Friday, January 10, 2014


Course Code: ECO - 12
Course Title : Elements of Auditing
Assignment Code : ECO – 12/TMA/2015-16
Coverage : All Blocks
Maximum Marks: 100

Attempt all the questions.

1. Define Auditing. Explain its objectives and advantages.                                           (20)
Ans: Meaning of Auditing: The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially auditor was a person appointed by the owners to check account whenever the suspected fraud, he was to hear explanation given by the person responsible for financial transactions. Emergence of joint stock companies changed the approach of auditing as ownership was pestered from management. The emphasis now is clearly on the verification of accounting date with a view on the reliability of accounting statement.
In the words of Montgomery, “Auditing is a systematic examination of the books and records of a business or other organization, in order to ascertain or verify and report upon the facts regarding its financial operation and the result thereof”. 
In the words A.W. Hanson, “An audit is an examination of such records to establish their reliability and the reliability of statement drawn from them”. 
From the above definitions it is clear that the auditor’s basic duty is to examine the accounts and its arithmetical accuracy. He must ensure than the financial statements depicts true and fair view of the state of affairs of the business. Since, Auditing is a full and critical examination of the books of accounts to find out their accuracy.

Objectives of Auditing:
1.       Reporting: The objective of an audit of financial statement is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects in accordance with an identified financial reporting frame work. The phrases used to express the auditor's opinion are given a true and fair view or present fair in all material respects, which are equivalent terms.
2.       Purpose of Audit: The purpose of audit is to check the proper accounting to policies. For the better accounting system it is necessary to follow the accounting policies. Only by this way we can get the effective result.
3.       Opinion: The purpose of the audit is to get the correct opinion about the business so for this the auditor should be honest, confident and he must have the ethical standard for his work.
4.       True and Fair View: The purpose of the auditing is to determine the correctness of statement. After auditing the financial statement has the correct and true view about the business.
5.       Detection and Prevention of Errors: The audit is committed for the detection and prevention of errors. These errors can be prevented through internal check also.
6.       Detection and Prevention of Fraud: The detection and prevention of fraud is another purpose of auditing. It consists of the omission of the effect of transaction, recording or transaction without substance etc.
7.       Profit Verification: Audit is concern to check the profit verification in a business concern. Profit has to main position in any type of business, only the expert auditors can check the fluctuation of the Profit.
8.       Admission of Partners: For the admission of the new partner the audit plays an important role. It provides information to new as well as old partner for the settlement of the new terms according to the volume of assets and liabilities.
9.       Purchasing Price: For the buyers and sellers of a certain business concern it is necessary to know the real value of the business assets and liabilities. The audit is helpful in finding out the real value of the business.

Advantages of Auditing
A. Benefits of Business: Business may get many advantages of conducting audit by a qualified auditor. The advantages are discussed below:
(a) True and Fair view: With the help of audit of accounts, it is possible get a true and fair view of the financial position of the business.
(b) Detection of errors and frauds: If books of accounts are audited, errors and frauds can be detected and necessary action can be taken to prevent it.
(c) Moral pressure on the employees: If audit is conducted by the organization, employees should be cautions and there should be a moral pressure on them. As a result, chances of errors and frauds will be minimized.
(d) Proper accounting control: A system of regular audit helps the organization to maintain proper books of accounts regularly and books of accounts are kept up to date.
B. To the Owner: The owners of the business are also interested to know the financial position of the business. There are discussed below:
(a) Benefit to the sole proprietor: In case of large business, the proprietor can get a true and fair view of the accounts maintained by his employees and also able to know the state of affairs and profit made by him. The proprietor is also benefited for getting loan from financial institutions, to pay income tax etc.
(b) Benefits to the partners: With the help of audited accounts help to the partners to settle their unsettled disputed, for taking loan from financial institutions, to get off the books of accounts maintained by the employees etc.
(c) Benefits to the shareholders: Shareholders are the owners of a company. With the help of audited accounts they get a real picture of the financial position of The company and they can assure that business is running efficiently.
C. To the third parties: Besides business and the owners, there are different outside interested parties who required audited accounts for different purposes: These are:
(a) Government may be interested to get the audited accounts to show the deficiency of the business for giving grant and subsidy.
(b) Financial institutions sections loan to the organization on the basis of verification of financial soundness form the audited accounts.
(c) Tax authorities may depend on audited accounts for determination of income tax, sales tax, excise duty etc.
(d) For settlement of insurance claim, insurance companies can barely on audited accounts.

