Q. 1. A] Define and explain the term Auditing ? [ A – 97 ]
B] What are the principles of Auditing ? [ A – 97 ]
C] Distinguish between Accounting & Auditing . [ A – 98 ]
Ans :
A] 1. Prof. Dicksee defines the term as “An examination of accounting records with a view of establish whether they correctly and completely reflect the transactions to which they purport to relate”.
2. Prof. Robert R. Coomber says “Modern audit is verification of financial statements, usually a Balance Sheet and Profit and Loss Account in the light of certain principles of accounts to establish whether or not, it is a true and correct statement drawn”.
3. Splcer and Pegler have defined an audit as “ such an examination of books of accounts and vouches of a business, as will enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and whether the profit and loss account gives a true and fair view of the profit/loss for the financial period, according to the best of information and the explanation given to him and as shown by the books, and if not, in what respect he is not satisfied”.
4. Montegomery defines auditing as “ A systematic examination of books and records of business or other organisation in order to ascertain or verify or report the facts regarding its financial operations and the results thereof.”
Thus from the above definitions the following is clear :
1) Auditing means and involves a systematic, critical and intelligent examination of Books of Accounts.
2) This is done by an independent person or body of persons qualified for the job.
3) With the help of vouchers, documents, information and explanations received from the authorities, the auditor may satisfy himself with the authenticity of financial statements prepared for a fixed term and ultimately report that they exhibit a true and fair view of the state of affairs of the business.
Thus, auditing is not only “ticking” the figures appearing in the books of accounts and seeing the arithmetical accuracy, but also confirming that the figures appearing in the financial statements reflect the true position.
B] Principles governing Auditing :
Auditor being a professional and responsible person has to keep in mind several principles and guidelines :
1. Integrity : Auditor should be sincere and honest to his work.
2. Objectivity : Auditor should not be bins, he has to present the facts without any personal feeling or opinion.
3. Independence : He should be impartial to all the parties – internal or external.
4. Confidentiality : Unless required by the competent authority the auditor should not disclose the information to any party on person.
5. Skill and competence : Though auditor has acquired specialised knowledge and skill in the
subject, he should continuously be aware of the developments on accounting and auditing matters and laws pertaining to it.
6. Work of Subordinates : Auditor is responsible for the work carried out by his assistants and even when he makes use of the work performed by other auditor. He can rely on the work of auditor exercising proper care and skill. It is in his interest to point out such reliance while expressing opinion.
7. Documentation : Auditor should keep the record of the documents used as evidence while performing audit.
8. Planning : Audit becomes effective only if performed efficiently and without delay. Skilled persons are required for carrying out the work efficiently. At different stages of work the proper planning in advance will pave the path of perfection and success.
9. Evidence : Audit report expresses opinion of the auditor. Opinions are based on drawings of conclusions. Conclusions are drawn on the basis of evidences. Evidences should, therefore, be checked to assure that they are in effect and are complete, reliable and valid.
10. Accounting system and control : The functioning of the accounts department, i.e. accounting system should be set up in such a way that each piece of work is subject to control. It should be checked by some other person. Such control should be reliable, otherwise he has to carry out detailed checking .
11. Conclusion and Report : Conclusions drawn by auditor should be based on :
a) his examination of books and records,
b) information provided to him,
c) acceptable accounting policies adopted by the organisation.
d) legal requirements and
e) disclosure whether substantial or negligible.
C] Distinguish between Accountancy & Auditing :
Accountancy Auditing
1. Definition :
Accountancy is recording of all the day -to-day Auditing is an examination of these data and the
transactions in books of accounts, classifying them financial statements. It is also to see how they have
and summarising them in the form of financial adhered to the management policies and generally
statements. accepted accounting principles.
It is collection of data, and then classifying and It is a critical examination of the data prepared
summarising them and then converting them in and presented by the accountant.
understandable forms.
2. Objectives :
Main objectives is to prepare books of account and Main objectives is to examine the books of accounts
finally to find out the result (profit or loss) of the and financial statements for the ultimate objective
business for the year and its financial position as at of certifying the financial statement as per the laws
the close of the year. in force from time to time.
3. Scope :
Maintenance of the books of accounts, preparation Examination of books of accounts and the financial
of the final financial statements. But the scope statements and reporting thereon as per the laws in
does not go beyond the books of accounts. force. This may be beyond the books of accounts.
4. In- charge and his Qualifications :
Accountant is in charge. He need not be a qualified Under the statues, whenever prescribed, the auditor
person, but should have knowledge of book-keep- should be a practicing Chartered Accountant.
ing and accountancy.
5. Nature of Work : Auditor verifies and examines these books and
Accountancy feeds all the details for preparation of financial statements and reports thereon.
all the financial statements for the management for
their present use as well as for future policy
decisions and also for the auditors to enable them
to report thereon.
6. Statements :
Accountancy will ultimately bring out books of Auditor examines these books of accounts and the
account and the financial statements which may financial statements and detects frauds and errors
contain frauds and errors – intentional or unintenti- before reporting on the same.
onal,
Accountant may afford to commit errors and Auditor cannot afford to commit errors and
frauds. frauds.
7. Reporting :
Accountant has to prepare the final accounts and Auditor has to examine the final accounts and
the financial statements from time to time. He will financial statements. He has then to give his report
explain them to the management but has not to thereon.
report thereon. He has also to present these
accounts to the auditor for his report thereon.
Q. 2. A] What is an error ? What are the different types of errors ? [ A – 88 ]
B] What are the measures for detection and prevention of errors ?
Ans :
A] An error is a mistake usually not a deliberate act. It represents a fault in the work or an improper completion of work. It is not willfully made but it arises during the course of work due to fatigue, ignorance, human tendencies etc. If any mistake is deliberately made, with any particular purpose, it is fraud & not an error.
In accounting, the errors are mainly of the following types : 1. Errors of omission, 2. Errors of commission, 3. Errors of principle, 4. Errors of duplication, 5. Compensating errors.
1. Errors of Omission : There can be partial omissions or complete omission. When a transaction is partly unrecorded it is an error or partial omission and when a transaction is fully unrecorded it is an error of complete omission e.g. a purchase is recorded but creditor’s account is not credited, it is a
partial omission. Trial balance remains untallied in this case. When a complete purchase transaction is omitted, the debit to the purchase account is omitted and correspondingly an equal credit of the supplier also omitted. Thus, both the debit and credit effects are omitted equally and the arithmetical accuracy of the trial balance is not affected. As this has no effect on trial balance, it is difficult to locate such errors.
2. Errors of Commission : When the transactions is wrongly recorded in the books of accounts, it is error of commission e.g. wrong amount, wrong totalling, wrong carry forward of total etc. If the whole entry is passed with wrong amount, trial balance will still tally and the error is difficult to detect. But if totalling or carry forward is wrong, it leaves the trial balance untallied e.g. the amount of Rs. 214 in the books of original entry, if posted into ledger as Rs. 124, it will be an error of commission. In this case, trial balance will not tally.
