for future problem. Such amount can be invested in the company or other outside companies. Management can transfer certain amount of the profit to reserves instead of distributing it as dividend. According to the amendment of Companies Act, from the profit of that year out of which dividend is to be distributed, the percentage decided by the Central Government but not more than 10% of profit has to be transferred to reserves before the company announces dividend. Q. 2 What is dividend? Who can declare the dividend? As an auditor of a public limited company, directors ask for your advice regarding recommendation of interim dividend. Which points will you keep in mind while advising them ? (Sau. Uni. 81, 83) Directors of public limited company where you have been appointed as an auditor, ask for your advice regarding the announcement of interim dividend. Discuss the steps you would suggest to be followed before announcing this decision. (Sau. Uni. 97)Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ When the directors ask for your advice regarding announcement of interim dividend verifying which points, you will advise them? (G.U.) How will you audit the interim dividend ? (Sau. Uni. 95, South G.U. 90) Describe auditors duties regarding dividend. (Sau. Uni. 95) Write Short Notes : Interim Dividend (Sau. Uni. 85, 97, 98, 2003, 2005, 2008, 2009, 2010) Ans. What is dividend? Dividend is the profit distributed among shareholders according to the proportion of share. If Company earns profit and the part of profit which is distributed among shareholders is called dividend. Every share-holder has a right to receive his share the profit of the company. Of course, it is decided by articles to what proportions can the dividend be demanded only after it has been announced in the general meeting of the company. This means up to when the dividend is not announced in the general meeting, no shareholder can demand dividend. There are mainly two types of dividends: 1. Interim Dividend 2. Final Dividend. Let us verify the provisions of Companies Act regarding the announcement of both types of dividend. Provisions of Companies Act, Regarding the announcement of dividend: It is the basic principle of Companies Act to pay dividend from the profit. Dividend cannot be paid out from capital and dividend should be paid on cash. The announcement of dividend shows that company has earned profit. After deducting depreciation, dividend can be paid from the profit. After the announcement of dividend in the general meeting, dividend should be paid out to the shareholders within 42 days. 1. Regarding Interim Dividend: The dividend which is declared in the middle of the year before the final dividend is called interim dividend. If there is provision in the articles, interim dividend can be announced. For this resolution of the board of directors is necessary. The permission of general meeting is not necessary for announcement of interim dividend. 2. Regarding final dividend: Dividend that id declared at the end of the accounting year is called final dividend. At the end of the year, annual accounts of the company are prepared and dividend is announced after calculating net profit. The Board of Directors has authority to recommend dividend and general meeting has the authority to announce dividend on the basis of the recommendation. Guidance to the management regarding the announcement of interim dividend: As an auditor of the company, while guiding the management regarding the announcement of interim dividend, following points should be kept in mind: (1) It should be verified whether the management has authority to declare dividend according to the company articles or not ! If it doesnt possess such authority, it should be obtained. If table-A has been adopted, there must be provision regarding this in it. (2) After preparing interim accounts of the company, profit of the period should be calculated, while calculating such profit, depreciation, bad debts, bad debts reserve, interest adjustments should be kept in enough for the announcement of interim dividend? If the management wants to use the amount of the profit in development activities, and if sufficient possibility ofPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ profit is not seen in the time afterwards, it is not advisable to announce interim dividend. (3) If interim dividend has been announced in the past years, its rate, accounts of that time, economic situation of business at that time etc. should be taken into consideration so that while taking the decisions in present, past experiences will provide proper guidance. (4) The profit during the remaining period of the year should be estimated too. There would be no question if the condition of interim is going to prevail all the year. But suppose if the business is seasonal like warm (woolen) cloth, raincoat, umbrella, fire crackers etc. and after preparing interim accounts and the business season comes in other times, there would be no business. So, the earning of all 12 months is already included in the interim calculation of profit. Therefore, there is no question of earning profit during that time. Instead earned profit will be used for expenses. So, in these circumstances recommendation of distributing interim dividend will prove a danger and fatal! (5) While estimating future profit factors like orders in hand, production capacity, prices of goods, labor, government policy etc. will affect the profit. If such effect is inconvenient, no possibility of profit is seen, and a difficult situation arises. Management and auditor of the company are considered liable for this. Precise Estimates of the companys business potential and future profit in the remaining period of the financial year should be ascertained. It cannot be considered fair to allocate interim dividend if the company is likely to face any economic liabilities in future. (6) Before announcing the rate of interim dividend, rate of final dividend should be considered. Generally, rate of final dividend is more than that of the rate of interim dividend. Auditor should see to it that if the rate of final dividend does not increase, at least it should be maintained. There