Fb Sharing Audit Material for DEC 2014

CA Rahul Ranka Vivekananda Institute of Learning (ViL)

CHAPTER 1- BASIC CONCEPTS

1. Define Auditing. State its features.

Definition

The term Auditing refers to the process of systematic and independent

examination of books of accounts, data, statements, records, operations and

performance of an enterprise for a stated purpose.

The auditor perceives and recognizes the propositions before him for

examination, collects evidence, evaluates the same and on this basis forms his

opinion/judgement which is communicated through his audit report.

Auditing is necessary for all organizations -whether profit - oriented or not and

whether it is required by law or not, whether small or large organization,

whether sole proprietor, partnership firm or company.

Auditing is done with the purpose of forming an opinion whether the financial

statements disclose true and fair view or not.

Features of Auditing

� Systematic and scientific examination

� Independent examination

� By a qualified person (Auditor)

� Purpose – forming an opinion whether the financial statements (profit and

loss account, balance sheet, cash flow statements) disclose true and fair

view or not.

� It involves critical review of the system of accounting and internal control.

� It involves inspection, verification, vouching of various documents, vouchers,

minutes books,AOA,MOA, minutes books etc.


2. What are the Objectives of Audit?

Objective of Audit Can be classified as

(i) Primary object is to form opinion on the true and fair view disclosed by

financial statements. Financial statements include Balance Sheet, P & L

accounts and cash flow statements.

(ii) Secondary object is to detect and prevent frauds and errors.

The auditor should ensure that the financial statements do not contain

misstatement on a/c of fraud and error. Both objectives are interdependent and

not independent.

3. What is the Scope of Audit

Scope of audit refers to the extent and coverage of Auditing. While the object is

the end of Auditing, scope refers to means/areas/domain of Auditing.

Audit scope determines the time involved in audit exercise, depth of auditing,

aspects to be covered etc.

Determinants of Scope

The following are the 4 sources through which scope can be determined

A. Statute

It means the relevant legislation I Act passed in the parliament. In case of Co’s,

Banking Co’s and insurance Co’s the scope of Auditor is determined Act eg.

Companies Act, 2013.

B. Terms of Engagement:

In the case of sole traders/Partnerships, the scope is determined by terms of

engagement arrived at mutually between the Auditor and client. Upon receipt

of appointment letter from the client, the Auditor issues a letter of engagement

to the client laying down his understanding of the scope of the work.


C. Pronouncements of ICAI

ICAI issues pronouncements on various matters such as Accounting and

Auditing through

1. AS - Accounting Standards.

2. AAS - Auditing Assurance Standards.

3. Guidance Notes.

4. Statements.

D. Nature of Audit

Whether it is internal audit, statutory audit, tax audit, investigation etc based

on it the scope of auditing would defer.

Can the scope of audit be MODIfied?

The scope determined by statue is minimum requirement and it cannot be

reduced even by passing special resolution or by engagement terms. On the

other hand it can be expanded based on mutual agreement.

4. State the Basic Principles governing an Audit (AAS 1)

1) Integrity

i) Honest and straight forward

ii)Auditor not to practice dishonest means for satisfying client’s

requirement

2) Objectivity:

i) Refers to purposefulness

ii) To conduct audit keeping in mind secondary and primary objectives

3) Independence:

i) Should not be capable of being influenced by anybody

ii) Relevant for judging opinion on view presented by Financial Statements


4) Confidentiality

i) Not to divulge information about the clients to third parties

ii) If required by law, he may disclose information with the consent of

client.

5) Skill and Competence

i) Be capable of applying the skill in practical situation.

ii) Update and upgrade knowledge in the relevant fields.

6) Audit planning

i) Audit be based on proper planning

ii) The plan of Audit must be developed before commencement of Audit

iii) It also includes programming

7) Audit evidence

i) Audit be conducted by considering evidences

ii) Evidence is available in the form of books and records, voucher.

iii) It is available form from internal and external sources.

8) Audit Documentation

i) Auditor to record his observation of findings in working paper

ii) To be maintained at Auditor’s Office

9) Using the work of others

i) Involvement of other experts in the Audit of financial statement

ii) Auditor to use the work of other intelligently

10) Evaluation of ICS(Internal Control System) and AS (Accounting Standards)

i) Client’s responsibility to introduce ICS which includes AS

ii) Auditor to evaluate the system before commencing Audit

iii) It is useful for Audit to determine the extent of checking and nature

of Audit procedure


11) Audit conclusion and reporting

i) Formation of Opinion (whether accounting policies consistently

applied, whether financial information complies with statutory

requirements, whether material matters adequately disclosed)

ii) Report in specific format

iii) Address to specific authority (Shareholders/board/Govt.as case be)

5. List Down The Advantages Of Independent Audit

1 Improves the reliability of financial statements.

2. Statutory requirements are fulfilled -filing returns, holding meetings,

declaring dividends

3. It helps in detecting internal control weaknesses.

4. Enables settlement of trade disputes.

5. In case of change in constitution it enables settlement of accounts.

6. Useful for determination of losses.

7. Enables assessment of net worth of the entity for the investors.

8. Satisfies requirements for borrowings from financial Institutions

9. Acts as a basis for settlement of statutory dues like taxes, duties, E.S.I, P.F. etc

10. Useful for financial planning in subsequent years.

6. List down various advantages and limitations of auditing

Advantages of Auditing

1. Unbiased professional opinion

2. Acts as a moral check on employees

3. Highlighting of weakness in the internal control system

4. Enables timely tax assessments and quick disposal of tax returns.

5. Financial assistance made easier.

6. Solutions to trade disputes and labour disputes

7. Enables sanctioning of license by Govt.


8. Enables early settlement of Insurance claims

9. Determination of purchase consideration at the time of Amalgamation,

Inherent Limitations of an audit:

Audit has the following limitations:

a. Audit is test natured

b. Audit evidence is more persuasive rather than conclusive

c. Limitations of Internal control system

d. Use of judgement

7. What is the difference between True & Correct and True & Fair View?

Difference between “True and Correct” and “True and Fair”

True and Correct means that audit can be relied upon to ensure arithmetical

accuracy of books and records and detection of frauds and errors and is in the

nature of investigation or certification

whereas

True and Fair means discovery of frauds and errors is not the main objective

of an audit and auditing includes examination of items whose values cannot be

determined with substantial accuracy and therefore auditing is mainly

concerned with the reliability of financial statements and true and fair financial

position and operating results of an enterprise.

8. What is Investigation and how is it different from Auditing?

Investigation is an exercise carried out with a specific objective. It means in-

depth analysis of books of accounts, transaction and event. Investigation

exercise is voluntary in nature and used extensively by auditors.


Reasons for carrying out Investigation :-

1. Proposed purchase/sale of business

2. Reasons for low profitability, high labour turnover

3. Borrowing/Lending funds

4. Suspected fraud, suspected misfeasance against directors/trustees

5. Detection of undisclosed income for tax purposes.

Difference between auditing and investigation - P3 - LODER

Legal binding

Object

Documents

Extent of work

Report

Period covered

Parties for whom conducted

Person performing work.

9. What are the various types of Audit?

The Companies Act, 2013 is focused on transparency and disclosure. In the

new Act, attempt has been made to cover each aspect of corporate functioning

under audit by prescribing various types of audits like internal audit and

secretarial audit.

The various types of audits prescribed under the Companies Act, 2013 are:

• Statutory Audit

• Internal Audit

• Secretarial Audit

• Cost Audit


CHAPTER 2 – STATUTORY AUDIT

Question 1 - Bring out various Provisions relating to Statutory Audit

w.r.t appointment, removal and rotation of statutory auditor

Statutory audit means any audit which is required compulsorily under any law.

Here statutory audit refers to mandatory audit to be done as per Companies

Act by a Statutory Auditor

Sec 139 to 147 under Chapter X of the Companies Act,2013 along with the

Companies(Audit and Auditors) Rules, 2014 contain provisions regarding audit

and auditors.

•Section 139 contains provision regarding Appointment of auditors.

•Removal, resignation of auditor,giving of special notice is provided in Sec 140.

•Sec 141 prescribes eligibility, qualifications and disqualifications of auditors.

•Section 142 deals with the provisions of Remuneration of auditors.

•Powers and duties of auditors and auditing standards is provided in Sec 143.

•Section 144 provides a list of certain services which auditor is not to render.

•Section 145 deals with signing of Audit Reports.

•Section 146 deals with Auditors to atteng General Meeting

•Section 147 deals with punishment for contravention


Appointment of Statutory Auditor (Sec 139(1))

1. Regular Auditor [Sec 139]

a. Every company shall, at the first AGM, appoint an individual/firm as an

auditor who shall hold office from the conclusion of that meeting till the

conclusion of its 6th AGM. Auditor, thereafter, would be appointed at every

6th meeting. (The meeting where he is appointed being counted as 1st

meeting)

b. The company shall seek a formal approval(ratification) by members(ordinary

resolution) at every AGM about the appointment of auditor.

c. Before the appointment is made, the written consent of the auditor and a

certificate from him/it that the appointment, if made, shall be in accordance

with the conditions as may be prescribed, shall be obtained from the auditor.

[The certificate shall also state whether the auditor satisfies the criteria

provided in Sec 141.]

d. Company shall inform the auditor concerned of his/its appointment, and also

file a notice of such appointment with ROC within 15 days(in Form ADT-1) of

the meeting in which the auditor is appointed.

e. The “appointment” includes reappointment.

2. First Auditor – Sec 139(6)

(a) The first auditor is one who is appointed for the first time after the

incorporation of the co.

(b) The first auditor(other than for Govt.Company) is appointed by BOD’s

within 30 days from the date registration of the co.

(c) If the BOD fails to appoint such auditor, it shall inform the members of

the company, who shall within 90 days at an EGM appoint such auditor who will

hold office till the conclusion of the first AGM.


(d) The co. cannot appoint the first auditor by mentioning his name in the

A.O.A of the co.

Mandatory Rotation of Auditors (Sec 139)

U/s 139(1), the system of rotation of auditors has been introducted for the

auditors of listed companies and other class of companies.

Other class of companies – means following classes of companies excluding

OPC and small companies as prescribed in Rule 5 of Companies (Audit and

Auditors) Rules.

a) all unlisted public companies having paid-up capital of Rs.10 crore or more

b) all private limited companies having paid-up capital of Rs.20 crore or more

c) all companies having paid-up share capital of below threshold limit given

above, but having public borrowings from financial institutions, banks, or public

deposits of Rs.50 crores or more

Provisions for rotation of auditors –

• If the auditor is an individual, he cannot be auditor of such a company for

more than 5 consecutive years.

• If an audit firm/LLP is auditor of the company, it cannot be auditor of such a

company for more than two terms of 5 consecutive years (i.e. 10 years)

• If an individual auditor who has completed his one term of 5 years, shall not

be eligible for reappointment as auditor in the same company for 5 years from

the completion of his term.

• In an audit firm/LLP which has completed its one term of 10 years, shall not

be eligible for reappointment as auditor in the same company for 5 years from

the completion of its term.


• It may be noted that any firm/LLP which has one or more partners who are

also partners in the outgoing audit firm/LLP cannot be appointed as auditors

during this 5 year period.

• There is a transition period of three years, from date of enactment of the

2013 Act, to comply with this requirement. All listed companies or specified

companies will have to comply with the above provisions relating to rotation of

auditors within 3 years from the date of commencement of this Act i.e. within

31st March 2017. (The term of the auditor before commencement of this Act

will be considered)

• However there will be no effect on the right of the company to remove an

auditor or the right of the auditor to resign from such office of the company

because of the provisions mentioned above.

• The members of a company may also provide for the rotation of auditing

partner and his team at specified intervals in the audit firm appointed by the

company.

• The members of a company may also provide that the audit shall be

conducted by more than one auditor.

Removal of Auditors

•New Section 140 provides for Removal, Resignation etc. of Auditors.

• (i) Under new section 140 an auditor can be removed from his office before

the expiry of his term only after obtaining the previous approval of the Central

Government and after passing a Special Resolution by the Members. For this

purpose the company will have to comply with the prescribed rules.


• (ii) If an auditor resigns from his office, he is required to file, within 30 days,

a statement in the prescribed form with the company and ROC. In the case of a

Government company, this form is also required to be filed with C& AG. In this

statement the auditor has to give reasons and other facts relevant for his

resignation.

