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Notes for Private Circulation only

AUDITING AND ASSURANCE

Practical Insight
Into Auditing
 by 

CA. Rishabh Jain

© 2020-21 - All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or copied
in any form or by any means, electronic, mechanical, photographic or otherwise, without the written
permission of the Ekatvam Academy Breach of this condition is liable for legal action.
Chapter
Chapter Name Page Nos.
No.
1. Nature, Objective and Scope of Audit 1.1 – 1.10

2. Audit Strategy, Audit Planning and Audit Programme 2.1 – 2.2

3. Audit Documentation and Audit Evidence 3.1 – 3.2

4. Risk Assessment and Internal Control 4.1 – 4.24

5. Fraud and Responsibilities of The Auditor 5.1 – 5.2

6. Audit in an Automated Environment 6.1 – 6.18

7. Audit Sampling 7.1 – 7.2

8. Analytical Procedures 8.1 – 8.2

9. Audit of Items of Financial Statements – Chapter Overview 9.1 – 9.2

9A. Introduction 9A.1 - 9A.8

9B. Balance Sheet Captions (Liabilities) 9B.1 – 9B.20

9C. Balance Sheet Captions (Assets) 9C.1 – 9C.25

9D. Income Statement Captions 9D.1 – 9D.20

10. The Company Audit 10.1 – 10.44

11. Audit Report 11.1 – 11.10

12. Bank Audit 12.1 – 12.36

13A. Audit of Different Type of Entities 13A.1 – 13A.28

13B. Government Audit 13B.1 – 13B.10

13C. Audit of Cooperative Society 13C.1 – 13C.14



Inter / Auditing and Assurance

Inter / Auditing and Assurance
 NATURE,
OBJECTIVE AND
SCOPE OF AUDIT

1.1
 1. MEANING AND DEFINITI ON OF AUDITING
“An audit is independent examination of financial information of any entity, whether
profit oriented or not, and irrespective of its size or legal form, when such an
examination is conducted with a view to expressing an opinion thereon.”
Analysis of the Definition:
• Audit is Independent examination of financial information of any entity – that entity may
be profit oriented or not and irrespective of its size or legal form.
• For example – Profit oriented – Audit of Listed Company engaged in business.
• On the other hand, Audit of NGO – not profit oriented.
• The objective of the audit is to express an opinion on the financial statements.

The person conducting this task should take care to ensure that financial statements
would not mislead anybody. This he can do honestly by satisfying himself that:
• the accounts have been drawn up with reference to entries in the books of account;
• the entries in the books of account are adequately supported by sufficient and appropriate
evidence;
• none of the entries in the books of account has been omitted in the process of
compilation and nothing which is not in the books of account has found place in the
statements;
• the information conveyed by the statements is clear and unambiguous;
• the financial statement amounts are properly classified, described and disclosed in
conformity with accounting standards; and
• the statement of accounts present a true and fair picture of the operational results and of
the assets and liabilities.

2. OBJECTIVES OF AN AUDIT
• As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit
of financial statements, the overall objectives of the auditor are:
a) To obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement; and
b) To report on the financial statements, and communicate as required by the SAs, in
accordance with the auditor’s findings.

1.2
 To ensure the financial
To obtain reasonable
statements as a whole are free
assurance
from material misstatemenmt

Overall objective
of the auditor

To report on the financial To communicate as required

statements by the SAs

3. SCOPE OF AUDIT
The following points merit consideration in regard to scope of audit:
• The audit should be organized to cover adequately all aspects of the enterprise
relevant to the financial statements being audited.
• To form an opinion on the financial statements, the auditor should be reasonably satisfied
as to whether the information contained in the underlying accounting records and
other source data is reliable and sufficient as the basis for the preparation of the financial
statements.
• In forming his opinion, the auditor should also decide whether the relevant information
is properly disclosed in the financial statements subject to statutory requirements,
where applicable.
• The auditor assesses the reliability and sufficiency of the information contained in
the underlying accounting records and other source data by:
✓ making a study and evaluation of accounting systems and internal controls and
✓ carrying out such other tests, enquiries and other verification procedures of
accounting transactions and account balances as he considers appropriate in the
particular circumstances.
• The auditor determines whether the relevant information is properly disclosed in the
financial statements by:
✓ comparing the financial statements with the underlying accounting records and
other source data to see whether they properly summarize the transactions and
events recorded therein; and

1.3
 ✓ considering the judgments that management has made in preparing the
financial statements accordingly, the auditor assess the selection and consistent
application of accounting policies, the manner in which the information has been
classified, and the adequacy of disclosure.
• The auditor is not expected to perform duties which fall outside the scope of his
competence. For example, the professional skill required of an auditor does not include
that of a technical expert for determining physical condition of certain assets.
• Constraints on the scope of the audit of financial statements that impair the auditor’s
ability to express an unqualified opinion on such financial statement should be set out in
his report, and a qualified opinion or disclaimer of opinion should be expressed as
appropriate.

ASPECTS TO BE COVERED IN AUDIT

The principal aspects to be covered in an audit concerning final statements of account are
the following:

An
Examination of
the system of
acounting and
internal control

Verification of
Reporting to
the authenticity
the appropriate
and validity of
person/body
transaction

Aspects
to be
Checking the
covered Comparision of
result shown
by the profit &
in Audit the Items of FS
with the
underlying
loss
record

Verification of
Verification of Title, Existence
the liabilities & Value of the
assets

• An examination of the system of accounting and internal control to ascertain whether

it is appropriate for the business and helps in properly recording all transactions.

1.4
• Reviewing the system and procedures to find out whether they are adequate and
comprehensive and incidentally whether material inadequacies and weaknesses exist to
allow frauds and errors going unnoticed.
• Checking of the arithmetical accuracy of the books of account by the verification of
postings, balances, etc.
• Verification of the authenticity and validity of transaction entered into by making an
examination of the entries in the books of accounts with the relevant supporting
documents.
• Ascertaining that a proper distinction has been made between items of capital and
of revenue nature and that the amounts of various items of income and expenditure
adjusted in the accounts corresponding to the accounting period.
• Comparison of the balance sheet and profit and loss account or other statements
with the underlying record in order to see that they are in accordance therewith.
• Verification of the title, existence and value of the assets appearing in the balance
sheet.
• Verification of the liabilities stated in the balance sheet.
• Checking the result shown by the profit and loss and to see whether the results shown
are true and fair.
• Where audit is of a corporate body, confirming that the statutory requirements have
been complied with.
• Reporting to the appropriate person/body whether the statements of account
examined do reveal a true and fair view of the state of affairs and of the profit and loss of
the organisation.

4. TYPES OF AUDIT
• Audit is not legally obligatory for all types of business organisations or institutions.
On this basis audits may be of two broad categories i.e., audit required under law
and voluntary audits.
✓ Audit required under law: The organisations which require audit under law are the
following: e.g. companies governed by the Companies Act; banking companies; other
statutory bodies required by their regulators or by specific Act.
✓ In the voluntary category are the audits of the accounts of proprietary entities,
partnership firms, Hindu undivided families, etc.
Note:
• Trust, however, stands on a slightly different footing; these may be public trusts or
private trusts.
• Trusts can carry on business as well. In most cases trustees are private persons.

1.5
 • Trusts generally have two classes of beneficiaries; tenants for life and remainders;
persons to whom the accounts are of the supreme importance are often widows and
minors, who cannot criticize the accounts in any effective manner.
• Though audit of trusts, except for public trusts, is not compulsory most of the trust
deeds contain a clause for audit of accounts.
• Private trustees also recognise the advantages of audit in their own interest, since any
erroneous treatment in the accounts for which they might be personally liable will be
pointed out by the auditor.

5. ADVANTAGES OF AUDIT OF FINANCIAL STATEME NTS

Some or all of these are of considerable value even to those enterprises and organisations
where audit is not compulsory, these advantages are given below:
• It safeguards the financial interest of persons who are not associated with the
management of the entity, whether they are partners or shareholders, bankers, FI’s, public
at large etc.
• It acts as a moral check on the employees from committing defalcations or
embezzlement.
• Audited statements of account are helpful in settling liability for taxes, negotiating
loans and for determining the purchase consideration for a business.
• These are also useful for settling trade disputes for higher wages or bonus as well as
claims in respect of damage suffered by property, by fire or some other calamity.
• An audit can also help in the detection of wastages and losses to show the different
ways by which these might be checked, especially those that occur due to the absence of
inadequacy of internal checks or internal control measures.
• Audit ascertains whether the necessary books of account and allied records have
been properly kept and helps the client in making good deficiencies or inadequacies in
this respect.
• As an appraisal function, audit reviews the existence and operations of various
controls in the organisations and reports weaknesses, inadequacies, etc., in them.
• Audited accounts are of great help in the settlement of accounts at the time of
admission or death of partner.
• Government may require audited and certified statement before it gives assistance or
issues a license for a particular trade.

1.6
7. RELATIONSHIP OF AUDI TING WITH OTHER DISCIPLINES

Introduction
The field of auditing as a discipline in simple words involves review of various assertions; both
in financial as well as in non-financial terms, with a view to prove the veracity of such
assertions and expression of opinion by auditor on the same.
Thus, it is quite logical and natural that the function of audit can be performed if and only if the
person also possesses a good knowledge about the fields in respect of which he is conducting
such a review.
1. Auditing and Accounting: Auditing reviews the financial statements which are nothing
but a result of the overall accounting process.
2. Auditing and Law: An auditor should have a good knowledge of business laws affecting
the entity.
3. Auditing and Economics: Auditor is expected to be familiar with the overall economic
environment of the client.
4. Auditing and Behavioral Science: Knowledge of human behavior is essential for an
auditor to effectively discharge his duties
5. Auditing and Statistics & Mathematics: auditor is also expected to have the knowledge
of statistical sampling for meaningful conclusions and mathematics for verification
of inventories.
6. Auditing and Data Processing: EDP auditing in itself is developing as a discipline in
itself.
7. Auditing and Financial Management: the auditor is expected to have knowledge about
various financial techniques such as working capital management, funds flow, ratio
analysis, capital budgeting etc.
8. Auditing and Production: good auditor is one who understands the client and his
business functions such as production, cost system, marketing etc.

Auditing and Behavioral Science (Imp):

• The field of auditing as a discipline involves review of various assertions; both in financial
as well as in non-financial terms, with a view to prove the veracity of such assertions
and expression of opinion by auditor on the same.
• Thus, it is quite logical and natural that the function of audit can be performed if and only
if the person also possesses a good knowledge about the fields in respect of which he is
conducting such a review.
• The discipline of behavioral science is closely linked with the subject of auditing. While
it may be said that an auditor, particularly the financial auditor, deals basically with the
figures contained in the financial statements but he shall be required to interact with
a lot of people in the organisation.

1.7
 • As against the financial auditor, the internal auditor or a management auditor is expected
to deal with human beings rather than financial figures. One of the basic elements in
designing the internal control system is personnel.
• Howsoever, if a sound internal control structure is designed, it cannot work until and
unless the people who are working in the organisation are competent and honest.
The knowledge of human behavior is indeed very essential for an auditor so as to
effectively discharge his duties.

9. QUALITIES OF AN AUDITOR
• The qualities required, are tact, caution, firmness, good temper, integrity, discretion,
industry, judgement, patience, clear headedness and reliability.
• In short, all those personal qualities that goes to make a good businessman contribute to
the making of a good auditor. In addition, he must have the shine of culture for attaining a
great height.
• He must have the highest degree of integrity backed by adequate independence.
• In fact, Code of ethics mentions integrity, objectivity and independence as one of the
fundamental principles of professional ethics.
• He must have a thorough knowledge of the general principles of law which govern
matters with which he is likely to be in intimate contact.
• The Companies Act need special mention but mercantile law, specially the law relating to
contracts, is no less important.
• Needless to say, where undertakings are governed by a special statute, its knowledge will
be imperative; in addition, a sound knowledge of the law and practice of taxation is
unavoidable.
• He must pursue an intensive programme of theoretical education in subjects like
financial and management accounting, general management, business and corporate laws,
computers and information systems, taxation, economics, etc.
• Both practical training and theoretical education are equally necessary for the
development of professional competence of an auditor for undertaking any kind of audit
assignment.
• The auditor should be equipped not only with a sufficient knowledge of the way in
which business generally is conducted but also with an understanding of the special
features peculiar to a particular business whose accounts are under audit.
• The auditor, who holds a position of trust, must have the basic human qualities apart
from the technical requirement of professional training and education.
• He is called upon constantly to critically review financial statements and it is obviously
useless for him to attempt that task unless his own knowledge is that of an expert.
• An exhaustive knowledge of accounting in all its branches is the sine qua non of the
practice of auditing. He must know thoroughly all accounting principles and techniques.

1.8
 10. CONCEPT OF TRUE AND FAIR
• The concept of true and fair is a fundamental concept in auditing.
• The phrase “true and fair” in the auditor’s report signifies that the auditor is required to
express his opinion as to whether the state of affairs and the results of the entity as
ascertained by him in the course of his audit are truly and fairly represented in the
accounts under audit.
• This requires that the auditor should examine the accounts with a view to verify that
all assets, liabilities, income and expenses are stated as amounts which are in accordance
with accounting principles and policies which are relevant and no material amount, item
or transaction has been omitted.
• What constitutes a ‘true and fair’ view is a matter of an auditor’s judgment in the
particular circumstances of a case.
• In more specific terms, to ensure true and fair view, an auditor has to see:
✓ that the assets are neither undervalued or overvalued, according to the applicable
accounting principles,
✓ no material asset is omitted;
✓ the charge, if any, on assets are disclosed;
✓ material liabilities should not be omitted;
✓ the profit and loss account and balance sheet discloses all the matters required to be
disclosed;
✓ accounting policies have been followed consistently; and
✓ all unusual, exceptional or non-recurring items have been disclosed separately

Note:
• SA 700 “Forming an Opinion and Reporting on Financial Statements”, requires the
auditor to form an opinion on the financial statements based on an evaluation of the
conclusions drawn from the audit evidence obtained; and express clearly that
opinion through a written report that also describes the basis for the opinion.
• The auditor is required to express his opinion on the financial statements that, the
accompanying financial statements present fairly, in all material respects, (or give a true
and fair view of) the financial position of the Company as at December 31, 20X1, and (of)
its financial performance and its cash flows for the year then ended in accordance with
Accounting Standards.

1.9
 Notes:

1.10
AUDIT STRATEGY,
AUDIT PLANNING
AND AUDIT
PROGRAMME

2.1
 Please refer SA 300 & 320 in Module 1(SA Module)

Notes:

2.2
 AUDIT
DOCUMENTATION AND
AUDIT EVIDENCE

3.1
 Please refer SA 230, 500, 501, 505, 510, 550, 560, 570, 580,
from Module 1 (SA Module)
Notes:

3.2
RISK ASSESSMENT
AND INTERNAL
CONTROL

4.1
 INTERNAL CONTROL
Meaning of Internal Control
• As per SA-315, “Identifying and Assessing the Risk of Material Misstatement Through
Understanding the Entity and its Environment”, the internal control may be defined as
“the process
✓ designed, implemented and maintained
✓ by those charged with governance, management and other personnel
✓ to provide reasonable assurance about the achievement of an entity’s objectives with
regard to:
▪ reliability of financial reporting,
▪ effectiveness and efficiency of operations,
▪ safeguarding of assets, and
▪ compliance with applicable laws and regulations.
• The term “controls” refers to any aspects of one or more of the components of internal
control.”

Objectives of Internal Control

• transactions are executed in accordance with managements general or specific
authorization;
• all transactions are promptly recorded in the correct amount in the appropriate accounts
and in the accounting period in which executed so as to permit preparation of financial
information within a framework of recognized accounting policies and practices and
relevant statutory requirements, if any, and to maintain accountability for assets;
• assets are safeguarded from unauthorised access, use or disposition; and
• the recorded assets are compared with the existing assets at reasonable intervals and
appropriate action is taken with regard to any differences.

The Entity’s Internal Control

• The auditor shall obtain an understanding of internal control relevant to the audit.
• Although most controls relevant to the audit are likely to relate to financial reporting, not
all controls that relate to financial reporting are relevant to the audit.
• It is a matter of the auditor’s professional judgment whether a control, individually or in
combination with others, is relevant to the audit.

Benefits of Understanding of Internal Control

An understanding of internal control assists the auditor in:
• identifying types of potential misstatements;
• identifying factors that affect the risks of material misstatement, and
• designing the nature, timing, and extent of further audit procedures.

4.2
 ILLUSTRATION:
Auditor GR and Associates, appointed for audit of PNG Ltd, a manufacturing
company engaged in manufacturing of various food items. While planning an audit,
the auditor does not think that it would be necessary to understand internal
controls. Advise the auditor in this regard.
SOLUTION -
The auditor shall obtain an understanding of internal control relevant to the audit.
Although most controls relevant to the audit are likely to relate to financial
reporting, not all controls that relate to financial reporting are relevant to the audit.
It is a matter of the auditor’s professional judgment whether a control, individually
or in combination with others, is relevant to the audit.

Study of various aspects of internal control is divided

into four sections, as follows:

(I) General Nature and Characteristics of Internal Control:

a) Purpose of Internal Control: Internal control is designed, implemented and
maintained to address identified business risks that threaten the achievement of any of
the entity’s objectives that concern:
✓ The reliability of the entity’s financial reporting;
✓ The effectiveness and efficiency of its operations;
✓ Its compliance with applicable laws
✓ and regulations; and
✓ Safeguarding of assets.
The way in which internal control is designed, implemented and maintained varies
with an entity’s size and complexity.
b) Limitations of Internal Control:
i. Internal control can provide only reasonable assurance:
Internal control, no matter how effective, can provide an entity with only
reasonable assurance about achieving the entity’s financial reporting objectives.
The likelihood of their achievement is affected by inherent limitations of internal
control.

4.3
 ii. Human judgment in decision-making:
Realities that human judgment in decision-making can be faulty and that
breakdowns in internal control can occur because of human error.
Example: There may be an error in the design of, or in the change to, a control.
iii. Lack of understanding the purpose:
Equally, the operation of a control may not be effective, such as where
information produced for the purposes of internal control (for example, an
exception report) is not effectively used because the individual responsible for
reviewing the information does not understand its purpose or fails to take
appropriate action.
iv. Collusion among People:
Additionally, controls can be circumvented by the collusion of two or more people
or inappropriate management override of internal control. For example,
management may enter into side agreements with customers that alter the terms
and conditions of the entity’s standard sales contracts, which may result in
improper revenue recognition. Also, edit checks in a software program that are
designed to identify and report transactions that exceed specified credit limits
may be overridden or disabled.
v. Judgements by Management:
Further, in designing and implementing controls, management may make
judgments on the nature and extent of the controls it chooses to implement, and
the nature and extent of the risks it chooses to assume.
vi. Limitations in case of Small Entities:
Smaller entities often have fewer employees due to which segregation of duties is
not practicable. However, in a small owner-managed entity, the owner-manager
may be able to exercise more effective oversight than in a larger entity. This
oversight may compensate for the generally more limited opportunities for
segregation of duties.
On the other hand, the owner-manager may be more able to override controls
because the system of internal control is less structured. This is taken into account
by the auditor when identifying the risks of material misstatement due to fraud.

(II) Controls Relevant to the Audit:

There is a direct relationship between an entity’s objectives and the controls it
implements to provide reasonable assurance about their achievement. The entity’s
objectives, and therefore controls, relate to financial reporting, operations and compliance;
however, not all of these objectives and controls are relevant to the auditor’s risk
assessment.

4.4
Factors relevant to the auditor’s judgment about whether a control, individually or in
combination with others, is relevant to the audit may include such matters as the
following:

• Materiality.
• The significance of the related risk.
• The size of the entity.
• The nature of the entity’s business, including its organisation and ownership
characteristics.
• The diversity and complexity of the entity’s operations.
• Applicable legal and regulatory requirements.
• The circumstances and the applicable component of internal control.
• The nature and complexity of the systems that are part of the entity’s internal
control, including the use of service organisations.
• Whether, and how, a specific control, individually or in combination with others,
prevents, or detects and corrects, material misstatement.

Controls over the completeness and accuracy of information

• Controls over the completeness and accuracy of information produced by the entity
may be relevant to the audit if the auditor intends to make use of the
information in designing and performing further procedures.
• For example, in auditing revenue by applying standard prices to records of sales
volume, the auditor considers the accuracy of the price information and the
completeness and accuracy of the sales volume data.
• Controls relating to operations and compliance objectives may also be relevant to
an audit if they relate to data the auditor evaluates or uses in applying audit
procedures.

Internal control over safeguarding of assets

• Internal control over safeguarding of assets against unauthorized acquisition, use, or
disposition may include controls relating to both financial reporting and operations
objectives.
• The auditor’s consideration of such controls is generally limited to those relevant to
the reliability of financial reporting.
• For example, use of access controls, such as passwords, that limit access to the data
and programs that process cash disbursements may be relevant to a financial
statement audit.
• Conversely, safeguarding controls relating to operations objectives, such as controls
to prevent the excessive use of materials in production, generally are not relevant to
a financial statement audit.

4.5
 Controls relating to objectives that are not relevant to an audit
• An entity generally has controls relating to objectives that are not relevant to an audit
and therefore need not be considered.
• For example, an entity may rely on a sophisticated system of automated controls to
provide efficient and effective operations (such as an airline’s system of automated
controls to maintain flight schedules), but these controls ordinarily would not be
relevant to the audit.
• Further, although internal control applies to the entire entity or to any of its operating
units or business processes, an understanding of internal control relating to each
of the entity’s operating units and business processes may not be relevant to the
audit.

The statute may require the auditor to report on compliance with certain internal
controls:
• In certain circumstances, the statute or the regulation governing the entity may
require the auditor to report on compliance with certain specific aspects of
internal controls as a result, the auditor’s review of internal control may be broader
and more detailed.

(III) Nature and Extent of the Understanding of Relevant Controls:

• Evaluating the design of a control involves considering whether the control,
individually or in combination with other controls, is capable of effectively
preventing, or detecting and correcting, material misstatements
• Implementation of a control means that the control exists and that the entity is
using it.
• There is little point in assessing the implementation of a control that is not effective,
and so the design of a control is considered first.
• An improperly designed control may represent a significant deficiency in internal
control.
• Risk assessment procedures to obtain audit evidence about the design and
implementation of relevant controls may include-
✓ Inquiring of entity personnel.
✓ Observing the application of specific controls.
✓ Inspecting documents and reports.
✓ Tracing transactions through the information system relevant to financial
reporting.
Inquiry alone, however, is not sufficient for such purposes.

4.6
 • Obtaining an understanding of an entity’s controls is not sufficient to test their
operating effectiveness, unless there is some automation that provides for the
consistent operation of the controls.

Example:
Obtaining audit evidence about the implementation of a manual control at a point
in time does not provide audit evidence about the operating effectiveness of the
control at other times during the period under audit. However, because of the
inherent consistency of IT processing, performing audit procedures to determine
whether an automated control has been implemented may serve as a test of that
control’s operating effectiveness, depending on the auditor’s assessment and
testing of controls such as those over program changes.

(IV) Components of Internal Control:

The division of internal control into the following five components provides a useful
framework for auditors to consider how different aspects of an entity’s internal control
may affect the audit:
1. The control environment;
2. The entity’s risk assessment process
3. The information system, including the related business processes, relevant to
financial reporting, and communication
4. Control activities
5. Monitoring of controls.

1. Control Environment
The auditor shall obtain an understanding of the control environment. As part of obtaining
this understanding, the auditor shall evaluate whether:
a) Management has created and maintained a culture of honesty and ethical
behavior; and
b) The strengths in the control environment elements collectively provide an
appropriate foundation for the other components of internal control.

What is included in Control Environment?

The control environment includes:
i. the governance and management functions and
ii. the attitudes, awareness, and actions of those charged with governance and
management.
iii. the control environment sets the tone of an organization, influencing the control
consciousness of its people.

4.7
 Elements of the Control Environment
Elements of the control environment that may be relevant when obtaining an understanding of
the control environment include the following:
a) Communication and enforcement of integrity and ethical values– These are
essential elements that influence the effectiveness of the design, administration and
monitoring of controls.
b) Commitment to competence– Matters such as management’s consideration of the
competence levels for particular jobs and how those levels translate into requisite skills
and knowledge.
c) Participation by those charged with governance– Attributes of those charged with
governance such as:
✓ Their independence from management.
✓ Their experience and stature.
✓ The extent of their involvement and the information they receive, and the
scrutiny of activities.
✓ The appropriateness of their actions, including the degree to which difficult
questions are raised and pursued with management, and their interaction with
internal and external auditors.
d) Management’s philosophy and operating style – Characteristics such as
management’s:
✓ Approach to taking and managing business risks.
✓ Attitudes and actions toward financial reporting.
✓ Attitudes toward information processing and accounting functions and personnel.
e) Organisational structure– The framework within which an entity’s activities for
achieving its objectives are planned, executed, controlled, and reviewed.
f) Assignment of authority and responsibility– Matters such as how authority and
responsibility for operating activities are assigned and how reporting relationships and
authorisation hierarchies are established.
g) Human resource policies and practices– Policies and practices that relate to, for
example, recruitment, orientation, training, evaluation, counselling, promotion,
compensation, and remedial actions.

2. The Entity’s Risk Assessment Process

The auditor shall obtain an understanding of whether the entity has a process for:
a) Identifying business risks relevant to financial reporting objectives;
b) Estimating the significance of the risks;
c) Assessing the likelihood of their occurrence; and
d) Deciding about actions to address those risks.
The entity’s risk assessment process forms the basis for the risks to be managed. If that
process is appropriate, it would assists the auditor in identifying risks of material
misstatement. Whether the entity’s risk assessment process is appropriate to the
circumstances is a matter of judgment.

4.8
 3. The information system, including the related
business processes, relevant to financial reporting
and communication
The auditor shall obtain an understanding of the information system, including the
related business processes, relevant to financial reporting, including the following are as:
a) The classes of transactions in the entity’s operations that are significant to the
financial statements;
b) The procedures by which those transactions are initiated, recorded, processed,
corrected as necessary, transferred to the general ledger and reported in the financial
statements;
c) The related accounting records, supporting information and specific accounts in
the financial statements that are used to initiate, record, process and report
transactions;
d) How the information system captures events and conditions that are significant
to the financial statements;
e) The financial reporting process used to prepare the entity's financial statements;
f) Controls surrounding journal entries.
Communicating Financial Roles and Responsibilities– Obtaining an
Understanding by the Auditor: The auditor shall obtain an understanding of how
the entity communicates financial reporting roles and responsibilities including:
(a) Communications between (b) External communications, such
management and those charged with as those with regulatory
governance;and authorities.
The following points need consideration in this regard:
(i) Understanding of Roles and Responsibilities: Communication by the entity
of the financial reporting roles and responsibilities would involves providing
an understanding of individual roles and responsibilities pertaining to internal
control over financial reporting.
(ii) Understanding regarding Relation of Activities: It includes understanding
by employees as to how their activities relate to the work of others and the
means of reporting exceptions to higher level within the entity.
(iii) Policy Manuals and Financial Reporting Manuals: Communication may
take such forms as policy manuals and financial reporting manuals.
(iv) Open Communication Channels: Open communication channels help
ensure that exceptions are reported and acted on.
(v) Less structured and easier for Small Entities: Communication may be less
structured and easier to achieve in a small entity than in a larger entity due to
fewer levels of responsibility and management’s greater visibility.

4.9
 4. Control Activities
• The auditor shall obtain an understanding of control activities relevant to the audit,
which the auditor considers necessary to assess the risks of material misstatement.
• An audit requires an understanding of only those control activities related to
significant class of transactions, account balance, and disclosure in the financial
statements and the assertions which the auditor finds relevant in his risk assessment
process.
• Control activities are the policies and procedures that help ensure that management
directives are carried out.
• Control activities, whether within IT or manual systems, have various objectives and are
applied at various organisational and functional levels.

Examples of specific control activities include those relating to the following:

a) Control activities that are relevant to the audit are:

• Control activities that relate to significant risks and those that relate to risks for
which substantive procedures alone do not provide sufficient appropriate audit
evidence; or
• Those that are considered to be relevant in the judgment of the auditor;
• As part of the risk assessment, the auditor shall determine whether any of the
risks identified are, in the auditor’s judgment, a significant risk.

In exercising judgment as to which risks are significant risks, the auditor shall
consider at least the following:
(a) Whether the risk is a risk of fraud
(b) Whether the risk is related to recent significant economic, accounting, or other
developments like changes in regulatory environment, etc., and, therefore, requires
specific attention;
(c) The complexity of transactions;
(d) Whether the risk involves significant transactions with related parties;

4.10
 (e) The degree of subjectivity in the measurement of financial information related to the
risk, especially those measurements involving a wide range of measurement
uncertainty; and
(f) Whether the risk involves significant transactions that are outside the normal course of
business for the entity, or that otherwise appear to be unusual.

b) Identifying Significant Risks: Significant risks often relate to significant non- routine
transactions or judgmental matters. Non-routine transactions are transactions that are
unusual, due to either size or nature, and that therefore occur infrequently. Judgmental
matters may include the development of accounting estimates for which there is
significant measurement uncertainty.

c) Significant risks are inherent risks with both a higher likelihood of occurrence and a
higher magnitude of potential misstatement. The auditor assess assertions affected by
a significant risk as higher inherent risk. The following are always significant risks:
• Risks of material misstatement due to fraud
• Significant transactions with related parties that are outside the normal course
of business for the entity

d) Risks of Material Misstatement– Greater for Significant Non-Routine Transactions

Risks of material misstatement may be greater for significant non-routine transactions
arising from matters such as the following:
• Greater management intervention to specify the accounting treatment.
• Greater manual intervention for data collection and processing.
• Complex calculations or accounting principles.
• The nature of non-routine transactions, which may make it difficult for the entity
to implement effective controls over the risks.

e) Risks of material misstatement– Greater for Significant Judgmental Matters

Risks of material misstatement may be greater for significant judgmental matters that
require the development of accounting estimates, arising from matters such as the
following:
• Accounting principles for accounting estimates or revenue recognition may be
subject to differing interpretation.
• Required judgment may be subjective or complex, or require assumptions about
the effects of future events, for example, judgment about fair value.

4.11
 5. Monitoring of Controls
The auditor shall obtain an understanding of the major activities that the entity uses to
monitor internal control over financial reporting.
a) Monitoring of controls Defined: Monitoring of controls is a process to assess the
effectiveness of internal control performance over time.
b) Helps in assessing the effectiveness of controls on a timely basis: It involves assessing
the effectiveness of controls on a timely basis and taking necessary remedial actions.
c) Management accomplishes through ongoing activities, separate evaluations etc.:
Management accomplishes monitoring of controls through ongoing activities, separate
evaluations, or a combination of the two. Ongoing monitoring activities are often built into
the normal recurring activities of an entity and include regular management and
supervisory activities.
d) Management’s monitoring activities include: Management’s monitoring activities may
include using information from communications from external parties such as customer
complaints and regulator comments that may indicate problems or highlight areas in need
of improvement.
e) In case of Small Entities: Management’s monitoring of control is often accomplished by
management’s or the owner-manager’s close involvement in operations. This involvement
often will identify significant variances from expectations and inaccuracies in financial data
leading to remedial action to the control.

Monitoring of Controls– If the entity has an internal audit function

If the entity has an internal audit function, the auditor shall obtain an understanding of the
following:
a) The internal audit function’s responsibilities and how the internal audit function fits
in the entity’s organisational structure; and
b) The activities performed, or to be performed, by the internal audit function.

The following points merit consideration in this regard:

i. Internal Audit Function relevant to the Audit: The entity’s internal audit function is
likely to be relevant to the audit if its activities are related to the entity’s financial
reporting. Also if the auditor expects to use the work of the internal auditors to
modify the audit procedures to be performed. When the auditor determines that the
internal audit function is likely to be relevant to the audit, SA 610 applies.
ii. Size and Structure of the Entity: The objectives of an internal audit function vary
widely depending on the size and structure of the entity and the requirements of
management.

4.12
 iii. Internal audit function may include: The responsibilities of an internal audit function
may include, for example, monitoring of internal control, risk management, and review
of compliance with laws and regulations.
On the other hand, the responsibilities of the internal audit function may be limited to
the review of the economy, efficiency and effectiveness of operations, for example, and
accordingly, may not relate to the entity’s financial reporting.
iv. External auditor’s activities- on the basis of Internal Audit activities: If the internal
audit function’s responsibilities are related to the entity’s financial reporting, the
external auditor’s consideration of the activities performed may include review of the
internal audit function’s audit plan for the period.

(Important Note):
Satisfactory Control Environment – not an absolute deterrent to fraud:
• The existence of a satisfactory control environment can be a positive factor when the
auditor assesses the risks of material misstatement.
• However, although it may help reduce the risk of fraud, a satisfactory control
environment is not an absolute deterrent to fraud.
• Conversely, deficiencies in the control environment may undermine the effectiveness
of controls, in particular in relation to fraud.
• For example, management’s failure to commit sufficient resources to address IT
security risks may adversely affect internal control by allowing improper changes to be
made to computer programs or to data, or unauthorized transactions to be processed.
• As explained in SA 330, the control environment also influences the nature, timing,
and extent of the auditor’s further procedures.
• The control environment in itself does not prevent, or detect and correct, a material
misstatement.
• It may, however, influence the auditor’s evaluation of the effectiveness of other
controls (for example, the monitoring of controls and the operation of specific
control activities) and thereby, the auditor’s assessment of the risks of material
misstatement.

EVALUATION OF INTERN AL CONTROL BY THE AU DITOR

Introduction
• The examination and evaluation of the internal control system is an indispensable part of
the overall audit programme.
• The auditor needs reasonable assurance that the accounting system is adequate and
that all the accounting information which should be recorded has in fact been
recorded. Internal control normally contributes to such assurance.