2. What is meant by verification? How does it differ from valuation? How would you verify the following? (10+10)
a) Goodwill
b) Plant and Machinery                               

Ans: Meaning of Verification: Verification is a process carried out to confirm the ownership valuation and existence of items at the balance sheet date. Spicer and Pegler have defined verification as “it implies an inquiry into the value, ownership and title, existence and possession and the presence of any charge on the assets”. Verification is a process by which an auditor satisfies himself about the accuracy of the assets and liabilities appearing in the Balance Sheet by inspection of the documentary evidence available. Verification means proving the truth, or confirmation of the assets and liabilities appearing in the Balance Sheet. Thus, verification includes verifying:
a)       The existence of the assets
b)       Legal ownership and possession of the assets
c)       Ascertaining that the asset is free from any charge, and
d)      Correct valuation
Differences between Verification and Valuation:
Verification is done to prove the existence, ownership and title to assets.
It certifies the correct value of the asset at the date of the BS.
Verification is done or both assets and liabilities.
Usually only values of assets are certified.
Verification is done by the auditor.
It’s done by the experts and responsible officials. 
Verification is made on the basis of evidence.
Valuation is made based upon the certificate issued by the officials.

Verification of Goodwill:  Goodwill is an intangible asset representing the value of the reputation of the firm which enables it to earn more than normal profit. The value of goodwill varies with the earning capacity of the business. When a business has been purchase and goodwill is paid for the auditor should verify the agreement with the vendors. Whenever a business is acquired, goodwill is the difference between the value of acquisition and cost of acquisition. Sometimes, goodwill may also be created by spending huge amounts to innovate new products. Such goodwill is known as Deferred Goodwill. It’s capitalized over a period of time. Goodwill is shown in the books at cost less the written off amount.
Verification of Plant and Machinery: He should obtain a schedule of plant and machinery certified by responsible official. It gives all details about each machinery. He should compare the schedule with the plant register. If machinery is acquired under hire purchase he should verify the hire purchase agreement. If the machinery is imported he should verify the export license copy of invoice, permission of RBI from foreign exchange payment. Plant and Machinery is valued at cost less depreciation. Depreciation rate is decided by the management. The only duty of the auditor here is to see whether depreciation is charged as per the provision of the IT Act.                                                            