For failure to comply with this requirement, the auditor is punishable with a

minimum fine of Rs. 50,000/- which may extend upto Rs. 5 lakh.

• (iii) If the auditor is found to have, directly or indirectly, acted in a fraudulent

manner or abetted or colluded in any fraud by the company or any of its

officers, the Tribunal can direct the company to change the auditors.

The auditor who is removed by the Tribunal cannot be appointed as an auditor

of that company for 5 years. Further, under the new section 447 the auditor

who is guilty of fraud will be punishable with imprisonment for a minimum term

of six months which may extend to 10 years and shall also be liable to pay a

minimum fine of an amount involved in the fraud which may extend to 3 times

the said amount. If the fraud involves public interest the minimum period of

imprisonment will be 3 years.

• Rules 7 and 8 provide for procedure for removal and resignation of an Auditor

Question 2 – State qualifications and disqualification of Statutory auditor

Qualifications of Auditors – Sec 141

• A Chartered Accountant holding a certificate of practice(COP) or a firm of

Chartered Accountants (only) can be appointed as auditor(s) of a company.

• A firm of Chartered Accountants or Limited Liability Partnership (LLP) can be

appointed as an auditor of a company only if majority partners practicing in

India are qualified for appointment as an auditor of a company.


• Where a firm including a limited liability partnership is appointed as an

auditor of a company, only the partners who are chartered accountants shall be

authorised to act and sign on behalf of the firm.

Disqualifications

According to the section 141 (3) of the Companies Act 2013, the following

persons shall not be eligible for appointment as an auditor of a company:–

(a) a body corporate (other than LLP);

(b) an officer or employee of the company;

(c) a person who is a partner/employee of an officer or employee of the

company;

(d) a person who, or his relative or partner—

• is holding (directly or indirectly) any security of or interest in the company or

its subsidiary. Provided that the relative may hold security or interest in the

company of face value not exceeding rupees one lakh;

• is indebted to the company, or its subsidiary (or its holding or associate

company or a subsidiary of such holding company) in excess of Rs.5 Lacs or

• has given a guarantee/security in connection with the indebtedness of any

third person to the company(or its subsidiary, or its holding or associate

company or a subsidiary of such holding company) in excess of one lakh rupees

(e) a person or a firm who, whether directly or indirectly, has business

relationship with the company, or its subsidiary, or its holding or associate

company or subsidiary of such holding company or associate company.

The term “business relationship” shall be construed as any transaction entered

into for a commercial purpose, except –


•commercial transactions which are in the nature of professional services

permitted to be rendered by an auditor or audit firm under the Act and the

Chartered Accountants Act, 1949 and the rules or the regulations made under

those Acts;

•commercial transactions which are in the ordinary course of business of the

company at arm’s length price - like sale of products or services to the auditor,

as customer, in the ordinary course of business, by companies engaged in the

business of telecommunications, airlines, hospitals, hotels and such other

similar businesses.

(f) a person whose relative is a director or is in the employment of the

company as a director or key managerial personnel;

(g) a person who is in full time employment elsewhere or a person or the

concerned partner of a firm is holding appointment as auditor of more than 20

companies;

(h) a person who has been convicted by a court of an offence involving fraud

and a period of ten years has not elapsed from the date of such conviction;

(i) any person whose subsidiary or associate company or any other form of

entity, is engaged as on the date of appointment in consulting and specialised

services as provided in section 144.

A person who is 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 according to section 141(4) of the

Companies Act 2013.


Remuneration of Auditors:

According to section 142 of the Companies Act 2013, the remuneration of the

auditor of a company shall be fixed in its general meeting or in the manner as

determined in the general meeting.

•The remuneration of the first auditor appointed by the board may be fixed by

the Board.

•The remuneration shall be in addition to the fee payable to an auditor,

including the expenses, if any, incurred by the auditor in connection with the

audit of the company and any facility extended to him but does not include any

remuneration paid to him for any other service rendered by him at the request

of the company.

Question 3 – State various rights, powers and duties of a Statutory Auditor

Rights and Powers of a company Auditor:

1. Right to receive information and explanation from the co/management:

1. It should be noted that the auditor shall seek only such information which

is required for conducting the audit.

2. In addition to above AAS-11 (representation by management) also

requires an auditor to obtain a letter of representation from management

duly signed by directors supporting the various matters included in the

financial statements

3. In case an auditor does not obtain information & explanation which is

material in nature he has right to draw the attention of shareholders in his

report.


Amongst other matters inquire into the following matters, namely:—

(a) 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;

(b)whether transactions of the company which are represented merely by book

entries are prejudicial to the interests of the company;

(c)where the company not being an investment company or a banking

company, whether so much of the assets of the company as consist of shares,

debentures and other securities have been sold at a price less than that at

which they were purchased by the company;

(d)whether loans and advances made by the company have been shown as

deposits;

(e)whether personal expenses have been charged to revenue account;

(f)where it is stated in the books and documents of the company that any

shares have been allotted forcash, whether cash has actually been received in

respect of such allotment, and if no cash has actually been so received,

whether the position as stated in the account books and the balance sheet is

correct, regular and not misleading:

2. Right of access to books of accounts

1. The following are the books which the auditor can have access to:

• Cash book, ledger , Journal, etc are books of a/c’s

• Statutory registers

• Memorandum records

• Statistical records


2. He also has to right to take extracts from the above records

3. While checking the records, he can place his signature/ identification

marks therein.

4. The right of access also includes the records maintained in branches in

other locations

5. This right can be exercised at reasonable time and not odd hours

3. Right to visit branches:

1. An auditor has right of visiting the branch offices of the co.

2. This right is available irrespective of the fact whether a branch auditor has

been appointed u/s 228

3. According to AAS-10, using the work of other auditor, the co. auditor can

also have the right of holding discussion with the branch auditor and

branch manager and he may perform additional audit procedures by

himself

4. This right is given to the auditor for enabling him to discharge his duties

to share holders

5. The management of the entity shall not restrict a statutory auditor from

visiting the branches

4. Right of Lien

1. The term lien refers to right of retaining physical possession of properties

belonging to the debtor

2. When the auditor des not receive remuneration, he has a right to retain

possession of books of accounts on which he has exercised due skill, care

and diligence


3. The following are the conditions for exercising right of lien;

(a) The lien shall cover only fees and not out of pocket exp’s

(b) The lien shall be exercised only on the books of a/c’s and vouchers on

which the auditor has exercised skill, care and diligence.

(c) The lien shall not be exercised on statements, registers and records

(d) The lien is a specific and particular lien and shall not be assigned in

favor of a third party

(e) The lien extinguishes when the client pays the amount due

(f) The books of a/c’s on which lien is exercised shall be relating to the year

for which the client owes money.

(g) The auditor should get hold of the books of a/c’s on the basis of

permission from the directors of the co.

5. Right to get notice of and attend AGM

6. Right to be heard at GM

7. Right to sign the audit report:

The auditor has a right to issue the audit report under his signature. He also

has to sign the B/S and P/L a/c not as an authority for an approval but as

attesting agency. While signing the audit report on behalf the firm he also

mention the fact that he is partner of the firm. There is no need to mention his

membership no and other qualifications. However u/s 44 AB of the IT Act while

issuing tax audit report, he should clearly mention his membership no. also

8.Right to receive remuneration

9.Right of indemnification i.e. the co. has an obligation to reimburse the loss

suffered by auditor while representing as company auditor.


10. Right to receive notice of removal and right to make representation on

removal

11. The auditor of a company which is a holding company shall also have the

right of access to the records of all its subsidiaries in so far as it relates to the

consolidation of its financial statements with that of its subsidiaries

Duties of auditors – sec 143(2)/(3)/(4)

1. Duty to make an audit report

2. Duty to make adequate disclosures in audit report

3. Duty to give reasons for qualifications/reservation/adverse remark

4. Duty to sign the audit report

The auditor shall make a report to the members of the company on the

accounts examined by him and on every financial statements which are to be

laid before the company in general meeting and the report shall after taking

into account the

- provisions of this Act,

- the accounting and auditing standards and

- matters which are required to be included in the audit report under the

provisions of this Act or any rules made thereunder and

- to the best of his information and knowledge, the said accounts, financial

statements give a true and fair view of the state of the company’s affairs

- whether the company has adequate internal financial controls system in place

and the operating effectiveness of such controls;


- whether the company has disclosed the impact, if any, of pending litigations

on its financial position in its financial statement;

- whether the company has made provision, as required under any law or

accounting standards, for material foreseeable losses, if any, on long term

contracts including derivative contracts;

- whether there has been any delay in transferring amounts, required to be

transferred, to the Investor Education and Protection Fund by the company.

-Auditors to attend general meeting:

Section 146 of the Companies Act 2013, provides that all notices of, and other

communications relating to, any general meeting shall be forwarded to the

auditor of the company, and

the auditor shall, unless otherwise exempted by the company, attend either by

himself or through his authorized representative, who shall also be qualified to

be an auditor, any general meeting and shall have right to be heard at such

meeting on any part of the business which concerns him as the auditor.

Question 4: Companies Act, 2013 makes an Auditor more responsible.

Discuss.

Fraud reporting by auditors – Sec 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/employees of the company,

he shall immediately report the matter to the Central Government immediately


but not later than 60 days of his knowledge and after following the procedure

indicated herein below:

•auditor shall forward his report to the Board or the Audit Committee, as the

case may be, immediately after he comes to knowledge of the fraud, seeking

their reply or observations within 45 days;

• on receipt of such reply or observations the auditor shall forward his report

and the reply/observations of the Board or the Audit Committee along with his

comments (on such reply/observations of the Board or the Audit Committee) to

the Central Government within 15 days of receipt of such reply/ observations;

• in case the auditor fails to get any reply or observations from the Board or

the Audit Committee within the stipulated period of 45 days, he shall forward

his report to the Central Government along with a note.

• The report shall be sent to the Secretary, Ministry of Corporate Affairs in a

sealed cover by Registered Post with Acknowledgement Due or by Speed post

followed by an e-mail in confirmation of the same.

• The report shall be on the letter-head of the auditor containing postal

address, e-mail address and contact number and be signed by the auditor with

his seal and shall indicate his Membership Number.

• The report shall be in the form of a statement as specified in Form ADT-4.

The provisions of this section shall mutatis mutandis apply to –

(a)the cost accountant in practice conducting cost audit under section 148; or

(b)the company secretary in practice conducting secretarial audit u/s 204.


If any auditor, cost accountant or company secretary in practice does not

comply with the provisions of sub-section (12), he shall be punishable with fine

which shall not be less than Rs.1 lakh but which may extend to Rs.25 lakh.

“Fraud” in relation to affairs of a company or anybody corporate, includes any

act, omission, concealment of any fact or abuse of position committed by any

person or any other person with the connivance in any manner, with intent to

deceive, to gain undue advantage from, or to injure the interests of, the

company or its shareholders or its creditors or any other person, whether or

not there is any wrongful gain or wrongful loss.

Prohibition on the services to be rendered by the auditors:

Section 144 provides that Statutory audit shall not provide any of the following

services directly or indirectly to the company or its holding company or

subsidiary company, namely:–

(a) accounting and book keeping services;

(b) internal audit;

(c) design and implementation of any financial information system;

(d) actuarial services;

(e) investment advisory services;

(f) investment banking services;

(g) rendering of outsourced financial services;

(h) management services; and

(i) any other kind of services as may be prescribed:


This is a new provision and there was no restriction of this type in the

Companies Act 1956. Therefore, an auditor or audit firm who or which has been

performing any non-audit services on or before the commencement of this Act

shall comply with the provisions of this section before the closure of the first

financial year after the date of commencement of the Act i.e within 31st March

2015.

It is also provided in this section that the prohibited non-audit services cannot

be rendered by the following associates of the auditor.

(i) If the auditor is an Individual:-

The Individual himself, his relative any person connected or associated with

him, or any entity in which the Individual has significant influence or control or

whose name or trade mark/brand is used by the Individual.

(ii) If the auditor is a firm or LLP:-

Such firm/LLP either itself or through its partner or through its parent,

subsidiary or associate or through any entity in which the firm/LLP or its

partner has significant influence or control or whose name, trade mark or brand

is used by the firm/LLP or any of its partners.