4.13
 • The auditor should gain an understanding of the accounting system and related
internal controls and should study and evaluate the operations of these internal controls
upon which he wishes to rely in determining the nature, timing and extent of other audit
procedures.

Benefits of Evaluation of Internal Control to the Auditor

The review of internal controls will enable the auditor to know:
1. whether errors and frauds are likely to be located in the ordinary course of operations
of the business;
2. whether an adequate internal control system is in use and operating as planned by the
management;
3. whether an effective internal auditing department is operating;
4. whether any administrative control has a bearing on his work (for example, if the
control over worker recruitment and enrolment is weak, there is a likelihood of dummy
names being included in the wages sheet and this is relevant for the auditor);
5. whether the controls adequately safeguard the assets;
6. how far and how adequately the management is discharging its function in so far as
correct recording of transactions is concerned;
7. how reliable the reports, records and the certificates to the management can be;
8. the extent and the depth of the examination that he needs to carry out in the different
areas of accounting;
9. what would be appropriate audit technique and the audit procedure in the given
circumstances;
10. what are the areas where control is weak and where it is excessive; and
11. whether some worthwhile suggestions can be given to improve the control system.

Formulate Audit Program after understanding Internal

Control
• The auditor can formulate his entire audit programme only after he has had a
satisfactory understanding of the internal control systems and their actual operation.
• If he does not care to study this aspect, it is very likely that his audit programme may
become unwieldy and unnecessarily heavy and the object of the audit may be
altogether lost in the mass of entries and vouchers.
• It is also important for him to know whether the system is actually in operation.
• Often, after installation of a system, no proper follow up is there by the management to
ensure compliance.

4.14
• The auditor, in such circumstances, may be led to believe that a system is in operation
which in reality may not be altogether in operation or may at best operate only
partially.
• This state of affairs is probably the worst that an auditor may come across and he
would be in the midst of confusion, if he does not take care.
• It would be better if the auditor can undertake the review of the internal control
system of client.
• This will give him enough time to assimilate the controls and implications and will
enable him to be more objective in the framing of the audit programme.
• He will also be in a position to bring to the notice of the management the weaknesses of
the system and to suggest measures for improvement.
• At a further interim date or in the course of the audit, he may ascertain how far the
weaknesses have been removed.
• From the foregoing, it can be concluded that the extent and the nature of the audit
programme is substantially influenced by the internal control system in operation.
• In deciding upon a plan of test checking, the existence and operation of internal control
system is of great significance.
• A proper understanding of the internal control system in its content and working also
enables an auditor to decide upon the appropriate audit procedure to be applied in
different areas to be covered in the audit programme.
• In a situation where the internal controls are considered weak in some areas, the auditor
might choose an auditing procedure or test that otherwise might not be required; he
might extend certain tests to cover a large number of transactions or other items than he
otherwise would examine and at times he may perform additional tests to bring him the
necessary satisfaction.

EVALUATION OF INTERN AL CONTROL– METHODS:

(GENERAL METHOD)
• A review of the internal control can be done by a process of study, examination and
evaluation of the control system installed by the management.
• The first step involves determination of the control and procedures laid down by the
management.
• By reading company manuals, studying organisation charts and flow charts and by
making suitable enquiries from the officers and employees, the auditor may ascertain
the character, scope and efficacy of the control system.
• To acquaint himself about how all the accounting information is collected and processed
and to learn the nature of controls that makes the information reliable and protect the
company’s assets, calls for considerable skill and knowledge.

4.15
 • In many cases, very little of this information is available in writing; the auditor must ask
the right people the right questions if he is to get the information he wants.
• It would be better if he makes written notes of the relevant information and
procedures contained in the manual or ascertained on enquiry.
Specific tools to review Internal Control System:
To facilitate the accumulation of the information necessary for the proper review and
evaluation of internal controls, the auditor can use one of the following to help him to know
and assimilate the system and evaluate the same:
• Narrative record;
• Check List;
• Questionnaire; and
• Flow chart.

Tools to review Internal Control System

The Narrative Record
• This is a complete and exhaustive description of the system as found in operation by the
auditor. Actual testing and observation are necessary before such a record can be
developed.
• It may be recommended in cases where no formal control system is in operation and
would be more suited to small business.
• The basic disadvantages of narrative records are:
✓ To comprehend the system in operation is quite difficult.
✓ To identify weaknesses or gaps in the system.
✓ To incorporate changes arising on account of reshuffling of manpower, etc.

Check List
• This is a series of instructions and/or questions which a member of the auditing staff
must follow and/or answer.
• When he completes instruction, he initials the space against the instruction.
• Answers to the check list instructions are usually Yes, No or Not Applicable.
• This is again an on the job requirement and instructions are framed having regard to the
desirable elements of control.

4.16
 A few examples of check list instructions are given hereunder:
1. Are tenders called before placing orders?
2. Are the purchases made on the basis of a written order?
3. Is the purchase order form standardised?
4. Are purchase order forms pre-numbered?
5. Are the inventory control accounts maintained by persons who have nothing to do
with custody of work, receipt of inventory, inspection of inventory and purchase of
inventory?

• The complete check list is studied by the Principal/Manager/Senior to ascertain

existence of internal control and evaluate its implementation and efficiency.

Internal Control Questionnaire

• This is a comprehensive series of questions concerning internal control.
• This is the most widely used form for collecting information about the existence,
operation and efficiency of internal control in an organisation.
• An important advantage of the questionnaire approach is that oversight or omission of
significant internal control review procedures is less likely to occur with this method.
• With a proper questionnaire, all internal control evaluation can be completed at one
time or in sections.
• The review can more easily be made on an interim basis.
• The questionnaire form also provides an orderly means of disclosing control defects.
• It is the general practice to review the internal control system annually and record the
review in detail.
• In the questionnaire, generally questions are so framed that a ‘Yes’ answer denotes
satisfactory position and a ‘No’ answer suggests weakness.
• Provision is made for an explanation or further details of ‘No’ answers.
• In respect of questions not relevant to the business, ‘Not Applicable’ reply is given.
• The questionnaire is usually issued to the client and the client is requested to get it
filled by the concerned executives and employees.
• If on a perusal of the answers, inconsistencies or apparent incongruities are noticed,
the matter is further discussed by auditor’s staff with the client’s employees for a
clear picture.
• The concerned auditor then prepares a report of deficiencies and recommendations for
improvement.

4.17
 Flow Chart
• It is a graphic presentation of each part of the company’s system of internal control.
• A flow chart is considered to be the most concise way of recording the auditor’s review
of the system.
• It minimises the amount of narrative explanation and thereby achieves a consideration
or presentation not possible in any other form.
• It gives bird’s eye view of the system and the flow of transactions and integration and in
documentation, can be easily spotted and improvements can be suggested.
• It is also necessary for the auditor to study the significant features of the business
carried on by the concern;
• the nature of its activities and various channels of goods and materials as well as cash,
both inward and outward; and also a comprehensive study of the entire process of
manufacturing, trading and administration.
• This will help him to understand and evaluate the internal controls in the correct
perspective.

TESTING OF INTERNAL CONTROL

1. Test of Controls:
Test of controls are performed to obtain audit evidence about the effectiveness of the:
a) Design of the accounting and internal control systems, i.e., whether they are
suitably designed to prevent or detect and correct material misstatements; &
b) Operation of the internal controls throughout the period.
2. Test of controls include tests of elements of the control environment where strengths in
the control environment are used by auditors to reduce control risk.
3. Some of the procedures performed to obtain the understanding of the accounting and
internal control systems may not have been specifically planned as tests of control but
may provide audit evidence about the effectiveness of the design and operation of
internal controls relevant to certain assertions and, consequently, serve as tests of
control.
4. For example, in obtaining the understanding of the accounting and internal control
systems pertaining to cash, the auditor may have obtained audit evidence about the
effectiveness of the bank reconciliation process through inquiry and observation.
5. When the auditor concludes that procedures performed to obtain the understanding of
the accounting and internal control systems also provide audit evidence about the
suitability of design and operating effectiveness of policies and procedures relevant to a
particular financial statement assertion, the auditor may use that audit evidence,
provided it is sufficient to support a control risk assessment at less than a high level.

4.18
6. Test of controls may include:
• Inspection of documents supporting transactions and other events to gain audit
evidence that internal controls have operated properly, for example, verifying that a
transaction has been authorised.
• Inquiries about, and observation of, internal controls which leave no audit trail, for
example, determining who actually performs each function and not merely who is
supposed to perform it.
• Re-performance involves the auditor’s independent execution of procedures or
controls that were originally performed as part of the entity’s internal control, for
example, reconciliation of bank accounts, to ensure they were correctly performed by
the entity.
• Testing of internal control operating on specific computerised applications or over the
overall information technology function, for example, access or program change
controls.
Note: Relationship between test of controls and substantive procedure.
• While obtaining audit evidence about the effective operation of internal controls, the
auditor considers how they were applied, the consistency with which they were applied
during the period and by whom they were applied.
• The concept of effective operation recognises that some deviations may have
occurred.
• Deviations from prescribed controls may be caused by such factors as changes in key
personnel, significant seasonal fluctuations in volume of transactions and human
error.
• When deviations are detected the auditor makes specific inquiries regarding these matters,
particularly, the timing of staff changes in key internal control functions.
• The auditor then ensures that the tests of control appropriately cover such a period of
change or fluctuation.
• Based on the results of the tests of control, the auditor should evaluate whether the
internal controls are designed and operating as contemplated in the preliminary
assessment of control risk.
• The evaluation of deviations may result in the auditor concluding that the assessed
level of control risk needs to be revised.
• In such cases, the auditor would modify the nature, timing and extent of planned
substantive procedures.
• Before the conclusion of the audit, based on the results of substantive procedures and
other audit evidence obtained by the auditor, the auditor should consider whether
the assessment of control risk is confirmed.
• In case of deviations from the prescribed accounting and internal control systems, the
auditor would make specific inquiries to consider their implications.

4.19
 • Where, on the basis of such inquiries, the auditor concludes that the deviations are such
that the preliminary assessment of control risk is not supported, he would amend the same
unless the audit evidence obtained from other tests of control supports that assessment.
• Where the auditor concludes that the assessed level of control risk needs to be revised, he
would modify the nature, timing and extent of his planned substantive procedures.
• It has been suggested that actual operation of the internal control should be tested by
the application of procedural tests and examination in depth.
• Procedural tests simply mean testing of the compliance with the procedures laid down
by the management in respect of initiation, authorisation, recording and documentation of
transaction at each stage through which it flows.

For example, the procedure for sales requires the following:

• Before acceptance of any order the position of inventory of the relevant article should be
known to ascertain whether the order can be executed in time.
• An advice under the authorisation of the sales manager should be sent to the party
placing the order, internal reference number, and the acceptance of the order. This
advice should be prepared on a standardised form and copy thereof should be
forwarded to inventory section to enable it to prepare for the execution of the order in
time.
• The credit period allowed to the party should be the normal credit period. For any
special credit period a special authorisation of the sales manager would be necessary.
• The rate at which the order has been accepted and other terms about transport,
insurance, etc., should be clearly specified.
• Before deciding upon the credit period, a reference should be made to the credit section
to know the creditworthiness of the party and particularly whether the party has honored
its commitments in the past.
• An auditor testing the internal controls on sales should invariably test whether any of the
aforesaid procedures have been omitted.
• If credit has actually been granted without a reference to the credit section to know the
creditworthiness of the party, it is possible that the amount may prove bad because of
the financial crisis or deadlock in the management of the party, a fact which could have
been easily gathered from the credit section.
• Similarly, if an order is received without a reference to the inventory section, it is likely
due to non-availability of the inventory on the stipulated date; execution of the order
may be delayed and the company may have to compensate the buyer for the damages
suffered by him.

4.20
 INTERNAL CONTROL AND IT ENVIRONMENT
Characteristics of Manual and Automated Elements of
Internal Control Relevant to the Auditor’s Risk
Assessment
An entity’s system of internal control contains manual elements and often contains automated
elements. The characteristics of manual or automated elements relevant to the auditor’s risk
assessment and further audit procedures are explained hereunder-
1. Controls in Manual and IT System: The use of manual or automated elements in internal
control affects the manner in which transactions are initiated, recorded, processed, and
reported:
✓ Controls in a manual system may include such procedures as approvals and
reviews of transactions, and reconciliations and follow-up of reconciling items.
Alternatively, an entity may use automated procedures to initiate, record, process, and
report transactions, in which case records in electronic format replace paper
documents.
✓ Controls in IT systems consist of a combination of automated controls (for
example, controls embedded in computer programs) and manual controls. Further,
manual controls may be independent of IT, may use information produced by IT, or
may be limited to monitoring the effective functioning of IT and of automated
controls, and to handling exceptions.
2. Use of IT: An entity’s mix of manual and automated elements in internal control varies
with the nature and complexity of the entity’s use of IT.
3. Generally, IT benefits an entity’s internal control by enabling an entity to:
✓ Consistently apply predefined business rules and perform complex calculations
in processing large volumes of transactions or data;
✓ Enhance the timeliness, availability, and accuracy of information;
✓ Facilitate the additional analysis of information;
✓ Enhance the ability to monitor the performance of the entity’s activities and its
policies and procedures;
✓ Reduce the risk that controls will be circumvented; and
✓ Enhance the ability to achieve effective segregation of duties by implementing
security controls in applications, databases, and operating systems.
4. IT also poses specific risks to an entity’s internal control, including, for example:
✓ Reliance on systems or programs that are inaccurately processing data, processing
inaccurate data, or both.

4.21
 ✓ Unauthorised access to data that may result in destruction of data or improper
changes to data, including the recording of unauthorised or non- existent
transactions, or inaccurate recording of transactions. Particular risks may arise where
multiple users access a common database.
✓ The possibility of IT personnel gaining access privileges beyond those necessary to
perform their assigned duties thereby breaking down segregation of duties.
✓ Unauthorised changes to data in master files.
✓ Unauthorised changes to systems or programs.
✓ Failure to make necessary changes to systems or programs.
✓ Inappropriate manual intervention.
✓ Potential loss of data or inability to access data as required.
5. Suitability: Manual elements in internal control may be more suitable where judgment and
discretion are required.
6. Reliability: Manual elements in internal control may be less reliable than automated
elements because they can be more easily bypassed, ignored, or overridden and they are
also more prone to simple errors and mistakes. Consistency of application of a manual
control element cannot therefore be assumed.
7. Nature of Entity’s Information System: The extent and nature of the risks to internal
control vary depending on the nature and characteristics of the entity’s information system.
The entity responds to the risks arising from the use of IT or from use of manual elements
in internal control by establishing effective controls in light of the characteristics of the
entity’s information system.

BENEfiTS OF IT IN AN ENTITY’S INTERNAL CONTROL

✓ Processing of large volumes of transactions or data becomes simple;
✓ Enhances the timeliness, availability, and accuracy of information;
✓ Facilitate the additional analysis of information;
✓ Enhance the ability to monitor the performance of the entity’s activities and its
policies and procedures;
✓ Reduce the risk that controls will be circumvented; and
✓ Effective segregation of duties through security controls.

4.22
 BASICS OF INTERNAL FINANCIAL CONTROL AND
REPORTING REQUIREMEN TS
• Clause (e) of Sub-section 5 of Section 134 explains the meaning of internal financial
controls as, “the policies and procedures adopted by the company for ensuring the
orderly and efficient conduct of its business, including adherence to company’s policies,
the safeguarding of its assets, the prevention and detection of frauds and errors, the
accuracy and completeness of the accounting records, and the timely preparation of
reliable financial information.”
• From the above definition, it is clear that internal financial controls are the policies and
procedures adopted by the company for:
✓ ensuring the orderly and efficient conduct of its business, including adherence to
company’s policies,
✓ the safeguarding of its assets,
✓ the prevention and detection of frauds and errors,
✓ the accuracy and completeness of the accounting records, and
✓ the timely preparation of reliable financial information.”
• Auditors’ Responsibility for Reporting on Internal Financial Controls over Financial
Reporting in India
✓ Clause (i) of Sub-section 3 of Section 143 of the Act requires the auditors’ report to
state whether the company has adequate internal financial controls system in
place and the operating effectiveness of such controls.
✓ It may be noted that auditor’s reporting on internal financial controls is a
requirement specified in the Act and, therefore, will apply only in case of reporting
on financial statements prepared under the Act and reported under Section 143.
✓ Accordingly, reporting on internal financial controls will not be applicable with
respect to interim financial statements, such as quarterly or half-yearly financial
statements, unless such reporting is required under any other law or regulation.
• Objectives of an auditor in an audit of internal financial controls over financial
reporting:
✓ The auditor’s objective in an audit of internal financial controls over financial reporting
is, “to express an opinion on the effectiveness of the company’s internal financial
controls over financial reporting.” It is carried out along with an audit of the
financial statements.
✓ Reporting under Section 143(3)(i) is dependent on the underlying criteria for
internal financial controls over financial reporting adopted by the management.
✓ However, any system of internal controls provides only a reasonable assurance on
achievement of the objectives for which it has been established. Also, the auditor shall
use the concept of materiality in determining the extent of testing such controls.

4.23
 ✓ Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the board report
of all companies to state the details in respect of adequacy of internal financial
controls with reference to the financial statements.
✓ The inclusion of the matters relating to internal financial controls in the directors
responsibility statement is in addition to the requirement of the directors stating
that they have taken proper and sufficient care for the maintenance of adequate
accounting records in accordance with the provisions of the 2013 Act for
safeguarding the assets of the company and for preventing and detecting fraud
and other irregularities.

12. DIFFERENCE BETWEEN I NTERNAL FINANCIAL CO NTROL

AND INTERNAL CONTROL OVER FINANCIAL REPORTING
• Internal Financial Control as per Section 134(5)(e), “the policies and procedures
adopted by the company for ensuring the orderly and efficient conduct of its business,
including adherence to company’s policies, the safeguarding of its assets, the prevention
and detection of frauds and errors, the accuracy and completeness of the accounting
records, and the timely preparation of reliable financial information.”
• On the other hand, Internal controls over financial reporting-is required where
auditors are required to express an opinion on the effectiveness of an entity’s internal
controls over financial reporting, such opinion is in addition to and distinct from the
opinion expressed by the auditor on the financial statements.

4.24
 FRAUD AND
RESPONSIBILITIES
OF THE AUDITOR

5.1
 Please refer SA 240 from Module 1(SA Module)

Notes:

5.2
 AUDIT IN AN
AUTOMATED
ENVIRONMENT

6.1
 1. WHAT IS AN AUTOMATED ENVIRONMENT?
An automated environment basically refers to a business environment where the processes,
operations, accounting and even decisions are carried out by using computer systems – also
known as Information Systems (IS) or Information Technology (IT) systems.

Key features of an Automated Environment:

• The fundamental principle of an automated environment is the ability to carry out
business with less manual intervention and more system driven.
• The complexity of a business environment depends on the level of automation i.e., if
a business environment is more automated, it is likely to be more complex.
• The Key Features are as follows:
✓ Enables faster business operations
✓ Accuracy in data processing and computation
✓ Ability to process large volumes of transactions
✓ Integration between business operations
✓ Better security and controls
✓ Less prone to human errors
✓ Provides latest information
✓ Connectivity and Networking Capability.
• Similarly, there are several other aspects that an auditor should consider to determine the
level of automation and complexity of a business environment which we will look at in the
following sections.

Example:
1. Think about how banking transactions are carried out using ATMs (Automated Teller
Machines), or how tickets can be purchased using “apps” on mobile phones, etc. In
these examples, you can see how these computer systems enable us to transact business
at any time and any day.
2. If a company uses an integrated enterprise resource planning system (ERP) viz., SAP,
Oracle etc., then it is considered more complex to audit. On the other hand, if a company
is using an off-the-shelf accounting software, then it is likely to be less automated and
hence less complex environment.

2. RELEVANCE OF ‘IT’ IN AN AUDIT

• When a business operates in a more automated environment it is likely that we will see
several business functions and activities happening within the systems. Consider the
following aspects instead of:

6.2
 ✓ Computation and Calculations are automatically carried out (for example, bank
interest computation and inventory valuation).
✓ Accounting entries are posted automatically (for example, sub-ledger to GL
postings are automatic).
✓ Business policies and procedures, including internal controls, are applied
automatically (for example, delegation of authority for journal approvals, customer
credit limit checks are performed automatically).
✓ Reports used in business are produced from systems. Management and other
stakeholders rely on these reports and information produced (for example,
debtors ageing report).
✓ User access and security are controlled by assigning system roles to users (for
example, segregation of duties can be enforced effectively).
• Companies derive benefit from the use of IT systems as an enabler to support various
business operations and activities.

Auditors need to understand the relevance of these IT systems to an audit of

financial statements.
• While it is true that the use of IT systems and automation benefit the business by making
operations more accurate, reliable, effective and efficient, such systems also introduce
certain new risks, including IT specific risks, which need to be considered, assessed and
addressed by management.
• To the extent that it is relevant to an audit of financial statements, even auditors are
required to understand, assess and respond to such risks that arise from the use of IT
systems.
• In an audit of financial statements, the primary focus is around those risks that are
relevant to financial reporting.
• However, there could be other non-audit assurance engagements that auditors maybe
involved wherein the area of focus could include those IT risks relevant to company’s
compliance and business operations in addition to financial reporting risks.

Examples of such non-audit assurance engagements are internal audits, IT audits, pre-
implementation reviews, data migration audits, third party assurance.

• In some of the above situations it is likely that carrying out audit using traditional
substantive audit procedures may be difficult or even not feasible if the company
prepares, records and conducts majority of business activities through IT systems only.
• On the other hand, many companies may use less complex IT systems including
desktop based accounting or spreadsheets. In such situations, the relevance of IT to an
audit could be less. However, the auditor is still required to carry out at least an
understanding the IT environment of the company and document the same.

6.3
 • Another area where IT can be relevant to audit is by using data analytics using computer
assisted audit techniques (CAATs). By using data analytics, it is possible to improve the
effectiveness and efficiency of an audit.

Conclusion
From the above, we can understand how IT is relevant to an audit under different
situations viz., audit, non-audit and meeting regulatory compliance requirements.

Note 1
As per Companies Act 2013, there is greater emphasis given to internal financial controls
(IFC) from a regulatory point of view.
a) Directors and those charged with governance (including Board of directors,
Audit committee) are responsible for the implementation of internal controls
framework within the company.
b) The auditors’ responsibilities now include reporting on Internal Financial
Controls over Financial Reporting which include and understanding IT
environment of the company and relevant risks & controls. We will learn more
about IFC in further sections of this chapter.

Note 2
Given below are some situations in which IT will be relevant to an audit,
• Increased use of Systems and Application software in Business (for example, use of
ERPs)
• Complexity of transactions has increased (multiple systems, network of systems)
• Hi-tech nature of business (Telecom, e-Commerce).
• Volumes of transactions are high (Insurance, Banking, Railways ticketing).
• Company Policy (Compliance).
• Regulatory requirements - Companies Act 2013, IT Act 2008.
• Required by Indian and International Standards -
• Increases efficiency and effectiveness of audit.

3. RISKS & CONTROLS IN AN AUTOMATED ENVIRONMENT

Understanding and Documenting Automated

Environment:

6.4
In an audit of financial statements, an auditor is required to understand the entity and its
business, including IT as per SA 315.
Understanding the entity and its automated environment involves understanding how IT
department is organised, IT activities, the IT dependencies, relevant risks and controls.
• Given below are some of the points that an auditor should consider obtaining an
understanding of the company’s automated environment:
✓ Information systems being used (one or more application systems and what they
are).
✓ Their purpose (financial and non-financial).
✓ Location of IT systems - local vs global.
✓ Architecture (desktop based, client-server, web application, cloud based).
✓ Version (functions and risks could vary in different versions of same application).
✓ Interfaces within systems (in case multiple systems exist).
✓ In-house vs Packaged.
✓ Outsourced activities (IT maintenance and support).
✓ Key persons (CIO, CISO, Administrators).
• The understanding of a company’s IT environment should be documented [Ref. SA 230 –
Audit Documentation] using any standard format or template.
An example of one such template that can be used to document our understanding
is illustrated below.

• Having a summarized document helps the auditor in determining the areas considered
in scope of audit as can be seen from the last column.
• Having obtained an understanding of the IT systems and the automated environment of a
company, the auditor should now understand the risks that arise from the use of IT
systems.
• Given below are some such risks that should be considered:
✓ Inaccurate processing of data, processing inaccurate data, or both.
✓ Unauthorized access to data.
✓ Direct data changes (backend changes).
✓ Excessive access / Privileged access (super users).

6.5
 ✓ Lack of adequate segregation of duties.
✓ Unauthorized changes to systems or programs.
✓ Failure to make necessary changes to systems or programs.
✓ Loss of data.

Impact of IT related risks i.e. on Substantive Audit,

Controls and Reporting:
The above risks, if not mitigated, could have an impact on audit in different ways. Let us
understand how:

✓ First, we may not be able to rely on the data obtained from systems where such risks
exist. This means, all forms of data, information or reports that we obtain from systems
for the purpose of audit has to be thoroughly tested and corroborated for
completeness and accuracy.
✓ Second, we will not be able to rely on automated controls, calculations, accounting
procedures that are built into the applications. Additional audit work may be required
in this case.
✓ Third, due to the regulatory requirement of auditors to report on internal financial
controls of a company, the audit report also may have to be modified in some
instances.

6.6
• In all the above scenarios, it is likely that the auditor will be required to obtain more
audit evidence and perform additional audit work.
• The auditor should also be able to demonstrate how the risks were identified and what
audit evidence was obtained and validated to address these IT risks.
• It should be remembered that as the complexity, automation and dependence of
business operations on IT systems increases, the severity and impact of IT risks too
increases accordingly.
• The auditor should apply professional judgment in determining and assessing such risks
and plan the audit response appropriately.
• To mitigate the above (and more) risks and maintain the confidentiality, integrity,
availability and security of data, companies implement IT controls.

Types of Controls in an Automated Environment

• General IT Controls
• Application Controls
• IT-Dependent Controls

General IT Controls
• “General IT controls are policies and procedures that relate to many applications and
support the effective functioning of application controls. They apply to mainframe,
miniframe, and end-user environments.
• General IT-controls that maintain the integrity of information and security of data
commonly include controls over the following:” (SA 315)
✓ Data center and network operations
✓ Program change
✓ Access security
✓ Application system acquisition, development, and maintenance (Business
Applications)
• These are IT controls generally implemented to mitigate the IT specific risks and
applied commonly across multiple IT systems, applications and business processes.
• Hence, General IT controls are known as “pervasive” controls or “indirect” controls.

Application Controls
• Application controls include both automated or manual controls that operate at a
business process level. Automated Application controls are embedded into IT

6.7
 applications viz., ERPs and help in ensuring the completeness, accuracy and integrity of
data in those systems.

Examples of automated applications include:

• Edit checks and validation of input data,
• Sequence number checks,
• User limit checks,
• Reasonableness checks,
• Mandatory data fields.

IT dependent Controls
• IT dependent controls are basically manual controls that make use of some form of data
or information or report produced from IT systems and applications. In this case, even
though the control is performed manually, the design and effectiveness of such controls
depends on the reliability of source data.
• Due to the inherent dependency on IT, the effectiveness and reliability of automated
application controls and IT dependent controls require the General IT Controls to be
effective.

General IT Controls vs. Application Controls

• These two categories of control over IT systems are interrelated.
• The relationship between the application controls and the General IT Controls is such that
General IT Controls are needed to support the functioning of application controls,
and both are needed to ensure complete and accurate information processing
through IT systems.

Examples of General IT Controls

a) Data Center and Network Operations

Objective: To ensure that production systems are processed to meet financial reporting
objectives.

Activities:
✓ Overall Management of Computer Operations Activities
✓ Batch jobs – preparing, scheduling and executing
✓ Backups – monitoring, storage & retention

6.8
✓ Performance Monitoring – operating system, database and networks
✓ Recovery from Failures – BCP, DRP
✓ Help Desk Functions – recording, monitoring & tracking
✓ Service Level Agreements – monitoring & compliance
✓ Documentation - operations manuals, service reports
✓ User Training

b) Program Change
Objective: To ensure that modified systems continue to meet financial reporting
objectives.

Activities:
✓ Change Management Process – definition, roles & responsibilities
✓ Change Requests – record, manage, track
✓ Making Changes – analyze, design, develop
✓ Test Changes – test plan, test cases, UAT
✓ Apply Changes in Production
✓ Emergency & Minor Changes
✓ Documentation – user/technical manuals
✓ User Training

c) Access Security
Objective: To ensure that access to programs and data is authenticated and authorized to
meet financial reporting objectives.

Activities:
✓ Security Organization & Management
✓ Security Policies & Procedures
✓ Application Security
✓ Data Security
✓ Operating System Security
✓ Network Security – internal network, perimeter network
✓ Physical Security – access controls, environment controls
✓ System Administration & Privileged Accounts – Sysadmins, DBAs, Super users

6.9
 d) Application system acquisition, development, and maintenance
Objective: To ensure that systems are developed, configured and implemented to meet
financial reporting objectives.
Activities:
✓ Overall Mgmt. of Development Activities
✓ Project Initiation
✓ Analysis & Design
✓ Construction
✓ Testing & Quality Assurance
✓ Data Conversion
✓ Go-Live Decision
✓ Documentation & Training

4. TESTING METHODS
There are basically four types of audit tests that should be used.
✓ Inquiry,
✓ Observation,
✓ Inspection and
✓ Re-performance.

Inquiry:
It is the most efficient audit test but it is also gives the least audit evidence.
Hence, inquiry should always be used in combination with any one of the other audit
testing methods.
Inquiry alone is not sufficient.

Re-performance
It is most effective as an audit test and gives the best audit evidence.
However, testing by re-performance could be very time consuming and least efficient.

Note 1:
Generally, applying inquiry in combination with inspection gives the most effective and
efficient audit evidence.

6.10
 Note 2:
However, which audit test to use, when and in what combination is a matter of
professional judgement and will vary depending on several factors including
✓ risk assessment,
✓ control environment,
✓ desired level of evidence required,
✓ history of errors/misstatements,
✓ complexity of business,
✓ assertions being addressed, etc.

The auditor should document the nature of test (or combination of tests) applied along
with the judgements in the audit file as required by SA 230.

When testing in an automated environment, some of the more common methods are as
follows:
• Obtain an understanding of how an automated transaction is processed by doing a
walkthrough of one end-to-end transaction using a combination of inquiry,
observation and inspection.
• Observe how a user processes transactions under different scenarios.
• Inspect the configuration defined in an application.
• To rely on the system and application-based information including
✓ Data,
✓ Reports,
✓ Automated controls,
✓ Configurations,
✓ Calculations and
✓ IT dependent controls
It is essential to first determine the existence and effectiveness of General IT Controls.
Note:
Where the general IT controls (GIT) are not existing or existing but ineffective, the
auditor should assess the impact of IT risks and complexity of the automated
environment in which the business operations take place and plan alternative audit
procedures in order to rely on the system-based information.

6.11
6.12
 5. INTERNAL FINANCIAL CONTROLS AS PER REGULATORY
REQUIREMENTS
The term Internal Financial Controls (IFC) basically refers to the policies and procedures put
in place by companies for ensuring:
• reliability of financial reporting
• effectiveness and efficiency of operations
• compliance with applicable laws and regulations
• safeguarding of assets
• prevention and detection of frauds

The Companies Act, 2013 has placed a greater emphasis on the effective implementation and
reporting on the internal controls for a company.
The table below gives a summary of the requirements of the Act.
Who is
Reference Applicability
responsible

Sec 134(5)(e) Board of Directors Listed Companies

Rule 8 (5) of Companies Board of Directors All Companies

(Accounts) Rules

Sec 149(8) and Schedule IV Independent All companies having

Directors Independent Directors

Sec 177 Audit Committee All companies having Audit

committee

Sec 143(3) (i) Statutory Auditors All Companies

• The directors and management have primary responsibility of implementing and

maintaining an effective internal controls framework and auditors are expected to
evaluate, validate and report on the design and operating effectiveness of internal
financial controls.
• The Guidance note on Audit of Internal Financial Controls over Financial Reporting
issued by the Institute of Chartered Accountants of India provides a framework that
auditors should follow to fulfil their responsibility.

6.13
 Control Based Audit Approach

6. DATA ANALYTICS FOR AUDIT

• The combination of processes, tools and techniques that are used to tap vast
amounts of electronic data to obtain meaningful information is called data analytics.
• While it is true that companies can benefit immensely from the use of data analytics in
terms of
✓ increased profitability,
✓ better customer service,
✓ gaining competitive advantage,
✓ more efficient operations, etc.,
Even auditors can make use of similar tools and techniques in the audit process and
obtain good results.
• The tools and techniques that auditors use in applying the principles of data analytics are
known as Computer Assisted Auditing Techniques or CAATs in short.
• Data analytics can be used in testing of electronic records and data residing in IT
systems using spreadsheets and specialized audit tools viz., IDEA and ACL to perform the
following:

6.14
 ✓ Check completeness of data and population that is used in either test of controls
or substantive audit tests.
✓ Selection of audit samples – random sampling, systematic sampling.
✓ Re-computation of balances – reconstruction of trial balance from transaction
data.
✓ Re-performance of mathematical calculations – depreciation, bank interest
calculation.
✓ Analysis of journal entries as required by SA 240.
✓ Fraud investigation.
✓ Evaluating impact of control deficiencies.

There are several steps that should be followed to achieve success with CAATs and any of the
supporting tools.

