Q-1

Indicate the precise nature of auditor's liability in the following situations and
support your views with authority, if any:
(a) Certain weaknesses in the internal control procedure in the payment of wages
in a large construction company were noticed by the statutory auditor who in
turn brought the same to the knowledge of the Managing Director of the
company. In the subsequent year huge defalcation came to the notice of the
management. The origin of the same was traced to the earlier year. The
management wants to sue the auditor for negligence and also plans to file a
complaint with the Institute.
(b) Based upon the legal opinion of a leading advocate appointed by auditor, X Ltd.
should made a provision of ` 5 crores towards Income Tax liability. The
assessing authority has worked out the liability at ` 15 crores. It is observed
that the opinion of the advocate was inconsistent with legal position with
regard to certain revenue items.

Q-2

Intelligent Ltd. entered into an agreement with Mr. Intellectual on 15th March,
2016, whereby it agreed to pay him ` 2 lakhs per month as retainership fee for
consultation in IT department. However, no amount was actually paid and ` 24
lakhs was provided in the Statement of Profit and Loss for the year ending on
March 31st, 2016.

Management of the company uttered that need-based consultation was
obtained throughout the year. However, on investigation, no documentary or
other evidence of receipt of such service was found. As the auditor of Innocent
Ltd., what would be your approach?

Q-3

Visual Limited, a company incorporated in India has nine members in its Audit
Committee. Due to recessionary conditions in India the revenue of the company is
going down and there is slowdown in other activities of the company. Therefore, it
was expected that there would not be significant work for members of the Audit
Committee.
Considering the overall recession in the company and the economy, the members
of the Committee decided unanimously to meet only once at the year end. They
reviewed monthly information system of the Company and found no errors.

As an auditor of Visual Limited would you consider the decision taken by the Audit
Committee to hold the meeting once in a year, is complying with the Clause 49 of
the (SEBI) Listing Agreement? Also state the quorum requirements for such
meetings.

Q-4

You are the manager responsible for the audit of Worth Ltd. which has a year end
of 31 March. This is the first year that your firm has undertaken the audit of Worth
Ltd., having succeeded the previous auditors at the last annuals general meeting
following a successful tender for the audit. Your firm has an office in Telangana and
in 15 other location throughout the India.
You have had preliminary discussions with the management of Worth Ltd. and
obtained some background information about the company. The company
produces fertilizer in a factory on the outskirts of Liverpool. The head office is
situated in Telangana. There are ten depots throughout the country which hold
large stocks of fertilizer so that local demand for its products can be met quickly.
Inventory records are not maintained and a full count is carried out at the year end.
You have also read recent government press release that indicates that ‘L’, a
product which forms a major part of the company’s sales, contains a chemical that
has been identified as being potentially dangerous to those who handle it. An
official government working party has been set up to review the situation.
Requirement

(a) Identify the circumstances that should be taken into account when planning
the audit of Worth Ltd., and set out your outline audit approach in these areas.

Explain the objectives of audit planning.

Q-5

De-garments Ltd. is a retailer of fashion accessories. It has a turnover of ` 54
million and 150 shops throughout the India. It also has six regional warehouses
from which the shops are supplied with goods.
The company has an internal audit department which is based at the company’s
head office in Delhi. Internal auditors make regular visits to the shops and
warehouses.

This is the first year that your firm has acted as auditor for De-garments Ltd. The
partner in charge of the audit has expressed his opinion that the internal audit
department might be able to assist the external audit team in carrying out its work.
Requirements

(a) State, with reasons, the information that you would require to make an
assessment of the likely effectiveness and the relevance of the internal audit
function.
Describe four typical procedures that might be carried out by the internal
auditors during their visits to the shops and warehouses and on which you
might wish to rely.
Assuming that you intend to rely on the work of the internal audit department
of De-garments Ltd., describe briefly the effect this will have on your audit of
company’s financial statements.

Q-6

You are a member of an audit team of RKP Associates, auditors of a
Multinational Company YB Co. Ltd. The company is working in CIS
environment. The partner in charge of RKP Associates asked you to draw out
the audit plan for evaluating the reliability of controls.

Q-7

The method of collecting Audit evidence and evaluating the same changes
drastically under CIS Environment”. – Comment.

Q-8

Fine Ltd. is engaged in the production of Jute. In January, 2012, the
management of the company decided to expand its business and started
manufacturing jute bags. For such expansion, it required fund of ` 80 lakhs
which was financed from Good Bank. The loan was repayable in 10 equal
yearly instalments (including interest) of ` 20 lakhs beginning from 31st
March, 2012 onwards. The company was regular in payment of instalments till

31st March, 2015. Due to improvement in financial condition of the company,
it decided for onetime settlement for its outstanding loan. Subsequently, Good
Bank rescheduled the loan to ` 50 lakhs to be repaid in August, 2015.

The accountant of the company has disclosed the said loan under the head
“Long-term Borrowings” in the Balance Sheet of the company for the financial
year 2014-15
As the auditor of Fine Ltd., kindly guide the management with regard to
disclosure of such liabilities in accordance with Schedule III of the Companies
Act, 2013?

Q-9

Amudha Ltd. is a Mumbai based company. The total turnover of the company is `
10 crores for the year 2015-16. The company has a branch office at an area which
was recently affected by flood. The transportation services are not available due to
destruction caused by flood. The branch office recorded turnover of ` 1,50,000 in
the Financial Year 2015-16. No audit of branch has been carried out. The statutory
auditor of the company has made no reference of the above branch in his report.
Comment

Q-10

R and H Associates, Chartered Accountants in practice have been appointed as
Statutory Auditor of Krishna Ltd. for the accounting year 2015-2016. Mr. H, a
partner of the R and H Associates, holds 100 equity shares of Shiva Ltd., a
subsidiary company of Krishna Ltd.

Q-11

Rick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by
Central Government, 25% by Uttar Pradesh Government and 10% by Madhya
Pradesh Government. Rick Ltd. appointed Mr. Remo as statutory auditor for
the year.

Q-12

Futura Ltd. appointed CA Innocent as an auditor for the company for the current financial year.
Further the company offered him the services of actuarial, investment advisory and investment
banking which was also approved by the Board of Directors

Q-13

Mr. Abhar, a Chartered Accountant, bought a car financed at ` 7,00,000 by
Chaudhary Finance Ltd., which is a holding company of Charan Ltd. and Das
Ltd. He has been the statutory auditor of Das Ltd. and continues to be even
after taking the loan.

Q-14

CA Jack, a recently qualified practicing Chartered Accountant got his first audit assignment of
Futura (P) Ltd. for the financial year 2014-15. He obtained all the relevant appropriate audit
evidence for the items related to Statement of Profit and Loss. However, while auditing the Balance
Sheet items, CA Jack left out obtaining appropriate audit evidence, say, confirmations, from the
outstanding Accounts Receivable amounting ` 150 lakhs, continued as it is from the last year, on the
affirmation of the management that there is no receipts and further credits during the year. CA Jack,
therefore, excluded from the audit programme, the audit of accounts receivable on the
understanding that it pertains to the preceding year which was already audited by predecessor
auditor. Comment.

Q-15

M/s Sureshchandra & Co. has been appointed as an auditor of SC Ltd. for
the financial year 2014-15. CA Suresh, one of the partners of M/s
Sureshchandra & Co., completed entire routine audit work by 29th May,
2015. Unfortunately, on the very next morning, while roving towards
office of SC Ltd. to sign final audit report, he met with a road accident and
died. CA Chandra, another partner of M/s Sureshchandra & Co., therefore,
signed the accounts of SC Ltd., without reviewing the work performed by
CA Suresh. State with reasons whether CA Chandra is right in expressing
an opinion on financial statements the audit of which is performed by
another auditor.

Q-16

CA Ashutosh has been appointed as an auditor of Awesome Health Ltd. for the financial year 2013-
14 which was audited by CA Amrawati in 2012-13. As the Auditor of Awesome Health Ltd., state the
steps that CA Ashutosh would take to ensure that the Closing Balances of the financial year 2012-13
have been brought to account in 2013-14 as Opening Balances and the Opening Balances do not
contain any misstatements

Q-17

A Company outsourced the activity of accounting data maintainance to the Service
Organisation to achieve cost reduction. As a Statutory Auditor of such company,
what are the precautions/checks that you would consider for conducting the
audit?

Q-18

You are the auditor of Vishakha Steel Pressing Limited, which manufactures small
pressing from sheet-steel. The process generates scrap steel which is placed daily by
the work force into a bin kept for that purpose in the yard. Every Friday a lorry arrives
from a small local scrap merchant. The bin is loaded on to the lorry and replaced by an
empty bin. The weight is obtained by the gatekeeper using the company weighbridge.
He notes the weight in a book kept for that purpose in the gate office. Each month a
cheque is received through the post from the scrap merchant accompanied by a
remittance advice stating the weight of scrap collected, the price and the amount of the
cheque. The cheque is banked by the cashier and the remittance advice is filed. There
are no other procedures in this area:
You are required to:
(a) Suggest major improvements to be made in the internal control in this area.
(b) Suggest key audit procedures under these circumstances to mitigate audit risk.

Q-19

Zantacs, a limited company having turnover of approximately ` 80 crores uses a
tailor made accounting software package. In the said package, all transactions are
recorded, processed and the final accounts generated from the system. The
management tells you that in view of the voluminous nature of day books, there is
no need to print them and that audit can be conducted on the computer itself. The
management further assures you that any 'query based reports' as required can be
generated and printed. As a statutory auditor of the company, enumerate the
procedures you would adopt to conduct the audit.
“The auditor must evaluate major clauses of control used in a Computerised
Information system to enhance its reliability” – Comment.

Q-20

Ram and Hanuman Associates, Chartered Accountants in practice have been appointed as Statutory
Auditor of Krishna Ltd. for the accounting year 2013-2014. Mr. Hanuman, a partner of the Ram and
Hanuman Associates, holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd.
Q-21

Nick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by
Central Government, 25% by Uttar Pradesh Government and 10% by Madhya
Pradesh Government. Nick Ltd. appointed Mr. Prem as statutory auditor for the
year.

Q-22

Contravene Ltd. appointed CA Innocent as an auditor for the company for the
current financial year. Further the company offered him the services of actuarial,
investment advisory and investment banking which was also approved by the
Board of Directors.

Q-23

Mr. Amar, a Chartered Accountant, bought a car financed at ` 7,00,000 by Chaudhary Finance Ltd.,
which is a holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das
Ltd. and continues to be even after taking the loan.

Q-24

M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognised nonprofit
organisation feels that the standards on auditing need not to be applied as
Goodwill Education Foundation is a non-profit making concern.

Q-25

Rama Pvt. Ltd. is a private company having paid up share capital of rupees twenty-
five crore but having public borrowing from nationalized banks and financial

institutions of rupees forty crore. The company appointed CA Raman as an auditor
in its AGM dated 29th September, 2014.
You are required to state the following provisions as the section 139 of the
Companies Act, 2013 in case of an individual auditor or an audit firm, both-
(i) Rotation of auditor;
(ii) Cooling off period;
(iii) Common partner(s) to the other audit firm whose tenure has expired;
(iv) Transitional period for the adoption of new Companies Act;
(v) Right of the company to remove an auditor;
(vi) Rotation between partners of audit firm;

Q-26

MSY & Co. is an Audit Firm having partners CA Mukti, CA Shakti and CA Yukti. CA Mukti, CA Shakti
and CA Yukti are holding appointment as an Auditor in 4, 6 and 10 Companies respectively.
(vii) Provide the maximum number of Audits remaining in the name of MSY & Co.

(viii) Provide the maximum number of Audits remaining in the name of individual
partner i.e. CA Mukti, CA Shakti, CA Yukti.

Q-27

State the provisions relating to filling of casual vacancies as per section 139
(8) of the Companies Act, 2013 and casual vacancy due to resignation.

Q-28

In the course of audit of Raja and Rank Ltd., the audit manager of Sharma & Co.
observed that Raja and Rank Ltd. has outsourced certain activities to an outsourcing
agency.

(a) As the engagement partner, guide the audit manager in the assessment of
services provided by the outsourcing agency in relation to the audit.
(b) Discuss the procedure to be applied in case the user auditor is unable to obtain
a sufficient understanding from the user entity?

Q-29

Briefly discuss the following statements in view of SA 300 “Planning an Audit of
Financial Statements”:
(a) For an initial audit, the auditor may need to expand the planning activities.
(b) Audit planning is not a discrete phase but a continuous phase.

Q-30

While commencing the statutory audit of Alex Co. Ltd., what would you
consider as an auditor to assess risk of material misstatement and responses
to such risks?

Q-31

Pasta Ltd., a manufacturing concern want to develop internal control system.
You are an expert in developing the internal control system, hereby called to

brief about the same. In view of above, you are required to brief about internal
control system and inherent limitations of the internal control?

Q-32

ZZZ Ltd. used to spend huge resources and time to maintain large data of accounts
management. Not only the maintenance of data, but the transfer of files from one
department to another took months. Most of the time, accounts department of the
company could not co-ordinate between data transferred from one department to
another.

Due to this complexity of data maintenance in the form of files, the management
opted switching to customised accounting software package. Now, in the said
package, all transactions are recorded, processed and the final accounts generated
from the system. The management tells you that in view of the voluminous nature
of day books and the motto of ‘save nature’, there is no need to take printouts and
that audit can be conducted on the computer itself. The management further
assures you that any 'query based reports' as required can be generated and
printed.
As a statutory auditor of the company, enumerate the procedures you would adopt
to conduct the audit in such environment.

Q-33

LN Ltd., a well reputed manufacturing public limited company has made a contribution of ` 2.5 lacs
during the financial year ended 31.3.16 to a political party for running a school, situated in the
village, where most of the workers of the company reside. It is admitted that the benefit of the
school is mostly for the children of the workers of the company. The company has not made any
profits in the last four years. Comment.

Q-34

Mr. XXX, a practicing Chartered Accountant, has been offered for appointment
as an auditor of Z Ltd., a leading company. Later on, Mr. YYY, the step-brother
of Mr. XXX, purchased securities of the company having face value of ` 89,000.
Comment, whether Mr. XXX may accept the offer of appointment as an
auditor?

Q-35

KM Pvt. Ltd., engaged in the manufacturing business of Silk Shirts, is a newly
incorporated company dated 01.09.2016. On 28.09.2016, the members of KM
Pvt. Ltd. themselves appointed CA Raj, a renowned practitioner, as the first

auditor of the company opposing that Board is not authorised to appoint the
auditor. You are required to comment on the action of the Members.

Q-36

Elucidate the power of tribunal to change the auditor of a company if found acted in a fraudulent
manner as provided under sub-section (5) of section 140 of the Companies Act, 2013.

Q-37

Fraud can be committed by management overriding controls using such
techniques as engaging in complex transactions that are structured to
misrepresent the financial position or financial performance of the entity.
In view of the above-mentioned circumstances of management fraud, explain briefly duties and
responsibilities of an auditor in case of material misstatement resulting from such Management
Fraud

Q-38

Gama Ltd. is a mobile phone operating company. Barring the marketing function it had outsourced
the entire operations like maintenance of mobile infrastructure, customer billing, payroll,
accounting functions, etc. Assist the auditor of Gama Ltd. as to how he can obtain an understanding
of how Gama Ltd. uses the services of the outsourced agency in its operations.

Q-39

While verifying the employee records in a company, it was found that a major
portion of the labour employed was child labour. On questioning the
management, the auditor was told that it was outside his scope of the financial
audit to look into the compliance with other laws. Comment.

Q-40

Lakshya Ltd. has a branch office located outside India. Company is in the
process of appointment of non-Chartered Accountant as an auditor but
otherwise qualified person from country where the branch office is situated.
Statutory auditor is of the opinion that non-Chartered Accountant cannot be
appointed as branch auditor. Comment.

You are also required to discuss the applicability of SA 600 using the work of another auditor by the
head office auditor in regard to branch located outside India, if non-Chartered Accountant is
appointed

Q-41

As an internal auditor for a large manufacturing concern, you are asked to verify whether there are
adequate records for identification and value of Plant and Machinery, tools and dies and whether
any of these items have become obsolescent and not in use. Draft a suitable audit programme for
the above.
Q-42

M/s Abu & Co. was appointed as auditor of Grand Airways Ltd. As the audit
partner, what factors shall be considered in the development of overall audit
plan?

Q-43

Yex Ltd. has five entertainment centers to provide frivolous facilities for public
especially for children and youngsters at 5 different locations in the peripheral
of 200 kms. Collections are made in cash. Specify the adequate control system
towards collection of money.

Q-44

Saras, a limited company having turnover of approximately ` 80 crores uses a tailor made
accounting software package. In the said package, all transactions are recorded, processed and the
final accounts generated from the system. The management tells you that in view of the voluminous
nature of day books, there is no need to print them and that audit can be conducted on the
computer itself. The management further assures you that any 'query based reports' as required
can be generated and printed. As a statutory auditor of the company, enumerate the procedures
you would adopt to conduct the audit

Q-45

“The auditor must evaluate major clauses of control used in a Computerised
Information system to enhance its reliability” – Comment.

Q-46

1 M/s SSS & Co. is an audit firm having partners CA. Satyam, CA. Shivam and CA.
Sundaram. CA. Satyam, CA. Shivam and CA. Sundaram are holding appointment as
an auditor in 4, 6 and 10 companies respectively.
a Provide the maximum number of audits remaining in the name of M/s SSS & Co.

b Provide the maximum number of audits remaining in the name of individual
partner i.e. CA. Satyam, CA. Shivam and CA. Sundaram.
c Can M/s SSS & Co. accept the appointment as an auditor in 60 private companies
having paid-up share capital less than ` 100 crore, 2 small companies and 1
dormant company?
(b) Would your answer be different, if out of those 60 private companies, 45
companies are having paid-up share capital of ` 110 crore each?

Q-47

7. CA. Rock is a partner in M/s Ajay & Associates and M/s Vijay & Associates
simultaneously. M/s Ajay & Associates has completed its tenure of 10 years as an
auditor in Sanjay Ltd. immediately preceding the current financial year. It may be
noted that the provisions for applicability of rotation of auditors are applicable to
Sanjay Ltd. Now, the company wants to appoint M/s Vijay & Associates as auditor
for 5 years.
(a) Whether M/s Vijay & Associates is allowed to accept the appointment as
auditor of Sanjay Ltd.?
(b) Would your answer be different from above if CA. Rock, being in-charge of M/s
Ajay & Associates and certifying authority of financial statements of Sanjay
Ltd., retires from the partnership in M/s Ajay & Associates and joins M/s Vijay
& Associates?

Q-48

FX Ltd. is engaged in the business of newspaper and radio broadcasting.
It operates through different brand names. During the Financial Year 15-16, it
incurred substantial amounts on external trade, business communication
and branding expenses by participation in various corporate social
responsibility initiatives. The company expects to benefits by this expenditure
by attracting new customers over a period of time and accordingly it has
capitalised the same under ‘brand development expenses’ and intends to
amortise the same over the period in which it expects the benefits to flow. As
the statutory auditor of the company, do you concur with this treatment? Give
reasons.

Q-49

Dabloo Ltd. is facing financial crunch and has sold significant part of machinery to repay 25%
amount of wages overdue. Many workers have also left the company due to non-payment of wages.

Dabloo Ltd. is also considering filing for bankruptcy. The financial statements (and notes thereto)
do not disclose the fact. As an Auditor, how would you deal with the situation? You are also
required to identify the type of opinion you would issue and draft the same.

Q-50

OST Limited, a manufacturing company donated ` 45,000 and ` 55,000 to Charitable Societies
namely ‘Healthy World Charitable Foundation’ and ‘Learning Kids Foundation’ respectively
during the financial year 2015-16. The company has not taken any approval in general meeting
for such donation. The average net profits of the company for the last three years were ` 15
lakhs. As an auditor, what will be your comment?

Q-51

1. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint
auditors to conduct auditing for the financial year 2013-14. For the valuation
of gratuity scheme of the company, Mr. X, Mr. Y and Mr. Z wanted to refer their
own known Actuaries. Due to difference of opinion, all the joint auditors
consulted their respective Actuaries. Subsequently, major difference was
found in the actuary reports. However, Mr. X agreed to Mr. Y’s actuary report,
though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be
considered in audit report due to majority of votes. Now, Mr. Z is in dilemma.
(I) You are required to briefly explain the responsibilities of auditors when
they are jointly and severally responsible in respect of audit conducted by
them and also guide Mr. Z in such situation.
(II) Explain the responsibility of auditors, in case, report made by Mr. Y’s
actuary, later on, found faulty.

Q-52

(b) Yummy Ltd., dealing in manufacturing and trading of milk butter, has a
benchmark in its product for so many years. Tasty Ltd., a rival company to
Yummy Ltd., has introduced its new product, peanut butter. Due to being
health conscious, the consumers have shifted from milk butter to peanut
butter within few months. This has result into massive loss during the year to
Yummy Ltd. due to non-selling of perishable milk products. The company has
also started having negative net worth. It's production head, finance head and
marketing head have also left the company. The company has no sound action
plan to mitigate these situations. Kindly guide the auditor of Yummy Ltd., how
he should deal with the situation.

Q-53

2. LMN Ltd. supplies navy uniforms across the country. The company has 4
warehouses at different locations throughout the India and 5 warehouses at the
borders. The major stocks are generally supplied from the borders. LMN Ltd.
appointed M/s OPQ & Co. to conduct its audit for the financial year 2013-14. Mr. O,
partner of M/s OPQ & Co., attended all the physical inventory counting conducted
throughout the India but could not attend the same at borders due to some
unavoidable reason.
You are required to advise M/s OPQ & Co.,

(i) How sufficient appropriate audit evidence regarding the existence and
condition of inventory may be obtained?
(ii) How an auditor is supposed to deal when attendance at physical inventory
counting is impracticable?

Q-54

3. Your firm has been appointed as an auditor of YSPPP Ltd. The company operates
30 petrol stations throughout India. You are the senior in-charge of the audit for
the year ending 31st March, 2014 and are engaged on the audit planning. The
company’s sites are long-established and supplying fuel, oil, air and water.
Over the last few years, due to the intense price competition in petrol trading, the
company has expanded its shops into mini-markets with a wide range of motor
accessories, food, drinks and household products. The induction of mini-markets
has increased the volume of cash transactions. This induction has also lead to
scarcity of staff at each and every location. For that reason, part-time staffs are also
recruited.

Point-of-sale PCs have been installed at all the petrol stations, linked on-line via a
network to the computer at head office. Sales and inventory data are entered
directly from the PCs at branches.
The company has an internal auditor, whose principal function is to monitor
continuously and test the operation of internal controls throughout the
organization. The internal auditor is also responsible for coordinating the year-end
inventory count.

Requirements:

Prepare notes for a planning meeting with the audit partner which-

(a) Identify, from the situation outlined above, circumstances particular to YSPPP
Ltd. that should be taken into account while planning the audit, explaining
clearly why these matters should be taken into account.
(b) Describe the extent to which the work performed by the internal auditor may
affect your planning, and the factors that could limit the use you may wish to
make of his work.

Q-55

5. MW&F Associates has been appointed as an auditor of a Multinational Company
TTS Ltd. The company is working in a CIS environment. You are a member of the
audit team of MW&F Associates. The partner in charge of MW&F Associates wants
you to train your audit team member about use of Computer Assisted Auditing
Techniques (CAATs). You are required to:

(a) Explain the factors that a statutory auditor has to consider, in determining,
whether to use Computer Assisted Auditing Techniques (CAATs).
(b) Indicate the control procedures which the auditor should adopt in applying
CAAT (Computer Assisted Audit Technique) in an audit under CIS
environment.

Q-56
M/s Renault & Co., Chartered Accountants, appointed as a statutory auditor of R Ltd. for the
financial year 2013-14. The company is also in need of some actuarial services. Consequently, the
Board of Directors of the company offered the same to M/s Sona & Co., an associate to M/s Renault
& Co., which has been duly accepted by the firm. Comment.

Q-57

(b) Navy and Cavy Associates, a Chartered Accountant firm, has been appointed as
Statutory Auditor of Poor Ltd. for the financial year 2013-2014. Mr. Savy, the
relative of Mr. Navy, a partner in Navy and Cavy Associates, is indebted for

` 6,00,000 to Wealthy Ltd., a subsidiary company of Poor Ltd. Comment

Q-58

(c) Orange Ltd. is an unlisted public company. Its balance sheet shows paid up
share capital of ` 5 crore and public deposits of ` 100 crore. The company
appointed M/s Santra & Co., a chartered accountant firm, as the statutory
auditor in its annual general meeting held at the end of September, 2014 for
11 years.
You are required to state the provisions related to- rotation of auditor and cooling off
period as per the section 139(2) of the Companies Act, 2013 in case of an individual
auditor or an audit firm, both, and comment upon the facts of the case provided above
with respect to aforesaid provisions.

Q-59

Mr. Pratiq, a practicing Chartered Accountant, has been appointed as an
auditor of Opus Ltd. He is holding securities of the company having face value
of ` 89,000 only.

(i) You are required to state, whether Mr. Pratiq is qualified to be appointed
as an auditor of Opus Ltd.
(ii) Would your answer be different, if instead of Mr. Pratiq; Mr. Quresh, the
step-father of Mr. Pratiq, is holding the securities?

Q-60

(a) You have been appointed as a statutory central auditor of SABKA Bank, a
Nationalized bank. What special points would you borne in mind while
conducting the audit of compliance with "Statutory Liquidity Ratio" (SLR)
requirements?
(b) While auditing APNA Bank, you observed that a lump sum amount has been
disclosed as contingent liability collectively. You are, therefore, requested by
the management to guide them about the disclosure requirement of
Contingent Liabilities for Banks. Kindly guide.

Q-61

(a) As a branch auditor of a Nationalised bank, how would you classify the
following advances based on securities?
(i) Advances covered by ECGC/DISGC guarantees.

(ii) An account which is fully secured but the margin in which is lower than
that stipulated by the bank.
(iii) Advances covered against cheques purchased including self cheques.
(iv) Advances against supply bill.
(b) As the concurrent auditor of Nagpur Main Branch of XYZ Bank Ltd., state the
issues which have to be considered in the audit of advances.

Q-62

(a) A firm of a father and a son is receiving ` 1 lakh towards job work done for ABC Ltd.
during the year ending on 31.03.14. The total job work charges paid by ABC Ltd. during
the year are over ` 25 lakhs. The father is a Managing Director of ABC Ltd. having
substantial holding. The Managing Director told the auditor that since he is not involved
in the activities of the firm and since the amount paid to it is insignificant; there is no
need to disclose the transaction explicitly. He further contended that such a payment
made in the last year was also not disclosed. Is Managing Director right in his approach?

Q-63

(a) Divergence Pvt. Ltd. is an unlisted closely held company with turnover less than

` 50 crores. While finalizing the accounts, Mr. Nix, Director (finance), disputed the
8. applicability of AS 20 to the company, on the basis of the fact that the company’s
shares are not listed on any recognised stock exchange in India.

Q-64

8. Mr. Man is a whole-time director of Manthan Ltd. who has a very good relation with
the Director (Operations) of the company. Consequently, he entered into a
purchase contract for supply of goods of ` 5,00,000 with the company without
obtaining prior consent of the Board. What is the responsibility of the auditor
in relation to the Companies Act, 2013?

Q-65

(b) Mr. A, a practicing Chartered Accountant, audited the financial statements of C
Ltd. for the previous year 2012-13 and expressed an unmodified opinion. C
Ltd. was of the view that Mr. A is not conducting the audit properly and
therefore, for the current year 2013-14, it appointed Ms. B, a leading practicing
Chartered Accountant to conduct the audit and present Comparative Financial
Statements. Ms. B, while performing the auditing procedures, found that C Ltd.
has undercharged the wages of ` 10 lakhs during the previous year resulting in
overstatement of profits. What are the further procedures, Ms. B is required to
pursue?

