VERIFICATION AND VALUATION OF ASSETS

AND LIABILITIES

MEANING

Verification means the procedures normally carried out at the end, to confirm the ownership, calculations and existence of item at the balance sheet date. It also involves confirming the presentation in financial statements is in accordance with legislation.

Definitions

“the verification of assets implies an enquiry into the value, ownership and title; existence and possession; the presence of any charge on the assets”. -- Spicer and Pegler.

“The verification of assets is a process by which the auditor substantiates the accuracy of the right –hand side of the Balance sheet, and must be considered as having three distinct objects:

a) the verification of existence of assets (b) the valuation of assets © the authority of their acquisition.”

• In the London Oil Storage Co. Ltd. Vs. Sear Hasluck and co. (1904), it was held that it is the duty of an auditor to verify the existence of the assets stated in the balance sheet and that he will be liable for any damage suffered by the client if he fails to do so.

Important points

• Comparing the ledger accounts with the balance sheet.

• Verifying the existence of the assets.• Satisfying that they are free from any charge • Assets were acquired for the business.• To satisfy himself that the assets are in

possession of the client.

• According to the ‘statement on Auditing Practices’ issued by the Research Committee

‘the Auditors’ object are:1. They exist;2. They belong to the client3. They are in possession of the client are person

authorised by him.4. They are not subject to lien5. They are recorded in the balance sheet at proper

amounts.

• The manufacturing and other companies (Auditor’s Report) order, 1975 (social Audit order)

• Liabilities• Cash, bills receivables and investment.• Inclusion of assets not existing on the balance

sheet date.

Objectives of verification

• Existence of assets on date of balance sheet.• Ownership of assets • Possession of assets and verify charges• Proper valuation and classification of assets• Fair and true view of financial position.• Deduct error and fraud.• Proper accounting of assets• Ensure assets are used for business.

VALUATION

• Valuation is a part of verification which is very important for audit. The accuracy of balance-sheet depends upon the valuation.

• It is process of ascertaining the real price of the assets and liabilities.

• “An auditor is not a valuer and cannot be expected to act as such. All that he can do is to verify the original cost price and to ascertain as far as possible that the current values are fair and reasonable and are in accordance with the accepted principles’. - Lancaster

Points considered while valuing assets

• Cost price• Replacement value• Market value• Realizable value• Book value• Break-up value and scrap value.• obsolete

Classification of Assets

• Fixed assets• Current or floating assets• Wasting assets • Intangible assets• Fictitious assets

General Principles

• Focus is on the balance sheet.• Ownership of the assets or liabilities• The value of assets or liability• The assets should be verified physically.• Valuation• Liability – nature and extent• Assets like cash and bills receivables should be

personally examined.

Differences between verification and valuation

• In case of verification auditor as to verify not only actual existence but also proper valuation.

• Verification of assets comes before valuation of assets.

• Verification of assets includes valuation also

• Auditor is entirely responsible

• auditor has to merely ensure that assets value shown in balance sheet are correct.

• valuation follows verification of assets.

• It is a part of verification of assets

• Auditor don’t undertake work of determining value of assets

verification• Auditor guarantees that asset

have been properly verified• It is made on evidence such as

title deeds, receipts, payment etc.,

• It is a process by which auditor satisfy himself not only about existence, ownership title of asset, but that the asset is free from charge

valuation• Does not give any

guarantee as to accuracy.

• Auditor has to depend upon the certificate of the owners.

• Not only determining value of assets as appearing in balance sheet but critical examination of value

Auditor’s Position as Regards Valuation of Assets• “he is not a valuer and cannot be expected to act as

such. All that he can do is to verify that original cost price and to ascertain as far as possible that the current values are fair and reasonable and are in accordance with the accepted commercial principles”

• “an auditor is not liable, if in the absence of suspicious circumstances, he relies on trusted officials of the company”

Kingston Cotton Mills Ltd.(1896)

• He should be very careful and cautious.• He should remember that that accuracy of profit and loss

account and balance sheet depends on accuracy of valuation.• He is not a valuer hence he has to rely on information

available.• Satisfy himself that the valuation of assets has been correctly

made.• It is fair and reasonable• How far the principles of accounting have been adopted• Whatever steps that are taken are accepted in the previous

years.