A suggested approach to benefit from the use of CAATs is given in the illustration below:

7. ASSESS AND REPORT AUDIT FINDINGS

• At the conclusion of each audit, it is possible that there will be certain findings or
exceptions in IT environment and IT controls of the company that need to be assessed
and reported to relevant stakeholders including management and those charged with
governance viz., Board of directors, Audit committee

6.15
 [Refer SA 260 (Revised) – Communication with Those Charged with Governance for
more details].
• Some points to consider are as follows:
✓ Are there any weaknesses in IT controls?
✓ What is the impact of these weaknesses on overall audit?
✓ Report deficiencies to management – Internal Controls Memo or Management
Letter.
✓ Communicate in writing any significant deficiencies to those charged with
Governance.
• The auditor needs to assess each finding or exception to determine impact on the audit
and evaluate if the exception results in a deficiency in internal control.
• This approach and thought process is the same when auditing in an automated
environment or when auditing in a more manual environment.

Note:
• A deficiency in internal control exits if a control is designed, implemented or
operated in such a way that it is unable to prevent, or detect and correct,
misstatements in the financial statements on a timely basis; or the control is missing.
• Evaluation and assessment of audit findings and control deficiencies involves applying
professional judgement that include considerations for quantitative and qualitative
measures.
• Each finding should be looked at individually and in the aggregate by combining
with other findings/deficiencies.

The illustration below is an example of a control deficiency in General IT Controls and

how this audit finding is reported to management.

6.16
 Reporting Audit Findings – An Illustration:
Password resets should be supported with proper request.
Observation As per Information Security Policy User Access changes should
be initiated and approved.
However, we observed that there is no formal process being
followed for password reset in SAP.
Password reset requests are presently communicated over
phone and there is no supporting documentation being
maintained for password reset requests.
[Ref Information Security policy sub-section no.........]
Exposure Passwords of User ID with critical privileges may be reset and
misused.
Non-compliance with Information Security Policy.

Recommendations It is recommended that all password resets should be

requested through a formal process.
Adequate supporting documentation should be
maintained for user changes in SAP, including password
resets, and reviewed periodically.
Management Comments
Response

6.17
 Notes:

6.18
AUDIT SAMPLING

7.1
 Please refer SA 530 from Module 1 (SA Module)
Notes:

7.2
ANALYTICAL
PROCEDURES

8.1
 Please refer SA 520 from Module 1 (SA Module)
Notes:

8.2
AUDIT OF ITEMS
OF FINANCIAL
STATEMENTS

9.1
 OVERVIEW

• Introduction
Part 9A

• Balance Sheet Captions (Liabilities)

Part 9B

• Balance Sheet Captions (Assets)

Part 9C

• Income Statement Captions

Part 9D

9.2
INTRODUCTION

9A.1
 INTRODUCTION
• Companies prepare their financial statements in accordance with the framework of
generally accepted accounting principles (Indian GAAP), also commonly referred to
as accounting standards or financial reporting standards (Ind AS).
• A financial statement audit comprises the examination of an entity’s financial
statements and accompanying disclosures by an independent auditor. The result of this
examination is a report by the auditor, attesting to the truth and fairness of presentation
of the financial statements and related disclosures.
• In preparing financial statements, Company’s management makes implicit or explicit
claims (i.e. assertions) regarding
✓ the completeness,
✓ Cut-offs
✓ existence/ occurrence,
✓ valuation / measurement,
✓ rights and obligations and
✓ presentation and disclosure
of assets, liabilities, equity, income, expenses and disclosures in accordance with the
applicable financial reporting standards/ accounting standards.

Example:
If Company X’s balance sheet shows building with carrying amount of ` 50 lakh, the
auditor shall assume that the management has claimed/ asserted that:
• The building recognized in the balance sheet exists as at the period- end
(existence assertion);
• Company X owns and controls such building (Rights and obligations assertion);
• The building has been valued accurately in accordance with the measurement
principles (Valuation assertion);
• All buildings owned and controlled by Company X are included within the carrying
amount of ` 50 lakh (Completeness assertion).

The auditor then needs to draw an audit programme to verify and obtain sufficient and
appropriate audit evidence for each of the above claims/ assertions made by the
management.

9A.2
 ASSERTIONS MAY BE BR OADLY CLASSIFIED INT O THE
FOLLOWING TYPES

1. Income Statement Captions Comprising Revenue and

Expense Balances:
Assertions Explanation Example: Employee benefit expenses
Occurrence Transactions recognized in the Employee benefit expense has been
financial statements have incurred during the period in respect of
occurred and relate to the the personnel employed by the entity.
entity. Employee benefit expense does not
include the cost of any unauthorized
personnel.
Completeness All transactions that were Employee benefit expenses in respect of
supposed to be recorded have all personnel have been fully accounted
been recognized in the for.
financial statements.

Cut-off Whether all income and Employee benefit expenses recognized

expenses are reported in the during the period relates to the current
appropriate period. accounting period only.
Cut-off is a separate assertion
because the substantive
procedures to verify it are
typically different from those
applied to the other
components of completeness.

Measurement Transactions have been Employee benefit expense has been

recorded accurately at their measured/ calculated accurately.
appropriate amounts in the Any adjustments such as tax deduction
financial statements. at source have been correctly
reconciled and accounted for.

Presentation • Transactions have been Employee benefit expense has

and Disclosure classified and presented been fairly allocated between:
fairly in the financial
• Operating expenses incurred in
statements.
production activities;
• Presentation and disclosure • General and administrative
assertions are considered expenses; and

9A.3
 during the course of the • Cost of personnel relating to any
audit by procedures to self-constructed assets other than
determine that disclosures inventory.
are complete and accurate.
• The disclosures that are
most susceptible to
material misstatement
are those that require
significant judgment and
qualitative assessments.
• Audit teams assess the
completeness and
accuracy of disclosures by
determining that the
disclosures provide
information in a manner
that does not materially
omit, distort or mislead
the user.

2. Balance Sheet Captions Comprising Assets, Liabilities

and Equity Balances:
Assertions Explanation Example: Inventory balance
Existence Assets, liabilities and equity Inventory recognized in the balance
balances exist as at the period sheet actually existed as at the period
end. end.
Completeness All assets, liabilities and equity All inventory units held by the audit
balances that were supposed entity and that should have been
to be recorded have been recorded, has been recognized in the
recognized in the financial financial statements.
statements. Any inventory held by a third party on
behalf of the audit entity has been
included as part of the inventory
balance.

Cut-off Whether all assets and Inventory balance as at the year- end
liabilities are reported in the does not include any element of next
appropriate period. financial year.

9A.4
 Assertions Explanation Example: Inventory balance
Valuation Assets, liabilities and equity • Inventory has been recognized at
balances have been valued the lower of cost and net realizable
appropriately. value in accordance with AS 2-
Inventories.
• Any costs that could not be
reasonably allocated to the cost of
production (e.g. general and
administrative costs) and any
abnormal wastage have been
excluded from the cost of
inventory.
• An acceptable valuation basis (e.g.
FIFO, Weighted average etc.) has
been used to value inventory cost
as at the period- end
Rights & Entity has the right to assets i.e. The entity owns or controls the
Obligations (whether the entity has inventory recorded in the financial
ownership and title to assets) statements. Any inventory held by the
and the liabilities recognized in entity on behalf of another entity has
the financial statements not been recognized as part of
represent all the entity’s the inventory of the entity
obligations at a given date.

Presentation • Whether particular items in Example 1

and Disclosure the financial statements are Employee benefit expense has been
properly classified, fairly allocated between:
described and disclosed. • Operating expenses incurred in
• Presentation and disclosure production activities;
assertions are considered • General and administrative
during the course of the expenses; and
audit by procedures to
Cost of personnel relating to any self-
determine that disclosures
constructed assets other than
are complete and accurate.
inventory.
• The disclosures that are
Example 2
most susceptible to
Whether related party transactions
material misstatement are
have been disclosed appropriately as
those that require
per the requirements of AS 18 –
significant judgment and
Related Party Disclosures.
qualitative assessments.

9A.5
 Assertions Explanation Example: Inventory balance
• Audit teams assess the
completeness and accuracy
of disclosures by
determining that the
disclosures provide
information in a manner
that does not materially
omit, distort or mislead the
user.

3. Assertions as per SA 315

Assertions used by the auditor to consider the different types of potential misstatements that
may occur fall into the following three categories and may take the following forms:
(a) Assertions about classes of transactions and events for the period under audit:
i. Occurrence - transactions and events that have been recorded have occurred and
pertain to the entity.
ii. Completeness - all transactions and events that should have been recorded have
been recorded.
iii. Accuracy - amounts and other data relating to recorded transactions and events have
been recorded appropriately.
iv. Cut-off - transactions and events have been recorded in the correct accounting
period.
v. Classification - transactions and events have been recorded in the proper accounts.

(b) Assertions about account balances at the period end:

i. Existence - assets, liabilities, and equity interests exist.
ii. Rights and obligations - the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
iii. Completeness - all assets, liabilities and equity interests that should have been
recorded have been recorded.
iv. Valuation and allocation - assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded.

(c) Assertions about presentation and disclosure:

i. Occurrence and rights and obligations - disclosed events, transactions, and other
matters have occurred and pertain to the entity.

9A.6
ii. Completeness - all disclosures that should have been included in the financial
statements have been included.
iii. Classification and understandability - financial information is appropriately
presented and described, and disclosures are clearly expressed.
iv. Accuracy and valuation - financial and other information are disclosed fairly and at
appropriate amounts.

Summary
Account Balances Class of Transactions Presentation & Disclosure
(Balance Sheet) (Profit and Loss) (Notes to Accounts)

• Existence • Occurrence • Occurrence

• Rights & Obligations • Completeness • Rights & Obligations
• Completeness • Accuracy • Completeness
• Valuation & Allocation • Cut-off • Accuracy & Valuation
• Classification • Classification
• Understandability

9A.7
 Notes:

9A.8
BALANCE SHEET
CAPTIONS
(LIABILITIES)

9B.1
 SHARE CAPITAL
The receipt of applications for shares and allotment of shares in pursuance thereto are two
important aspects of every issue of capital in so far as these constitute the legal basis of the
transactions in the matter of purchase of shares. These, therefore, should receive a careful
attention of the auditor.
He also must verify that each party has performed his part of the contract, within the allotted
time.
The below table summarizes the audit procedures generally required to be undertaken
while auditing share capital:

Assertions Explanation
Existence To establish the existence of share capital as at the period- end.

Completeness Equity balances that were supposed to be recorded have been recognized in
the financial statements.
Valuation Equity balances have been valued appropriately.
Presentation Required disclosures for equity have been appropriately made
and Disclosure

Audit Procedure
• Tally the period- end share capital balance- authorised, issued and paid up, to the
previous year audited financial statements.
• In case there in no change during the year, obtain a written confirmation/ representation
from the Company Secretary that there were no changes to entity’s capital structure during the
year
• In case there is any change, verify whether the paid up capital as at the period-end is within the
limits of authorised capital.
• Obtain the certified copies of relevant resolutions passed at the meetings of board of
directors, shareholders authorising the increase/ decrease in authorised share capital, if
required, or paid up share capital.
• Also, obtain and verify copies of forms filed with Ministry of Corporate Affairs (MCA)
(Form SH 7 for increase in authorised share capital, Form PAS 3 for increase in paid up capital)
and with Reserve Bank of India (Form FCGPR in case of Foreign Direct Investment (FDI) by a
Non-resident shareholder) and verify the number of securities issued along with the issue price.
• In case there was increase in share capital, verify whether the Company has accurately
calculated the required fee and stamp duty payable to MCA.

9B.2
 Shares Issued at Premium
In case a company has issued shares at a premium, that is, at amount in excess of the
nominal value of the shares, whether for cash or otherwise, section 52 of the Companies Act,
2013 provides that a Company shall transfer the amount received by it as securities premium
to securities premium account and state the means in which the amount in the account can be
applied.
The provisions of this Act relating to reduction of share capital of a company shall apply as
if the securities premium account were the paid- up share capital of the company.

Application of securities premium account: The securities premium account may be applied
by the Company:
(a) towards the issue of unissued shares of the company to the members of the
company as fully paid bonus shares;
(b) in writing off the preliminary expenses of the Company;
(c) in writing off the expenses of, or the commission paid or discount allowed on, any
issue of shares or debentures of the company;
(d) in providing for the premium payable on the redemption of any redeemable
preference shares or of any debentures of the company; or
(e) for the purchase of its own shares or other securities under section 68.
The auditor needs to verify whether the premium received on shares, if any, has been
transferred to a “securities premium account” and whether the application of any amount out
of the said “securities premium account” is only for the purposes mentioned above.

Shares Issued at discount

According to section 53 of the Companies Act, 2013, a company shall not issue shares at a
discount, except in the case of an issue of sweat equity shares given under section 54 of the
Companies Act, 2013.
Refer Companies Act, 2013 for explanation of this section.
The auditor needs to check the movement in share capital during the year and wherever
there is any issue, he should verify that the Company has not issued any of its shares at a
discount by reading the minutes of meeting of its directors and shareholders authorizing issue
of share capital and the issue price.

Issue of Sweat Equity Shares

According to section 54 of the Companies Act, 2013, the employees may be compensated in
the form of ‘Sweat Equity Shares”.
Refer Companies Act, 2013 for explanation of this section.

9B.3
 The auditor needs to verify that the Sweat Equity Shares issued by the company are of a class
of shares already issued and following conditions have been complied with:
(a) the issue is authorised by a special resolution passed by the company;
(b) the resolution specifies the number of shares, the current market price, consideration, if
any, and the class or classes of directors or employees to whom such equity shares are to
be issued;
(c) not less than one year has, at the date of such issue, elapsed since the date on which the
company had commenced business; and
(d) where the equity shares of the company are listed on a recognised stock exchange, the
sweat equity shares are issued in accordance with the regulations made by the
Securities and Exchange Board in this behalf and if they are not so listed, the sweat equity
shares are issued in accordance with such rules as may be prescribed.
(e) The rights, limitations, restrictions and provisions as are for the time being applicable to
equity shares shall be applicable to the sweat equity shares issued under this section and
the holders of such shares shall rank pari passu with other equity shareholders.
The auditor also needs to verify whether the fresh issue of shares was a rights issue or a
preferential issue and whether the relevant requirements for issue of share capital as per
provisions of Companies Act, 2013 have been complied with.

Reduction of Capital
For verifying reduction of capital, the auditor needs to undertake the following procedures:
(i) Verify that the meeting of the shareholder held to pass the special resolution was
properly convened and that the proposal was circularised in advance among all the
shareholders;
(ii) Verify that the Articles of Association authorises reduction of capital;
(iii) Examine the order of the Tribunal confirming the reduction and verify that a copy of
the order and the minutes have been registered and filed with the Registrar of
Companies;
(iv) Inspect the Registrar’s Certificate as regards to reduction of capital;
(v) Vouch the accounting entries recorded to reduce the capital and to write down the
assets by reference to the resolution of shareholders and other documentary evidence;
also check whether the requirements of Schedule III, Part I, have been complied with;
(vi) Confirm whether the revaluation of assets has been properly disclosed in the Balance
Sheet;
(vii) Verify the adjustment made in the members' accounts in the Register of Members and
confirm that either the paid up amount shown on the old share certificates have been
altered or new certificates have been issued in lieu of the old, and the old ones have
been cancelled;

9B.4
(viii) Confirm that the words "and reduced", if required by the order of the Tribunal, have
been added to the name of the company in the Balance Sheet.
(ix) Verify that the Memorandum of Association of the company has been suitably
amended.

Presentation & Disclosure

Ensure whether the following disclosure requirements of Schedule III (Part 1) to Companies
Act, 2013 have been complied with:
Issued and subscribed share capital (Number of shares and value)
✓ Balance at the beginning of the reporting period
✓ Changes in equity share capital during the year
✓ Balance at the end of the reporting period
For each class of capital
✓ Rights attached
✓ Preferences
✓ Restrictions, including
• Restrictions on the distribution of dividends
• Restrictions on the repayment of capital
Shares held in Company by the following entities:
✓ Holding company
✓ Ultimate holding company
✓ Subsidiaries of the holding company
✓ Associates of the holding company
✓ Subsidiaries of the ultimate holding company
✓ Associates of the ultimate holding company

Shares held in the company held by each shareholder holding more than 5% shares
specifying the number of shares held Disclosure to be made for a period of five years
immediately preceding the balance sheet date
Aggregate number and class of shares:
✓ Allotted as fully paid up pursuant to contract(s) without payment being received in cash
✓ Allotted as fully paid up by way of bonus shares
✓ Bought back.

9B.5
 RESERVE AND SURPLUS
• Reserves are amounts appropriated out of profits that are not intended to meet any
liability, contingency, commitment or diminution in the value of assets known to exist as at
the date of the Balance Sheet.
• Reserves represent amounts appropriated out of profits, held for purpose of distribution of
dividend or financing the expansion of the company or strengthening the company
financially.
The reserves can be segregated as revenue or capital reserves.
1. Revenue reserves represent profits that are available for distribution to shareholders or
below purposes such as:
✓ To supplement divisible profits in lean years,
✓ to finance an extension of business
✓ to augment the working capital of the business or
✓ to generally strengthen the company’s financial position.
2. Capital Reserve represents a reserve which does not include any amount regarded as
free for distribution.
Examples: Securities premium, capital redemption reserve.
• It may be noted that if a company appropriates revenue profit for being credited to the
asset replacement reserve with the objective that these are to be used for a capital
purpose, such a reserve shall also be in the nature of a capital reserve.
• A capital reserve, generally, can be utilised for writing down fictitious assets or losses or
(subject to provisions in the Articles) for issuing bonus shares if it is realized.
• But the amount of securities premium or capital redemption reserve account can be
utilised only for the purposes specified in Sections 52 and 55 of the Companies Act, 2013,
respectively.

The below table summarises the audit procedures generally required to be undertaken
while auditing reserves and surplus/ other equity:
Assertions Explanation
Existence To establish the existence of reserves and surplus as at the period- end
Completeness Reserves and Surplus balances that were supposed to be recorded have
been recognized in the financial statements.

Valuation Reserves and Surplus balances have been valued appropriately.

Presentation Required disclosures for reserves and surplus have been appropriately
and Disclosure made

9B.6
 Audit Procedures
• Trace and tally the opening balance of reserves and surplus to the previous year audited
financial statements. For addition/utilisation in current year, in case of:
a) Profit and Loss balance:
• Trace the movement as disclosed in Statement of changes in Equity to Surplus /
Deficit as per Income Statement for the year under audit.
• For adjustment related to dividend payment and the tax related thereto i.e. dividend
distribution tax, verify the resolution passed by the board of directors regarding
declaration of dividend.
• Students should note that as per AS-4 (revised), if dividends to holders of equity
instruments are proposed or declared after the balance sheet date, an entity should
not recognize those dividends as a liability as at the balance sheet date.
• It should, however, disclose the amount of dividends that were proposed or declared
after the balance sheet date, but before the financial statements were approved for
issue.

b) Securities Premium
• It needs to be confirmed that company has issued shares in excess of the nominal
value of the shares and for the same, the auditor should obtain and verify the
resolution passed by the board of directors.
• As already discussed under the caption - ‘share capital’, the withdrawal from securities
premium account could be done only for limited purposes; auditor needs to ensure
that same.
• Refer Companies Act, 2013 for explanation of this section.

Presentation & Disclosure

Ensure whether the following disclosure requirements of Schedule III (Part 1) to
Companies Act, 2013 have been complied with:
a) Has the company sub-classified reserves and surplus into the following:
• Capital reserve
• Capital redemption reserve
• Securities premium reserve
• Debenture redemption reserves
• Retained earnings
• Revaluation surplus
• Exchange difference on account of translation of financial statements of foreign
operations.

9B.7
 b) For each component of reserves and surplus, whether the company has disclosed
the following (to the extent applicable):
(i) Balance at the beginning of the reporting period
(ii) Changes, if any, due to changes in accounting policy or prior period error
(iii) Total profit/ loss for the year
(iv) Dividends
(v) Transfer to retained earnings
(vi) Any other change (to be specified)
(vii) Balance at the end of reporting period

BORROWINGS
• Liabilities are the financial obligations of an enterprise other than owners’ funds.
Liabilities include loans/ borrowings, trade payables and other current liabilities, deferred
payment credits and provisions.
• Verification of liabilities is as important as that of assets, for, if any liability is omitted (or
understated) or overstated, the Balance Sheet would not show a true and fair view of the
state of affairs of the company.

The below table summarizes the audit procedures generally required to be undertaken
while auditing borrowings:
Assertions Explanation
Existence All borrowings on the balance sheet represent valid claims by banks or
other third parties.
Completeness That all borrowings have been accounted for in the books of the
company on a timely basis.

Valuation That liability is recorded at the correct amount.

Presentation and That borrowings have been presented, classified and disclosed in the
Disclosure financial statements in accordance with the requirements of applicable
financial reporting framework i.e. Companies Act, 2013 and applicable
Indian GAAP

Existence
• Review board minutes for approval of new lending agreements.
• During review, make sure that any new loan agreements or bond issuances are
authorized.

9B.8
• Ensure that significant debt commitments should be approved by the board of directors.
• Agree details of loans recorded (interest rate, nature and repayment terms) to the loan
agreement. Verify that borrowing limits imposed by agreements are not exceeded.
• Roll out and obtain independent balance confirmations in respect of all the
borrowings from the lender (banks/ financial institutions etc.).
• Agree details of leases and hire purchase creditors recorded to underlying contracts /
agreements.
• Examine trust deed for terms and dates of redemption, borrowing restrictions and
compliance with covenants.
• When debt is retired, ensure that a discharge is received on assets securing the debt.

Completeness
• Obtain a schedule of short term and long term borrowing (including debt outstanding
at the end of the prior year, as well as any new debt or renewal of debt) showing
beginning and ending balances and borrowings and repayments during the year, and
perform the following:
(a) Consider any evidence of additional debt obtained through examination of minutes
of the board, significant contracts, confirmations of bank accounts, support for
subsequent cash disbursements (when testing payables), and other documents.
(b) Trace the closing balances as per the schedules to the general ledger.
• Review subsequent transactions after the end of the reporting period to determine if
there are unrecorded liabilities at year-end and the transactions are recorded in the
correct period.
Direct confirmation procedures
• Roll out and obtain independent balance confirmations in respect of all the borrowings
from the lender (banks/ financial institutions etc.) and perform the following:
(a) Ascertain that the confirmation asks for all information likely to be relevant to
our tests of debt and related interest balances (e.g., applicable interest rates, due
dates, the date to which interest has been paid, collateral and security interests).
(b) Send reminders for non-replies.
(c) Compare the balances are per the confirmations obtained to the books of the
accounts. Ask for reconciliations, if there are any differences and test the
supporting documents for the reconciling items on a test check basis.

9B.9
 Valuation
• Determine that the accounting policies and methods of recording debt are appropriate
and applied consistently.
• Agree loan balance and loan payables to the loan agreement.
• Recompute the interest, and discount or premium on redemption.
• Check computation of the amortization of premium or discount.
• For foreign currency loans, check the closing exchange rate(s) used and verify the
computations of the restatements of foreign currency balances outstanding at year
end.

Other Procedures
• Determine that the following items, if any, are properly recorded, classified, and / or
disclosed, as appropriate:
a. Bonds / debentures
b. Term loans
• from banks
• from related parties.
c. Deferred payment liabilities
d. Deposits
e. Loans and advances from related parties
f. Other loans and advances.
• Read the provisions in loan and debt agreements and perform the following:
a. Test that the entity is in compliance with loan covenants and other significant
provisions of the agreements.
b. If there are any provisions with which the entity is not in compliance, determine
whether the debt should be classified as current.
c. If enforcement of the provisions has been waived by the lender in case of breach
of any covenant by the entity, obtain confirmation of the waiver from the lender.
• Examine the due dates on loans for proper classification between long-term and short-
term.
• Where instalments of long-term loans falling due within the next twelve months have
been disclosed in the financial statements (e.g. in parentheses or by way of a footnote),
verify the correctness of the amount of such instalments.
• Examine the debt agreements for any restrictive covenants. Review restrictive covenant
and provisions relating to default and ensure disclosure thereof in the financial
statements.
• Examine the important terms in the loan agreements and the documents, if any,
evidencing charge in respect of such loans and advances.

9B.10
• Examine whether the requirements of the applicable statute regarding creation and
registration of charges have been complied with including disclosure of the same to
the extent mandated by statute and considered necessary for proper understanding of the
user of financial statements.
• In case the value of the security falls below the amount of the loan outstanding,
examine whether the loan is classified as secured only to the extent of the market value
of the security.
• Examine the hire purchase agreements for the purchase of assets by the entity and
ensure the correctness of the amounts shown as outstanding in the accounts, and also
examine the security aspect.
• Verify whether liabilities towards bank in respect of bills discounted, bills negotiated,
cheques discounted, etc. are correctly reflected and disclosed in the financial
statements.
• The auditor should also verify that the amount borrowed is within the borrowing
powers of the company as laid down by the Articles of Association and Memorandum of
Association.
• Verify that the company has not contravened the restrictions laid down by Section 180
of the Companies Act, in respect of the borrowings of the company. Also, check
compliance of Sections 185 and 186 of the Companies Act, 2013.
• Examine the purpose for which the amount is borrowed and ensure that the amount is
not used against the interest of the company.
• Where the entity has accepted deposits, examine whether the directives issued by the
Reserve Bank of India or other appropriate authority have been complied with.

Presentation & Disclosure

• Ensure whether the following disclosures as required under Schedule III (Part 1) to
Companies Act, 2013 are made for each amount disclosed under the heading ‘long term
borrowings’.
✓ Sub-classification as secured and unsecured.
✓ For secured borrowings, nature of security separately in each case.
✓ Where loans are guaranteed by directors or others, whether the company has
disclosed the aggregate amount of such loans under each head.
✓ Terms of repayment for each loan unless the repayment terms of individual loans
within a category are similar, in which case, they may be aggregated.
✓ Repayment terms should include the period of maturity at the balance sheet date,
number and amount of installments due, applicable interest rate and other
significant relevant terms (if any).

9B.11
 • In case of a default in repayment of borrowing and/ or interest on the balance sheet date,
ensure that following disclosures have been made separately for each case:
✓ Period of default.
✓ Amount of default.

TRADE PAYABLES AND OTHER C URRENT LIABILITIES

• Liabilities in addition to borrowings, include trade payables and other current
liabilities, deferred payment credits and provisions.
• Verification of liabilities is as important as that of assets, considering if any liability is
omitted (or understated) or overstated, the Balance Sheet would not show a true and
fair view of the state of affairs of the entity.

The below table summarizes the audit procedures generally required to be undertaken
while auditing trade payables and other current liabilities:
Assertions Explanation
Existence To establish the existence of trade payables and other current
liabilities as at the period- end

Completeness & Trade payables and liability balances that were supposed to be
Cut-Off recorded have been recognized in the financial statements.
Valuation Trade payables and other liability balances have been valued
appropriately.
Presentation and Required disclosures for trade payables and other liabilities have
Disclosure been appropriately made

Existence
• Check whether there are controls in place to ensure that the same purchase / expense
invoice cannot be recorded more than once and payable balances are automatically
recorded in the general ledger at the time of recording of expense.
• Obtain the accounts payable ageing report and trace its balances to the general ledger.
If there are any differences, investigate reconciling items. If there are journal entries in the
accounts payable account in the general ledger, review the justification for larger amounts.

9B.12
Direct confirmation procedures (Refer Procedure as per SA 505)
• An important audit activity is to contact vendors directly and ask them to confirm the
amounts of accounts payable as of the end of the reporting period under audit.
• This should necessarily be done for all significant account payable balances as at the
period- end and for parties from whom material purchases have been made during the
period under audit even if period- end balance of such parties is not significant.
• The auditor employs direct confirmation procedure with the consent of the entity under
audit.
• There may be situations where the management of the entity requests the auditor
not to seek confirmation from certain trade payables.
• In such cases, the auditor should consider whether there are valid grounds for such a
request.
• In appropriate cases, the auditor may also need to reconsider the nature, timing and
extent of his audit procedures including the degree of planned reliance on
management's representations.
• The trade creditors may be requested to confirm the balances either
(a) as at the date of the balance sheet, or
(b) as at any other selected date which is reasonably close to the date of the balance
sheet.
The date should be decided by the auditor in consultation with the Company.
• The form of requesting confirmation from the trade creditor may be either
a) the form with balance as at year end wherein the trade creditor is requested to
respond whether or not he is in agreement with the balance shown, or
b) the form with no balance wherein the trade creditor is requested to respond the
balance as per his records.
The use of the form with no balance is preferable.
• The method of selection of the trade creditors to be circularized should not be revealed
to the Company until the trial balance of the trade payables’ ledger is handed over to the
auditor.
• A list of trade creditors selected for confirmation should be given to the entity for
preparing request letters for confirmation which should be properly addressed.
• The auditor should maintain strict control to ensure the correctness and proper dispatch
of request letter.
• In the alternative, the auditor may request the client to furnish duly authorised
confirmation letters and the auditor may fill in the names, addresses and the amounts
relating to trade creditors selected by him and mail the letters directly.
• It should be ensured that confirmations as well as any undelivered letters are returned
to the auditor and not to the client.

9B.13
 • Any discrepancies revealed by the confirmations received or by the additional tests
carried out by the auditor may have a bearing on other accounts not included in the
original sample.
• The entity should be asked to investigate and reconcile the discrepancies.
• In addition, the auditor should also consider what further tests he can carry out in order
to satisfy himself as to the correctness of the amount of trade payables taken as a
whole.
• Where no reply is received, the auditor should perform additional testing regarding the
balances. This testing could include:
✓ Testing of subsequent payments in respect of the trade payables to whom
confirmations were rolled out but no replies received;
✓ Agreeing the details of the respective balance to the underlying vendor invoices;
✓ Preparing a detailed analysis of the balance, ensuring it consists of identifiable
transactions and confirming that these purchases/ expense transactions actually
occurred.
• If there are any related party payables, review whether they were properly authorized
and the value of such transactions were reasonable and at arm's length.
• Review a trend line of purchases / expenses and accounts payable, or a comparison of the
two over time, to see if there are any unusual trends. Make inquiries about reasons for
changes in trends from the management.

Completeness & Cut-Off

• The auditor needs to perform the following cut-off procedures:
✓ For the last 5 invoices received/ recorded at the end of the reporting date (cut
off date) and which have been included in the trade payables; the goods should have
been received/ risk and rewards of ownership in goods should have been transferred
in favour of the entity;
✓ All goods received prior to the period/ year- end should have been booked in
the form of purchases and included in trade creditors.
• Test purchases/ expenses on a sample basis selecting the same from the accounts
payable ledgers and checking their supporting documents to ensure that the purchases
were recorded at the correct amounts and correct dates.
• Match purchase invoice dates to the gate entry (inward) dates for those items in the log,
to see if purchases are being recorded in the correct accounting period.

• This can include an examination of purchase / expense invoices received subsequent to

the period being audited, to see if they should have been included in the period under
audit.

9B.14
• Review subsequent expense vouchers. Review all material expense vouchers recorded
post the balance sheet date to see if they relate to transactions from within the audit
period.
• For advance received from customers/ revenue received in advance, obtain the customer wise
listing along with its ageing and the nature. Verify if any advances are outstanding beyond 6
months.
• Enquire from the entity’s management if there has been any dispute with the customer and
if there is any additional liability to be recorded.
• For all such advances, the auditor should verify the underlying documentation based on
which the entity had received the advance.
• In relation to statutory dues liability like withholding tax (TDS) payable, GST payable, luxury tax
payable, professional tax payable, PF and ESI payable etc., prepare a reasonability with respect to
sales/ purchases/ employee benefit expenses.
Example- GST liability for last month may be calculated by applying the applicable rate to the
sales made and in case of any variance with the GST liability recorded by the entity, reasons for
variance should be requested from client and in case found satisfactory, the same should be
maintained as part of audit documentation.
• Similarly, Provident Fund liability for last month may be calculated by applying the applicable
rate to the employee benefit expense and in case of any variance with the liability recorded by
the entity, reasons for variance should be requested from client and in case found
satisfactory, the same should be maintained as part of audit documentation.
• Further, the auditor should obtain and verify the challans for deposits made subsequent to
the period- end for all statutory liabilities as at the balance sheet date and also analyse the
reasons, if any, in consultation with the management for any variance between the amounts
deposited subsequently vis-à-vis the liability recorded in books of account.

Valuation
• Review the process followed by the Company to identify if any old creditor balance/
liability needs to be written back. This will include a consistency comparison with the method
used in the last year, and a determination of whether the method is appropriate for the
underlying business environment.
• Obtain the ageing of payable balances, split between current, less than 30 days old, 30-60
days old, 60-180 days old, 180- 365 days old and more than 365 days old. Also, obtain the
list of vendors with whom the Company has disputes and any claims from customers, under
litigation and compare with previous year.
• Check that write backs in the liability balances assessed as no longer payable have been
approved by an appropriate and authorised member of senior management, for example
CEO / MD.

9B.15
 • Check that the restatement of foreign currency trade payables has been done properly.
Understand management’s process to identify the principal amount and the interest due
thereon (if any) remaining unpaid to any Micro, Small and Medium Sized Enterprises suppliers at
the end of accounting year.
• Test check the management process to assess if the auditor could rely on the management
process.

Presentation & Disclosure

• Ensure whether the following disclosures as required under Schedule III to Companies Act, 2013
have been made:
✓ Whether the Company has classified a payable as a trade payable if it is in respect of
the amount due on account of goods sold or services rendered in the normal course of
business.
✓ Whether the Company has disclosed the following details relating to micro and small
enterprises in the notes:
• the principal amount and the interest due thereon (to be shown separately) remaining
unpaid to any supplier at the end of each accounting year.
• the amount of interest paid by the buyer in terms of section 16 of the Micro, Small and
Medium Enterprises Development Act, 2006, along with the amount of the payment
made to the supplier beyond the appointed day during each accounting year.
• the amount of interest due and payable for the period of delay in making payment
(which have been paid but beyond the appointed day during the year) but without
adding the interest specified under the Micro, Small and Medium Enterprises
Development Act, 2006.
• the amount of interest accrued and remaining unpaid at the end of each accounting year.
• the amount of further interest remaining due and payable even in the succeeding years,
until such date when the interest dues above are actually paid to the small enterprise, for
the purpose of disallowance of a deductible expenditure under section 23 of the Micro,
Small and Medium Enterprises Development Act, 2006.
✓ Whether the amount disclosed under other current liabilities are classified as below:
• Current maturities of long-term debts.
• Interest accrued
• Income received in advance
• Others (specify nature).