If a purchase transaction is entered wrongly in the sales book or vice-versa, it will also be example of error of commission.
3. Errors of Principle : When the basic principles of accountancy are violated, it results in error of principle e.g. taking credit of unrealised profit, not providing for expected liabilities, wrong allocation of expenditure/income between Capital and Revenue, Stock valuation at a price higher than cost etc. These are the most important kinds of errors and they are not reflected in a tallied trial balance. These errors make the accounts unrealistic. Mostly these errors arise out of ignorance. Since they affect the true and fair view of the business to a significant extent, these errors must be properly rectified.
e.g. the valuation of stock, which is not made as per the basic principles of accountancy, will not be a correct valuation.
If depreciation is not provided as per the rules, such provision will not be correct provision and it will be an error of principle.
4. Errors of Duplication : Where the same transaction is recorded twice by the clerk concerned and the same is also posted twice in the ledger, it will be an error of duplication. Since both the debit and the credit effects are posted twice in the ledger, trial balance will tally, so, these are difficult to trace in the trial balance.
5. Compensating Errors : A compensating error consists of two errors that cancel out the effect of each other e.g. a short debit of Rs. 200 in one account is accompanied by a short credit of Rs. 200 in another account. The trial balance still tallies. This error is therefore a bit difficult to detect.
The Auditor has to be cautions enough to detect such errors otherwise the true and fair view of the business, is not reflected in the financial statements.
B] Steps to be taken for locating the errors :
If the Trial Balance of a firm does not agree then the auditor should take the following steps for locating the errors :
1. The debit and credit totals of the Trial Balance may be re-checked.
2. The next step should be to make sure that the balances or totals of all the Ledger Accounts have
been correctly shown in the Trial Balance.
3. If mistakes remain undetected make sure that all the closing balances from proceeding year’s balance sheet were correctly carried forward and recorded in respective accounts in the Ledger.
4. The totaling and balances of all Ledger Accounts should be done again so as to be sure that there is no mistake on that account.
5. If the mistake remains undetected then the next step is to find out the exact difference in Trial Balance, and to see from Ledger if any account shows this balance.
6. The totaling of schedule of debtors and creditors to be rechecked and find out that all the balances have been included in the list.
7. Check all the figures which are badly written.
8. If the differences is in round sums, if may be advisable to check castings and carry forwards. But if the difference is odd sum the balancing may be minutely checked.
9. Divide the difference by 2 in order to find out wrong placing of balance of some account in the Trial Balance.
10. The difference should be divided by 9. If the difference is evenly divisible by 9 the error may due to transpostation of figures.
11. Even then if error is not detected then all accounts should be checked thoroughly.
Prevention of Errors : If an auditor finds that the Internal Check System in an organization is inadequate to prevent errors to the minimum extent possible he will suggest to his client suitable measures to be adopted to strengthen the Internal Check System. Thus auditing also helps in preventing errors in accounting work of an organization to the minimum extent possible. Again, the account clerk will record the transactions very carefully, if they know their works are to be checked by an independent auditor. As a result, errors will be minimized. In this way, auditing helps in preventing errors as far as possible.
Q. 3. A] What is a ‘Fraud’ ? What are the different types of frauds ? [A – 97]
B] What are the duties of an auditor in respect of fraud ? [A – 97]
C] What are the circumstances which arouse auditor’s suspicion for frauds ? [A- 88]
Ans :
A] According to R.K. Mautz, fraud is a type of error with an intention of deceiving others. The classification are as follows :
1. Ignorance on the part of accounting department employees :
a) of generally accepted accounting principles,
b) of appropriate account classification,
c) of the necessity of reconciling subsidiary ledgers with controlling accounts and
d) of good accounting practice in general.
2. Carelessness on the part those doing the accounting work.
3. A desire to conceal the effect of defalcation or shortages of one kind or another
4. A tendency of the management to permit prejudice or bias to influence the interpretation of
transaction or events or their presentation in the financial statements.
5. An ever-present desire to hold taxes on income to minimum
6. A sixth cause may be added to those Mr. Mautz has listed and that is more serious in nature. It is the international effort committed by person in position of authority to :
i) Show up the picture depicted by the statement ;
ii) Depress the picture depicted by the statement ; &
iii) Convert the error to personal benefit.
Fraud means a false representation or entry made in the books of account intentionally or without belief in its truth, with a view to cheat some person and to benefit the person who committed the fraud. Fraud may be committed by doing any of the following :
FRAUD
1. Misappropriation of : 2. Manipulation of Accounts
i) Cash ii) Goods iii) Assets
1. MISAPPROPRIATION :
i) Misappropriation of cash : Misappropriation or defalcation of cash is a very easy affair. Anybody with a little skill on his part can misappropriate money, especially in a big business house where the contracts between the proprietor and the person handling cash are not so close as in the case of a small proprietary business. A transaction relating to the receipt of cash may either go tally unrecorded or recorded at a figure less than the actual one in the cash book, thus, the total or a part of the cash may be pocketed by cashier.
The following are some of the examples of misappropriation of cash :
a) Sales : i) omitting to record sales and pocketing money received from customers.
ii) teeming and lading, e.g. : concealing money received from one customer and entering in his account the cash received from another ;
iii) Making fictitious entries for the discount, return, bad debts, etc. in the customer account ;
iv) Omitting to enter cash received from the sales ;
b) Purchase v) recording fictitious purchase and thus, misappropriating the cash
involved
vi) suppressing credit notes received from creditor for purchase return and discount ;
c) Receipt of cash vii) concealing cash received or miscellaneous or extraordinary account
(e.g.) for sales of some rejected stock or from debtor declared previously as bad debt, etc.) ;
d) Payment viii) misappropriating money shown as wages in the wages sheet by
entering dummy names of worker therein.
ii) Misappropriation of goods : Goods may be moved out of factory premises or godowns without a proper entry of the same, and are sold privately. Then it is name as misappropriation of goods.
Likewise, good s might be shown in the books as purchased for more quantity but actually less quantity is entered thereby selling the balance outside privately and not according for such sales.
Showing the goods as damaged or obsolete etc. and taking out the same and realizing the same without recording the same.
While delivering the goods on a sale invoice or delivery challan more goods may be moved out than is specified in challan etc. This method is called as issuing a quantity of goods more than invoiced.
iii) Misappropriation of Assets : This type of fraud is usually committed by the management. This may be in any of the following ways.
1. After asset is purchased, it may remain in possession of the person in management for his personal use.
2. Assets may be depreciated year after year till it comes down to zero value. It is thereafter, not shown in the books of the account and sold which is pocketed.
3. Assets may be sold obtaining cheque for the part of the amount, balance being received in cash which is misappropriated.