is a danger of losing reputation if the final rate reduces. The graph of reputation of the company in the minds of shareholders and investors would go down too. There will be inconvenient reactions of this on share market. (7) In the provisions of Companies Act, we have shown that dividend should be allocated in cash only. Therefore, the companys cash liquidity has to be checked. Even if the profit earned by the company is good but it is invested in the business the company does not have enough cash for the distribution of dividend and it has announced interim dividend, assets of the company will have to be sold at a very low price. Existence of business might be endangered. (8) It should be verified whether the work of distributing interim dividend is ultra virus or not. (9) On the basis of the statement of inward and outward cash, if cash is seen and if the management decides to distribute interim dividend on the basis of such increase of cash, but this is a serious mistake. Auditor should explain management the difference between cashbook and profit loss account. Sometimes, it happens that seeing cashbook, cash in hand appears more but profit loss account may show loss! On the contrary, seeing cashbook, cash in hand appears to be less but profit loss account shows more profit! Therefore, it is not proper to take the decision of allocation of interim dividend on the basis of cash on hand. Even if profit loss account does not show profit, there can be more cash on hand in the following circumstances:Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ (i) Assets of company have been sold and cash has been received but later, that amount has not been invested in the purchase of other asset or other investments. (ii) Even if the purchases of goods is done on cash basis, if such purchase has been due on credit in the current year and its amount has not been paid. (iii) Company has received cash by issuing debentures but it has not been invested in any other form. (iv) If company has borrowed money order to follow the plans of development in future, but that money has not been used still. In the contrary situation, though the profit loss account shows profit, there is no cash in hand. (10) The profit loss account shows profit but if necessary entries like depreciation, bad debt reserve, interest etc have not been posted, as a result profit seems possible but in fact, there may not be profit. In these circumstances, the decision of declaring interim dividend cannot be considered proper. Audit of Computerised Accounts Q.1 What is Computerized Account ? Explain its importance. (Sau. Uni. 2010) What is electronic data processing ? Discuss its characteristics. Explain importance of computerized Accounting System. (Sau. Uni. 2008, 2009) Write Short Notes : Audit of EDP (Sau. Uni. 99, 2003, 2005, 2007, 2008) Ans. For auditor, it is very necessary to understand the specialties of electronic data processing (EDP) because it is prepared in various ways in comparison to accounts manually prepared by human beings. Therefore, auditor should be aware about it from general viewpoint as well as its special techniques and other important information about it. Important specialties of EDP are as follows: (1) Organizational Structure : With the adoption of EDP, the number of employees reduces a lot. Organisational structure will become small. The format of organization system will change. Staff control will also change. Duties of employees will also change. Certain information recorded individually as a result of special knowledge of that individual employee might also be connected with the process in adding information. When internal process and reports are also connected, it is in such condition that there are errors or frauds in that programme or information storage or process can be easily detected. (2) Lack of Documents giving information: CHAPTER: 4 COMPANY AUDIT - 4Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ In the accounting system depending on human beings, the accountant notes accounts in the books on the basis of documental evidences. E.g. vouchers invoice, receipt, bill etc. while in electronic data process of accounts, such documents is many times not available for noting. That entry is done directly on computer e.g. calculation of sales order received from the customer, discount given to him, interest etc. is done directly on computer. (3) Lack of visible audit trail: In human based method, the noting of accounting procedure is carried according to some order. e.g. transactions, its entry, posting, balance sheet, annual accounting, etc are directly dealt with. In data process stystem simultaneously as the effects are automatically given according to the computer system. All the information is stored in the machine code. Once the time is over, that information cannot be even seen. (4) Lack of visible report: In various mechanical accounting methods, some printed reports are received. While in certain methods, printed reports are not available. Lot of information is stored in the machine which can be read only through computer. (5) Information and process can be easily known: In mechanical accounting methods, with the help of computer, information retrieval and processes become easy and quick. Therefore, if effective internal check has not been arranged by the unit, there is a possibility of tempering, with the information. If an unauthorized person gets its information, there can be many frauds and misappropriations with the information available in it as well as its process. (6) Constant Procedure: Mechanical procedure is more trustworthy than the procedure depending on human beings. It works constantly according to the pre-set programme. On the contrary, if a wrong programme is fed, it works continuously according to that programme as a result errors are continued. (7) Programme Check: In mechanical method, much of control process is liked with programme and this process is arranged in such a way that it can be rarely seen. Suppose an unauthorized person tries to add or get information, computer will demand password. Many such checks have been arranged like limitation of printing the copy of report, specific