9B.16
 PROVISIONS AND CONTI NGENT LIABILITIES
A provision is recognised when:
(i) an entity has a present obligation (legal or constructive) as a result of a past event;
(ii) it is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; and
(iii) a reliable estimate can be made of the amount of the obligation.

If the above conditions are not met, no provision is recognised.

A contingent liability is:

1. a possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity; or
2. a present obligation that arises from past events but is not recognized because:
✓ it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
✓ the amount of the obligation cannot be measured with sufficient reliability.

9B.17
 The below table summarizes the audit procedures generally required to be undertaken
while auditing provisions and contingent liabilities:
Assertions Explanation
Existence To establish the existence of provisions as at the period- end
Completeness Provisions that were supposed to be recorded have been recognized in
the financial statements.

Valuation Provision balances have been valued appropriately.

Presentation Required disclosures for provisions have been appropriately made

and Disclosure

Existence, Completeness & Valuation

• Obtain a list of all provisions and compare them with balances in the ledger.
• Inspect the underlying arrangements like appointment agreement with customers to
assess warranty commitments, any legal and other claims on the entity i.e. litigations.
• Obtain the underlying working and the basis for each of the provisions made, from the
management and verify whether the same is complete and accurate.
• Wherever required, obtain experts report, calculation and underlying working for the
provision amount,
For Example, for warranty involving complex calculations, some entities get that valued
through an actuary.
• In such a case, the auditor may request the management to share the actuarial
valuation report and in case of any matter under legal dispute, the auditor should request
for assessment made by a legal expert in relation to likelihood of a liability devolving on
the entity i.e. whether probable or possible or remote as defined above.
• The auditor should then verify the underlying assumptions used by the expert with the
data shared by the management.
• As per SA 500- Audit Evidence, issued by ICAI, when using the work of a management's
Expert, audit evidence that the auditor should obtain include:
✓ Evaluate the competence, capabilities and objectivity of that expert:
• Whether the expert is employed by the entity or is an outside party.
• Whether the expert is independent in respect of the entity
• Auditor's previous experience of the work of the expert
• Knowledge of the expert's qualification, membership of a professional body or
industry association

9B.18
✓ Obtain an understanding of the work of that expert:
• Whether the auditor has expertise to evaluate the work of the expert
• Evaluating the assumptions and methods used by the management’s expert
• Evaluating the nature of internal or external data used by the expert
✓ Evaluate the appropriateness of his work as audit evidence for the relevant
assertion
• Relevance and reasonableness of the Expert's findings or conclusions
• Evaluating the relevance, completeness and accuracy of the source data used by
the Expert

Presentation & Disclosure

Ensure whether the following disclosures as required under Ind AS compliant Schedule III
to Companies Act, 2013 have been made:
✓ Whether current and non-current portions have been split for
• Provision for employee benefits
• Others (specify nature)
✓ Whether for each class of provision, disclosure has been made for:
• The carrying amount at the beginning and end of the period
• additional provisions made in the period, including increases to existing
provisions;
• amounts used (i.e. incurred and charged against the provision) during the
period;
• unused amounts reversed during the period.
✓ Whether for each class of provision, disclosure has been made for:
• a brief description of the nature of the obligation and the expected timing of any
resulting outflows of economic benefits;
• an indication of the uncertainties about the amount or timing of those outflows.
Where necessary to provide adequate information, an entity shall disclose the major
assumptions made concerning future events; &
• the amount of any expected reimbursement, stating the amount of any asset that has
been recognized for that expected reimbursement.
✓ Unless the possibility of any outflow in settlement is remote, whether disclosure has
been made for each class of contingent liability at the end of the reporting period a
brief description of the nature of the contingent liability and, where practicable:
• an estimate of its financial effect
• an indication of the uncertainties relating to the amount or timing of any
outflow; and
• the possibility of any reimbursement.

9B.19
 Notes:

9B.20
BALANCE SHEET
CAPTIONS
(ASSETS)

9C.1
 TRADE RECEIVABLES
 Trade receivable is an essential part of any organization’s balance sheet.
 Typically, an invoice is raised and issued to the customer with the invoice amount being
recorded as a debtor balance. Until the invoice is paid, the invoice amount is recorded on
the organization’s balance sheet as accounts receivable.
 If balances are not recoverable later on, then these amounts need to be written off as an
expense in the statement of profit and loss.
 It is important to carry out compliance procedures in the sales audit as part of the debtors’
audit procedure.

Points ✓ Only bona fide sales lead to receivables.

need to be ✓ All such sales are to approve customers.
considered
✓ All such sales are recorded.
in respect
of trade ✓ Once recorded, the debts can only be eliminated by receipt of cash or
receivables: on the authority of a responsible official.
✓ Debts are collected promptly.
✓ Balances are regularly reviewed. A proper system of follow up exists
and if necessary adequate provision for bad debt exists.

The below table summarizes the audit procedures generally required to be undertaken
while auditing trade receivables:
Assertions Explanation
Existence To establish the existence of trade receivables as at the period- end
Completeness & Trade receivable balances that were supposed to be recorded have
Cut-Off been recognized in the financial statements.

Valuation Trade receivable balances have been valued appropriately.

Presentation and Required disclosures for trade receivables have been appropriately
Disclosure made

Existence
• Check whether there are controls in place to ensure that invoices cannot be recorded
more than once and receivable balances are automatically recorded in the general
ledger from the original invoice.

9C.2
• Ask for a period-end accounts receivable aging report and trace the grand total to the
amount in the accounts receivable account in the general ledger.
• Check whether realization is recorded invoice- wise or not. If not, check that money
received from debtors is adjusted chronologically invoice- wise and on FIFO basis i.e.
previous bill is adjusted first.
• If realization is made on account, verify whether the Company has obtained
confirmations from debtors in respect of the same.

Direct confirmation procedures (Refer SA 505)

• A significant and important audit activity is to contact customers directly and ask them
to confirm the amounts of unpaid accounts receivable as of the end of the reporting
period under audit.
• This should necessarily be done for all significant account balances as at the period-
end while certain random customers having smaller outstanding invoices should also be
selected.
• The auditor employs direct confirmation procedure with the consent of the entity under
audit.
• There may be situations where the management of the entity requests the auditor not
to seek confirmation from certain trade receivables.
• In such cases, the auditor should consider whether there are valid grounds for such a
request.
• In appropriate cases, the auditor may also need to reconsider the nature, timing and
extent of his audit procedures including the degree of planned reliance on
management's representations.
• The trade receivables may be requested to confirm the balances either
(a) as at the date of the balance sheet, or
(b) as at any other selected date which is reasonably close to the date of the balance
sheet.
The date should be decided by the auditor in consultation with the Company.
• The form of requesting confirmation from the trade receivables may be either
(a) the form with balance outstanding amount as per the company, wherein the trade
receivable is requested to respond whether or not he is in agreement with the
balance shown, or
(b) the form without any balance mentioned therein, wherein the trade receivable is
requested to respond with the balance outstanding as per his records.
The use of the form without any balance is preferable.

9C.3
 • The method of selection of the trade receivables to be circularized should not be
revealed to the Company until the trial balance of the trade receivables’ ledger is handed
over to the auditor.
• A list of trade receivables selected for confirmation should be given to the entity for
preparing request letters for confirmation which should be properly addressed.
• The auditor should maintain strict control to ensure the correctness and proper
despatch of request letters.
• It should be ensured that confirmations as well as any undelivered letters are returned
to the auditor and not to the client.
• Any discrepancies revealed by the confirmations received or by the additional tests
carried out by the auditor may have a bearing on other accounts not included in the
original sample.
• The Company should be asked to investigate and reconcile the discrepancies.
• Where no reply is received, the auditor should perform additional testing regarding the
balances. This testing could include:
✓ Agreeing the balance to cash received;
✓ Preparing a detailed analysis of the balance, ensuring it consists of identifiable
transactions and confirming that these revenue transactions actually occurred;
• If there are any related party receivables, review them for collectability, as well as
whether they were properly authorized and the value of such transactions were
reasonable and at arm’s length.
• Check that receivables for other than sales or services are not included in the list.
• Review a trend line of sales and accounts receivable, or a comparison of the two over
time, to see if there are any unusual trends.
• Also, measure the average collection period.
• Make inquiries about reasons for changes in trends from the management and
document the same in audit work papers.

Completeness & Cut-Off

• The auditor needs to satisfy himself of correct and proper cut-offs. Without a correct
cut-off, sales could be understated or overstated, hence, the need to perform the
following cut off tests:
✓ For the invoices issued during the last few days (last 5 days of the reporting year)
i.e. cut-off date and which have been included in the debtors; check that the goods
should have been dispatched and not lying with the Company;
✓ Ensure that all goods dispatched prior to the period/ year-end have been
invoiced and included in debtors on a test check basis;

9C.4
 ✓ Ensure that no goods dispatched after the year- end have been invoiced and
included in debtors for the period under audit.
• Test invoices listed in receivable report. Select few invoices from the accounts
receivable ageing report and compare them to supporting documentation to see if they
were billed with the correct amounts, to the correct customers, and on the correct dates
• Match invoices to shipping / dispatch log. Match invoice dates to the shipment dates
for those items in the shipping / dispatch log, to see if sales are being recorded in the
correct accounting period. This can include an examination of invoices issued
subsequent to the period being audited, to see if they should have been included in the
period under audit
• Assess bill and hold sales. If there is a situation where the Company is billing customers
for sales despite still retaining the goods on-site (known as “bill and hold”), examine
supporting documentation to determine whether a sale has actually taken place or not.
• Review the receiving log to see if the Company has recorded an inordinately large
amount of customer returns after the audit period, which would suggest that the
Company may have shipped more goods near the end of the audit period, than the
customers had authorized
• Review the process of giving discounts/ incentives and check whether the same were
given as per the Company’s policy/ general industry trends.
• Review credit memos, on a sample basis, issued during the audit period to see if they
were properly authorized and whether they were issued in the correct period.
• Also, review credit memos issued after the period end to see if they relate to transactions
belonging to the period under audit.
• Where any deduction has been made against a bill, check the reason and
correspondence for the same.

Valuation
• Review the process followed by the Company to derive an allowance for doubtful
accounts.
• This will include a consistency comparison with the method used in the last year, and a
determination of whether the method is appropriate for the underlying business
environment.
• Obtain the ageing report of accounts receivable (both Dr/Cr balance), split between not
currently due, 30 days old, 30-60 days old, 60- 180 days old, 180- 365 days old and more
than 365 days old.
• Also, obtain the list of debtors under litigation and compare with previous year.
• Scrutinize the analysis and identify those debts which appear doubtful.
• Discuss with management their reasons, if any of these debts are not included in the
provision for bad debts.

9C.5
 • Perform further testing where any disputes exist.
• Prepare schedule of movements on Bad Debts – Provision Accounts and Debts written
off and compare the proportion of bad debt expense to sales for the current year in
comparison to prior years, to see if the current expense appears reasonable.
• Check that write-offs or other reductions in the receivable balances have been
approved by an appropriate and authorised member of senior management, for example
the financial controller or finance director.

Presentation & Disclosure

• Check that the restatement of foreign currency trade receivables has been done
properly.
• Verify that the split between more than 6 months and less than 6 months has been
done from the due date and not from invoice date.
• Check classification of amount due is properly disclosed as:

✓ Secured, considered good

✓ Unsecured, considered good
✓ Doubtful.
• Verify that proper disclosure of amounts due from the following parties has been made:
✓ Directors
✓ Other officers of the company
✓ Any of them either severally
✓ Jointly with any other person
✓ Firms
✓ Private companies respectively in which any director is a partner or director
or member.
• Ensure that the transactions with parties covered under Section 189 of the Companies Act,
2013 are reported properly in Companies Auditors’ Report Order (CARO).

9C.6
 CASH AND CASH EQUIVA LENTS
Cash and cash equivalent in the form of
✓ cash in hand,
✓ stamps in hand,
✓ balances held with bank in current accounts/ margin money accounts,
✓ cash credit accounts (debit balance),
✓ fixed deposits,
✓ cheques in hand etc.
represent the most liquid assets of an enterprise. Utmost professional skepticism needs
to be exercised while auditing such balances.

The below table summarizes the audit procedures generally required to be undertaken
while auditing cash and cash equivalents:
Assertions Explanation
Existence To establish the existence of cash and cash equivalent balances as at
the period- end.

Completeness Cash and cash equivalent balances that were supposed to be recorded
have been recorded in the financial statements.

Valuation Cash and cash equivalent balances have been valued appropriately.
Presentation and Required disclosures for cash and cash equivalents have been
Disclosure appropriately made

Existence & Completeness

• Special care is necessary in regard to verification of cash balances for unless they are
checked by surprise, there can be no certainty that the cash produced for inspection was in
fact held by the custodian.
• For this reason, the cash should be checked not only on the last day of the year, but
also checked again sometime after the close of the year without giving notice of the
auditor’s visit either to the client or to his staff.
• If there are more than one cash balances, e.g., when there is a cashier, a petty cashier, a
branch cashier and, in addition, there are impress balances with employees, all of them
should be checked simultaneously, as far as practicable so that the shortage in one balance
is not made good by transfer of amount from the other.

9C.7
 • It is desirable for the cashier to be present while cash is being counted and he should be
made to sign the statement prepared containing details of the cash balance counted.
• If he is absent at the time the cash is being verified, he may hold the auditor responsible
for the shortage, if any, in cash.
• If there is any rough Cash Book or details of daily balance are separately kept, the auditor
should test entries from the rough Cash Book with those in the Cash Book to prove that
entries in the Cash Book are correct.
• If the auditor finds any slip, chit or I.O.U.s in respect of temporary advances paid to the
employees included as part of the cash balance, he should check whether those are
approved by an authorized official or not and recorded in the appropriate accounts.
• The auditor should also perform a cash sensitivity analysis by compiling a summary of
total cash receipts and payments each month and analyses the trends to see if there have
been variations in any specific month and request explanations from the management.
 The auditor needs to obtain bank reconciliation statements for all bank accounts
maintained by the entity as at the reporting period and additionally needs to understand
the client’s process and periodicity of making the BRS.
 The auditor should ensure that BRS is signed by the authorized personnel so that he is
able to assign responsibility in case of any errors.
 Verification of BRS shall entail the following:
✓ Tallying the balance as per bank to the bank confirmation/ statement
✓ Checking of all material reconciling items included under cheques issued but
presented 'for payment' to the underlying bank book forming part of books of
account.
✓ In addition, the auditor should request for bank statement of subsequent period and
should verify if the cheques issued have subsequently been cleared by bank.
✓ For all cases where cheques have become stale i.e. 3 months or more has lapsed since
the issue date, the same should not appear in the BRS and should have instead been
clubbed under liabilities.
✓ Checking of all material reconciling items included under cheques issued but
presented for payment to the underlying bank book forming part of books of account.
In addition, the auditor should request for bank statements of subsequent period and
should verify if the cheques issued have subsequently been cleared by the bank.
✓ For all cases where cheques have become stale i.e. 3 months or more have lapsed
since the issue date, the same should not appear in the BRS and should instead be
taken to liabilities.
✓ Checking of all material reconciling items included under cheques deposited but not
credited by bank by requesting for bank deposit slips, duly acknowledged by bank and
verifying if the balances were credited by bank subsequently by tallying to the bank
statement of subsequent period.

9C.8
 ✓ For any instances related to cheques not cleared beyond reasonable time, the auditor
should seek brief descriptions from the management and in case such explanations
are found to be unsatisfactory, the auditor should verify the revenue recognition
related to such parties was in order and as per the Company's revenue recognition
policy.
✓ Checking of all material reconciling items included under amounts/ charges debited/
credited by bank but not accounted for by requesting for bank statements for the
period under audit and tallying the same.
✓ If the amounts are found to be material, the auditor should ensure that the
management records the adjustments for the same in its books of account.

Direct confirmation procedures:

 A significant and important audit activity is to contact banks / financial institutions
directly and ask them to confirm the amounts held in current accounts, deposit
accounts, EEFC account, cash credit accounts, restrictive use accounts like dividend, escrow
accounts as of the end of the reporting period under audit.
 This should necessarily be done for all account balances as at the period-end.
 The Company should be asked to investigate and reconcile the discrepancies, if any
including seeking written explanations / clarifications from the banks / financial institutions
on any unresolved queries.
 The auditor should emphasize for confirmation of 100% of bank account balances.
 In remote situations where no reply is received, the auditor should perform additional
testing regarding the balances.
 This testing could include:
✓ Agreeing the balance to bank statement received by the Company or internet/ online
login to account in auditor’s personal presence;
✓ Sending the audit team member to the bank branch along with the entity’s personal to
obtain balance confirmation from the bank directly.

Valuation
• In addition to the procedures performed above, the auditor should ensure that all bank
account holding foreign currency have been restated at the closing exchange rates.

Presentation & Disclosure

• Ensure whether the following disclosures as required under Ind AS and Schedule III to
Companies Act, 2013 have been complied:
Cash and cash equivalents

9C.9
 ✓ Cash and cash equivalents shall be classified as:
a) Balances with banks;
b) Cheques, drafts on hand
c) Cash on hand;
d) Others (specify nature)
✓ Earmarked balances with banks (for example, for unpaid dividend) shall be separately
stated.
✓ Balances with banks to the extent held as margin money or security against the
borrowings, guarantees, other commitments shall be disclosed separately.
✓ Repatriation restrictions, if any, in respect of cash and bank balances shall be
separately stated.
✓ Bank deposits with more than 12 months' maturity shall be disclosed separately.

9C.10
 INVENTORIES
Inventories are a form of current asset held for sale in the ordinary course of business or in
the process of production for such sale or for consumption in the production of goods or
service for sale or in the form of materials or supplies to be consumed in the production
process or in the rendering of services
As per generally accepted accounting principles under AS 2- ‘Valuation of Inventories’ ,
inventory is valued at lower of cost and net realisable value.

The below table summarizes the audit procedures generally required to be undertaken
while auditing ‘’inventories’’:
Assertions Explanation
Existence To establish the existence of Inventories as at the period- end.

Completeness & Only the inventories held by entity have been recorded in the financial
Cut-Off statements and do not include any inventories that belong to third
parties but does include inventories owned by the entity and lying with
a third party

Rights and The entity has valid legal ownership rights over the inventories claimed
Obligations to be held by the entity and recorded in the financial statements
Valuation Inventories have been valued appropriately and as per generally
accepted accounting policies and practices

Presentation and Required disclosures for inventories have been appropriately made
Disclosure

Existence
• Review client’s plan for performing inventory count.
• Ensure that consigned goods have been segregated.
• Test counts by auditor should include:
✓ Observing employees are adhering to the agreed plan.
✓ Assuring that all items are properly tagged.
✓ Observing that proper amounts are shown on tags.
✓ Determining that tags and summary sheets are controlled and reconciled.
✓ Reconciliation of test counts with tags and summary sheets and discrepancies
noted, if any are summarized and agreed with client personnel.

9C.11
 ✓ Staying alert at all times and specifically being cautious about empty boxes, etc.
and obsolete items.
✓ Performing cut-off testing by documenting last 5-10 receiving reports and
shipping documents as of the period end.
✓ Ensuring exclusion of third party stock and damaged or obsolete stock.
✓ Ensuring the accounting of all stock sheets.
✓ Investigating any significant differences between the physical stock take and the
stock records. Further, the auditor should ask the client personnel to sign all stock
count sheets and also agree the variances observed, if any, to avoid any conflicts.
• When the entity uses periodic system for inventory count, it should be undertaken at the
end of the period.
• If client uses perpetual system with proper and adequate records, inventory may be
counted at interim dates.
• Confirm or investigate public warehouse inventory of client and also, any inventory of
client lying with a third party (specifically relevant for cases where the clients get job
work done in its process of production).

Completeness & Cut-Off

• Perform analytical procedures (comparison tests with industry averages, budgets, prior
years, trend analysis, etc.).
✓ Compute inventory turnover ratio (COGS/ average inventory)
✓ Perform vertical analysis (inventory/ total assets)
✓ Compare budgetary expectations vis-à-vis actuals
• Examine non-financial information related to inventory, such as weights and measures.
• Perform purchase and sales cut-off tests. Trace shipping documents (bills of lading and
receiving reports, warehouse records, and inventory records) to accounting records
immediately before and after year-end.
• With respect to tagged inventory, perform tests for omitted transactions and tests for
invalid transactions.
• Verify the clerical and arithmetical accuracy of inventory listings.
• Reconcile physical inventory amounts with perpetual records.
• Reconcile physical counts with general ledger control totals.

Rights & Obligations

• Vouch recorded purchases to underlying documentation (purchase requisition, purchase
order, receiving report, vendor invoice, and cancelled check or payment file).
• Evaluate the consigned goods.

9C.12
• Examine client correspondence, sales and receivables records, purchase documents.
• Determine existence of collateral agreements.
• Review consignment agreements.
• Review material purchase commitment agreements.
• Examine invoices for evidence of ownership.
• For instances of inventory held by third party, the auditor should insist on obtaining
declaration from the third party on its business letterhead and signed by authorized
personnel of that third party confirming that the items of inventory belong to the entity
and are being held by such third party on behalf of and for the benefit of the entity under
audit

Valuation
• Depending on how the business operates, the management may value inventory using
“first-in first- out,” or a weighted average system.

a) Raw materials and consumables

• Ascertain what elements of cost are included e.g. carriage in, duties etc.
• If standard costs are used, enquire into basis of standards, how these are compared
with actual costs and how variances are analyzed and accounted for / treated in
accounting records.
• Test check cost prices used with purchase invoices received in the month(s) prior to
counting.
• Follow up valuation of all damaged or obsolete inventories noted during observance of
physical counting with a view to establishing a realistic net realizable value.

b) Work in progress
• Ascertain how the various stages of production / value add are measured and in case
estimates are made, understand the basis for such estimates.
• Ascertain what elements of cost are included.
• If overheads are included, ascertain the basis on which they are included and compare
such basis with the available costing and financial data / information maintained by the
entity.
• Ensure that material costs exclude any abnormal wastage factors.

c) Finished goods and goods for resale

9C.13
 • Enquire into what costs are included, how these have been established and ensure that
the overheads included have been determined based on normal costs and appear
reasonable in relation to the information disclosed in the draft financial statements.
• Ensure that inventories are valued at net realizable value if they are likely to fetch a
value lower than their cost.
• For any such items, also verify if the relevant semi / partly processed inventories (work
in progress) and raw materials have also been written down.
• Follow up for items that are obsolete, damaged, slow moving and ascertain the possible
realizable value of such items.
• For the purpose, request the client to provide inventory ageing split between less than 30
days, 30-60 days old, 60- 90 days old, 90- 180 days old, 180- 385 days old and more than
365 days old.
• Follow up any inventories which at time of observance of physical counting were noted
as being damaged or obsolete.
• Compare recorded costs with replacement costs.
• Examine vendor price lists to determine if recorded cost is less than current prices.
• Calculate inventory turnover ratio. Obsolete inventory may be revealed if ratio is
significantly lower.
• In manufacturing environments, test overhead allocation rates and ensure that only
direct labor, direct material and overhead have been included.
• Verify the correct application of lower-of-cost-or-net realizable value principles

Presentation & Disclosure

Ensure whether the following disclosures as required under Schedule III (Part 1) to the
Companies Act, 2013 have been made:
✓ Whether mode of valuation has been stated separately for each class of inventory
✓ Whether inventory has been classified as:
▪ Raw materials
▪ Work-in-progress
▪ Finished goods
▪ Stock-in-trade (goods acquired for trading)
▪ Stores and spares
▪ Loose tools
▪ Others (specify nature).
✓ Whether goods-in-transit have been disclosed separately under each sub-head of
inventory.

9C.14
 FIXED ASSETS -TANGIBLE ASSETS
(“PROPERTY, PLANT AND EQUIPMENT” (“PPE”)

The below table summarizes the audit procedures generally required to be undertaken
while auditing tangible fixed assets:
Assertions Explanation
Existence To establish the existence of tangible fixed assets (PPE) as at the
period- end

Completeness Additions to PPE during the period under audit have been recorded in
the financial statements and do not include any PPE that belong to
third parties but does include PPE owned and controlled by the entity
although lying with a third party
Valuation PPE have been valued appropriately and as per generally accepted
accounting policies and practices

Rights and The entity has valid legal ownership rights over the PPE claimed to be
Obligations held by the entity and recorded in the financial statements
Presentation and Required disclosures for PPE have been appropriately made
Disclosure

Existence
 Review client’s plan for performing physical verification of PPE i.e. whether performed
by own staff or by a third party and the policy regarding periodicity i.e. whether physical
verification shall be done on annual basis or once in two years/ three years.
 Evidence of appropriate supervision of those performing physical verification of PPE
should be examined.
 Obtain PPE physical verification report backed by the working sheets from the client
and perform the following procedures:
✓ Assess if all items of PPE are properly tagged and carry identification marks /
numbers and physical verification work papers do capture the asset identification
numbers for assets physically verified.
✓ Reconciliation of items of PPE as physically verified with the fixed asset register
maintained by the entity as at the date/ period of undertaking physical verification.
Specifically verify if the PPE additions up to the date of physical verification have been
updated in the fixed asset register.

9C.15
 ✓ Verify the discrepancies noted, based on physical verification undertaken and the
manner in which such discrepancies have been dealt with in the entity's books and
financial statements,
For example any identified shortages/ assets not in working condition and/ or active
use should be accounted for as deletions in the books of account post approvals by
the entity's management and depreciation charge should have ceased to be charged
beyond the date of deletion.

Completeness
• Verify the movement in the PPE schedule (asset class wise like building, P&M etc.) compiled
by the management i.e. Opening + Additions – Deletions = Closing and tally the
closing balance to the entity’s books of account.
• Check the arithmetical accuracy of the movement in PPE schedule, tally the opening
balances to the previous year audited financial statements.
• For additions during the period under audit, obtain a listing of all additions from the
management and undertake the following procedures:
✓ For all material additions, verify if such expenditure meets the criteria of PPE as per
AS 10 Revised.
✓ These costs include costs incurred initially to acquire or construct an item of property,
plant and equipment and costs incurred subsequently to add to, replace part of, or
service it.
✓ Verify that the cost of an item of property, plant and equipment is as per AS 10
Revised.
✓ Verify and ensure that items such as spare parts, stand-by equipment and servicing
equipment are recognised as property, plant and equipment only when they are
held for more than one period as per the requirements of AS 10 Revised.
✓ Ensure that the entity is not recognizing costs of the day-to-day servicing in the
carrying amount of an item of property, plant and equipment.
✓ Test the purchase invoice, installation certificate or report or other similar
documentation maintained by the entity to verify the date of addition, for all
additions samples of PPE during the period under audit.
✓ Verify whether the PPE additions have been approved by authorized personnel.
✓ Verify whether proper internal processes and procedures like inviting competitive
quotations/ floating tenders etc. were followed prior to finalizing the vendor for
procuring items of PPE/ awarding of work contract for capital projects by checking
the supporting documents of the samples selected.

9C.16
• In relation to deletions to PPE,
✓ understand from the management the reason and rationale for deletion
(example could be new purchase of similar asset once the old asset was no longer
fit to be used in production process) and
✓ the manner of disposal.
✓ Obtain the management approval and discard note authoring discard of the asset
from its active use.
✓ Verify the process followed for sale of discarded PPE, for example inviting
competitive quotes, tenders and the basis of calculation of sales proceeds.
✓ Verify that the management has accurately recorded the deletion of PPE
(original cost and accumulated depreciation up to the date of disposal) and the
resultant gain/ loss on discard in the entity’s books of account.

Valuation
• It is a common understanding that the value of fixed assets/ PPE depreciates due to efflux
of time, use and obsolescence. The diminution of the value represents an item of cost
to the entity for earning revenue during a given period.
• Unless this cost in the form of depreciation is charged to the accounts, the profit or loss
would not be correctly ascertained and the values of PPE would be shown at higher
amounts.
• The auditor should:
✓ Verify that the entity has charged depreciation on all items of PPE unless any
item of PPE is non- depreciating like freehold land;
✓ Assess that the depreciation method used reflects the pattern in which the asset's
future economic benefits are expected to be consumed by the entity.
✓ The auditor should also verify whether the management has done an impairment
assessment to determine whether an item of property, plant and equipment is
impaired as per the requirements of AS 28 - Impairment of Assets.

Rights & Obligations

• In addition to the procedures undertaken for verifying completeness of additions to PPE
during the period under audit, the auditor while performing testing of additions should
also verify that all PPE purchase invoices are in the name of the entity that entitles
legal title of ownership to the respective entity.
• For all additions to land, building in particular, the auditor should obtain copies of
conveyance deed / sale deed to establish whether the entity is mentioned to be the legal
and valid owner.

9C.17
 • The auditor should insist and verify the original title deeds for all immoveable
properties held as at the balance sheet date.
• In case the entity has given such immoveable property as security for any borrowings
and the original title deeds are not available with the entity, the auditor should request the
entity’s management for obtaining a confirmation from the respective lenders that they
are holding the original title deeds of immoveable property as security.
• In addition, the auditor should also verify the register of charges, available with the
entity to assess the PPE that has been given as security to any third parties.

Presentation & Disclosure

Ensure whether the following disclosures as required under Schedule III (Part 1) to
Companies Act, 2013 have been made:
• Whether all items of property, plant and equipment have been classified as:
✓ Land
✓ Buildings
✓ Plant and equipment
✓ Furniture and Fixtures
✓ Vehicles
✓ Office equipment
✓ Others (specify nature)
• Whether the entity has disclosed assets "under lease" separately under each
class of asset. The term "under lease" means assets given on operating lease
and assets taken on Finance lease.
• For each class of Property, Plant and Equipment, whether the entity has
disclosed a reconciliation of the gross and net carrying amounts at the
beginning and end of the reporting period showing separately:
✓ Opening balance of gross carrying amount
✓ Additions
✓ Acquisitions through business combinations
✓ Disposals
✓ Disposals through demergers
✓ Other adjustments
✓ Borrowing costs capitalized
✓ Closing balance of gross carrying amount
• For each class of property, plant and equipment, whether the entity has
disclosed:
✓ Opening accumulated depreciation
✓ Charge for the year
✓ Deduction/ other adjustments for depreciation
✓ Closing accumulated depreciation

9C.18
• For each class of property, plant and equipment, whether the entity has
disclosed:
✓ Opening accumulated impairment losses
✓ Impairment losses
✓ Impairment reversals
✓ Closing accumulated impairment losses.

9C.19
 FIXED ASSETS - INTANGIBLE ASSETS
• An Intangible Asset is an identifiable non-monetary asset, without physical
substance, held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes.
• Enterprises frequently expend resources, or incur liabilities, on the acquisition,
development, maintenance or enhancement of intangible resources such as
scientific or technical knowledge, design and implementation of new processes or
systems, licenses, intellectual property, market knowledge and trademarks
(including brand names and publishing titles).
• Common examples of items encompassed by these broad headings are computer
software, patents, copyrights, motion picture films, customer lists, mortgage
servicing rights, fishing licenses, import quotas, franchises, customer or supplier
relationships, customer loyalty, market share and marketing rights.
• Goodwill is another example of an item of intangible nature which either arises on
acquisition or may be internally generated.
• As per AS 26 – Intangible Assets, internally generated goodwill is not recognized as an
asset because it is not an identifiable resource controlled by the enterprise that can be
measured reliably at cost.
The below table summarizes the audit procedures generally required to be undertaken
while auditing intangible fixed assets:
Assertions Explanation
Existence To establish the existence of intangible fixed assets as at the period-
end

Completeness Additions to Intangible assets during the period under audit have
been recorded appropriately in the financial statements
Valuation Intangible have been valued appropriately and as per generally
accepted accounting policies and practices

Rights and The entity has valid legal ownership rights over the PPE claimed to
Obligations be held by the entity and recorded in the financial statements
Presentation and Required disclosures for PPE have been appropriately made
Disclosure

9C.20
 Existence
• Since an Intangible Asset is an identifiable non-monetary asset, without physical
substance, for establishing the existence of such assets, the auditor should verify whether
such intangible asset is in active use in the production or supply of goods or services,
for rental to others, or for administrative purposes.
Example- for verifying the existence of software, the auditor should verify whether such
software is in active use by the entity and for the purpose, the auditor should verify the
sale of related services / goods during the period under audit, in which such software has
been used.
• In case any intangible asset is not in active use, deletion should have been recorded in
the books of account post approvals by the entity’s management and amortization
charge should have ceased to be charged beyond the date of deletion.

Completeness
• Verify the movement in the Intangible assets schedule (asset class wise like software,
designs / drawings, goodwill etc.) compiled by the management i.e. Opening + Additions
– Deletions = Closing and tally the closing balance to the entity’s books of account.
• Check the arithmetical accuracy of the movement in intangible asset schedule, tally the
opening balances to the previous year audited financial statements.
• For additions during the period under audit, obtain a listing of all additions from the
management and undertake the following procedures:
✓ For all material additions, verify if such expenditure meets the criterion for
recognition of an intangible asset as per AS 26.
✓ Ensure that no cost related to research (or from the research phase of an
internal project) gets recognized as intangible asset.
✓ Check the certificate or report or other similar documentation maintained by the
entity to verify the date of use of the intangible which could be linked to date of
commencement of commercial production/ economic use to the entity, for all
additions to intangible assets during the period under audit.
✓ Verify whether the additions (acquisitions) have been approved by appropriate
entity’s personnel.
✓ Verify if proper internal processes and procedures like inviting competitive
quotations/ floating tenders etc. were followed prior to finalizing the vendor for
procuring item of intangible assets.
• In relation to deletions to intangible assets,
✓ understand from the management the reason and rationale for deletion and the
manner of disposal.