Q-66

PK Ltd. has taken a term loan from a nationalized bank in 2012 for ` 350 lakhs repayable in 7 equal
yearly instalments (including interest) of ` 50 lakhs beginning from 31st March, 2013 onwards. It
had repaid the instalments due in 2013 & 2014, but defaulted in repayment of principal as well as
interest for the current financial year 2015. Discuss the reporting responsibilities of the auditor of
PK Ltd. in accordance with the Companies Act, 2013

Q-67

1. While auditing the accounts of XYZ Ltd., it has come to the notice of the auditor that
receipts have been suppressed. Discuss explaining at least five techniques as to how receipts may be suppressed

Q-68

What do you understand by the Rolling Settlements? State briefly
Enumerate the main areas to be covered by the auditor in the case of environment audit of an
industrial unit.

Q-69

Explain in brief the behavioural aspects encountered in the management audit
and state the ways to solve them.
The Managing Director of xYuki Ltd is concerned about high employee
attrition rate in his company. As the internal auditor of the company he
requests you to analyze the causes for the same. What factors would you
consider in such analysis?

Q-70

An American Company engaged in the business of manufacturing and distribution
of industrial gases, is interested in acquiring a listed Indian Company having a
market share of more than 65% of the industrial gas business in India, request you
to conduct a “Due Diligence” of this Indian Company and submit your Report.
(a) As due Diligence Auditor, what key areas you will cover in your review?
(b) List out the contents of your Due Diligence Review Report that you will submit
to your USA based Client.

Q71

In assessment procedure of ABC Ltd., Income Tax Officer observed some irregularities.
Therefore, he started investigation of books of accounts audited and signed by Mr. X, a
practicing Chartered Accountant. While going through books he found that ABC Ltd. used to
maintain two sets of books of accounts, one is the official set and other is covering all the
transactions. Income Tax Department filed a complaint with the Institute of Chartered
Accountants of India saying Mr. X had negligently performed his duties. Comment.

Q-72

“Permanent Consolidation Adjustments are made only on the first occasion of
the preparation and presentation of consolidated financial statements”. What
are the Permanent Consolidation Adjustments? Explain the role of auditor in
this context.
(b) While doing the audit of consolidated Financial Statements, which current
period consolidation adjustments are to be taken into account?

Q-73

(b) (a) You have been appointed as management auditor of a large engineering
company suffering from a working capital crunch. Enlist and discuss the
related areas which you would probe into to overcome the company’s
problem.
Amazekart, a manufacturing unit does not accept the recommendations for
improvements made by the Operational Auditor. Suggest an alternative way to
tackle the hostile management.

Q-74

Mr. Manan is above 80 years old and wishes to sell his proprietary business of
manufacture of specialty chemicals. Preeto Ltd. wants to buy the business and
appoints you to carry out a due diligence audit to decide whether it would be
worthwhile to acquire the business. What procedures you would adopt before
you could render any advice to Preeto Ltd.?
(b) Runri Ltd., a company engaged in manufacturing of chemicals is consistently
recording higher sales turnover, but declining net profits since the last 5 years.
As an investigator appointed to find out the reasons for the same, what are the
points you would verify?

Q-75

10. (a) “In an audit of an insurance company, the Receipts and Payments Account is
also subjected to audit”. Comment.
Mention the duties of Auditor of Co-operative Societies in regard to the following:
Over-due interest.
Compliance with provisions of Co-operative Act and Rules thereunder.
Special Report to Registrar of Co-operative Societies.

Q-76

9. (a) Enumerate the issues addressed in the SEBI (Listing Obligations and Disclosure
Requirements) Regulations, 2015 regarding Corporate Governance.
(b) Briefly explain the role of auditor in audit committee and certification of
compliance of conditions of Corporate Governance.
(c) Pataka Limited is a listed Company in which no code of conduct is laid down
for its board members and senior members.
As an auditor of Pataka Limited:

(i) Briefly explain the compliance requirements with respect to Code of Conduct
as per Listing Order Disclosure Requirement (LODR) Regulations.

(ii) What will be your role in compliance of above-mentioned Code of
Conduct as per LODR Regulations?

Q-77

The RBI restrict companies from carrying on the business of a non-banking
financial institution without obtaining the certificate of registration,
therefore, obtaining registration under section 45-IA of the Reserve Bank
of India Act, 1934 is necessary. Additionally, new clause has been inserted
under CARO, 2016 for commenting whether the registration has been
obtained, if required.
Being an expert in latest provisions under CARO, 2016, you are required to
state in brief the audit procedure and reporting to be followed under above
mentioned circumstances.

(b) You are appointed as the auditor of a Hire-Purchase Finance Company.

Enumerate the verification procedures in relation to audit of such Non-
Banking Financial Company.

Q-78

Mr. A is appointed as statutory auditor of XYZ Ltd. XYZ Ltd is required to appoint
internal auditor as per statutory provisions given in the Companies Act, 2013 and
appointed Mr. B as its internal auditor. The external auditor Mr. A asked internal
auditor to provide direct assistance to him regarding evaluating significant
accounting estimates by the management and assessing the risk of material
misstatements.
(a) Discuss whether Mr. A, statutory auditor, can ask direct assistance from Mr. B,
internal auditor as stated above in view of auditing standards.
(b) Will your answer be different, if Mr. A ask direct assistance from Mr. B,
internal auditor with respect to external confirmation requests and evaluation
of the results of external confirmation procedures?

Q-79

(a) General objective of an audit is to find out whether the financial statements
show true and fair view. On the other hand, investigation implies systematic,
critical and special examination of the records of a business for a specific
purpose.
In view of the above, you are required to brief out the difference between
Audit and Investigation.

(b) Zeta Ltd. is anticipating taking over a manufacturing concern and appoints you
for due diligence review. While reviewing, it requests you to look specifically
for any hidden liabilities and overvalued assets. State in brief the major areas
you would examine for hidden liabilities and overvalued assets.

Q-80

11. Hold Ltd. has two subsidiaries and one associate. While doing the audit of
Consolidated Financial Statements (CFS) of Hold Ltd., you have come to know
that the associate entity had made a provision for proposed dividend in its
financial statements. Hold Ltd. computed its share of the results of operations
of the associate after taking into account the proposed dividend. Comment.

Q-81

While auditing Secure Insurance Ltd., you observed that the major proportion
of expense of the company is the remuneration/commission paid to its
insurance agents. As the auditor of the company, what audit procedure would
you adopt for verification of such expense?

Q-82

19. Comment on the following with reference to the Chartered
Accountants Act, 1949, and Schedules thereto:

(a) CA Brilliant is a leading income tax practitioner and consultant for derivative
products. He resides in Mumbai near to the XYZ commodity stock exchange
and does trading in commodity derivatives. Every day he invests most of his
time to
settle the commodity transactions though he has not obtained any
permission from the Institute for conducting such business.

(b) CA Intelligent, a Chartered Accountant in practice, provides part-time tutorship
under the coaching organization of the Institute. On 30th June, 2015, he was awarded
‘Best Faculty of the year’ as gratitude from the Institute. Later on, CA Intelligent
posted his framed photograph on his website wherein he was receiving the said
award from the Institute.

Q-83

(b) Mr. Hopeful, an aspiring student of ICAI, approached Mr. Witty, a practicing
Chartered Accountant, for the purpose of articleship. Mr. Witty, the principal, offered
him stipend at the rate of ` 2,000 per month to be paid every sixth month along with
interest at the rate of 10% per annum compounded monthly to compensate such late
payment on plea that cycle of professional receipts from clients is six months. Mr.
Hopeful agreed for such late payment in the hope of getting extra stipend in the form
of interest.

Mr. Witty, however, used to disburse salary to all of his employees on time.

(c) MNC Pvt. Ltd. appointed CA Posh for some professional assignments like company’s
ROC work, preparation of minutes, statutory register etc. For this, CA Posh charged
his fees depending on the complexity and the time spent by him on each assignment.

Later on, MNC Pvt. Ltd. filed a complaint against CA Posh to the Institute of
Chartered Accountants of India (ICAI) that he has charged excessive fees
for the assignments comparative to the scale of fees recommended by the
Committee as well as duly considered by the Council of ICAI.

Q-84

19. Comment on the following with reference to the Chartered Accountants Act, 1949, and
Schedules to the Act:
(a) CA N, in practice, started project consultancy work as a part of his practice and to advance
the same, sent mail to all the CAs in the country informing them of his services and for
securing professional work.
CA T, in practice, was appointed to carry out Internal audit of a stock broker, listed with BSE.
However, he failed to intimate his appointment to the statutory auditors of the company. The
statutory auditor feels this is violation of professional ethics

Q-85

(a) Mr. Ram, a Chartered Accountant in practice, received ` 15,00,000 on 15th
December, 2013 on behalf of one of his clients, who has gone to USA. Mr. Ram
deposited the said amount in his saving bank account (SB Account). As per
instruction of the client, the said amount is to be returned to the client on March 31,
2014 when he will return to India. On the occasion of birthday of his wife Sita, Mr.
Ram withdrew ` 5,00,000 and spent on Birthday party. He re-deposited ` 5,00,000 in
the said SB account on 25th March, 2014 and then returned the entire amount of `
15,00,000 to the client on March, 31, 2014.

(b) CA. Smart, a CA in practice runs his proprietorship firm as “M/s Smart & Co.”. His
annual gross receipts are in excess of ` 40 Lakhs. He maintains a small pocket diary
in which he writes the fees received from various clients. Based on his record, he
prepares and files his income tax return.

Q-86

19. Comment on the following with reference to the Chartered Accountants Act, 1949
and schedules thereto:
(a) M/s LMN & Associates, a firm of Chartered Accountants responded to a tender
issued exclusively for Chartered Accountants by an organisation in the area of
tax audit. However no minimum fee was prescribed in the tender document.
(b) PQR Pvt Ltd. approached CA. Whai, a Chartered Accountant in Practice, for
debt recovery services. CA Whai accepted the work and insisted for fees to be
based on 2% of the debt recovered.

Q-87

M/s ABZ & Co., a firm of Chartered Accountants, develops a website “abz.com”.
The colour chosen for the website was a very bright green and the web-site
was to run on a “push” technology where the names of the partners of the firm
and the major clients were to be displayed on the web-site without any
disclosure obligation from any regulator.
(d) M/s XYC & Co., a firm of Chartered Accountants, received ` 4.8 lakhs in January,
2016 on behalf of one of their clients, who has gone abroad and deposited the
amount in their Bank account, so that they can return the money to the client
in July, 2016, when he is due to return to India.

Q-88

Comment on the following with reference to the Chartered Accountants Act, 1949, and Schedules
thereto

(a) CA. Arjit registered his proprietorship firm last year and started practicing in
the name of “M/s Arjit & Co.”. He is of the view that a professional need to
maintain books of accounts only if his earnings exceed the minimum
prescribed limit as per section 44AA of the Income Tax Act, 1961. Therefore,
he decided not to maintain his books of accounts as his earnings are below the
prescribed limit given under section 44AA of the said Act.

(b) CA. Sufi is practicing since 2008 in the field of company auditing. Due to his
good practical knowledge, he was offered editorship of a ‘Company Audit’
Journal which he accepted. However, he did not take any permission from the
council regarding such editorship.

.

Q-89

(a) As a Chartered Accountant in practice, Mr. Denis is offered to conduct a review
of the "Profit Forecast" prepared by a company in connection with its
application for a term loan from a financial institution.
(b) CA. Sonu and CA. Monu are two partners of the CA firm ‘Sonu Monu and
Associates’. Being very pious, CA. Sonu organised a religious ceremony at his
home for which he instructed his printing agent to add his designation
“Chartered Accountant” with his name in the invitation cards. Later on, the
invitations were distributed to all the relatives, close friends and clients of
both the partners.

Q-90

19. Comment on the following with reference to the Chartered Accountants Act, 1949,
and Schedules thereto:
(a) Mr. Clever, a Chartered Accountant, prepared a project report for one of his
client, Mr. King, to obtain long term loan of ` 100 lakhs from a scheduled bank
and decided to charge fees @10% of the loan approved. Subsequently, the
bank approved the loan amounting to ` 80 lakhs. Consequent to the approval of
loan by the bank, Mr. Clever raised an invoice for his services @10% of the
loan approved, as decided.
(b) Ms. Preeti is a practicing Chartered Accountant. Mr. Preet is a practicing
Advocate representing matters in the court of law. Ms. Preeti and Mr. Preet
decided to help each other in the matters involving their professional
expertise. Accordingly, Ms. Preeti recommends Mr. Preet in all tax litigation
matters in the court of law and Mr. Preet consults Ms. Preeti in all matters
related to finance and other related matters, which comes to him in arguing
various cases in the court of law. Consequently, they started sharing some part
in the profits of their professional work.

Q-91

(a) A special notice has been issued for a resolution at 3rd annual general meeting of Fiddle
Ltd. providing expressly that CA Smart shall not be re-appointed as an auditor of the

company. Consequently, CA Smart submitted a representation in writing to the
company as provided under section 140(4)(iii) of the Companies Act, 2013. In the
representation, CA Smart incorporated his independent working as a professional
throughout the term of office and also indicated his willingness to continue as an
auditor if reappointed by the shareholders of the Company.
(b) Mr. Brainy, a Chartered Accountant in practice, is the auditor of Fair Ltd. He advised the
Managing Director of the company to include ‘orders under negotiation’ in sales, to
reflect higher profit and better financial position for obtaining bank loans in future. Mr.
Brainy, thereafter, gave clean reports on the balance sheet prepared accordingly
without examining the accounts.

Q-92

19. Comment on the following with reference to the Chartered Accountants Act, 1949 and
schedules thereto:
(a) The Cashier of a company committed a fraud and absconded with the proceeds
thereof. This happened during the course of the accounting year. The Chief
Accountant of the company also did not know about fraud.
In the course of the audit, at the end of the year, the auditor failed to discover the
fraud. After the audit was completed, however, the fraud was discovered by the
Chief Accountant. Investigation made at that time indicates that the auditor did not
exercise proper skill and care and performed his work in a desultory and
haphazard manner. With this background, the Directors of the company intend to
file disciplinary proceedings against the auditor.
Discuss the position of the auditor with regard to the disciplinary proceedings.
(b) Priya Co. Ltd. has applied to a bank for loan facilities. The bank on studying the
financial statements of the company notices that you are the auditor and requests
you to call at the bank for a discussion. In the course of discussions, the bank asks
for your opinion regarding the company and also asks for detailed information
regarding a few items in the financial statements. The information is available in
your working paper file. What should be your response and why?

.

Q-93

(a) Binaca & Co, a firm of Chartered Accountants, accepted an assignment for
audit under State level VAT Act, without any prior communication with the
previous auditor.
(b) Qurashi, a Chartered Accountant, failed to report to the shareholders of the
Zee Ltd, about the non-creation of a sinking fund in accordance with the

Debenture Trust Deed and did not make clear that the amount shown as
Sinking Funds were borrowed from the Managing Agents of the Zee Ltd.
(c) M/s. Appu, a firm of Chartered Accountants responded to a tender from a
State Government for computerization of property takings records. For this
purpose, the firm also paid ` 60, 000 as earnest deposit as part of the terms
of the tender.

Q-94

Concession Ltd. is engaged in the business of manufacturing of threads. The company recorded the
turnover of ` 1.13 crore during the financial year 2017-18 before adjusting the following:
Discount allowed in the Sales Invoice` 8,20,000
Cash discount (other than allowed in Cash memo/ sales invoice)` 9,20,000
Trade discount ` 2,90,000
Commission on Sales` 6,00,000
Sales Return (F.Y. 2016-17)` 1,60,000
Sale of Investment ` 6,60,000
You are required to ascertain the effective turnover to be considered for the prescribed limit of tax
audit under the relevant Act and guide the company whether the provisions relating to tax audit
applies.

Q-95

Vijay Maniyar & Associates, a firm of Chartered Accountants, is of the view that under GST law,
audit can only be undertaken by the Departmental officers and there is no scope of audit under said
law for the Chartered Accountants. You are required to advise Vijay Maniyar & Associates on the
same

Q-96

You are doing the tax audit of a Limited Company. After submission of Tax Audit Report,
management notices that there was apparent mistake of law and due to this mistake, revised the
final accounts. As a tax auditor, company seeks your opinion whether the taxaudit can also be
revised or not.

Q-97

Beam Ltd., having principal place of business in Gujarat, is engaged in the generation, transmission,

distribution and supply of electricity throughout the India. The management of the company came
to know that the provisions related to maintenance of cost records and cost audit are applicable to
the company. The company, therefore, appointed a cost auditor for the financial year 2017-18. The
cost auditor reported certain disqualifications in Form CRA-3 of the cost audit report to which the
management of the company disagreed.The management of Beam Ltd. ingeniously instructed its tax
auditor not to reveal any of the disqualifications related to the cost audit while filling particulars to
be furnished in Form No. 3CD contendingthat the disqualifications are not relevant and there is no
correlation between tax audit and cost audit as well. As a tax auditor, how would you deal with the
matter?

Q-98

Mr. R, the Tax Auditor finds that some payments inadmissible under Section 40A(3) were made,
and advised the client to report the same in form 3CD. The client contends that cash payments were
made since the other parties insisted upon the same and did not have Bank Accounts. Comment

Q-99

Mr. Deepesh, is a renowned criminal lawyer, practising in Meerut. During the previous year, he
collected service tax of ` 25 lakhs but utilized it for his personal use. The Commissioner of Central
Excise issued a show cause notice to him as to why the tax, collected by him, is not deposited to the
government account. He appeared before the Commissioner and stated his inability to pay the sum
due to financial crisis. The proceedings are still pending before the Commissioner.

Q-100

A leading manufacturing concern valued its inventory following a method not in
line with the provisions of Income Computation and Disclosure Standard (ICDS)- 2
‘Valuation of Inventories’.
In such a situation, discuss the relevant clause of Form No. 3CD under which the
tax auditor is required to report?

 

 

 

 

A-1

 

1. (a) In the given case, certain weaknesses in the internal control procedure in the payment of wages in a large construction company were noticed by the statutory auditor and brought the same to the knowledge of the Managing Director of the company. In the subsequent year, a huge defalcation took place, the ramification of which stretched to the earlier year. The management of the company desires to sue the statutory auditor for negligence. The precise nature of auditor's liability in the case can be ascertained on the basis of the under noted considerations:

 

Whether the defalcation emanated from the weaknesses noticed by the statutory auditor, the information regarding which was passed on to the management; and

Whether the statutory auditor properly and adequately extended the audit programme of the previous year having regard to the weaknesses noticed.

 

SA 265 on “Communicating Deficiencies in Internal Control to Those Charged with Governance and Management” clearly mentions that, “The auditor shall determine whether, on the basis of the audit work performed, the auditor has identified one or more deficiencies in internal control. If the auditor has identified one or more deficiencies in internal control, the auditor shall determine, on the basis of the audit work performed, whether, individually or in combination, they constitute significant deficiencies. The auditor shall communicate in writing significant deficiencies in internal control identified during the audit to those charged with governance on a timely basis. The auditor shall also communicate to management at an appropriate level of responsibility on a timely basis”. The fact, however, remains that, weaknesses in the design of the internal control system and non-compliance with identified control procedures increase the risk of fraud or error. If circumstances indicate the possible existence of fraud or error, the auditor should consider the potential effect of the suspected fraud or error on the financial information. If the auditor believes the suspected fraud or error could have a material effect on the financial information, he should perform such modified or additional procedures as

 

he determines to be appropriate. Thus, normally speaking, as long as the auditor took due care in performing the audit work, he cannot be held liable.

 

The fact that the matter was brought to the notice of the managing director may be a good defence for the auditor as well. According to the judgement of the classic case In re Kingston Cotton Mills Ltd., (1896) it is the duty of the auditor to probe into the depth only when his suspicion is aroused. The statutory auditor, by bringing the weakness to the notice of the managing director had alerted the management which is judicially held to be primarily responsible for protection of the assets of the company and can put forth this as defence against any claim arising subsequent to passing of the information to the management. In a similar case S.P. Catterson & Sons Ltd. (81 Acct. L. R.68), the auditor was acquitted of the charge.

 

1. SA 620 on "Using the Work of an Auditor’s Expert" discusses the auditor's responsibility in relation to and the procedures the auditor should consider in, using the work of an expert as audit evidence. During the audit, the auditor may seek to obtain, in conjunction with the client or independently, audit evidence in the form of reports, opinions, valuations and statements of an expert, e.g., legal opinions concerning interpretations of agreements, statutes, regulations, notifications, circulars, etc. Before relying on advocate's opinion, the auditor should have seen that opinion given by the expert is prima facie dependable. The question states very clearly that the opinion of the advocate was inconsistent with legal position with regard to certain items. It is, perhaps, quite possible that auditor did not seek reasonable assurance as to the appropriateness of the source data, assumptions and methods used by the expert properly.

 

 

In fact, SA 620 makes it incumbent upon the part of the auditor to resolve the inconsistency by discussion with the management and the expert. In case, the expert's' work does not support the related representation in the financial information the inconsistency in legal opinions could have been detected by the auditor if he had gone through the same. This seems apparent having regard to wide difference in the liability worked out by the assessing authority. Under the circumstance, the auditor should have rejected the opinion and insisted upon making proper provision.

 

 

 

A-2

 

Fraud Committed by Management of the Company: As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial

Statements”, fraud can be committed by management overriding controls using such techniques as recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.

 

In the given case, Intelligent Ltd. has entered into an agreement with Mr. Intellectual, at year-end, for consultation in IT department. It also charged yearly fee of ` 24 lakhs in the Statement of Profit and Loss, however, no documentary or other evidence of receipt of such service was found, on investigation . It is clear that company has passed fictitious journal entries, near year-end, to manipulate the operating results.

 

 

Accordingly, the auditor would adopt the approach which will be based on the result of misstatement on the basis of such fictitious journal entry, i.e. if, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities; or the auditor may consider for appropriateness of withdrawal from such engagement, where withdrawal from the engagement is legally permitted.

 

In addition, the auditor is required to report according to section 143(12) of the Companies Act, 2013. As per Section 143(12), if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the audit committee within 2 days of his knowledge (as amount involved is less than one crore rupees) and after following the prescribed procedure such as reporting on :

 

1. Nature of Fraud with description;

 

1. Approximate amount involved; and

 

1. Parties involved etc

 

A

1. Holding of Meeting and Review Requirements as per Clause 49 of the (SEBI) Listing Agreement: One of the requirement as stipulated under clause 49 [Clause 49

(B)] (on which Section 177 of the Companies Act, 2013 relating to audit committee,

 

is silent) is – The Audit Committee should meet at least four times in a year and not more than one hundred and twenty days shall lapse between two meetings.

 

The quorum shall be either two members or one third of the members of the audit committee whichever is greater, but there should be a minimum of two independent members present.

 

 

In this case, Visual Limited is a company incorporated in India and have 6 members in it’s Audit Committee. Contention of audit committee members to meet only once due to recessionary conditions in India, at the year end is not in line with the clause 49 of the (SEBI) Listing Agreement.

 

Besides, there is a mandatory review requirement as per Clause 49 (III) (E), according to which the Audit Committee shall mandatorily review the following information:

 

1. Management discussion and analysis of financial condition and results of operations;

 

 

1. Statement of significant related party transactions (as defined by the Audit Committee), submitted by management;

 

1. Management letters / letters of internal control weaknesses issued by the statutory auditors;

2. Internal audit reports relating to internal control weaknesses; and

 

1. The appointment, removal and terms of remuneration of the Chief internal auditor shall be subject to review by the Audit Committee.

 

In the instant situation, though, the Audit Committee has reviewed monthly information system, but, failed to comply with the above requirements mentioned at point no. 1 to 5 of Clause 49 (III) (E) of Listing Agreement.

 

A-4

(a)Audit Planning

Circumstances	Outline audit approach
This is the first year that the firm has undertaken the audit of previous financial statements the Worth Ltd.	In order to be satisfied about the previous financial statements the Worth Ltd. auditor should :
	1. Hold consultations with management 2. Review client’s records, working papers and accounting and control procedures for the previous period 3. (Possibly) hold consultations with the previous auditor. 4. Be familiarizing with the nature of the business, market, accounting systems etc by discussions with management and by review of interim/management accounts
Worth Ltd.has -  A head office in Telangana -  A factory in Liverpool - Ten depots throughout the country	-The staff must be planned to carry out the audit from the firm’s offices throughout the country. They must all be adequately briefed and  provided with a copy of the audit plan detailing their specific tasks and deadlines.
No inventory records have been maintained but a full inventory count is to be carried out at the year end.	- It is very important that the auditors are satisfied with the inventory count . - The written count instruction must be year end. reviewed well in advance of the, so that improvement can be suggested by the auditors and incorporate d into the client’s instructions. - The auditors should ensure that sufficient staff with the necessary experienced is available to attend the count at all material locations.
‘L’, a major product of the company, has been identified as being potentially dangerous.	Ascertain - For how long Worth Ltd. has been selling ‘L’and in what quantity? - How much ‘L’ the company now holds in inventory? Ensure that the firm keeps up-to-date with the findings of the government working party. whether any of the employees of Consider Worth Ltd. may have been harmed and, if so, the consequential liability of the company to them

 

 

 

Objectives of audit planning

•  To ensure that appropriate attention is devoted to important areas of the audit: This is done via a formal written audit plan, laying down the objectives and the procedures to be followed in order to meet those objectives.

•  To facilitate review: Work should be delegated to staff with the appropriate level of experience. All work should be properly supervised and reviewed by a more senior member of staff.

•  To ensure that potential problems are identified: The auditor must ensure that resources are directed towards material/high risk areas.

• To assist in the proper assignment of work: This may be to members of the audit team or to experts or other auditors. It helps the audit to proceed in a timely and efficient manner.

 

A-5

Information	Reason
The organizational status and reporting  responsibilities of the internal auditor and any constraints and restrictions thereon.	The degree of objectivity is increased  when internal audit : - is free to plan and carry out its work and communicate fully with the external auditor - has access to the highest level of management.
Areas of responsibility assigned by  management to internal audit, such as  review of - Accounting systems and internal  controls - Implementation of corporate plans	Not all areas in which internal audit may operate will be relevant to the external  auditor.  - (Relevant) - (Not relevant)
Routine tasks carried out by internal audit staff such as authorization of petty cash reimbursements	In these respects staff are not functioning as internal audit, they are working simply as an internal control.
Internal auditors formal terms of reference	Internal auditor’s role will be most  relevant where it: - Has a bearing on the financial statements. - Involves a specialization
Internal audit documentation such as an audit manual and audit plans	It is more likely that due professional care is being exercised where the work of internal audit is properly planned, controlled, recorded and reviewed.
Professional membership and practical experience (including computer auditing skills) of internal audit staff.	Unless internal audit is technically competent it is inappropriate to place reliance on it.
Internal audit reports generated and feedback thereon.	How the company responds to internal audit findings may be regarded as a department measure of the department’ s effectiveness.
Number of staff, computer facilities and any other resources available to internal audit.	The effectiveness of internal audit (and hence the reliance placed thereon) will be limited if the department is under resourced.

 

 

(b)Typical procedures

 

• Inspection of tangible non-current assets: Assets seen at the warehouses (e.g. delivery vehicle fleet) should be noted and subsequently agreed to the fixed asset register maintained at head office (HO). Assets recorded in the register (e.g. shop fixtures and fittings) should be selected for inspection prior to visits to ensure their existence.