verification on information etc. (8) Every side of a transaction and its information gives its effects in the mechanical file: In mechanical accounting method, if you enter one transaction, instantly it affects to related all places e.g. If goods is received, effect of this transaction is seen in purchase account, in the account of goods supplier, in stock account and in cash or bank account. If any wrong entry is done, many wrong entries will be passed under different account heads. (9) Medium for information and programme storage: Vast information and numerous computer programmes are stored in the small and portable, fixed storage media like CD and floppy etc. Of course, there is a risk of theft of these media. It may be lost or destroyed in accident. (10) Use of Code: In order to clarify name and details of cmputerised methods, code number is used at a large scale. Auditor should know about all these. It can create problems many times particularly, in the beginning stage, as there is lack of detailed description, it is specially difficult to understand different transactions.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Q. 2 Discuss internal control in computerized accounting. What is common EDP control? Describe in detail. (Sau. Uni. 2006) Control over the use of computer. (Sau. Uni. 2000, 2002) Ans. In computerized accounting system, control is necessary for the proper maintenance of information. Of course, in certain methods, internal control has been properly arranged. The principles of control which are applied in the method depending on human beings are applicable to computerized accounting method also. Like planning of organization, entrusting power and method of clarification, allocation of duties etc. are some of the examples. Moreover, some special controls are necessary in computerized accounting method. In internal control process, human based process and programme based process, both are used in data processing which is divided into two parts: (1) General control in computerized accounting system (2) Control over processing in data processing Object of general data processing is to create a format for General Control system. For general control in data processing allocation of duties, maintenance of software, control over development process, control over the use of stationery, control over data entry and programme, file control, ancillary arrangement for security, etc. are included. (1) Allocation of duties and responsibilities: Generally, data processing section is very small. There will be less employees in it. So, it is necessary to allocate every employees duties and responsibilities clearly. In possible responsibility of designing system, responsibility of processing, exerting and maintaining responsibility, of maintaining information and its storage should be allocated to different people, otherwise because of less number of people, possibility of frauds and misappropriation increases. For clear allocation of duties and responsibility, organization of computerized accounting system department is arranged. Let us examine it. Frauds or misappropriation are committed by unauthorized person or many times by the computer operator also. Therefore at the same time, arrangement for personal verification should be done. (2) Control for development and maintenance of software: It is necessary to have specific control for development and maintenance of software. If application software or system software is to be developed or used, it should be done through an authorized and efficient person. Documents which are required for the development of the latest process should be clear. If possible, it should be human based. The construction of the method should start with input, through master file, it should pass through process and reach output. The whole process starting from input to output should be clear. For programming, proper documentation should be followed. Information for it should be given while programming. There should be a detailed description of control process in programming. There should be details for operation. List of instructions of programming should be ready for proper verification of information should be done. There should be a complete control over programme by system and proper care should be taken so that unauthorized person will not be able to play mischief with programme in any circumstances. After authorized verification of programme. Its analysis should be checked, one copy of it should be stored at some other place and if there is any necessity of change in the original programme, it should be done by data processing manager only. Thus beforePrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ using the system practically, should be verified completely, and in the same way, before its application, responsibility of authorized person should be fixed. (3) Control over operator: Certain controls depend on the utility of human beings and preparation. Man is useful in time table and operating instructions. Operating logs are possible after personal verification at certain time intervals. Duties of operator should be order wise and as far as possible, there should be at least two operators. (4) Routine errors: If process is properly followed, errors can be avoided, Errors should be corrected under the observation of supervisor. Auditor should also verify errors. Indicators showing errors make internal check more powerful. Auditor should also pay attention to such errors which were not detected at first sight. (5) Control over stationery: There should be a proper process to obtain stationery, particularly so, when stationery is related to pay order, cheque etc. specific procedure is required for control. (6) Control on data entry and programme: A specific arrangement should be made to see that only an authorized person can feed the transactions into computer as well as only an authorized person should be able to make use of the software and only that specific person should have the authority to do so. (7) Control and maintenance of data files: It is necessary to have an extra arrangement for the maintenance and storage of data because many times by accident data gets destroyed