3. Discuss the main provisions of company law regarding the appointment, duties and removal of an auditor.  (20)
Ans: Appointment of a Company Auditor:
According to Section 224 of the Companies Act, every company whether private or public must appoint an Auditor or auditors to audit the final accounts. The provisions relating to the appointment of auditor are as follows:
1.       Appointment of First Auditors:
(a) In case of a Non-Government Company[Sec. 139(6)]: The first auditor of the company is to be appointed by BOD within 30 days from the date of incorporation of company. Note here that this is not from the date of commencement of business. First auditor shall hold office upto the conclusion of first AGM. If BOD fails to appoint the first auditor, it shall inform the members of the company. The members of the shall within 90 days at an extraordinary general meeting appoint the auditor.
(b) In case of a Government Company [Sec. 139(7)]: In case of any government company or any other company which is owned or controlled by central or state government either directly or indirectly, the first auditor shall be appointed by the Comptroller and Auditor General (CAG) of India within 60 days from the date of registration of the company. In case the CAG does not appoint such auditor within the above period, the Board of directors of the company shall appoint such auditor within next 30 days.
2.       Appointment of Subsequent auditors:
(a) In case of Non-Government Company [Sec. 139(1)]: Every company shall, at the first AGM appoint an individual or firm as an auditor who shall hold office form the conclusion of that meeting till the conclusion of its 6th AGM and thereafter till the conclusion of every 6th meeting. The following points need to be noted in this regard:
a. The company shall place the matter relating to such appointment by member at every annual general meeting.
b. Before such appointment is made, the written consent of the Auditor to such appointment and a certificate should be obtained. The certificate shall also indicate whether the auditor satisfies the criteria provided in sec. 141.
c. The company shall inform the auditor concerned of his or its appointment.
d. The company shall also file a notice of such appointment with the registrar within 15 days of such appointment.
(b) In Case of Government Companies [Sec. 139(5)]: In case of any government company or any other company which is owned or controlled by central or state government either directly or indirectly, the Comptroller and Auditor General (CAG) shall in respect of a financial year, appoint an auditor duly qualified to be appointed as an auditor of companies under this act, within a period of 180 days from the commencement of the financial year, who shall hold office till the conclusion of the AGM.
3.       Filling of Casual Vacancies [Section 139(8)]:
In the case of a company other than a company whose accounts are subject to audit by an auditor appointed by the CAG of India:
(a) Any Casual Vacancy due to reasons other than resignation: Any casual vacancy in the office of an auditor shall be filled by the board of directors within 30 days.
(b) Any Casual vacancy due to resignation: Such appointment shall also be approved by the company at a general meeting convened within 3 months of the recommendation of the board and he shall hold the office till the conclusion of the next annual general meeting.
In the case of a company whose accounts are subject to audit by an auditor appointed by the CAG of India:
(a) Any casual vacancy in the office of an auditor shall be filled by the CAG of India within 30 days.
(b) In case the CAG of India does not fill the vacancy within the said period the board of directors shall fill the vacancy within next 30 days.

Removal, Resignation of auditor and giving of special notice to the Company Auditor
Provisions relating to removal of auditor before the expiry of term [Sec. 140 (1)]: As per section 140(1), the auditor appointed under sec. 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the central government in that behalf.
Procedure for removal:
a) Holds board meeting to pass the resolution
b) Make an application to the central government along with prescribed fees within 30 days of the board’s resolution.
C) Hold the general meeting to pass the special resolution within 60 days of receipt of approval of the central government.
d) Before taking any action for removal before expiry of terms, the auditor concerned shall be given a reasonable opportunity of being heard.
Resignation by auditor [Sec. 140 (2) and Sec. 140(3)]: When an auditor resigns, he is required to file a statement in the prescribed form with the company and the registrar stating the reasons and other facts which are relevant with regard to his resignation. In case of a government company, the statement shall also be filled with the CAG. The above mentioned statement shall be filled within 30 days form the date of resignation.
Special notice for not appointing the retiring auditor [Sec. 140(4)]:  According to Sec. 140:
a)      special notice at an AGM shall be required for appointing as auditor a person other than the retiring auditor or providing expressly that the retiring auditor shall not be reappointed. However, special notice shall not be required if the retiring auditor has completed consecutive tenure of 5 years/ 10 years as provided u/s 139(2).
b)      On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring auditor.
c)       The retiring auditor is entitled to make a representation against his removal. The representation shall be in writing and shall be sent to the company.
d)      The company shall send a copy of the representation to every member of the company to whom notice of the meeting is sent.
e)      If a copy of the representation is not sent because if was received too late or because of the company’s default, then the auditor may require that the representation shall be read out at the meeting and a copy of representation shall be filed with the registrar.

Duties of a Company Auditor
According to Sec. 143 of the Companies Act, 2013, the duties of auditors are classified under the following headings:
a)      Duty to Enquire: It is the duty of auditor to inquire into the following matters:
i.         Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members.
ii.       Whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company.
iii.      Whether loans and advances made by the company have been shown as  deposits.
iv.     Whether personal expenses have been charged to revenue accounts.
v.       Whether or not cash has actually been received from allotment of shares.
vi.     Where the company not being an investment company or a banking company, whether so such of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than at which they were purchased by the company.
b)      Duty to make report: The auditor shall make a report to the members of the company. In his report, the auditor shall report on:
                     i.            Whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief necessary for the purpose of his audit and if not, the details thereof and the effect of such information on financial statements.
                   ii.            Whether in his opinion, proper books of account are required by law have been kept by the company so far as appears from his examination.
                  iii.            Whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of accounts and returns.
                 iv.            Whether in his opinion, the financial statements comply with the accounting standards.
                   v.            Whether any director is disqualified from being appointed as a director.
                 vi.            Whether the company has adequate internal financial control system in place and the operating effectiveness of such control.
                vii.            Such other matters as may be prescribed under rule 11: The auditor’s report shall also include views and comments on the following matters.
1)      Whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement.
2)      Whether the company has made provisions, as required under any law or accounting standards, for material losses, if any on long term contracts including derivative contracts.
3)      Whether there has been any delay in transferring amounts, required to be transferred, to the investor education and protection fund by the company.
c)       Duty to report on frauds u/s 143 and rules 13: If an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offense 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 within such time and in such manner prescribed in rule 13.