2. MANIPULATION OF ACCOUNTS :
The falsification of account is not so common as the misappropriation of cash or goods. The accounts of business can be falsified by making false entries in respect of fictitious sale or purchases. It is true that whenever such a class of fraud occurs, it involves usually very large amounts and it can be detected with a great difficulty by the auditor because such frauds are committed by high official of a business, viz. director, managers, or other responsible person.
There are normally two object behind this type of fraud :
a) Showing more profit than the actual
i) to earn more commission on profit if they get it on profit basis ; or
ii) to win the confidence of the shareholders by claiming that higher profits are a result of their efficiency ; or
iii) to fetch high price for their shares as high profits will lead to the declaration of more dividends, or
iv) to enjoy better reputation in the market by showing more sound financial position than what it actually is ; or
b) Showing less profits than the actual ones so as
i) to mislead income-tax authorities and to reduce or avoid the liability for income-tax ; or
ii) to deceive competitors by creating wrong impressions in their minds about the success of the business ; or
iii) to purchase share in the market at a lower price.
The following are some of the devices to falsify accounts :
i) providing less or more or not providing for depreciation on various assets
ii) over-valuation or under-valuation of assets and liabilities ; or
iii) inflating or deflating profits by entering non-existent items as sale, purchases or returns ; or
iv) changing capital expenditure to revenue account or vice versa ;or
v) inflating profits by omitting to record some items of expenditure or showing less profits by
entering fictitious expenditure; or
vi) utilizing secret reserves without making the fact known to the shareholders during a period when
there is no profit or less profit ; or
vii) showing income of next year to the current year’s Profit and Loss Account with the objet of
manipulating the accounts thereby ; and
viii) window dressing, i.e. showing outwardly a more prosperous position than what it actually is.
B] Auditor’ Duty ( in relation to the detection and prevention of errors and fraud) :
The duty of an auditor is quite signification in relation to the detection and prevention of errors and fraud.
He knows fully well that he has to detect such acts of errors and fraud on the one side and also to prevent them from occurring in the future on the other. Really, it is difficult for him to do so since frauds are usually committed by the officers who are presumed to be honest, sincere and responsible.
Detection : It is true that auditor should exercise considerable care and skill and only then he can detect errors and frauds. He can be successful in his task if he carries routine checking and vouching most carefully and checks thoroughly books of account, ledger accounts and vouchers. Thus, his duty is mainly ; confined to making intelligent and carefully enquiry.
In doing so, if he is not successful but feels that he has exercised a great degree of skill, care and tact, his job is over. However, he will decide himself the degree and level of the scrutiny. If to the best of his knowledge, care and skill, he certifies the accounts as correct, he cannot be held responsible for an error or fraud which is still there in the accounts.
Prevention : So far as the prevention of errors and fraud is concerned, he cannot do anything concrete directly. All that he can do is to advise his client and tell him the way to prevent their future occurrence, if he is asked for that. His job is simply to give advice but it is the proprietor who is responsible for getting things done. It is certain that if his advice is taken properly in the right spirit, chances of errors and frauds can be reduced to the minimum.
Then, the visits made by the auditor to check accounts serve also as a considerable influence on those whose accounts are to be audited. The persons responsible for the maintenance of accounts know well that the book prepared by them would be subjected to a close scrutiny by the auditor and if some errors and frauds are found therein, they will held responsible for such acts of gross negligence and bad name. Hence, under this fear, they always try to be on their guard. This is a sort of moral influence exercised by the auditor which helps a lot in the prevention of further occurrence of errors and frauds.
C] Auditor’s suspicions for fraud can arouse in the following circumstances :
1. Missing evidences e.g. Vouchers, Invoices, Cheques, Contracts etc.
2. Where control accounts do not agree with subsidiary ledgers.
3. Difference in trial balance cannot be located.
4. Fluctuations in gross and net profit ratios.
5. Confirmations of balance received show difference with the balances in the books of account.
6. Difference between physical count of inventory and inventory as per books and records.
Q. 4. Write short notes on :
1. Necessity of Auditing
2. Qualities of an Auditor
3. Window Dressing [A – 97, 98]
4. Secret reserves [ O- 96, 97 ]
5. Concept of True and Fair view [ A – 96 ]
1. Necessity of Auditing :
In the good old days the transactions were very few and this fewness of transactions did not involve any complication. However in the modern business world the markets for the goods and services are not only local or national but they have become international.
The business is growing and expanding heavily because of the world market and on account of production of more and more articles every day for the necessaries, comforts and luxuries of the people in general. Accounting has now become inevitable part of business, so accounts are Huge volume of business which requires expert personnel and heavy finance. Auditors being an expert check the results and gives report as a responsible person and that he invites liability for mis-statement or wrong statement. He acts as a trustee. His role in the national economy is vital. The very survival of Management, Capitalism and of government is dependent on the reports of auditors.
Necessity of audit can be summed up as under :
1. Multiplicity of transactions : With increase in the volume of business and also accounting transactions, it may not be possible for a person to keep track of all the transactions. He has to rely on an expert to go through the records to see that they are correct and perfect.
2. Corporate bodies : Joint Stock companies have separated ownership from management. Owners are the shareholders and not the Board of Directors. If shareholders start examining accounts everyday, the working of company becomes difficult, hence it is necessary that these records should be checked only by an expert who gives report afterwards to the owners, i.e. shareholders.
3. Provisions of different Acts : The Provisions of Companies Act, 1956, Trust Act, Co-operative Societies Act and even some provisions of Income tax Act have made audit compulsory.
Auditor has to report on number of matters, like :
a) whether proper books of accounts are maintained properly or not,
b) whether final accounts reflect True and Fair View or not,
c) whether system of internal check is prevailing in the organisation or not,
d) whether proper register of fixed assets is maintained or not,
e) Nature and parties from whom loans are taken.
2. Qualities of an Auditor :
An auditor must have certain qualities to perform his duties well and efficiently for smooth conduct of audit and maintain the high traditions of the profession. An auditor is an independent person and his reports and certificate are believed to be true. People repose confidence in him.
In light of this the auditor needs the following qualities :
1. Required Qualification : The accounts of Joint Stock Companies are to be audited by a Chartered Accountant. Therefore, it is necessary that auditor of a Company must be a C.A. within the meaning of the Chartered Accountants Act, 1949.
2. Detailed knowledge of Accountancy and the Commercial Laws : The auditor has to examine the books of accounts and satisfy himself that they reveal the true and fair view of the state of affairs of the business. Hence, he should know the principles of accountancy.
The auditor must be familiar with the modern techniques and system of recording business transactions. He should also know the Rules and Provisions relating to the Income-Tax, Companies Act, Estate Duty, etc.
3. Honesty, Integrity and Vigilance : The auditor’s certificates are taken as true and the profession is recognised for its morale and honesty. The social recognition to the profession is such that the public looks forward to him with confidence for his report on business.