9C.21
 ✓ Obtain the management approval and discard note authoring discard of the asset
from its active use. Verify the process followed for sale of discarded asset, example
inviting competitive quotes, tenders and the basis of calculation of sales proceeds.
✓ Verify that the management has accurately recorded the deletion of intangible
asset (original cost and accumulated amortization up to the date of disposal) and the
resultant gain/ loss on discard in the entity’s books of account.

Valuation
• The value of intangible assets may diminish due to efflux of time, use and/ or
obsolescence. The diminution of the value represents an item of cost to the entity for
earning revenue during a given period.
• The auditor should:
✓ Verify that the entity has charged amortization on all intangible assets;
✓ Verify that the amortization method used reflects the pattern in which the
asset’s future economic benefits are expected to be consumed by the entity.
✓ The auditor should also verify if the management has undertaken an impairment
assessment to determine whether an intangible asset is impaired.
✓ For the purpose, the auditor needs to verify if the entity has applied AS 28,
Impairment of Assets for determining
▪ the manner of reviewing the carrying amount of its intangible asset,
▪ determining the recoverable amount of the asset to determine impairment
loss, if any.

Rights & Obligations

• In addition to the procedures undertaken for verifying completeness of additions to
intangible assets during the period under audit, the auditor while performing testing of
additions should also verify that all expense invoices / purchase contracts are in the
name of the entity that entitles legal title of ownership to the respective entity.

Presentation & Disclosure

Ensure whether the disclosures as required under Schedule III to Companies Act, 2013
have been made complied.
• Whether all items of intangible assets have been classified as:
✓ Goodwill
✓ Brands/trademarks
✓ Computer software

9C.22
 ✓ Mastheads and publishing titles
✓ Mining rights
✓ Copyrights, and patents and other intellectual property rights, services and
operating rights
✓ Recipes, formulae, models, designs and prototypes
✓ Licenses and franchise
✓ Others (specify nature).
• For each class of intangible asset, whether the entity has disclosed a
reconciliation of the gross and net carrying amounts at the beginning and end
of the reporting period showing separately:
✓ Opening balance of gross carrying amount
✓ Additions
✓ Disposals
✓ Impairments
✓ Other adjustments.
• For each class of intangible assets, whether the entity has disclosed:
✓ Opening accumulated amortization
✓ Charge for the year
✓ Deduction/ other adjustments for amortization
✓ Closing accumulated amortization.
• For each class of intangible assets, whether the entity has disclosed:
✓ Opening accumulated impairment losses
✓ Impairment losses
✓ Impairment reversals
✓ Closing accumulated impairment losses.

9C.23
 LOANS AND ADVANCES AND OTHER CURRENT ASSETS
• Loans and advances include loans and advances to
✓ related parties,
✓ security deposits,
✓ capital advances,
✓ amounts recoverable in cash or in kind or for value to be received, e.g., rates,
taxes and insurance paid in advance/ prepaid.
• Other current assets primarily include balances with statutory/ government
authorities etc.

The below table summarizes the audit procedures generally required to be undertaken
while auditing loans and advances and other current assets:
Assertions Explanation
Existence To establish the existence of loans and advances and other current assets
as at the period- end

Completeness Loans and advances and other current asset balances that were supposed
to be recorded have been recognized in the financial statements.

Valuation Loans and advances and other current asset balances have been valued
appropriately.

Presentation Required disclosures for loans and advances and other current assets
and Disclosure have been appropriately made

Existence
• For establishing existence of loans and advances, direct confirmation procedures, similar
to those performed for ‘’Accounts receivable’’ balances are undertaken with the only
difference that while undertaking circularization of direct confirmations, in addition to the
principal amount, interest received / receivable, if any, as per the agreed terms between
the parties, may also be included as part of the balance to be confirmed.

Completeness
• Obtain a list of all advances and other current assets and compare them with balances in
the ledger.
• Verify loan agreements and acknowledgements of parties in respect of outstanding loans.
A loan or an advance, if material, is granted only if authorised by the Memorandum and
Articles of Association in the case of Company. In addition, the auditor should confirm that

9C.24
 the loans advanced were within the competence of persons who had advanced the same,
directors in the case of a Company, partners in the case of a firm and trustees in the case of
a trust.
• Inspect the minutes of meeting of board of directors to confirm if all material loans and
advances were approved by the board of directors.
• Verify that the loan has been acknowledged by the party and in addition, inspect if any
security has been deposited against due repayment of the loan.
• Ascertain if loans are being recovered regularly as per agreed instalments.
• If there are any related party loans and advances, review whether they were properly
authorized and the value of such transactions were reasonable and at arm’s length.
• In relation to balances with statutory authorities like GST input credit, prepare a
reasonability with respect to purchases/ expenses by applying the applicable rate to the
purchases/ expenses and in case of any variance with the asset recorded by the entity,
reasons for variance should be requested from the entity.
• Further, the auditor should obtain statutory returns filed with the authorities like GST
returns and verify whether the amount recorded as per books of account tallies with the
claim made with the authorities.

Valuation
• Assess the allowance for doubtful accounts. Review the process followed by the
Company to derive an allowance for doubtful accounts.
• This will include a consistency comparison with the method used in the last year, and a
determination of whether the method is appropriate for the underlying business
environment.
• Obtain the ageing report of loans and advances, split between not currently due, 30 days
old, 30 - 60 days old, 60 - 180 days old, 180 - 365 days old and more than 365 days old.
• Also, obtain the list of loans and advances under litigation and compare with previous
year.
• Scrutinize the analysis and identify those loans and advances that appear doubtful;
Discuss with management about the reasons as to why these loans/ advances are not
included in the provision for doubtful balances.
• Assess bad loans / advances write-offs. Prepare schedule of movements on Bad loans/
advances – Provision Accounts and loans/ advances written off.
• Check that write-offs or other reductions in the recoverable balances have been approved
by the BOD.
• Check that the restatement of foreign currency loans and advances / other current
assets has been done properly.

9C.25
 Presentation & Disclosure
Ensure whether the following disclosures as required under Schedule III to Companies Act,
2013 have been made:
Whether loans have been classified as:
✓ Security deposits
✓ Loans to related parties (giving details thereof)
✓ Capital advances
✓ Other loans (specify nature).
Whether all the above loans have been further sub-classified as:
✓ Secured, considered good
✓ Unsecured, considered good
✓ Doubtful.
Whether allowance for bad and doubtful loans has been disclosed separately under
the relevant heads i.e. separately for each category of loans For loans, whether
separate disclosure has been made for amounts due by:
✓ Director(s) of the company
✓ Director(s) of the company jointly with other persons
✓ Other officer(s) of the company
✓ Other officer(s) of the company jointly with other persons
✓ Firm(s) in which director is a partner
✓ Private company(ies) in which director is a director or a member.

9C.26
 INCOME
STATEMENT
CAPTIONS

9D.1
 SALE OF PRODUCTS AND SERVICES
• The sales and collections cycle in a business refers to the set of processes that begin when
a customer purchases goods or services and ends when the entity receives complete
payment against the sales.
• As part of the year-end audit of an entity’s financial statements, external accountants
(auditors) test sales transactions and the internal controls over those transactions to
ensure that the entity is not materially misstating its revenues or accounts receivable.
• Auditor needs to obtain a clear understanding about the organization and its revenue
centers
1. An auditor needs to obtain an understanding of the management control in respect
of sales process.
2. An auditor tests the controls the entity has set up for the sales cycle to determine
how strong and reliable they are. If they are strong, the auditor can reduce the
amount of transaction testing he must do.
3. The auditor selects a random sample of transactions and examines the related
customer purchase orders invoices and customer statements. If the control being
tested is numbered sales invoices
4. Performing substantive audit procedures is must. Substantive analytical procedure
will consist of sales trend analysis, comparison with previous accounting period,
category wise sales, any analysis the auditor may find relevant and most important of
all building a sales expectation and compare that with the client’s sales records.
5. The auditor will need to know the sales prices of the products or services over the
year, monthly average sales price per product or service, discount policy.

The below table summarises the audit procedures generally required to be undertaken
while auditing sales:
Assertions Explanation
Occurrence Recorded sales represent goods shipped / services performed
during the period

Completeness & All sales made during the period were recorded and there in no
Cut-Off understatement or overstatement.
Measurement All sales are accurately measured as per applicable accounting
standards and correctly journalized, summarized, and posted

Presentation and Required disclosures for sales have been appropriately made
Disclosure

9D.2
 Occurrence
• Ensure revenue is not overstated by performing following audit procedures:
✓ Check whether a single sales invoice is recorded twice or a cancelled sales invoice
could also be recorded.
✓ Whether any fictitious customer and sale has been recorded.
✓ Whether any shipments were done without the consent and agreement of the
customer.
✓ Whether unearned revenue recorded as earned.
✓ Whether any substantial uncertainty exists about collectability.
✓ Whether customer obligations are contingent on other actions (financing, resale,
etc.).
• Review sequence of sales invoices
• Review journal entries for unusual transactions
• Calculate the ratio of sales return to sales and compare it with previous year and note
down the reason for increase/ decrease.
• Check the sales return with sales invoice, challan, credit note, stock register, etc.

Completeness & Cut-Off

• Perform cut-off test to ensure that revenues are recognised in the current accounting
period and sales were not tampered towards the period end.
• Cut-off errors will usually arise when companies recognise revenue based on the date
on which the sales invoices are generated rather than the date on which the risks and
rewards are transferred to the buyer.
• In order to perform a robust sales cut-off test, auditors need to understand and consider
the specific cut-off error risk of each engagement.
• Auditors will also have to see “Credit notes” issued after the accounting period.
• Sometimes sales team or sales personnel can make fictitious / ghost sales before the
year-end to meet performance target and cancel out the sale with a post year end credit
note.
• Trace from the shipping documents to the sales journal
• Check whether quantity is appearing in sales register or not and check reconciliation
of total sales/goods dispatched as per stock records and financial records and statutory
records like GST.
• Review GST tax and GST returns and ensure that the same are reconciled with revenue
reported in the profit and loss account. Prepare a reasonability say of GST by applying the
applicable rate to the gross sales value and compare the amount of GST as per statutory
returns and analyze the reasons for variance, if any.

9D.3
 Measurement
• Trace a few transactions from inception to completion
• Auditor must understand client's operations and related GAAP issues e.g. point of sale
revenue recognition vs. percentage of completion, wherever applicable.
• Compare the rate of sales affected with related parties and review them for
collectability, as well as whether they were properly authorized and the value of such
transactions were reasonable and at arm’s length.

Presentation & Disclosure

• Ensure whether the following disclosures as required under Schedule III (Part 1) to
Companies Act, 2013 have been made:
✓ Whether disclosure of sales in respect of each class of goods has been made
✓ Whether revenue from operations is disclosed separately in the notes as revenue
arising from:
• Sale of products (including excise duty)
• Sale of services
• Other operating revenues
✓ Whether brokerage and discount on sales, other than the usual trade discount has
been disclosed
✓ Whether the transactions with related parties are appropriately disclosed in notes to
accounts

9D.4
 OTHER INCOME COMPRIS ING INTEREST INCOME,
DIVIDEND INCOME, GAIN/ LOSS ON SALE OF
INVESTMENTS ETC.

• Any form of income earned by an entity which is not linked to the entity’s core
business operations is generally classified as other income.
• Examples – interest on excess funds parked in fixed deposits with banks (the entity not
being a bank or financial institution), interest on loans given to third parties/ within the
group, return on mutual fund investment etc.
• Interest income on fixed deposits is recognized on a time proportion basis taking
into account the amount outstanding and the applicable interest rate.
• Dividends are recognised in the statement of profit and loss only when:
i. the entity's right to receive payment of the dividend is established;
ii. it is probable that the economic benefits associated with the dividend will flow
to the entity; and
iii. the amount of the dividend can be measured reliably.
• Gain/(loss) on sale of investment in mutual funds is recorded as other income on transfer
of title from the entity and is determined as the difference between the redemption price and
carrying value of the investments.

Assertions Explanation
Occurrence Recorded other income was earned during the period
Completeness Other income earned during the period was appropriately recorded
and there in no understatement or overstatement.

Measurement Other income has been measured appropriately as per the

applicable accounting standards.

Presentation and Required disclosures for other income have been appropriately
Disclosure made

Interest Income
• For verifying interest income on fixed deposits:
✓ Obtain a listing of fixed deposits opened during the period under audit along with
the applicable interest rate and the number of days for which the deposit was
outstanding during the period.

9D.5
 ✓ Verify the arithmetical accuracy of the interest calculation made by the entity by
recomputing i.e. multiplying the deposit amount with the applicable rate and number
of days during the period under audit.
✓ For deposits still outstanding as at the period- end, trace the same to the direct
confirmation obtained from the respective bank/ financial institution.
✓ Obtain a confirmation of interest income from the bank and verify that the interest
income as per bank reconciles to the calculation shared by the entity.
✓ Also, obtain a copy of Form 26AS (TDS withholding by the bank / financial institution)
and reconcile the interest reflected therein to the calculation shared by client.

Dividend Income
• For Dividends, verify that the same are recognised in the statement of profit and loss only
when the entity’s right to receive payment of the dividend is established.

Gain / (loss) on sale of Investment in Mutual Funds

• Verify that Gain / (loss) on sale of investment in mutual funds is recorded as other
income only on transfer of title from the entity and is determined as the difference
between the redemption price and carrying value of the investments.
• For the purpose, obtain the mutual fund statement and trace the gain / loss as recorded
in the books of account to the gain/ loss as reflected in the statement.

Presentation and Disclosure

Ensure whether the following disclosures as required under Schedule III to Companies
Act, 2013 have been made:
Whether ‘other income’’ has been classified as:
✓ Interest income
✓ Dividend income
✓ Other non-operating income (net of expenses directly attributable to such
income)

9D.6
 PURCHASES
• Purchases are another significant process of an entity.
• Similar to sales as discussed above, purchases and disbursement cycle in a business refers
to the set of processes that begin when an order for buying goods or services is placed
based on requirements of the production / user department and ends when the entity
received the product and makes complete payment to the vendor.
• As part of the year-end audit of an entity’s financial statements, auditors test purchase
transactions and the internal controls over those transactions to ensure that the entity is
not materially misstating its purchases or accounts payables.
• Auditor needs to obtain a clear understanding about the organisation and its production
centres e.g. type of services or products they procure that are used in the production /
rendering of services, sources of procurement whether domestic or overseas, general
availability and terms and conditions of purchase of the service or products, major
vendors, credit period, quality checks, purchase terms (Credit or cash purchase) etc.
1. An auditor needs to identify the control points over purchases e.g.
✓ whether segregation of duties exist,
✓ whether competitive quotes are invited,
✓ whether a purchase committee exists who authorises purchase price,
✓ who issues and authorizes purchase orders,
✓ when and how the goods are received and acknowledged,
✓ who checks the quality, quantity and specifications of the goods received and
prepares Goods Receipt Note (GRN),
✓ who approves the vendor invoice,
✓ whether a 2 way / 3 way match process exists (i.e. tally between purchase
order, GRN and vendor invoice),
✓ how the purchases have been recognized in the system.
2. An auditor tests the controls the entity has set up for the purchase cycle to determine
whether they are effective or not.
3. If the controls are effective, the auditor can reduce the extent of substantive
testing.
4. Common internal controls over the purchase cycle include
✓ inviting of competitive quotations for shortlisting the vendor,
✓ numbered purchase orders,
✓ purchase order authorization over a certain limit,
✓ generation of GRN on receipt of goods,
✓ quality inspection of goods,
✓ 2 way/ 3-way match, authorization of purchase invoices.

9D.7
 5. The auditor selects a random sample of transactions and examines the related
purchase orders, GRN, purchase invoices, inward gate entry register and vendor
reconciliation/ statements.
6. Performing substantive audit procedures is must. Substantive analytical procedure
will consist of purchase trend analysis, comparison with previous accounting
period, category wise purchases, any analysis auditor may find relevant and most
important of all setting a purchase expectation in relation to the sales made during the
period under audit and compare that with the client’s purchase records.
7. The auditor would need to know the purchase prices of the products or services over
the year, monthly average purchase price per product or service etc.

The below table summarises the audit procedures generally required to be undertaken
while auditing purchases:
Assertions Explanation
Occurrence Recorded purchases represent goods actually received / services
availed during the period

Completeness & Cut- All purchases made during the period were recorded and there in
Off no understatement or overstatement.

Measurement All purchases have been measured appropriately

Presentation and Required disclosures for purchases have been appropriately made
Disclosure

Occurrence
Ensure purchases are not understated/ overstated by performing following audit
procedures:
• Whether any fictitious vendor and purchase has been recorded by reviewing the vendor
selection process followed by the entity and also performing procedures to ensure
existence of the vendor.
• Whether the goods were received at the factory gate and whether there exists an
entry in the security gate inward register
• Whether quality inspection of goods was done
• Whether a goods receipt note was prepared and signed by an appropriate client
personnel
• Whether the purchase invoice was approved as per delegation of authority and whether
a 3 or 2-way match (as discussed above) was done
• Whether stock record has been updated by the stores personnel

9D.8
Special considerations during audit of purchases
• The purchase invoice received should be the "Original" copy (and not photocopy / carbon
copy) against which the auditee has recorded the purchase in its books of account.
• Purchase invoice should have been booked only once risk and reward incidental to
ownership has been transferred to the entity. Specific consideration for cases where the
terms of delivery as agreed with vendor are F.O.B., C.I.F. etc.
• Purchase invoice should be in the name of auditee. However, in case of different
branches, it should be addressed to the appropriate branch.
• Input tax component should have been booked in the input tax ledger, the auditor
should obtain a copy of the input tax returns filed with the authorities and tally the input
tax as reflected in the books to the amount disclosed in the returns.
• In case of purchases made from related parties or allied and associated concerns, the
auditor needs to verify if requisite approval from Board has been obtained and should
verify the selected samples and perform analytical procedures in relation to price of goods
to confirm that the price charged is at arm's length.
• The auditor should review whether purchases should be capitalized or expensed of in
Statement of Profit and loss according to his professional judgment.
• Review journal entries for unusual transactions.

Completeness & Cut-Off

In addition to the procedures for establishing occurrence of purchases as discussed
above, the auditor should:
• Perform cut-off test to ensure that purchases are recognised in the correct accounting
period.
• For the purpose, the auditor should examine material inward records for few days say
last 5 days prior to closing date to check that all corresponding invoices have been duly
entered in the Purchases book and none have been omitted.
• Ensure correct accounting treatment of goods - in - transit as per the agreed terms
with the vendor regarding transfer of risk and reward of ownership in goods.

Measurement
Perform analytical procedures to obtain audit evidence as to overall reasonableness of
purchase quantity and price which may include:
✓ Consumption Analysis: Auditor should scrutinize raw material consumed as per
manufacturing account and compare the same with previous years with closing stock
and ask for the reasons from Management If any significant variations found.

9D.9
 ✓ Stock Composition Analysis: Auditor to collect the reports from management for
composition of stock i.e. raw materials as a percentage of total stock and compare the
same with previous year and ask for reasons from management in case of significant
variations.
✓ Ratios: Auditor should compare the creditors turnover ratios and stock turnover ratios
of the current year with previous years.
✓ Auditor should review quantitative reconciliation of closing stocks with opening
stock, purchases and consumption

Presentation & Disclosure

Ensure whether the following disclosures as required under Schedule III to Companies
Act, 2013 have been made:
✓ Whether purchases of stock-in-trade has been specifically disclosed
✓ Whether changes in inventories of finished goods, stock–in-trade and work- in-
progress has been specifically disclosed
✓ Whether the transactions with related parties are appropriately disclosed in notes to
accounts.

9D.10
 EMPLOYEE BENEFITS EXPENSE
• Employee benefits expense or commonly called payroll represents the aggregate sum an
entity pays to its employees for their labour / efforts, as well as associated expenses
such as perquisites / benefits, post- employment benefits like gratuity, superannuation,
leave encashment, provident fund contribution etc. as well as towards their hiring, their
welfare and training.
• In many industries, employee benefit expense is the biggest expense category and
hence, it is critical for businesses to manage this expenditure shrewdly and for the
auditors, to verify and ensure that such expenditure is appropriate and has been
accounted as per applicable accounting standards and generally accepted accounting
principles.

Auditor needs to obtain a clear understanding about the organisation and its hiring,
appraisal and retirement process in the following manner:
• An auditor tests the controls the entity has set around employee benefit payment process
to determine how effective they are. If they are effective, the auditor can reduce the
substantive testing.
• Common internal controls over the employee benefit payment cycle includes
✓ maintaining of attendance records,
✓ employee master,
✓ authorisation and approval of monthly payroll processing and
✓ disbursement,
✓ computation of employee deductions like payroll taxes,
✓ accrual of other benefits like gratuity, leave encashment, bonus etc.
• The auditor selects a random sample of transactions and examines the related
appointment letters, appraisal letters, attendance records, HR policies, employee master
etc.
• Performing substantive audit procedures is must. Substantive analytical procedure will
consist of monthly expense reasonability, comparison with previous accounting
period, any analysis auditor may and relevant and most important of all setting an
expectation in relation to the expense incurred during the period under audit and compare
that with the client's business operations and overall trend in the industry.

The below table summarises the audit procedures generally required to be undertaken
while auditing employee benefits expense:
Assertions Explanation
Occurrence Recorded employee benefit expenses were actually incurred during
the period

9D.11
 Assertions Explanation
Completeness Employee benefit expenses pertaining to the period have been
recorded appropriately and there in no understatement or
overstatement.

Measurement Employee benefit expenses have been measured appropriately

Presentation and Required disclosures for employee benefit expenses have been
Disclosure appropriately made

Occurrence & Completeness

• Obtain an understanding of entity’s process of capturing employee attendance.
• There is always a risk that an entity could record expense for fictitious employees.
• To address this risk, the auditor may choose to meet the employees in person, on a
sample basis.
Example:
Auditor may choose to be physically present at the entry gate at any given date and
himself count the employees entering the premises and also, understand the manner of
recording/ capturing their time.
• Further, the auditor may choose to select a sample of employees and ask the payroll
department to share their bank details / identity proofs of the employees.
• Obtain a list of employees as at the period- end along with a monthly movement split
between new hires, leavers and continuing employees.
• For a sample (selected randomly) of new hires, obtain the appointment letter and verify
whether the salary for first month and subsequent months was processed as per the agreed
terms.
• For a sample (selected randomly) of resigned employees, obtain their full and final
computation and verify whether all their dues including post-retirement benefits like
gratuity, leave encashment have been paid and whether the respective employee’s
acknowledgement on final computation has been obtained.

Measurement
• Obtain the monthly salary registers for all 12 months. Compile a monthly payroll
reasonability by calculating the average salary per employee per month and compare with
the previous year and preceding month and analyses the reasons for variance which could
be attributable to annual increments, an employee at senior level joining/ leaving the
entity, bonus pay-out etc.

9D.12
• Verify if accrual/ provision has been made for all employee benefits and obligations
like bonus, gratuity, leave encashment etc.
• In case Provident Fund (PF), Employee State Insurance (ESI) are applicable to the entity,
compile a reasonability by applying the rate to the basic wages and comparing to the
amount recorded in books and analyses reasons for variance, if any.
• Also, obtain monthly deposit challans to verify if the month on month liability was
subsequently deposited with the authorities and within the defined timelines.
• Perform analytical procedures to obtain audit evidence as to overall reasonableness of
employee benefit expense which may include production per employee analysis.
• Auditor should analyse units produced per employee and compare the same with
previous years and prevent industry trends and ask for the reasons from Management, if
any significant variations are found.

Presentation & Disclosure

Ensure whether the following disclosures as required under Schedule III to Companies Act,
2013 have been made:
Whether employee benefit expense has been classified as:
✓ Salaries and wages.
✓ Contributions to provident and other funds.
✓ Staff welfare expenses.

9D.13
 DEPRECIATION AND AMO RTISATION
• One of the key principles of accrual basis of accounting requires that an asset’s cost is
proportionally expensed based on the period over which the asset is expected to be
used.
• Both depreciation and amortization are methods that are used to prorate the cost of a
specific type of asset over its useful life.
• Depreciation represents systematic allocation of the depreciable value of an asset over
its useful life while amortisation represents systematic allocation of the depreciable
amount of an intangible asset over its useful life.
• Depreciation and amortisation generally constitute an entity’s significant part of overall
expenses and have direct impact on the profit/ loss of the entity, hence, auditors need to
verify and ensure that such expenditure is appropriate, accurately calculated and has
been accounted as per applicable provisions of Companies Act or other statutes, to the
extent applicable on the respective industry and as per generally accepted accounting
principles.

Auditor needs to consider the following attributes while verifying for depreciation and
amortisation expenses:
• Obtain the understanding of entity’s accounting policy related to depreciation and
amortisation.
• Ensure the Company policy for charging depreciation and amortisation is as per the
relevant provisions of Companies Act, applicable accounting standards.
• Whether the depreciation has been calculated after making adjustment of residual value
from the cost of the assets.
• Whether depreciation and amortisation charges are valid.
• Whether depreciation and amortisation charges are accurately calculated and recorded.
• Whether all depreciation and amortisation charges are recorded in the appropriate
period.
• Ensure the parts (components) of each item of property, plant and equipment that are to
be depreciated separately has been properly identified.
• Whether the most appropriate depreciation method for each separately depreciable
component has been used.

9D.14
The below table summarises the audit procedures generally required to be undertaken
while auditing depreciation and amortization expense:
Assertions Explanation
Completeness Depreciation and Amortisation expenses pertaining to the period have
been recorded appropriately and there in no understatement /
overstatement.

Measurement Depreciation and amortisation expenses have been measured

appropriately

Occurrence Recorded depreciation and amortisation expenses were actually

incurred during the period

Presentation and Required disclosures for depreciation and amortisation have been
disclosure appropriately made.

Completeness & Occurrence

• Obtain an understanding of entity’s process of charging depreciation and amortization.
• Obtain the fixed asset register maintained by the entity.
• There is always a risk that an entity could capitalize expense of revenue nature to
increase its profit or charge capital expenditure directly in income and expense
statement to reduce its profit.
• To address this risk, the auditor may choose to check the nature of asset from fixed
asset register and further, there is always a risk that fake asset has been capitalized in the
books and to mitigate this risk, auditors should physically verify the fixed assets, at least
the ones that are material in value.

Measurement
• Obtain a list of all additions / deletions along with their proper approval from the
authorised person for the same.
• Select the sample of assets from the Fixed Assets Register, on materiality considerations
and verify the rates of depreciation, depreciation calculation.
✓ Obtain the list of all the components identified by the management.
✓ Ensure Intangible assets like patents, goodwill, copy rights have been properly
amortized over the period.
✓ Ensure depreciation is charged on the assets from the date when it is ready to use.
✓ Ensure depreciation on revalued amount has been properly accounted from
revaluation reserve.

9D.15
 ✓ Depreciation computation as per Income tax Act, 1961- Ensure that additions are
tallying with the additions as per Companies Act and the opening WDV to the Tax
audit schedule for the assessment year preceding the previous year under audit.
✓ Perform analytical procedures to obtain audit evidence as to overall reasonableness
of depreciation and amortisation expense- check the arithmetical accuracy of records
and perform independent calculations example- compute or re-compute the
depreciation expense for the year (Refer the format below that could be used for
compiling reasonability of the expenditure for the year).
✓ Ensure that the depreciation and amortization has been charged as per the useful
lives of PPE and intangible assets.
✓ Ensure that residual values have been properly verified as that impacts the
computation of depreciation.
✓ Ensure that the depreciation and amortization has been computed prospectively
whenever there is any change in useful lives of PPE and intangible assets.

Presentation & Disclosure

Ensure whether the following disclosures as required under Schedule III to Companies
Act, 2013 have been made:
✓ Accounting policy for depreciation and amortization
✓ Useful lives of assets as per schedule II
✓ Residual value of assets
✓ Depreciation method

Book Value Useful Computation of Actual Variance Reasons

life Depreciation/ Depreciation/ for
amortization on amortization Variance
the basis of useful as per
life and books
residual
value
Opening Closing Average
%
Balance Balance Balance
A B C= (A+ B)/2# D E F G=F-E H
# Alternatively, any other most accurate number/ estimate can also be used

9D.16
 OTHER EXPENSES LIKE POWER AND FUEL, RENT , REPAIR
TO BUILDING, PLANT A ND MACHINERY, INSURA NCE,
TRAVELLING, LEGAL AND PROFESSIONAL, MISCELLANEOUS
EXPENSES
An entity in addition to undertaking purchases and incurring employee benefit expenses also
spends on other expenditure like rent, power and fuel, repairs and maintenance, insurance,
travelling, miscellaneous expenses etc., that are essential and incidental to running of business
operations.

While the auditor may choose to analyse the monthly trends for expenses like rent,
power and fuel, an auditor generally prefers to vouch for other expenses to verify
following attributes:
• Whether the expenditure pertained to current period under audit;
• Whether the expenditure qualified as a revenue and not capital expenditure;
• Whether the expenditure had a valid supporting like travel tickets, insurance policy,
third party invoice etc.;
• Whether the expenditure has been classified under the correct expense head;
• Whether the expenditure was authorised as per the delegation of authority matrix;
• Whether the expenditure was in relation to the entity’s business and not a personal
expenditure.

The below table summarises the audit procedures generally required to be undertaken
while auditing other expenses:
Assertions Explanation
Occurrence Recorded other expenses were actually incurred during the period.

Completeness Other expenses pertaining to the period have been recorded

appropriately and there in no understatement or overstatement
Measurement Other expenses have been measured appropriately

Presentation and Required disclosures for other expenses have been appropriately
Disclosure made

9D.17
 Audit Procedures for specific expenses
Rent expense
✓ Obtain a month wise expense schedule along with the rent agreements.
✓ Verify if expense has been recorded for all 12 months and whether the rent amount is as
per the underlying agreement.
✓ Specific consideration should be given to escalation clause in the agreement to verify if
the rent was to be increased/ adjusted during the period under audit.
✓ Also, verify if the agreement is in the name of the entity and whether the expense
pertains to premises used for running business operations of the entity.

Power and fuel expense

✓ Obtain a month wise expense schedule along with the power bills. Verify if expense
has been recorded for all 12 months.
✓ Also, compile a month wise summary of power units consumed and the
applicable rate and check the arithmetical accuracy of the bill raised on monthly basis.
✓ In relation to the units consumed, analyse the monthly power units consumed by
linking it to units of finished goods produced and investigate reasons for variance in
monthly trends.

Insurance expense
✓ Obtain a summary of insurance policies taken along with their validity period.
✓ Verify if the expense has been correctly classified between prepaid and expense for the
period based on number of days.

Legal and professional expenses-

✓ Obtain a month wise and consultant wise summary.
✓ In case of monthly retainer ship agreements, verify if the expenditure for all 12
months has been recorded correctly.
✓ For non- recurring expenses, select a sample and vouch for the attributes
discussed above.
✓ The auditor should be cautious while vouching for legal expenses as the same
may highlight a dispute for which the entity may not have made any provision and the
matter may also not have been discussed/ highlighted to the auditor for his specific
consideration.

9D.18
 Travel, repair and maintenance, printing and stationery,
miscellaneous expenses-
✓ The auditor should select a sample and vouch for the attributes discussed above.
Wherever possible, the auditor and try and prepare a summary of expenditure on
monthly basis and then analytically compare the trends.
✓ Perform analytical procedures to obtain audit evidence as to overall reasonableness
of other expense which may include expenditure per unit produced analysis.
✓ Auditor should analyse expense per unit produced and compare the same with
previous years and prevent industry trends and ask for the reasons from Management
If any significant variations are found.

Presentation and Disclosure

Ensure other expense have been classified under:
• Rent.
• Insurance.
• Power and fuel.
• Repairs and maintenance- Building, Plant and machinery, others.
• Legal and professional.
• Printing and stationary.
• Travel expenses.
• Miscellaneous expenses.

9D.19
 Notes:

9D.20
AUDIT OF LIMITED
COMPANIES
(COMPANY AUDIT)

10.1
 APPOINTMENT OF SUBSE QUENT AUDITORS IN CA SE OF
NON-GOVERNMENT COMPANIES [SEC. 139. (1)]
Appointment and • At the 1st AGM, every company shall appoint an individual or
reappointment of a firm as an auditor. The auditor so appointed shall hold
auditors till sixth AGM office from the conclusion of 1st AGM till the conclusion of
6th AGM.
• After the 1st AGM, when any appointment of auditor is made
at any AGM, the auditor so appointed shall hold office till the
conclusion of 6th AGM, with the AGM wherein such
appointment has been made being counted as the first AGM.
• At every AGM (viz. 2nd, 3rd, 4th and 5th AGM), the
appointment of auditor shall be ratified by the member. (As
per amendment now Ratification not required in every
subsequent AGM)
• If at any AGM, the appointment of auditor is not ratified by
the members, the Board of directors shall appoint another
individual or firm as its auditor(s) after following the
procedure laid down under the Act [Explanation to Rule 3(7).]
• In simple terms, if the appointment is not ratified at any
AGM, the auditor shall have to vacate his office, and such
vacancy shall amount to casual vacancy. The Board shall fill
such casual vacancy in accordance with sub - section (8) of
section 139.
Manner and procedure Rule 3 of the Companies (Audit and Auditors) Rules, 2014
of selection & prescribes the following procedure:
appointment of • The qualifications and experience of the individual or
auditors the firm proposed to be appointed as auditor shall be
(Rule 3) considered by - the Board; or the Audit committee, if
the company is required to constitute an Audit
Committee.
1. While considering the appointment, the Board / Audit
Committee shall have due regard to -
• any order of professional misconduct passed against the
proposed auditor; and
• any proceedings of professional misconduct pending
against the proposed auditor.
2. The Board / Audit Committee may call for such other
information from the proposed auditor as it may deem fit.