Verification and valuation of assets

1.Property• Freehold property:He should examine the title deeds in order to

verify the correct position.For purchase price – statement o f purchase

received from client solicitors.Should see that the property is in the client

name.

• In case mortgaged property – obtain a certificate from the mortgagee regarding the possession.

• Rented out- examine the receipt of rent particularly the receipt of the last rent collected.

• In case the property is acquired in the current year the cast may be verified with the help of bank pass book.

• He should obtain a certified copy of the valuation of the property from professional valuers or architect.

Lease hold property

• Should examine the lease contract• A lease exceeding one year is not valid unless it has

been granted by a registered instrument.• Should see term and conditions are properly

complied with.• Termination of lease on account of non-payment.• He should examine the last receipt of the lease rent.• Depreciation • Sub-let

Property which is in the process of construction

• Examine the certificate of the architect • Allocation between revenue and capital

expenditure is made correctly.• Obtain a certificate from a responsible officer

PLANT AND MACHINERY

• Machinery account• Balances sheet• Vouching• Plant Register-cost, records about sales, provision for

depreciation.• Personal inspection• Charges on the asset• Valued at going concern value• Shown in in balance sheet at cost – depreciation.• Repairs revenue account.

Furniture and fixtures

• Furniture stock register• On the date of balance sheet , the register has

been properly balanced and shown in the B/S• Lease –Lease deed.• Properly valued • Depreciation

Good Will

• It is valued at the time of purchase of the business

• In case of partnership firms• In case of purchase of the business, the auditor

should verify contract with the vendors.• Revaluation of assets • Partnership firm-Deed• Goodwill is valued and shown in balance sheet at

cost less amount written off.

Factors determining the value of goodwill

• Location factors• Nature of business• Efficiency of management• Past profits of a business• Stability of a business• Future prospects of business.

Circumstances

1. Sole trading concerns• When it is sold• Converted into partnership2. Partnership firm• Admission of a new partner• Retirement and death of a partner.• Amalgamation of partnership firm.

3. Joint stock company• Amalgamation of companies• Absorption • External reconstruction• Valuation of shares.

• Methods– Average profit method– Capitalisation method– Super profit method– Annuity

Patents

• Patent is stated in the balance sheet• Patents are registered in the name of the

client• Patent rights1.By purchase: fee is capital expenditure debited

to patents account , renewal fees – revenue expenditure.

2.By development and Research

• If the client holds large number of patent or trade mark

-The description of the patent-Registered number-Date of purchase• Examine receipt for payment of fees.• Renewal fees is paid each year.• A patent has 16 years of time.

Valuation of asset

• With the lapse of time, they lose their value• Causes for depreciation area)Lapse of timeb)Obsolescencec) Going out of fashion.

Copy rights

• An exclusive right to produce or reproduce a book • The duration of the copyright is the lifetime of the

author and fifty years after his death.• The auditor should proceed with their verification

similar to patents• Agreement of author and client is to be examined.• If there are many copyright with a business, the

auditor should ask for schedule

Motor Vehicles

• Separate account should be opened.• Register is maintained• check the registration books and licenses.• Purchases and additions during the year• He should check premium receipts.• Fees paid for renewal should be properly

entered.• Depreciation.

Live stock

• The auditor should check the asset with the help of certified inventory of all the animals.

• Separate registers are maintained.• Valuation he should see that they are annually

revalued and any loss on account of death or sale of an animal is written off.

Stores and spare parts

• It consists of materials which are meant for consumption in the business and not for resale.

• While spare parts of the machinery are preserved to maintain it in proper order.

• Auditor should obtain an inventory of stores and spare parts duly certified by a responsible officer.

• He should count the stock himself and verify their existence.

• The loss on breakage or waste or duly writeen off. • Stores and spares consumed.

Assets acquired on HPs or Installment agreement

• It should be properly recorded.• Each year installment has to be paid and so

much of money paid in this connection is be recorded.

• The agreement should be examined.• The interest paid on the unpaid balance

should be charged to profit and loss account.• Provision of depreciation should made.

INVESTMENTS

• The authority of purchase of investment.• The prices of investment be checked by

reference to allotment letters or stock brokers’ bought note.

• Ensure that all investments are in the name of the client.

• The MOA and AOA of the company be examined.

• Approval of BOD.