Lord Justice Lindley in the course of his judgement in London and General Bank case (1895) remarked “An auditor must be honest, that is, he must not certify what he does not believe to be true and he must take reasonable care and skill before he believes what he certifies is true”.
He has not to conceal any matter. This will enable him to convey any known cause of disorder in the financial position of a business.
4. Skilled and Tactful : An auditor often has to be very tactful so as to get the required information from his clients and the accounting staff of the business to establish the truthfulness of the transactions. He has to travel far behind the books of accounts. An auditor must have the knack to ask questions which may not be against the will of the staff or prejudicial to any one of them.
He should not be ignorant of matters in which he needs clarification. He has to maintain his profession with pride, zeal and enthusiasm.
5. Not to be unduly suspicious : Justice Lopes in the Kingston Cotton Mills Co. Ltd. (1896) case, said, “An auditor is not bound to be a detective, or as was said to approach his work with suspicion or with a foregone conclusion, that there is something wrong. Auditor is a watch-dog but not a blood hound.”
6. Patience and Perseverance : To make his work meaningful and result-oriented an auditor must have utmost patience in carrying out his duties and to hear his clients fully. In matters of difference of opinion, he must not allow the opinion of the client to rest on him. He should have firm conviction of his actions. The volume of work involved in the conduct of audit of big business houses may be more. He may feel the difficulty of the task but still he should conduct himself with calmness to find out the irregularities in business. Then only his work will be more meaningful.
7. Ability to Work Hard and with Dedication : The work of auditor is mechanical in nature as it involves checking the posting, castings, carry forwards, scrutinising the totals, examination of the vouches, verification of the assets and liabilities, inspection of innumerable books and documents calling for information and explanations etc. he may have to deal with client’s staff of the business. All these need painstaking and desire to execute the task perfectly and effectively. He should be proud of his hard work, thoroughness and dedication.
8. Ability to Maintain Secrets : Auditor while dealing with the books of accounts of his clients may come across information which needs to be maintained secret. Certain facts observed to the success of running the business. The auditor has to preserve utmost secrecy of the client and should not discuss or reveal the same unless he is obliged under the law. Society expects certain ethical and moral standards from him.
9. Knowledge of Report-writing : The auditor’s report is to be written in a concise form and in an understandable language free from ambiguity and contradictions. At the same time his opinion is to be given in clear terms. The auditor must know as to how to write a report.
10. Pleasing personality : If auditor possesses pleasing personality, qualities like judgement, resourcefulness, self-control, dignity and diligence, he will be more successful in discharging his duties to the satisfaction of his clients, Society and Law.
11. Independence : Auditor must be independent and impartial. However, he should not be hostile and rude though he should be free from any bias or prejudice.
12. Common Sense : Auditor must have practical wisdom and act with presence of mind. He should act in a rational manner. He should exercise constant vigilance.
3. Window Dressing : Window dressing refers to the art of showing the position of a concern at a better level than the existing one. It means that the real state of affairs of the company is not shown in the Balance Sheet. A sound financial position is painted on the face of Balance Sheet by concealing the actual state of affairs of the concern. Hence, window dressing is a position where true and fair view is distorted.
A rosy picture of assets and liabilities of the business is presented. It is a reverse procedure to the creation of secret reserve. The following are the methods by which window dressing may take place :
1. Inadequate depreciation is provided on fixed assets.
2. No provision for doubtful debts is created on debtors.
3. Revenue expenditure treated as capital expenditure.
4. Overvaluation of stock.
5. Slow moving item of stock or damaged stock etc. are shown at full cost.
6. Fictitious assets are not written off but shown as real assets.
7. Actual liability shown as contingent liability.
8. Underestimation of liability.
9. Showing fictitious credit sales.
The purpose of window dressing is as under :
1. To attract more applications for shares or debentures in case of public issue.
2. To get more remuneration to the managerial personnel on a percentage of profit basis.
3. To get finance facilities like overdraft or loan from banks etc.
4. To get credit terms on purchases.
5. To attract more purchase consideration in case of amalgamation etc.
6. To demand more goodwill in case of admission of partner.
Window dressing is manipulation of account in which certain adjustment is made in such a way by the management that the financial statement show the position of the company much better and sound than the actual position. It dose not necessarily involves misappropriation of cash. It does not mean that there is fraud done by cashier in maintaining cash book. It is just fraudulent manipulation of account generally done by management and therefore it does not necessarily contains or results into misappropriation of cash and goods.
Auditors duty towards window dressing :
If window dressing is done, the financial statement will not give true and fair view. So auditor should not allow existence of window dressing. It is against the principles of accountancy. If he find window dressing then first he should ask the directors to put the matter right but if directors do not agree then he should report this fact to shareholders. In short he should disclose the existence of window dressing.
4. Secret Reserves : A Secret Reserve is any reserve which is not seen on the face of the balance sheet. Other terms for secret reserve are Inner Reserve, Internal Reserve or Hidden Reserve. This is enacted by understating the assets of overstating the liabilities. There is no account called secret reserve. It is in indirectly created by recording the usual accounting transactions in an unusual manner.
Only Banking and Insurance companies have a provision to create secret reserves. Other companies do not usually create such reserves.
Why Secrete Reserves are created ? or Objects of Secret Reserve :
1. Mislead Competitors : A concern may like to mislead its competitors by hiding its real earnings.
2. Hide Abnormal Profits : Sometimes, the concern may earn extra-ordinary or abnormal profits. The concern may be earn such profits in future. Such profits may be preferred to Secret reserve to set off losses or for maintaining dividends in long years in future.
3. Mislead workers : Workers may be mislead by showing low profit in order to avoid increase in wages and bonus.
4. Speculation in share : Management circle may buy shares at low price and sell later on at higher price by showing more profit.
5. Banks : In banking companies, a secret reserve is legally allowed to be created. Banks are allowed not to disclose their provision for bad and doubtful debts in order to maintain public confidence.
Method of Creating Secret Reserves :
a) By charging excess depreciation.
b) Writing down goodwill disproportionately.
c) Omitting the value of an assets permanently.
d) Posting capital expenses as revenue expenses.
e) Showing contingent liabilities as real.
f) Creating fictitious liabilities.
g) Excessive provision for doubtful debts.
h) Not adjusting the appreciation in value of an asset.
i) Overvaluing liabilities.
j) Showing assets as contingent assets.
k) Undervaluing closing stock.
l) Suppressing sales.
m) Showing lower quantity of closing stock in the books.
n) Treating an item of income as capital receipt, e.g. treating a receipt of sale price from a debtor as a deposit.
o) Ignoring accrued income and pre-paid expenses.
p) Treating an item of income as a liability, e.g. treating receipt received as receipt of loan.
q) Showing reserves as current liabilities.