Signing of Audit Reports:

Sec 145 of the Companies Act 2013, provides that the statutory auditor shall

sign the auditor’s report or sign/certify any other document of the company.

It also provides that the qualifications, observations or comments on financial

transactions or matters, which have any adverse effect on the functioning of

the company mentioned in the auditor’s report shall be read before the

company in general meeting and shall be open to inspection by any member of

the company.


Penal Provisions:

Section 147 provides for punishment for contravention of the provisions of

sections 139 to 146. These penalty provisions are as under.

• If a company contravenes any of the provisions of sections 139 to 146 it

shall be liable to pay minimum fine of Rs. 25,000/- which may extend to

Rs. 5 lakh. Further, every officer who is in default shall be punishable with

imprisonment upto one year or minimum fine of Rs. 10,000/- which may

extend to Rs. 1 lakh or with both.

• If an auditor of a company contravenes any of the provisions of sections

139, 143, 144 or 145, the auditor shall be punishable with minimum fine of

Rs.25,000/- which may extend to Rs. 5 lakh.

• If it is found that the auditor has contravened the provisions of sections 139,

143, 144 or 145, knowingly or willfully with the intention to deceive the

company, its share holders, creditors or tax authorities, he shall be punishable

with imprisonment for a term upto 1 year and with a minimum fine of

Rs.1 lakh which may extend upto Rs. 25 lakh.

• If any auditor contravened any of the provisions of sections 139, 143,144 or

145, he shall also be liable to-

(a) refund the remuneration received by him to the company and

(b) pay for damages to the company, statutory bodies/authorities or to any

other persons for loss arising out of incorrect or misleading statements of

particulars made in his audit report.


Other Penalties on Auditor under Companies Act 2013:

(a) Class action suit against the Auditors u/s 245:

To protect investor interest, Section 245 of Companies Act 2013 has introduced

the concept of class action suits, through which shareholders, depositors can

initiate legal action against the company and auditors in the event of fraudulent

activity. A class of shareholders or deposit holders can now claim damages or

compensation or demand other suitable action against the auditor, including

the audit firm, by filing an application with the NCLT.

(b) Prosecution by NFRA (National Financial Reporting Authority) U/s

132: NFRA may investigate either suo moto or on a reference made to it by the

Central Government on matters of professional or other misconduct committed

by any member or firm of chartered accountants. If professional or other

misconduct is proved, NFRA has the power to make order for-

•imposing penalty of (I) not less than one lakh rupees, but which may extend

to five times of the fees received, in case of individuals; and (II) not less than

ten lakh rupees, but which may extend to ten times of the fee received, in

case of firms;

•debarring the member or the firm from engaging himself or itself from practice

as member of the Institute of Chartered Accountant of India referred to in

clause (e) of sub-section (1) of section 2 of the Chartered Accountants Act,

1949 for a minimum period of six months or for such higher period not

exceeding ten years as may be decided by the National Financial Reporting

Authority.


(c) Punishment for fraud U/s 447:

Any person who is found to be guilty of fraud, shall be punishable with

imprisonment for a term which shall not be less than six months but which may

extend to ten years and shall also be liable to fine which shall not be less than

the amount involved in the fraud, but which may extend to three times the

amount involved in the fraud. Provided that where the fraud in question

involves public interest, the term of imprisonment shall not be less than three

years.

(d) Punishment for false statement U/s 448:

If any return, report, certificate, financial statement, prospectus,

statement or other document required by, or for, the purposes of any of the

provisions of this Act or the rules made thereunder, any person makes a

statement-

• which is false in any material particulars, knowing it to be false; or

• which omits any material fact, knowing it to be material, he shall be liable

under section 447.

Question 5: Write a short note on Brach Audit – Sec 143(8)

Every branch office shall maintain proper books of a/c’s for accounting the

transactions which have taken place in the branch.

The branch office may be subjected to audit either by statutory auditor himself

or by an independent auditor.


While appointing co. auditor, if no separate resolution is passed appointing

some other person as branch auditor, then the co auditor is deemed to be

branch auditor also. In such case, the co. auditor can visit the branch and

check the transactions entered in the branch books and finally consolidate the

branch trial balance with H.O he will not prepare a separate report on audit of

branches.

On other hand, if a separate auditor is appointed as branch auditor he will act

independently and conduct the audit of the branches and forward his report to

H.O auditor

Qualification – same as statutory auditor

Appoinment:

The branch auditor shall be appointed by the shareholders of the co. in the

AGM and the nature of resolution to be passed shall be the same which is

applicable for co. auditor, sometimes the shareholders may pass a resolution

delegating the power to BOD to appoint the branch auditor in consultation with

the statutory auditor.

Rights and duties:

The branch auditor enjoys similar rights and those similar duties as that of a

company auditor except that

• He cannot visit other branches

• He cannot attend AGM

• He has submit his report to statutory auditor


Scope

The scope of the branch auditor is restricted to the operations of the branch. He

shall covers same matters which are covered by the co. auditor in his report.

The provisions of Section 143(12) read with rule 12 hereunder regarding

reporting of fraud by the auditor shall also extend to such branch auditor to the

extent it relates to the concerned branch.

Qualifications In Branch Auditors Report

The branch auditor may qualify his report and include same in his report

to the statutory auditor. The latter may drop the qualifications based upon:

(a) Concept of materiality

(b) Availability of adequate information & explanation at the H.O

Question 6 – Can branch audit be exempted?

Exemption of branch auditor

Under the branch auditor exemption rules 1961, a branch may be exempted

from audit under the following conditions:

(a) Automatic exemption

(b) Exemption based on application to the Central Govt

(a) Automatic Exemption

According to the above rules, if the average quantum of activity of the

branch does not exceed 2% of the turnover of the co. or Rs.200000 whichever

is higher, the exemption is automatically granted. For this purpose, average

quantum of activity refers to the highest of following 3 items:


(a) Aggregate value of the goods sold by branch

(b) Aggregate value of goods traded

(c) Aggregate expenses incurred for both capital revenue purposes

(b) Application to central Govt.

(i) Where proper arrangements have been made for scrutiny of branch

accounts person competent to be the branch auditors

(ii) Where satisfactory arrangements are being made for review of branch

a/c’s by a person qualified to be the branch auditor even though he is the

employee of the co.

(iii) Where no branch auditor is available, at reasonable cost considering the

quantum of activity of the branch

(iv) Where it is considered & deemed fit by central Govt

Question 7 – Write a short note on Joint Audit

1. Joint audit refers to audit of accounts of one single company by more than

one auditor or firm of auditors.

2. Generally applicable in PSU’s and banks

3. Object is to get additional profession opinion

4. The joint auditors are responsible for giving a joint audit report after

carrying out audit.

5. There is a need for division work among the joint auditors which may be

carried out in following manner.

a. Period wise

b. Activity wise

c. Component of financial statements wise.

d. Location wise


6. The purpose of division of work is to fix the responsibility on each of the

joint auditors.

7. One the work is divided, it should be communicated to the management

with the idea of ensuring the management to provide necessary

assistance to audit.

8. Management has no say with regard to manner of division of work

Obligations of Co-Auditors

1. To maintain proper working paper file

2. To draft audit programme covering his area

3. To exercise due skill, care and diligence in performance of audit

4. No to give direction or review the work of other co-auditor

5. To convey the information received during the course of audit which may

be found useful to other co-auditor.

6. To hold discussion with the other auditor regarding matters of common

interest on

a. Compliance with AAS

b. Accounting policies

c. Adjustments arising at the year end

7. To audit the accounts of branches which fall within his jurisdiction

Joint and several liabilities

1. Where there is a division of work, the liability of joint auditors is individual

in nature

2. In the following cases, the liability of joint auditor is joint and several

a. Where there is no division or work


b. When one co-auditor has conveyed the information to other co-

auditor in which there is concurrence.

c. Disclosure requirements

d. Compliance with statutory requirements

Difference of opinion between auditors

1. Not always necessary for total concurrence between the auditors

2. If there is non concurrence on certain matters, each auditor may issue

separate audit report expressing their individual views.

3. Majority opinion does not bind individual co-auditor.

Advantages of joint Audit

1. Timely completion of audit

2. Extensive coverage in a systematic manner

3. Pooling of expertise.

4. Mutual consultations and thereby increasing the quality

Limitations

1. Ego problem

2. Sharing of fees

3. Difficulty in fixing responsibility in common areas.

CA Rahul Ranka Vivekananda Institute of Learning (ViL) Page 33

CHAPTER 3 - INTERNAL AUDIT(SECTION 138)

Question 1: Bring out the meaning and importance of Internal Audit

Meaning: Refers to independent appraisal of management activities within the

organization as a service to management and it acts as control over other

controls.

Definition

"Internal auditing is an independent, objective assurance and consulting

activity designed to add value and improve an organization’s operations. It

helps an organization accomplish its objectives by bringing a systematic,

disciplined approach to evaluate and improve the effectiveness of risk

management, control and governance processes."

It is a risk management tool in regard to –

a. Effectiveness and efficiency of operations

b. Reliability and integrity of financial and operational information

c. Safeguarding the assets

d. Compliance with laws, regulations and contracts.

Features:-

• It is an appraisal function on behalf of management

• It’s a risk management tool

• It is a part of control system of the organisation

• Continuous audit activity

• May be done by an individual who is an employee or by a firm of

accountants

• Report to management or audit committee.

• The management decides about scope of the work of internal auditor.


Qualifications for the internal auditor: -

The internal auditor shall either be a chartered accountant whether engaged in

practice or not or a cost accountant, or such other professional as may be

decided by the Board to conduct internal audit of the functions and activities of

the company.

The report of internal audit shall be submitted to the Board of the company.

Internal audit is very useful to management for

a. Review of Internal control system

b. Review of procedures adopted for safeguarding assets

c. Review of organizational structures

d. Review of management information system

e. Review of implementation of policies, plans and strategies

f. Review of accomplishment of result by line managers.

It is useful to statutory audit in the following areas.

1. Evaluation IC system

2. Carrying out physical stock taking procedure

3. Obtaining evidences for contingent liability

4. While sending out request for confirmation of balance debtors and

creditors

5. Ensuring correctness of FINANCIAL STATEMENTS through a system of

pre-audit.


Companies required to appoint internal auditor:

The following class of companies shall be required to appoint an internal auditor

or a firm of internal auditors, namely:-

(a) every listed company;

(b) every unlisted public company having-

•paid up share capital of Rs.50 crores or more during the preceding financial

year(PFY); or

•turnover of Rs.200 crores or more during the PFY; or

•outstanding loans or borrowings from banks or public financial institutions

exceeding Rs.100crores or more at any point of time during the PFY; or

•outstanding deposits of Rs.25 crores or more at any point of time during the

PFY; and

(c)every private company having-

•turnover of Rs.200 crores or more during the PFY; or

•outstanding loans or borrowings from banks or public financial institutions

exceeding Rs.100 crores or more at any point of time during the PFY

Other Provisions:

•All the companies covered under any of the above criteria will have to comply

with the requirements of Section 138 and this rule within six months of

commencement of such section.

•The internal auditor may or may not be an employee of the company.

•The Audit Committee of the company or the Board shall, in consultation with

the Internal Auditor, formulate the scope, functioning, periodicity and

methodology for conducting the internal audit.


Question 2 – Discuss the nature of Internal Audit

1. A Management tool:

Internal Audit is management tool performed by the employees of the

organization or the engaged professional firm to check the appropriateness of

internal checks and control in the organisation. The reporting authority is

generally board of directors and audit committee.

2. A continuous Exercise:

Internal Audit is a continuous and systematic process of examining and

reporting the operations and records of a concern by its employees or external

agencies specially assigned for this purpose. It is, in essence, auditing for the

management and its scope may vary depending upon the nature and size of

the concern.

3. A Control System:

It is a control system concerned with examination and appraisal of other control

mechanisms.

4. A Risk Management Tool:

The internal audit work encompasses fostering the creation of a risk

management process and ensuring it addresses key objectives, and the

subsequent evaluation of the process. The internal audit work also

encompasses an identical role in the creation and subsequent evaluation of, the

business continuity planning process, and the information security and privacy

system.


Question 3 – What is the scope of Internal Audit

Scope Of Internal Audit

The Institute of Internal Auditors defines scope of internal auditing as ‘The

examination and evaluation of the adequacy and effectiveness of organization’s

system of internal control and the quality of actual performance’

Thus Internal auditing is concerned with an evaluation of both internal control

as well as the quality of actual performance.