• Attendance at inventory counts: Periodic counts (eg monthly) should be attended on a rotational basis at warehouses and larger shops to ensure adherence to the company’s procedures. Test counts should be made to confirm the accuracy and completeness of the inventory counts

• Cash: Cash counts should be carried out on each register takings (and petty cash floats) whenever shops (and warehouses) are visited on a ‘surprise’ basis.

• Goods despatch: Internal control procedures should be observed to be in operation, for example to ensure that all dispatches are documented and destined for the company’s retail outlets.

• Employee verification: Payroll procedures are likely to be carried out at HO, warehouses and shops informing HO on a weekly basis of hours worked by employees, illness and holiday etc. However, new employees, especially in the shops (and probably also in the warehouses) will be recruited locally and their details notified to HO.

Internal audit will be able to select a sample of employees from HO records and ensure on the visits to shops and warehouses’ that these represent bona fide employees.

 

(c)Effect on audit

 

• Systems documentation: The accuracy of systems documentation which has been prepared by internal audit need only be confirmed using ‘walk- through tests’. This saves time (if the systems documentation is correct) since only copies will be required for the audit file.

• Tests of controls: The level of independent testing (i.e. by the external auditor) can be reduced where controls have been satisfactorily tested by internal audit, especially if error rates are found to be similar. In particular, attendance at stocktaking at the year end may be limited to those locations with the highest stockholdings.

• Substantive procedures: Internal audit’s evidence (e.g. concerning the existence of tangible non-concern assets), will reduce sample sizes for year end verification work. Substantive procedures may also be reduced where the internal audit checks reconciliations’ (e.g. of supplier’s statements to ledger balances, receivable and payables control accounts and bank reconciliations.)

 

A-6

 

Audit Plan for Evaluating the Reliability of Controls in CIS Environment: In evaluating the effects of a control, the auditor needs to assess the reliability by considering the various attributes of a control. Some of the attributes for example are that the control is in place and is functioning as desired, generality versus specificity of the control with respect to the various types of errors and irregularities that might occur, general control inhibit the effect of a wide variety of errors and irregularities as they are more robust to change controls in the application sub-system which tend to be specific control because component in these sub-system execute activities having less variety, that whether the control acts to prevent, detect or correct errors etc.

The auditor focuses here on-

• Preventive controls: Controls which stop errors or irregularities from occurring.

• Detective controls: Controls which identify errors and irregularities after they occur.

• Corrective controls: Controls which remove the effects of errors and irregularities after they have been identified.

The auditors are expected to see a higher density of preventive controls at the early stages of processing or conversely they expect to see more detective and corrective controls later in system processing.

Further, while evaluating the reliability of controls, the auditor should:

• Ensure that authorized, correct and complete data is made available for processing

• Provide for timely detection and correction of errors.

• Ensure that the case of interruption in the work of the CIS environment due to power, mechanical or processing failures, the system restarts without distorting the completion of the entries and records;

• Ensure that accuracy and completeness of output;

• Provide adequate data security against fire and other calamities, wrong processing, frauds etc.,

• Prevent unauthorized amendments to the program;

• Provide for safe custody of source code of application software and data files.

 

A-7

 

Auditor must provide a competent, independent opinion as to whether the financial statements records and report a true and fair view of the state of affairs of an entity. However, computer systems have affected how auditors need to collect and evaluate evidence. These aspects are discussed below:

• Changes to Evidence Collection - Collecting evidence on the reliability of a computer system is often more complex than collecting evidence on the reliability of a manual system. Auditors have to face a diverse and complex range of internal control technology that did not exist in manual system, like:

• accurate and complete operations of a disk drive may require a set of hardware controls not required in manual system,

• system development control include procedures for testing programs that again are not necessary in manual control.

Since, Hardware and Software develop quite rapidly, understanding the control technology is not easy. With increasing use of data communication for data transfer, research is focussed an cryptographic controls to project the privacy of data. Unless auditor's keep up with these developments, it will become difficult to evaluate the reliability of communication network competently.

 

The continuing and rapid development of control technology also makes it more difficult for auditors to collect evidence on the reliability of controls. Even collection of audit evidence through manual means is not possible. Hence, auditors have to run through computer system themselves if they are to collect the necessary evidence. Though generalized audit softwares are available the development of these tools cannot be relied upon due to lack of information. Often auditors are forced to compromise in some way when performing the evidence collection

1. Changes to Evidence Evaluation - With increasing complexity of computer systems and control technology, it is becoming more and more difficult for the auditors to evaluate the consequences of strength and weaknesses of control mechanism for placing overall reliability on the system.

Auditors need to understand:

• whether a control is functioning reliably or multi functioning,

• traceability of control strength and weakness through the system. In a shared data environment a single input transaction may update multiple data item used by diverse, physically disparate user, which may be difficult to understand.

 

Consequences of errors in a computer system are a serious matter as errors in computer system tend to be deterministic, i.e., an erroneous program will always execute data incorrectly. Moreover, the errors are generated at high speed and the cost and effort to correct and rerun program may be high. Errors in computer program can involve extensive redesign and reprogramming. Thus, internal controls that ensure high quality computer systems should be designed implemented and operated upon. The auditors must ensure that these control are sufficient to maintain assets safeguarding, data integrity, system effectiveness and system efficiency and that they are in position and functioning.

 

A-8

 

Reporting Requirement as per Schedule III to the Companies Act, 2013: As per the general instructions for preparation of Balance Sheet, provided under Schedule III to the Companies Act, 2013, current maturities of long-term debt is required to be disclosed under the head “Other Current Liabilities” in the notes to accounts.

It may be noted that “Current Maturities of Long-Term Debt” refers to that portion of liabilities of a company that are becoming due in next 12 months. Since, these obligations are repayable in next 12 months, they are shifted from Long-Term Liabilities section of the Balance Sheet to Current Liabilities section.

In the given case, Fine Ltd. has taken a loan, from Good bank, of ` 80 lakhs, repayable in 10 equal yearly instalments (including interest) of ` 20 lakhs. The company has repaid its four instalments upto 31st March, 2015. Further, due to good financial condition of the company, it decided for its entire outstanding loan as on 31st March, 2015, to be repaid in August, 2015.

Thus, it is clear that the outstanding loan of ` 50 lakhs, taken from Good Bank, is repayable in next 12 months. However, the accountant of the company has disclosed the said loan under the head “Long-term Borrowings”. Therefore, the management of the company is advised to show the amount of outstanding loan under the head “Other Current Liabilities” and further classify it under sub-heading “Current Maturities of Long-Term Debt” of heading “Other Current Liabilities” in the notes to accounts.

 

A-9

Branch Audit: As per section 143(8) of the Companies Act, 2013 if a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company (herein referred to as the company's auditor) under this Act or by any other person qualified for appointment as an auditor of the company under this Act and appointed as such under section 139, or where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company's auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.

In the given situation, Amudha Ltd. is a Mumbai based company, having total turnover of ` 10 Crore. The company is having a branch office at an area which is recently affected by flood.

Therefore, the company has to get its branch audited. In case no branch audit has been carried out, company’s auditor is required to mention this fact in the audit report and deal appropriately. Thus, no reference of above branch in statutory auditor’s report is not correct.

 

A-10

Auditor Holding Securities of a Company : As per sub-section (3)(d)(i) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. Provided that the relative may hold security or interest in the company of face value not exceeding rupees one lakh.

Also, as per sub-section (4) of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. H, Chartered Accountant, a partner of M/s R and H Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm, M/s R and H Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd. as per section 141(3)(d)(i), which is the holding company of Shiva Ltd., because Mr. H one of the partner is holding equity shares of its subsidiary.

 

A-11

 

According to Section 139(7) of the Companies Act, 2013, the auditors of a government company shall be appointed or re-appointed by the Comptroller and Auditor General of India. As per section 2(45), a Government company is defined as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined”.

In the given case Ajanta Ltd is a government company as its 20% shares have been held by Central Government, 25% by U.P. State Government and 10% by

M.P. State Government. Total 55% shares have been held by Central and State governments. Therefore, it is a Government company.

Rick Ltd. is a subsidiary company of Ajanta Ltd. Hence Rick Ltd. is covered in the definition of a government company. Therefore, the Auditor of Rick Ltd. can be appointed only by C & AG.

Consequently, appointment of Mr. Remo is invalid and he should not give acceptance to the Directors of Rick Ltd.

 

A-12

Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

 

• accounting and book keeping services;

• internal audit;

• design and implementation of any financial information system;

• actuarial services;

• investment advisory services;

• investment banking services;

• rendering of outsourced financial services;

• management services; and

• any other kind of services as may be prescribed.

 

Further section 141(3)(i) of the Companies Act, 2013 also disqualifies a person for appointment as an auditor of a company who is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

In the given case, CA Innocent was appointed as an auditor of Futura Ltd. He was offered additional services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors. The auditor is advised not to accept the services as these services are specifically notified in the services not to be rendered by him as an auditor as per section 144 of the Act.

 

A-13

 

According to section 141(3)(d)(ii) of the Companies Act, 2013, a person is not eligible for appointment as auditor of any company, If he is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees five lakh.

In the given case Mr. Abhar is disqualified to act as an auditor under section 141(3)(d)(ii) as he is indebted to M/s Chaudhary Finance Ltd. for more than 5,00,000. Also, according to section 141(3)(d)(ii) he cannot act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd. Therefore he has to vacate his office in Das Ltd. Even though it is a subsidiary of Chaudhary Finance Ltd.

Hence audit work performed by Mr. Abhar as an auditor is invalid, he should vacate his office immediately and Das Ltd should appoint another auditor for the company.

 

A-14

 

• Verification of Accounts Receivable: As per SA 510 “Initial Audit Engagements

                     – Opening Balances”, while conducting an initial audit engagement, the objective of the auditor with respect to opening balances is to obtain sufficient appropriate audit evidence about whether-

• Opening balances contain misstatements that materially affect the current period’s financial statements; and

• Appropriate accounting policies reflected in the opening balances have been consistently applied in the current period’s financial statements, or changes thereto are properly accounted for and adequately presented and disclosed in accordance with the applicable financial reporting framework.

When the financial statements for the preceding period were audited by another auditor, the current auditor may be able to obtain sufficient appropriate audit evidence regarding opening balances by perusing the copies of the audited financial statements.

Ordinarily, the current auditor can place reliance on the closing balances contained in the financial statements for the preceding period, except when during the performance of audit procedures for the current period the possibility of misstatements in opening balances is indicated.

For current assets and liabilities, some audit evidence about opening balances may be obtained as part of the current period’s audit procedures, say, the collection of opening accounts receivable during the current period will provide some audit evidence of their existence, rights and obligations, completeness and valuation at the beginning of the period.

In addition, according to SA 580 “Written Representations”, the auditor may consider it necessary to request management to provide written representations about specific assertions in the financial statements; in particular, to support an understanding that the auditor has obtained from other audit evidence of management’s judgment or intent in relation to, or the completeness of, a specific assertion. Although such written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own for that assertion.

In the given case, the management of Futura (P) Ltd. has restrained CA Jack, its auditor, from obtaining appropriate audit evidence for balances  of Accounts Receivable outstanding as it is from the preceding year. CA Jack, on believing that the preceding year balances have already been audited and on the statement of the management that there are no receipts and credits during the current year, therefore excluded the verification of Accounts Receivable from his audit programme.

Thus, CA Jack should have requested the management to provide written representation for their views and expressions; and he should also not exclude the audit procedure of closing balances of Accounts Receivable from his audit programme. Consequently, CA Jack shall also be held guilty for professional misconduct for not exercising due diligence, or grossly negligence in the conduct of his professional duties as per the Code of Ethics.

 

A-15

 

Relying on Work Performed by Another Auditor: As per SA 220 “Quality Control for an Audit of Financial Statements”, an engagement partner taking over an audit during the engagement may apply the review procedures such as the work has been performed in accordance with professional standards and regulatory and legal requirements; significant matters have been raised for further consideration; appropriate consultations have taken place and the resulting conclusions have been documented and implemented; there is a need to revise the nature, timing and extent of work performed; the work performed supports the conclusions reached and is appropriately documented; the evidence obtained is sufficient and appropriate to support the auditor’s report; and the objectives of the engagement procedures have been achieved.

Further, one of the basic principles, which govern the auditor’s professional responsibilities and which should be complied with wherever an audit is carried, is that when the auditor delegates work to assistants or uses work performed by other auditor and experts, he will continue to be responsible for forming and expressing his opinion on the financial information. However, he will be entitled to rely on work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. This is the fundamental principle which is ethically required as per Code of Ethics.

However, the auditor should carefully direct, supervise and review work delegated. He should obtain reasonable assurance that work performed by other auditors/experts and assistants is adequate for his purpose.

In the given case, all the auditing procedures before the moment of signing of final report have been performed by CA Suresh. However, the report could not be signed by him due to his unfortunate death. Later on, CA Chandra signed the report relying on the work performed by CA Suresh. Here, CA Chandra is allowed to sign the audit report, though, will be responsible for expressing the opinion. He may rely on the work performed by CA Suresh provided he further exercises adequate skill and due care and review the work performed by him.

 

A-16

Obtaining sufficient appropriate audit evidence while conducting Initial Audit Engagement : According to SA 510 on “Initial Audit Engagements- Opening Balances”, the objective of the Auditor while conducting an initial audit engagement with respect to opening balances is to obtain sufficient appropriate audit evidence so that the-

 

1. opening balances of the preceding period have been correctly brought forward to the current period;

2. opening balances do not contain any misstatement that materially affect the current period’s financial statements; and

3. appropriate accounting policies reflected in the opening balances have been consistently applied in the current period’s financial statements, or changes thereto are properly accounted for and adequately presented and disclosed in accordance with the applicable financial reporting framework.

Being a new assignment, audit evidence regarding opening balances can be obtained by perusing the copies of the audited financial statements.

For current assets and liabilities, some audit evidence about opening balances may be obtained as part of the current period’s audit procedures. For example, the collection/ payment of opening accounts receivable/ accounts payable during the current period will provide some audit evidence of their existence, rights and obligations, completeness and valuation at the beginning of the period.

In respect of other assets and liabilities such as property plant and equipment, investments, long term debts, the auditor will examine the records relating to opening balances. The auditor may also be able to get the confirmation from third parties (e.g., balances of long term loan obtained from banks can be confirmed from the Bank Loan statement).

 

A-17

 

Precautions to be taken by auditor in case Accounting Data Processed by Service Organisation: A client may use a service organisation such as one that executes transactions and maintains related accountability or records transactions and processes related data (e.g., a computer systems service organisation). If a client uses a service organisation, certain policies, procedures and records maintained by the service organisation might be relevant to the audit of the financial statements of the client. Consequently, the auditor would consider the nature and extent of activities undertaken by service organisations so as to determine whether those activities are relevant to the audit and, if so, to assess their effect on audit risk.

SA 402 on “Audit Considerations relating to an Entity Using a Service Organisation” deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations.

While planning the audit, the auditor of the client should determine the significance of the activities of the service organisation to the client and their relevance to the audit. In doing so, the auditor of the client would need to consider the following, as appropriate:

 

1. The nature of the services provided by the service organisation and the significance of those services to the user entity, including the effect thereof on the user entity’s internal control.

2. The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation.

3. The degree of interaction between the activities of the service organisation and those of the user entity.

4. The nature of the relationship between the user entity and the service organisation, including the relevant contractual terms for the activities undertaken by the service organisation.

 

A-18

 

(a)Improvements to be made in the internal control in this area:

1. Ensure that all scrap is put into the bin by the work force. This can be achieved by documenting the scrap generated in every production lot/shift/day.

2. Check should be available that the merchant is paying the best prices for the scrap. This can be achieved by getting a quote periodically from few dealers or getting market price and validation.

3. Ensure that quantity collected is paid for this can be achieved by company quantity lifted with the amount paid/quantity for which payment is received.

4. An independent official should attend the weighing and the enter in the book.

(b)Key audit procedures under these circumstances to mitigate audit risk:

1. Budget figures should be prepared for waste and compared to actual waste and variance being investigated.

2. Compare remittance advices/related quantity and reconcile with the quantity in gate keeper’s book.

3. Ensure all entries in the weight book is paid for.

4. Ensure all remittance matching entries in the cash book.

5. Review the reasonableness of total scarp sold during the period by comparing with manufacturing records of steel used in processing.

 

A-19

A key feature of the accounting software package used by the company definitely involves the absence of a clear audit trail. In other words, transactions cannot be easily traced or co-related from the individual supporting documents of those transactions. Moreover, the management does not wish to print the daybooks in view of the voluminous nature since it may involve extensive costs. This has naturally led to extensive dependence by management upon the "exception reporting" principle.

From the auditor's point of view, it must also be conceded, the exception reports in the form of 'query-based reports' which isolate the above data provide him with the very material that he requires for most of his verification work. The only problem which it raises, and it is a serious one, is that he cannot simply assume that the programmes which produce the exception reports are reliable in respect of the following factors:

 

1. operating accurately;

2. printing out all the exceptions which exist; and

3. bound by programmed control parameters which meet the company's genuine internal control requirements.

 

In view of the above, whether management relies upon exception reports, it effectively eliminated the audit trail between input and output and the auditor is forced to test the invisible processes which purport to embody the controls, and produce the output such as it is. These tests, which invariably involve the use by the auditor of the computer itself, are known as tests through the machine. In the 'through the machine' approach, the auditor starts by proving the accuracy of the input data, and then thoroughly examines (by applying tests) the processing procedures with a view to establishing the following that:

1. all input is actually entered into the computer.

2. neither the computer nor the operators can cause undetected irregularities in the final reports.

3. the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly.

4. all operator intervention during processing is logged and scrutinised by the DP manager.

The auditor in such circumstances will have to first evaluate the existing controls. For the same, he has to do the following:

1. Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., he has to verify at what level transactions can be entered into the system and what checks are available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered.

2. Evaluate at what level there authority is given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated, no further modifications are possible thereto.

3. Whether there is a provision in the software for carrying out an on line audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company.

4. Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed.

In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors.

(vi) The auditor may introduce some dummy data into the system and see the results obtained.

After the auditor has evaluated the above procedures, he has to prepare an audit plan depending on the results obtained from his earlier evaluation. Since the daybooks are not being printed, the plan can contain procedures wherein data is verified directly on the computer from the vouchers/invoices, etc. The audit plan will also require a lot of analytical procedures to be performed. Depending on the importance of various expense heads and other important account heads, the auditor will also obtain various reports from the system depending on various queries that he would have to identify. Some illustrative reports can be:

1. To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding ` one lakh.

2. To check whether all freight outward bills are accounted for a report containing a month-wise co-relation between goods despatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills.

Once the auditor has performed the above procedures, he would be able to form an opinion whether reliance can be placed on the accounting systems and the data recorded. If the auditor finds that reliance cannot be placed on the systems he can inform the management about the fact and also that the daybooks, etc., will need to printed to allow him to conduct the audit. The finalisation procedures to be followed even under this system would remain more or less similar to other accounting systems. The auditor can obtain reports of depreciation on fixed assets, inventory valuation and using the normal procedures find out whether reliance can be placed on them, e.g., if while valuing stocks the system is using the LIFO method, the same would not be acceptable and will need to be modified. Similarly depreciation calculations will have to verify on a random basis to find out its reliability.

 

The reliability of a component is a function of control that acts on the component. In a computer system the following are the major types of controls and used to enhance component reliability which the auditor must evaluate:

1. .Authenticity Control: They are exercised to verify the identity of the individuals or process involved in a system. (Pass word, digital signature etc.)

2.  Accuracy Control: These attempts to ensure the correctness of the data and processes in a system (Programme validation check).

3. Completeness Control: This ensures that no data is missing and all processing is carried through to its proper conclusion.

4. Privacy Control: This ensures the protection of data from inadvertent or unauthorised disclosure.

5. Audit Trail Controls: This ensures the traceability of all events occurred in a system.

6. Redundancy Control: It ensures that processing of data is done only once.

7. Existence Control: It attempts to ensure the on going availability of all system resources

8. .Asset safeguarding controls: It attempts to ensure that all resources within a system are protected from destruction or corruption.

9. Effectiveness Control: It attempts to ensure that the system achieves its goals.

10. Efficiency Control: It attempts to ensure that a system uses minimum resources to achieve its goals.

 

A-20

 

1. Auditor holding securities of a company : As per sub-section (3)(d)(i) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. Provided that the relative may hold security or interest in the company of face value not exceeding rupees one lakh.

Also, as per sub- section 4 of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub- section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm, M/s Ram and Hanuman Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd. as per section 141 (3)(d)(i), which is the holding company of Shiva Ltd., because Mr. Hanuman one of the partner is holding equity shares of its subsidiary

 

A-21

 

1. According to Section 139 (7) of the Companies Act, 2013, the auditors of a government company shall be appointed or re-appointed by the Comptroller and Auditor General of India. As per section 2(45), a Government company is defined as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined”.

In the given case Ajanta Ltd is a government company as its 20% shares have been held by Central Government, 25% by U.P. State Government and 10% by M.P. State Government. Total 55% shares have been held by Central and State governments. Therefore, it is a Government company.

Nick Ltd. is a subsidiary company of Ajanta Ltd. Hence Nick Ltd. is covered in the definition of a government company. Therefore, the Auditor of Nick Ltd. can be appointed only by C & AG.

Consequently, appointment of Mr. Prem is invalid and he should not give acceptance to the Directors of Nick Ltd.

 

A-22

 

1. Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

2. accounting and book keeping services;

3. internal audit;

4. design and implementation of any financial information system;

5. actuarial services;

6. investment advisory services;

7. investment banking services;

8. rendering of outsourced financial services;

9. management services; and

10. any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualify a person for appointment as an auditor of a company who is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

In the given case, CA Innocent was appointed as an auditor of Contravene Ltd. He was offered additional services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors. The auditor is advised not to accept the services as these services are specifically notified in the services not to be rendered by him as an auditor as per section 144 of the Act.

 

A-23

 

1. According to section 141 (3)(d) (ii) of the Companies Act, 2013, a person is not eligible for appointment as auditor of any company, If he is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees five lakh.

In the given case Mr. Amar is disqualified to act as an auditor under section141 (3)(d) (ii) as he is indebted to M/s Chaudhary Finance Ltd. for more than 5’00’000 ` Also according to Section141 (3)(d) (ii) he cannot act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das

Ltd. Therefore he has to vacate his office in Das Ltd. Even though it is a subsidiary of Chaudhary Finance Ltd.

Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his office immediately and Das Ltd should appoint another auditor for the company

 

 

A-24

 

1. Compliance with Standards on Auditing : As per sub section 9 of section 143 of the Companies Act, 2013, every auditor shall comply with the auditing standards. Further as per sub section 10 of section 143 of the Act, the Central Government may prescribe the standards of auditing or any addendum thereto, as recommended by the Institute of Chartered Accountants of India, constituted under section 3 of the Chartered Accountants Act, 1949, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority.

Provided that until any auditing standards are notified, any standard, or standards of auditing specified by the Institute of Chartered Accountants of India shall be deemed to be the auditing standards.

Further, the Preface to Standards on Auditing gives the scope of the Standards on Auditing. As per the Preface, the SAs will apply whenever an independent audit is carried out; that is, in the independent examination of financial statements/information of any entity; whether profit oriented or not and irrespective of its size, or legal form (unless specified otherwise) when such an examination is conducted with a view to expressing an opinion thereon.

Also while discharging their attest function; it is the duty of the Chartered Accountant to ensure that SAs are followed in the audit of financial information covered by their audit reports.

In the given case, even though the client is a non-profit oriented entity the SAs shall apply and the auditor shall be guilty of professional misconduct for failing to discharge his duty in case of non- compliance with SAs.

 

 

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1. (i) Rotation of Auditor: The provisions related to rotation of auditor are applicable to those companies which are prescribed in Companies (Audit and Auditors) Rules, 2014, which prescribes the following classes of companies excluding one person companies and small companies, namely:-

   1. all unlisted public companies having paid up share capital of rupees ten crore or more;

   2. all private limited companies having paid up share capital of rupees twenty crore or more;

   3. all companies having paid up share capital of below threshold limit mentioned in

      1. and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees fifty crores or more.

 

As per Section 139(2) of the Companies Act, 2013, no listed company or a company belonging to such class or classes of companies as mentioned above, shall appoint or re-appoint-

1. an individual as auditor for more than one term of five consecutive years; and

2. an audit firm as auditor for more than two terms of five consecutive years.

In the given case, Rama Pvt. Ltd. is a private company having paid up share capital of rupees twenty-five crore but having public borrowing from nationalized banks and financial institutions of rupees forty crore. The company appointed CA Raman as an auditor in its AGM dated 29th September, 2014.

The provisions relating to rotation of auditor will be applicable as the paid up share capital exceeds rupees twenty crore. Therefore, Rama Pvt. Ltd. shall appoint CA Raman as an auditor of the company for not more than one term of five consecutive years and CA Raman will hold office of Auditor from the conclusion of this meeting upto conclusion of sixth AGM i.e. AGM to be held in the year 2019.

 

1. Cooling off period: As per the proviso to section 139(2) of the Companies Act, 2013:-

   1. an individual auditor who has completed his term under clause (a) shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term;

   2. an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term.

Therefore, CA Raman shall not be re-appointed as Auditor in Rama Pvt. Ltd. for further term of five years i.e. he cannot be appointed as Auditor upto year 2024.

2.Common partner(s) to the other audit firm whose tenure has expired: As per the second proviso to section 139(2) of the Companies Act, 2013, as on the date of appointment, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years. For Example, M/s XYZ & Co., is an audit firm having partner Mrs. X, Mr. Y and Mr. Z, whose tenure has expired in the company immediately preceding the financial year. M/s ABZ& Co., is another audit firm in which Mr. Z is a common partner, will also be disqualified for the same company along with M/S XYZ & Co.for the period of five years.

Transitional period for the adoption of new Companies Act: As per the third proviso to section 139(2) of the Companies Act, 2013, every company, existing on or before the commencement of this Companies Act, 2013 which is required to comply with provisions of this sub-section, shall comply with the requirements of this sub-section within three years from the date of commencement of this Act. For example-

1. Mr Ram, a Chartered Accountant, is an individual auditor of M/s. Pinaco Ltd by last 5 years as on March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a continuous period of five years will not be considered as fulfilling the requirement of rotation. Thus, Mr Ram can continue the audit of M/s. Pinaco Ltd. for another 3 years due to transitional effect, i.e. aggregate period in the same company will be 8 years.

2. M/s Ram Associates, a Chartered Accountants Audit Firm, is doing audit of M/s. Pinaco Limited by last 11 years as on March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a continuous period of two terms of five consecutive years will not be considered as fulfilling the requirement of rotation. Thus, M/s Ram Associates can continue the audit of M/s. Pinaco Ltd. for another 3 years due to transitional effect, i.e. aggregate period in the same company will be 14 years.

1. Right of the company to remove an Auditor: As per the fourth proviso to section 139(2) of the Companies Act, 2013, it has also been provided that right of the company to remove an auditor or the right of the auditor to resign from such office of the company shall not be prejudiced.

2. Rotation between partners of audit firm: Under section 139(3) of the Act, subject to the provisions of this Act, members of a company may resolve to

provide that-

1. in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members; or

2. the audit shall be conducted by more than one auditor.

Further, it is important to note that as per the section 139(4) of the Companies Act, 2013, the Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors in pursuance of section 139(2) of the Act.

 

 

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1. Ceiling Number of Audit: As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies;

As per section 141 (3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits. Sometimes, a chartered accountant is a partner in a number of auditing

firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account.