However, there are many charges and objectives of maintaining secret reserves. Some of them are :
a) Financial statements do not show a true and fair view.
b) The dividend declared will be less than possible.
c) Fall in dividend could cause fall in share market value.
d) Insurance claims for damages will be less in case of under-valuation of assets.
e) Misuse of funds drawn to pay fictitious liabilities by directors.
f) Use of funds by directors to cover losses caused due to their negligence.
g) Directors could speculate in shares of the company by varying dividend.
Secret Reserves could be used by directors to misuse the power they hold. Creation of secret reserves is now prohibited by Parts I and II of Schedule VI of the ICA. The Central Government can exempt any class of company to maintain secret reserve in public interest. Now, Banks and Insurance companies are allowed to maintain secret reserves.
Non-provision of depreciation amounts to creation of secret reserves and the shareholder have to be made aware of this act by means of a footnote to the profit and loss account.
Auditor’s Duties with regard to Secret Reserves :
1. Audit Report :
The auditor of a company has to report whether the accounts give a true and fail view.
a) in case of the B/S the state of the company’ affairs as at the end of its financial year, and
b) in the case of the profit and loss for its financial year. So, it is his duty to report and secret reserve.
2. Articles :
He should study the Articles of Association of the company to verify the provision regarding reserves contained there in. For other companies registered under Indian Co’s Act 1956 it is not allowed but in case of banking company it is allowed if it is the interest of general public.
5. Concept of True and Fair View : Under Section 227(2) of the companies act, an auditor is to state clearly in his report his opinion as to whether the Balance Sheet gives a true and fair view of the state of affairs of the company and whether Profit and Loss Account gives a true and fair view of the Profit or loss for the year. In short he has to report whether the accounts are true and fair.
However, quite remarkably, this important concept of True and Fair is no where defined in the companies Act clearly. Only section 211(5) of the Companies Act states that the Balance Sheet and the Profit and Loss Account of a company shall be deemed as not disclosing true and fair view of the state of affairs of the company in case any matter which is required to be disclosed by the provisions contained in schedule VI or by virtue of a notification issued under sub-section (3) and (4) of sec. 41 is not disclosed.
Hence it can be conclude that so long as the statement of account are drawn up in confirmity with the provision contained in schedule VI and in compliance with Section 209, 211 and 212, they would be deemed to disclose a true and fair view of the state of affairs of the company. The phrase “true and fair view” has been introduced in the Companies Act, 1956. Before the enactment of this Act the words “true and correct” were used in Section 145 of the Companies Act, 1913. In that expression there was a loophole. The word correct signifies that the accounts are merely in the form of reproduction from the books of record. That is if the assets were undervalued by providing for more depreciation or otherwise by passing necessary entries in the books of accounts, the Balance Sheet was supposed to be correct even though the Balance Sheet did not reflect a true and fair view of the affairs of the company. The auditor thus could not be held liable for false statements. On the other hand, ”fair” denotes that they are truly representatives of financial record. Thus the emphasis has now shifted from mere arithmetical accuracy to presenting a fair and exact view of the records and the financial position revealed thereby.
The auditor’s role become quite significant. He has to report to the shareholders that the annual accounts disclose a fair view of the financial position of the company.
It means two things :
1. Absence of window dressing.
2. Absence of secret reserve.
The auditor should pay attention to the following points in order to ensure that the financial statements represents a ‘true and fair view’
1. The assets are not under or over valued and each of the asset is valued according to the accepted accounting principle.
2. Liabilities are not over or under stated.
3. Adequate provision for depreciation on fixed assets is made. Also, any excess provision for depreciation is treated as a reserve and not as a provision.
4. The items of income and expenditure of the previous year adjusted in the profit and loss account of the current year are separately disclosed.
5. The books of accounts are properly kept so as to give a ‘true and fair’ view of the state of affairs to the company and to explain its transactions. If the books reveal material facts, the annual accounts will definitely disclose the true position and present a true picture of the financial affairs of the company.
6. Proper distinction should be made between capital and revenue expenditure, capital and revenue profit and fixed and floating assets.
7. The Balance Sheet and Profit and Loss Account should disclose all the information as required under Schedule VI Part I and Part II so that the final accounts definitely give a true and fair view.
8. Consistent practice from year in relation to accounts is adhered to.
9. The events, occurring after the balance sheet date are disclosed.
10. Various accounting principles, conventions like disclosures, materiality etc. are complied with.
Thus the concept of ‘true and fair view’ postulates that all the information whether or not required legally – but considered essential for a proper disclosure, should be included in the statements of accounts. Hence it is not practicable to devise either a rigid formula which is followed or a standard of judgement which when applied would ensure that the statements of accounts reflect the true and fair state of affairs of the company. In this respect, the duties and obligations of the auditor are quite onerous.
Thus the auditor has to go beyond or behind the transactions rather than going by the financial statements from a narrow angle. Also with the introduction of social audit under Section 227(4A) the concept of “true and fair” has still greater emphasis and an auditor should be more careful in adhering to it.
Q. 5. A] What is a Continuous Audit ? What are the advantages & disadvantages of continuous audit ? [ O - 95, A – 98 ]
B] How can the disadvantages of continuous audit be overcome ?
Ans :
A] Continuous audit is the audit in which the auditor visits his client more than once in a year. He may visit him 3 to 4 times or even more often than that in a year. His visits to the company may be monthly or quarterly or bimonthly, depending upon the requirements. This is the type of audit wherein the auditor’s staff checks the books of accounts, starting from where they had left, in their last visit. Thus at the end of the year, the auditor is not required to check again all the books of accounts for all the twelve months. It is a system of audit in which the audit work is carried out almost simultaneously with the accounting work.
Advantages of continuous Audit :
1. Quick presentation of accounts :
As most of the audit work is completed during the year. It is possible to prepare final accounts quickly
at the end of the year. Thus final accounts can be quickly presented to the shareholders at the annual general meetings.
2. Easy and quick discovery of errors :
The auditor checks the accounts regularly. This make it possible for him to discover errors and frauds at an early stage. This would be not possible and easy, if accounts are checked only at the end of the year.
3. Moral check on employees :
The moral force of the presence of the audit staff discourages dishonesty among the employees. They often avoid committing frauds.
4. Familiarity with technical details :
The auditor remains in constant touch with the business of his client when there is continuous audit. This helps him to know the technical details of the business more thoroughly.
5. Efficient audit work :
There is no rush to finish the audit quickly as in the case of final audit. Thus an auditor has more time at his disposal to do his work more efficiently.
6. Preparation of interim accounts :
With the process of continuous audit, the company can prepare Interim accounts quickly. This is necessary to declare interim dividends.
7. Audit staff is kept busy :
Since continuous audit is a running process, audit staff is kept busy throughout the year. The auditor can shift his staff from one client to another, as soon as the staff completes its work at the office of one client.
Disadvantages of continuous audit :
1. Alteration of figures :
There is a gap between two visits of an auditor. So a dishonest clerk can alter the figures in the books of accounts which have already been checked by the auditor during his previous visit.