According to The Institute of Internal Auditors, internal audit involves five areas

of operations, which can be discussed as follows:

1. Reliability and Integrity of Financial and Operating Information:

Internal Auditors should review the reliability and integrity of financial and

operating information and the means used to identify, measure, classify and

report such information.

2. Economical and Efficient Use of Resources:

Internal Auditor should ensure the economic & efficient use of resources.

3. Compliance with Laws, Policies, Plans, Procedures, and Regulations:

Internal Auditor should review the systems established to ensure compliance

with policies, plans and procedures, law and regulations which could have a

significant impact on operations and should determine whether the organization

is in compliance thereof.

4. Accomplishment of Established Goals for Operations:

Internal Auditor should review operations, programmes to find whether results

are consistent with established objectives and goals and whether the operations

or programmes are being carried out as planned.


5. Safeguarding of Assets:

Internal Auditor should verify the existence of assets and should review means

of safeguarding assets.

Question 4 – Distinguish between Internal Audit and Statutory Audit

Relationship between internal auditor and statutory auditor.

Statutory Auditor and Internal Auditor both are independent entity. A statutory

Auditor of a company cannot be the internal auditor of the same company. In

certain cases, statutory auditor refers the report of internal auditor and he

expresses his opinion based on the report of internal auditor. Similarly in

certain cases, internal auditor also refers the report of statutory auditors. The

relationship between statutory auditor and internal auditor may be summed up

as given below:

1. Comment on the Internal Audit System in place:

The statutory auditor has to comment upon the effectiveness and suitability of

internal audit system laid down by the management. To discharge this

responsibility statutory auditor should evaluate the internal audit system. He

should evaluate the strength of the internal audit staff, their qualification and

experience.

2. Evaluation of the actual work of internal auditor:

After studying the internal audit system and structure actual work of the

internal auditor should also be evaluated. Statutory auditor has to make use of

the work of internal auditor. This he can do only when he himself puts faith in

the work of internal auditor.


3. Relying on the work of internal auditor:

Statutory auditor has to decide that up to what extant he can rely upon the

work of the internal auditor. This will decide the extent of checking by statutory

auditor. If he feels that internal auditor has properly done his work he can

reduce the extent of his checking.

4. No reduction in responsibility:

Relying on work of internal auditor in no way reduces the responsible for the

discharge of his duties as statutory auditor. Relying on the internal auditor can

only reduce the burden of the statutory auditor. For all his works statutory

auditor would remain responsible.

Difference between Internal Audit and Statutory Audit

There are some differences between statutory audit and internal audit. The

details are as given below:

1. Appointment:

Internal Auditor is appointed by the management of the organization while the

statutory auditor is appointed by owners i.e. shareholder for a company. First

statutory auditors of a company are appointed by the board of directors.

2. Term of Office:

Internal auditor appointment is continuous until he is removed or resigns.

However, Statutory auditor(in some cases) is appointed for 5/10 years with

cooling off period of 5 years(rotation provisions).


3. Qualification:

Qualifications of the statutory auditor are prescribed in the Companies Act,

2013. In case of a company, a Practicing CA or a firm of Practicing CA can only

be appointed as a statutory auditor. There are no fixed qualifications for the

position of an internal auditor.

4. Objects:

The main object of the statutory audit is to form an opinion on the financial

statement of the organization. Auditor has to state that whether the financial

statements are showing the true and fair view of the affairs of the organization

or not. The main object of the internal audit is to detect and prevent the errors

and frauds.

Proprietary oriented approach towards auditing by internal auditor.

Compliance oriented approach towards auditing by statutory auditor.

5. Scope:

The scope of the statutory audit is fixed by the Companies Act. It cannot be

changed by mutual consent between the auditor and the management of the

audited business unit. The scope of the internal audit is fixed by the mutual

consent of the auditor and the management of the unit under audit.

6. Report:

The statutory auditor submits his report to the shareholder of the company in

its general meeting. The internal auditor submits his report to the management

of the company who is also his appointing authority.


7. Removal:

The procedure of removal of the statutory auditor is very complex. Only the

company in the general meeting can remove the auditor. It also has to take the

permission of the central government. The management of the entity can easily

remove internal auditor. No permission of Central Government is required.

8. Audit Ceiling

Internal audit is not considered for upper ceiling under Companies Act, whereas

statutory audit is considered for ceiling limit.

Question 5: State techniques of conducting internal audit (Refer ICSI

Text for detail explanation of each point)

i. Review of operating environment

ii. Review of Controls

iii. Testing controls

iv. Account Details

Question 6 – Why internal audit is required/advantages of internal

audit?

Management is responsible for establishing and maintaining a system of

internal controls within an organization.

Internal controls are those structures, activities, processes, and systems which

help management effectively mitigate/reduce the risks to an organization’s

achievement of objectives. Management is charged with this responsibility on


behalf of the organization’s stakeholders and is held accountable for this

responsibility.

A dedicated, independent and effective internal audit activity assists

management in fulfilling their responsibilities by bringing a systematic

disciplined approach to assessing the effectiveness of the design and execution

of the system of internal controls and risk management processes.

The objective assessment of internal controls and risk management processes

by the internal audit activity provides management and external stakeholders

with independent assurance that the organization’s risks have been

appropriately mitigated. Because internal auditors are experts in understanding

organizational risks and internal controls available to mitigate these risks, they

assist management in understanding these topics and provide

recommendations for improvements.

Beside above, Internal Audit has become an important management

tool for the following reasons

1. Internal Auditing is a specialized service to look into the standards of

efficiency of business operation.

2. Internal Auditing can evaluate various problems independently in terms of

overall management control and suggest improvement.

3. Internal Audit’s independent appraisal and review can ensure the reliability

and promptness of MIS and the management reporting on the basis of which

the top management can take firm decisions.

4. Internal Audit system makes sure the internal control system including

accounting control system in an organization is effective.


5. Internal Audit ensures the adequacy, reliability and accuracy of financial and

operational data by conducting appraisal & review from an independent angle.

6. Internal Audit is an integral part of “Management by System”.

7. Internal Audit can break through the power ego and personality factors and

possible conflicts of interest within the organization.

8. It ensures compliance of accounting procedures and accounting policies.

9. Internal Auditor can be of valuable assistance to management in acquiring

new business, in promoting new products and in launching new projects for

expansion or diversification of business

Question 7: Internal audit is not free from limitations. Discuss

Limitation of internal audit

Despite numerous benefits, internal audit has got some limitations -

• Extra expenditure therefore might not be affordable for small companies

• Lack of independence & objectivity and ability to report fraud/error to senior

management because of fear of losing employment.

• Since no legal qualification is prescribed the audit may not be conducted that

effectively and efficiently. Internal auditors are not required to be

professionally qualified and so there may be limitations in their knowledge

and technical expertise.

• There might be time lag between recording of transactions and audit

• The tool by itself depends upon how it is used by the manager. There are

occasions when managers cannot accept the finding of internal audit and

take consequent actions.


Question 8 – State Functions and Responsibilities of Internal Auditor

Functions and responsibilities of internal auditors

“Internal auditing is an independent, objective assurance and consulting

activity designed to add value and improve an organisation’s operations. It

helps an organisation in accomplishing its objectives by bringing a systematic,

disciplined approach to evaluate and improve the effectiveness of risk

management, control,and governance processes.”

Major roles and responsibilities of internal auditor are summarized below

1. To work with board and management to ensure that a system is in place

which ensures that all major risks are identified and analyzed. Evaluate and

provide reasonable assurance that risk management, control, and governance

systems are functioning as intended and will enable the organisation’s

objectives and goals to be met.

2. To plan, organize and carry out the internal audit function including the

preparation of an audit plan which fulfils the responsibility of the department,

scheduling and assigning work and estimating resource needs.

3. Report risk management issues and internal controls deficiencies identified

directly to the audit committee and provide recommendations for improving the

organisation’s operations, in terms of both efficient and effective performance.


4. Evaluation of information security and associated risk exposures. Evaluation

of the organisation’s readiness in case of business interruption.

5. Evaluation of regulatory compliance program with consultation from legal

counsel.

6. Maintain open communication with management and the audit committee.

Team with other internal and external resources as appropriate. Engage in

continuous education and staff development. To report to both the audit

committee and management on the policies, programmed and activities of the

department.

7. Provide support to the company’s anti-fraud programs.

8. To coordinate coverage with the external auditors and ensure that each

party is not only aware of the other’s work but also well briefed on areas of

concern.

9. To make recommendations on the systems and procedures being reviewed,

report on the findings and recommendations and monitor management’s

response and implementation.

10. To review and report on the accuracy, timeliness and relevance of the

financial and other information that is provided for management.


Question 9 –Can statutory auditor rely on the work of Internal Auditor?

Reliance on work on internal Audit (AAS 7)

1. Not mandatory for statutory auditor to compulsorily rely on work of internal

audit.

2. Even if he relies on the work of internal audit, he is still not protected from

liability

3. CARO 2003 requires statutory auditor to mention in his report whether

internal audit system is commensurate with size and nature of business. In

case of company having share capital + reserves at Rs.50 Lacs or the average

annual turnover has crossed Rs. 5 Crores for last 3 financial years.

Question 10 – Discuss the role of internal auditor in an organisation.

Role Of Internal Audit In Different Areas:

1. Role of Internal Audit in Internal Control

The Internal auditor should examine and contribute to the ongoing

effectiveness of the internal control system through evaluation and

recommendations. However, the internal auditor is not vested with

management’s primary responsibility for designing, implementing, maintaining

and documenting internal control. Internal audit functions add value to an

organization’s internal control system by bringing a systematic, disciplined

approach to the evaluation of risk and by making recommendations to

strengthen the effectiveness of risk management efforts.

The internal auditor should focus towards improving the internal control

structure and promoting better corporate governance.


The role of the internal auditor encompasses:

–Evaluation of the efficiency and effectiveness of controls

–Recommending new controls where needed or discontinuing unnecessary

controls

–Using control frameworks

–Developing Control self-assessment

2. Role of Internal Audit in risk management

Internal auditor needs to monitor and evaluate the effectiveness of the

organization’s Risk management processes. Risk management relates to how

an organization sets objectives, then identifies, analyzes, and responds to

those risks that could potentially impact its ability to realize its objectives.

Under the COSO Enterprise Risk Management (ERM) Framework, risks fall

under strategic, operational, financial reporting, and legal/regulatory

categories. Management performs risk assessment activities as part of the

ordinary course of business in each of these categories.

Internal auditors may evaluate each of these activities, or focus on the

processes used by management to report and monitor the risks identified. For

example, internal auditors can advise management regarding the reporting of

forward-looking operating measures to the Board, to help identify emerging

risks.


3. Role of Internal Audit in corporate governance

Internal auditing activity as it relates to corporate governance is generally

informal, accomplished primarily through participation in meetings and

discussions with members of the Board of Directors. Corporate governance is a

combination of processes and organizational structures implemented by the

Board of Directors to inform, direct, manage, and monitor the organization’s

resources, strategies and policies towards the achievement of the organizations

objectives. The internal auditor is often considered one of the “four pillars” of

corporate governance, the other pillars being the Board of Directors,

management, and the external auditor.

A primary focus area of internal auditing as it relates to corporate governance

is helping the Audit Committee of the Board of Directors (or equivalent)

perform its responsibilities effectively. This may include reporting critical

internal control problems, informing the Committee privately on the capabilities

of key managers, suggesting questions or topics for the Audit Committee’s

meeting agendas, and coordinating carefully with the external auditor and

management to ensure the Committee receives effective information.


CHAPTER 4 – VARIOUS OTHER TYPES OF AUDIT

Question 1: Write a brief note on Secretarial Audit

The Companies Act 2013 has introduced a new requirement of Secretarial Audit

for bigger companies, which has been prescribed under Section 204 of the Act.

The provisions regarding secretarial audit of the company according to section

204 of the Companies Act, 2013 and the Companies (Appointment and

Remuneration of Managerial Personnel) Rules, 2014 are discussed below-

Companies required conducting secretarial audit:

(1) Every listed company and

(2) Company belonging to other class of companies:

The other class of companies are

•every public company having a paid-up share capital of Rs.50 crore or more;

or

•every public company having a turnover of Rs.250 crore rupees or more.