10.2
3. In case the company is not required to constitute the Audit
Committee, the Board shall consider and recommend an
individual or a firm as auditor to the members in the AGM for
appointment,
4. In case the company is required to constitute the Audit
Committee, following procedure shall be adopted:
• The Audit committee shall recommend the name of an
individual or a firm as auditor to the Board for
consideration.
• If the Board agrees with the recommendation of the
Audit Committee, it shall further recommend such
individuals or such firm as auditor to the members in the
AGM for appointment.
• If the Board disagrees with the recommendation of the
Audit Committee, it shall refer back the recommendation
to the Audit committee for reconsideration citing reasons
for such disagreement.
• If the Audit Committee, after considering the reasons
given by the Board, decides not to reconsider its original
recommendation, and the Board continues to disagree
with the recommendations of the Audit Committee, the
Board shall
✓ Record reasons for its disagreement with the
committee
✓ Send its own recommendation for consideration of
the members in the AGM
• If the Audit Committee, after considering the reasons
given by the Board, decides not to reconsider its original
recommendation, and the Board agrees with the
recommendations of the Audit Committee, the Board
shall recommend the name of the individual or the firm
as recommended by the Audit Committee to the
members in the AGM for appointment.

10.3
 APPOINTMENT OF SUBSE QUENT AUDITOR FOR A
GOVERNMENT COMPANY [SEC. 139. (5)]
Applicability of Sec. Appointment or Re-
Tenure
139(5) appointment
•In case of Govt. •In case of •The auditor shall hold
companies or any other aforementioned office till the conclusion
company owned or companies CAG shall, in of the AGM.
controlled, directly or respect of a financaial
indirectly, by - year, appoint an auditor
•CG; or duly qualified to be
•SG(s); or appointed within 180
days from the
•Partly by CG and partly
commencement of the
by SG(s)
financial year.

APPOINTMENT OF FIRST AUDITOR [SEC. 139. (6) AND

139(7)]
Manner of Case I [Sec. 139(7)] Case II [ Sec. 139(6)]
appointment The company is a Government The Company is any other
of first auditor
company or any other company company
owned or controlled, directly or
indirectly, by CG, or by SG(s), or
partly by CG and
partly by SG (s).
• Appointment by CAG within 60 • Appointment by the Board
days of registration of the within 30 days from the date
company. of registration of the
• If CAG fails to appoint the first company.
auditor within 60 days, the • If the Board fails to appoint
Board shall appoint the first the first auditor within 30
auditor within next 30 days. days, the Board shall inform
• If the Board fails to appoint the the members of the
first auditor within next 30 days, company who shall appoint
the Board shall inform the the first auditor within 90
members of the company who days at an extraordinary
shall appoint the first auditor general meeting.
within 60 days at an
extraordinary general meeting.

10.4
Tenure of The first auditor shall hold office till the conclusion of the first AGM
first auditor [Sec.139(6) and 139(7)]

Definition of Government company’ means any company in which not less than 51%
‘government of the paid - up share capital is held by -
company’ [Sec.
a) CG; or
2(45) of the
b) SG(s); or
Companies
c) Partly by CG and partly by SG(s).
Act, 2013]
‘Government Company’ includes a company which is a subsidiary
company of a Government company.

CASUAL VACANCY [SEC. 139. (8)]

Case 1 Case II

The casual vacancy arising in any The casual vacancy in case of a

other company company whose accounts are subject
to audit by an auditor appointed by
the CAG
Manner of • Such casual vacancy shall be • Such casual vacancy shall be filled
filling filed within 30 days by the within 30 days by CAG.
casual Board. • If CAG does not fill the casual
vacancy vacancy within 30 days, the Board
• If such a casual vacancy is as a
result of the resignation of an shall fill the casual vacancy within
auditor, such appointment shall next 30 days.
also be approved by the
company at a general meeting
convened within 3 months of
the recommendation of the
Board.
Tenure of Any auditor appointed to fill a casual vacancy shall hold office till the
office conclusion of the next AGM.

The term 'casual vacancy’ has not been defined under the Companies Act,
Meaning of 2013. It generally means a vacancy created by the auditor ceasing to act as
casual such after accepting a valid appointment, e.g. due to death, disqualification,
vacancy resignation, dissolution of firm of auditors etc.
Where no auditor is appointed or reappointed, it does not result into a
casual vacancy.

10.5
10.6
 REAPPOINTMENT OF RETIRING AUDITORS (SEC. 139 (9))
• Reappointment of retiring auditor 139(9)
A retiring auditor may be re-appointed at an AGM, if -
✓ He is not disqualified for re- appointment;
✓ He has not given the company a notice in writing of his unwillingness to be re-
appointed; and
✓ A special resolution has not been passed at AGM appointing some other auditor or
providing expressly that he shall not be re-appointed.

Note: No auditor is appointed at AGM 139(10)

Where at any AGM,

✓ No auditor is appointed or re-appointed.
✓ The existing auditor shall continue to be the auditor of the company.

ROTATION OF AN AUDITOR [SECTION 139(2)]

Applicability of rotation The concept of rotation of auditors is applicable to - listed
of auditors companies; and all companies belonging to such class or classes
[Sec. 139(2)] of companies as may be prescribed.
a) Following classes of companies have been prescribed for the
purpose of rotation of auditors [Rule 5 of the Companies
(Audit and Auditors) Rules, 2014]:
• All unlisted public companies having paid up share
capital of 10 crore or more;
• All private limited companies having paid up share
capital of 50 crore or more;
• All companies having paid up share capital below the
limits mentioned in (a) and (b) above, but having public
borrowings from financial institutions, banks or public
deposits of 50 crore or more.
b) The concept of rotation of auditors shall not apply to One
Person Companies (OPC’s) or Small Companies.

10.7
 Manner of In case of an individual In case of a firm
rotation of
a) No individual shall be a) No audit firm shall be
auditors
appointed or reappointed as appointed or reappointed as
auditor for more than 1 term auditor for more than 2 terms
of 5consecutive years. of 5 consecutive years.

b) An individual auditor who has b) An audit firm which has

completed his term of 5 completed its 2 terms of 5
consecutive years, shall not be consecutive years shall not be
eligible for re-appointment eligible for re-appointment as
as auditor in the same auditor in the same company
company for 5 years from the for 5 years from the completion
completion of his term. of such term.
Restriction on An audit firm having one or more common partner to the other audit
another audit firm, whose tenure has expired, shall not be appointed as the auditor of
firm(s) having the same company for a period of 5 years.
common
In other words, if two or more audit firms have common partner(s), and
partner(s)
one of these firms has completed its 2 terms of 5 consecutive years, none
of such audit firms shall be eligible for reappointment as auditor in the
same company for 5 years.
Time period for Every company, existing on the commencement of this Act, which is
compliance for required to comply with provisions relating to rotation of auditors, shall
existing comply with these requirements within 3 years from the date of
companies commencement of this Act (Sec. 96).
Right of removal 1. The right of the company to remove an auditor before expiry of
or resignation one/two term(s) of 5 consecutive years shall not be affected due to
not affected any provision contained in Sec. 139(2).
2. The right of the auditor to resign from the office of auditor before
expiry of one/two term(s) of 5 consecutive years shall not be affected
due to any provision contained in Sec. 139(2).
Strict provisions Members of a company may resolve to provide that -
may be imposed • in the audit firm appointed by it, the auditing partner and his team
by members
shall be rotated at such intervals as may be resolved by members;
or
• the audit shall be conducted by more than one auditor.
Rules for manner 1. In case the company is required to constitute an Audit Committee,
of rotation on the procedure shall be as follows;
expiry of their • The Audit Committee shall recommend to the Board, the name
term of an individual auditor or of an audit firm who may replace the
(Rule 6) incumbent auditor on expiry of the term of such incumbent.

10.8
 • The Board shall consider the recommendation of the Audit
Committee.
2. In case the company is not required to constitute an Audit
Committee, the procedure shall be as follows:
• The Board shall itself consider the matter of rotation of auditors
• Make its recommendation for appointment of the next auditor
by the members in the AGM.
3. In case of an auditor the period for which the individual or the firm
has held office as auditor prior to the commencement of the Act shall
be taken into account for calculating the period of 5 consecutive
years or 10 consecutive years, as the case may be.
4. The incoming auditor or audit firm shall not be eligible if such auditor
or audit firm is associated with the outgoing auditor or audit firm
under the same network of audit firms.
‘Same network’ includes the firm operating or functioning, under
the same brand name, trade name or common control.
5. A break in the term for a continuous period of 5 years shall be
considered as fulfilling the requirement of rotation.
6. If a partner, who is in charge of an audit firm and also certifies the
financial statements of the company, retires from the said firm and
joins another firm of chartered accountants, such other firm shall
also be ineligible to be appointed for a period of 5 years.
7. Where a company has appointed two or more individuals or
Firms or a combination thereof as joint auditor, the company
may follow the rotation of auditors in such a manner that both
or all of the joint auditors, as the case may be, do not complete
their term in the same year.

Illustration explaining rotation in case of individual

auditor
Column 1 Column II Column III

Number of consecutive years Maximum number of Aggregate period which

for which an individual has consecutive years for which he the auditor would
been functioning as auditor in may be appointed in the same complete in the same
the same company [in the first company (including transitional company in view of
AGM held after the period) column I and II
commencement of provisions
of section 139(2)]

10.9
 Column 1 Column II Column III

5 years (or more than 5 years) 3 years 8 years

4 years 3 years 7 years

3 years 3 years 6 years

2 years 3 years 5 years

1 year 4 years 5 years

Note 1: Individual auditor shall include other individuals or firms whose name or trade mark or
brand is used by such individual, if any.
Note 2: Consecutive years shall mean all the preceding financial years for which the individual
auditor has been the auditor until there has been a break by five years or more.

Illustration explaining rotation in case of audit firm

Column 1 Column II Column III

Number of consecutive years Maximum number of Aggregate period which the

for which an audit firm been consecutive years for which firm would complete in the
functioning as auditor in the the firm may be appointed same company in view of
same company [in the first in the same company column I and II.
AGM held after the (including transitional
commencement of provisions period).
of section 139(2)].

10 years (or more than 10 3 years 13 years or more

years)

9 years 3 years 12 years

8 years 3 years 11 years

7 years 3 years 10 years

6 years 4 years 10 years

5 years 5 years 10 years

4 years 6 years 10 years

3 years 7 years 10 years

2 years 8 years 10 years

1 year 9 years 10 years

10.10
Note 1: Audit Firm shall include other firms whose name or trade mark or brand is used by the
firm or any of its partners.
Note 2: Consecutive years shall mean all the preceding financial years for which the firm has
been the auditor until there has been a break by five years or more.

CERTIFICATE AND CONC ENT BY AUDITOR AND N OTICE OF

APPOINTMENT BY COMPA NY [SEC. 139]
Certificate and Before any appointment of auditor is made, the auditor shall
Consent to be given furnish to the company -
by the Auditor a) His written consent for such appointment; and
b) A certificate that -
i. The appointment, if made, shall be in accordance with the
conditions as may be prescribed; and
ii. The auditor satisfies the criteria provided in section 141
Conditions prescribed for appointment and notice to
Registrar (Rule 4)
The auditor proposed to be appointed shall submit a certificate
that -
a) the individual or the firm is eligible for appointment and is
not disqualified for appointment under the Act, the
Chartered Accountants Act, 1949 and the rules or regulations
made there under.
b) The proposed appointment is as per the term provided
under the Act;
c) The proposed appointment is within the limits of the Act;
d) The list of proceedings against the auditor or audit firm or
any partner of the audit firm pending with respect to
professional matters of conduct, as disclosed in the
certificate, is true and correct.

Notice of The company shall -

Appointment to be a) Inform the auditor concerned of his or its appointment; and
given by the b) File a notice of such appointment with the Registrar
company
Within 15 days of the meeting in which the auditor is appointed

10.11
 MISCELLANEOUS PROVIS IONS W.R.T APPOINTMENT OF
AUDITORS [SEC. 139]
1) Firm’ to include ‘LLP’
For the purposes of this Chapter (viz. ‘Audit and Auditors’, consisting of Sections 139
to148) the word ‘firm’ shall include a limited liability partnership incorporated under the
Limited Liability Partnership Act, 2008.
2) Meaning of ‘appointment’
For the purposes of this Chapter {viz. 'Audit and Auditors’, consisting of Sections 139 to
148) “appointment” includes reappointment.
3) Recommendation [Sec. 139(11)]
Where a company is required to constitute an Audit Committee u/s 177 all appointments,
including the filling of a casual vacancy of an auditor u/s 139 shall be made after
considering the recommendations of the Audit Committee.

REMOVAL, RESIGNATION OF AUDITORS AND GIV ING OF

SPECIAL NOTICE (SEC. 140)
Removal of auditor (a) Resolution Such removal requires a Special Resolution
before expiry of his (SR).
term [Sec. 140(1)]
(b) Approval Previous approval of CG must be obtained
in the manner prescribed.
Procedure for obtaining approvals of CG
and passing SR (Rule 7)
a) An application shall be made to CG in
Form ADT -2.
b) The application shall be made to CG
within 30 days of passing of the Board
resolution.
c) The company shall hold the general
meeting within 60 days of receipt of
approval of CG for passing the special
resolution.

(c) Opportunity Before taking any action for removal, the

auditor shall be given a reasonable
opportunity of being heard.

10.12
Resignation by (a) Duty of auditor When an auditor resigns, he is required to file
Auditor [Sec. a Statement in the prescribed form (ADT –
140(2) and 140(3)] 3)
(b) Contents of The Statement shall indicate the reasons and
Statement other facts as may be relevant with regard to
his resignation.

(c) Filing with • The company

whom? • The Registrar
• The CAG (in the case of a Government
company).

(d) Time limit for The Statement shall be filed within 30 days
filing from the date of resignation
Fine for non- • Minimum: ` 50,000 or Remuneration
filing of Auditor whichever is
less.
• If Failure Continues: ` 500 per day
• Maximum: ` 5,00,000

Special Notice for (a) Requirement of a) Special notice during AGM is required
not reappointing special notice for -
the retiring auditor i. Appointment as auditor a person
[Sec. 140(4)] other than the retiring auditor; or
ii. Providing expressly that the retiring
auditor shall not be reappointed,
b) Special notice shall not be required if
the retiring auditor has completed
consecutive tenure of 5 years /10
years, as provided u/s 139 (2).
(b) Copy to be sent On receipt of notice of such a resolution, the
to retiring Company shall forthwith send a copy
auditor thereof to the retiring auditor.

(c) Right of auditor a) The retiring auditor is entitled to make a

to make a representation against his removal. The
representation representation (not exceeding a
and to get it reasonable length) shall be in writing and
circulated shall be sent to the company.
b) He may request the company to
circulate the representation to the
members of the company.

10.13
 (d) Duties of the a) The company shall state the fact that the
company w.r.t. retiring auditor has made a
representation representation against his removal, in
any notice of the resolution that is given
to members of the company.
b) The company shall send a copy of the
representation to every member of the
company to whom notice of the meeting
is sent (unless the representation is
received by the company too late).
c) If a copy of the representation is not sent
because it was received too late or
because of the company's default, then -
• the auditor may require that the
representation shall be read out at
the meeting.
• A copy of the representation shall be
filed with the Registrar.

Note:
Curtailing right of the auditor regarding circulation of copy of representation in the case
of appointment of auditor other than retiring auditor under section 140(4) of the
companies act, 2013:
If the Tribunal is satisfied on an application either of the company or of any other aggrieved
person that the rights conferred by section 140(4) of the Companies Act, 2013 are being
abused by the auditor, then, the copy of the representation may not be sent and the
representation need not be read out at the meeting.

DIRECTION BY TRIBUNA L IN CASE AUDITOR AC TED IN A

FRAUDULENT MANNER: S ECTION 140(5)
Change of Who may issue Tribunal
Auditor based directions
on Tribunal’s
When directions i. Suo moto by Tribunal or
direction
may be issued ii. On an application made to Tribunal by the C.G.
or
iii. By any person concerned.

10.14
Circumstances in If tribunal is satisfied that the auditor of a company
which directions has, whether directly or indirectly,
may be issued.
• acted in a fraudulent manner or
• abetted or colluded in any fraud by, or in
relation to, the company or its director or
officers.
Appointment of If the application is made by the Central
Auditor by C.G. – Government and the Tribunal is satisfied that any
Proviso to Sec. change of the auditor is required,
140(5)
• it shall within fifteen days of receipt of such
application, make an order that he shall not
function as an auditor
• and the Central Government may appoint
another auditor in his place.
Effect of Tribunal’s • It may be noted that an auditor, whether
final order. individual or firm, against whom final order has
been passed by the Tribunal under this section
shall not be eligible to be appointed as an
auditor of any company for a period of five
years from the date of passing of the order and
• The auditor shall also be liable for action under
section 447.
• If the order is against any Firm, the liability
shall be of the firm and of every Partner who
have acted in a fraudulent manner or
abetted or colluded in the fraud.
• In case of criminal liability of any Audit Firm,
the liability other than fine shall devolve only
on the concerned Partner who acted in
fraudulent manner or abetted or colluded in
the fraud.

10.15
 ELIGIBILITY, QUALIFI CATIONS AND DISQUALIFICATION OF
AUDITORS (SEC. 141)
1) Eligibility for an individual:
An individual shall be eligible for appointment as an auditor of a company only if he is a
chartered accountant.
2) Eligibility for a firm:
• A firm shall be eligible for appointment as an auditor of a company only if majority of
its partners practicing in India are qualified for appointment.
• 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 authorized to act
and sign on behalf of the firm.
3) Disqualifications of Auditor [Sec. 141 (3)]
The following persons shall not be eligible for appointment as an auditor of a company,
namely-
a) A body corporate other than a limited liability partnership.
b) An officer or employee of the company. (Refer Sec. 2(59) & (51)of Companies Act,
2013)
c) A person who is a partner, or who is in the employment, of an officer or employee of
the company;
d)
- the company, or
- its subsidiary
(i) A person company,or

- Who, or - Is holding any - its holding

security or interest company, or
His relative, or in
- associate company,
His partner or
- a subsidiary of such
holding company.

✓ However, a person shall not be disqualified if his relative holds any security in the
company of face value not exceeding the prescribed amount of `1 lakh.
✓ If a relative acquires any security exceeding `1 lakh, then, the auditor shall take the
corrective action within next 60 days to maintain the limit of' `1 lakh.
Section 2(77) of the Companies Act, 2013 defines the term “relative” to mean
anyone who is related to another as:
(i) Members of a Hindu Undivided Family;
(ii) Husband and wife;
(iii) Father (including step- father);
(iv) Mother (including step-mother);

10.16
(v) Son (including step- son);
(vi) Son’s wife;
(vii) Daughter;
(viii) Daughter’s husband;
(ix) Brother (including step - brother);
(x) Sister (including step- sister).
The following points may be noted in this regard:

(i) For the purposes of this clause, the term ‘relative’ means the spouse of a person; and
includes a parent, sibling or child of such person or of the spouse, financially
dependent on such person, or who consults such person in taking decisions in
relation to his investments.
(ii) The limit of 1,00,000 would be applicable where the securities are held by the relative
of an auditor & not where the securities are held by an auditor himself or his partner.
In case of an auditor or his partner, securities of even small value shall be a
disqualification.
(iii) Grace period of 60 days for corrective action shall apply only in respect of securities
held by relatives. This would not apply to auditor or his partner.
(iv) Limit of 1,00,000 & grace period of 60 days would be applicable where securities are
held in the company only.
OR
- the company, or
- its subsidiary
(ii) A person company,or
- Is indebted, in excess of
- Who, or such amount as may be - its holding company,
His relative, or prescribed (the sum or
prescribed is 5 lakh) to
His partner - associate company, or
- a subsidiary of such
holding company.

OR
- the company, or
- Has given a guarantee
- its subsidiary
(iii) A person or provided any security
company,or
in connection with the
- Who, or indebtedness of any third - its holding company,
His relative, or person, in excess of such or
amount as may be - associate company, or
His partner prescribed (the sum
prescribed is 1 lakhs) to - a subsidiary of such
holding company.

OR

10.17
 - the company, or
- its subsidiary company, or
(e) a person or a firm who, - its holding company,
whether directly or indirectly, has
business relationship of such - associate company, or
nature as may be or prescribed - a subsidiary of such holding
with company.
- a subsidiary of such associate
company.

As per Rule 10, 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;
✓ 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 and such other similar businesses.
f) A person whose relative is a director or is in the employment of the company as
director or key managerial personnel.
g) A person who is in full time employment elsewhere or a person or a partner of a firm
holding appointment as its auditor, if such persons or partner is at the date of such
appointment or reappointment holding as auditor of more than 20 companies
excluding one-person company, dormant company and private limited with paid-
up share capital less than 100 crores.
h) A person who has been convicted by a court of an offence involving fraud and a
period of 10 years has not elapsed from the date of such conviction.
i) A person who, directly or indirectly, renders any service referred to in Section 144 to
the Company or its Holding company or its Subsidiary company.
Explanation – For the purpose of this clause, the term “Directly or Indirectly”
shall have the same meaning assigned to it in Section no. 144.

Vacation of office [Sec. 141(4)]

• If, after appointment, an auditor incurs any of the disqualifications mentioned in Section
141(3), he shall vacate his office as such auditor.
• Such vacation shall be deemed to be a casual vacancy in the office of auditor.

10.18
A person shall be deemed to be the relative of another, if he or she is related to another
in the following manner, namely:
1) As members of a Hindu Undivided Family;
2) Husband and Wife;
3) Father (including step-father)
4) Mother (including step - mother)
5) Son (including step - son)
6) Son’s wife
7) Daughter
8) Daughter’s husband
9) Brother (including step - brother)
10) Sister (includes step - sister)

CEILING ON NUMBER OF AUDITS

1. In computing the specified number of 20 company Audits per person of audit
assignments:
a) the number of such assignments, which he or any partner of his firm has accepted
whether singly or in combination with any other chartered accountant in practice or
firm of such chartered accountants, shall be taken into account.
b) the number of partners of a firm on the date of acceptance of audit assignment shall
be taken into account.
c) a chartered accountant in full time employment elsewhere shall not be taken into
account.
Ceiling on Tax Audit Assignments: The specified number of tax audit assignments that an
auditor, as an individual or as individual or as a partner of a firm, can accept is
The ceiling limit was increased from 45 to 60 numbers in the year 2014, ICAI has notified that a
chartered accountant in practice shall be deemed to be guilty of professional misconduct, if he
accepts in a financial year, more than the specified number of tax audit assignments u/s 44AB

REMUNERATION OF AUDITOR (SEC. 142)

The remuneration of the auditor of a company shall be fixed:
• in the general meeting; or
• in such manner as may be decided in the general meeting.

10.19
 Certain sums to be included in remuneration
The remuneration shall, in addition to the fee payable to an auditor, include:
• the expenses, if any, incurred by the auditor in connection with the audit of the company;
and
• any facility extended to the auditor.

Therefore, it has been clarified that the remuneration to Auditor shall also include any facility
provided to him. However, the remuneration shall not include any remuneration paid to the
auditor for any other service rendered by him at the request of the company.
Note - Board may fix the remuneration of the first auditor appointed by it.

Disclosure of remuneration in Final Accounts as per Schedule III

A company shall disclose by way of notes additional information regarding aggregate
expenditure on the following item:

Payments to the auditor as:

a) Auditor
b) For taxation matters
c) For company law matters
d) For management services
e) For other services
f) For reimbursement of expenses

POWERS AND DUTIES OF AUDITORS (SEC. 143)

Rights as Right of access to • The auditor shall have access, at all times, to the
per books books of account and vouchers of the company.
Sec.143(1) • His right extends to all the books, whether kept at
the registered office of the company or at any other
place.
• The auditor shall also have access to the records of
all the subsidiaries of the company and associates
companies, in so far as access to the books of
subsidiaries and associates is required for the
purpose of consolidation of financial statement of
the company with its subsidiaries and associates
companies.

10.20
 Right to obtain The auditor shall be entitled to require from the officers
information of the company such information and explanation as
& explanation he may consider necessary for the performance of his
duties as
auditor.

Right to receive The auditors of a company are entitled to

notices and to 1. attend any general meeting of the company (the
attend general
right is not restricted to those at which the accounts
meeting
audited by them are to be discussed);
2. receive all the notices and other communications
relating to the general meetings, which members are
entitled to receive and
to be heard at any general meeting in any part of the
business of the meeting which concerns them as
auditors.

Right to report to The auditor shall make a report to the members of the
the members of company on the accounts examined by him and on
the company on every financial statements which are required by or
the accounts under this Act to be laid before the company in general
examined by him 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 there under or under any order
made under this section 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 as at the end of its
financial year and profit or loss and cash flow for the
year and such other matters as may be prescribed.

Right to Lien:
The Auditor can exercise his lien on client’s books and documents, in terms of general
principles of law subject to the following conditions -
• Documents retained must belong to the client who owes the money
• Such documents must have come into the Auditor’s possession on the client’s authority
and not acquired through irregular or illegal means.
• Some work must have been done in relation to such documents

10.21
 • The fees for work performed must be outstanding.

Note on Lien:
• Under section 128 of the Act, books of account of a company must be kept at the
registered office.
• These provisions ordinarily make it impracticable for the auditor to have possession of the
books and documents.
• The company provides reasonable facility to auditor for inspection of the books of account
by directors and others authorised to inspect under the Act.
• Taking an overall view of the matter, it seems that though legally, auditor may exercise
right of lien in cases of companies, it is mostly impracticable for legal and practicable
constraints.
• His working papers being his own property, the question of lien, on them does not arise.

DUTIES OF AUDITORS ( SEC. 143)

Duty to make a) Whether loans and advances made by the company on the basis of
inquiries about security have been properly secured and whether the terms on
certain matters which they have been made are prejudicial to the interests of the
[143(1)] 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 deposit.
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 for cash, 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.
Note:
The opinion of the Research Committee of the Institute of Chartered
Accountants of India on section 143(1) is reproduced below:
• The auditor is not required to report on the matters specified in sub-

10.22
 section (1) unless he has any special comments to make on any of
the items referred to therein.
• If he is satisfied as a result of the inquiries, he has no further duty to
report that he is so satisfied.
• In such a case, the content of the Auditor’s Report will remain exactly
the same as the auditor has to inquire and apply his mind to the
information elicited by the enquiry, in deciding whether or not any
reference needs to be made in his report. In our opinion, it is in this
light that the auditor has to consider his duties under section
143(1).”
• Therefore, it could be said that the auditor should make a report to
the members in case he finds answer to any of these matters in
adverse.
Duty to make • The auditor shall make a report to the members of the company on
and sign the accounts examined by him and on every financial statements
Report [Sec. which are required by or under this Act to be laid before the company
143 (2)] in general meeting.
• The report shall be prepared 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 or
under any order made under sub-section (11)
• The Auditor shall state in his report to the best of his information
and knowledge, as to whether the said accounts and financial
statements give a true and fair view of
✓ The state of the company’s affairs as at the end of its financial year
and
✓ Profit or loss for the year and
✓ Cash Flow for the year.
• The Auditor shall also state in his report such other matters as may
be prescribed.

Report on a) Whether he has sought and obtained all the information and
principal explanations which to the best of his knowledge and belief were
assertions [Sec. necessary for the purpose of his audit and if not, details thereof and
143 (3)] the effect of such information on the financial statements.
b) Whether, in his opinion, proper books of account as required by
law have been kept by the company so far as appears from his
examination of those books and proper returns, adequate for the
purposes of his audit have been received from branches not visited
by him.

10.23
 c) Whether the report on the accounts of any branch office of the
company audited by a person other than the company’s auditor has
been sent to him and the manner in which he has dealt with it in
preparing his report.
d) Whether the company’s balance sheet and profit and loss account
dealt with in the report are in agreement with the books of account
and returns.
e) Whether, in his opinion, the financial statements comply with the
accounting standards.
f) The observations or comments of the auditors on financial
transactions or matters which have any adverse effect on the
functioning of the company.
g) Whether any director is disqualified from being appointed as a
director under sub - section (2) of section 164.
h) Any qualification, reservation or adverse remark relating to the
maintenance of accounts and other matters connected therewith.
i) Whether the company has adequate Internal Financial Control
with reference to Financial Statements in place and the operating
effectiveness of such controls.
Applicability of Reporting on IFC’s under Section 143(3)(i)
Section 143(3)(i) shall not apply to a private limited company:
• which is a one-person company or
• a small company or
• which has turnover less than rupees fifty crore as per latest
audited financial statements AND
• which has aggregate borrowings from banks or financial
institutions or anybody corporate at any point of time during the
financial year less than rupees twenty-five crore.
Clarification:
Note 1 - Clarification regarding applicability of exemption given to
certain private companies under section 143(3)(i), the circular also clarified
that the exemption shall be applicable for those audit reports in respect
of financial statements pertaining to financial year, commencing on or
after 1st April, 2016, which are made on or after the date of the said
notification. (25-07-2017)
Note 2 - The above exemption shall be applicable to a private company
which has not committed a default in filing its financial statements under
section 137 of the Companies Act 2013.

Other matters The auditor shall include in his report, his views and comments on the

10.24
to be included following matters:
(Rule 11) a) Whether the company has disclosed the impact, if any, of pending
[143(3)(j)] litigations on its financial position in its financial statement.
b) 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.
c) Whether there has been any delay in transferring amount, required
to be transferred, to the Investor Education and Protection Fund by
the company.
d) (Now Not Applicable) Disclosure is required in Audit Report Under
“Reporting on other legal and regulatory requirement”
paragraph “whether the company had provided requisite disclosures
in its financial statements as to holdings as well as dealings in
Specified Bank Notes during the period from 8th November, 2016 to
30th December, 2016 and if so, whether these are in accordance with
the books of accounts maintained by the company”).
For the Company - As per Schedule III in the notes to accounts for
“Cash and Cash Equivalents” as a separate disclosure.

Reasons to be Where any of the matters required to be included in the audit report is
given [Sec. answered in the negative or with a qualification, the report shall state the
143 (4)] reasons thereof.

10.25
 SPECIAL PROVISIONS W.R.T GOVERNMENT COMP ANIES
[SEC. 143(5), (6) AND (7)]
Directions by CAG to • In the case of a Government company, CAG shall direct the
the auditor [Sec. 143 auditor the manner in which the accounts of the Government
(5)] company are required to be audited.
• The auditor shall submit a copy of his audit report to CAG.
• The audit report shall, among other things, include the
directions, if any, issued by CAG, the action taken thereon and
its impact on the accounts and financial statement of the
company.

Right of CAG to CAG shall, within 60 days from the date of receipt of the audit
conduct report, have the following rights:
supplementary
Supplementary CAG may order conduct of a supplementary
Audit or supplement
Audit audit of the financial statement of the company
the audit report
[Sec. which shall be conducted by such person (s) as
CAG may authorize in this behalf.
143 (6)]
Supplement/ • CAG may comment upon the audit report.
comment • CAG may supplement the audit report.
• Any such comments or supplement shall be
sent by the company to every person
entitled to copies of audited financial
statements.
• Any such comments or supplement shall also
be placed before the members in the AGM
along with the audit report.

Test Audit [Sec. 143 CAG may, by an order, cause test audit to be conduct of the
(7)] accounts of a Government company.

BRANCH AUDIT [SEC. 1 43(8)]

Branch in India - The accounts of any branch office in India, shall be audited by -
Appointment of a) the company’s auditor; or
auditor
b) any other person qualified for appointment as an auditor of the
company.

10.26
Branch outside India The accounts of any branch office outside India, shall be
- Appointment of audited by -
auditor a) the company’s auditor; or
b) by an accountant or
c) by any other person duly qualified to act as an auditor of the
accounts of the branch office in accordance with the laws of
that country.
Duties and powers of The duties and powers of the company’s auditor with reference to
the company’s the audit of the branch and the branch auditor, shall be such as
auditor may be prescribed.
Duties and powers of the company’s auditor prescribed under
the Rules (Rules 12)
a) The duties and powers of the company’s auditor with reference
to the audit of the branch and the branch auditor, if any, shall
be as contained in sub - sections (1) to (4) of section 143.
b) The provisions regarding reporting of fraud by the auditor shall
also extend to such branch auditor to the extent it relates to
the concerned branch.

Report of Branch • The branch auditor shall prepare a report on the accounts of
Auditor the branch examined by him.
• The branch auditor shall send his report to the auditor of the
company.
• The auditor of the company shall deal with the report of the
branch auditor, in his report in such manner as he considers
necessary.
Definition of 'branch ‘Branch office’, in relation to a company, means any establishment
office’ described as such by the company [Sec. 2(14) of the Companies
Act, 2013].

The provisions of this section i.e. section 143 shall mutatis

mutandis apply to -
a) the cost accountant in practice conducting cost audit under
Special Points section 148; or
b) the company secretary in practice conducting secretarial audit
under section 204.

10.27
 AUDITOR TO COMPLY WI TH AUDITING STANDARD S
[SEC. 143(9) AND (10 )]
Duty Every auditor shall comply with the auditing standards.

CG to prescribe Stages in prescribing the auditing standards are as follows:

auditing standards i. At the first stage, ICAI recommends the Standards of Auditing.
ii. At the second stage, these Standards of Auditing shall be
examined by the National Financial Reporting Authority (NFRA).
NFRA may also make its own recommendations.
iii. At the third stage, CG examines the recommendations made by
NFRA. Then, CG may prescribe, after consultation with NFRA, the
Auditing Standards.