or lost. C.D., magnetic tape etc. can be destroyed by fire and also data in it might be destroyed or damaged. So, storage system should be properly arranged. Many times it is possible that stored information (data) gets deleted because of operators mistake. So, to avoid such errors, floppy and disc should be labeled properly. Computer centre should have proper arrangement for storing data. Documents and files should be properly stored, so that even if data is lost and destroyed by accident, it becomes possible to get original data again, therefore, original data, documents of sources should be stored outside the computer centre. Generally, file is stored in three copies in floppy or disc. This is known as son, father and grandfather concept. This means today, data is entered and copied in the disc. Next day, the data is added in the copied disc and other opy of copied disc is made. Thus, data is preserved in three generations. This means, if the data of the first second and third day is destroyed, it can be obtained immediately and used also. (8) Control over embezzlement in data processing system: Data processing method possesses vast electronic and mechanical thought and error or misappropriation is possible in any part as a result of which process appears to be full of mistakes and method took full of misappropriation. Certain steps for control are taken in the method which can be divided into 5 points Useless or similar words, copying, eco. Verification, verification of instrument etc. Useless word is joined with data item so that errors can be defected. It is related with basic features of data and development. In copy process, same data is processed again and it is verified by comparison with original process. In eco. Verification, checking is done on the input and output plans. In the same way instrument is verified too. (9) Protection and safety:Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ Data processing equipments must be properly insured. Not only hardware but important documents and data can be damaged by accident or error of man. Such unplanned arrangement is damaging to the firm. Many times careless employees also damage data and programme files. So, proper arrangement for their safety must be verified. Verification & Evaluation of Assets and Liabilities Q.1 What is verification of assets? How does it differ from vouching? (Sau. Uni. 94, 97, 98, 99, 2005, 2007, 2008, 2009, 2011) What is verification of assets? How does it differ from vouching? What are the duties of auditor regarding verification of assets ? (Sau. Uni. 92, 2000) What is verification of assets? Describe auditors duties regarding it. (B.U. 2004) Explain the meaning of verification of assets. Describe the points to be kept in mind by the auditor while verifying and evaluating assets. (Sau. Uni. 90, Oct. 98) Differentiate: Verification and Vouching. (Sau. Uni. 95, 96, 2001) Ans. 1. Meaning of verification and valuation of assets and liabilities: Careful verification means checking the following points: Whether the assets shown in the balance sheet really exist or not. The assets are in the name or the unit or in the name of any person? Whether any liability is there on it or not ? Whether its valuation has been done as per the accepted principles or not ? In brief examining existence, possession, ownership, valuation and liability of CHAPTER: 5 COMPANY AUDIT - 5Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ assets is called verification. Now, let us examine various definitions regarding verification given by famous writers. According to the definition of verification given by Shri. J. Prakash, Verification means such a procedure in which auditor is satisfied about the existence, ownership, valuation and authenticity of assets shown in the balance sheet after the real verification. According to the opinion of Spicer and Pegler, Verification means verification of the valuation, ownership and rights, existence and possession of assets and if there is any liabilities on assets. In verification, vouching of assets and existence, ownership of assets are verified. Moreover, verification includes valuation. On the basis of definitions given above, here are the characteristics of verification : In verification of assets, assurance of the following is included Existence and possession of assets; Ownership and rights of assets; Valuation of assets; and If there is any liability on assets? 2. Points to be considered during the verification of assets and liabilities: While carrying out verification of assets and liabilities, following directive principles of verification should be considered: (1) If the assets shown in the balance sheet are purchased in the previous years, then it should be verified on the basis of last years balance sheet. But if the assets have been purchased during the current year, deep examination is necessary. It should be checked whether asset has been purchased for the purpose of business? Also authority of purchasing, copy of resolution, have been purchased after the proper process ? Purchase bill, payment receipt etc. details should be checked minutely. (2) If any asset has been sold out or discarded during the year, authority regarding it, copy of resolution, proper proceeds, sales-figures, profit or loss due to sales, entries of these etc. should be examined in detail. (3) During the verification of assets, types of assets should be considered. In comparison to current assets, verification of fixed assets is easier but current assets are changeable. So, it can be converted in cash. As it is not fixed, it goes on changing now and then. So, more care should be taken in its verification. Generally, in rare cases, auditor comes for verifying accounts at the end of the year means on the date of preparation of balancesheet but once the annual accounts are ready, a convenient date for both the parties is fixed and auditor comes for verification and there would be a difference between the current assets of that date and current date of balance sheet. Naturally, stock has been used, debtors are reduced, cash is increased or opposite condition prevails. This means current assets showed in the balance sheet on the