• City Equitable fire insurance company Ltd.:• The auditor should try to inspect all securities.• Examine the transfer Deed when no certificate

has been issued .• Inspect the bought note.• If securities are held by any trustee on behalf

of the company the Trust deed should be inspected.

• Should vouch the sale proceeds.• Company brokers…………..

• Sec 49 0f the companies act.• The auditor should also obtain a complete

schedule of all such investments made in the shares and debentures of a subsidiary.

Investments may be

• Registered stocks, debentures or bonds and shares and Government securities.

• Inscribed stocks.• Bearer bonds and share warrants.

• VALUATION OF INVESTMENT

STOCK -IN - TRADE• The methods of stock taking should be examined.• He should obtain a list of instruction issued .• A few items should be checked in the rough stock sheet.• Total and balances of stock sheets should be examined

with the help of valuation sheets• The principles and bases followed.• Valuation is done on the basis cost price or market price

which ever is less’• Goods inward registrar should be examined.• The goods sold on or prior to the closing day • Goods not related to business are not recorded.• The percentage of gross profit to sales of the current

year……

• METHOD OF STOCK TAKING

• PRECAUTIONS TO BE TAKEN There may be some goods which may be

legally in the ownership of the client but not actually in his possession.

Balance of unsold stock at the branches… Goods received but not entered in the

financial books should be included. Goods sold but not delivered to the buyer

Certificate obtained by the auditor

• I hereby certify that the value and the quantity of stock as entered in the stock sheet on December 31 2010, are correct.

• The goods included in the stock-sheet are the property of the concern.

• The goods have been properly valued and adequate provision has been made for old and obsolete goods.

• The basis of valuation of stock is the same as in the previous year.

Finally checked and approved by……………. Managing Director.

Characteristics of a good system of stock-taking• It should take place at the close of business on the last day

of the accounting period.• The work of calling out quantities and description of the

goods and the making of the entries should be done by senior clerks.

• Such entries should be thoroughly checked.• A responsible officer should enter the price on the stock

sheet.• Additions should be done by another clerk and their

checking should be independently done.• Stock –taking sheet should be initialized.

Methods of finding out cost prices

• Unit cost or actual cost • Average cost method• FIFO• LIFO• Base stock method• Standard cost• Adjusted selling price.

Methods of valuation of different items of stock

• Raw material• Semi-finished goods• Finished goods• Goods on consignment• Goods with customers under hire purchase

agreement.• Goods of plantation products.

Valuation of stock and auditor’s duty

• In the case of kingston cotton mills(1986) it was held that it is not the duty of the auditor to take the stock, and that he is not guilty of negligence if he accepts the certificate of a responsible official in the absence of suspicious circumstances.

• Points to be considered:• The auditor is not a valuer;• It is not his duty to take stock.• If he has some suspicion in his mind as regards the valuation

of stock he should rely on the certificate of a responsible official.

• Physical verification of stock-in-tradeThe first guiding legal cases are Kingston Cotton

Mills Case (1896) and Irish Woollen Co. Ltd. Vs. Tyson and others (1900)

American accountants have not accepted the principles in view of McKesson and Robbins case.

The Westminster Road Construction and Engineering Co. Ltd.(1939)case and

the Deputy Secretary, Minister of Home affairs vs. S.N. Dass Gupta (1955)

The Institute of C.A. of India

• Attendance of the auditor at stock taking

• Examination of records

• Confirmation with third party.

• Verifying the valuation of the stock –in-trade.As to the cost the auditor must satisfy himself

that they have been calculated on some acceptable method.

Should see that the stock sheets are duly signed.Goods with consignee are not valued at selling

priceExamine the purchase and sale ledger.Depreciation

Sundry Debtors

• Should see that debts disclosed in balance sheet are recoverable.

• Obtain certified statement of types of debt.• The balance of the sales ledger should be checked

with the schedule of the book debts .• Written of debt• In case of hire purchase debts• Debts due by the directors or other officers• In case of debts in a foreign currency

ACCORDING TO THE COMPANIES ACT

• Debts considered good in respect of which the company is fully secured.

• Debts considered bad or doubtful. 1. the age of debts 2. Regular payments3. Heavy dishonored bills4. Noting on the accounts5. Comparison of bad debts, budgeted and actual.

Bills Receivables

• Bills receivables should be compared and counted• Some times the bills might have mature and

honoured subsequent to the date of the balance sheet

• He should see the bills are properly drawn, stamped and accepted

• Discounted bills should be examined….• If bills have been deposited with the bank for safe

custody or for security of loan, they should be verified.