In the given case, CA Mukti is holding appointment in 4 companies, whereas CA Shakti is having appointment in 6 Companies and CA Yukti is having appointment in 10 Companies. In aggregate all three partners are having 20 audits.

(i) Therefore, MSY & Co. can hold appointment as an auditor of 40 more companies:

 

Total Number of Audits available to the Firm	= 20*3 =	60
Number of Audits already taken by all the partners
In their individual capacity	= 4+6+10 =	20
Remaining number of Audits available to the Firm	=	40

With reference to above provisions an auditor can hold more appointment as auditor = ceiling limit as per section 141(3)(g)- already holding appointments as an auditor. Hence (1) CA Mukti can hold: 20 - 4 = 16 more audits. (2) CA Shakti can hold 20-6 = 14 more audits and (3) CA Yukti can hold 20-10

= 10 more audits

 

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1. As per Section 139(8), any casual vacancy in the office of an auditor shall-

 

1. In the case of a company other than a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within thirty days.

If such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the Board and he shall hold the office till the conclusion of the next annual general meeting;

        2. In the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Comptroller and Auditor-General of India within thirty days:

It may be noted that in case the Comptroller and Auditor-General of India does not fill the vacancy within the said period the Board of Directors shall fill the vacancy within next thirty days.

 

Casual Vacancy by Resignation: As per section 140 (2) the auditor who has resigned from the company shall file within a period of thirty days from the date of resignation, a statement in the prescribed form ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar, and in case of the companies referred to in section 139(5) i.e. subsequent auditor of Government company, the auditor shall also file such statement with the Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant with regard to his resignation. In case of failure the auditor shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees as per section 140 (3).

 

A-28

 

1. As per SA 402 “Audit Considerations relating to an Entity Using a Service Organisation”, for obtaining understanding of the user entity in accordance with SA 315, the user auditor shall obtain an understanding of how a user

entity uses the services of a service organization in the user entity’s operation including:

1. The nature of services provided by the service organisation and the significance of such services to the user entity, including its effect on the internal control of user entity.

2. The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation.

3. The degree of interaction between the activities of the service organization and those of user entity and

4. The nature of the relationship between the user entity and the service organization including the relevant contractual terms for the activities undertaken by the service organisation.

 

When obtaining an understanding of internal control relevant to the audit in accordance with SA 315 “Identifying and Assessing the Risks of Material Mis- statement through Understanding the Entity and its Environment”, the user auditor shall evaluate the design and implementation of relevant controls at the user entity that relate to the services provided by the service organisation, including those that are applied to the transactions processed by the service organisation.

 

1. The user auditor shall determine whether a sufficient understanding of the nature and significance of the services provided by the service organisation and their effect on the user entity’s internal control relevant to the audit has been obtained to provide a basis for the identification and assessment of risks of material misstatement.

 

If the user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall obtain that understanding from one or more of the following procedures:

 

1. Obtaining a Type 1 or Type 2 report, if available;

2. Contacting the service organisation, through the user entity, to obtain specific information;

3. Visiting the service organisation and performing procedures that will provide the necessary information about the relevant controls at the service organisation; or

4. Using another auditor to perform procedures that will provide the necessary information about the relevant controls at the service organisation.

 

 

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1. Additional Considerations in Initial Audit Engagements: As per SA 300, Planning an Audit of Financial Statements, the purpose and objective of planning the audit are the same whether the audit is an initial or recurring engagement. However, for an initial audit, the auditor may need to expand the planning activities because the auditor does not ordinarily have the previous experience with the entity that is considered when planning recurring engagements.

For initial audits, additional matters the auditor may consider in establishing the overall audit strategy and audit plan include the following:

♦Unless prohibited by law or regulation, arrangements to be made with the predecessor auditor, for example, to review the predecessor auditor’s working papers.

♦Any major issues (including the application of accounting principles or of auditing and reporting standards) discussed with management in connection with the initial selection as auditor, the communication of these matters to those charged with governance and how these matters affect the overall audit strategy and audit plan.

♦The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances (as per SA 510 “Initial Audit Engagements– Opening Balances”).

♦Other procedures required by the firm’s system of quality control for initial audit engagements (for example, the firm’s system of quality control may require the involvement of another partner or senior individual to review the overall audit strategy prior to commencing significant audit procedures or to review reports prior to their issuance).

 

1. Audit Planning – a Continuous Process: As per SA 300, Planning an Audit of Financial Statements, planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit engagement. Planning, however, includes consideration of the timing of certain activities and audit procedures that need to be completed prior to the performance of further audit procedures. For example, planning includes the need to consider, prior to the auditor’s identification and assessment of the risks of material misstatement, such matters as-

• The analytical procedures to be applied as risk assessment procedures.

• Obtaining a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework.

• The determination of materiality.

• The involvement of experts.

• The performance of other risk assessment procedures.

The auditor may decide to discuss elements of planning with the entity’s management to facilitate the conduct and management of the audit engagement (for example, to coordinate some of the planned audit procedures   with   the   work   of   the   entity's   personnel).   Although   these discussions often occur, the overall audit strategy and the audit plan remain the auditor's responsibility. When discussing matters included in the overall audit strategy or audit plan, care is required in order not to compromise the effectiveness of the audit. For example, discussing the nature and timing of detailed audit procedures with management may compromise the effectiveness of the audit by making the audit procedures too predictable.

 

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Considerations of Auditor for Assessing the Risk of Material Misstatement: As per SA 315 “Identifying and Assessing the Risk of Material Misstatement through understanding the Entity and its Environment”, the auditor shall identify and assess the risks of material misstatement at the financial statement level; and the assertion level for classes of transactions, account balances, and disclosures to provide a basis for designing and performing further audit procedures. For this purpose, the auditor shall:

1. Identify risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls that relate to the risks, and by considering the classes of transactions, account balances, anddisclosures in the financial statements

2. Assess the identified risks, and evaluate whether they relate more pervasively to the financial statements as a whole and potentially affect many assertions;

3. Relate the identified risks to what can go wrong at the assertion level, taking account of relevant controls that the auditor intends to test; and

4. Consider the likelihood of misstatement, including the possibility of multiple misstatements, and whether the potential misstatement is of a magnitude that could result in a material misstatement.

 

Auditor’s Responses to the Assessed Risk of Material Misstatement: According to SA 330 “The Auditor’s Responses to Assessed Risks”, the auditor shall design and implement overall responses to address the assessed risks of material misstatement. In designing the audit procedures to be  performed, the auditor shall:

 

1. Consider the reasons for the assessment given to the risk of material misstatement at the assertion level for each class of transactions, account balance, and disclosure, including:

2. The likelihood of material misstatement due to the particular characteristics of the relevant class of transactions, account balance, or disclosure; and

3. Whether the risk assessment takes into account the relevant controls, thereby requiring the auditor to obtain audit evidence to determine whether the controls are operating effectively; and

4. Obtain more persuasive audit evidence the higher the auditor’s assessment of risk.

 

 

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1. Internal Control System and its Inherent Limitations: As per Guidance Note on Audit of Internal Financial Control over Financial Reporting, internal controls are a system consisting of specific policies and procedures designed to provide management with reasonable assurance that the goals and objectives it believes important to the entity will be met.

 

"Internal Control System" means all the policies and procedures (internal controls) adopted by the management of an entity to assist in achieving management's objective of ensuring, as far as practicable, the orderly and efficient conduct of its business, including adherence to management policies, the safeguarding of assets, the prevention and detection of fraud and error, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.

To state whether a set of financial statements presents a true and fair view, it is essential to benchmark and check the financial statements for compliance with the framework. The Accounting Standards specified under the Companies Act, 2013 (which are deemed to be applicable as per Section 133 of the 2013 Act, read with Rule 7 of Companies (Accounts) Rules, 2014) is one of the criteria constituting the financial reporting framework on which companies prepare and present their financial statements under the Act and against which the auditors evaluate if the financial statements present a true and fair view of the state of affairs and the results of operations of the company in an audit of the financial statements carried out under the Act.

The fundamental therefore is that effective internal control is a process effected by people that supports the organization in several ways, enabling it to provide reasonable assurance regarding risk and to assist in the achievement of objectives.

Fundamental to a system of internal control is that it is integral to the activities of the company, and not something practiced in isolation.

 

An internal control system:

 

• Facilitates the effectiveness and efficiency of operations.

• Helps ensure the reliability of internal and external financial reporting.

• Assists compliance with laws and regulations.

• Helps safeguarding the assets of the entity.

 

Limitations of Internal Control - Internal control, no matter how effective, can provide an entity with only reasonable assurance and not absolute assurance about achieving the entity’s operational, financial reporting and compliance objectives. Internal control systems are subject to certain inherent limitations, such as:

♦Management's consideration that the cost of an internal control does not exceed the expected benefits to be derived.

♦The fact that most internal controls do not tend to be directed at transactions of unusual nature. The potential for human error, such as, due to carelessness, distraction, mistakes of judgement and misunderstanding of instructions.

♦The possibility of circumvention of internal controls through collusion with employees or with parties outside the entity.

♦The possibility that a person responsible for exercising an internal control could abuse that responsibility, for example, a member of management overriding an internal control.

♦Manipulations by management with respect to transactions or estimates and judgements required in the preparation of financial statements.

 

A-32

 

1. Audit under CIS Environment: A key feature of the accounting software package used by the company definitely involves the absence of a clear audit trail. In other words, transactions cannot be easily traced or co-related from the individual supporting documents of those transactions. Moreover, the management does not wish to print the daybooks in view of the voluminous nature since it may involve extensive costs. This has naturally led to extensive dependence by management upon the "exception reporting" principle.

From the auditor's point of view, it must also be conceded, the exception reports in the form of 'query-based reports' which isolate the above data provide him with the very material that he requires for most of his verification work. The only problem which it raises, and it is a serious one, is that he cannot simply assume that the programmes which produce the exception reports are reliable in respect  of the following factors:

 

1. operating accurately;

2. printing out all the exceptions which exist; and

3. bound by programmed control parameters which meet the company's genuine internal control requirements.

 

In view of the above, whether management relies upon exception reports, it effectively eliminated the audit trail between input and output and the auditor is forced to test the invisible processes which purport to embody the controls, and produce the output such as it is. These tests, which invariably involve the use by the auditor of the computer itself, are known as tests through the machine. In the 'through the machine' approach, the auditor starts by proving the accuracy of the input data, and then thoroughly examines (by applying tests) the processing procedures with a view to establishing the following that:

 

1. all input is actually entered into the computer.

2. neither the computer nor the operators can cause undetected irregularities in the final reports.

3. the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly.

4. all operator intervention during processing is logged and scrutinised by the DP manager.

 

The auditor in such circumstances will have to first evaluate the existing controls. For the same, he has to do the following:

 

1. Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., he has to verify at what level transactions can be entered into the system and what checks are available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered.

2. Evaluate at what level there is authority given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated no further modifications are possible thereto.

3. Whether there is a provision in the software for carrying out an online audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company.

4. Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed.

5. In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors.

6. The auditor may introduce some dummy data into the system and see the results obtained.

 

After the auditor has evaluated the above procedures, he has to prepare an audit plan depending on the results obtained from his earlier evaluation. Since the daybooks are not being printed, the plan can contain procedures wherein data is verified directly on the computer from the vouchers/invoices, etc. The audit plan will also require a lot of analytical procedures to be performed. Depending on the importance of various expense heads and other important account heads, the auditor will also obtain various reports from the system depending on various queries that he would have to identify. Some illustrative reports can be:

1. To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding ` one lakh.

2. To check whether all freight outward bills are accounted for a report containing a month-wise co-relation between goods dispatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills.

 

Once the auditor has performed the above procedures, he would be able to form an opinion whether reliance can be placed on the accounting systems and the data recorded. If the auditor finds that reliance cannot be placed on the systems he can inform the management about the fact and also that the daybooks, etc., will need to printed to allow him to conduct the audit. The finalisation procedures to be followed even under this system would remain more or less similar to other accounting systems. The auditor can obtain reports of depreciation on fixed assets, inventory valuation and using the normal procedures find out whether reliance can be placed on them, e.g., if while valuing inventories the system is using the LIFO method, the same would not be acceptable and will need to be modified. Similarly depreciation calculations will have to be verified on a random basis to find out its reliability.

 

 

A-33

1. Restrictions Regarding Political Contribution: Section 182 of the Companies Act, 2013 deals with prohibitions and restrictions regarding political contributions. According to this section, a government company or any other company whichhas been in existence for less than three financial years cannot contribute any amount directly or indirectly to any political party. In other cases, contribution in any financial year should not exceed 7½ % of average net profits during the three immediately preceding financial years.

In the given case, LN Ltd. has not made any profit in last four years and contributed` 2.5 lacs during the year to a political party for running a school. This is violation of the provisions of section 182 of the said Act although the children of its workers are benefited. The auditor would have to qualify his report stating the contravention of the provisions of the Companies Act.

 

A-34

 

1. Holding of Securities by Relative: According to section 141(3)(d)(i) of the Companies Act, 2013 read with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, as per the proviso to this section, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

Further, the term “relative” as defined under the Companies Act, 2013 includes step- brother.

In the present situation, Mr. YYY, the step-brother of Mr. XXX, is holding the securities having face value of ` 89,000 in Z Ltd. It may be noted that step- brother is included in the definition of the term “relative” as per the Companies Act, 2013. However, the proviso to section 141(3)(d)(i) of the said Act allows a relative of the auditor to hold securities in the company of face value not exceeding of ` 1,00,000.

Here, holding securities by the relative of Mr. XXX is below the limit as prescribed under the said proviso.

Therefore, Mr. XXX may accept the offer of appointment as an auditor of Z Ltd.

 

A-35

 

1. Appointment of First Auditor in the case of a company, other than a Government Company: As per the provisions of section 139(6) of the Companies Act, 2013, the first auditor of a company shall be appointed by the Board of Directors within 30 days from the date of registration of the company.

In the case of failure of the Board to appoint the auditor, it shall inform the members of the company.

The members of the company shall within 90 days at an extraordinary general meeting appoint the auditor. Appointed auditor shall hold office till the conclusion of the first annual general meeting.

As per the facts given in the case, the appointment of CA Raj as first auditor by the Members of KM Pvt. Ltd. by themselves is in violation of section 139(6) of the Companies Act, 2013, which authorizes the Board of Directors to appoint the first auditor of the company within one month of registration of the company. It may be noted that, only in the case of failure by the Board to appoint the auditor, the members of the company may appoint the auditor at an extraordinary general meeting.

Thus, the appointment of CA Raj by the Members of the company is not in order.

 

A-36

 

1. Power of Tribunal in case Auditor acted in a Fraudulent Manner: As per sub- section (5) of the section 140 of the Companies Act, 2013, the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors.

However, if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place.

It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447 of the said Act.

It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its director or officers.

 

 

A-37

1. Duties & Responsibilities of an Auditor in case of Material Misstatement resulting from Management Fraud: Misstatement in the financial statements can arise from fraud or error. The term fraud refers to an ‘Intentional Act’ by one or more individuals among management, those charged with governance. The auditor is concerned with fraudulent acts that cause a material misstatement in the financial statements.

As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, fraud can be committed by management overriding controls using such techniques as engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity.

Fraud involving one or more members of management or those charged with the governance is referred to as “management fraud”. The primary responsibility for the prevention and detection of fraud rests with those charged with the governance and the management of the entity.

Further, an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the SAs.

The risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud, because management is frequently in a position to directly or indirectly manipulate accounting records, present fraudulent financial information or override control procedures designed to prevent similar frauds by other employees

Auditor’s opinion on the financial statements is based on the concept of obtaining reasonable assurance, hence in an audit, the auditor does not guarantee that material misstatements will be detected.

Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government (in case amount of fraud is ` 1 crore or above) or Audit Committee or Board in other cases (in case the amount of fraud involved is less than `1 crore) within such time and in such manner as may be prescribed.

The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016, whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year. If yes, the nature and the amount involved is to be indicated.

If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:

 

1. Determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities;

2. Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the engagement is legally permitted; and

3. If the auditor withdraws:

4. Discuss with the appropriate level of management and those  charged with governance, the auditor’s withdrawal from the engagement and the reasons for the withdrawal; and

 

Determine whether there is a professional or legal requirement to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities, the auditor’s withdrawal from the engagement and the reasons for the withdrawal.

 

 

A-38

1     Understanding How User Entity Uses the Services of Service Organisation: As per SA 402 on “Audit Considerations Relating to an Entity Using a Service

Organisation”, when obtaining an understanding of the user entity in accordance with SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment”, the user auditor shall obtain an understanding of how a user entity uses the services of a service organisation in the user entity’s operations, including:

1. The nature of the services provided by the service organisation and the significance of those services to the user entity, including the effect thereof on the user entity’s internal control;

2. The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation;

3. The degree of interaction between the activities of the service organisation and those of the user entity; and

4. The nature of the relationship between the user entity and the service organisation, including the relevant contractual terms for the activities undertaken by the service organisation.

 

 

A-39

 

1. Compliance with Other Laws: As per SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”, the auditor shall obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements including tax and labour laws.

Further, non-compliance with other laws and regulations may result in fines, litigation or other consequences for the entity, the costs of which may need to be provided for in the financial statements, but are not considered to have a direct effect on the financial statements.

If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with management. If management does not provide sufficient information that supports that the entity is in compliance with laws and regulations and, in the auditor’s judgment, the effect of the suspected non- compliance may be material to the financial statements, the auditor shall consider the need to obtain legal advice.

If the auditor is precluded by management from obtaining sufficient appropriate audit evidence to evaluate whether non-compliance that may be material to the financial statements has, or is likely to have, occurred, the auditor shall express a qualified opinion or disclaim an opinion on the financial statements on the basis of a limitation on the scope of the audit.

In the instant case, major portion of the labour employed in the company was child labour. While questioning by auditor, reply of the management that it was outside his scope of financial audit to look into the compliance with other laws is not acceptable as it may have a material effect on financial statements.

Thus, auditor should ensure the disclosure of above fact and provision for the cost of fines, litigation or other consequences for the entity. In case, the auditor concludes that non-compliance has a material effect on the financial statements and has not been adequately reflected in the financial statements, the auditor shall express a qualified or adverse opinion on the financial statement.

 

 

A-40

 

Non-Chartered Accountant as Branch Auditor: As per section 143(8) of the Companies Act, 2013, where a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company under this Act or by any other person qualified for appointment as an auditor of the company. Where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country and the duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor, if any, shall be such as may be prescribed.

Thus, a non- Chartered Accountant can be appointed as an auditor of branch office located outside India provided he is qualified for appointment as an auditor in that country.

Using the Work of Another Auditor: When the accounts of the branch are audited by a person other than the company’s auditors, there is need for a clear understanding of the role of such auditor and the company’s auditor in relation to the audit of accounts of the branch and the audit of the company as a whole. Also, there is great necessity for a proper rapport between these two auditors for the purpose of an effective audit. In recognition of these needs, the Council of the Institute of Chartered Accountants of India has dealt with these issues in SA 600, “Using the Work of another auditor”. It makes clear that in certain situations, the statute governing the entity may confer the right on the principal auditor to visit a component and examine the books of accounts and other records of the said component, if he thinks it necessary to do so. Where another auditor has been appointed for the component, the principal auditor would normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it necessary for him to visit the component and/or to examine the books of accounts and other records of the said component. Further, it requires that the principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditors’ purpose, in context of the specific assignment.

 

 

A-41

 

1     The Internal Audit Programme in connection with Plant and Machinery, Tools and Dies may be on the following lines:

1. Internal Control Aspects - The following may be incorporated in the audit programme to check the internal control aspects:

   1. Maintaining separate register for hired assets, leased asset and jointly owned assets.

   2. Maintaining register of fixed asset and reconciling to physical inspection of fixed asset and to nominal ledger.

   3. All movements of assets are accurately recorded.

2. Authorisation be obtained for –

a declaring a fixed asset scrapped. selling a fixed asset.

1. Check whether additions to fixed asset register are verified and checked by authorised person. Proper recording of all additions and disposal.

2. Examining procedure for the purchase of new fixed assets, including written authority, work order, voucher and other relevant evidence.

3. Regular review of adequate security arrangements. iv   Periodic inspection of assets is done or not.

4. Regular review of insurance cover requirements over fixed assets.

 

Assets Register: To review the registers and records of plant, machinery, etc. showing clearly the date of purchase of assets, cost price, location, depreciation charged, etc.

 

Cost Report and Journal Register: To review the cost relating to each plant and machinery and to verify items which have been capitalised. Code Register: To see that each item of plant and machinery has been given a distinct code number to facilitate identification and verify the maintenance of Code Register.

Physical Verification: To see physical verification has been conducted at frequent intervals.

Movement Register: To verify (a) whether a Movement Register for movable equipments and (b) log books in case of vehicles, etc. are being maintained properly.

 

Assets Disposal Register: To review whether assets have been disposed off after proper technical and financial advice and sales/disposal/retirement, etc. of these assets are governed by authorisation, sales memos or other appropriate documents.

 

Spare Parts Register: To examine the maintenance of a separate register of tools, spare parts for each plant and machinery.

 

Review of Maintenance: To scrutinise the programme for an actual periodical servicing and overhauling of machines and to examine the extent of utilisation of maintenance department services.

 

Review of Obsolescence: To scrutinise whether expert’s opinion have been obtained from time to time to ensure purchase of technically most useful efficient and advanced machinery after a thorough study.

 

Review of R&D: To review R&D activity and ascertain the extent of its relevance to the operations of the organisation, maintenance of machinery efficiency and prevention of early obsolescence.

 

 

A-42

 

a Development of an Overall Plan: Overall plan is basically intended to provide direction for audit work programming and includes the determination of timing, manpower development and co-ordination of work with the client, other auditors and

other experts. The auditor should consider the following matters in developing his overall plan for the expected scope and conduct of the audit-

 

1. Terms of his engagement and any statutory responsibilities.

2. Nature and timing of reports or other communications.

3. Applicable Legal or Statutory requirements.

4. Accounting policies adopted by the clients and changes, if any, in those policies.

5. The effects of new accounting and auditing pronouncement on the audit.

6. Identification of significant audit areas.

7. Setting of materiality levels for the audit purpose.

8. Conditions requiring special attention such as the possibility of material error or fraud or involvement of parties in whom directors or persons who are substantial owners of the entity are interested and with whom transactions are likely.

9. Degree of reliance to be placed on the accounting system and internal control.

10. Possible rotation of emphasis on specific audit areas.

11. Nature and extent of audit evidence to be obtained.

12. Work of the internal auditors and the extent of reliance on their work, if any in the audit.

13. Involvement of other auditors in the audit of subsidiaries or branches of the client and involvement of experts.

14. Allocation of works to be undertaken between joint auditors and the procedures for its control and review.

15. Establishing and coordinating staffing requirement

 

 

A-43

 

1. Control System over Selling and Collection of Tickets: In order to achieve proper internal control over the sale of tickets and its collection by the Y Co. Ltd., following system should be adopted -

2. Printing of tickets: Serially numbered pre-printed tickets should be used and designed in such a way that any type of ticket used cannot be duplicated by others in order to avoid forgery. Serial numbers should not be repeated during a reasonable period, say a month or year depending on the turnover. The separate series of the serial should be used for such denomination.

3. Ticket sales: The sale of tickets should take place from the Central ticket office at each of the 5 centres, preferably through machines. There should be proper control over the keys of the machines.

Daily cash reconciliation: Cash collection at each office and machine should be reconciled with the number of tickets sold. Serial number of tickets for each entertainment activity/denomination will facilitate the reconciliation.

Daily banking: Each day’s collection should be deposited in the bank on next working day of the bank. Till that time, the cash should be in the custody of properly authorized person preferably in joint custody for which the daily cash in hand report should be signed by the authorized persons.

Entrance ticket: Entrance tickets should be cancelled at the entrance gate when public enters the centre.

Advance booking: If advance booking of facility is made available, the system should ensure that all advance booked tickets are paid for.

Discounts and free pass: The discount policy of the Y Co. Ltd. should be such that the concessional rates, say, for group booking should be properly authorized and signed forms for such authorization should be preserved.

Surprise checks: Internal audit system should carry out periodic surprise checks for cash counts, daily banking, reconciliation and stock of unsold tickets etc.

 

 

A-44

 

A key feature of the accounting software package used by the company definitely involves the absence of a clear audit trail. In other words, transactions cannot be easily traced or co-related from the individual supporting documents of those transactions. Moreover, the management does not wish to print the daybooks in view of the voluminous nature since it may involve extensive costs. This has naturally led to extensive dependence by management upon the "exception reporting" principle.

From the auditor's point of view, it must also be conceded, the exception reports in the form of 'query-based reports' which isolate the above data provide him with the very material that he requires for most of his verification work. The only problem which it raises, and it is a serious one, is that he cannot simply assume that the programmes which produce the exception reports are reliable in respect of the following factors:

 

1. operating accurately;

2. printing out all the exceptions which exist; and

3. bound by programmed control parameters which meet the company's genuine internal control requirements.

 

In view of the above, whether management relies upon exception reports, it effectively eliminated the audit trail between input and output and the auditor is forced to test the invisible processes which purport to embody the controls, and produce the output such as it is. These tests, which invariably involve the use by the auditor of the computer itself, are known as tests through the machine. In the 'through the machine' approach, the auditor starts by proving the accuracy of the input data, and then thoroughly examines (by applying tests) the processing procedures with a view to establishing the following that:

 

1. all input is actually entered into the computer.

2. neither the computer nor the operators can cause undetected irregularities in the final reports.

3. the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly.

4. all operator intervention during processing is logged and scrutinised by the DP manager.

The auditor in such circumstances will have to first evaluate the existing controls.

For the same, he has to do the following:

 

1. Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., he has to verify at what level transactions can be entered into the system and what checks are  available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered.

2. Evaluate at what level there authority is given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated, no further modifications are possible thereto.

3. Whether there is a provision in the software for carrying out an on line audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company.

 

` Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed.

` In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors.

` The auditor may introduce some dummy data into the system and see the results obtained.

After the auditor has evaluated the above procedures, he has to prepare an audit plan depending on the results obtained from his earlier evaluation. Since the daybooks are not being printed, the plan can contain procedures wherein data is verified directly on the computer from the vouchers/invoices, etc. The audit plan will also require a lot of analytical procedures to be performed. Depending on the importance of various expense heads and other important account heads, the auditor will also obtain various reports from the system depending on various queries that he would have to identify. Some illustrative reports can be:

1. To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding ` 1 lakh.

2. To check whether all freight outward bills are accounted for a report containing a month-wise co-relation between goods despatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills.

 

Once the auditor has performed the above procedures, he would be able to form an opinion whether reliance can be placed on the accounting systems and the data recorded. If the auditor finds that reliance cannot be placed on the systems he can inform the management about the fact and also that the daybooks, etc., will need to printed to allow him to conduct the audit. The finalisation procedures to be followed even under this system would remain more or less similar to other accounting systems. The auditor can obtain reports of depreciation on fixed assets, inventory valuation and using the normal procedures find out whether reliance can be placed on them, e.g., if while valuing stocks the system is using the LIFO method, the same would not be acceptable and will need to be modified. Similarly depreciation calculations will have to verify on a random basis to find out its reliability

 

 

A-45

 

1. The reliability of a component is a function of control that acts on the component. In a computer system the following are the major types of controls and used to enhance component reliability which the auditor must evaluate:

2. Authenticity Control: They are exercised to verify the identity of the individuals or process involved in a system. (Pass word, digital signature etc.)