date does not match with the current date showed on the date of account checking by the auditor. From the date of balance sheet to the date of checking of accounts, it should be checked how much balance is left on the basis of transactions in the books. Moreover, it is necessary to be careful concerning movable assets e.g. when cash has been paid at different places, when auditor goes to calculate cash at other place after getting cash figures from one place, meanwhile it is possible that he used amount to fill up the difference in cash from the earlier calculated amount. In the same way, if any asset hasPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ been mortgaged, effort is made to show that there are no liabilitie4s on assets by releasing those mortgaged assets with the help of assets that have been verified by the auditor. In order to prevent this type of frauds, current assets and movable assets should be verified together. (4) Physical verification of assets should be done according to the register of fixed assets. It would become difficult for the auditor to check technical type of assets because we cannot expect knowledge about technical aspects from auditor regarding different subjects. So, for such matters, auditor should depend on the certificate of the responsible officer. If there is any doubt regarding this, auditor should ask for the advice of an expert and then give his own opinion. (5) According to the provisions of Companies Act, it is necessary to have provision for depreciation on the fixed assets. Before allocating dividend, company should arrange for the provision of depreciation according to the section 205 and section 350 of Companies Act. Auditor should specially examine this. (6) It should be carefully verified whether valuation of assets has been done according to the accepted principles of valuation or not ? Moreover, it should be checked that without reason, there is no change in the method of valuation. (7) Immovable assets should be showed under the following heads under partI, of schedule-VI of Companies Act: (i) Goodwill (ii) Land (iii) Building (iv) Leasehold assets (v) Railway- siding (vi) Machinery and Plant (vii) Furniture-fixture (viii) Asset development expenditure (ix) Patent, trademarks, patterns copy-right (x) Live Stock (xi) Vehicles. (8) If any assets have been mortgaged, certificate of the ownership should be verified. (9) It should be verified that the allocation of capital and revenue expenditure has been properly allotted or not ! 3. Auditors duties concerning verification : Auditor should check the accounts very carefully and skillfully as per the study of accepted principles and objects of verification presented above. Following brief details will be useful : (1) When new assets are purchased for business, it should be checked that it has been purchased for business purpose authentically after following proper procedure. (2) If assets have been purchased previously, balance showed in the last years balance sheet and if any expense has been incorrect for improvements, it should be verified with the balance of asset shown in the current balance sheet. (3) Physical existence and possession of asset should be verified. (4) The ownership of assets is that of the institute or not? Should be verified. (5) It should be ascertained whether the valuation has been carried out according to the accepted principles of valuation or not. (6) Is there is any liability or if the asset is mortgaged, it should be verified. (7) It should be carefully verified whether the allocation of capital and revenue expenditure has been done properly or not? (8) It should be verified whether the assets are properly shown in the balance- sheet according to provisions of Companies Act.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+ (9) Like assets, Liabilities to should be properly checked. Auditor has to follow his duty very carefully and minutely. If he shows carelessness or negligence, he is held responsible. Many Judgments have been passed showing auditors responsibility. A few interesting references are presented below. In the case of London Oil Storage Co. Ltd. V/s. Seer Hasluck & Co., the auditor was careless in the verification of assets. Auditor had failed to verify the cash on hand. Cash on hand shown in the balance-sheet was 796 Pounds, while actually cash on hand was only 30 Pounds. While announcing the judgment of this case, Justice Mr. Alverstone said that it was the duty of an auditor to verify the assets shown in the balance sheet. If auditor failed in his duty, he will be considered liable for any damage suffered by the client. In the case of City Equitable Insurance Company Ltd., the company did not possess the documents of securities. The auditor did not verify the security physically. In fact, these documents were with the broker of the company named Mr. Elis and he had received money for his personal objective on security documents. As a result, the company suffered losses later n. In this case, Justice Mr. Roman had specifically motioned that if the securities of the company are found in the possession of such a person, generally who is not entrusted with the responsibility of securities of the company and if the auditor himself has not personally verified it and did not submit a report in this regard, then his work cannot be forgiven. Vouching and Verification: (How do vouching and verification differ?) As vouching and verification both are the processes of examining accounts, there is possibility of misunderstanding them as synonyms of each other. But difference is seen among them. As the scopes of vouching and verification are not the same, it is necessary to understand the difference between them. There are differences between vouching and verification from the view point of definition, time, scope, valuation, working method, phase etc. These differences can be clarified by the following table: Verification Vouching 1. Definition : Verification means checking with regards to existence of assets and liabilities, as well as possession, ownership, valuation and liability. 1. Vouching means verifying an entry in the book of account with supporting documentary eviden