Guidance Notes-Part 2 IPCC Paper 6, Auditing & Assurance, Volume 2

CA. Anurag Singal

5. Guidance Note on Audit of Cash & Bank Balances

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Features of Cash & Bank Balances with an impact on the related auditing procedures

Cash and bank balances may constitute a significant proportion of the total assets of an entity

These assets are highly prone to misappropriation, misapplication and other forms of fraud.

Audit Evidence w.r.t. Existence, Rights and obligations and Completeness

Internal Control Evaluation

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Segregation of duties relating to authorisation of transactions, handling of cash/issuance of cheques and writing of books etc

Proper authorisation of cash and banking transactions

Daily recording of cash transactions

Safeguards such as restrictive crossing of cheques, use of pre-printed, pre-numbered forms

Periodic reconciliation of bank balances

Reconciliation of cash-on-hand with book balance on a daily basis or at other appropriate intervals, including surprise checks by higher authorities

Safe custody of cash, cheque books, receipt books etc

Verification of Cash Balances

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The auditor should carry out physical verification of cash at the date of the balance sheet

If this is not feasible, physical verification may be carried out, on a surprise basis, at any time shortly before or after the date of the balance sheet.

All cash balances in the same location should be verified simultaneously

If IOUs (‘I owe you’) or other similar documents are found during physical verification, the auditor should obtain explanations from a senior official

If entity is consistently maintaining an unduly large balance of cash- on-hand, he should carry out surprise verification of cash more frequently to ascertain whether the actual cash-on-hand Vs books

Verification of Bank Balances

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Advise the entity to send a letter to all its bankers to, directly confirm the balances to the auditor

Examine the bank reconciliation statement prepared as on the last day of the year

If post-dated cheques are issued by the entity, verify whether any cheques pertaining to the subsequent period have not been accounted for as payments during the period under audit

Pay special attention to those items in the reconciliation statements which are outstanding for an unduly long period

If large number of cheques has been issued/deposited in the last few days of the year, and a sizeable proportion of such cheques has subsequently remained unpaid/uncleared, this may indicate an intention of understating creditors/debtors or understating/overstating bank balances

Examine and Ensure that Valuation and Disclosure is as per

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Recognized accounting policies (e.g. AS 11 for foreign currency held as cash-in-hand and bank balances designated in foreign currencies)

Accounting practices Relevant statutory requirements

Illustrative Letter of Confirmation – Bank

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[Letterhead of Entity] [Name and Address of Bank] [Date] Dear Sirs, Please send directly to our auditors ......................... (name and address of the auditors) details of balances as at the close of business on [date] .................... of all our accounts with you as well as details of charges held against such balances, with a copy to us. For your convenience, we enclose in duplicate a form in which details of our balances with you can be filled in. If you find the spaces on the form insufficient to contain all the relevant information, please attach a separate statement. Please note that this request covers all our accounts with you as at the above-mentioned date, including any dormant accounts. We would also request you to give particulars of any of our accounts closed during the year. We would request you to state “Nil”, wherever applicable. Yours faithfully, (Signature of person authorised to operate accounts)

6. Guidance Note on Audit of Miscellaneous

Expenditure (Revised)

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Items that Normally Constitute ‘Miscellaneous Expenditure'

Preliminary expenses

Expenses including commission or brokerage on underwriting or subscription of shares or debentures including discount allowed on the issue of shares or debentures

Research and development expenditure

Features of Miscellaneous Expenditure with an Impact on the Related Auditing Procedures

The items of expenditure included under this heading do not represent any tangible asset

Expenditure on these items is usually of a non-recurring nature

Deferring the expenditure is justified as benefits from the expenditure can reasonably be expected as flowing into the future

Balance in these items reduces each year by the amount written-off in the year

Auditor’s primary objective in audit

Whether it is proper to defer the expenditure shown in the balance sheet under the head Miscellaneous Expenditure?

Whether the period of amortisation of the expenditure is reasonable?