3. Accuracy Control: These attempts to ensure the correctness of the data and processes in a system (Programme validation check).

4. Completeness Control: This ensures that no data is missing and all processing is carried through to its proper conclusion.

5. Privacy Control: This ensures the protection of data from inadvertent or unauthorised disclosure.

6. Audit Trail Controls: This ensures the traceability of all events occurred in a system.

7. Redundancy Control: It ensures that processing of data is done only once.

8. Existence Control: It attempts to ensure the on going availability of all system resources.

9. Asset safeguarding controls: It attempts to ensure that all resources within a system are protected from destruction or corruption.

10. Effectiveness Control: It attempts to ensure that the system achieves its goals.

11. Efficiency Control: It attempts to ensure that a system uses minimum resources to achieve its goals.

 

A-46

 

1. Ceiling on Number of Audit: As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than 20 companies other than one person companies, dormant companies, small companies and private companies having paid-up share capital less than ` 100 crore.

As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits.

Sometimes, a chartered accountant is a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account.

In the given case, CA. Satyam is holding appointment in 4 companies, whereas CA. Shivam is having appointment in 6 Companies and CA. Sundaram is having appointment in 10 Companies. In aggregate all three partners are having 20 audits.

1. Therefore, M/s SSS & Co. can hold appointment as an auditor of 40 more companies:

 

Total Number of Audits available to the Firm	= 20*3 =	60
Number of Audits already taken by all the partners
in their individual capacity	= 4+6+10 =	2 0
Remaining number of Audits available to the Firm	=	4 0

 

With reference to above provisions an auditor can hold more appointment as auditor = ceiling limit as per section 141(3)(g) - already holding appointments as an auditor Hence (1) CA. Satyam can hold: 20 - 4 = 16 more audits. (2) CA. Shivam can hold 20 - 6 = 14 more audits and (3) CA. Sundaram can hold 20 -10

= 10 more audits.

 

1. In view of above disussed provisions M/s SSS & Co. can hold appointment as  an auditor in all the 60 private companies having paid-up share capital less than ` 100 crore, 2 small companies and 1 dormant company as these are excluded from the ceiling limit of company audits given under section 141(3)(g) of the Companies Act, 2013.

2. As per fact of the case, M/s SSS & Co. is already having 20 company audits and they can also accept 40 more company audits. In addition, they can also conduct the audit of one person companies, small companies, dormant companies and private companies having paid up share capital less than ` 100 crores. In the given case, out of the 60 private companies, M/s SSS & Co. is offered 45 companies having paid-up share capital of ` 110 crore each.

Therefore, M/s SSS & Co. can also accept the appointment as an auditor for 2 small companies, 1 dormant company, 15 private companies having paid-up share capital less than ` 100 crore and 40 private companies having paid-up share capital of` 110 crore each in addition to above 20 company audits already holding.

 

 

A-47

 

1. (a) Audit Firm having Common Partner: Section 139(2) of the Companies Act, 2013 provides that as on the date of appointment, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years.

In the given case, CA. Rock is a common partner in M/s Ajay & Associates and M/s Vijay & Associates. The tenure of 10 years of M/s Ajay & Associates as an auditor has been expired in Sanjay Ltd. immediately preceding the current financial year i.e. the firm shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

Therefore, M/s Vijay & Associates will also be disqualified to be appointed as auditor of Sanjay Ltd. for next 5 financial years as CA. Rock was the common partner of M/s Vijay & Associates whose tenure in Sanjay Ltd. has expired.

 

(b) Retiring Partner being In-charge in Previous Audit Firm: As per 139(2) of the Companies Act, 2013 read with the explanation given under Companies (Audit and Auditors) Rules, 2014 for the purpose of rotation of auditors, if a partner, who is in-charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of 5 years.

In the given case, CA. Rock was in-charge of M/s Ajay & Associates and certifying authority of financial statements of Sanjay Ltd. who retires from the said firm and joins M/s Vijay & Associates. The tenure of 10 years of M/s Ajay & Associates as an auditor has been expired in Sanjay Ltd. immediately preceding the current financial year i.e. the firm shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

Therefore, M/s Vijay & Associates will also be disqualified to be appointed as auditor of Sanjay Ltd. for next 5 financial years as newly joined partner CA. Rock has retired from M/s Ajay & Associates immediately preceding the current financial year whose tenure in Sanjay Ltd. has expired.

 

 

A-48

 

1. Capitalisation of Expenses: As per Accounting Standard 26 on “Intangible Assets”, expenditure on an intangible item should be recognised as an expense when it is incurred unless it forms part of the cost of an intangible asset that meets the recognition criteria.

In the given case, FX Ltd. incurred substantial amounts on external trade, business communication and branding expenses by participation in various corporate social responsibility initiatives. The company expects to benefits by this expenditure by attracting new customers over a period of time and accordingly it has capitalised the same under brand development expenses. Here, no intangible assets or other asset is acquired or created that can be recognised.

Therefore, the accounting treatment by the company to amortise the entire expenditure over the period in which it expects the benefits to flow is not correct and the same should be debited to the Statement of Profit and Loss in the year of incurring.

 

 

A-49

 

1. Disclosure for Uncertainty about Going Concern: As per SA 570 “Going Concern”, it is the responsibility of the Auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

In the given case, Dabloo Ltd. has sold significant part of machinery to repay its wages overdue and also considering filing for bankruptcy. These events indicate a material uncertainty that may cast significant doubt on the company’s ability to continue as a going concern and, therefore, it would be unable to realize its assets and discharge its liabilities in the normal course of business.

Thus, the auditor should ask the management for its adequate disclosure in the financial statement and include the same in his report. However, if the management fails to make adequate disclosure, the auditor should express a qualified or adverse opinion. In view of circumstances mentioned in SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”, the auditor should give adverse opinion in above case as follows -

In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion paragraph, the financial statements do not give information required by the Companies Act, 2013 in the manner so required and also do not give a true and fair view in conformity with the accounting principles generally accepted in India:

1. In the case of the Balance sheet, of the state of affairs of the Company as at March 31,20xx;

2. In the case of the Profit & Loss account, of the profit/loss for the year ended on that date; and

3. In the case of the Cash flow statement, of the cash flow for the year ended on that date.

 

 

A-50

 

1. Donation to Charitable Institutions: Section 181 of the Companies Act, 2013 provides that the Board of Directors of a company may contribute to bona fide charitable and other funds with prior permission of the company in general meeting for such contribution in case any amount the aggregate of which, in any financial year, exceed 5 per cent of its average net profits for the three immediately preceding financial years.

In the instant case, OST Limited has given donation of ` 1,00,000/- (` 45,000/- +` 55,000/-) to two charitable organisations. The average profit of the last 3 years is ` 15 lakhs and the 5% of this works out to ` 75,000. Hence the maximum of donation could be ` 75,000 only. For excess of ` 25,000 the company is  required to take prior permission in general meeting which is not been taken.

Therefore, by paying donations of ` 1,00,000 which is more than ` 75,000, the Board has contravened the provisions of section 181 of the Companies Act, 2013. Hence, the auditor should qualify his report accordingly

 

A-51

 

(a) (I) Difference of Opinion Among Joint Auditors: SA 299 on, “Responsibility of Joint Auditors” deals with the professional responsibilities, which the auditors undertake in accepting such appointments as joint auditors. In respect of the work divided amongst the joint auditors, each joint auditor is responsible only for the work allocated to him, whether or not he has made a separate report on the work performed by him. On the other hand the joint auditors are jointly and severally responsible in respect of the audit conducted by them as under:

 

1. in respect of the audit work which is not divided among the joint auditors and is carried out by all of them;

2. in respect of decisions taken by all the joint auditors concerning the nature, timing or extent of the audit procedures to be performed by any of the joint auditors;

3. in respect of matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors;

4. for examining that the financial statements of the entity comply with the disclosure requirements of the relevant statute;

5. for ensuring that the audit report complies with the requirements of the relevant statute;

6. it is the separate and specific responsibility of each joint auditor to study and evaluate the prevailing system of internal control relating to the work allocated to him, the extent of enquiries to be made in the course of his audit;

7. the responsibility of obtaining and evaluating information and explanation from the management is generally a joint responsibility of all the auditors;

8. each joint auditor is entitled to assure that the other joint auditors have carried out their part of work in accordance with the generally accepted audit procedures and therefore it would not be necessary for joint auditor to review the work performed by other joint auditors.

 

Normally, the joint auditors are able to arrive at an agreed report. However where the joint auditors are in disagreement with regard to any matters to be covered by the report, each one of them should express their own opinion through a separate report. A joint auditor is not bound by the views of majority of joint auditors regarding matters to be covered in the report and should express his opinion in a separate report in case of a disagreement.

In the instant case, there are three auditors, namely, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd. For the valuation of gratuity

scheme of the Company they referred their own known Actuaries. Mr. Z (one of the

joint auditor) is not satisfied with the report submitted by Mr. Y’s referred actuary. He is not agreed with the matters to be covered by the report whereas Mr. X agreed with the same.

Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a separate report whereas Mr. X and Mr. Y may provide their joint report for the same.

(II) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities associated with insurance contracts or employee benefit plans etc., however, the auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.

The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence as per SA 500.

Further, in view of SA 620, if the expert’s work involves use of significant assumptions and methods, then the relevance and reasonableness of those assumptions and methods must be ensured by the auditor and if the expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data in the circumstances must be verified by the auditor.

In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later on found faulty. Further, Mr. Z is not agreed with this report therefore he submitted a separate audit report specifically for such gratuity valuation.

In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to examine the relevance, completeness and accuracy of source data used for such report before expressing their opinion.

Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty report without examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate opinion expressed by him.

 

 

A-52

 

1. Inability to Continue as a Going Concern: As per SA 570 on “Going Concern”, it is the responsibility of the Auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude

2. whether there is a material uncertainty about the entity’s ability to continue as a going concern. The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern. In evaluating management’s assessment, the auditor shall consider whether management’s assessment includes all relevant information of which the auditor is aware as a result of the audit. (d)

 In the instant case, Yummy Ltd. has suffered massive loss due to introduction of a substitute of its product by its rival company, Tasty Ltd., and having negative net worth also. Besides this, its production head, finance head and marketing head have also left the company. The company, in addition, has no action plan to mitigate these situations. Thus there are clear indications that there is danger to entity’s ability to continue in future. Considering the fact that there is no sound plan of action from the management to mitigate these factors and to put the company back on the recovery, t(fh)e going concern assumption does not hold appropriate.

1. Therefore, the auditor should ask the management for its adequate disclosure in the financial statement and include the same in his report. However, if the management fails to make adequate disclosure, the auditor should express a qualified or adverse opinion.

    If the result of the inappropriate assumption used in the preparation of financial statements is so material and pervasive as to make the financial statements misleading, the auditor should express an adverse opinion

 

A-53

 

1. Special Consideration with Regard to Inventory: As per SA 501 “Audit Evidence-Specific Considerations for Selected Items”, when inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by:

Attendance at physical inventory counting, unless impracticable, to:

Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting;

Observe the performance of management’s count procedures; Inspect the inventory; and

Perform test counts; and

Performing audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results.

ii Attendance at Physical Inventory Counting Not Practicable: In some cases,

attendance at physical inventory counting may be impracticable. This may be due to factors such as the nature and location of the inventory, for example, where inventory is held in a location that may pose threats to the safety of the auditor. The matter of general inconvenience to the auditor, however, is not sufficient to support a decision by the auditor that attendance is impracticable. Further, as explained in SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, the matter of difficulty, time, or cost

1. involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than persuasive.

2. Further, where attendance is impracticable, alternative audit procedures, for example, inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting, may provide sufficient

3. appropriate audit evidence about the existence and condition of inventory.

4. In some cases, though, it may not be possible to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by performing alternative audit procedures. In such cases, SA 705 on Modifications to the Opinion in the Independent Auditor’s Report, requires the auditor to modify the opinion in the auditor’s report as a result of the scope limitation

 

 

A-54

 

3.    Planning an Audit: As per SA 300 “Planning an Audit of Financial Statements”, the objective of the auditor is to plan the audit so that it will be performed in an effective manner. For this, the auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit and that guides the development of the audit plan. The auditor is also required to update and change the overall audit strategy and the audit plan as necessary during the course of the audit.

In the instant case, YSPPP Ltd. is a company which operates 30 petrol stations throughout India. The company’s sites are long-established and supplying fuel, oil, air and water. Over the last few years, due to the intense price competition in petrol trading, the company has expanded its shops into mini -markets as discussed in question. This induction has also lead to scarcity of staff; therefore, part-time staffs were also recruited. Point-of-sale PCs are also linked on-line via a network to the computer at head office. However, sales and inventory data are entered directly from the PCs at branches.

Circumstances particular to YSPPP Ltd. that should be taken into account while planning the audit, along with explanation for consideration is as under:

 

Circumstances		Why taken into account
Multiple business locations.		inherent Increases  risk                (e.g. if the organizational structure is loose and difficult to manage).
Intense price competition.		May lead to uneconomic price discounting,  possibly                                     threatening viability of business.
Recent expansion of outlets into      mini- markets		Increases   complexity  of business and may lead to loss of management control.

Perishable nature   and limited shelf-life of food and drinks inventories.	Increase risk of over statement of inventory values.
Large  volume of cash transactions.	Increases risk of incomplete income recording.
Nature of the business (garage environment).	Increases risk of loss of inventories and cash due to theft or staff pilferage. May limit effectiveness of physical security controls (e.g. over access to terminals).
Direct input via PCs at branches.	Increases risk of misstatement, as batch controls will not be feasible and scope for other input controls may be limited.

Small   number of staff at each location (e.g.one or two)	Limits  scope for segregation     of duties within branches and therefore increases control risk.
Branch-based    nature of business.	Limits effectiveness of management control over activities of individual branches thereby increasing control risk.
Use of part-time  staff and high staff turnover.	May inhibit effectiveness of controls within branches.

 

(b)Effect of Work of Internal Auditor on Audit Planning:

1. The internal auditor’s identification and documentation of areas of weakness will give direction to areas requiring increased substantive procedures.

2. Work of the internal auditor may assist in selection of branches for audit visits, (e.g. where control failures have occurred).

3. The internal auditor may attend year-end inventory counts at one or more branches, potentially reducing the number of branches to be visited by us.

4. Work performed by the internal auditor may provide evidence to confirm operation of control procedures, on which we may seek to rely to reduce the extent of our own procedures.

5. Documentation of systems and controls by the internal auditor may reduce extent of our planning visits, as walkthrough checks may be sufficient to confirm systems documentation.

 

A-55

 

1. (a) Consideration of Factors in Use of CAATs: In determining whether to use CAATs, the auditor should consider the following factors:

2. Availability of sufficient IT knowledge and expertise- It is essential that members of the audit team should possess sufficient knowledge and experience to plan, execute and use the results of CAAT. The audit team should have sufficient knowledge to plan, execute and use the results of the particular CAAT adopted.

3. Availability of CAATs and suitable computer facilities and data in suitable format- The auditor may plan to use other computer facilities when the use of CAATs on an entity’s computer is uneconomical or impractical, for example, because of an incompatibility between the auditor’s package programme and entity’s computer.

4. Impracticability of manual tests due to lack of evidence- Some audit procedures may not be possible to perform manually because they rely on complex processing (for example, advanced statistical analysis) or involve, amounts of data that would overwhelm any manual procedure.

5. Impact on effectiveness and efficiency in extracting a data- It includes selection of samples, applying analytical procedures, time involved in application of CAAT, etc.

6. Time constraints in certain data, such as transaction details, are often kept for a short time and may not be available in machine-readable form by the time auditor wants them. Thus, the auditor will need to make arrangements for the retention of data required, or may need to alter the timing of the work that requires such data.

 

(b) Control Procedure While Applying Computer Assisted Auditing Techniques (CAATs): Computer Assisted Auditing Techniques (CAATs) involve performing audit procedures while conducting audit through the computer. Audit software and Test Data are two common types of CAATs. Using CAATs involves taking various measures including monitoring so that the use of CAATs by the auditor provides reasonable assurance that the audit objectives and detailed specifications of CAATs have been met. It is to be seen that CAATs are not manipulated by staff of the entity. The specific procedures necessary to control the use of CAATs will depend on the particular application.

Procedures Carried Out by the Auditor to Control CAATs Applications may include:

 

©     participating in the design and testing of CAAT;

©     checking, if applicable, the coding of the program to ensure that it conforms with the detailed program specifications;

©     asking the entity’s staff to review the operating system instructions to ensure that the software will run in the entity’s computer installation;

©     running the audit software on small test files before running it on the main data files;

© checking whether the correct files were used, for example, by checking external evidence, such as control totals maintained by the user, and that those files were complete;

©     obtaining evidence that the audit software functioned as planned, for example, by reviewing output and control information; and

©     establishing appropriate security measures to safeguard the integrity and confidentiality of the data.

When using a CAAT, the auditor may require the cooperation of the entity’s staff who have extensive knowledge of the computer installation. In such circumstances, the auditor should have reasonable assurance that the entity’s staff did not improperly influence the results of the CAAT.

 

 

A-56

 

1. Services Not To Be Rendered By Auditor: This provision is newly inserted by section 144 of the Companies Act, 2013. Section 144 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely (i) accounting and book keeping services; (ii) internal audit; (iii) design and implementation of any financial information system; (iv) actuarial services; (v) investment advisory services; (vi) investment banking services; (vii) rendering of outsourced financial services; (viii) management services; and (ix) any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualify a person for appointment as an auditor of a company whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

Additionally, in accordance with section 141(4) of the Act, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned above after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the given case, M/s Renault & Co., Chartered Accountants, was appointed  as an auditor of R Ltd. Further, the company offered actuarial services to M/s Sona & Co., an associate to M/s Renault & Co., which has also been duly accepted by the firm. Therefore, M/s Renault & Co. is disqualified to hold office as an auditor of R Ltd. under section 141(3)(i), as its associate is involved in providing such services, to R Ltd., as mentioned in section 144 of the Companies Act, 2013.

Subsequently, M/s Renault & Co. shall have to vacate the office of auditor of R Ltd. accordingly.

 

 

A-57

 

(b) Indebtness to the Subsidiary Company: As per sub-section (3)(d)(ii) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of ` 5 lakhs.

Also, as per sub-section 4 of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Savy, the relative of Mr. Navy, a partner in Navy and Cavy Associates, has been indebted to Wealthy Ltd., a subsidiary company of Poor Ltd., for ` 6 lakhs.

Therefore, the firm, Navy and Cavy Associates would be disqualified to be appointed as statutory auditor of Poor Ltd. as per section 141(3)(d)(ii), which is the holding company of Wealthy Ltd., because Mr. Savy, the relative of Mr. Navy, a partner in Navy and Cavy Associates, has been indebted to Wealthy Ltd. for an amount exceeding the minimum approved limit

 

 

A-58

 

1. Rotation of Auditor & Cooling Off Period Provisions: The provision related to Rotation of Auditor & Cooling Off Period is newly inserted by section 139(2) of the Companies Act, 2013 read with Rule 5 of the Companies (Audit & Auditors) Rules, 2014, which is discussed as under:

The provisions related to rotation of auditor are applicable to those companies which are prescribed in Companies (Audit and Auditors) Rules, 2014, which prescribes the following classes of companies excluding one person companies and small companies, namely:-

1. all unlisted public companies having paid up share capital of ` 10 crore or more;

2. all private limited companies having paid up share capital of ` 20 crore or more;

3. all companies having paid up share capital of below threshold limit mentioned above, but having public borrowings from financial institutions, banks or public deposits of ` 50 crores or more.

 

As per Section 139(2) of the Companies Act, 2013, no listed company or a company belonging to such class or classes of companies as mentioned above, shall appoint or re-appoint-

 

1. an individual as auditor for more than one term of 5 consecutive years; and

2. an audit firm as auditor for more than two terms of 5 consecutive years.

 

In the given case, Orange Ltd. is an unlisted public company having paid up share capital of ` 5 crore and public deposits of ` 100 crore. The company has appointed M/s Santra & Co., a chartered accountant firm, as the statutory auditor in its AGM held at the end of September, 2014 for 11 years.

The provisions relating to rotation of auditor will be applicable as the public deposits exceeds ` 50 crore. Therefore, Orange Ltd. can appoint M/s Santra & Co. as an auditor of the company for not more than one term of five consecutive years twice i.e. M/s Santra & Co. shall hold office from the conclusion of this meeting upto conclusion of sixth AGM to be held in the year 2019 and thereafter can be re appointed as auditor for one more term of five years i.e. upto year 2024. The appointment shall be subject to ratification by members at every annual general meeting of the company. As a result, the appointment of M/s Santra & Co. made by Orange Ltd. for 11 years is void.

 

Cooling off period: As per the proviso to section 139(2) of the Companies Act, 2013-

 

1. an individual auditor who has completed his term under clause (a) shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of his term;

2. an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

 

Therefore, M/s Santra & Co. shall not be re-appointed as Auditor in Orange Ltd. for further term of 5 years i.e. upto year 2029

 

 

A-59

 

1. Disqualification due to Holding of Securities: According to section 141(3)(d)(i) of the Companies Act, 2013 read with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, an auditor is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, as per the proviso to this Section, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

Further, the term “relative” has been defined under the Companies Act, 2013 which means anyone who is related to another as members of a Hindu Undivided Family; husband and wife; Father (including step- father), Mother (including step-mother), Son (including step- son), Son’s wife, Daughter, Daughter’s husband, Brother (including step- brother), Sister (including step- sister).

In the present situation,

1. Mr. Pratiq is holding securities in Opus Ltd., which is not allowed as per the provisions of section 141(3)(d)(i) of the Act. Therefore, Mr. Pratiq will be disqualified to be appointed as an auditor of Opus Ltd.

2. Mr. Quresh, the step-father of Mr. Pratiq, is holding the securities in Opus Ltd.

It may be noted that step-father is included in the definition of the term “relative” as per the Companies Act, 2013. Further, proviso to section 141(3)(d)(i) of the Act allows a relative of the auditor to hold securities in the company of face value not exceeding of ` 1,00,000.

Here, Mr. Quresh is holding securities for face value of ` 89,000 which is below the limit as prescribed under the said provision

Therefore, Mr. Pratiq will not be disqualified to be appointed as an auditor of Opus Ltd.

 

A-60

Statutory Liquidity Ratio (SLR) Requirements: The Reserve Bank of India requires statutory central auditors of banks to verify the compliance with SLR requirements of 12 odd dates in different months of a financial year not being Fridays. The resultant report is to be sent to the top management of the bank and to the Reserve Bank. The report of the statutory auditors in relation to compliance with SLR requirements has to cover two aspects-

 

1. correctness of the compilation of DTL (Demand and Time Liabilities) position; and

2. maintenance of liquid assets.

 

Audit Approach and Procedure:

 

1. Obtain an understanding of the relevant circulars of the RBI, particularly regarding composition of items of DTL.

2. Require the branch auditors to send their weekly trial balance as on Friday and these are consolidated at the head office. Based on this consolidation, the DTL position is determined for every reporting Friday. The statutory central auditor should request the branch auditors to verify the correctness of the trial balances relevant to the dates selected by him. The branch auditors should also be specifically requested to examine the cash balance at the branch on the selected dates.

3. Examine, on a test basis, the consolidations regarding DTL position prepared by the bank with reference to the related returns received from branches. The auditor should examine whether the valuation of securities done by the bank is in accordance with the guidelines prescribed by the RBI.

4. While examining the computation of DTL, specifically examine that the following items have been excluded from liabilities-

   1. Part amounts of recoveries from the borrowers in respect of debts considered bad and doubtful of recovery.

   2. Amounts received in Indian currency against import bills and held in sundry deposits pending receipts of final rates.

   3. Un-adjusted deposits/balances lying in link branches for agency business like dividend warrants, interest warrants, refund of application money, etc., in respect of shares/debentures to the extent of payment made by other branches but not adjusted by the link branches.

5. Margins held and kept in sundry deposits for funded facilities-

6. Similarly, specifically examine that the following items have been included in liabilities-

   1. Net credit balance in branch adjustment accounts including these relating to foreign branches.

7. Interest on deposit as at the end of the firm half year reversed in the beginning of the next half-year.

8. Borrowings from abroad by banks in India needs to be considered as ‘liabilities to other’ and thus, needs to be considered at gross level unlike ‘liabilities towards banking system in India’, which are permitted to be netted off against ‘assets towards banking system in India’. Thus, the adverse balances in Nostro Mirror Account needs to be considered as ‘Liabilities to other’

9. The reconciliation of Nostro accounts (with Nostro Mirror Accounts) needs to be scrutinized carefully to analyze and ascertain if any inwards remittances are received on behalf of the customers / constituents of the bank and have remained unaccounted and / or any other debit (inward) entries have remained unaccounted and are pertaining to any liabilities for the bank.

10. Examine whether the consolidations prepared by the bank include the relevant information in respect of all the branches.

11. It may be noted that, even though interest accrues on a daily basis, it is recorded in the books only at periodic intervals. Thus, examine whether such interest accrued but not accounted for in books is included in the computation of DTL.

 

 

The auditor at the central level should apply the audit procedures listed above to the overall consolidation prepared for the bank as a whole. Where such procedure is followed, the central auditor should adequately describe the same in his report.

 

1. While reporting on compliance with SLR requirements, the auditor should specify the number of unaudited branches and state that he has relied on the returns received from the unaudited branches in forming his opinion. Recently, there has been introduction of Automated Data Flow (ADF) for CRR & SLR reporting and the auditors should develop necessary audit procedures around this

 

1. Contingent Liabilities for Banks: The Third Schedule to the Banking Regulation Act, 1949, requires the disclosure of the following as a footnote to the balance sheet-

 

1. Contingent liabilities

2. Claims against the bank not acknowledged as debts.

3. Liability for partly paid investments.

4. Liability on account of outstanding forward exchange contracts.

5. Guarantees given on behalf of constituents-

6. In India.

7. Outside India.

8. Acceptances, endorsements and other obligations.

 

1. Other items for which the bank is contingently liable.

2. Bills for collection.

 

 

A-61

 

1. (a) Classification of Advances of a Bank based on Security:

 

1. Advances covered by ECGC/DICGC guarantee should be treated as covered by guarantee to the extent of guarantee cover available. The amount received from ECGC/DICGC and kept in sundry creditor account pending adjustment should be deducted from advances.

2. An account which is fully secured but the margin in which is lower than stipulated by the bank should nevertheless be treated as fully secured for the purpose of balance sheet presentation Cheques purchased including self cheques should be treated as unsecured.

3. Advances against supply bill unless collaterally secured, should be classified as unsecured even if they have been accepted by the drawee.

4. Audit of Advances: The items to be covered in the current audit of advances of a bank are as follows-

5. Ensure that loans and advances are sanctioned properly.

6. Verify whether the sanctions are in accordance with the delegated authority.

7. Ensure that securities and documents have been received and properly charged/registered.

8. Ensure that post disbursement supervision and follow up is proper.

9. Verify whether there is any misuse of loans and advances and whether there are instances indicative of diversion of funds.

10. Check whether letters of credit issued by the branch are within the delegated power and ensure that they are genuine trade transactions.

11. Check bank guarantees issued are properly worked and recorded.

12. Ensure proper follow up of overdue bills of exchange.

13. Verify the classifications of advances are as per RBI directions.

14. Verify whether the submission of claims to DICGC and ECGC is in time.

15. Verify the instances of exceeding delegated powers have been promptly reported.

16. Verify the frequency and genuiness of such exercise of authority beyond to delegated powers of the concerned officials.