Loans

• Against the security of land and property• Against the security of stock and shares• Against the personal security of the borrower• against the security of insurance policy• Against the security of goods

Against the security of land and property

• Examine the documents relating to the security.• If the land or property is mortgaged…• If it is a second mortgage, he should see that the first

mortgagee has been duly informed.• Examine title deed relating to the property.• The amount of loan and the date should be inquired into.• The rate of interest and the date on which it is payable.• Should see the property is insured against fire and

examine the last receipt for the premium paid.• Should see the mortgage is duly registered.

Loans against security of stock and shares

• Should obtain a list of stock and share which have been held as security and transferred in favour of client.

• Examine the concerned document to find out the value

• The amount of loan advanced must be confirmed from the borrower on the balance sheet date.

• See whether the security is easily marketable• Partly paid shares should not be accepted as

security,

Loan against security of goods

• Godown-keepers receipts should be examined.• See that the warehouse rent has been paid by the

borrower;• It has been advanced against goods in transit,

railway receipts or bills of ladings etc duly endorsed in favour of his client.

• the value of the goods may be ascertained from the market quotations

• He should examine quality control report• If the goods are of perishable nature, he should

examine the turnover of the stock.

Verification of liabilities

• The liabilities shown in the balance sheet are actually payable.

• All liabilities are properly recorded• The recorded liabilities are payable for the

legitimate operations of the business,• the nature and extent of contingent liabilities

has been disclosed in the balance sheet by way of foot note.

Capital

• Partnership firm the auditor should examine the agreement.

• In JSC- MOA , AOS, cash book, pass book and the minutes book of Board of directors

• In case of new company.– Forfeiture of shares – The calls in arrears– All the requirements of schedule VI of the companies

act in connection with the share capital.• In case of sole proprietors

Loans

• The auditor must ascertain the borrowing power of the company.

• Should see any restriction on the borrowing power of the officers is not exceeded.

• see agreement pertaining to the borrwings.• In case of secured loan• When debentures are issued having a charge on

the asset.• Examine the entry in mortgage register….

Sec 227 (IA)

• It is necessary for an auditor to find out the purpose or purposes for which the loans have been raised.

• He should also confirm whether the loans so raised have been fully utilised.

• In case BOD, the auditor should ascertain the amount of OD and the conditions on which the overdraft has been secured by his client.

• it is always advisable to get confirmation from the lending institutions.

Trade Creditors

• Should take a balance of trade creditors duly signed by the authorised officer of the organisation.

• Obtain confirmatory statement from the creditors.• Examine the invoices sent by the suppliers, and an

inward Goods Book.• Test checking.• Compare percentage of gross profit with P.Y• If debts have not been paid for a long time.• For any purchases return, he should examine the

‘returns outward Book’

Outstanding Liabilities for expenses

• Obtain certificate from the authorised officer of the company stating that accounts are maintained.

• He should ascertain the accuracy of the accounting records and test the calculations.

Bills payable

• These are acknowledgements of debt payable.• Get a statement of bills payable and compare

with the B.P book.• Examine the cash book – for bills already met

after balance sheet date and before audit.• Examine bank pass book and cash book.• Ensure bill already paid are not recorded as

outstanding.

Contingent liabilities

• A future uncertain liability which is dependent on the happening of some other event.

• Liabilities which have not arisen upto the date of the balance sheet, but may arise out of contingent contracts such liabilities are called as contingent Liabilities.

Contingent liability categories

• Liabilities in respect of which a provision has been made:

Ex: claims which in the opinion of directors are likely to become legal obligations and as such provisions have been made for such claims.

• Those not provided for by the management: Ex: BOE discounted, Claims against company

not acknowledged as debit etc.

• The auditor should check various C.L• For liabilities for which no provision has been made

in the books while preparing B/S it should be shown under the heading “C.L not provided for’.

• The auditor should note down such liabilities while auditing the various books of accounts of a company.

• Make enquires regarding such liabilities if they have not shown in the balance sheet.

Examples

• Liability on bills discounted but not matured on the date of balance sheet.

• For damages claimed by staff for accidents where the case is before the law of court for decision,

• Liability under a guarantee• Liability on calls on partly paid shares