2. Queries may remain unanswered :
The Auditor may lose his grip over the work as audit is done in instalments. It is possible that queries of an audit staff remain outstanding due to long intervals between two visits.
3. Expensive system of audit :
It is an expensive system as compared to final audit. In this system, auditors visit their client many times in a year for which higher audit fees are required to be paid to him by the client.
4. Dis-location of client’s work :
Auditor’s frequent visits dislocate the work of his client. At the cost of the routine work, the client’s staff has to attend to the auditor.
5. Client’s staff depending on auditor’s staff :
Client’s staff may seek the help of the auditor’s staff to find out even small errors. This will result in loss of the auditors’ time.
B] Precautions to be taken to overcome the disadvantages in case of Continuous audit :
1. Alternation only by passing adjusting entries :
The auditor should not allow any alteration in the books of accounts by canceling or erasing of any figures. He should always insist on alterations being made by passing suitable journal entries in the journal.
2. Using secret tick-marks :
Whenever an auditor himself has made alterations, he should make it a habit to put coded ticks. On his subsequent visit, he should check all such coded ticks made by him earlier.
3. Note down the totals upto a certain date :
The Auditor should check the entries upto a particular date. He should note down that date in his dairy. If it is possible, he should note down the totals upto that date, so that he can verify them during his next visit.
4. Pay a surprise visit :
The Auditors should not declare to his client the exact date of his next visit. He should pay surprise visits so that a dishonest employee may be detected red-handed.
Q. 6. A] What is Periodic or Final or Annual Audit ? What are it’s advantages & disadvantages ?
B] Distinguish between Continuous Audit & Final Audit .
Ans :
A] Periodic audit is the audit which is undertaken at the end of the financial period, when all the accounts have been balanced and final accounts have been prepared. This audit is completed in one continuous session. There is no interval in between. Such an audit may be started before the preparation of final accounts and may be continued even after the end of the financial period. In other words, the auditor visits his clients only once a year and goes on checking the accounts until the audit is completed for the entire period. This type of audit is usually adopted in the case of small business concerns where the number of transactions are not very large. It is also known as final or complete audit.
Advantages of Periodic Audit
1. An auditor gets the full facts and materials for the audit work. He can thus plan to complete his work conveniently, and comparatively, in a shorter time.
2. The routine work of the client is not dis-located or disturbed as the auditor visits only once during an accounting year.
3. There is less possibility of alteration of figures by the client or his staff as there is no gap between the audit sessions.
4. The auditor’s arrangements of the time-table of audit work is simplified. He knows the number of his clients and the total quantum of work. So he can plan his work properly.
5. It is less expensive as compared to continuous audit because the auditor visits only once at the end of an accounting year.
Dis-Advantages of Periodic Audit
1. There may be delay in completing the audit if the concern is large and there are many transactions. This may delay the publication of accounts and holding of the annual general meeting.
2. The errors and frauds are committed throughout the year but their detection is possible only at the end of the year, so their rectification becomes very difficult.
3. If several clients have their financial year ending on the same day, the auditor may find it difficult to assign work to his audit staff.
B] Distinguish between Continuous Audit and the Final Audit
Continuous Audit Final Audit
1. When taken up ?
Continuous audit is carried out throughout Final or periodic audit is done in one session
the year. after the end of the year.
2. How done ?
Audit is done in a detailed and extensive As time available is comparatively shorter, audit
manner as more time is available. may not be done in detailed and extensive
manner.
3. Cost :
Continuous audit is more expensive and Auditor has not to visit the client frequently.
small concerns may not afford. This is Hence final audit is not as expensive as the
because of frequent visits of the auditor at continuous audit.
the client’s officers.
4. Frauds and errors :
Frauds and errors are discovered before the Frauds and errors are discovered only after the
books are closed. end of the year and after the close of the books.
5. Alternation of figures :
After the auditor puts the tick, the figures can It is difficult to alter the figures as the year is
be altered by a clerk as the books are open over and the accounts are closed.
and not closed for final accounts.
6. Solving the queries :
As noting down the queries is necessary, it is Queries are normally solved on the spot while
likely that some queries many remain the audit is in progress.
unsolved.
7. Continuous Accounting Work :
The accounting work is held up when the The accounting work is not held up for want of
books are busy for audit. books, the books are already completed.
8. Mechanical work :
Work becomes mechanical and monotonous This is not so in final audit.
in continuous audit.
Q. 7. A] What is an interim Audit ? What are its advantages & disadvantages ?
B] Distinguish between Continuous Audit & Interim Audit.
Ans :
A] Meaning : An Audit conducted between two annual audits is called as Interim Audit. This is usually carried out at half yearly interval.
Purpose : The main purpose of Interim audits are :
1. To know the interim profit of the business.
2. To declare interim dividend if possible.
3. To know result of financial operations of the organisation.
4. To compare half yearly report with budgeted or planned figures and to revise budget and plans suitably on the basis of experience of the previous half year’s business.
Applicability : Generally large business organisations, banks, Insurance corporations, Government undertakings get their accounts audited half yearly.
Advantages of Interim Audit :
1. It helps to find half yearly performance of organisation and declare interim dividend, if possible.
2. The final audit can be completed early without much lapse of time.
3. Next half year’s plans and strategies can be formulated on the basis of previous half year’s experience.
4. It keeps moral check over the client and increase their efficiency.
5. Errors and irregularities can be found earlier than in the system of final audit.
Disadvantages of Interim Audit :
1. Alteration of figures and records are possible after interim audit is over. This may affect the final audit adversely.
2. Extensive notes are to be prepared by audit staff to keep records of work completed and for the use at final audit to maintain the link.
3. Thus, it involves additional work of audit staff and comparatively costly also.
B] Distinguish between continuous Audit and Interim Audit
Continuous Audit Interim Audit
1. Meaning :
Means audit involving detailed examination of Audit conducted between two final audits is
books of account simultaneously with called interim audit.
preparation of accounts.
2. Periodicity :
Timing and period are fixed as per arrangement Generally timings of interim audit is fixed, i.e.
between client and auditor. after half year.
3. Purpose :
Purpose is to carry out checking of accounts as Purpose is to find out half yearly performance to
and when they are recorded to make work of enable company to declare interim dividend.
final audit simple, smooth and time saving.
4. Profit & Loss A/c, Balance Sheet :
It is a continuing work. Hence, no final accounts It necessitates preparation and checking of Trial
are prepared. Balance to check arithmetical accuracy.
5. Verification of Assets & Liabilities :
In case of continuous audit, assets and It is audit at the end of half year, so it is
liabilities are verified at the end of the year. necessary to prepare half yearly P & L A/c and
Balance Sheet to find results.