 

A-62

 

1. Related Party Disclosures: As per definition given in the AS 18 “ Related Party Disclosures” parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions. Related party transaction means a transfer of resources or obligations between related parties, regardless of whether or not a price is charged.

In the instant case, the managing director of ABC Ltd. is a partner in the firm with his son which has been paid ` 1 lakh as job work charges. The managing director is having a substantial holding in ABC Ltd. The case is squarely covered by AS 18. According to AS-18, in the case of related party transactions, the reporting enterprise should disclose the following:

 

1. the name of the transacting related party;

2. a description of the relationship between the parties;

3. a description of the nature of transactions;

4. volume of the transactions either as an amount or as an appropriate proportion.

5. any other elements of the related party transactions necessary for an understanding of the financial statements;

6. the amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and

7. amounts written off or written back in the period in respect of debts due from or to related parties.”

 

Further, SA 550 on Related Parties, also prescribes the auditor’s responsibilities and audit procedures regarding related party transactions.

The approach of the managing director is not tenable under the law and accordingly all disclosure requirements have to be complied with in accordance with the AS 18. Auditor should insist to make proper disclosure as per the AS and if management refuses, the auditor shall have to modify his report. Also it has to be seen whether section 184 of the Companies Act, 2013 regarding disclosure of interest by director has been complied with. If it is not complied with, the auditor needs to modify the report appropriately.

 

 

A63

 

1. Applicability of Accounting Standard: AS 20, “Earning Per Share”, came into effect in respect of accounting periods commencing on or after 1-4-2001 and is mandatory in nature, from that date, in respect of enterprises whose equity shares or potential equity shares are listed on a recognised stock exchange in India. As such AS 20 does not mandate an enterprise, which has neither equity shares nor potential equity shares which are so listed, to calculate and disclose earnings per share, but, if that enterprise discloses earnings per share for complying with the

2. requirements of any statute or otherwise, it should calculate and disclose earnings per

3. share in accordance with AS 20.

4. Further, Part II of Schedule III to the Companies Act, 2013, requires, among other things,disclosure of earnings per share. Accordingly, every company, which is required to give information under Part II of Schedule III to the Companies Act, 2013, should calculate and disclose earning per share in accordance with AS 20, whether or not its equity

5. (e)shares or potential equity shares are listed on a recognised stock exchange in India.

6. Accordingly, Divergence Pvt. Ltd. should compute and disclose EPS according to AS 20.

Therefore, the contention of Mr. Nix, Director (Finance) of the company, is incorrect. The auditor will have to ensure that EPS is disclosed as per AS 20 or else the auditor should appropriately modify the audit report accordingly.

 

 

A-64

 

Responsibility of Auditor in Relation to the Companies Act, 2013: As per Section 188 of the Companies Act, 2013, no company shall enter into any contract or arrangement with a related party to sale, purchase or supply of any goods or materials, except with the consent of the Board of Directors given by a resolution at a Board Meeting. Further, it is provided that no contract or arrangement, in the case of a company having specified paid-up share capital, or transactions exceeding prescribed sum, shall be entered into except with the prior approval of the company by a special resolution.

The contracts or arrangements mentioned above are those for which the register(s) are maintained under section 189 of the Companies Act, 2013 .The scope of the auditor’s inquiry under this clause is restricted to such transactions referred to in sections 184 and 188 of the Act.

The auditor should, while reporting, in the first instance, determine whether the aggregate value of all the transactions entered into with any of the companies/firms/parties covered in the register maintained under section 189 of the Act exceed the value of rupees five lakhs in the year. If so, the auditor has to examine whether each of the transactions entered into with such a company/firm/party have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time. Further, the auditor while reporting should clearly bring out the reasons as to why no adverse comment was considered necessary.

The contracts referred to in section 188 are for sale, purchase or supply of any goods, materials or services and contract of underwriting the subscription of any securities or derivatives of the company between a Company and its director or, its relative, a firm in which the director or relative is a partner, any other partner in such a firm or a private company of which the director is a member or director. The auditor will have to obtain the list of such parties which are covered by section 188 mentioned above.

Hence, the auditor should ensure that all the above mentioned provisions have been compiled with.

 

A-65

 

1. Misstatement in Prior Period Financial Statements Audited by a Predecessor Auditor: According to SA 710 “Comparative Information—Corresponding Figures and Comparative Financial Statements”, if the financial statements of the prior period were audited by a predecessor auditor, in addition to expressing an opinion on the current period’s financial statements, the auditor shall state in an Other Matter paragraph.

2. That the financial statements of the prior period were audited by a predecessor auditor;

3. The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reasons therefor; and

4. The date of that report,unless the predecessor auditor’s report on the prior period’s financial statements is revised with the financial statements.

 

However, if the auditor concludes that a material misstatement exists that affects the prior period financial statements on which the predecessor auditor had previously reported without modification, the auditor shall communicate the misstatement with the appropriate level of management and those charged with governance and request that the predecessor auditor be informed. If the prior period financial statements are amended, and the predecessor auditor agrees to issue a new auditor’s report on the amended financial statements of the prior period, the auditor shall report only on the current period.

In the given case, Mr. A has issued an audit report without modification for the previous year 2012-13. While Ms. B found a material discrepancy of undercharging wages of ` 10 lakhs during the year 2012-13. Hence, Ms. B is required to communicate the matter to the management and request them to inform the same to Mr. A. After revision or non-revision of the prior period’s financial statements, Ms. B may report accordingly as stated above.

 

A-66

 

1. Reporting Requirement as per Schedule III to the Companies Act, 2013: As per the general instructions for preparation of Balance Sheet, provided under Schedule III to the Companies Act, 2013, terms of repayment of term loans and other loans is required to be disclosed in the notes to accounts. It also requires specifying the period and amount of continuing default as on the balance sheet date in repayment of loans and interest, separately in each case.

In the given case, PK Ltd. has taken a loan from a nationalized bank three years back in 2012. It was regular in payment of instalments (including interest) for last two years but defaulted for the current financial year 2015. Therefore, it needs to be reported in the notes to accounts.

The draft report for above matter is as under“PK Ltd. has taken a loan during the year 2012, from a nationalized bank amounting to` 350 lakhs @ X% p.a. which is repayable by yearly installment of ` 50 lakhs for 7 years.

The company has defaulted in repayment of dues including interest to a nationalized bank during the financial year 2014-15 amounting to ` 50 lakhs which remained outstanding as at March 31, 2015.”

 

A-67

 

1. Five Techniques of how receipts are suppressed are:

   1. Teeming and Lading: Amount received from a customer being misappropriated; also to prevent its detection the money received from another customer subsequently being credited to the account of the customer who has paid earlier. Similarly, moneys received from the customer who has paid thereafter being credited to the account of the second customer and such a practice is continued so that no one account is outstanding for payment for any length of time, which may lead the management to either send out a statement of account to him or communicate with him.

   2. Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to customer accounts and misappropriating amount paid by them.

   3. Writing off as debts in respect of such balances against which cash has already been received but has been misappropriated.

   4. Not accounting for cash sales fully.

   5. Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the employees, etc.

 

 

A-68

 

1. Rolling Settlements: A rolling settlement is one in which trades outstanding at the end of the day have to be settled (payments made for purchases or deliveries in the case of sale of securities) within “X” business days from the transaction date. Thus, in a T+2 rolling settlement, a transaction entered into on Monday for instance, will be settled on Wednesday when the pay-in or pay-out takes place.

In the rolling settlement, trades on each single day are settled separately from the trades done earlier or subsequent trade days. The netting of trades is done only for the day and not for multiple days.

SEBI has gradually mandated most of the scrips to be settled exclusively on Rolling Settlement basis (T+2). The transactions in the Compulsory Rolling Settlement (CRS) are settled on T+2 basis, i.e., both pay- in and pay- out of monies and securities for transactions in scrips on transaction day (T day) would take place on the day after immediately following day.

However, transactions in ‘Z’ group securities are settled only on trade to trade basis on T+2, i.e., the facility of netting up of buy and sell transactions of the same day, as available in other securities, is not available with securities falling under ‘Z’ group. In other words, if an investor buys and sells X no. of shares on the same day then he shall first have to actually deliver and then receive the securities on the settlement day.

Value at Risk (VaR) based margining approach has been adopted for transactions done in CRS scrips with effect from July 2, 2001. In the VaR system of margining, historical volatilities of scrips and overall market volatility is considered to arrive at a VaR margin percentage for a scrip. Further, the mark-to-market differences are collected on a daily basis and the broker members are required to maintain a capital level, as prescribed by the Exchange, adequate to support their exposure at all times.

In case, a member fails to deliver the shares sold in rolling settlement, the Exchange conducts an auction session on T+2, to meet the shortfall created by non-delivery of shares. In this auction session, offers are invited from the other

members to deliver the shares sold by originally selling member, since delivery has to be made to the buying member. In case no shares are received in auction, the sale transaction is closed-out at a close-out price, determined by higher of the following:

Highest price recorded in the scrip from the settlement in which the transaction took place upto a day prior to the auction.

OR

20% above the closing price on a day prior to the auction.

In this case, the auction price/close-out and difference between sale price, if positive is payable by the seller who failed to deliver the scrips. In case, auction /close out price is less than sale price, the difference is not given to the seller but is credited to Investor Protection Fund.

 

(b)Main areas to be covered in the case of Environment Audit of an Industrial Unit:

1. Layout and Design – The layout to be sketched in the style which will allow adequate provisions for installing pollution control devices, as well as provision for up gradation of pollution control measures and the meeting of the requirements of the regulations framed by the Government. In the course of the audit, the area which requires attention but not attended to by the industry to be pinpointed as well as the future requirements of the environmental measures required in commensuration with the proposed future course of working plan are to be identified.

2. Management of Resources – Management resources includes air, water, land, energy, raw materials and human resources besides others. The use of all resources is interlinked and the best uses in a synchronised manner results the best output and minimum waste. The waste of resources to the minimum possible extent is good for the health of the industry as well as the environment.

3. Pollution Control System – An effective system of pollution control should be in existence. One aspect should be whether all required pollution control measures are in vogue or not next aspect should be whether the same is effective or not, further it is to investigate, whether more measures are required, keeping ill view the type of industry and it’s nature of working with respect to it’s grade of polluting the environment.

4. Emergent Safety Arrangement – The chemical, gas, etc., industries which are prone to sudden requirement of safety arrangements, must remain alert all the while. The emergency plans are to be reviewed periodically; sufficient staff along with other required safety amenities should be kept ready. The staff, remained so engaged, must possess the required awareness and alertness to meet the contingency. The degree of awareness, however, can be upgraded with proper training provisions.

5. Medical & Healthcare Facilities – The medical services should be maintained. The health of the workers should be a big consideration for the management.

6. Industrial Hygiene – Proper system should be in vogue to eliminate industrial unhygienic state.

7. Occupational Health – The requirement for safeguarding against occupational health hazards should be available for all the workers. As the occupational health hazards varies from industry to industry due to the difference in the nature of working atmosphere and the pollutants present in it, the concerned industry must pay proper weightage to those diseases which are prone to that particular type of industry.

8. Information Assimilation and Reporting System – The information system should be strengthened to generate and its reporting system should be proper, keeping in view, the authorities, responsibilities and subsequent delegations. A report of compliance of all statutory environmental laws along with other preventive and precautionary measures should be put to Board at regular intervals.

9. EIA Methodology – The Environmental Impact Assessment (EIA) is usually are pre-requisites to start an industry. This is done considering the known spheres of activities on the existing environmental conditions. But the predictions necessarily deviate from the actual happenings when the industry starts working. To accommodate the deviation in the system is also to be incorporated in the EIA report, if it is noticed that the degradation to the environment caused on the establishment and running of the industry is much higher than what was predicted, the mitigatory measures suggested must also be furthered.

10. Compliance to the Regulatory Mechanism – As the persons who are directly working with the system, may be unaware of the latest developments and requirements for the compliance of stipulations and standards prescribed by the various regulatory authorities, they should be trained and instructed on regular basis, to avoid making the Board/owner vulnerable to prosecution and penalty.

11. Concern for the Society – The industry very often transforms the agrarian environment into an industrial environment. The people so displaced by industrialisation feel alienated and develop a feeling of facing the gaseous, dustful, clumsy state of surroundings. The audit should look into this aspect how the industry is making a balance between its own development and the society’s concern

 

A-69

1. Behavioural aspects encountered in Management Audit : Financial auditors deal mainly with figures. Management auditors deal mainly with people. There are many causes for behavioural problems arising in the review function of management audit. Particularly, when management auditors performs comprehensive audit of operations, they cannot be as well informed about such operations as a financial auditor in a financial department. Operating processes may be unfamiliar and complex. The operating people may be speaking a language and using terms that are foreign to the auditor’s experience. The nature and causes of behavioural problems that the management auditor is likely to face in the discharge of the review function that is expected of him and possible solutions to overcome these problems are discussed below:

2. Staff / Line conflict: Management auditors are staff people while the members of other departments are line people. Management auditors tend to discount the difficulties the line staff may face, if called on to act on the ideas of management auditors. Management auditors are specialists in their field and they may think their approach and solutions are the only answers.

3. Control: The management auditor is expected to evaluate the effectiveness of controls, there is an instinctive reaction from the auditee that the report of the auditor may affect them. There is a fear that the action taken based on the management audit report will affect the line people. It breeds antagonism. The causes are as under:

4. Fear of criticism stemming from adverse audit findings.

5. Fear of change in day to day working habits because of changes resulting from audit recommendations.

6. Punitive action by superior prompted by reported deficiencies.

7. Insensitive audit practices.

8. Hostile audit style.

 

Solution to behavioural problems: The following steps may be taken to overcome the aforesaid problems:

 

1. To demonstrate that audit is part of an overall programme of review for protective and constructive benefit.

2. To demonstrate the objective of review is to provide maximum service in all feasible managerial dimensions.

3. To demonstrate the review will be with minimum interference with regular operation.

4. The responsible officers will be involved in the process of review of the findings and recommendations before the audit report is formally released.

 

It is essential to create an atmosphere of trust and friendliness so that audit reports will be understood in their proper perspective.

Finally, it needs hardly any emphasis that there should be right management culture, enlightened auditees and auditors of the right calibre. May be to expect a combination at all times of all the three is asking for the impossible. But, a concerted effort by the management, auditors and auditees to achieve a more acceptable climate would go a long way to achieve the goal.

 

(c)The factors responsible for high employee attrition rate are as under:

 

1. Job Stress & work life imbalance

2. Wrong policies of the Management

3. Unbearable behaviour of Senior Staff

4. Safety factors

5. Limited opportunities for promotion

6. Low monetary benefits

7. Lack of labour welfare schemes

8. Whether the organization has properly qualified and experienced personnel for the various levels of works?

9. Is the number of people employed at various work centres excessive or inadequate?

10. Does the organization provide facilities for staff training so that employees and workers keep themselves abreast of current techniques and practices?

 

A-70

 

1. Due Diligence – Key Areas: The American company engaged in the business of manufacturing and distribution of industrial gases wishing to acquire a listed Indian company has commissioned the Due Diligence Audit to assess the strengths and weaknesses of this company. It is quite important for the acquirer to assess the proposal from different angles and specifically as per terms of the assignment and also see whether proposed merger would create operational synergies. On the other hand, financial due diligence review would be performed after the commercial valuation. Accordingly, while a preliminary review might be performed during initialstages of the restructuring exercise and may in fact, be performed simultaneously with the commercial evaluation, at a later stage, financial due diligence may be performed on the books of account and other information directly pertaining to the financial matters of the entity. In addition, a legal due diligence may be required where legal aspects of functioning of the entities are reviewed; for example, the legal aspects of property owned by the entity or compliance with various statutory requirements under various laws. Like other due diligence exercises, environmental and personnel due diligence are also carried out in order to establish whether various propositions with regard to environment and personnel of the enterprise under review are appropriate. In any case, it is quite important to look behind the veil of initial information provided by the company and to assess the benefits and costs of the proposed acquisition/merger by inquiring into all relevant aspects of the past, present and future of the business to be acquired. Some of the significant key areas which shall be covered under the review are as under:

 

(1) Historical Background: The accountant should begin the financial due diligence review by looking into the history of the company and the background of the promoters. The details of how the company was set up and who were the original promoters have to be gone into, before verification of financial data in detail. An eye into the history of the company may reveal its turning points, survival strategies adopted from time to time, the market share enjoyed by and changes therein, product life cycle and adequacy of resources. It could also help the accountant in determining whether, in the past, any regulatory requirements have had an impact on the business of the said company. This could, inter alia, include the nature of business(es), location of production facilities, warehouses, offices, products or services and markets.

Significant Accounting Policies: The accounting policies being followed by the company and the appropriateness thereof is another key area. The impact of the recent changes in the accounting policies in the recent past keeping in view its intention of offering itself for sale. The accountant has to look at the main effect of accounting policies on the overall profitability and their correctness. It is also quite important to ascertain significant accounting policies used by the company, that changes that have been made to the accounting policies in the recent past, the areas in which accounting policies followed by the company are different from those adopted by the acquiring enterprise and the effect of such differences. Finally, examine whether the financial statements of the company have been prepared in accordance with the governing statutory requirements.

1. Review of Financial Statements: An evaluation of the profit reported by the company would be largely based upon its operating results. Any extraordinary item of income or expense that might have affected the operating results would require close examination. It is advisable to compare the actual figures with the budgeted figures for the period under review and those of the previous accounting period. It is important that the trading results for the past four to five years are compared and the trend of normal operating profit arrived at. The normal operating profits should further be benchmarked against other similar companies. Besides the above, and based on the trend of operating results, the accountant has to advise the acquiring enterprise, through due diligence report, on the indicative valuation of the business. The exercise to evaluate the balance sheet of the company has to take into consideration the basis upon which assets have been valued and liabilities have been recognised. The net worth of the business has to be arrived at by taking into account the impact of over/under valuation of assets and liabilities.

2. Cash Flow: A review of historical cash flows and their pattern would reflect the cash generating abilities of the company and should highlight the major trends. It is important to know if the company is able to meet its cash requirements through internal accruals or does it have to seek external help from time to time. It is necessary to check:

3. Whether the company is able to honour its commitments to its trade payables, to the banks, to government and other stakeholders;

4. How well is the company able to turn its trade receivables and inventories;

5. How well does it deploy its funds; and

6. Whether any funds are lying idle or is the company able to reap maximum benefits out of the available funds.

 

1. Financial Projections: The projections for the next five years with detailed assumptions and workings and the appropriateness of assumption used in the preparation and presentation of financial projections. If the accountant is of the opinion that as assumption used by the company are unrealistic, the accountant should consider its impact on the overall valuation of the company.

2. Human Resources: In the Indian context, the status of work force, staff and employees is a complex problem. It is important to work out how much of the labour force has to be retained. It is also important to judge the job profile of the administrative and managerial staff to gauge which of these match the requirements of the new incumbents. The aspects whether all employee benefits like PF, Gratuity, ESI and superannuation have been properly paid/funded. The pay packages of the key employees will be thoroughly reviewed since this can be a crucial factor in future employee costs.

3. Statutory Compliance: This is one area that has to be examined in detail. It is important to make a list of laws that are applicable to the entity as well as to make a checklist of compliance required from the company under those laws. If the company has not been regular in its legal compliance, it could lead to punitive charges under the law. The impact on such violations be quantified and assessed in respect of entity; financial status and even on its governing concern status.

4. Contents of a Due Diligence Report: Briefly, the contents of a due diligence report can be discussed under:

 

                   ♦Terms of reference and scope of verification.

                   ♦Objective of due diligence.

                   ♦Brief history of the company including shareholding pattern.

                   ♦Assessment of management structure.

                   ♦Assessment of financial liabilities with special emphasis on Interlocking investments and financial obligations with group/associates companies, amounts receivables subject to litigation, any other likely liability which is not provided for in the books of                            account.

                   ♦Assessment of valuation of assets including comments on properties, terms of leases, lien and encumbrances including status of charges, liens, mortgages, assets and properties of the company

                                      - Assessment of operating results.

                                      - Assessment of taxation and statutory liabilities.

                   ♦ Assessment of possible liabilities on account of litigation and legal proceedings against the company and suggestion on ways and means including affidavits, indemnities, to be executed to cover unforeseen and undetected contingent liabilities.

                                     -  Assessment of net worth.

                 ♦ Suggestions on various aspects to be taken care of before and after the proposed merger / acquisition.

                                    -  Status of franchises, license and patents.

Finally, an executive summary may be prepared highlighting the significant areas.

 

A-71

 

Liability of Auditor: It is the auditor’s responsibility to audit the statement of accounts and prepare tax returns on the basis of books of accounts produced before him. Also if he is satisfied with the books and documents produced to him, he can give his opinion on the basis of those documents only by exercising requisite skill and care and observing the laid down audit procedure.

In the instant case, Income tax Officer observed some irregularities during the assessment proceeding of ABC Ltd. Therefore he started investigation of books of accounts audited and signed by Mr. X, a practicing Chartered Accountant. While going through the books, he found that ABC Ltd. used to maintain two sets of books of accounts, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the ICAI saying Mr. X had negligently performed his duties.

Mr. X, the auditor was not under a duty to prepare books of accounts of assessee and he should, of course, neither suggest nor assist in the preparations of false accounts. He is responsible for the books produced before him for audit. He completed his audit work with official set of books only.

In this situation, as Mr. X, performed the auditing with due skill and diligence, therefore, no question of negligence arises. It is the duty of the Department to himself investigate the truth and correctness of the accounts of the assessee.

 

A-72

 

1. Permanent Consolidation Adjustments: Permanent consolidation adjustments are those adjustments that are made only on the first occasion of the preparation and presentation of consolidated financial statements. Permanent consolidation adjustments are-

2. determination of excess or deficit of the cost to the parent of its investment in a subsidiary over the parent’s portion of equity of the subsidiary, at the date on which investment in the subsidiary is made (determination of goodwill or capital reserve);

3. determination of the amount of equity attributable to minorities at the date on which investment in subsidiary is made; and

4. determination of goodwill or capital reserve arising on application of equity method to account for investments in associates in consolidated financial statements.

 

Role of Auditor – Verification Procedure:

 

1. The auditor should verify that the above calculations have been made appropriately.

2. The auditor should pay particular attention to the determination of pre- acquisition reserves of the subsidiary and associates. Date(s) of investment in subsidiary and associates assumes importance in this regard.

The auditor should also examine whether the pre-acquisition reserves have been allocated appropriately between the parent and the minorities of the subsidiary.

The auditor should also verify the changes that might have taken place in these permanent adjustments on account of subsequent acquisition of shares in the subsidiary/ associates, disposal of the subsidiary/associate in the subsequent years.

The auditor should also examine the joint venture agreements, to establish whether any change has taken place in the interest of the parent in the joint venture.

It may happen that in the case of one subsidiary, goodwill arises and in the case of another subsidiary a capital reserve arises. The parent may choose to net off these amounts to disclose a single amount in the consolidated balance sheet. In such cases, the auditor should verify that the gross amounts of goodwill and capital reserves arising on acquisition of various subsidiaries have been disclosed in the notes to the consolidated financial statements to reflect the excess/shortage over the parents’ portion of the subsidiary’s equity.

 

(iii)Following are the Current Period Consolidation Adjustments while making Consolidation of Financial Statements:

1. Elimination of intra-group transactions relating to interest or management fees etc.

2. Elimination of unrealized intra-group profits on assets acquired from other subsidiaries.

3. Elimination of intra-group indebtedness.

4. Adjustments for harmonizing different accounting policies of parent unit and its subsidiaries.

5. Adjustments for impairment loss that might exist for goodwill.

6. Adjustment for significant events that occur between date of financial statements of the parent and of its components when the date/s of financial statements of components are different from the reporting date.

7. Determination of movement in equity attributable to the minorities since the date of acquisition of the subsidiary.

8. Treatment of minority interests’ share of the losses, if such losses exceed the minority interests’ share in the equity.

 

A-73

 

1. (a) Action Plan to Overcome Working Capital Crunch: Adequate working capital is required for liquidity and smooth operations of the company. To ensure an adequate flow of working capital to the manufacturing company, the following action plan may be considered -

2. Working Capital Estimation: The company should start by preparing a statement of the projected working capital requirements. This should be based on the functional budgets in sales, production, expenses, capital expenditure and the Master Budget consisting of projected profit and loss and the Balance Sheet.

3. Cash Flow Statement / Cash Budget: Month-wise cash budgets showing inflows and outflows of cash heading-wise should be prepared to analyse the major inflows and outflows affecting the entity. At this stage any wasteful outflow can be traced and eliminated. Bank reconciliation should be undertaken periodically so that outstandings can be traced and acted upon. This is also necessary to reduce the float time.

4. Inventory / Stock Management: Raw materials and inventories should be classified properly to determine the level of stock of materials. The method of costing also needs to be looked at minutely. There is a need to establish linkage with the production pattern and work backwards accounting for time factor in receipt of material. This needs to be worked out carefully since at no cost, production schedule should be hampered. The caution also need to be exercised that there is not unused/obsolete inventory. The system of inventory management needs to be looked at so as to check the avoidable wastes/scraps generated during storage and handling. Just in time philosophy will enable the company to reduce processing time, stocks and related costs. The adoption of such a mechanism would bring down the cost to a considerable extent.

5. Credit Management: The company should lay down a proper policy for evaluating customers, determining the credit period and offering discounts for early payment. An age-wise analysis of debtors should also be prepared so as to avoid credit to defaulters. The sale department needs to be geared up so that realisation can be made in time. A careful analysis should be done of various customers according to pattern of sales so as to exercise control on their respective debit balances. The company should through its purchase department endeavour to avail the maximum credit period from its creditors. This would enhance the working capital of the company.

6. Funds Flow Analysis: The company should prepare a funds flow analysis, distinguishing between long-term and short-term sources and applications.

7. Investment Management: The idle funds of the company, if any, should be invested in short-term securities to augment the income.

8. WIP Analysis: Minimum WIP should be monitored and for the purpose it is necessary to ensure that no bottlenecks develop at any stage during the production process.

 

(b) Alternative Way to Tackle the Hostile Management: While conducting the operational audit, the auditor has to come across many irregularities and areas where improvement can be made and therefore he gives his suggestions and recommendations.

 

These suggestions and recommendations for improvements may not be accepted by the hostile managers and in effect there may be cold war between the operational auditor and the managers. This would defeat the very purpose of the operational audit.

The Participative Approach comes to the help of the auditor. In this approach the auditor discuses the ideas for improvements with those managers that have to implement them and make them feel that they have participated in the recommendations made for improvements. By soliciting the views of the operating personnel, the operational audit becomes co-operative enterprise.

This participative approach encourages the auditee to develop a friendly attitude towards the auditors and look forward to their guidance in a more receptive fashion. When participative method is adopted then the resistance to change becomes minimal, feelings of hostility disappear and gives room for feelings of mutual trust. Team spirit is developed. The auditors and the auditee together try to achieve the common goal. The proposed recommendations are discussed with the auditee and modifications as may be agreed upon are incorporated in the operational audit report. With this attitude of the auditor it becomes absolutely easy to implement the proposed suggestions as the auditee themselves take initiative for implementing and the auditor do not have to force any change on the auditee.

Hence, Operational Auditor of Amazekart manufacturing unit should adopt above mentioned participative approach to tackle the hostile management of Amazekart

 

A-74

 

1. Due Diligence: A due diligence audit on behalf of Preeto Ltd. with a view to acquiring the business shall involve following steps -

 

Brief history of the target and background of its promoters - The accountant should begin the financial due diligence review by looking into the history of the company and the background of the promoters. The details of how the company was set up and who were the original promoters have to be gone into, before verification of financial data in detail. An eye into the history of the target may reveal its turning points, survival strategies adopted by the target from time to time, the market share enjoyed by the target and changes therein, product life cycle and adequacy of resources. It could also help the accountant in determining whether, in the past, any regulatory requirements have had an impact on the business of the target. Broadly, the accountant should make relevant enquiries about the history of target's business products, markets, suppliers, expenses, operations.