4. What important documents would you inspect before commencing the audit of a company? Explain.              (20)
Ans: Important Documents which an auditor must examine before commencement of audit of a joint stock company:
a. Memorandum of Association: Section 2 (56) of the Companies Act, 2013 defines Memorandum as “Memorandum means the Memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous companies law or of this act”.
One of the essentials for the registration of a company is memorandum of association. It is the first step in the formation of a company. Its importance lies in the fact that it contains the fundamental clauses which have often been described as the conditions of the company’s incorporation.
Memorandum of association is divided into 5 clauses/contents [Sec. 4 of the Companies Act, 2013]:
1.       Name clause
2.       Situation or Registered office clause
3.       Objects clause
4.       Liability clause and
5.       Capital clause
6.       Subscription or Association Clause
1. Name clause: This clause state the name of the company. Name of every company limited by shares or by guarantee must end by the word 'Ltd.' or 'Pvt. Ltd.' except companies exempted u/s 8.  The name must not be undesirable or most not resemble the name of any other registered company.
2. Situation or Registered office clause: Must contain the name of state is which registered office is situated.  Actual address of registered office is notified to ROC with in 30 days of in corporation.
3. Object clause: It sets out object or vires of the company. The objects must be legal and not be against the provision of the companies Act, 2013. It is divided into two parts:
(a) The main objects and Objects incidental or ancillary to the main objects.
(b) Other objects.
4. Liability clause: States that liability of members is limited to the amount unpaid on their shares and in case of company limited by guarantee the amount which every member undertakes to contribute to the assets of the company in the even of its winding up.
5. Capital clause: Every company having a share capital, the amount of share capital with which the company is proposed to be registered and the division of its shares into a fixed denomination.
6. Subscription clause: This clause shall state the number of shares that each subscriber to member has agreed to subscribe. Every subscriber shall agree to subscribe for at least one share.
Auditor’s Duty: The auditor should proceed in the following way in examining the Memorandum of Association:
(1) He should very carefully examine the ‘Object Clause’ of the Memorandum to ensure that the company is carrying on the work as specified.
(2) He should check the ‘Capital Clause’ and see that the issue of share capital is within the ‘Authorised Capital’.
(3) If the Authorised Capital has been increased according to law, it should be verified and traced out.
(4) If the Memorandum has been altered, it should be seen that such an alteration has been made within the provisions of sections 17 and 18 of the Companies Act.
2. Articles of Association: The Articles contain rules and regulations for the internal management of the company. They are framed with the object of carrying out the aims and object of the memorandum of association and also to monitor that the same are carried as prescribed.
Section 2 (5) of the Companies Act, 2013 defines articles as “Articles means Articles of Association of a company as originally framed or altered from time to time in pursuance of any previous law or of this act including so far as they apply to the company the regulations contain as the case may be in Table A to Schedule I of this act”
Auditor’s Duty: The auditor should examine the Articles of Association of the company for the following matters:
(i) Issue of Share Capital.
(ii) Calls on shares.
(iii) Calls in advance.
(iv) Calls in arrears.
(v) Forfeiture and re-issue of shares.
(vi) Transmission of shares.
(vii) Payment of commission of shares.
(viii) Rights of various classes of shareholders.
(ix) Appointment, remuneration, rights and duties of Managing Director or Manager.
(x) Appointment, remuneration, qualification shares, rights and duties of Directors.
3. Prospectus: Section 2(70) of the Companies Act, 2013 defines a prospectus as ““A prospectus means Any documents described or issued as a prospectus and includes any notices, circular, advertisement, or other documents inviting deposit fro the public or documents inviting offer from the public for the subscription of shares or debentures in a company.” A prospectus also includes shelf prospectus and red herring prospectus. A prospectus is not merely an advertisement. A document shall be called a prospectus if it satisfy two things:
a)      It invites subscription to shares or debentures or invites deposits.
b)      The aforesaid invitation is made to the public.
Auditor’s Duty: The auditor should examine the Prospectus for the following matter:
(i) Amount of capital to be issued, classification of shares and right of shareholders attached therewith,
(ii) Amount payable on allotment and calls,
(iii) Amount of minimum subscription,
(iv) Particulars of any contract entered into with the vendors for the purchase of business,
(v) Amount payable for underwriting commission on shares or debentures,
(vi) Amount of preliminary expenses paid or payable,