Q. 8. Write short notes on :
1. Balance Sheet Audit [ O – 96 ]
2. Special Audit
3. Cost Audit
4. Test check
1. Balance sheet Audit : Normally, in other audit procedure, the books of accounts and relative documents are checked first and after that Balance Sheet and Profit and Loss accounts are checked. But in Balance Sheet audit, the work starts from the Balance Sheet, going backwards to the books of accounts and related documents. In this system, Balance Sheet is checked and verified first. Vouching is not done fully but only to the extent necessary. It also includes verification of all nominal accounts which are closely related to the Balance Sheet items.
This type of audit is more popular in U.S.A. and U.K. than in any other country. Such audit can be adopted in the following cases :
1. Where an extremely good system of internal control is in operation.
2. Where there are large number of transactions.
3. Where qualified accountants are employed to maintain the books of accounts.
4. Where mechanised system of accounting is in force, ensuring a good arithmetic accuracy of the accounts.
5. Where the organisation is professionally managed.
Procedure to conduct Balance Sheet Audit :
1. Each item in the current year’s Trading and Profit and Loss account is to be compared with the corresponding one of the previous year to make sure if there is any material difference.
2. Compare the gross profit and net profit ratio of current year with those recorded during the preceding two or three years.
3. Check the material consumed figure with previous year’s figures and find out the cause of increase or decrease.
4. All transactions which are of non-recurring and exceptional nature are to be checked thoroughly.
5. See that depreciation is provided for, using the same method as adopted during the previous year. If the method is changed, the effect of the same should be shown in the Profit and Loss Account.
6. Examine the basis of valuation of assets and see if there is any addition or sale of assets during the year. If there are assets, see that the profit or loss on sale of assets is properly recorded.
7. Compare the current assets with the previous year’s and see whether there is any variation and find
out the reason thereof.
8. See that all the contingent liabilities are shown by the way of foot notes to the Balance Sheet.
9. Check whether adequate provision has been made for doubtful debts, taxation, forward contracts etc.
10. Examine the minute books for Director’s and Shareholder’s meetings to know the details about resolutions affecting the accounts.
11. Examine various documents filed with the government, Insurance companies, sales tax and income tax authorities etc. to see their effect on the accounts.
2. Special Audit :
Special audit is the type of re-audit conducted on behalf of the Government. The Government may appoint either the Company’s Auditor or any other Chartered Accountant to conduct special audit. Such a special Auditor has to submit his report directly to the Central Government. On the basis of this report, the Central Government may take requisite action or after four months it may send it to the Company with the instructions to circulate it among the management personnel members. The Company has to bear the cost of such an audit. Such a Special Auditor will have the same rights, duties, powers and liabilities as any other auditor of the Company.
The Central Government has powers to order a special audit as per Section 233(A) of the Companies Act in the following cases :
1. When the financial position of a company is very weak and its solvency is in danger.
2. When the affairs of a company are not being managed in accordance with sound business principles of prudent commercial practices.
3. When a company is being managed in a manner likely to harm the interests of the trade or industry concerned seriously or to damage such interests.
3. Cost Audit :
As per Section 233 (B) of Companies Act, the Central Government may direct an audit of cost records by a qualified Cost Accountant. In such audit, there is detailed checking of the costing system, techniques and accounts to verify their correctness and to ensure that the objectives of Cost Accountancy are achieved. Such an auditor will have the same powers, rights and duties as the financial auditor. He submits his report to the Central Government and one copy of his report is to be sent to the Company.
Cost audit is made compulsory for selected industrial undertakings keeping the following objectives in mind :
1. To fix the selling price in order to safeguard the interest of the consumers.
2. To grant price concession or subsidy to a unit in order to expand its production programmes.
3. To fix differential pricing, when required.
4. To decide whether protection needs to be granted, removed or continued.
5. To compare the costs of production of two different industrial units producing the same or identical goods.
4. Test checking :
Introduction :
Often , in the case of big organisations where the transactions are numerous and the business is voluminous, it may be difficult for an Auditor to complete the audit work within the required time limit. Moreover, the system of Internal checks existing within the organisation may be very satisfactory. Under such circumstances, complete or full checking of all items may be neither possible nor worthwhile. The auditor may, in such cases, select a few sample transactions or items for vouching or verification. This technique of test check would enable an auditor to judge whether the remaining entries are correct or not.
Definition :
In the words of Prof. Meig “Test checking means selecting and examining representative samples from a large number of similar items”.
Example :
The auditor may give instructions to his assistants to test check in the following manner :
a) Check 20% of the postings from the cash book to the ledger for all the months.
b) Check 100% of the postings from the cash book to the ledger for any two months.
c) Get valuation for 10% of the total trade debtors.
A test check must contain elements of surprise in it. The staff of the client should not understand the pattern of selecting the samples. If the selecting of sample becomes routine, predictable and mechanical, then the test check loses its value. The use of test checking is dependent on the system of internal checks in operation. If the system is efficient, test checking would be adequate. But if it is inefficient, then detailed checking is preferable.
Precautions to be taken while adopting test checking :
The auditor should keep in mind the following points while selecting samples :
1. More entries of the first and the last month of the year should be selected for checking as fraudulent manipulations occur usually during these months.
2. The samples selected should represent all the months of the year and all the books of accounts.
3. The sample should represent all the types of entries.
4. The period chosen for the purpose of test checking should not be uniform for different years of audit. This ensures that all types of entries of all the months are covered within 3 to 4 years.
5. The method of test checking should be kept confidential from the staff of the client.
6. The selection of sample should be done in such a way that the work is almost all the employees of the client is checked.
Advantages of Test checking :
1. Test checking reduces the volume of work. The time of the Auditor thus saved can then be utilized for some other purpose.
2. If selection of transactions is done intelligently, test checking is useful and productive.
3. There is a moral check on the client’s staff as they do not know the period or portion of the work which will be taken up as sample for checking.
4. As the volume of work is reduced, the auditor can undertake different audits easily and simultaneously.
Disadvantages of Test checking :
1. The client’s staff may become careless and lazy as it knows that its work will not be checked in details by the Auditor.
2. Some of the errors and frauds may not be detected as test checking is based on the selection of representative items.
3. The auditor’s responsibility increases and although the whole of the work is checked by him through test checking, suspicion and double still remain in his mind about the validity of all details.
Q. 9. A] What is an Audit Programme ? What are the contents of an Audit programme ?
[ O –97 ]
B] What are the advantages & disadvantages of Audit Programme ?
Ans :
A] An audit programme is an outline or description of the work to be done by the senior and the junior staff of an auditor during the period of audit. It is generally drawn by the Chief Auditor. An audit programme is a detailed statement giving full instructions and guidance to the audit staff. It is the time table of audit work showing who has to do what work, by what time and in what order. The whole procedure to be followed from the starting of the audit to the end is clarified in it. It aims at controlling and guiding the audit staff. It helps in arranging and distributing the work in order to avoid omission and repetition of work.