Expenditure shown to have been incurred during the year actually occurred during the year and there is proper authority for the expenditure and for its deferral

Criteria which previously justified the deferral of the expenditure continue to be met

Expected future revenue/other benefits related to the expenditure continue to exceed the amount of unamortized expenditure

Proper application of Accounting Standard -26 has been made?

Internal Control Evaluation in Respect of Misc Exp

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There should be a system of control over expenditure incurred (Budgeting/ Proper Authorisation)

Accountability should be established over each item (up-to-date maintenance of proper records )

Reliable information (including reports of experts) is available for assessment of the results achieved against the objectives

Verification

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Nature, timing and extent of substantive procedures to be performed : -

are matters of professional judgment of the auditor

based, inter alia, on the auditor’s evaluation of the effectiveness of the related internal controls

E.g. Preliminary Expenses , Expenses Related to Subscription or Issue of Shares , R&D Expenditure

Disclosure

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Adequate disclosures as required by AS 26

Whether financial statements disclose the accounting policy with regard to miscellaneous

expenditure?

7. Guidance Note on Audit of Liabilities

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Introduction

Liabilities are the financial obligations of an enterprise other than owners’ funds

Liabilities include loans and borrowings, trade creditors and other current liabilities, deferred payment credits, instalments payable under hire purchase agreements, and provisions

This Guidance Note also deals with contingent liabilities

The audit of liabilities is primarily directed at ensuring that all known liabilities have been properly recorded and stated at fair and reasonable amounts

Features of Liabilities with an Impact on the Related Auditing Procedures

These are represented only by documentary evidence

which originates mostly from third parties in their dealings with the entity

Internal Control Evaluation in Respect of Liabilities (Loans and borrowings (including advances and deposits)

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Check the borrowing powers and limits; persons authorised and competent to borrow , terms of borrowings etc

Any variations in the terms of loans and borrowings should be truly approved

Security offered against loans and borrowings should be properly recorded and periodically reviewed

The records and documents should be kept in proper custody and reviewed periodically

Bring out all cases of non-compliance with terms and conditions including amounts of principal and/or interest which have become overdue

Internal Control Evaluation in Respect of Liabilities (Trade Creditors)

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Ensure proper recording of transactions and facilitate the linking of payments with outstandings

Payments made to creditors should be in line with the approved policies

Specific procedures for payments against duplicate invoices /unclaimed amounts since long time

Statements of account should be called for creditors at periodic intervals and the discrepancies, if any, should be duly investigated and reconciled.

Adjustment for claims for returns, defectives, short receipts of goods, rebates, allowances and commissions etc., should be authorised

Verification

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Nature, timing and extent of substantive procedures to be performed : -

are matters of professional judgment of the auditor

based, inter alia, on the auditor’s evaluation of the effectiveness of the related internal controls

Verification –Key Methodologies

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Examination of records;

Direct confirmation procedure

Examination of disclosure

Analytical review procedures

Obtaining management representations

Documentation

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The auditor should maintain adequate working papers regarding audit of liabilities and contingent liabilities

He should maintain on his audit file, confirmations received as well as any undelivered letters of request for confirmation.

The management representation letter w.r.t.contingent liabilities should also be maintained on the audit file

8. Guidance Note on Audit of Revenue

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Introduction

Revenue is the gross inflow of cash, receivables or other consideration from

Sale of goods, rendering of services, and use by others of entity resources yielding interest, royalties and dividends

Occurrence

• Recorded revenue arose from transactions which took place during the relevant period and pertain to the entity.

Completeness • That there is no unrecorded revenue

Measurement

• That revenue is recorded in the proper amounts and is allocated to the proper period

Presentation and Disclosure

• That revenue is disclosed, classified, and described in accordance with recognized accounting policies and practices and relevant statutory requirements, if any.

Key Assertions:

Internal Control Evaluation in respect of Revenue

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The systems and procedures relating to generation of revenue including authority to fix prices, offer discounts and other terms of sale

Accounting procedures relating to recognition of revenue

Existence of periodic reports on actual performance vis-à-vis budgets

Verification –Key Methodologies

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Examination of records- whether the basis of recognition of revenue by the entity is in accordance with Accounting Standard (AS) 9, Revenue Recognition?