Qualifications for the secretarial auditor:

Secretarial Audit has to be conducted by a Practising Company Secretary(PCS)

in respect of the secretarial and other records of the company.


Report of the secretarial audit:

A secretarial audit report shall be annexed with the Board’s report of the

company. The Board of Directors, in their report made in terms of section

134(3), shall explain in full any qualification or observation or other remarks

made by the company secretary in practice in his report. The format of the

Secretarial Audit Report shall be in Form No.MR.3.

Other Provisions:

• It shall be the duty of the company to give all assistance and facilities to the

PCS, for auditing the secretarial and related records of the company.

• If a company or any officer of the company or the PCS, contravenes the

provisions of this section, the company, every officer of the company or the

PCS, who is in default, shall be punishable with fine which shall not be less than

Rs.1 lakh but which may extend to Rs.5 lacs. As per Section 143(14), all

provisions regarding rights, duties and obligations of statutory auditors shall

also apply to Company Secretary in Practice conducting secretarial audit.

Question 2 – Write a short note on Cost Audit

Section 148 of the Companies Act provides that the Central Government may,

by order, in respect of such class of companies engaged in the production of

such goods or providing such services as may be prescribed, direct that

specified cost particulars shall also be included in the books of account kept by

that class of companies.

Certain class of companies are compulsorily required to get their cost books

audited by a Cost accountant in practise.


The Cost Accountant in practice who shall be appointed by the Board on such

remuneration as may be determined by the members in such manner as may

be prescribed: Provided that statutory auditor of the company cannot be a cost

auditor.

Provided further that the auditor conducting the cost audit shall comply with

the cost auditing standards(issued by ICWAI)

• An audit conducted under this section shall be in addition to the audit

conducted under section 143(Secretarial audit).

• The qualifications, disqualifications, rights, duties and obligations applicable

to auditors under this Chapter shall, so far as may be applicable, apply to a

cost auditor also.

• The report on the audit of cost records shall be submitted by the cost

accountant in practice to the Board of Directors of the company.

• A company shall within 30 days from the date of receipt of cost audit report

furnish to the Central Government such report along with full information and

explanation on every reservation or qualification contained therein.

• If, after considering the cost audit report the Central Government is of the

opinion that any further information or explanation is necessary, it may call for

such further information and explanation and the company shall furnish the

same within such time as may be specified by that Government.

• If any default is made in complying with the provisions of this section,—

(a) the company and every officer of the company who is in default shall be

punishable in the manner as provided in sub-section (1) of section 147;

(b) the cost auditor of the company who is in default shall be punishable in the

manner as provided in sub-sections (2) to (4) of section 147.


Question 3: Write a note on Special Audit (Sec 233A of Companies Act, 1956)

1. Meaning

Special audit is ordered by C.Govt in some cases and therefore it is not

mandatory for all the companies.

Special audit may be ordered by CG without providing an opportunity of being

heard to the company.

2. Circumstances for appointment

As per sec 233A (1) under the following circumstances, special audit may be

ordered by Central Government –

Where the Central Government is of opinion that –

(a) the affairs of the company are not being managed in accordance with sound

business principles or prudent commercial practices; or

(b) the company is being managed in such a manner that it would cause

serious injury or damage to the interests of the trade, industry or business to

which it pertains; or

(c) the financial position of the company is such as to endanger its solvency

3. Who can be a special auditor?

Special auditor is appointed by CG. The person appointed can be the company’s

auditor or any other CA (whether in practice or not)


4. Scope

The scope of special auditor is determined by sec 227 of co’s Act,(which is the

same the regular auditor), however, Central Govt may direct the special auditor

to extend his scope to other areas.

5. Rights and duties

He enjoys similar rights as co. auditor except he cannot attend AGM, he also

owes similar duties as co. auditor except that his report shall be addressed to

Central Govt and not to shareholders

6. Reporting

The special auditor addresses his report to the central govt. The copy of the

report need not addressed to company.

7. Remuneration – Fixed by CG and paid by Company

8. Central Govt’s Obligation

On the basis on special audit report, Central Govt shall take appropriate action

as considered deemed fit .It can also ask the special auditor to clarify any

matters of qualification included by the auditor. In any case Central Govt shall

forward to the co: within 120 days a copy/extract of the report and may direct

the co. to forward a copy thereof to all the shareholders or get the contents of

the report read in the AGM.


Question 4 – Write a short note on Propriety Audit

Propriety Audit

Kohler has defined propriety as that which meets the test of public interest,

commonly accepted customs and standard of conduct and particularly as

applied to professional performance, requirements of Government regulations

and professional codes. Propriety Audit carry out to check, mean whether the

transactions have been done in conformity with established rules, principles

and established standard.

The Propriety Audit means the verification of following main aspects to find out

whether:

(i) Proper recording has been done in appropriate books of accounts.

(ii) The assets have not been misused and have been properly safeguarded.

(iii) The business funds have been utilized properly.

(iv) The concern is yielding the expected results.

The system of Propriety Audit is applied in respect to Government companies,

Government Department because public money and public interest are involved

therein. It is an essential function of audit to bring to light not only cases of

clear irregularity but also every matter which in its judgement appears to

involve improper expenditure or waste of public money or stores, even though

the accounts themselves may be insufficient to see that sundry rules or orders

of competent authority have been observed. It is of equal importance to ensure

that the broad principles of orthodox finance are borne in mind not only by

disbursing officers but also by sanctioning authorities.


The CAG should bring out cases of improper avoidable expenditure even though

they are as per the rules.

To protect the interest of public, mere regular audit of expenditure is

inadequate.

It should be subject to principle of propriety i.e. whether it is wasteful in

nature.

Audit should look into the wisdom, faithfulness & economy of govt.

transactions.

The following broad principles are normally followed:

a. Expenditure should not be prima facie more than the occasion demands.

b. The Government officials not to sanction expenditure that will directly or

indirectly accrue advantage to them.

c. Public money should not be wrongly utilized for a particular person or section

of community.

Question 5 – Write a short note on Performance Audit

Performance Audit

It covers efficiency, economy and effectiveness audit.

Efficiency audit looks into whether the Government projects are executed &

their operations are conducted as per the expected results. Efficiency indicates

how best an organization uses its given resources . Efficiency audit focuses on

input, output and productivity. It refers to comparing and analyzing actual

output with the desired/expected output.

It brings out deficiencies/negatives in the system and how it can be improved.


Economy audit looks into whether the Government has acquired the financial,

human and physical resources in an economical manner and also whether

sanctioning authorities have observed economy.

Effectiveness audit refers to appraisal of the performance of the projects with

reference to a predetermined target.

The procedure for performance audit includes the following:

a. Identification of the projects.

b. Preliminary studies

c. Planning & execution of audit

d. Reporting

The auditor determines the circumstances by exercising his professional

judgement to come to a conclusion whether he has to perform both types of

audit.

Question 6 - Write a brief note on CAG AUDIT/GOVT AUDIT

The Comptroller and Auditor General (CAG) of India is an authority,

established by the Constitution of India, who audits all receipts and expenditure

of the Government of India and the state governments, including those of

bodies and authorities substantially financed by the government.

C&AG shall hold office for a term of 6 years or upto the age of 65 years, which

is earlier. He can resign at any time through a resignation letter addressed to

the President.


Organizations subject to the audit of the CAG

The organisations subject to the audit of the Comptroller and Auditor General of

India are:-

– All the Union and State Government departments and offices including the

Indian Railways and Posts and Telecommunications.

– About 1500 public commercial enterprises controlled by the Union and State

governments, i.e. government companies and corporations.

– Around 400 non-commercial autonomous bodies and authorities owned or

controlled by the Union or the States.

– Over 4400 authorities and bodies substantially financed from Union or State

revenues

Question 7: Write a short note on audit of government companies.

Audit of Government Companies(Commercial Audit)

The CAG is also the external auditor of Government-owned corporations and

conducts supplementary audit of government companies, i.e., any non-

banking/ non-insurance company in which the state and Union governments

have an equity share of at least 51 per cent or subsidiary companies of existing

government companies. The report of CAG is submitted to the Parliament.

The audit done by CAG is broadly classified into Regularity Audit and

Performance Audit.

Regularity Audit (Compliance)

– Audit against provision of funds to find whether the moneys shown as

expenditure in the Accounts were authorized for the purpose for which they

were spent.


– Audit against rules and regulation to see that the expenditure incurred was in

conformity with the laws, rules and regulations framed to regulate the

procedure for expending public money.

– Audit of sanctions to expenditure to see that every item of expenditure was

done with the approval of the competent authority in the Government for

expending the public money.

– Propriety Audit which extends beyond scrutinizing the mere formality of

expenditure to it wisdom and economy and to bring to light cases of improper

expenditure or waste of public money.

While conducting the audit of receipts of the Central and State Governments,

the Comptroller & Auditor General satisfies himself that the rules and

procedures ensure that assessment, collection and allocation of revenue are

done in accordance with the law and there is no leakage of revenue which

legally should come to Government.

Regularity Audit (Financial)

In regularity (financial) audit and in other types of audit when applicable,

auditors analyze the financial statements to establish whether acceptable

accounting standards for financial reporting and disclosure are complied with.

Analysis of financial statements is performed to such a degree that a rational

basis is obtained to express an opinion on financial statements.

Performance Audit

Performance audit is done to see that Government programmes have achieved

the desired objectives at lowest cost and given the intended benefits.


Question 8 - Write a brief note on Compliance Audit

A compliance audit is a comprehensive review of an organization’s adherence to

regulatory guidelines.

What, precisely, is examined in a compliance audit will vary depending upon

whether an organization is a public or private company, what kind of data it

handles and if it transmits or stores sensitive financial data.

It is common to us that the business undertakings require some certified

statement on various matters and the auditors certify such statements after

carrying out audit which might be necessary under the particular cases. All

such audits are called Compliance Audit. Suppose when a company applies to a

bank for some loan, a certified statement showing the turnover of the company

for the past two or three years along with the current year might be necessary,

and for this purpose the certified statements are to be attached with the

application, otherwise the application will be rejected. So these certified

statements showing the turnover of the company fall under the category of

compliance audit. Internal audit for compliance could be more broad base to

include compliance with documented procedures/policies, compliance with

statutory requirements in the relevant areas etc.

The objective of a compliance audit is to determine whether the auditee is

following prescribed laws, regulations, policies, or procedures. These audits can

be performed within a business organization for internal purposes or in

response to requirements by outside groups, particularly government.

Benefits of Compliance Audit

1. Adherence to the established standards.


2. Improvement of internal processes and technologies.

3. Maintenance of Certifications.

4. Adherence to governmental regulations.

5. Cost recovery.

6. Elevate fraud awareness and deter fraudulent activity.

7. Manage contract areas of risk.

Audit conducted with the objective to report whether the company is in

compliance with internal corporate

procedures/rules/regulations/policies/standards, external regulatory

requirements such as Companies Act, or compliance with industry codes of

conduct such as ISO 14001. Effective compliance audit can protect a company

against potential litigation, financial implications and reputational damages. It

is a tool to manage risk and prevent errors and frauds.

Question 9: Write a short note on Efficiency Audit

In essence, efficiency indicates how well an organization uses its resources to

produce goods and services. It focuses on resources (inputs), goods and

services (outputs), and the rate (productivity) at which inputs are used

to produce or deliver the outputs. To understand the meaning of “efficiency”, it

is necessary to understand the following terms: inputs, outputs (including

quantity and quality), productivity, and level of service.

Inputs are resources (e.g., human, financial, equipment, material, facilities,

information, energy and land) used to produce outputs.


Outputs are goods and services produced to meet client needs. Outputs are

defined in terms of quantity and quality and are delivered within parameters

relating to level of service.

Quantity refers to the amount, volume, or number of outputs produced.

Quality refers to various attributes and characteristics of outputs such as

reliability, accuracy, timeliness, service courtesy, safety, and comfort.

Productivity is the ratio of the amount of acceptable goods and services

produced (outputs) to the amount of resources (inputs) used to produce them.

Productivity is expressed in the form of a ratio such as cost or time per unit

of output.

Efficiency is a relative concept. It is measured by comparing achieved

productivity with a desired norm, target, or standard. Output quantity and

quality achieved and the level of service provided are also compared to targets

or standards to determine to what extent they may have caused changes in

efficiency. Efficiency is improved when more outputs of a given quality are

produced with the same or fewer resource inputs, or when the same amount of

output is produced with fewer resources.