 

1. Accounting policies - The accountant should study the accounting policies being followed by the target and ascertain whether any accounting policy is inappropriate. The accountant should also see the effects of the recent changes in the accounting policies. The target might have changed its accounting policies in the recent past keeping in view its intention of offering itself for sale. The overall scope has to be based on the accounting policies adopted by the management. The accountant has to look at the main effect of accounting policies on the overall profitability and their correctness. It is reiterated that the accountant should mainly look at all material changes in Accounting Policies in the period subjected to review very carefully.

The accountant's report should include a summary of significant accounting policies used by the target, that changes that have been made to the accounting policies in the recent past, the areas in which accounting policies followed by the target are different from those adopted by the acquiring enterprise, the effect of such differences.

 

1. Review of Financial Statements - Before commencing the review of each of the aspect covered by the financial statements, the accountant should examine whether the financial statements of the target have been prepared in accordance with the Statute governing the target, Framework for Preparation and Presentation of the Financial Statements and the relevant Accounting Standards. If not the accountant should record the deviations from the above and consider whether it warrant an inclusion in the final report on due diligence.

After having an overall view of the financial statements, as mentioned in the above paragraphs, the accountant should review the operating results of the target in great detail. It is important to make an evaluation of the profit reported by the target. The reason being the price of the target would be largely based upon its operating results. The accountant should consider the presence of an extraordinary item of income or expense that might have affected the operating results of the target. It is advisable to compare the actual figures with the budgeted figures for the period under review and those of the previous accounting period.

 

1. Taxation - Tax due diligence is a separate due diligence exercise but since it is an integral component of the financial status of a company, it is generally included in the financial due diligence. It is important to check if the company is regular in paying various taxes to the Government. Generally taxes are levied both by the Central Government as well as by the State Government. Further taxes may be direct or indirect. Most of the tax laws require the enterprise to register itself with the government and it is important to check if all necessary registrations have been made. The accountant has to also look at the tax effects of the merger or acquisition.

2. Cash Flow - A review of historical cash flows and their pattern would reflect the cash generating abilities of the target company and should highlight the major trends. It is important to know if the company is able to meet its cash requirements through internal accruals or does it have to seek external help from time to time. It is necessary to check if a) Is the company able to honour its commitments to its creditors, to the banks, to government and other stakeholders b) How well is the company able to turn its debtors and stocks c) How well does it deploy its funds d) Are there any funds lying idle or is the company able to reap maximum benefits out of the available funds?

3. Financial Projections - The accountant should obtain from the target company the projections for the next five years with detailed assumptions and workings. He should ask to give projections on optimistic, pessimistic and most likely bases.

Ordinarily, it would be desirable that the accountant evaluates the appropriateness of assumption used in the preparation and presentation of financial projections. If, the accountant is of the opinion that as assumption used by the target is unrealistic, the accountant should consider its impact on the overall valuation of the company. He should offer his comments on all the assumption, highlighting those which, in his opinion are not inappropriate. In case he feels the projections provided by the target are not achievable or aggressive he has to mention this in his report. He should thoroughly check the arithmetic of the calculations made for financial projections.

 

1. Management and Employees - In the Indian context, the status of work force, staff and employees and their demands is a complex problem. In most of the companies which are available for take over the problem of excess work force is often witnessed. It is important to work out how much of the labour force has to be retained. It is also important to judge the job profile of the administrative and managerial staff to gauge which of these match the requirements of the new incumbents. Due to complex set of labour laws applicable to them, companies often have to face protracted litigation from its workforce and it is important to gauge the likely impact of such litigation.

It is important to see if all employee benefits like Provident Fund (P.F.), Employees State Insurance (E.S.I), Gratuity, leave and Superannuation have been properly paid/ provided for/funded. In case of un-funded Gratuity, an actuarial valuation of the liability has to be obtained from a reputed actuary. The assumptions regarding increase in salaries, interest rate, retirement etc. have to be gone into to see if they are reasonable. It is also necessary to see if the basic salary /wage considered for the valuation is correct and includes all elements subject to payment of Gratuity. In the case of PF, ESI etc. the accountant has to see if all eligible employees have been covered.

It is very important to consider the pay packages of the key employees as this can be a crucial factor in future costs. One has to carefully look at Employees Stock Option Plans; deferred compensation plans; Economic Value Addition and other performance linked pay; sales incentives that have been promised etc. It is also important to identify the key employees who will not continue after the acquisition either because they are not willing to continue or because they are to be transferred to another company within the 'group' of the target company.

 

1. Statutory Compliance - During a due diligence this is one aspect that has to be investigated in detail. It is important therefore, to make a list of laws that are applicable to the entity as well as to make a checklist of compliance required from the company under those laws. If the company has not been regular in its legal compliance it could lead to punitive charges under the law. These may have to be quantified and factored into the financial results of the company.

In addition to the above steps, the following further points have to be seen:

 

1. Reason for sale of business and the effect on turnover and profits due to the exist of the present proprietor.

2. The length of the lease under which business has been operating.

3. The unexpired period of patents if any held by the vendors.

4. The age of managerial staff and prospects of their continuing in service in the new environment; the effect of trained managerial staff learning the organisation in production/sales/administrative and the financial liability to pay terminal benefits/compensation, etc.

5. If bulk sales are to a few limited customers, the profitability should be discounted greatly, because any substantial withdrawal of customers might cause business crashes.

6. A company with a sound financial structure can better withstand the stresses and strains of business. A low debt-equity ratio would indicate an ability to grow through debt financing without raising equity.

7. The cash generated from operations; the need for redeployment of resources and funds needed for repayment of loans become major factors in determining growth potential.

8. The valuation of goodwill if any should be on reasonable basis having regards to all factors mentioned above.

9. Investigation for Higher Sales Turnover: As per the facts that there has been consistently high turnover but declining net profits is an anomalous situation. It may be attributed to one or more following reasons requiring further investigation -

10. Unfavourable Sales mix - Where the company sells different chemical products with different product margins, the product with the maximum PV ratio/margin should have a higher share in the total sales. If due to revision of sales mix, more quantities of unprofitable products are sold, profits will be reduced in spite of an increase in sales.

11. Negative Impact of Financial Leverage - Where the company does not have sufficient own funds (equity) but has a higher debt-equity ratio, the interest commitments will be higher. As the volume of its operation increases, higher debt and interest charges would result in lower profits.

12. Other Items Included in Sales - The figure of sales as per Profit and Loss Account may include incidental revenues, e.g., freight, excise duty, sales- tax, etc. where the amount of excise duty goes up considerably the total sales may show an increase which is not represented by a real increase in sales quantity/value.

13. High Administrative and Selling Expenses - Administrative and selling costs are generally period costs which are fixed in nature. Their increase is generally not proportional to sale increase. However, a reduction in profit could also be due to increase in administrative overheads and sales overheads at a rate higher than the rate of increase in sales.

14. Cost-Price Relationship - If the increases in cost of raw materials and labour has not been compensated by a corresponding increase in the sales price this would also result in higher sales and declining profits. In spite of same sales quantity, for the increasing cost of raw materials and other services, per unit values of the product has been increased which is however unmatched by the increase in cost.

15. Competitive Price - Where sales have been made at cut-throat prices in order to eliminate competition from the market, the profits would be in the declining trend in the short-run.

Additions to Fixed Assets - Where there are heavy additions to fixed assets and consequent depreciation charges in the initial years of additions, there may be reduction in profits in spite of increased sales

 

A-75

 

1. Audit of Receipts and Payments Account: Every insurer, in respect of insurance business transacted by him and in respect of his shareholders’ funds, should prepare at the end of each financial year, a Balance Sheet, a Profit and Loss Account, a separate account of receipts and payments and a Revenue Account in accordance with the Regulations made by the IRDA. Since receipts and payments account has been made a part of financial statements of an insurer, it is implied that the receipts and payments account is also required to be audited.

The IRDA (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations require that the auditor of an insurance company should:

1. report whether the receipts and payments account of the insurer is in agreement with the books of account and returns;

2. express an opinion as to whether the receipts and payments account has been prepared in accordance with the provisions of the relevant statutes; and express an opinion whether the receipts and payments account give a true an fair view of the receipts and payments of the insurer for the financial year/period under audit.

It may hence be said that auditor is required to audit the Receipts and Payments Account of the insurer and also express an opinion on the same.

 

1. (i) Overdue interest: Overdue interest should be excluded from interest outstanding and accrued due while calculating profit. Overdue interest is interest accrued or accruing in accounts, the amount of which the principal is overdue. In practice an overdue interest reserve is created and the credit of overdue interest credited to interest account is reduced.

2. Compliance with provisions of the Act and Rules: An auditor of a co- operative society is required to point out the infringement with the provisions of the relevant Co-operative Act Rules and bye-laws. The auditor of a co-operative society is also required to point out various irregularities, improprieties, and departure from the provision of the Act, rules framed thereunder and the bye-laws of the society. The financial implications of such infringements should be properly assessed and quantified by the auditor and they should be reported. Some of the State laws contain restrictions on the payment of dividends, which should be noted by the auditor and if dividend is declared in excess of the prescribed percentage, the fact should be reported by the auditor. Auditor should also ensure that various provisions in the Co-operative Societies Act, such as, restriction on borrowings, investment of funds, contribution to education funds, restriction on loans, etc are also complied with.

3. Special Report to the Registrar: The auditors are required to report on number of matters as prescribed in various states. In addition to the main report, the auditors are also required to submit by way of schedules/audit memorandum information on the working of the company as well. During the course of audit, if the auditor notices that there are some serious irregularities in the working of the society he may report these special matters to the Registrar, drawing his specific attention to the points. The Registrar on receipt of such a special report may take necessary action against the society. In the following cases, for instance a special report may become necessary:

 

Personal profiteering by members of managing committee in transactions of the society, which are ultimately detrimental to the interest of the society. Detection of fraud relating to expenses, purchases, property and stores of the society.Specific examples of mis-management. Decisions of management against co-operative principles.

In the case of urban co-operative banks, disproportionate advances to vested interest groups, such as relatives of management, and deliberate negligence about the recovery thereof. Cases of reckless advancing, where the management is negligent about taking adequate security and proper safeguards for judging the credit worthiness of the party

 

 

A-76

 

1. Issues of Corporate Governance: Issues addressed in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 regarding corporate governance are-

 

1. Responsibilities and key functions of the Board, it’s composition, compensation and disclosures;

2. Code of Conduct and vigil mechanism;

3. Composition, meetings, powers, role and responsibilities of the Audit Committee which is an important pillar of corporate governance;

4. Management of subsidiary companies;

5. Procedures related to risk management;

6. Disclosures on important issues regarding related party transactions, accounting treatment, etc.;

7. Content of management discussion and analysis;

8. Information to shareholders;

9. Compliance Certificate by the CEO and CFO;

10. Compliance Certificate from either the auditors or practising company secretaries regarding compliance of conditions on corporate governance.

11. Role of Auditor in Audit Committee and Certification of Compliance of Conditions of Corporate Governance: The LODR Regulations as well as the Companies Act, 2013 in respect of the constitution of Audit Committee underline the importance of audit process and its contribution to the corporate governance process.

 

Regulation 18(1)(f) stipulates that a representative of the statutory auditor, when required, shall be invited to the meetings of the Audit Committee. Similarly, section 177 of the Companies Act, 2013 provides the auditors of a company and the key managerial personnel, the right to be heard in the meetings of the Audit Committee when it considers the auditor’s report but they shall not have the right to vote.

The auditor must ensure that he communicates frequently and openly with the Audit Committee on key accounting or auditing issues that, in the auditor’s judgment, give rise to a greater risk of material misstatement of the financial statements, and also ensure that he addresses any questions or concerns voiced by the Audit Committee.

He can contribute significantly in assisting and advising the Audit Committee on improving corporate governance, oversight of financial reporting process, implementation of accounting policies and practices, compliance with accounting standards, strengthening of the internal control systems in regard to financial reporting and reporting processes.

The auditor must devote substantial professional time in assisting the management and the Audit Committee to enable them to discharge their functions effectively and in certification of the requirements of corporate governance.

The auditor has to keep in mind that his role is not to drive corporate governance directly. Rather, it is the management’s responsibility to do so and, in the process,he should play a significant role in assisting management to ensure better standards of corporate governance.

The auditor’s responsibility in certifying compliance with the requirements of corporate governance relates to the verification and certification of factual implementation of requirements of corporate governance as stipulated in the LODR Regulations. Such verification and certification is neither an audit nor an expression of opinion on the financial statements of the company.

The certificate from the auditor as regards compliance with the requirements of corporate governance is neither an assurance as to the future viability of the company, nor the efficiency or effectiveness with which the management has conducted the affairs of the company.

 

(c)(i) Compliance Requirements for Code of Conduct as per Listing Order Disclosure Requirement (LODR) Regulations:

 

1. The Board shall lay down a code of conduct for all Board members and senior management of the listed entity.

2. All Board members and senior management personnel shall affirm compliance with the code on an annual basis.

3. The Code of Conduct shall suitably incorporate the duties of Independent Directors as laid down in the Companies Act, 2013.

4. The code of conduct shall be posted on the website of the company.

5. The Annual Report of the company shall contain a declaration to this effect signed by the CEO.

 

The term “senior management” shall mean personnel of the listed entity who are members of its core management team excluding Board of Directors. Normally, this would comprise all members of management one level below the executive directors, including all functional heads.

 

1. Role of Auditor: The auditor should ascertain-

2. whether the Board of Directors of the company has laid down a Code of Conduct for all Board members and senior personnel of the company and obtain a copy of the same.

3. He should also verify whether all Board members and senior management personnel have affirmed compliance with the code on an annual basis and whether the code has been posted on company’s website.

 

 

A-77

 

Reporting under CARO, 2016 for Registration under section 45-IA of the RBI Act, 1934: As per Clause (xvi) of paragraph 3 of the CARO, 2016, the auditor is required to report whether the company is required to be registered under section 45-IA of the Reserve Bank of India Act, 1934. If so, whether the registration has been obtained.

 

Audit Procedures and Reporting-

 

1. The auditor should examine the transactions of the company with relation to the activities covered under the RBI Act and directions related to the Non-Banking Financial Companies.

2. The financial statements should be examined to ascertain whether company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income.

3. Whether the company has net owned funds as required for the registration as NBFC.

4. Whether the company has obtained the registration as NBFC, if not, the reasons should be sought from the management and documented.

5. The auditor should report incorporating the following:-

6. Whether the registration is required under section 45-IA of the RBI Act, 1934.

7. If so, whether it has obtained the registration.

8. If the registration not obtained, reasons thereof.

 

(b)Verification Procedures in Relation to Audit of a Hire Purchase Finance company:

 

 

1. Ascertain whether the NBFC has an adequate appraisal system for extending hire purchase finance. The system of appraisal is basically concerned with obtaining information regarding the credit worthiness of the hirer, his experience in the field, assets owned, his past track record and future projections of his income.

2. Verify that the payment for acquiring an asset should be made directly to the supplier/dealer and that the original invoice has been drawn out in the name of the NBFC.

3. In the case of high value hire purchase items relating to machinery/equipment, an auditor should ascertain whether the valuation reports and installation reports are called for. In case of some high value items, he should also physically verify the asset in possession of the hirers, particularly in a situation where he has any doubts as regards the genuineness of the transaction.

4. If the hire purchase finance is against vehicles, check whether the registration certificate contains an endorsement in favour of the hire purchase company.

5. The auditor should verify whether the NBFC has a system in place for verifying the hire purchase assets periodically to ensure that the hirers have not sold the assets or otherwise encumbered them.

6. Check whether hire purchase instalments are being received regularly as and when they fall due. Check whether adequate provision has been made for overdue hire purchase instalments as required by the NBFC Prudential Norms directions.

7. Examine the method of accounting followed by the hire purchase finance company for appropriation of finance charges over the period of the hire purchase contract. Ascertain that there is no change in the method of accounting as compared to the immediately preceding previous year.

8. Verify that the assets given on hire purchase have been adequately insured against.

9. In case the goods are repossessed by the hire purchase finance company on account of non-repayment of hire purchase instalments, verify that the repossessed goods have been valued on a realistic basis by the hire purchase finance company.

 

A-78

 

Direct Assistance from Internal Auditor: As per SA 610 “Using the Work of Internal Auditor”, the external auditor shall not use internal auditors to provide direct assistance to perform procedures that Involve making significant judgments in the audit.

Since the external auditor has sole responsibility for the audit opinion expressed, the external auditor needs to make the significant judgments in the audit engagement.

 

Significant judgments include the following:

♦Assessing the risks of material  misstatement;

♦Evaluating the sufficiency of tests performed;

♦Evaluating the appropriateness of management’s use of the going concern assumption;

♦ Evaluating significant accounting estimates; and

♦Evaluating the adequacy of disclosures in the financial statements, and other matters affecting the auditor’s report.

 

In view of above, Mr. A cannot ask direct assistance from internal auditors regarding evaluating significant accounting estimates and assessing the risk of material misstatements.

 

(b) Direct Assistance from Internal Auditor in case of External Confirmation Procedures: SA 610 “Using the Work of Internal Auditor”, provide relevant guidance in determining the nature and extent of work that may be assigned to internal auditors. In determining the nature of work that may be assigned  to internal auditors, the external auditor is careful to limit such work to those areas that would be appropriate to be assigned.

Further, in accordance with SA 505, “External Confirmation” the external auditor is required to maintain control over external confirmation requests and evaluate the results of external confirmation procedures, it would not be appropriate to assign these responsibilities to internal auditors. However, internal auditors may assist in assembling information necessary for the external auditor to resolve exceptions in confirmation responses.

 

A-79

 

Audit and Investigation: As per SA 200 “Overall Objectives of the Independent Auditor and the conduct of an audit in accordance with standards on auditing”, the purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

For auditing on the other hand, the general objective is to find out whether the financial statements show true and fair view. The auditor seeks to report what he finds in the normal course of examination of the accounts adopting generally followed techniques unless circumstances call for a special probe.

Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government (in case amount of fraud is `1 crore or above )or Audit Committee or Board in other cases (in case the amount of fraud involved is less than ` 1 crore) within such time and in such manner as may be prescribed. The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016, whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year. If yes, the nature and the amount involved is to be indicated.

Fraud, error, irregularity, whatever comes to the auditor’s notice in the usual course of checking, are all looked into in depth and sometimes investigation results from the prima facie findings of the auditor.

Investigation implies systematic, critical and special examination of the records of a business for a specific purpose. The examination conducted under investigation is intensive as well as exhaustive so far as the activities or areas of accounting is concerned. Investigation requires a concentrated focus on the subject matter of inquiry and related matters. Often, investigations may spread over a period longer than one year and its scope may extend to inquiry beyond the books of accounts if the circumstances so require.

For example, if fraud is suspected and an accountant is called upon to check the accounts to whether fraud really exists and if so, the amount involved, the character of the enquiry changes into investigation. Investigation may be undertaken in numerous areas of accounts, e.g., the extent of waste and loss, profitability, cost of production etc. It extends scope beyond books of accounts.

Etymologically, auditing and investigation are largely overlapping concepts because auditing is nothing but an investigation used in a broad sense. Both auditing and investigation are fact finding techniques but their basic nature and objectives differ as regards scope, frequency, basis, thrust, depth and conclusiveness. Audit and investigation differ in objectives and in their nature. Auditing is general while investigation is specific.

 

 

Basis of Difference	Investigation	Audit
(i) Objective	An investigation aims at establishing a fact or a happening or at assessing a particular	The main objective of an audit is to verify whether the financial statements display a true and fairview of the state ofaffair and the workingresults of an entity.
(ii)Scope	The scope of investigation  may     be    governed          by statute or it may be non-statutory.	The scope of audit is wide and in case of statutory audit the scope of work is determined by  the provisions of relevant law.
(iii) Periodicity	The work is not limited by rigid time frame. It may cover  several years, as the outcome of the same is not certain	The audit is carried on quarterly either,half- yearly or yearly
(iv) Nature	Requires a detailed study and examination of factsand figures.	Involves tests checkingor sample technique to evidence draws for forming a judgement and expression of opinion.

Inherent (v)   Limitations		No  limitation owing to its nature of engagement.			Audit suffers from inherent limitation.
(vi) Evidence		It see evidence conclusive			Audit        is         mainly concerned with prima- facie evidence.
(vii)Observance of  Accounting Principles		It is analytical in natureand requires a thorough mind capable of collecting and evaluating facts.			Is governed       by compliance with generally  accepted accounting principles,procedure auditors and disclosure requirements.
(viii) Reporting		The outcome is reported to of the  person(s)  n   whose behalf  investigation    is carried out.			The outcome is reported to the owners of the business entity.

 

1. Major areas to examine in course of Due Diligence Review: 'Due Diligence' is a term that is often heard in the corporate world these days in relation to corporate

2. restructuring. The purpose of due diligence is to assist the purchaser or the investor in finding out all he can, reasonably about the business he is acquiring or investing in prior to completion of the transaction including its critical success factors as well as its strength and weaknesses. Due diligence is an all pervasive exercise to review all important aspects like financial, legal, commercial, etc. before taking any final decision in the matter. As far as any hidden liabilities or overvalued assets are concerned, this shall form part of such a review of Financial Statements. Normally, cases of hidden liabilities and overvalued assets are not apparent from books of accounts and financial statements. Review of financial statements does not involve examination from the view point of extraordinary i(tfe) ms, analysis of significant deviations, etc.

3. However, in order to investigate hidden liabilities, the auditor should pay his attention to the following areas:

4. ♦The company may not show any show cause notices which have not matured to demands, as contingent liabilities. These may be material and important.

(j)         ♦The company may have given “Letters of Comfort” to banks and Financial

Institutions. Since these are not “guarantees”, these may not be disclosed in the Balance sheet of the target company.

(l)         ♦The Company may have sold some subsidiaries/businesses and may have agreed to take over and indemnify all liabilities and contingent liabilities of the same prior to the date of transfer. These may not be reflected in the books of accounts of the c(mom) pany.

(n)        ♦Product and other liability claims; warranty liabilities; product returns/discounts; liquidated damages for late deliveries etc. and all litigation.

(p)        ♦Tax liabilities under direct and indirect taxes.

(q)        ♦ Long pending sales tax assessments.

(r)        ♦Pending final assessments of customs duty where provisional assessment only has been completed.

(t)         ♦Agreement to buy back shares sold at a stated price.

(u)        ♦ Future lease liabilities.

(v)        ♦ Environmental problems/claims/third party claims. (w)

(x)        ♦Unfunded gratuity/superannuation/leave salary liabilities; incorrect gratuity valuations. 

(z)        ♦Huge labour claims under negotiation when the labour wage agreement has already expired.

(bb)      ♦ Contingent liabilities not shown in books.

(cc)            Regularly Overvalued Assets:

(dd)

(ee)      The auditor shall have to specifically examine the following areas: (ff)

(gg)      ♦ Uncollected/uncollectable receivables. (hh)

1. ♦Obsolete, slow non-moving inventories or inventories valued above NRV; huge

i(njjv) entories of packing materials etc. with name of company.

(kk)      ♦Underused or obsolete Plant and Machinery and their spares; asset values

w(llh) ich have been impaired due to sudden fall in market value etc.

(mm)   ♦Assets carried at much more than current market value due to capitalization

of expenditure/foreign exchange fluctuation, or capitalization of expenditure mainly in

t(nhne)nature of revenue.

(oo)      ♦ Litigated assets and property. (pp)

(qq)      ♦Investments carried at cost though realizable value is much lower.

(rr)        ♦ Investments carrying a very low rate of income / return.

(ss)      ♦Infructuous project expenditure/deferred revenue expenditure etc.

(tt)        ♦Group Company balances under reconciliation etc.

(uu)      ♦ Intangibles of no value.

 

A-80

Accounting for Investments in Associate: As per Accounting Standard 23 on “Accounting for Investments in Associates in Consolidated Financial Statements”, adjustments to the carrying amount of investment in an investee arising from changes in the investee’s equity that have not been included in the statement of profit and loss of the investee are directly made in the carrying amount of investment without routing it through the consolidated statement of profit and loss. The corresponding debit/credit is made in the relevant head of the equity interest in the consolidated balance sheet. For example, in case the adjustment arises because of revaluation of fixed assets by the investee, apart from adjusting the carrying amount of investment to the extent of proportionate share of the investor in the revalued amount, the corresponding amount of revaluation reserve is shown in the consolidated balance sheet.

In case an associate has made a provision for proposed dividend in its financial statements, the investor’s share of the results of operations of the associate is computed without taking in to consideration the proposed dividend.

Applying the above provisions to the given problem, Hold Ltd. should have computed its share of the results of operations of the associate without taking into consideration the proposed dividend. Therefore, treatment made by Hold Ltd. is not correct.

 

A-81

 

Commission Paid to Insurance Agents: It is a well-known fact that insurance business is solicited by insurance agents. The remuneration of an agent is paid by way of commission which is calculated by applying a percentage to the premium collected by him. Commission is payable to the agents for the business procured through them and is debited to Commission on Direct Business Account. There is a separate head for commission on reinsurance accepted which usually arise in case of Head Office. It may be noted that under section 40 of Insurance Act, 1938, no commission can be paid to a person who is not an agent or intermediary of the insurance company.

The auditor should, inter alia, do the following for verification of commission-

 

1. Vouch disbursement entries with reference to the disbursement vouchers with copies of commission bills and commission statements.

2. Check whether the vouchers are authorised by the officers-in–charge as per rules in force and income tax is deducted at source, as applicable.

3. Test check correctness of amounts of commission allowed.

4. Scrutinise agents’ ledger and the balances, examine accounts having debit balances, if any, and obtain information on the same. Necessary rectification of accounts and other remedial actions have to be considered.

Check whether commission outgo for the period under audit been duly accounted.

 

A-82

(a) Engaging into a Business: As per clause (11) of Part I of First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he engages in any business or occupation other than the profession of Chartered Accountant unless permitted by the Council so to engage.

However, the Council has granted general permission to the members to engage in certain specific occupation. In respect of all other occupations specific permission of the Institute is necessary.

In this case, CA Brilliant is engaged in the occupation of trading in commodity derivatives which is not covered under the general permission. Further, he has not even obtained any permission from the Institute for conducting such business.

Hence, he will be deemed to be guilty of professional misconduct under clause (11) of Part I of First Schedule to the Chartered Accountants Act, 1949.

 

(b) Posting Photograph on Website: A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct under clause  (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949, if he solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means.

In the given case, CA Intelligent shared his framed photograph on website wherein he was receiving ‘Best Faculty of the year’ award from the Institute.

In this context, it may be noted that according to the guidelines approved by the Council of the Institute of Chartered Accountants of India, no photographs of any sort are permitted. Only display of passport size photograph is permitted.

Therefore, CA Intelligent is guilty of professional misconduct under clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949

 

A-83

 

(b) Contravening Provisions of the Act: A  member of the Institute, whether  in practice or not, shall be deemed to be guilty of professional misconduct under clause (1) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, if he contravenes any of the provisions of this Act or the regulations made there under or any guidelines issued by the Council.

In the given case, Mr. Witty has failed to make the payments of stipend to articled assistant every month in accordance with Regulation 48. The fact that the articled assistant will be compensated with extra sum in the form of interest on late payment is not relevant and the plea that cycle of professional receipts from clients is six

months is not acceptable as Mr. Witty has disbursed salary to all of his employees on time.