Analytical review procedures such as comparison, product-wise and location-wise, of revenue; ratio of gross margin to sales , ratio of excise duty/sales tax/export incentives to sales etc

Whether the transactions of sale of goods, materials and services

Under contracts or arrangements entered in the register(s) maintained under section 301 of the Act and

And exceeding the limits specified in the Order ( Rs 50,000 p.a.)

Have been made at prices which are reasonable having regard to prevailing market prices for such goods, materials or services

CARO Reporting Requirements in Case of Company

Documentation

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The auditor should maintain adequate working papers regarding audit of revenue

9. Guidance Note on Audit of Expenses

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Features of Expenses with an Impact on the Related Auditing Procedures

In the case of most items of expenses, documentary evidence originating from third parties is available

The nature and relative significance of various items of expenses usually differ from one enterprise to another (Importance of Labour and Overheads in a Manufacturing via-a-vis Trading)

Logical relationship exist between items inter-se ( e.g. consumption of raw materials to output)

Occurrence

• Recorded expenses arose from transactions which took place during the relevant period and pertain to the entity.

Completeness • That there is no unrecorded expenses

Measurement

• That expense is recorded in the proper amounts and is allocated to the proper period

Presentation and Disclosure

• That expense is disclosed, classified, and described in accordance with recognized accounting policies and practices and relevant statutory requirements, if any.

Key Assertions:

Internal Control Evaluation in Respect of Expenses

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The systems and procedures relating to incurring of expenses including authorisation procedures

Accounting procedures relating to recognition of expenses.

Existence of periodic reports on actual performance vis a vis budgets and internal management reports, if any

Verification –Key Methodologies

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Examination of records- validity, accuracy and other assertions with regard to various expenses incurred by the entity?

Analytical review procedures : Analysis of significant ratios and trends, including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or which deviate from predicted amounts

Managerial remuneration paid or payable by the company is within the limits laid own under section 198 and Schedule XIII to the Companies Act, 1956

Contributions, if any, made by the company to charitable and other funds not directly relating to the business of the company or the welfare of its employees comply with the provisions of section 293 of the Companies Act, 1956

Political contributions made by the company are within the limit prescribed in section 293A of the Companies Act, 1956

Contribution, if any, to the National Defense Fund etc u/s 293B

Auditor’s Reporting Requirements in case of Company

In respect of payments to sole-selling agents, the auditor should examine whether the provisions of sections 294, 294A and 294AA

Compliance with the provisions of section 297

Compliance with provisions of section 314 for partner or relative of a director of the company etc holding office or place of profit under the company

Whether any personal expenses have been charged to revenue account.

Auditor’s Reporting Requirements in case of Company-2

Whether the transactions of purchase of goods, materials and services

Under contracts or arrangements entered in the register(s) maintained under section 301 of the Act

And exceeding the limits specified in the Order ( Rs 50,000 p.a.)

Have been made at prices which are reasonable having regard to prevailing market prices for such goods, materials or services

CARO Reporting Requirements in case of Company

Whether any undisputed amounts payable in respect of income tax, wealth tax, sales tax, customs duty and excise duty

were outstanding as at the last day of financial year concerned,

for a period of more than six months from the date they became payable

CARO Reporting Requirements in case of Company-2

10. Guidance Note on Provision for Proposed

Dividend

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Introduction

This Statement summarizes the Council’s view regarding the responsibility of the auditor relating to the provision for and disclosure of proposed dividend

The Council is of the view that a proposed dividend does not represent a liability nor does it amount to a provision, pending the approval of the shareholders in General Meeting

Since the meeting to approve the accounts would take place after the Balance Sheet date, there could not be any liability in respect of the proposed dividend on the date of the Balance Sheet

The Council is of the opinion that merely because the form requires proposed dividend to be shown under “Current Liabilities and Provisions”, it does not mean that in fact the proposal for the dividend becomes a liability or is necessarily a provision

Council’s Recommendation

The Council, therefore, recommends that the fact that provision for proposed dividend has not been made should be disclosed by means of a note in the accounts

The auditor should refer to the note in his report and make his report subject thereto

Thank You

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