5. Write short notes on the following:                                   (10+10)
a) Cost Audit
Ans: It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.
As per ICWA London’ “cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.”
The ICWAI defines cost audit as " system of audit introduced by the government of India for the review, examination and appraisal of the cost accounting records and attendant information required to be maintained by specified industries"
From above definition of cost audit, it is clear that cost audit is a sytematic examination of cost accounts to verify correctness of cost accounting records.
Following are the advantages of cost audit
To The Management
a)      Cost audit helps in detection of errors and frauds.
b)      It helps in cost control and cost reduction.
c)       It facilitates the system of standard costing and budgetary control.
d)      It helps the management in inter-unit / firm comparison.
e)      It enables the management to identify loss making propositions.
 To The Government
a)      Cost audit ensures efficient functioning of the industry. This in turn, nurtures a healthy competition among the different companies and paves a path for fast progress.
b)      It helps in identification of sick units and enables the Government to make relevant decisions.
c)       It helps in fixing prices in the case of essential commodities and checking undue profiteering.
d)      It helps to take decisions as to levies, duties and taxes.
To the Society
a)      Cost audit enables the Government to fix prices of essential commodities. This safeguards the interests of the society.
b)      Cost audit enables the Government to keep a check on undue profiteering by the manufacturers and avoids artificial price rise due to monopolistic tendencies.
To the Shareholders
a)      Cost audit reveals whether any of the products of the company are making losses. Thus though the company making an overall profit, a loss making line may eating up the company’s profits.
b)      Cost audit ensures that the shareholders get a fair return on their investments.
b) Clean and Qualified Report
Ans: Clean Report: Audit report is a statement on financial position of the company which is issued after the conclusion of audit. It is a medium through which an auditor expresses his opinion on the financial statements under audit.  It generally shows the nature and scope of audit conducted by the auditor and his opinion on the final accounts of the company. Audit report may be clean or qualified. Clean Report is also known as Unqualified Report. It is given by the auditor if he is satisfied with the fairness of Balance Sheet and Profit and Loss account with all the contents of the financial statements and he is satisfied with evidences, documents and explanation given by his clients.
Qualified Audit Report: A qualified report means an audit report which is not clean. In case auditor has any reservation in respect of certain methods mentioned in the financial statements he may qualify his report. A qualified opinion shall be expressed as being subject of or except for the effects of the matter to which the qualification matters. If the accounting standards issued by Institute of Chartered Accounts of India is not followed by the company the auditor may qualify his report. In following circumstances the auditor has to qualify his report.
(a) He cannot conduct audit satisfactorily due to non availability of certain books of accounts or records, information or explanations necessary for conduct of his audit.
(b) He finds that the Balance Sheet and Profit & loss Account have not been prepared in accordance with accepted accounting principles.
(c) He detects that provisions for Bad & Doubtful Debts, Depreciation etc. are not adequate.
(d) He detects that the company has created certain secret reserve.
(e) The stock in trade has been valued at market price which is more than cost price.
(f) He finds that the contingent liability for bills discounted has not been disclosed.