Efficiency audit refers to comparing the actual results with the desired or

projected results. It is directed towards the measurement of whether plans

have been effectively executed. It is concerned with the utilisation of the

resources in economic and most remunerative manner to achieve the

objectives of the concern. It comprises of studying the plans of organisation,

comparing actual performance with plans and investigating the reasons for

variances to take remedial action


Objectives Of Efficiency Audit

Objectives of efficiency audit include assessing one or more of the following:

– the level of efficiency achieved by an organization or operation in relation to

reasonable standards;

– the adequacy and reliability of systems or procedures used to measure and

report efficiency;

– an organization’s efforts to explore and exploit opportunities to improve

efficiency; and

– whether the management processes and information systems, operational

systems, and practices of an organization help to achieve efficiency.

Advantages of Efficiency Audit

Auditing efficiency enables the management/owner to know whether the

departments and agencies manage resources with due regard to efficiency. It

can also directly or indirectly help departments and agencies to identify

opportunities to provide more or better services at the same or lower cost.

More specifically, such audits can:

– help managers and staff to be more sensitive to their obligation of due regard

to efficiency;

– underline the importance of measuring efficiency and of using that

information for managing operations and providing accountability;

– identify means for improving efficiency, even in operations where efficiency is

difficult to measure;


– demonstrate the scope for lowering the cost of delivering programs without

reducing the quantity or quality of outputs or the level of service;

– increase the quantity or improve the quality of outputs and level of service

without increasing spending; and

– identify needed improvements in existing controls, operational systems, and

work processes for better use of resources


CHAPTER 5 - INTERNAL CONTROL

Question 1 – Bring out the meaning of Internal Control System

Definition of Internal Control

“Internal controls as a system comprising of controls environment and

procedures. It includes polices and ways adapted by management of an

enterprise to assist it in achieving its objectives.” - The International

Standards of Auditors

The plan of organization and all the methods and procedures adopted by the

management of an entity to assist in achieving the 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, prevention and detection of fraud and error,

- the accuracy and completeness of the accounting records,

- compliance of law and

- the preparation of reliable financial information.

Question 2 – List the objectives of Internal control system

Objectives of Internal control

a) Authorization - the objective is to ensure that all transactions are approved

by responsible personnel in accordance with their specific or general authority

before the transaction is recorded.


b) Completeness - the objective is to ensure that no valid transactions have

been omitted from the accounting records.

c) Accuracy - the objective is to ensure that all valid transactions are accurate,

consistent with the originating transaction data, and information is recorded in

a timely manner.

d) Validity - the objective is to ensure that all recorded transactions fairly

represent the economic events that actually occurred, are lawful in nature, and

have been executed in accordance with management’s general authorization.

e) Physical Safeguards and Security- the objective is to ensure that access to

physical assets and information systems are controlled and properly restricted

to authorized personnel.

f) Error Handling - the objective is to ensure that errors detected at any stage

of processing receive prompts corrective action and are reported to the

appropriate level of management.

g) Segregation of Duties - the objective is to ensure that duties are assigned to

individuals in a manner that ensures that no one individual can control both the

recording function and the procedures relative to processing a transaction.

Question 3 – State the different Nature/types of internal controls

Internal controls can be detective, corrective or preventive in nature.

Preventive controls – not to let the errors/irregularities happen –

following are such controls

Segregation of duties

Security of assets

Approvals, authorizations and verifications


Detective controls – controls to detect errors/irregularities – following

are such controls

Review of performance

Reconciliation

Physical inventories

Internal Audit

Corrective controls – controls to correct the errors/irregularities which

are detected.

Question 4 – What are the elements of Internal Control

Elements of Internal Control

1. Control Environment

2. Risk Assessment

3. Control Activities

4. Information and communication

5. Monitoring

Question 5 – What are the advantages of Internal Control System

a) Increase in operational efficiency

Internal controls bring efficiency in operation. Technological advances to

improve the accuracy of each transaction also streamline manual processes.

b) Accurate Recording

Internal controls help prevent errors and irregularities from occurring. If errors

or irregularities do occur, internal controls will help ensure they are detected in


a timely manner. It creates confidence that only authorized transactions have

taken place.

c) Safeguarding Assets

It minimizes the risk of fraud and misappropriation of assets. It involves fraud

monitoring and prevention techniques. For example in case of a banking

internal control system, monitoring activities include security cameras and

security guards and prevention activities include cash counting by two

employees at a time and cash reconciliation by non-tellers..

d) Compliance

Another advantage of using internal controls includes increasing compliance

with regulatory agencies. Internal controls encourage adherence to prescribed

policies and procedures. It assures that adequate documentation supporting

transactions is created and retained.

e) Protection of Employees

Internal controls protect employees: 1) by clearly outlining tasks and

responsibilities, 2) by providing checks and balances, and, 3) from being

accused of errors, misappropriations, or irregularities

f) Benefits of Internal Control to the Auditor

If the audit client benefits from a sound system of internal control, it is likely

that the auditor will also be benefited.

All of the above stated benefits help to promote a situation where the financial

statements present a true and fair view. A good system of internal control will

make life easier for the auditor.


Question 6 – What are the limitations of Internal Control

Limitations of Internal control

No matter how well the internal controls are designed, they can only provide a

reasonable assurance that objectives will be achieved. Some limitations are

inherent in all internal control systems. These limitations include:

a) Judgment - the effectiveness of controls will be limited by decisions made

with human judgment under pressures to conduct business based on the

information available at hand.

b) Breakdowns - even well designed internal controls can break down.

Employees sometimes misunderstand instructions or simply make mistakes.

Errors may also result from new technology and the complexity of

computerized information systems.

c) Management Override - high level personnel may be able to override

prescribed policies or procedures for personal gains or advantages. This should

not be confused with management intervention, which represents management

actions to depart from prescribed policies and procedures for legitimate

purposes.

d) Collusion - control system can be circumvented by employee collusion.

Individuals acting collectively can alter financial data or other management

information in a manner that cannot be identified by control systems.

e) Others -

• Control system may become redundant with passage of time.

• Most controls tend towards transaction of usual nature.

A well designed process with appropriate internal controls should meet most if

not all of these control objectives


Question 7: What are various techniques used in Internal Control

System

There are two types of techniques used in internal control system Preventive

internal control techniques and Detective internal control techniques. From a

quality standpoint, preventive controls techniques are essential because they

are proactive and emphasize quality. However, detective controls techniques

play a critical role by providing evidence that the preventive controls

techniques are functioning as intended.

Preventive Controls techniques are designed to discourage errors or

irregularities from occurring. They are proactive in nature that helps to ensure

departmental objectives are being met.

Examples of preventive controls techniques are:

1. Segregation of Duties:

Duties are segregated among different people to reduce the risk of error or

inappropriate action. Normally, responsibilities for authorizing transactions

(approval), recording transactions (accounting) and handling the related asset

(custody) are divided.

2. Approvals, Authorizations, and Verifications:

Management authorizes employees to perform certain activities and to execute

certain transactions within limited parameters. In addition, management

specifies those activities or transactions that need supervisory approval before

they are performed or executed by employees. A supervisor’s approval (manual

or electronic) implies that he or she has verified and validated that the activity

or transaction conforms to established policies and procedures.


3. Security of Assets (Preventive and Detective):

Access to equipment, inventories, securities, cash and other assets is

restricted; assets are periodically counted and compared to amounts shown on

control records.

Detective Controls techniques are designed to find errors or irregularities

after they have occurred. Examples of detective controls techniques are:

1. Reviews of Performance:

Management compares information about current performance to

budgets,forecasts, prior periods, or other benchmarks to measure the extent to

which goals and objectives are being achieved and to identify unexpected

results or unusual conditions that require follow-up.

2. Reconciliations:

An employee relates different sets of data to one another, identifies and

investigates differences, and takes corrective action, when necessary.

3. Physical Inventories

4. Internal Audits

Question 8 – How do you test and evaluate Internal Control in an

Organisation

Review/Evaluation of Internal Control by the Auditor

Internal Controls are to be an integral part of any organization’s financial and

business policies and procedures.

Internal controls consists of all the measures taken by the organization for the

purpose of;


(1) protecting its resources against waste, fraud, and inefficiency;

(2) ensuring accuracy and reliability in accounting and operating data;

(3) securing compliance with the policies of the organization; and

(4) evaluating the level of performance in all organizational units of the -

organization.

Internal controls are simply good business practices.

Review of internal control system is a very important task for an auditor. It is

required to ensure that any inefficiency or ineffectiveness in system is

captured. A statutory auditor us also required to evaluate the effectiveness of

internal control system and to state in his report to shareholders.

Testing of internal control

This is normally done by the application of procedural tests and examination in

depth

a) Procedural tests

It means testing the compliance of the procedures laid down by the

management in respect of each stage through which a transaction flows. The

purpose of such compliance procedures is to provide reasonable assurance that

internal controls are being applied as prescribed. The auditor should carry out

procedural tests in respect of all internal controls on which audit reliance is

desired to be placed. Based on such tests, the auditor is able to satisfy that a

system of internal control exists, which is effective and which has been so

operated throughout the period of intended reliance.


b) Examination in depth

It means examination of a few selected transactions from the beginning to the

end. It involves studying of the recording of the transactions at the various

stages, examination of the relevant records, documents, authorities etc. It also

involves satisfying that the person who has exercised the authority is fit to do

so in the first place and has done so in accordance with the prescribed norms.

On the basis of above tests and proper understanding the internal controls in

force, the auditor arrives at a conclusion as given below:

1. The degree, nature and extent of weaknesses in the system.

2. The areas and the extent to which audit reliance may be placed.

3. The nature, timing and extent of his substantive procedures.

Techniques for evaluation of Internal control system

1. Narrative record; 2. Check List; 3. Flow Charts; 4. Questionnaire.

Flow Charts

It is a pictorial representation of the internal control system showing the

various operations, controls and stages involved in such system. It gives a

concise and comprehensive view of what happens in the organization. E.g. how

and when documents are raised, how they are dealt with, the departments

through which they pass, the authorities / personnel responsible for the

maintenance of records/registers, how the flow of goods and cash take place,

what the various operations are and so on. This enables the user of such flow

chart to understand clearly what control systems are in place and gives a bird’s

eye view of the transactions so as to enable him to evaluate internal controls in

the right perspective and improvements could be suggested. Flowcharts are

essentially a means of communication. Hence it should convey precisely and

clearly what it intends to convey.


Internal control questionnaire

It lists the various questions which an auditor may ask to his client in order to

verify the existence and efficiency of internal control system. Its the most

convenient and widely used method for collecting information regarding the

internal control system. Generally the questions are pre-designed and, hence, it

can be ensured that all aspects of the system are covered. Questions are so

designed that the answer can be “Yes” or “No” or “Not applicable”. However

space may be provided below each answer for justifying/amplifying such

answers wherever necessary.

It is usually issued to the client who fills it. Based on the answers given by the

client, inherent weaknesses, if any, are noticed by the auditor, the matter is

further discussed and a report of deficiencies is given to the client with

suggestions for improvement.

This questionnaire is prepared taking into consideration broad categories like -

1. Segregation and rotation of duties

2. Maintenance of records and documents

3. Accountability for, and safeguarding of, assets

4. Procedure for authorizations

5. Independent Checks.

Question 9 – What do you understand by audit in depth?

It implies auditing a transaction extensively from the origin to the end. It is a

audit technique used to evaluate the effectiveness of internal control system in

an organization. Through check of the transaction – like sanctity of the

transaction, validity of transaction, adherence to the procedures and polices

while executing the transaction, arithmetic accuracy, accounting treatment,etc.

It is also called as Vertical Vouching.


Question 10– Who is responsible for installing a good Internal Control

System?

Responsibilities of Management vis-à-vis Auditors

It is the responsibility of the management for maintaining an adequate

accounting system incorporating various internal controls to the extent

appropriate to the size and nature of the business.

The management is also vested with the responsibility of closely monitoring the

system in place in order to ensure that the basic objectives of installing such

control systems are achieved.

Whereas the Auditor, to safeguard his own interest, might resort to

examination and evaluation of the internal control that exist in the organization

so that his entire audit programme may be formulated only after he satisfies

himself that such control systems are adequate and in consonance with the

requirements of the business.