Professor Meigs defines an audit programme as “a detailed plan of the audit work to be performed, specifying the procedures to be followed in verification of each item in the financial statements, and giving the estimated time period.” It is generally prepared with the columns provided for the name of the clerk doing the work, the type of work, the dates of starting and finishing the work. Each audit assistant has to sign for the work he performs, so that the responsibility for the work he has done rests on him.
Type of Audit programme
There are two ways in which an audit programme can be prepared.
a) Predetermined or Standard programme
Here, the complete audit programme is preplanned and drawn out. Each assistant knows by which date he should complete the work and accordingly he completes the work assigned to him. This schedule is prepared before hand and so, all items are included in it, whether they are applicable to a given audit or not. This is also known as a fixed programme.
b) Progressive or Flexible programme
Here, no preplanned programme is available. This programme varies from year to year. Under this
type, the Chief Auditor chalks out a programme for each junior clerk step by step, as each part of the
work gets completed. Details of the work are collected step by step and tasks are distributed among the audit clerks, as per their ability and competence. In both cases, the audit assistant is not allowed to make any alteration in the audit programme without the consent of Chief Auditor.
Contents of an audit programme
1. Name of the undertaking.
2. Date of commencement of the Audit.
3. Duration of the Audit.
4. System of accounting adopted by the client concerned.
5. Internal check and Internal control system in operation and its effectiveness.
6. Report of the previous auditors and their remarks.
7. Examination of various books with datewise schedule.
B] Advantages of Audit programme
1. Simplifies the allocation of work :
It helps the auditor to assign the work to various assistants, at different levels of education and experience. Work can be allocated according to the ability and competence of each assistant.
2. Guide to the audit assistants :
It serves as a guide to the audit staff for carrying out the audit work. If an assistant goes on leave, his work can be easily continued by another assistant because the work that has already been completed by the previous assistant is recorded in the programme.
3. Responsibility can be fixed :
In case of any mistake or negligence on the part of an audit clerk, responsibility is fixed on the concerned clerk. This is because the work allotted to him is already noted and he has to sign against his name in the programme every day for the work completed by him during that day.
4. Evidence in the court of law :
If a suit for negligence is brought against the auditor, it serves as the best evidence in his support. In such a case, the auditor can defend himself by proving that the work has been done not by him, but by his assistants.
5. Less chances of omission and repetition of work :
The entire work and all the books of accounts are considered in audit programme. Hence, there are less chances of any work being omitted. At the same time, repetition of work is also avoided as every bit of work done is recorded.
6. It is very useful for an auditor in taking a final review before preparing and signing his audit report.
7. It is very helpful for planning the programme for the subsequent year.
8. The Chief Auditor is spared of the botheration of issuing fresh instructions to his staff at intervals.
Disadvantages of audit programme :
1. The work may become too mechanical :
The work to be carried out as per the audit programme may become mechanical, it is possible that some parts of the programme are carried out without understanding the object of those parts in the whole audit scheme.
2. Gives shelter to inefficient assistants :
Some inefficient assistants may get shelter under audit programme. They may defend themselves on the ground that the audit programme did not contain proper instructions for the matter in which they have committed a mistake.
3. An efficient clerk loses the initiative :
An efficient clerk may lose his initiative as he has to follow a pre-determined procedure and work within the time limit given. A rigid programme may not take into account the changes that may have taken place in the organisation.
4. A common programme cannot be drawn for a group of clients because each client’s business may have different problems and procedures.
5. As the time limit is fixed, work may be done hurriedly and completed within the required time schedule.
Q. 10. A] What is an Audit Note Book ? What are it’s contents ?
B] Why is it necessary to make notes during the conduct of an audit ?
Ans :
A] An Audit Note-Book is a book which is maintained by the audit clerk. During the course of audit, the clerk comes across several difficulties or new points which he has to discuss with his senior or the auditor. He makes several inquiries which, he thinks, have not been satisfactorily answered. Lest he might forget these points, he notes down these in a book which is called by different names such as Audit Note Book or Audit Memoranda. Such a book is a written record of queries made, replies received thereto, correspondence entered into etc. This book may be of great help to the Auditor preparing his Audit Report from such a record. A separate Audit Note Book is maintained for each concern.
Contents of an Audit Note Book
Some of the points which are noted down in an Audit Note book are given below :
1. A list of books of account maintained by the client ;
2. The names of the principal officers, their powers, duties and responsibilities.
3. The technical terms used in the business ;
4. The points which require further explanation and clarification ;
5. The particulars of the missing vouchers, the duplicates of which have to be obtained ;
6. The mistakes and errors discovered ;
7. Totals or balances of certain books of account, Bank Reconciliation statement ;
8. Notes and queries which might be required at a subsequent audit ;
9. The points which have to be incorporated in the Audit Report ;
10. Any matter which requires discussion with the senior or with the auditor ;
11. Accounting method followed in the business ;
12. Dates of commencement and completion of the Audit ;
13. Provision in the Articles and Memorandum of Association affecting the accounts and audit.
The following is an example of notes made in the Audit Note Book :
28-8-98 Entry in Cash Book Folio 63 for Rs. 500 wrongly debited to Freehold Land and Building Instead of Leasehold Improvement – Accountant advised.
29-8-98 Receipt for Rs. 1,000 paid to Messrs. ABC vide C.B. Folio 69, not available.
2-9-98 Receipt for Rs. 1,000 paid to Messrs. ABC seen and cancelled.
B] Audit is an examination of books and documents with supporting evidence to find out whether they show a true and fair view of the business position. This examination is vast in scope and covers usually one full year. To frame the opinion, an auditor has to be very cautions as he cannot check every single transaction. He has mainly to verify whether the systems leading to the records are operating properly. It is therefore necessary that the auditor should keep a track of all the important non-compliances and queries so as to get adequate explanations from management. He has a reporting responsibility and in order to discharge it satisfactorily, he should note all the important observations which later on, while finalising his report, assist him in discharging his duties.
Justice Vaugham Williams in the London and General Bank case. Similarly the Audit Note Book which contained detailed information was of great assistance to the auditor in the case of the City Equitable Fire Insurance Company.
Such a book should be clear, concise and complete so that it may be quite intelligible to the clerk who audits the accounts of the same concern next year. In fact it would be a guide to such a clerk.
In summarized form, following are the reasons, why notes are necessary.
1. They represent important observations on the basis of which he has to form an opinion about the true and fair view of the business.
2. These notes collectively convey to the auditor the information regarding non-compliance with statutory requirements and generally accepted accounting principles.
3. Auditor can assure himself whether all the audit procedures have been applied, and no area has been left out.
4. To defend himself against the charge of negligence, he can produce his notes as evidence, e.g. London and General Bank’s case.
5. In future, for planning and conduct of audit, these notes are helpful.
6. All the important information regarding a client is available from these notes at a glance.
In General, these notes form an integral part of auditing process. By a review of these notes, even a new member of the audit staff can get used to the client. For an effective audit, therefore, notes are essential.