Position, until • Until any auditing standard are notified,

Auditing Standards • Any standard or standards of auditing specified by ICAI
are notified • Shall be deemed to be the auditing standards.

AUDIT REPORT TO INCL UDE A STATEMENT ON

PRESCRIBED MATTERS [SEC. 143(11)]
CG may, in consultation with the National Financial Reporting Authority, by general or special
order, direct, in respect of such class / description of companies, as may be specified in the
order, that the auditor’s report shall also include a statement on such matters as may be
specified therein.
Note – The Companies (Auditor’s Report) Order, 2016.

10.28
 REPORTING OF FRAUD B Y AN AUDITOR
[SEC. 143(12) AND (1 5)]
Reporting of a) If an auditor has reason to believe that an offence involving fraud
frauds involving ` has been committed; or is being committed against the company
1 crore or above by officers or employees of the company, the auditor is required
[Section 143(12)] to report such matter to the Central Government.

As per Rule 13, any fraud which

involves or is expected to involve
individually an amount of ` 1 crore
or above is required to be reported
to the CG.

b) The auditor shall report such fraud within such time and in such
manner as prescribed below:
As per Rule 13, the manner of reporting of such fraud shall be as
follows:
1. The auditor shall report such fraud to the Audit Committee /
Board, immediately but not later than 2 days of his
knowledge. The auditor shall seek reply from the Audit
Committee/Board within 45 days.
2. If auditor receives the reply or observations, the auditor shall,
within 15 days of receipt of such reply or observations, forward
to CG -
a) His report;
b) The reply or observations of the Board / Audit Committee
and
c) his comments on reply or observation
3. In case the auditor fails to get any reply or observations from the
Board / Audit Committee within 45 days, he shall forward
• his report to CG
• along with a note containing the details of his report that was
earlier forwarded to the Board / Audit Committee for which
he has not received any reply or observation.
4. 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.

10.29
 5. After the report is sent, an e-mail shall also be sent to the
Secretary, Ministry of Corporate Affairs in confirmation of the
report sent.
6. The report shall be on the letter-head of the auditor containing
postal address, e-mail address and contract number.
7. The report shall be signed by the auditor with his seal and shall
indicate his Membership Number.
8. The report shall be in the form of a statement as specified in Form
ADT - 4.
9. These provisions shall also apply, mutatis mutandis, to –
a) A cost auditor during the performance of his duties u/s 148;
and
b) A secretarial auditor during the performance of his duties
u/s 204
No liability of An auditor shall not be deemed to be guilty for breach of any of his
auditor [Section duties by reason of his reporting any matter to CG if such reporting is
143(13)] done in good faith.
Provisions The provisions w.r.t. reporting of fraud shall mutatis mutandis apply to
applicable to other a) The cost accountant in practice conducting cost audit u/s 148;
auditors [Section
b) The company secretary in practice conducting secretarial audit.
143(14)]
Punishment for • Minimum Fine: ` 1,00,000
non – compliance • Maximum Fine: ` 25,00,000
[143(15)]
Reporting of 1. In case of a fraud involving lesser than ` 1 crore, the auditor shall
frauds involving report the matter to the Audit Committee (Section 177) or
amount less than ` Board when audit committee is not required.
1 crore [Section 2. The Company shall disclose the details about such frauds in
143(12)] Board’s report in such manner as may be prescribed.
As per Rule 13, the manner of reporting of such fraud shall be as
follows:
1. The auditor shall report such fraud to the Audit Committee /
Board, immediately but not later than 2 days of his
knowledge. The auditor shall specify the following points in his
report:
a) Nature of fraud with description;
b) Approximate amount involved and
c) Parties involved.

10.30
 2. The following details of each such fraud shall be disclosed in
the Board’s report:
a) Nature of fraud with description;
b) Approximate amount involved;
c) Parties involved, if remedial action not taken; and
d) Remedial action taken.

AUDITOR NOT TO RENDER CERTAIN SERV ICES [SEC. 144]

Services to be An auditor shall provide to the company only such other services as
approved [Sec. 144] are approved by -
a) The Board of Directors or
b) The audit committee, as the case may be.
Prohibited Services An auditor shall not provide any of the following services (whether
[Sec. 144] such services are rendered directly or indirectly to the company or its
holding company or subsidiary company).
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
i) Any other kind of services as may be prescribed (No service has
been prescribed so far).
Discontinuation of An auditor or audit firm who or which has been performing any non
existing non - audit - audit services On or before the commencement of this Act shall
services [Proviso to comply with the provisions of this section before the closure of the
Sec. 144] first financial year after the date of such commencement.

Meaning of ‘directly and indirectly’ [Explanation to Sec. 144]

For the purposes of this sub - section, the term ‘directly or indirectly’ shall include – rendering
of services by the auditor.

10.31
 In case of auditor being an
In case of auditor being a firm
individual

•either himself or •either itself or

•through his relative or •through any of its partners or
•any other person connected or •through its parent, subsidiary or
associated with such individual or associate entity or
•through any other entity, •through any other entity,
•in which such individuals has •in which the firm or any partner of the
significant influence or control, or firm has significant influence or
•whose name or trade mark or brand is control, or
used by such individual. •whose name or trade mark or brand is
used by the firm or any of its partners.

AUDITOR TO SIGN AUDIT REPORT [SEC. 145]

Signing and The auditor’s report shall be signed only by the person appointed as an
Certification auditor of the company. Any other document of the company required to
be signed or certified by the auditor, shall be signed or certified only by the
person appointed as an auditor of the company.

Qualification The qualifications, observations or comments on financial transactions or

to be read in matters, which have any adverse effect on the functioning of the company
GM and mentioned in the auditor’s report shall be - read before the company in
inspection general meeting and will be open to inspection by any member of the
thereof company.

10.32
 AUDITOR TO ATTEND GE NERAL MEETING [SEC. 146]
Right of the auditor All notices of, and other communications relating to any GM shall be
to receive notices of forwarded to the auditor of the company.
GM
Duty of the auditor • The auditor shall attend the general meetings.
to attend GM • The auditor may attend the GM –
✓ Himself; or
✓ through his authorized representative, who shall also be
qualified to be an auditor,
• The company may exempt an auditor from attending the GM.
Right to be heard at The auditor shall have a right to be heard at a GM on any part of the
GM business which concerns him.

PUNISHMENT FOR CONTR AVENTION [SEC. 147]

Punishment for Punishment for • Minimum Fine: ` 25,000
contravention of the company • Maximum Fine: ` 5,00,000
Sec. 139 to 146
Punishment for • Maximum Imprisonment: 1 year or
(Both Inclusive)
every Officer in • Minimum Fine: ` 10,000 or
default • Maximum Fine: ` 1,00,000 or Both

Punishment for Minimum Fine: ` 25,000

Auditor (Section Maximum Fine: ` 5,00,000 or Four times the remuneration of the
139, 143, 144 and auditor, whichever is less
145) If a contravention is committed knowingly or willfully with the
intention to deceive the company or its shareholders or creditors or
tax authorities, then punishment shall be -
a) Maximum Imprisonment: 1 year
b) Minimum Fine: ` 50,000
c) Maximum Fine: ` 25,00,00 or Eight times the remuneration of
the auditor, whichever is less.
Consequences of Refund of The auditor shall be liable to refund to the
conviction of auditor remuneration company the remuneration received by him.
for contravention of
Payment of The auditor shall be liable to pay damages to
Sec. 139, 143, 144
damages by the the company / statutory bodies or authorities /
or 145 auditor any other persons for loss arising out of

10.33
 incorrect or misleading statements of
particulars made in his audit report.

Measures to ensure • For ensuring prompt payment of damages by the auditor, CG

prompt shall, by notification, specify any statutory body / authority / an
payment of officer.
damages • Such statutory body / authority / an officer shall pay the
damages to the persons entitled to damages.
• Such statutory body / authority/an officer shall file a report with
CG containing particulars of damages.
Jointly and several In case of auditor being an audit firm, the liability (whether civil or
liabilities of partners criminal) shall be of the partner(s) concerned and of the firm
jointly and severally.

COST AUDIT
Concept of Cost Audit
According to the Institute of Cost and Management Accountants of England, cost audit
represents the verification of cost accounts and a check on the adherence to cost accounting
plan. Cost audit, therefore, comprises:
(a) verification of the cost accounting records (b) examination of these records to ensure
such as the accuracy of the cost accounts, cost that they adhere to the cost accounting
reports, cost statements, cost data and costing principles, plans, procedures and objectives.
techniques, and

POWER OF CG TO ORDER MAINTENANCE OF COST

RECORDS & CONDUCT OF COST AUDIT [SEC. 14 8]
Order by CG for Whether Maintenance of cost records is mandatory
maintenance of cost mandatory only if such an order is made by CG.
records
Order for which • Such class of companies as are engaged
companies in the production of such goods as may
be prescribed.
• Such class of companies providing such
services as may be prescribed

Nature of cost Prescribed particulars relating to -

records to be a) The utilization of material;
maintained

10.34
 b) Labour;
c) Other items of cost.

Consultation Before issuing any such order in respect of

before making any class of companies regulated under a
order special Act, CG shall consult the regulatory
body constituted or established under such
special Act.

Appointment of Cost • Cost audit shall be conducted by a Cost Accountant in

Auditor by Board [Sec. practice.
148(3) &148 (4)] & • The Cost Auditor shall be appointed by the Board within 180
Rule 6 days of the commencement of every financial year.
• Before such appointment is made, the written consent of the
cost auditor to such appointment and a certificate from him or
it shall be obtained.
• Every referred company shall inform the cost auditor concerned
of his or its appointment as such and file a notice of such
appointment with the Central Government within a period of
thirty days of the Board meeting in which such appointment is
made or within a period of one hundred and eighty days of the
commencement of the financial year, whichever is earlier,
through electronic mode, in Form CRA-2, along with the fee as
specified in Companies (Registration Offices and Fees) Rules,
2014.
• The cost auditor appointed as such shall continue in such
capacity till the expiry of one hundred and eighty days from the
closure of the financial year or till he submits the cost audit
report, for the financial year for which he has been appointed.
• The cost audit shall be in addition to the audit conducted u/s
143.
• The auditor appointed u/s 139 shall not be appointed as the
Cost Auditor.
• The remuneration of the Cost Auditor shall be determined by
the members in such manner as may be prescribed.
• The company shall give all assistance and facilities to the cost
auditor.

Who can be cost Only a cost accountant in practice or a firm of cost accountants
Auditor in practice can be appointed as a cost auditor.
Casual Vacancy in the Any casual vacancy in the office of a Cost Auditor, whether due to
office of a Cost resignation, death or removal, shall be filled by the Board of

10.35
 Auditor Directors within 30 days of occurrence of such vacancy and the
company shall inform the central government in Form CRA-2 within
30 days of such appointment of cost auditor.

Removal of Cost • The cost auditor may be removed from his office before the
Auditor expiry of his term, through a board resolution after giving a
reasonable opportunity of being heard to the cost auditor and
recording the reasons for such removal in writing.
• It may be noted that the Form CRA-2 to be filed with the
Central Government for intimating appointment of another cost
auditor shall enclose the relevant Board Resolution to the effect.
• Provided also that nothing shall prejudice the right of the cost
auditor to resign from such office of the company.

Compliance with Cost The Cost Auditor shall comply with the cost auditing standards.
Auditing Standards 'Cost auditing standards’ mean such standards as are issued by the
institute of Cost and Works Accountants of India, with the approval
of CG.
Disqualification rights The qualifications, disqualifications, rights, duties and obligations
and duties of cost applicable to auditors’ u/s 141 and 143 shall, so far as may be
auditor applicable, apply to the cost auditor.
Cost Audit Report • The cost auditor shall submit the cost audit report along with
his or its reservations or qualifications or observations or
suggestions, if any, in Form CRA-3.
• The cost auditor shall submit his report to the Board of
directors within a period of 180 days from the closure of the
related financial year.
• Within 30 days of receipt of cost audit report, the company
shall furnish to CG in Form CRA-4 (in Extensible Business
Reporting Language (XBRL) format in the manner as specified in
the Companies (Filing of Documents and Forms in Extensible
Business Reporting language) Rules, 2015 along with fees
specified in the Companies (Registration Offices and Fees)
Rules, 2014)-
✓ A copy of the cost audit report; and
✓ Along with full information and explanation on every
reservation or qualification contained in the cost audit
report.
• CG may call for such further information and explanation as it
may deem fit.

10.36
Note: Provided that the companies which have got extension of time of holding Annual
General Meeting under section 96 (1) of the Companies Act, 2013, may file form CRA -4
within resultant extended period of filing financial statements under section 137 of the
Companies Act, 2013.

Procedure for Case 1: The company is required Case Ianthe company is not
appointment and to constitute an audit required to constitute and
fixation of committee audit committee
remuneration of the The Board shall appoint
• The Board shall appoint the •
Cost Auditor (Rule 14) the cost auditor.
cost auditor on the
recommendations of the Audit • The remuneration of the
Committee. cost auditor shall be fixed
• The Audit Committee shall by the Board and
recommend the remuneration ratified subsequently by
of the cost auditor. the members.
• The remuneration of the cost
auditor shall be considered
and approved by the Board
and ratified subsequently by
the members.
Contravention of If any default is made in complying with the provisions of section
Section 148 148, -
The company and every officer of the company who is in default
shall be punishable in the manner as provided in section 147 (1):
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.
Applicability of Cost For the purpose of 148(1) of the Companies Act, 2013, the specified
records – Rule 3 classes of companies, engaged in the production of goods or
providing services, having an overall turnover from all products
& services of ` 35 crores or more during the immediately
preceding financial year, required to include cost records in
their books of account.
These companies include Foreign Companies defined in sub-
section (42) of section 2 of the Act.
Exempted: a company classified as a Micro enterprise or a Small
enterprise including as per the turnover criteria provided under
Micro, Small and Medium Enterprises Development Act, 2006.
Regulated Sector

10.37
 Telecommunication services made available to users by means of
any transmission or reception of signs, signals, images etc. (other
than broadcasting services) and regulated by the Telecom
Regulatory Authority of India.

Generation, transmission, distribution and supply of electricity

Petroleum products regulated by the Petroleum and Natural gas

Regulatory Board

Drugs and Pharmaceutical

Fertilisers

Sugar and industrial alcohol

Non – Regulated Sector

Machinery and mechanical appliances used in defence, space and

atomic, energy sectors excluding any ancillary item or items

Turbo jets and turbo propellers

Arms, ammunitions and explosives

Propellant powders; prepared explosives (other than propellant

powders); safety fuses; detonating fuses; percussion or detonating
caps; igniters; electric detonators

Radar apparatus, radio navigational aid apparatus and radio remote

control apparatus

Tanks and other armoured fighting vehicles, motorized, whether or

not fitted with weapons and parts of such vehicles, that are funded
(investment made in the company) to the extent of ninety per cent
or more by the Government or Government agencies

Port services of stevedoring, pilotage, hauling, mooring, re-

mooring, hooking, measuring, loading and unloading services
rendered by a Port in relation to a vessel or goods regulated by the
Tariff Authority for Major Ports

Aeronautical services of air traffic management, aircraft operations,

ground safety services, ground handling, cargo facilities and
supplying fuel rendered by airports and regulated by the Airports
Economic Regulatory Authority

Iron and Steel

Roads and other infrastructure projects

10.38
 Rubber and allied products

Coffee and tea

Railway or tramway locomotives, rolling stock, railway or tramway

fixtures and fittings, mechanical (including electro mechanical)
traffic signaling equipment’s of all kind

Cement

Ores and Mineral products

Mineral fuels (other than Petroleum), mineral oils etc.

Base metals

Inorganic chemicals, organic or inorganic compounds of precious

metals, rare-earth metals of radioactive elements or isotopes, and
organic chemicals

Jute and Jute Products

Edible Oil

Construction machinery

Health services, namely functioning as or running hospitals,

diagnostic centres, clinical centres or test laboratories

Education services, other than such similar services failing under

philanthropy or as part of social spend which do not form part of
any business

Milk powder

Insecticides

Plastics and polymers

Tyres and tubes

Paper

Textiles

Glass

Other Machinery and Mechanical Appliances

Electricals or electronic machinery

Production, import and supply or trading of medical devices

Applicability of Cost Regulated Sector • “Regulated Sectors” are required to have

10.39
 Audit – Rule 4 Industry cost records audited when overall
annual turnover of company from all its
products and services during the
immediately preceding financial year is `
50 crore or more and
• The aggregate turnover of the
individual product(s) or service(s) for
which cost records are required to be
maintained under rule 3 is ` 25 crore or
more.
Non - Regulated • “Non-Regulated Sectors” are required to
Sector Industry get its cost records audited if the overall
annual turnover of the company from all
its products and services during the
immediately preceding financial year is `
100 crore or more and
• the aggregate turnover of the
individual product(s) or service(s) for
which cost records are required to be
maintained under rule 3 is ` 35 crore or
more.
Exemption The requirements for cost audit under these
rules shall not apply to a company which is
covered in rule 3; and
• whose revenue from exports, in foreign
exchange, exceeds seventy-five percent of
its total revenue, or
• which is operating from a special
economic zone; or
• which is engaged in generation of
electricity for captive consumption
through Captive Generating Plant.

Maintenance of Every company under these rules including all units and branches
Records –Rule 5 thereof, shall, in respect of each of its financial year, is required to
maintain cost records in Form CRA-1. The cost records shall be
maintained on regular basis in such manner as to facilitate
calculation of per unit cost of production or cost of operations, cost
of sales and margin for each of its products and activities for every
financial year on monthly or quarterly or half-yearly or annual basis.

10.40
 INTERNAL AUDIT [SEC. 138]
Applicability of As per section 138 of the Companies Act, 2013 the following class
Provisions of Section of companies (prescribed in rule 13 of Companies (Accounts) Rules,
138 2014). 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-
i. paid up share capital of fifty crore rupees or more during
the preceding financial year; or
ii. turnover of two hundred crore rupees or more during the
preceding financial year; or
iii. outstanding loans or borrowings from banks or public
financial institutions exceeding one hundred crore rupees
or more at any point of time during the preceding financial
year;
iv. outstanding deposits of twenty-five crore rupees or more
at any point of time during the preceding financial year;
and
c) every private company having-
i. turnover of two hundred crore rupees or more during the
preceding financial year; or
ii. outstanding loans or borrowings from banks or public
financial institutions exceeding one hundred crore rupees
or more at any point of time during the preceding financial
year:
Provided that an existing company covered under any of the above
criteria shall comply within six months of commencement of such
section.
Who can be The Internal Auditor shall be –
appointed as a) a chartered accountant whether engaged in practice or not
Internal Auditor?
b) or a cost accountant, or
c) such other professional as may be decided by the Board
He may or may not be an employee of the company.

Other Points 1. 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

10.41
 internal audit.
2. Main responsibility of Internal Auditor must be to maintain
adequate system of internal control by a continuous
examination of accounting procedures, receipts and
disbursements and to provide adequate safe-guards against
misappropriation of assets.

AUDIT COMMITTEE (SEC. 177)

Mandatory constitution Constitution of an audit committee is mandatory for –
of audit committee by a) every listed company; and
certain companies
b) such other class or classes of companies, as may be prescribed.
As per Rule 6 of the Companies (Meetings of Board and its Powers)
Rules, 2014, following classes of companies have been prescribed for
this purpose:
• All public companies with a paid up capital of 10 crore rupees or
more;
• All public companies having turnover of 100 crore rupees or
more;
• All public companies, having in aggregate, outstanding loans or
borrowings or debentures or deposits exceeding 50 crore
rupees or more.
Explanation - The paid up share capital, turnover or outstanding
loans, or borrowings or debentures or deposits, as the case may
be, as existing on the date of last audited Financial Statements
shall be taken into account for the purposes of this rule.
Composition of audit a) The Audit Committee shall consist of a minimum of 3 directors
committee b) The majority of members of the Audit Committee shall be
independent directors.
c) Majority of members of the Audit Committee (including the
Chairperson of the Audit Committee) shall be persons with
ability to read and understand the financial statement.
Functions of the audit Every Audit Committee shall act in accordance with the terms of
committee reference specified in writing by the Board which shall include-
a) The recommendation for appointment, remuneration and
terms of appointment of auditors of the company
b) Review and monitor the auditor’s independence and

10.42
 performance, and effectiveness of audit process;
c) Examination of the financial statement and the auditor’s report
thereon;
d) Approval or any subsequent modification of transactions of
the company with related parties;
e) Scrutiny of inter-corporate loans and investments;
f) Valuation of undertakings or assets of the company, wherever
it is necessary;
g) Evaluation of internal financial controls and risk management
systems;
h) Monitoring the end use of funds raised through public offers
and related matters.

All public
companies with
a paid up
capital > ` 10
crore

Class of
Companies to
constitute Audit
Committee
[including Listed
Public
All public Companies]
companies,
having in All public
aggregate, companies
outstanding loans having
or borrowings or turnover > `
debentures or 100 crore
deposits > ` 50
crore

10.43
 Notes:

10.44
AUDIT REPORT

11.1
 FORMING AN OPINION ON THE FINANCIAL STAT EMENTS -
OBJECTIVE OF AN AUDITOR

Objective of the Auditor as per SA 700

The objectives of the auditor as per SA 700 (Revised), “Forming an Opinion and
Reporting on Financial Statements” are:
• To form an opinion on the financial statements based on an evaluation of the
conclusions drawn from the audit evidence obtained; and
• To express clearly that opinion through a written report.
The auditor shall form an opinion on whether the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting framework.

11.2
 To Form Opinion - Auditor to Obtain Reasonable
Assurance
• In order to form that opinion, the auditor shall conclude as to whether the auditor
has obtained reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error.
• That conclusion shall take into account:
✓ whether sufficient appropriate audit evidence has been obtained;
✓ whether uncorrected misstatements are material, individually or in
aggregate.
✓ The evaluations.

EVAUATION BY THE AUD ITOR

• The auditor shall evaluate whether the financial statements are prepared in accordance
with the requirements of the applicable financial reporting framework.
• This evaluation shall include consideration of the qualitative aspects of the entity’s
accounting practices, including indicators of possible bias in management’s judgments.

Qualitative Aspects of the Entity’s Accounting Practices

• Management makes a number of judgments about the amounts and disclosures in
the financial statements.
• SA 260 (Revised) contains a discussion of the qualitative aspects of accounting
practices.
• In considering the qualitative aspects of the entity’s accounting practices, the
auditor may become aware of possible bias in management’s judgments.
• The auditor may conclude that lack of neutrality together with uncorrected
misstatements causes the financial statements to be materially misstated.
Indicators of a lack of neutrality include the following:
✓ The selective correction of misstatements brought to management’s
attention during the audit.
✓ Possible management bias in the making of accounting estimates.
• SA 540 addresses possible management bias in making accounting estimates.

11.3
 Specific Evaluations by the Auditor
In particular, the auditor shall evaluate whether:
• The financial statements adequately disclose the significant accounting policies selected
and applied
• The accounting policies selected and applied are consistent with the applicable
financial reporting framework and are appropriate
• The accounting estimates made by management are reasonable
• The information presented in the financial statements is relevant, reliable, comparable,
and understandable
• The financial statements provide adequate disclosures to enable the intended users to
understand the effect of material transactions and events on the information conveyed in
the financial statements
• The terminology used in the financial statements, including the title of each financial
statement, is appropriate

FORM OF OPINION

11.4
 MODIFICATIONS TO THE OPINION IN THE INDEPENDENT
AUDITOR’S REPORT
Standard on Auditing (SA) 705 “Modifications To the Opinion in The Independent
Auditor’s Report” deals with the auditor’s responsibility to issue an appropriate report in
circumstances when, in forming an opinion in accordance with SA 700 (Revised) “Forming an
Opinion and Reporting on Financial Statements”, the auditor concludes that a modification
to the auditor’s opinion on the financial statements is necessary.
This SA also deals with how the form and content of the auditor’s report is affected when the
auditor expresses a modified opinion.

Circumstances When a Modification to the Auditor’s

Opinion Is Required
The auditor shall modify the opinion in the auditor’s report when:
• The auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatement; or
• The auditor is unable to obtain sufficient appropriate audit evidence to conclude that
the financial statements as a whole are free from material misstatement.

Objective of the Auditor - To express clearly an

appropriately modified opinion
As per Standard on Auditing (SA) 705 “Modifications to The Opinion in the Independent
Auditor’s Report”, the objective of the auditor is to express clearly an appropriately modified
opinion on the financial statements that is necessary when:
• The auditor concludes, based on the audit evidence obtained, that the financial
statements as a whole are not free from material misstatement
• The auditor is unable to obtain sufficient appropriate audit evidence to conclude that
the financial statements as a whole are free from material misstatement

Types of Modified Opinions:

There are three types of modified opinions, namely-
• A qualified opinion
• An adverse opinion
• A disclaimer of opinion

11.5
 REPORTING UNDER COMP ANIES
(AUDITOR’S REPORT) ORDER, 2016 [CARO, 2016]
The Central Government, after consultation with the committee constituted under proviso to
section 143(11) of the Companies Act, 2013, and in supersession of the Companies (Auditor's
Report) Order, 2015 dated the 10th April, 2015, has issued the Companies (Auditor’s Report)
Order, 2016, (CARO, 2016) under section 143(11) of the Companies Act, 2013, dated 29th
March, 2016. The requirements of the Order are supplemental to the existing provisions of
section 143 of the Act regarding the auditor’s report.
The Order is not intended to limit the duties and responsibilities of auditors but only requires a
statement to be included in the audit report in respect of the matters specified therein.
Applicability of the Order: The CARO, 2016 is an additional reporting requirement Order.
The order applies to every company including a foreign company as defined in clause (42) of
section 2 of the Companies Act, 2013.
However, the Order specifically exempts the following class of companies-
(i) a banking company as defined in clause (c) of section 5 of the Banking Regulation Act,
1949;
(ii) an insurance company as defined under the Insurance Act,1938;
(iii) a company licensed to operate under section 8 of the Companies Act;
(iv) a One-Person Company as defined under clause (62) of section 2 of the Companies
Act;
(v) a small company as defined under clause (85) of section 2 of the Companies Act; and
(vi) a private limited company,
✓ not being a subsidiary or holding company of a public company,
✓ having a paid up capital and reserves and surplus not more than ` 1 crore as on the
balance sheet date and

11.6
 ✓ which does not have total borrowings exceeding ` 1 crore from any bank or financial
institution at any point of time during the financial year and
✓ which does not have a total revenue as disclosed in Scheduled III to the Companies
Act, 2013 (including revenue from discontinuing operations) exceeding ` 10 crore
during the financial year as per the financial statements.

It may be noted that the Order shall not be applicable to the auditor’s report on consolidated
financial statements.

Matters to be included in the Auditor’s Report: Paragraph 3 of the Order requires the
auditor to include a statement in the auditor’s report on the following matters, namely -
(i) (a) whether the company is maintaining proper records showing full particulars,
including quantitative details and situation of fixed assets;
(b) whether these fixed assets have been physically verified by the management at
reasonable intervals; whether any material discrepancies were noticed on such
verification and if so, whether the same have been properly dealt with in the
books of account;
(c) whether the title deeds of immovable properties are held in the name of the
company. If not, provide the details thereof;
(ii) whether physical verification of inventory has been conducted at reasonable
intervals by the management and whether any material discrepancies were noticed and
if so, whether they have been properly dealt with in the books of account;
(iii) whether the company has granted any loans, secured or unsecured to companies,
firms, Limited Liability Partnerships or other parties covered in the register maintained
under section 189 of the Companies Act, 2013. If so,
(a) whether the terms and conditions of the grant of such loans are not
prejudicial to the company’s interest;
(b) whether the schedule of repayment of principal and payment of interest has
been stipulated and whether the repayments or receipts are regular;
(c) if the amount is overdue, state the total amount overdue for more than ninety
days, and whether reasonable steps have been taken by the company for
recovery of the principal and interest;
(iv) in respect of loans, investments, guarantees, and security whether provisions of
section 185 and 186 of the Companies Act, 2013 have been complied with. If not,
provide the details thereof.
(v) in case the company has accepted deposits, whether the directives issued by the
Reserve Bank of India and the provisions of sections 73 to 76 or any other relevant
provisions of the Companies Act, 2013 and the rules framed there under, where
applicable, have been complied with? If not, the nature of such contraventions be
stated; If an order has been passed by Company Law Board or National Company Law
Tribunal or Reserve Bank of India or any court or any other tribunal, whether the same
has been complied with or not?

11.7
 (vi) where maintenance of cost records has been specified by the Central Government
under sub-section (1) of section 148 of the Companies Act, 2013 and whether such
accounts and records have been so made and maintained.
(vii) (a) whether the company is regular in depositing undisputed statutory dues
including provident fund, employees' state insurance, income-tax, sales-tax,
service tax, duty of customs, duty of excise, value added tax, cess and any other
statutory dues with the appropriate authorities and if not, the extent of the
arrears of outstanding statutory dues as at the last day of the financial year
concerned for a period of more than six months from the date they became
payable, shall be indicated ;
(b) where dues of income tax or sales tax or service tax or duty of customs or duty of
excise or value added tax have not been deposited on account of any dispute,
then the amounts involved and the forum where dispute is pending shall be
mentioned. (A mere representation to the concerned Department shall not
constitute a dispute).
(viii) whether the company has defaulted in repayment of loans or borrowing to a
financial institution, bank, Government or dues to debenture holders? If yes, the
period and the amount of default to be reported (in case of defaults to banks, financial
institutions, and Government, lender wise details to be provided).
(ix) whether moneys raised by way of initial public offer or further public offer
(including debt instruments) and term loans were applied for the purposes for
which those are raised. If not, the details together with delays or default and
subsequent rectification, if any, as may be applicable, be reported;
(x) whether any fraud by the company or any fraud on the Company by its officers or
employees has been noticed or reported during the year; If yes, the nature and the
amount involved is to be indicated;
(xi) whether managerial remuneration has been paid or provided in accordance with the
requisite approvals mandated by the provisions of section 197 read with Schedule V to
the Companies Act, 2013? If not, state the amount involved and steps taken by the
company for securing refund of the same;
(xii) whether the Nidhi Company has complied with the Net Owned Funds to Deposits
in the ratio of 1:20 to meet out the liability and whether the Nidhi Company is
maintaining ten per cent unencumbered term deposits as specified in the Nidhi Rules,
2014 to meet out the liability;
(xiii) whether all transactions with the related parties are in compliance with sections
177 and 188 of Companies Act, 2013 where applicable and the details have been
disclosed in the Financial Statements etc., as required by the applicable accounting
standards;

11.8
(xiv) whether the company has made any preferential allotment or private placement of
shares or fully or partly convertible debentures during the year under review and if so,
as to whether the requirement of section 42 of the Companies Act, 2013 have been
complied with and the amount raised have been used for the purposes for which the
funds were raised. If not, provide the details in respect of the amount involved and
nature of non - compliance;
(xv) whether the company has entered into any non-cash transactions with directors or
persons connected with him and if so, whether the provisions of section 192 of
Companies Act, 2013 have been complied with;
(xvi) whether the company is required to be registered under section 45 -IA of the Reserve
Bank of India Act, 1934 and if so, whether the registration has been obtained.

Reasons to be Stated for Unfavourable or Qualified Answers:

• Where the answer to any of the questions referred to in paragraph 3 of the Order is
unfavourable or qualified, in the auditor's report, the auditor shall also state the basis for
such unfavourable or qualified answer, as the case may be.

Reporting for Physical Verification of Inventory:

• Clause (ii) of Para 3 of CARO, 2016, requires the auditor to report whether physical
verification of inventory has been conducted at reasonable intervals by the management
and whether any material discrepancies were noticed and if so, whether they have been
properly dealt with in the books of account.
• The physical verification of inventory is the responsibility of the management of the
company which should verify all material items at least once in a year and more often in
appropriate cases.
• Further, where the auditor is unable to express any opinion on any specified matter, his
report shall indicate such fact together with the reasons why it is not possible for him to
give his opinion on the same.

Example:

Examples
Ex. 1: ‘Educating Child’ is a limited company registered under section 8 of the Companies Act,
2013.
Ans. In the given case, ‘Educating Child’ is licensed to operate under section 8 of the Companies
Act, 2013. Therefore, CARO, 2016 shall not be applicable to ‘Educating Child’ accordingly.

11.9
 Ex. 2: Ashu Pvt. Ltd. has fully paid capital and reserves of ` 50 lakh. During the year, the
company had borrowed ` 70 lakh each from a bank and a financial institution
independently. It has the turnover of ` 900 lakh.
Ans. In the given case of Ashu Pvt. Ltd., it has paid capital and reserves of ` 50 lakh i.e. less
than ` 1 crore, turnover of ` 9 crore i.e. less than ` 10 crore. However, it has maximum
outstanding borrowings of ` 1.40 crore (` 70 lakh + ` 70 lakh) collectively from bank
and financial institution.
Therefore, it fails to fulfil the condition relating to borrowings. Thus, CARO, 2016 shall
be applicable to Ashu Pvt. Ltd. accordingly.

Ex. 3: The company has dispensed with the practice of taking inventory of their inventories at
the year-end as in their opinion the exercise is redundant, time consuming and intrusion to
normal functioning of the operations. Explain reporting requirement under CARO, 2016.

Ans. In the given case, the above requirement of physical verification of inventory by the
management has not been taken place and therefore the auditor should point out the same
under CARO, 2016. He may consider the impact on financial statement and report
accordingly.

11.10
BANK AUDIT

12.1
 1. INTRODUCTION
• Banking sector is the backbone of any economy as it is essential for sustainable socio-
economic growth and financial stability in the economy.
• The banking sector is also crucial as it deals with mammoth amounts of public monies and
is highly sensitive to reputational risk.
• Like all economic activities, the banking sector is also exposed to various risks in its
operations.
• It is of utmost importance to ensure that banking sector stays healthy, safe and sound.
• For safe and sound banking sector, one of the most important factors is reliable
financial information supported by quality bank audits.