After a thorough examination and review of internal controls, if the auditor

becomes aware of weaknesses in such internal controls, he should make the

client aware of material weaknesses that have come to his attention. Such

communication is normally sent to the management in writing, which is termed

as a “letter of weakness” or “management letter”.

Question 11 – What do you understand by Internal Check

Internal check is best regarded as indicating checks on the day-to-day

transactions which operate continuously as a part of the routine systems

whereby work of one person is proved independently or is complementary to

the work of another, the object being the prevention of or early detection of

errors and frauds”.


The main objective of internal check is prevention of errors and frauds and/or

detection of errors and frauds at the earliest. Internal check is a continuous

process and is part of the day-to-day routine. It relates to all the transactions

that take place every day. Internal check is achieved by complementary

allocation of duties and by independent verification of the work of one person

by another.

Internal check is a part of internal control system. It ensures that all financial

transactions are properly recorded.

It also ensures efficiency of the accounting system followed by the organization

and enables easy preparation of financial statements. It achieves its main

object of minimizing errors and frauds.

A sound system of internal check increases the reliability of financial

statements. Internal check discourages fraud and collusion among employees

by instilling a fear of detection in their minds. Internal check assigns

responsibilities to persons and enables maintenance of records and documents

properly and thereby ensures smooth flow of work.

Internal check is a part of Internal control system. Internal check refers to the

whole system established within the organization by which work of one

employee is automatically (& continuously, objectively, independently) checked

by another ensuring that the process accounting information is accurate.

Internal check vs. Internal Control System

Internal check is a smaller concept compared to a broader concept of internal

control. Internal check is a part of internal control system. Internal control

includes internal check, internal audit, quality control etc


Question 12 - Internal check vs. Internal audit

Way of checking:

In internal check system work is automatically checked whereas in internal

audit system work is checked specially.

Cost involvement:

In internal check system checking is done when the work is being done.

Mistake can be checked at an early stage in internal check system.

Thrust of system:

Thrust of internal check system is to prevent the errors and whereas the thrust

of internal audit system is to detect the errors and frauds.

Time of checking:

In internal check system checking is done when the work is being done

whereas in internal audit system work is checked after it is done. Mistakes can

be checked at an early stage in internal check system.

Note: Same above difference between internal control and internal

audit.

Question 13 – What do you understand by Compliance Test and

Substantive Tests

Auditor can gather evidences by testing. Following are the two categories of

tests

1. Compliance Test

1) Compliance means adherence

2) Management introduces IC system


3) Evaluation of ICS by auditor

4) The auditor carries out auditing in depth and surprise check for this

purpose

5) Object is to find whether the personnel have complied with ICS.

Objective of compliance test

1) Existence of system

2) Effectiveness of system

3) Continuance of system

The Auditor is concerned with all the above concurrently

2. Substantive test

1) Phrase ‘substantive’ derived from the word to substantiate i.e. to prove

2) It refers to

a) Test of details of transaction

b) Analytical test

Following are objective with reference to Balance sheet

1) Existence

2) Rights and obligations

3) Valuation

4) Disclosure

With regard to P & L account following are the objectives

a) Occurrence of transaction

b) Measurement of transaction

c) Disclosure


CHAPTER 6 – AUDIT ENGAGEMENT AND DOCUMENTATION

Question 1: What do you understand by Audit procedure and process?

Audit procedures refer to the methodology adopted by an auditor in carrying

out an audit assignment.

Audit procedures have a very important role in the successful execution of an

audit assignment. The most successful audits are those involving sound

planning and those in which the auditee and the auditors have a constructive

working environment. In a conducive environment, auditee, should understand

what auditor has been doing and why. Although every audit is unique, the audit

process is similar for most engagements, and normally consists of three stages:

planning, executing and reporting

Question 2 – Bring out the meaning and importance of Audit Planning

AAS 8- In order to ensure a high standard of performance, it is important that

the auditor should prepare adequately for his work. Planning for an audit, just

like every human endeavour, is essential for the smooth performance of the

audit work and its successful completion. Planning ahead for an audit work will

not only guarantee a valid audit opinion but will also help the auditor to ensure

that:

(a) The audit objective is established and achieved;

(b) The audit is properly controlled and adequately directed at all stages;

(c) High risk and critical areas of the engagement are not omitted but that

adequate attention is focused on these areas; and


(d) The work is completed economically and expeditiously, hence, saving on

audit resources.

Points for Consideration in Audit Planning: In order to make the planning

more meaningful, the auditor should take into consideration the following

matters in relation to the audit engagement:

(a) Preliminary Work to be done in addition to the real audit work

This will include such matters as stocktaking, cash count,debtors’ circularisation

and review of previous year’s working papers. This will remind the auditor of

those matters brought forward from the previous year and any other points to

be resolved in the current year or problems anticipated.

(b) Changes in legislation, accounting or any auditing standards or guidelines

The auditor should acquaint himself with all the changes that took place during

the year in applicable legislation, accounting and auditing standard. This will

help an auditor in carrying out the auditing assignment in away that meets the

legislative requirement.

(c) Analytical review of available management accounts and other management

information that relate to the accounts.

This will assist in establishing valuable ratios and indicators that will guide the

auditor. For instance, the computation of the gross profit percentage compared

with that of the previous year will provide a good indicator to the auditor of the

accuracy and reliability of sales and cost of sales.

(d) Changes in the business or management

The appointment of a new finance controller and the establishment of a new

business line or the creation of a new branch are significant changes in the

circumstances of the company which will necessitate changes in the existing


audit plans. There may be similary changes for which change may be required

in audit plan.

(e) Changes in the accounting system

The introduction of computers such that when a company introduces significant

changes in its operating procedures will require a review and evaluation of the

system of internal control.

(f) Deadlines established for the submission of audit report

Where a client has set deadlines for its statutory activities such as the annual

general meeting, it is important for the auditor to work in line with such

programmes.

(g) Use of Rotational Testing and Verification

In practice, the auditor may not carry out a hundred percent testing or

verification of the client’s transactions or segments of the business. Where

rotational testing or verification is adopted, it will be necessary for the auditor

to determine ahead of the date of the engagement which aspects of the

business should be selected for testing or verification. An example of rotational

testing could be applied on the client’s branches to be visited.

Coverage of Audit planning

It covers the following aspects:-

1) Acquiring knowledge of client’s accounts system accounts polices and IC

procedure

2) Establishment of expected degree of reliance to be placed on IC

3) Determination of nature, timing and extent of audit procedures through

proper programming

4) Co-ordination of the audit.


Constituents of Audit Planning:-

The planning process includes

a. Development of an overall audit plan

b. Development of an audit programme showing nature, timing and extent

of audit procedures

Advantages

a. Appropriate attention is devoted to important areas of audit

b. Identification of potential problems.

c. Completion of work expeditiously (on time)

d. Utilization of assistance properly

e. Coordinating work done by other auditors and experts.

Question 3 – What do you understand by Audit Programme? State its

content and advantages.

Most of the time audit is conducted by a team instead of just an individual.

Depending on the audit, audit team can have different number of members.

Usually the team is structured in a Partner, Manager and Assistants which may

further be divided into senior assistants and juniors.

In order to properly assign work to each individual and what is required to be

done by whom there must be some kind of instructions set, otherwise, more

than one member might be auditing the same area or in other case some areas

may be left completely unaudited.

To ensure efficient and effective conduct of audit assignment, audit

programmes are used.


Audit programme contains step by step instructions to be carried out by team

members i.e. it is simply a list of audit procedures to be executed by team

members.

Audit programme or audit program is not a name of any computer program.

Also it has nothing to do with computer programming in any way. However,

audit programmes can be made using computer software in computer assisted

auditing environment

Even though audit programme sets out the whole agenda for every member of

the team but the main users are juniors for whom it acts as a dictation to be

followed.

The main purpose of audit programme is that every material area has been

audited appropriately and sufficient appropriate audit evidence has been

obtained in respect of every important areas of audit.

Audit programmes are prepared on the basis of audit plan usually by the

auditor – who in the audit team is either partner or manager. But sometimes,

audit firms have a basic audit programme and the same is used by the auditor

after making some modifications to it to make it according the audit

engagement in hand.

Mostly it is in the form of a checklist which can be used by the juniors to make

sure every required procedure has been implemented. This can also help in

monitoring the work of juniors in specific or assistants in general.

Audit programmes may be laid down in advance for the whole year for some

aspects of the audit which auditor expects to be audited after regular intervals

of time or when needed. For understandability and convenience, audit

programmes are written for each audit area separately and then assigned to

specific team members.


What procedures shall be part of audit programme is to be decided by the

auditor and depends on the auditor’s judgement.

Contents of a Audit Programme:

1. Extent of checking i.e.% of checking of transactions as a test check.

2. Initial /Signature by audit staff

3. Remarks

4. Level of staff deputed

5. Audit procedures and techniques.

The Audit Programme normally covers both B/S and P & L audits.

Advantages:

1. Replaces mental plan

2. Effective monitoring device

3. Coverage (wide)

4. Systematic approach to audit

5. Source of planning for future

6. It provides guidance to audit staff

7. Acts as evidence in the court of law.

8. Enables fixation of responsibility on the audit staff

9. Ensures continuity of audit

10. Compliance with Auditing practices

Limitations:

1. Rigidity

2. Monotony

3. Does not encourage creativity

4. Provides an easy way of escape for inefficient staff


Question 4 – Write a Specimen of audit programme for Cash Audit

Sample Audit Program For Cash Audit

1. Discuss and document with the cashier about the procedures for the

receiving and disbursement of cash.

A. sources of cash (funds)

B. frequency of deposits

C. who makes the deposits

D. the level of “cash” received

E. the nature of documentation of expenditures (invoices, check requests,

agreements...)

F. authorization procedures

2. Determine whether the level of cash held in the field and in the office is

appropriate.

3. For petty cash funds–

Is an accurate petty cash voucher maintained?

–Are physical cash counts

(a) Conducted routinely by a person or people who are not direct custodians of

the petty cash funds?

(b) Reconciled with the petty cash voucher? Can all variances be explained?

(c) Documented by those people who performed the counts and reconcile these

counts against the petty cash voucher?

– Is access to petty cash funds restricted? Who has access to these funds?


4. For all field checking accounts

(a)Determine the number of signatures required on each check.

(b) Determine the process by which cash is received for mission operations.

(c) Obtain bank statements for each bank account.

(d) Determine the frequency and timing of the preparation of bank

reconciliations.

Who does the reconciliations?

(e) Summarize a listing of deposits from the bank statements and reconcile the

amounts with reported home office transfers and other sources of income

reflected on the field’s financial reports.

(f) Obtain bank reconciliations and test for accuracy.

(g) Verify whether a second party reviews bank reconciliations monthly. These

examinations should be documented with a date of examination and a

signature of the second party.

Question 5 – List the differences between Vouching and Verification.

Vouching

Vouching is referred to as “The art of examining vouchers”. The objective of

vouching is to establish the authenticity of the transactions recorded in the

primary books of accounts. This is done by

a. Verifying transactions recorded in the books of account with relevant

documentary evidence (voucher–eg cheque, invoices, goods received

note,challans,agreements,counterfoil,minutes book,MOA,AOA, deeds,bank

statement,registers).


b. Verifying the authority on the basis of which the entry has been made

c. Confirming that the amount mentioned in the voucher has been posted

to appropriate account

The following are the essential points to be kept in mind while examining a

voucher:

a. Vouchers should be numbered

b. Voucher should be dated and fall within the accounting period

c. Vouchers should be Authorized

d. Should relate to clients business

e. Accounted under proper a/c that would clearly disclose the character of

the receipts or payments posted

f. Alterations in the voucher should be authorized

g. Amount in words and figures should match.

h. Cancelled vouchers should be retained in the book

i. Unused vouchers should be kept under lock and key

Objective of vouching – to ensure genuine,valid,complete transactions are

properly recorded in the books and they have evidence in the form of vouchers.

To ensure only transactions relating to business are recorded. In the process of

vouching frauds and errors might be detected.

Verification- Verification implies an enquiry into the value, ownership and

title, existence, possession, presence of any charge on the assets of the

company.


Points to be considered in verification –existence, possession, ownership,

charge/lien,record,audit report, event occurring after the balance sheet date.

Techniques of verification

Inspection – physical inspection of assets

Observation – observing the verification done by others

Confirmation – getting written confirmation from outsiders regarding the

existence of the assets.