Therefore, Mr. Witty is guilty of professional misconduct under clause (1) of Part II of the Second Schedule to the Chartered Accountants Act, 1949 as he has contravened Regulation 48 by not making the payment every month.

 

(d) Charging Excess Fees: The prescribed scale of fees for the professional assignments done by the chartered accountants is recommendatory in nature. Charging an excessive fee for a professional assignment does not constitute any misconduct in the context of the provisions of the Chartered Accountants Act, 1949 and regulation made thereunder since the matter of fixation of actual fee charged in individual cases depends upon the mutual agreement and understanding between the member and the client.

In the given case, CA Posh has charged excess fees comparative to the scale of fees recommended by the Committee as well as duly considered by the Council of ICAI. In this context, it may be noted that the scale of fees is the minimum prescribed scale of fees.

From the above facts and provisions, it may be concluded that CA Posh is not liable for any misconduct under the Chartered Accountants Act, 1949. Therefore, the contention of MNC Pvt. Ltd. is not tenable

 

A-84

 

(a) As per clause 6 of Part I of First Schedule to the Chartered Accountants Act, a chartered accountant in practice is deemed to be guilty of professional misconduct, if he solicit clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means.

However, nothing herein contained shall be construed as preventing or prohibiting, any chartered accountant from applying or requesting for or inviting or securing professional work from another chartered accountants in practice.

In the instant case, CA N has written email to all the CA for securing professional work from them and has not approached any other person or professional or communicated with any client, Thus as per exception to the clause 6, CA N is well within the regulation of the act and has not committed any professional misconduct.

(b) As per clause 8 of Part I of First Schedule to the Chartered Accountants Act, a chartered accountant in practice is deemed to be guilty of professional misconduct, if he accepts a position as auditor previously held by another chartered accountant or a certified auditor who has been Issued certificate under the Restricted Certificate Rules, 1932 without first communicating with him in writing.

This clause is applicable in situation of replacing of one auditor by another auditor. Internal auditor and statutory audition are parallel positions and not replacement positions. The management generally appoints the internal auditor whereas the statutory auditor will be appointed by the shareholders in the AGM. In this situation there is no need for communication by one to other.

In view of above the contention of the statutory auditor is unacceptable and there is no question of communicating in writing by Mr. T.

 

 

A-85

 

1. Clause 10 of Part I of Second Schedule states that a Chartered Accountant shall be deemed to be guilty of professional misconduct if “he fails to keep money of his clients in separate banking account or to use such money for the purpose for which they are intended.”

       Mr. Ram received the money on 15th December, 2013 which is to be paid to the client only on March 31, 2014. Hence, it should be deposited in a separate bank account.

Since in this case Mr. Ram have failed to keep the sum of ` 15 lakhs in a separate Bank Account and utilised the part money for personal purpose on birthday occasion. Therefore, it amounts to professional misconduct under clause 10 of part I of Second Schedule.

Connected case Law: Mr. R. S. Murugai Vs. (1) S K Gadh & (2) V. K. Bajaj

1. Chapter V of the Council General Guidelines, 2008 specifies that a member of the Institute in practice or the firm of Chartered Accountants of which he is a partner shall maintain and keep in respect of his/its professional practice, proper books of accounts including the following:

2. a Cash Book

3. a Ledger

Thus, a Chartered Accountant in practice is required to maintain books of accounts. In the instant case, CA Smart does not maintain books of accounts and writes the fees received from various clients in small pocket diary. A small pocket diary maintained by him cannot be books of accounts.

Hence, Mr. Smart, being a practicing Chartered Accountant will be held guilty for professional misconduct for violation of Council General Guidelines, 2008.

 

A-86

Responding to Tenders: Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 lays down guidelines for responding to tenders, etc. It states that a member may respond to tenders or enquiries issued by various users of professional services or organizations from time to time and secure professional work as a consequence.

However, a member of the Institute in practice shall not respond to any tender issued by an organization or user of professional services in areas of services which are exclusively reserved for Chartered Accountants, such as audit and attestation services. Though, such restriction shall not be applicable where minimum fee of the assignment is prescribed in the tender document itself or where the areas are open to other professionals along with the Chartered Accountants.

In the instant case, M/s LMN & Associates responded to a tender of tax audit which is exclusively reserved for Chartered Accountants even though no minimum fee was prescribed in the tender document.

Therefore, M/s LMN & Associates shall be held guilty of professional conduct for responding to such tender in view of abovementioned guideline.

Charging of Fees based on Percentage: Clause (10) of Part I to First Schedule to the Chartered Accountants Act, 1949 prohibits a Chartered Accountant in practice to charge, to offer, to accept or accept fees which are based on a percentage of profits or which are contingent upon the findings or results of such work done by him. However, this restriction is not applicable where such payment is permitted by the Chartered Accountants Act, 1949. The Council of the Institute has framed Regulation 192 which exempts debt recovery services where fees may be based on a percentage of the debt recovered.

In the given case, CA. Whai has insisted for fees to be based on percentage of the debt recovered (which is exempted under Regulation 192). Hence, CA. Whai will not be held guilty for professional misconduct.

 

A-87

 

1. Posting of Particulars on Website: The Council of the Institute had approved posting of particulars on website by Chartered Accountants in practice under Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949 subject to the prescribed guidelines. The relevant guidelines in the context of the website hosted by M/s ABZ & Co. are:

                    ♦ No restriction on the colours used in the website;

                    ♦ The websites are run on a “pull” technology and not a “push” technology

                    ♦ Names of clients and fees charged not to be given.

 

However, disclosure of names of clients and/or fees charged, on the website is permissible only where it is required by a regulator, whether or not constituted under a statute, in India or outside India, provided that such disclosure is only to the extent of requirement of the regulator. Where such disclosure of names of clients and/or fees charged is made on the website, the member/ firm shall ensure that it is mentioned on the website [in italics], below such disclosure itself, that “This disclosure is in terms of the requirement of [name of the regulator] having jurisdiction in [name of the country/area where such regulator has jurisdiction] vide [Rule/ Directive etc. under which the disclosure is required by the Regulator].

In view of the above, M/s ABZ & Co. would have no restriction on the colours used in the website but failed to satisfy the other two guidelines. Thus, the firm would be liable for professional misconduct since it would amount to soliciting work by advertisement.

 

1. Money of Clients to be Deposited in Separate Bank Account: Clause (10) of Part I of Second Schedule states that a Chartered Accountant shall be deemed to be guilty of professional misconduct if “he fails to keep money of his clients in separate banking account or to use such money for the purpose for which they are intended”.

In the given case, M/s XYC & Co. received the money in January, 2016 which is to be paid only in July 2016, hence, it should be deposited in a separate bank account. Since in this case M/s XYC & Co. has failed to keep the sum of ` 4.8 lakhs received on behalf of their client in a separate Bank Account, it amounts to professional misconduct under Clause (10) of Part I of Second Schedule

 

A-88

 

1. Maintenance of Books of Accounts: Chapter V of the Council General Guidelines, 2008 specifies that a member of the Institute in practice or the firm of Chartered Accountants of which he is a partner shall maintain and keep in respect of his/its professional practice, proper books of accounts including the following:

 

1. a Cash Book

2. a Ledger

 

Thus, a Chartered Accountant in practice is required to maintain books of accounts. In the instant case, CA. Arjit does not maintain books of accounts bearing in mind the provisions of section 44AA of the Income Tax Act, 1961.

Accordingly, it does not matter whether section 44AA of the Income Tax Act, 1961 applies or not. Hence, Mr. Arjit, being a practicing Chartered Accountant will be held guilty of professional misconduct for violation of Council General Guidelines, 2008.

 

1. Permission from the Council: As per Clause (11) of Part I of First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice will be deemed to be guilty of professional misconduct if he engages in any business or occupation other than the profession of Chartered Accountant unless permitted by the Council so to engage.

2. However, the Council has granted general permission to the members to engage in certain specific occupation. In respect of all other occupations specific permission of the Institute is necessary.

 In the instant case, CA. Sufi accepted editorship of a journal for which he did not take  any  permission  from  the  Council.  In  this  context,  it  may  be  noted  that  the editorship of professional journals is covered under the general permission.

1. Therefore, CA. Sufi shall not be held guilty of professional misconduct in terms of Clause (11) of Part I of First Schedule to the Chartered Accountants Act, 1949.

 

A-89

 

1. Certification of Financial Forecast: Under Clause (3) of Part I of Second Schedule to the Chartered Accountants Act, 1949, a CA in practice is deemed to be guilty of professional misconduct if he permits his name or the name of his firm to be used in connection with an estimate of earnings contingent upon future transactions in manner which may lead to the belief that he vouches for the accuracy of the forecast.

 

Further, SAE 3400 “The Examination of Prospective Financial Information”, provides that the management is responsible for the preparation and presentation of the prospective financial information, including the identification and disclosure of the sources of information, the basis of forecasts and the underlying assumptions. The auditor may be asked to examine and report on the prospective financial information to enhance its credibility, whether it is intended for use by third parties or for internal purposes. Thus, while making report on projection, the auditor need to mention that his responsibility is to examine the evidence supporting the assumptions and other information in the prospective financial information, his responsibility does not include verification of the accuracy of the projections, therefore, he does not vouch for the accuracy of the same.

Hence, Mr. Denis may accept the offer if the above requirements are complied with.

 

 

1. Printing of Designation “Chartered Accountant” on Invitations for Religious Ceremony: As per Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means.

 

However, the Council of the ICAI is of the view that the designation “Chartered Accountant” as well as the name of the firm may be used in greeting cards, invitations for marriages, religious ceremonies and any other specified matters, provided that such greeting cards or invitations etc. are sent only to clients, relatives and close friends of the members concerned.

In the given case, CA. Sonu has instructed to write designation “Chartered Accountant” on invitation cards for a religious ceremony and distributed the same to all the relatives, close friends and clients of both the partners.

In this context, it may be noted that the Council has allowed using designation “Chartered Accountant” in invitations for religious ceremony, provided these are sent to clients, relatives and close friends of the members concerned only.

Therefore, CA. Sonu would be held guilty of professional misconduct under the said clause for sending such invitations to the relatives, close friends and clients of CA. Monu as well.

 

 

A-90

 

Charging of Fees Based on Percentage: As per Clause (10) of Part I of First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he charges or offers to charge, accepts or offers to accept in respect of any professional employment fees which are based on a percentage of profits or which are contingent upon the findings, or results of such employment, except as permitted under any regulations made under this Act.

In the given case, Mr. Clever has prepared a project report, to obtain a long term loan, for Mr. King. However, he decided to raise the invoice of his service @10% of the loan to be sanctioned in future, which is basically contingent upon the findings. Therefore, Mr. Clever will he held guilty for professional misconduct under the abovementioned clause.

 

1. Sharing and Accepting of Part of Profits with an Advocate: According to Clause(2) of Part I of the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or brokerage in the fees or profits of his professional business, to any person other than a member of the Institute, for the purpose of rendering such professional services from time to time in or outside India.

Furthermore, Clause (3) of Part I of the First Schedule to the said Act states that a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he accepts any part of the profits of the professional work of a person who is not a member of the Institute.

However, a practicing member of the Institute can share fees or profits arising out of his professional business with such members of other professional bodies or with such other persons having such qualifications as prescribed by the Council under Regulation 53- A of the Chartered Accountants Regulations, 1988. Under the said regulation, the member of “Bar Council of India” is included.

Therefore, Mr. Preet, an advocate, a member of Bar Council, is allowed to share part of profits of his professional work with Ms. Preeti. Hence, Ms. Preeti, a practicing Chartered Accountant, will not be held guilty under any of the abovementioned clauses for paying and accepting part of profits from Mr. Preet.

 

A-91

 

1. Soliciting Clients: As per Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means except applying or requesting for or inviting or securing professional work from another chartered accountant in practice and responding to tenders.

Further, section 140(4)(iii) of the Companies Act, 2013, provides a right, to the retiring auditor, to make representation in writing to the company. The retiring auditor has the right for his representation to be circulated among the members of the company and to be read out at the meeting. However, the content of letter should be set out in a dignified manner how he has been acting independently and conscientiously through the term of his office and may, in addition, indicate, if he so chooses, his willingness to continue as auditor, if re- appointed by the shareholders.

Thus, the incorporation as an independent professional, made by CA Smart, while submitting representation under section 140(4)(iii) of the Companies Act, 2013 and indication of willingness to continue as an auditor if reappointed by shareholders, does not leads to solicitation.

Therefore, CA Smart will not be held guilty for professional misconduct under Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949.

 

1. Grossly Negligent and Bringing Disrepute to the Institute: Clause (7) of Part I of the Second Schedule to the Chartered Accountants Act, 1949 states that a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he does not exercise due diligence, or is grossly negligent in the conduct of his professional duties.

 

Furthermore, Clause (2) of Part IV of the First Schedule to the said Act states that a member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he, in the opinion of the Council, brings disrepute to the profession or the Institute as a result of his action whether or not related to his professional work.

In the given case, Mr. Brainy, a Chartered Accountant in practice, is grossly negligence in conduct of his professional duties by issuing clean reports on the balance sheet without examining the accounts. Further, he has also brought disrepute to the profession by advising unethical practice to the managing director of the company. Therefore, Mr. Brainy will be held guilty for professional and other misconduct under abovementioned Clauses to the Chartered Accountants Act, 1949.

 

A-92

Failure to Exercise Reasonable Care and Skill: Apparently, as it appears from the facts of the case that the auditor did not exercise proper skill and care and that he performed his work in a desultory and haphazard manner. In this matter, the test for auditor’s liability lies in whether he has applied reasonable care, skill and caution called for in the circumstances of the case and whether he reasonably used all the information that he came across in the course of audit. Cash is a very significant item in any situation and the fact that the cashier had left during the

year without notice should have placed the auditor on alert as regards the cash book. In fact, the very fact that the cashier was absconding, i.e., left without any notice constituted  sufficient circumstances to excite suspicion of the auditor to probe to the bottom. As per SA 240, “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements”, it can be concluded that the auditor did not plan and perform the audit with an attitude of professional skepticism. Thus, having regard to this and a fraud has actually taken place during the year, committed by the absconding cashier, it is reasonable to think that prima facie there is a case against the auditor for gross negligence.

Clause (7) of Part I of Second Schedule to the CA Act, 1949 requires that it is the duty of an auditor to bring to bear in the work he has to perform that skill, care and caution as per the circumstances in an honest and reasonable manner. As it appears from the facts of the case, the auditor has been grossly negligent in performing his duties which constitutes professional misconduct.

Conclusion:

Thus, such instances require reference to Disciplinary Committee of the Council of the Institute. If a member is found guilty by the Council of any of the acts or

omissions stated in the Schedule, its finding with recommendations are to be referred to the High Court for decision.

2 Clause (1) of Part I of the Second Schedule to  the Chartered Accountants Act, 1949  states that a chartered accountant in practice shall be deemed to be guilty of professional misconduct if he discloses information acquired in the course of his professional engagement to any person other than his client, without the consent of the client or otherwise than as required by law for the time being in force. SA 200 on "Basic Principles Governing an Audit" also reiterates that, "the auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority or  unless there is a legal or professional duty to disclose". In the instant case, the bank has asked the auditor for detailed information regarding few items in the financial statements available in his working papers. Having regard to the position stated earlier, the auditor cannot disclose the information in his possession without specific permission of the client as far as working papers are concerned, SA 230 on "Audit Documentation" states "working papers are the property of the auditor. The auditor may at his discretion, make portions of or extracts from his working papers available to his client".

 

Conclusion:

Thus, there is no requirement compelling the auditor to divulge information obtained in the course of audit and included in the working papers to any outside agency except as and when required by any law.

 

A-93

 

1. As per Clause 8 of Part I of First Schedule to the CA Act, 1949, A chartered accountant in practice is deemed to be guilty of professional misconduct if he accepts a position as auditor previously held by another chartered accountant or a certified auditor who has been issued certificate under the Restricted Certificates Rules 1932, without first communicating with him in writing.

In the instant case, Binaca & Co. accepted VAT – audit under State Level Act, carried out by another firm of chartered accountants in the previous year, without prior communication with the previous auditor.

Conclusion:

A communication is mandatory requirement for all types of audit, if the previous auditor is a chartered accountant. Hence, the firm is guilty of professional misconduct.

1. As per Clause 5 of Part I of Second Schedule to the Chartered Act, 1949, if a chartered accountant in practice shall be deemed to be guilty of professional misconduct, if he fails to disclose a material fact known to him which is not disclosed in the financial statement, but disclosure of which is necessary in making such financial statement in a professional capacity.

In the instant case, Qurashi was in duty bound to see that the nature and subject matter of the charge over a security and the nature and mode of valuation of the Sinking Fund Investments were disclosed in the Balance Sheet of Zee Ltd., in accordance with Form F.

Conclusion:

Hence, Q was found guilty of misconduct.

Responding to Tenders: Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 lays down guidelines for responding to tenders, etc. As per the guidelines if a matter relates to any services other than audit, members can respond to any tender. Further, in respect of a non-exclusive area, members are permitted to pay reasonable amount towards earnest money/security deposits.

In the instance case, since computerisation of property takings records does not fall within exclusive areas for chartered accountants, M/s Appu can respond to tender as well as deposit ` 60,000 as earnest deposit and shall not have committed any professional misconduct.

 

A-94

 

The provisions relating to tax audit under section 44AB of the Income Tax Act, 1961 applies to every person carrying on business, if his total sales, turnover or gross receipts in business exceed the prescribed limit of ` 1 crore and to a person carrying on a profession, if his gross receipts from profession exceed the prescribed limit of ` 50 lakhs (w.e.f. A.Y. 2017-18) in any previous year. However, the term "sales", "turnover" or "gross receipts" are not defined in the Act, and therefore the meaning of the aforesaid terms has to be considered for the applicability of the section. Some of the points for merit consideration in this regard as discussed in the Guidance Note issued by the Institute are given below-

(i)Discount allowed in the sales invoice will reduce the sale price and, therefore, the same can be deducted from the turnover.

(ii)Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing charge and is not related to turnover. Therefore, should not be deducted from the turnover.

(iii)Turnover discount is normally allowed to a customer if the sales made to him exceed a particular quantity. As per trade practice, it is in the nature of trade discount and should be deducted from the figure. (iv)Special rebate allowed to a customer can be deducted from the sales if it is in the nature of trade discount. If it is in the nature of commission on sales, the same cannot be deducted from the figure of turnover.

(v)Price of goods returned should be deducted from the turnover even if the returns are from the sales made in the earlier year/s.

(vi)Sale proceeds of any shares, securities, debentures, etc., held as investment will not form part of turnover 

However, if the shares, securities, debentures etc., are held as stock- in-trade, the sale proceeds thereof will form part of turnover. In the given case, Concession Ltd. is engaged in manufacturing business. Therefore, the tax audit would be applicable if the turnover exceeds ` 1 crore during the financial year 2017-18. The calculation of effective turnover for the prescribed limit purpose, in accordance with abovementioned conditions, is given below: Recorded turnover during the year` 1,13,00,000 Less:

(i) Discount allowed in the Sales Invoice(`8,20,000)

(ii) Trade discount (`2,90,000)

(iii) Sales Return(`1,60,000)

Effective turnover ` 1,00,30,000

Conclusion: The effective turnover of Concession Ltd. is rupees one crore and thirty thousand only which is over and above the prescribed limit for tax audit under section 44AB of the Income Tax Act, 1961.

Thus, the provisions related to tax audit are applicable to the company and is therefore liable for tax audit.

 

A-95

Types of Audit under GST Law by Chartered Accountants: Contention of Vijay Maniyar & Associates, a firm of Chartered Accountants is not correct. GST envisages two types of Audit by Chartered Accountants i.e. (1) Audit of accounts [Section 35(5) read alongwith section 44(2) and rule 80] (2 ) Special Audit wherein the registered person can be directed to get his records including books of account examined and audited by a chartered accountant or a cost accountant during any stage of scrutiny, inquiry, investigation or any other proceedings; depending upon the complexity of the case. [Section 66 and rule 102]

1. Audit of Accounts [Section 35(5) read alongwith section 44(2) and rule 80]As per sub-section 5 of section 35 read alongwith section 44(2) and rule 80 of the CGST Rules, 2017 stipulates as follows:

Every registered person must get his accounts audited by a Chartered Accountant or a Cost Accountant if his aggregate turnover during a FY exceeds ` 2 crores.

Such registered person is required to furnish electronically through the common portal alongwith Annual Return a copy of:qAudited annual accountsqA Reconciliation Statement, duly certified, in prescribed FORM GSTR-9C.

Reconciliation Statement will reconcile the value of supplies declared in the return furnished for the financial year with the audited annual financial statement and such other particulars, as may be prescribed.

Special Audit under section 66: Availing the services of experts is an age old practice of due process of law. These experts have done yeoman service to the process of delivering justice. One such facility extended by the Act is in Section 66 where an officer not below the rank of Assistant Commissioner, duly approved, may avail the services of a Chartered Accountant or Cost Accountant to conduct a detailed examination of specific areas of operations of a registered person.

Availing the services of the expert be it a Chartered Accountant or Cost Accountant is permitted by this section only when the officer considering the nature & complexity of the business and in the interest of revenue is of the opinion that: Value has not been correctly declared; orCredit availed is not within the normal limits.

It would be interesting to know how these ‘subjective’ conclusions will be drawn and how the proper officers determines what is the normal limit of input credit availed.

 

A-96

 

Revision of Tax Audit Report:

(i)Normally, the report of the tax auditor cannot be revised later.

(ii)However, when the accounts are revised in the following circumstances, the tax Auditor may have to revise his Tax audit report also.

(a)Revision of accounts of a company after its adoption in the annual general meeting.

(b)Change in law with retrospective effect.

(c )Change in interpretation of law

(e.g.) CBDT Circular, Notifications,Judgments, etc.

The Tax Auditor should state it is a revised Report, clearly specifying the reasons for such revision with a reference to the earlier report.Thus, the Tax Audit Report can be changed under the given circumstances.

 

A-97

Reporting Requirement for Disqualifications in Cost Audit Report: A tax auditor is required to ascertain under Clause (37) of Form 3CD whether cost audit was carried out and if yes, provide the details of disqualification or disagreement on any matter/item/value/quantity as may be reported/identified by the cost auditor.The tax auditor should obtain the copy of cost audit from the assessee. Even though the tax auditor is not required to make any detailed study of such report, he has to take note of the details of disqualification or disagreement on any matter/item/value/quantity as may be reported/identified by the cost auditor. The tax auditor need not express any opinion in a case where such audit has been ordered but the same has not been carried out.In the given case, the cost auditor of Beam Ltd. has reported certain disqualifications in Form CRA-3 of the cost audit report.

Therefore, the tax auditor of Beam Ltd. is required to provide the details of disqualifications reported by the cost auditor under Clause (37) of the Form 3CD. Thus, the contention of the management of Beam Ltd. not to reveal any of the disqualifications related to the cost audit on the belief that there is no correlation between tax audit and cost audit is not acceptable.

 

A-98

 

Form 3CD: The audit under section 44AB of the Income Tax Act 1961 requires that the taxauditor should report whether in his opinion the particulars in respect of Form 3CD are true and correct. It is the primary responsibility of the assessee to prepare the information in form 3CD. The auditor has toexamine whether the information given is true and correct. The form 3CD is not a report of Tax Auditor. The report is in the form of 3CA or 3CB depending on the nature of the organization of the entity. If the tax auditor is satisfied that the informationcontained in form 3CD is true and correct then he can give unqualified report in form 3CA or 3CB saying" in my opinion and to the best of my information and according to the explanations given to me and considering the materiality the particulars given inform 3CD are true and correct.” But in the given case the tax auditor has found that the form 3CD contains the incomplete, misleading and false information.Disallowance under section 40A(3) is attracted if the assessee incurs any expenses in respect of which payment of aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draftexceedsRs.10,000. However, exemption is provided in respect of certain expenditure in Rule 6DD. In such cases, disallowance under section 40A(3) would not be attracted.Under clause 21(d)(A) of Form 3CD, the tax auditor has to scrutinize on the basis of the examination of books of account and other relevant documents/evidence, whether the expenditure covered under section 40A(3) read with rule 6DD were made by account payee cheque drawn on a bank or account payee bank draft. If not, the same has to be reported under abovementioned clause. Cash payment made on insistence of other parties on the contention that they do not have bank accounts is not covered under the list of exceptions provided under Rule 6DD. Therefore, Mr. R has to report the payments inadmissible under section 40A(3) under clause 21(d)(A) of Form 3CD

 

 

A-99

 

Reporting Requirement Under Clause (4) of Form 3CD: Mr. Deepesh has defaulted in payment of service tax for the previous year. Consequently, the Commissioner of Central Excise issued a show cause notice for such non-payment of tax. The arguments are still going on between the department and assessee.

He also restrained his tax auditor from disclosing service tax registration details in tax audit report.A tax auditor is required to report under Clause (4) of Form 3CD, which requires him to mention the registration number or any other identification number, if any, allotted, in case the assessee is liable to pay indirect taxes like excise duty, service tax, sales tax, customs duty, etc. Part A of Form No. 3CD generally requires the auditor to give the factual details of the assessee. Thus, the auditor is primarily required to furnish the details of registration numbers as provided to him by the assessee. The reporting is however, to be done in the manner or format specified by the e-filing utility in this context. The information may be obtained and maintained in the following format:-

 

Sr. No

Relevant Indirect tax Law which requires registration

Place of Business / profession / service unit for which registration is in place / or has been  applied for:-

Registration/ Identification number

1

2

3

4

 

Furthermore, the auditor has to keep in mind the provisions of Standard on Auditing 580 “Written

Representation”. In case the auditor prima facie is of the opinion that any indirect tax laws is applicable on the business or profession of the assessee but the assessee is not registered under the said law, the auditor should report the same appropriately.

Therefore, the tax auditor of Mr. Deepesh is required to furnish service tax registration number under Clause (4) of the Form 3CD. Thus, contention of Mr. Deepesh not to disclose the service tax details is not tenable.

 

A-100

 

Reporting for Adjustment to be made to the Profits or Loss for complying with ICDSs: Clause 13(d) of Form No. 3CD of the tax audit report requires the tax auditor to state whether any adjustment is required to be made to the profits or loss for complying with the provisions of income computation and disclosure standards notified under section 145(2) of the Income Tax Act, 1961.

Further, the tax auditor is also required to report under Clause 13(e), if answer to Clause 13(d) above is in the affirmative i.e. the auditor is required to give details of such adjustments as follows:

Increase	Decrease	Net
in profit	in profit	effect
(`)	(`)	(`)
ICDS I	Accounting Policies
ICDS II	Valuation of Inventories
ICDS III	Construction Contracts
ICDS IV	Revenue Recognition
ICDS V	Tangible Fixed Assets
ICDS VI	Changes in Foreign Exchange Rates
ICDS VII	Governments Grants
ICDS VIII	Securities
ICDS IX	Borrowing Costs
ICDS X	Provisions, Contingent Liabilities and Contingent Assets

 

Furthermore, Clause 13(f) also requires the tax auditor for disclosure of the following as per ICDS:

 

(i)	ICDS I-Accounting Policies
(ii)	ICDS II-Valuation of Inventories
(iii)	ICDS III-Construction Contracts
(iv)	ICDS IV-Revenue Recognition
(v)	ICDS V-Tangible Fixed Assets
(vi)	ICDS VII-Governments Grants
(vii)	ICDS IX Borrowing Costs
(viii)	ICDS X-Provisions, Contingent Liabilities and Contingent Assets”.