Distinction between Vouching and Verification (look into your ICSI for

detail of each point) – Points of differences - Meaning, Nature, Person,

Time

Question 6 – State meaning, purpose and importance of Audit

Documentation. Also state the types of audit files.

“Documentation” refers to the working papers prepared or obtained by the

auditor and retained by him, in connection with the performance of the audit.

AUDIT DOCUMENTATION: (AAS 3)

(i) Meaning

Refers to various information provided to the Auditor by the client in support of

matters disclosed in financial statement.

Collectively known as working paper.

Also includes Audit note book


(ii) Purpose

It supports Audit conclusions reached

Evidence which can be presented in the court supporting nature of Audit work.

Provides guidance for future period audit staff

Fixes responsibility on the audit staff executing the Audit work

It is a proof that GAAP has been regularly followed

Classification / Kinds

1) Broadly classified as (a) Permanent file & (b) Current file

Permanent file

Kept at Auditor’s office

Contains documents which are required for Audit of recurring nature

Members of Audit team refer to this for updating basic information about client.

Cannot be taken to client’s location

Contents are updated periodically

CONTENTS OF PERMANENT FILE (few examples)

1) Copies of MOA and AOA

2) Copies of collaboration agreements

3) Extract of legal provisions applicable

4) Extract of legal pronouncements such as AS

5) Published accounts previous periods

6) Major frauds occurred and detected in previous period

7) Organizational charts

8) List of officers, their power and duties

9) List of accounting policies followed


10) List of bank accounts operated

11) Evidence that ICS has been evaluated

12) Statement showing trend of accounting ratios

Current file

1) Refers to papers linked to current period F.S.

2) Generated at the client’s office

3) Information are either founded by clients or generated by Auditor

directly

4) The contents support conclusions reached by Auditors

5) Ultimately stored in Audit’s offices

6) It is indexed and numbered in the systematic manner

Contents of Current File (Few examples):-

1) Advance planning memorandum

2) Audit programme

3) Inventory sheet

4) Confirmation letters

5) Draft financial statements

6) Draft Audit report

7) Branch financial statement

8) Management representation

9) Statement of accounting ratios

10) Audit conclusions


Ownership and custody

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.

The auditor should adopt reasonable procedures for custody and confidentiality

of his working papers

General guidelines for the preparation of working papers are:

1. Clarity and Understanding

– As a preparer of audit documentation, step back and read your work

objectively. Would it be clear to another auditor? Working papers should be

clear and understandable without supplementary oral explanations. With the

information the working papers reveal, a reviewer should be able to readily

determine their purpose, the nature and scope of the work done and the

preparer’s conclusions.

2. Completeness and Accuracy

– As a reviewer of documentation, if you have to ask the audit staff basic

questions about the audit, the documentation probably does not really serve

the purpose. Work papers should be complete, accurate, and support

observations, testing, conclusions, and recommendations. They should also

show the nature and scope of the work performed.

3. Pertinence

– Limit the information in working papers to matters that are important and

necessary to support the objectives and scope established for the assignment.


4. Logical Arrangement – File the working papers in a logical order.

5. Legibility and Neatness

– Be neat in your work. Working papers should be legible and as neat as

practical. Sloppy work papers may lose their worth as evidence. Crowding and

writing between lines should be avoided by anticipating space needs and

arranging the work papers before writing.

6. Safety – Keep your work papers safe and retrievable.

7.Initial and Date – Put your initials and date on every working paper.

8. Summary of conclusions – Summarize the results of work performed and

identify the overall significance

of any weaknesses or exceptions found.

Question 7 - Distinction between Permanent file and Current File

Permanent File

1. It is static and kept in Auditor office

2. It is referred before commencement

of audit

3. It is useful for Audit staff to conduct

Audit

4. The contents are updated every year

Current File

It is dynamic & generated at client’s

office & finally kept at Auditor office

Created after completion of Audit

Useful for Auditor to support his

Audit conclusion

Contents are static.


Q 8 – What do you understand by Audit Materiality and Sampling &

Sampling Risk?

Audit Materiality (AAS 13)

An information could be regarded as material if its misstatement, (may be

omission or erroneous) could influence the economic decisions of users taken

on the basis of the financial information.

Materiality depends on the size and nature of the item, judged in the particular

circumstances of its misstatement. However, what is material in a given

situation is a matter of professional judgement. Some items, which individually

may not be material but collectively, might be material. It could either be

qualitative or quantitative. The auditor should consider materiality from the

point of view of both the following:

a. Overall financial information

b. Individual account balances.

Relationship between Materiality and Audit risk

When planning the audit, the auditor considers what would make financial

statements materially misstated. His consideration of materiality at the

planning stage enables him to decide which items should be examined by

application of sampling and analytical procedures and thus to reduce the audit

risk.

There is an inverse relationship between materiality and the degree of audit

risk. Higher the materiality, lower is the audit risk. The auditor should

therefore, at the planning state itself consider the materiality and the risk

attached to it so as to carry out the audit more effectively.


The audit should be planned so that audit risk is kept at an acceptably low

level. On assessment of the inherent and control risks, he should consider the

level of detection risk which he could afford and based upon his judgement,

select appropriate substantive audit procedures. The auditor reduces detection

risk by performing substantive procedures. The more extensive the procedures

performed, the lower the detection risk.

Audit Sampling (AAS 15)

In an audit, sampling procedures are used because it is not practical to

examine every single item in a population. For example, the auditor may select

an audit sample of non-current assets, and verify their existence, condition and

value. It would not be practical for the auditor to track down every single asset

on the books.

But, if all the items in the audit sample are verified then it may be appropriate

to draw the conclusion that all the assets are correctly recorded in the books

(assuming the audit sample has been selected correctly and is of sufficient size)

It means carrying out audit procedures in less than 100% of items within an

account balance or class of transactions. When using sampling methods, the

auditor should design and select an audit sample, perform audit procedures

thereon, and evaluate sample results so as to provide sufficient and appropriate

audit evidence. There are two methods in which the size of the sample and the

selection of individual items of the sample are determined. They are 1.

Judgemental sampling and 2. Statistical sampling.

Judgemental sampling

The auditor, on the basis of his personal experience and professional

judgement, will determine the size of the sample and express it in terms of

number of accounts or transactions to be checked. However, whether the

sample selected on the above basis would represent the population in order


that the audit objective would be achieved is a questionable matter. This is

because of the risk of personal bias in selection of sample items cannot be

eliminated.

Statistical Sampling

It is a method of audit testing which is more scientific than testing based

entirely on the auditor’s own judgement because it involves use of theory of

probability. The sample should be selected in such a manner that it is truly

representative of the population from which it is being selected. Each item in

the population should have an equal chance of being included in the sample.

The most important method of selecting a sample using a statistical approach is

Stratified Sampling.

Stratified sampling

Stratification refers to the process of dividing a population into sub-populations,

each of which is a group of sampling units, which have similar characteristics.

Each such sub-population is known as a stratum. Each stratum is treated as if

it was a separate population and proportionate items are selected from each of

this stratum. From these groups, the auditor may pick up different percentage

of items for checking / verification or for applying his audit procedures.


Question 9 – What do you understand by Sampling risk and tolerable

error and expected error in Auditing

Sampling Risk, Tolerable Error and Expected Error

1. Sampling risk arises from the possibility that the auditor conclusion, based on

a sample, may be different from the conclusion that would be reached if the

entire population were subjected to the same audit procedure.

Sampling risk in test of control – a) Risk of under reliance b) Risk of over reliance

Sampling risk in substantive test – a) Risk of incorrect acceptance b) Risk of

incorrect rejection

Note:

The risk of under reliance and incorrect rejection would affect audit efficiency

The risk of over reliance and incorrect acceptance would affect audit effectiveness

2. Tolerable error is the maximum error in the population that the auditor

would be willing to accept and still concludes that the result from the sample has

achieved the audit objective. Tolerable error is considered during the planning

stage and, for substantive procedures, is related to the auditor’s judgement about

materiality. The smaller the tolerable error, the greater the sample size will need

to be.

3. Expected Error

If the auditor expects error to be present in the population, a larger sample than

when no error is expected ordinarily needs to be examined to conclude that the

actual error in the population is not greater than the planned tolerable error.

Smaller sample sizes are justified when the population is expected to be error


free. In determining the expected error in a population, the auditor would

consider such matters as error levels identified in previous audits, changes in the

entity’s procedures, and evidence available from other procedures

Question 10: What is the meaning of Test check

Test checks and techniques of test checking

Carrying out detailed check of each and every transaction of a large business

shall be time consuming for the auditor. In auditing the accounts of a business,

every single copy is not usually checked by the auditor; what is usually done in

practice is that a representative number of entries of each class are selected and

checked and if they are found correct, the remaining entries are taken to be

correct. This is known as Test Checking. In those organizations, where

satisfactory internal check system is in existence, the auditor need not carry out

detailed checking. He may adopt Test checking. It is a system of sampling

employed by the auditor for the purpose of reducing the volume of detail

checking involved in the audit. If, in Test Checking, he finds that the records

checked by him are correct then no further detail checking need be carried out.

Test Checking V/S Statistical Sampling

Selection of items for the purpose of checking can be done in two ways:

(i)Judgment (ii) Statistical Sampling.

When the judgment method is applied, the method of checking is called test

checking. When sampling techniques are applied it is called statistical sampling.

Precautions To Be Taken- While adopting the test check, the auditor must take

the following precautions:

1.Entries selected for test checking must be representative of all transactions.


2.The selection of the items should be at random.

3.It cannot be adopted in case of vouching the cash book.

4.Client’s staff should not come to know of the entries selected for test checking.

5.Period selected for test checking should differ from book to book and year to

year.

6.He should not adopt test checking where the law requires thorough audit.

7.A number of entries of the first and last month of the year must be checked

thoroughly.

8.Test should be so devised that a sizeable portion of the work done by each

employee is checked.

9.Control accounts or impersonal ledger should not be subject to test checking.

10.Auditor should select the test independently without regard to the suggestions

of the member of the client’s staff.

11.Bank statement and entries for cash withdrawal and cash deposits should be

checked in full.

The extent of the test checking will depend upon the judgment and wishes of the

auditor but it must be remembered that time unnecessarily spent in routine

checking is a waste of resources. Caution must also be taken to see that the test

checking may not become insignificant in extent or automatic and

unrepresentative. Test checking will be of no use unless the representative items

selected for checking are chosen with great intelligence and imagination.

Advantages of Test Check

1. Volume of work is considerably reduced.

2. There is a saving in terms of time, cost and energy.


3. The extra time available can be utilised for concentrating on areas of

considerable importance.

4. If done carefully, test checking can be quite effective.

Disadvantages of Test Check

1. The auditor always is under fear whether he has missed out certain important

items or that errors have remained undetected while test checking.

2. Where the client’s staff is aware that the auditor resorts to test checking, the

staff may become careless.

Auditor’s Liability

If any errors are found in the accounts the auditor cannot take the shield against

the fact that he conducted test check. The auditor should very carefully select the

items for test check and ensure on the whole that the accounts show a true and

fair view of the Profit/Loss in the case of the Profit & Loss Account and of the

state of affairs of the organisation in the case of Balance Sheet.

Question 11: State in brief standard SA 230 on Audit Documentations.

SA 230: Audit Documentations

This Standard deals with the auditor’s responsibility to prepare audit

documentation for an audit of financial statements. It also deals with the

requirements of timely preparation of audit documentation; documentation of the

audit procedures performed and audit evidence obtained and assembly of the


final audit file. It outlines about vesting of property of working papers with the

Auditor.

This Standard spells out two essential principles viz. period of maintaining

working papers and assembly of audit file by the auditor.

According to SA 230, Audit Documentation refers to the record of audit

procedures performed, relevant audit evidence obtained, and conclusions the

auditor reached. Preparing sufficient and appropriate audit documentation on a

timely basis helps to enhance the quality of audit and facilitates effective review

and evaluation of audit evidence obtained and conclusions reached before

finalizing auditor’s report. According to this standard, retention period for audit

engagements ordinarily is no shorter than ten years from the date of auditor’s

report, or, if later, the date of group auditor’s report

Fb Sharing Audit Material for DEC 2014

Documents

Transcript of Fb Sharing Audit Material for DEC 2014