Types of Banks
• There are different types of banking institutions prevailing in India which are as follows:
✓ Commercial Banks
✓ Cooperative Banks
✓ Development Banks (more commonly known as ‘Term-Lending Institutions’)
✓ Regional Rural Banks
✓ Payment Banks
✓ Small Finance Banks

Commercial banks are the widest spread banking institutions in India, that provide a number
of products and services to general public and other segments of economy.
Two of its main functions are
1. accepting deposits and
2. granting advances.

Two Major Functions of Banks

12.2
 Reserve Bank of India: Regulating Body
• The functioning of banking industry in India is regulated by the Reserve Bank of India
(RBI) which acts as the Central Bank of our country.
• RBI is responsible for development and supervision of the constituents of the Indian
financial system (which comprises banks and non-banking financial institutions) as well as
for determining, in conjunction with the Central Government, the monetary and credit
policies keeping in with the need of the hour.
• Important functions of RBI are :
✓ issuance of currency;
✓ regulation of currency issue;
✓ acting as banker to the central and state governments; and
✓ acting as banker to commercial and other types of banks including term-lending
institutions.
• Besides, RBI has also been entrusted with the responsibility of regulating the activities of
commercial and other banks.
• No bank can commence the business of banking or open new branches without
obtaining license from RBI.
• The RBI also has the power to inspect any bank.

Independent audit of financial statement of banks is important

for a healthy, safe and sound banking system.

Banking Operations - Conducted only at Branches

• Banking operations are conducted only at the branches, while other offices act as
controlling authorities or administrative offices that lay down policies, systems and
internal control procedures for conduct of business, in compliance with the statutory /
regulatory impositions and in compliance of accepted accounting principles and
practices that cover all transactions and economic events.
• These controlling / administrative offices also stipulate the delegation of powers and fix
responsibilities and accountability and these are involved generally in effective
supervision, monitoring and control over the business activities and operations,
including seeking faithful compliance of the bank’s laid down policies/ procedures /
controls and deal with deviations therefrom.
• Peculiarities involved:
• Huge volumes and complexity of transactions,
• Wide geographical spread of banks’ network,

12.3
 • Large range of products and services offered,
• Extensive use of technology,
• Strict vigilance by the banking regulator etc.

Types of Audit Reports to be issued (generally)

• Presently, the Statutory Central Auditors (SCAs) have to furnish the following
reports in addition to their main audit report:
▪ Report on adequacy and operating effectiveness of Internal Controls over
Financial Reporting in case of banks which are registered as companies under
the Companies Act in terms of Section 143(3)(i) of the Companies Act, 2013
which is normally to be given as an Annexure to the main audit report as per the
Guidance Note on Audit of Internal Financial Controls over Financial Reporting
issued by the ICAI.
▪ Long Form Audit Report.
▪ Report on compliance with SLR requirements.
▪ Report on whether the treasury operations of the bank have been conducted in
accordance with the instructions issued by the RBI from time to time.
▪ Report on whether the income recognition, asset classification and
provisioning have been made as per the guidelines issued by the RBI from
time to time.
▪ Report on whether any serious irregularity was noticed in the working of the
bank which requires immediate attention.
▪ Report on status of the compliance by the bank with regard to the
implementation of recommendations of the Ghosh Committee relating to
frauds and malpractices and of the recommendations of Jilani Committee on
internal control and inspection/credit system.
▪ Report on instances of adverse credit-deposit ratio in the rural areas.

2. UNDERSTANDING OF ACC OUNTING SYSTEMS IN B ANKS

• From the time that customers had to physically visit and deal with a bank, there is a sea
change in banking as use of technology and its continuous evolution has enabled banks
to reach their customers in providing them the convenience and comfort of anytime-
anywhere-banking by letting them access their information/data on real time basis, as
stored in a safe and secure environment on the bank’s servers.
• With many customers having access to Internet and mobile connectivity, monetary
transactions from inception to finish have become expeditious through E banking; and but

12.4
 for Core banking technology and extensive advancement therein and the availability and
extensive use of technology tools.
• Banks could not have achieved such phenomenal and accelerated growth and could not
have ventured into and offered a wide range of innovative products and services to their
customers.
• The transactions in banks have become voluminous and it needs to be ensured that in
the system of recording , transmission and storage of information/ data, integrity thereof
is optimally maintained and control systems ensure that the same is free of risks of
errors, omissions, irregularities and frauds; and considering the challenges of
technology , bank managements continuously endeavor to make the internal control
systems robust , safe and secure as well as convenient and expeditious for the
customers.
• In the Computerized environment, it is imperative that the auditor is familiar with, and is
satisfied that, all the norms/parameters as per the latest applicable RBI guidelines
are incorporated and built into the system that generates information/data having a
bearing on the classification/ provisions and income recognition.
• The auditor should not go by the assumption that the system generated information
is correct and can be relied upon without evidence that demonstrates that the
system driven information is based on validation of the required parameters for the
time being in force and applicable.

Banks may be divided into three board categorizes based on the level of computerization:
✓ Non-computerized banks.
✓ Partially Computerized banks.
✓ Fully computerized banks

3. BANK AUDIT APPROACH

• Based on the nature and thrust of operations, nature of adverse features, level of
compliance of previous reports, and audit risks based on lack of, inadequacy in or breach
of internal controls/ discipline and the familiarization exercise carried out, an audit plan
should be drawn up.
• A bank should have appropriate controls to manage its risks, including effective
segregation of duties (particularly, between front and back offices), accurate
measurement and reporting of positions, verification and approval of transactions,
reconciliation of positions and results, setting of limits, reporting and approval of
exceptions, physical security and contingency planning.

12.5
 The following are certain common questions / steps, which have to be kept in mind
while undertaking/ performing control activities:
Nature of
Questions to be considered / answered
Questions
(a) Who • Who performs the control?
• Does the above person have requisite knowledge and authority to
perform the control?
(b) What • What evidence is generated to demonstrate /prove that the
control is performed?
(c) When • When and with what frequency is the control performed?
• Is the frequency enough to prevent, detect and correct Risk of
Material Misstatements?
(d) Where • Where is the evidence of performance of the control retained?
• For how long is the evidence retained?
• Is the evidence accessible for / available for audit?
(e) Why • Why is the control being performed?
• What type of errors are prevented or detected through the
performance of the control?
(f) How • How is the control performed?
• What are the control activities?
• Can these activities be bypassed?
• Can the bypass, if any, be detected?
• How are exceptions / deviations resolved on identification?
• What is the time frame for resolving the exceptions / deviations?

Engagement Team Discussions

• The engagement team should hold discussions to gain better understanding of the
bank and its environment, including internal control, and also to assess the potential
for material misstatements of the financial statements.
• All these discussions should be appropriately documented for future reference.
• The discussion between the members of the engagement team and the audit engagement
partner should be done on the susceptibility of the bank’s financial statements to
material misstatements. These discussions are ordinarily done at the planning stage of
an audit.

12.6
• Specific emphasis should be provided to the susceptibility of the bank’s financial
statements to material misstatement due to fraud, that enables the engagement team to
consider an appropriate response to fraud risks, including those related to
engagement risk, pervasive risks, and specific risks.
• It further enables the audit engagement partner to delegate the work to the
experienced engagement team members, and to determine the procedures to be
followed when fraud is identified.
• Further, audit engagement partner may review the need to involve specialists to address
the issues relating to fraud.

4. INCOME RECOGNITION POLICY

• The policy of income recognition should be objective and based on record of recovery
rather than on any subjective considerations.
• Income from Non-Performing Assets (NPA) is not recognised on accrual basis but is
booked as income only when it is actually received.

5. FORMS AND CONTENT OF FINANCIAL STATEMENTS

• Sub-sections (1) and (2) of section 29 of the Act deal with the form and content of
financial statements of a banking company and their authentication.
• These sub- sections are also applicable to nationalized banks, State Bank of India,
subsidiaries of the State Bank of India, and Regional Rural Banks.
• Every banking company is required to prepare a Balance Sheet and a Profit and Loss
Account in the forms set out in the Third Schedule to the Act or as near thereto as the
circumstances admit.
• Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form of
Balance Sheet and Form B contains the form of Profit and Loss Account.
• Every banking company needs to comply with the disclosure requirements under the
various Accounting Standards, as specified under section 133 of the Companies Act,
2013, read with Rule 7 of the Companies (Accounts) Rules 2014, in so far as they apply
to banking companies or the Accounting Standards issued by the ICAI.

12.7
 6. AUDIT OF ACCOUNTS
• Sub-section (1) of section 30 of the Act requires that the balance sheet and profit and
loss account of a banking company should be audited by a person duly qualified under
any law for the time being in force to be an auditor of companies.

7. ELIGIBILITY, QUALIFICATION AND DISQUALIFICATION

OF AN AUDITOR
Refer Section 141 of the Companies Act, 2013 discussed in the “Chapter-10 The
Company Audit”.

8. APPOINTMENT OF AUDITOR
• As per the provisions of the relevant enactments, the auditor of a banking company is to
be appointed at the annual general meeting of the shareholders, whereas the auditor
of a nationalized bank is to be appointed by the bank concerned acting through its
Board of Directors.
• In either case, approval of the Reserve Bank is required before the appointment is made.
• The auditors of the State Bank of India are to be appointed by the Comptroller and
Auditor General of India in consultation with the Central Government.
• The auditors of the subsidiaries of the State Bank of India are to be appointed by the
State Bank of India.
• The auditors of regional rural banks are to be appointed by the bank concerned with
the approval of the Central Government.

9. RENUMERATION OF AUDITOR
• The remuneration of auditor of a banking company is to be fixed in accordance with the
provisions of section 142 of the Companies Act, 2013 (i.e., by the company in general
meeting or in such manner as the company in general meeting may determine).
• The remuneration of auditors of nationalized banks and State Bank of India is to be
fixed by the Reserve Bank of India in consultation with the Central Government.

12.8
 10. POWER OF AUDITOR
• The auditor of a banking company or of a nationalized bank, State Bank of India, a
subsidiary of State Bank of India, or a regional rural bank has the same powers as those
of a company auditor in the matter of access to the books, accounts, documents and
vouchers.

11. AUDITOR’S REPORT

• In the case of a nationalized bank, the auditor is required to make a report to the Central
Government in which he has to state the following:
✓ whether, in his opinion, the balance sheet is a full and fair balance sheet containing all
the necessary particulars and is properly drawn up so as to exhibit a true and fair view
of the affairs of the bank, and in case he had called for any explanation or information,
whether it has been given and whether it is satisfactory;
✓ whether or not the transactions of the bank, which have come to his notice, have
been within the powers of that bank;
✓ whether or not the returns received from the offices and branches of the bank
have been found adequate for the purpose of his audit;
✓ any other matter which he considers should be brought to the notice of the
Central Government.
• The report of auditors of State Bank of India is also to be made to the Central Government
and is almost identical to the auditor’s report in the case of a nationalized bank.

Format of Report
• The auditors, central as well as branch, should also ensure that the audit report issued by
them complies with the requirements of Standards on Auditing discussed in Chapter
11 on Audit Report.
• The auditor should ensure that not only information relating to number of unaudited
branches is given but quantification of advances, deposits, interest income and
interest expense for such unaudited branches has also been disclosed in the audit
report.
• Such disclosure in the audit report is not only in accordance with the best international
trends but also provides useful information to users of financial statements.
• It may be noted that, in addition to the aforesaid, the auditor of a banking company is also
required to state in his report in respect of matters covered by Section 143 of the
Companies Act, 2013.

12.9
 • However, it is pertinent to mention that the reporting requirements relating to the
Companies (Auditor’s Report) Order, 2016 is not applicable to a banking company as
defined in clause (c) of section 5 of the Banking Regulation Act, 1949.

Long Form Audit Report

• Besides the audit report as per the statutory requirements discussed above, the terms of
appointment of auditors of public sector banks, private sector banks and foreign banks (as
well as their branches), require the auditors to also furnish a Long Form Audit Report
(LFAR).
• The matters which the banks require their auditors to deal with in the long form audit
report have been specified by the Reserve Bank of India.

• The LFAR is to be submitted before 30th June every year.

• To ensure timely submission of LFAR, proper planning for completion of the LFAR is
required.
• While the format of LFAR does not require an executive summary to be given, members
may consider providing the same to bring out the key observations from the whole
document.

Reporting to RBI
• The RBI issued a Circular relating to implementation of recommendations of Committee
on Legal Aspects of Bank Frauds applicable to all scheduled commercial banks (excluding
Regional Rural Banks).
• Regarding liability of accounting and auditing profession, the said circular provided as
under:
“If an accounting professional, whether in the course of internal or external audit or in
the process of institutional audit finds anything susceptible to be fraud or
fraudulent activity or act of excess power or smell any foul play in any transaction, he
should refer the matter to the regulator.Any deliberate failure on the part of the
auditor should render himself liable for action”.
• As per the above requirement, the member shall be required to report the kind of matters
stated in the circular to RBI.
• Auditor should also consider the provisions of SA 250, “Consideration of Laws and
Regulations in an Audit of Financial Statements”.
• The said Standard explains that the duty of confidentiality is over-ridden by statute, law or
by courts.
• SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements “states that an auditor conducting an audit in accordance with SAs is

12.10
 responsible for obtaining reasonable assurance that the financial statements taken as a
whole are free from material misstatement, whether caused by fraud or error.
• It must be noted that auditor is not expected to look into each and every transaction
but to evaluate the system as a whole.
• Therefore, if the auditor while performing his normal duties comes across any instance, he
should report the matter to the RBI in addition to Chairman/Managing Director/Chief
Executive of the concerned bank.

Duty to report on Frauds under the Companies Act,

2013
• As per sub-section 12 of section 143 of the Companies Act, 2013, if an auditor of a
company, in the course of the performance of his duties as auditor, has reason to believe that
an offence of fraud involving such amount or amounts as may be prescribed, is being or
has been committed in the company by its officers or employees, the auditor shall report
the matter to the Central Government within such time and in such manner as may be
prescribed.

12. CONDUCTING AN AUDIT

The audit of banks or of their branches involves the following stages –
1. Initial consideration by the statutory auditor:
• Declaration of Indebtedness: The RBI has advised that the banks, before appointing
their statutory central/circle/branch auditors, should obtain a declaration of
indebtedness.
• Internal Assignments in Banks by Statutory Auditors: The RBI decided that the
audit firms should not undertake statutory audit assignment while they are associated
with internal assignments in the bank during the same year.
• Planning: Standard on Auditing (SA) 300, “Planning an Audit of Financial
Statements” requires that the auditor shall undertake the following activities prior to
starting an initial audit:
✓ Performing procedures required by SA 220, “Quality Control for Audit Work”
regarding the acceptance of the client relationship and the specific audit
engagement; and
✓ Establish understanding of terms of engagement as per SA 210, “Agreeing the
Terms of Audit Engagements”.

12.11
 • Communication with Previous Auditor: As per Clause (8) of the Part I of the First
Schedule to the Chartered Accountants Act, 1949, a chartered accountant in practice
cannot accept position as auditor previously held by another chartered accountant
without first communicating with him in writing.
• Terms of Audit Engagements: SA 210, “Terms of Audit Engagements” requires
that for each period to be audited, the auditor should agree on the terms of the audit
engagement with the bank before beginning significant portions of fieldwork. It is
imperative that the terms of the engagement are documented, in order to prevent any
confusion as to the terms that have been agreed in relation to the audit and the
respective responsibilities of the management and the auditor, at the beginning of an
audit relationship.
• Initial Engagements: The auditor needs to perform the audit procedures as
mentioned in SA 510 “Initial Audit Engagements-Opening Balances” and if after
performing that procedures, the auditor concludes that the opening balances contain
misstatements which materially affect the financial statements for the current period
and the effect of the same is not properly accounted for and adequately disclosed, the
auditor should express a qualified opinion or an adverse opinion, as appropriate.
• Assessment of Engagement Risk: The assessment of engagement risk is a critical
part of the audit process and should be done prior to the acceptance of an audit
engagement since it affects the decision of accepting the engagement and also in
planning decisions if the audit is accepted.
• Establish the Engagement Team: The assignment of qualified and experienced
professionals is an important component of managing engagement risk. The size
and composition of the engagement team would depend on the size, nature, and
complexity of the bank’s operations.
• Understanding the Bank and its Environment: SA 315 “Identifying and Assessing
the Risks of Material Misstatement Through Understanding the Entity and Its
Environment” lays down that the auditor should obtain an understanding of the
entity and its environment, including its internal control, sufficient to identify and
assess the risks of material misstatement of the financial statements whether due to
fraud or error, and sufficient to design and perform further audit procedures.

2. Identifying and Assessing the Risks of Material Misstatements

SA 315 requires the auditor to identify and assess the risks of material misstatement at the
financial statement level and the assertion level for classes of transactions, account
balances, and disclosures to provide a basis for designing and performing further audit
procedures.

3. Understanding the Bank and Its Environment including Internal Control

12.12
 An understanding of the bank and its environment, including its internal control, enables
the auditor:
• to identify and assess risk;
• to develop an audit plan so as to determine the operating effectiveness of the
controls, and to address the specific risks.

4. Understand the Bank’s Accounting Process

The accounting process produces financial and operational information for management’s
use and it also contributes to the bank’s internal control. Thus, understanding of the
accounting process is necessary to identify and assess the risks of material misstatement
whether due to fraud or not, and to design and perform further audit procedures.
5. Understanding the Risk Management Process
Management develops controls and uses performance indicators to aid in managing key
business and financial risks. An effective risk management system in a bank generally
requires the following:
• Oversight and involvement in the control process by those charged with
governance: Those charged with governance (BOD/Chief Executive Officer) should
approve written risk management policies. The policies should be consistent with
the bank’s business objectives and strategies, capital strength, management
expertise, regulatory requirements and the types and amounts of risk it regards as
acceptable.
• Identification, measurement and monitoring of risks: Risks that could significantly
impact the achievement of bank’s goals should be identified, measured and
monitored against pre-approved limits and criteria.
• Control activities: A bank should have appropriate controls to manage its risks,
including effective segregation of duties (particularly, between front and back
offices), accurate measurement and reporting of positions, verification and approval
of transactions, reconciliation of positions and results, setting of limits, reporting and
approval of exceptions, physical security and contingency planning.
• Monitoring activities: Risk management models, methodologies and assumptions
used to measure and manage risk should be regularly assessed and updated. This
function may be conducted by the independent risk management unit.
• Reliable information systems: Banks require reliable information systems that
provide adequate financial, operational and compliance information on a timely and
consistent basis. Those charged with governance and management require risk
management information that is easily understood and that enables them to assess
the changing nature of the bank’s risk profile.

12.13
 6. Engagement Team Discussions
The engagement team should hold discussions to gain better understanding of banks and
its environment, including internal control, and also to assess the potential for material
misstatements of the financial statements.

7. Establish the Overall Audit Strategy

SA 300 “Planning an Audit of financial Statements’’ states that the objective of the
auditor is to plan the audit so that it will be performed in an effective manner. For this
purpose, the audit engagement partner should:
• establish the overall audit strategy, prior to the commencement of an audit; and
• involve key engagement team members and other appropriate specialists while
establishing the overall audit strategy, which depends on the characteristics of
the audit engagement.
8. Develop the Audit Plan
SA 300 deals with the auditor’s responsibility to plan an audit of financial statements
in an effective manner.
It requires the involvement of all the key members of the engagement team while
planning an audit.

9. Audit Planning Memorandum

The auditor should summarize their audit plan by preparing an audit planning
memorandum in order to:
• Describe the expected scope and extent of the audit procedures to be performed
by the auditor.
• Highlight all significant issues and risks identified during their planning and risk
assessment activities, as well as the decisions concerning reliance on controls.
• Provide evidence that they have planned the audit engagement appropriately
and have responded to engagement risk, pervasive risks, specific risks, and other
matters affecting the audit engagement.

10. Determine Audit Materiality

The auditor should consider the relationship between the audit materiality and audit
risk when conducting an audit.
The determination of audit materiality is a matter of professional judgment and depends
upon the knowledge of the bank, assessment of engagement risk, and the reporting
requirements for the financial statements.

12.14
11. Consider Going Concern
In obtaining an understanding of the bank, the auditor should consider whether there are
events and conditions which may cast significant doubt on the bank’s ability to
continue as a going concern.

12. Assess the Risk of Fraud including Money Laundering

As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements”, the auditor’s objectives are to identify and assess the risks of
material misstatement in the financial statements due to fraud, to obtain sufficient
appropriate audit evidence on those identified misstatements and to respond
appropriately.
The attitude of professional skepticism should be maintained by the auditor so as to
recognize the possibility of misstatements due to fraud.
The RBI has framed specific guidelines that deal with prevention of money laundering and
“Know Your Customer (KYC)” norms. The RBI has from time to time issued guidelines
(“Know Your Customer Guidelines – Anti Money Laundering Standards”), requiring banks
to establish policies, procedures and controls to deter and to recognize and report money
laundering activities.

13. Assess Specific Risks

The auditors should identify and assess the risks of material misstatement at the financial
statement level which refers to risks that relate pervasively to the financial statements as a
whole, and potentially affect many assertions.

14. Risk Associated with Outsourcing of Activities

The modern-day banks make extensive use of outsourcing as a means of both reducing
costs as well as making use of services of an expert not available internally.
There are, however, a number of risks associated with outsourcing of activities by banks
and therefore, it is quintessential for the banks to effectively manage those risks.

15. Response to the Assessed Risks

SA 330 “The Auditor’s Responses to Assessed Risks” requires the auditor to design and
implement overall responses to address the assessed risks of material misstatement at the
financial statement level.
The auditor should design and perform further audit procedures whose nature,
timing and extent are based on and are responsive to the assessed risks of material
misstatement at the assertion level.

12.15
 16. Stress Testing
RBI has required that all commercial banks shall put in place a Board approved ‘Stress
Testing framework’ to suit their individual requirements which would integrate into their
risk management systems.

17. BASEL III framework

The Basel Committee on Banking Supervision (BCBS) and the Financial Stability
Board (FSB) has undertaken an extensive review of the regulatory framework in the wake
of the sub-prime crisis. In the document titled ‘Basel III: A global regulatory framework
for more resilient banks and banking systems’, released by the BCBS in December
2010, it has inter alia proposed certain minimum set of criteria for inclusion of instruments
in the new definition of regulatory capital.

18. Reliance on / review of other reports

The auditor should take into account the adverse comments, if any, on advances
appearing in the following-
• Previous audit reports.
• Latest internal inspection reports of bank officials.
• Reserve Bank’s latest inspection report.
• Concurrent / Internal audit report.
• Report on verification of security
• Any other internal reports specially related to particular accounts.
• Manager’s charge-handing-over report when incumbent is changed.

• The above reports should be reviewed in detail. The Statutory Central Auditors must
review the Annual Financial Inspection report of RBI relating to the bank and ensure
that the variations in provisions, etc. reported by RBI have been properly considered by
the bank management.
• In carrying out his substantive procedures, the auditor should examine all large advances
while other advances may be examined on a sampling basis.
• The accounts identified to be problem accounts however need to be examined in detail
unless the amount involved is insignificant.
• The extent of sample checking would also depend on the auditor’s assessment of
efficacy of internal controls.
• What constitutes a ‘large advance’ would need to be determined in the context of
volume of operations of the branch.
• As a general rule, however, an advance may be considered to be a large advance if the
year-end balance is in excess of ` 2 crore or 5% of the aggregate year- end advances of
the branch, whichever is less.

12.16
 13. ADVANCES
• Lending constitutes a major activity of a bank besides the investment function. The core
business of banks is accepting deposits for onward lending. Advances, generally, constitute
the largest item on the assets side of the balance sheet of a bank and are major source of
its income.
• Audit of advances is one of the most important areas covered by auditors in bank audit. It
is necessary that auditors should have adequate knowledge of the banking industry and
the regulations governing the banks. Auditors must be aware of the various functional
areas of the bank/branches, its processes, procedures, systems and prevailing internal
controls with regard to advances.
13.1 What do advances comprise?
Advances comprises of funded amounts by way of:
• Term loans
• Cash credits, Overdrafts, Demand Loans
• Bills Discounted and Purchased
• Adverse balances in Deposit Accounts
• Participation on Risk Sharing basis
• Interest bearing Staff Loans

13.2 Legal requirements of Disclosure in the Balance Sheet.

• Bills purchased and discounted
✓ Cash credits, Overdrafts and loans repayable on demand
✓ Term Loans
• Secured by tangible assets
✓ Covered by Bank/Government guarantees
✓ Unsecured
• Advances in India
✓ Priority sectors
✓ Public sector
✓ Banks
✓ Others
• Advances outside India:
✓ Due from Banks
✓ Due from Others:
▪ Bills Purchased and discounted

12.17
 ▪ Syndicated loans
▪ Others

13.3 Classification of Advances

Classification of Advances as per RBI Prudential Norms

13.4 Nature of Security

Primary security refers to the security offered by the borrower for bank finance or the
one against which credit has been extended by the bank. This security is the principal
security for an advance.
Collateral security is an additional security. Security can be in any form i.e. tangible or
intangible asset, movable or immovable asset.

Examples of most common types of securities accepted by banks are the following.
• Personal Security of Guarantor

12.18
 • Goods/Stocks/Debtors /Trade Receivables
• Gold Ornaments and Bullion
• Immovable Property
• Plantations (For Agricultural Advances)
• Third Party Guarantees
• Banker’s General Lien
• Life Insurance Policies
• Stock Exchange Securities and Other Instruments

13.5 Mode of Security Creation

Depending on the nature of the item concerned, creation of security may take the form of
a mortgage, pledge, hypothecation, assignment, set-off, or lien.
• Mortgage: Mortgage are of several kinds but the most important are the
Registered Mortgage and the Equitable Mortgage.
✓ A Registered Mortgage can be affected by a registered instrument called the
‘Mortgage Deed’ signed by the mortgagor. It registers the property to the
mortgagee as a security.
✓ Equitable mortgage, on the other hand, is effected by a mere delivery of title
deeds or other documents of title with intent to create security thereof.
• Pledge: A pledge thus involves bailment or delivery of goods by the borrower
to the lending bank with the intention of creating a charge thereon as security for
the advance. The legal ownership of the goods remains with the pledger while the
lending banker gets certain defined interests in the goods. The pledge of goods
constitutes a specific (or fixed) charge.
• Hypothecation: The hypothecation is the creation of an equitable charge (i.e., a
charge created not by an express enactment but by equity and reason), which is
created in favour of the lending bank by execution of hypothecation agreement in
respect of the moveable securities belonging to the borrower.
Neither ownership nor possession are transferred to the bank. However, the
borrower holds the physical possession of the goods as an agent/trustee of the
bank.
The borrower periodically submits statements regarding quantity and value of
hypothecated assets (stocks, debtors, etc.) to the lending banker on the basis of
which the drawing power of the borrower is fixed.
• Assignment: Assignment represents a transfer of an existing or future debt, right or
property belonging to a person in favour of another person. Only actionable claims
(i.e., claim to any debt other than a debt secured by a mortgage of immovable

12.19
 property or by hypothecation or pledge of moveable property) such as book debts
and life insurance policies are accepted by banks as security by way of assignment.
An assignment gives the assignee absolute right over the moneys/debts assigned to
him.
• Set-off: Set-off is a statutory right of a creditor to adjust, wholly or partly, the debit
balance in the debtor’s account against any credit balance lying in another account
of the debtor. The right of set-off enables a bank to combine two accounts (a deposit
account and a loan account) of the same person provided both the accounts are in
the same name and in the same right (i.e., the capacity of the account holder in both
the accounts should be the same).
For the purpose of set-off, all the branches of a bank are treated as one single
entity. The right of set-off can be exercised in respect of time-barred debts
also.
• Lien: Lien is creation of a legal charge with consent of the owner, which gives
lender a legal right to seize and dispose / liquidate the asset under lien.

13.6 Prudential norms on Income Recognition, Asset Classification and provisioning

pertaining to Advances
1) Non-performing Assets: An asset becomes NPA when it ceases to generate income
for the Bank
• A non-performing asset (NPA) is a loan or an advance where:
a. interest and/ or installment of principal remains overdue for a period of
more than 90 days in respect of a term loan,
b. the account remains ‘out of order’ in respect of an Overdraft/Cash Credit
(OD/ CC),
c. the bill remains overdue for a period of more than 90 days in the case of
bills purchased and discounted,
2) Out of Order:
An account should be treated as ‘out of order’ if the outstanding balance remains
continuously in excess of the sanctioned limit/drawing power.
In cases where the outstanding balance in the principal operating account is less
than the sanctioned limit/drawing power, but there are no credits continuously
for 90 days as on the date of Balance Sheet or credits are not enough to cover
the interest debited during the same period, these accounts should be treated as
‘out of order’.
3) Overdue:
Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on
the due date fixed by the bank.

12.20
 Classification as NPA should be based on the record of recovery. Availability of
security or net worth of borrower/guarantor not be taken into account for purpose
of treating an advance as NPA or otherwise.
Asset Classification would be borrower wise and not facility wise. All facilities
including investment in securities would be termed as NPA.
4) Accounts regularized near about the Balance Sheet Date:
• The asset classification of borrower accounts where a solitary or a few credits are
recorded before the balance sheet should be handled with care and without
scope for subjectivity.
• Where the account indicates inherent weakness on the basis of the data
available, the account should be deemed as an NPA.
• Central Govt. Guaranteed Advances, where the guarantee is not invoked /
repudiated would be classified as Standard Assets but regarded as NPA for
Income Recognition purpose.
5) Advances under Consortium:
• Consortium advances should be based on the record of recovery of the
respective individual member banks and other aspect having a bearing on the
recoverability of the advances.
• Where the remittances by the borrower under consortium lending arrangements
are pooled with one bank and/or where the bank receiving remittances is not
parting with the share of other member banks, the account should be treated as
not serviced in the books of the other member banks and therefore, an NPA.
• The banks participating in the consortium, therefore, need to arrange to get their
share of recovery transferred from the lead bank or to get an express
consent from the lead bank for the transfer of their share of recovery, to ensure
proper asset classification in their respective books.
6) Drawing Power Allocation in case of Cash Credit Account:
The Lead Bank would be responsible for computing the drawing power of the
borrower and allocate the same to member banks. In certain special circumstances,
at the request of the Borrower, the Lead Bank may allot a higher or lower share of
Drawing Power to the member bank, as against their share of Advance.
The proforma DP Allocation Letter is presented hereunder for reference:

12.21
 Drawing Power for December 2018
As per Stock Statement November 2018
(` in Crores)
Description of Stocks Market Value Margin Advanced Value

Raw Materials 636.27 25 477.20

Finished Goods 372.75 25 279.56

Stock in Process 659.35 25 494.51

Stores and Spares 124.51 25 93.38

Book Debts (Upto 120/180 days) 37,379.90 35 24,296.94

Stock in Transit 52.31 25 39.23

Total 39,225.09 25,680.82

Less: Unpaid Stocks under LC 0.00 100 0.00

Total 39,225.09 26,680.82

(` in Crores)
Banks Share % Limit / D.P.

State Bank of India 32.26 500.00

Bank of Baroda 2.56 40.00

Bank of India 6.45 100.00

Canara Bank 5.16 80.00

Standard Chartered Bank 9.03 140.00

Union Bank of India 6.45 100.00

HSBC 13.87 215.00

Citi Bank 6.45 100.00

Bank of America 1.29 20.00

BNP Parihas 1.94 30.00

Punjab National Bank 6.45 100.00

ICICI Bank 4.84 75.00

IDBI Bank 3.23 50.00

Unallocated - -

Total 100.00 1550.00

13.7 Accounts where there is erosion in the value of security / frauds committed by
borrowers:

12.22
Not prudent to follow stages of asset classification. It should be straight-away classified as
doubtful or loss asset as appropriate.
• Erosion in the value of security can be reckoned as significant when the realisable
value of the security is less than 50 per cent of the value assessed by the bank or
accepted by RBI at the time of last inspection, as the case may be. Such NPAs may be
straight-away classified under doubtful category and provisioning should be made
as applicable to doubtful assets.
• If the realisable value of the security, as assessed by the bank / approved valuers /
RBI is less than 10 per cent of the outstanding in the borrowed accounts, the
existence of security should be ignored, and the asset should be straight-away
classified as loss asset. It may be either written off or fully provided for by the bank.

13.8 Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc.

Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life policies
need not be treated as NPAs, provided adequate margin is available in the accounts.

13.9 Agricultural Advances Affected by Natural Calamities

Master Circular issued by the RBI deals elaborately with the classification and income
recognition issues due to impairment caused by natural calamities.
Banks may decide on their own relief measures, viz., conversion of the short-term
production loan into a term loan or re-scheduling of the repayment period and the
sanctioning of fresh short-term loan, subject to the guidelines contained in RBI’s latest
Master Circular on Prudential Norms on Income Recognition, Asset Classification
and provisioning pertaining to Advances. In such cases, the NPA classification would
be governed by such rescheduled terms.

13.10 Advances to Staff

Interest bearing staff advances as a banker should be included as part of advances
portfolio of the bank. In the case of housing loan or similar advances granted to staff
members where interest is payable after recovery of principal, interest need not be
considered as overdue from the first quarter onwards.
Such loans/advances should be classified as NPA only when there is a default in
repayment of installment of principal or payment of interest on the respective due
dates. The staff advances by a bank as an employer and not as a banker are required to be
included under the sub-head ‘Others’ under the schedule of Other Assets.

13.11 Agricultural Advances

As per the guidelines, Agricultural Advances are of two types,

12.23
 (1) Agricultural Advances for “long duration” crops and
(2) Agricultural Advances for “short duration” crops
The “long duration” crops would be crops with crop season longer than one year and
crops, which are not “long duration” crops would be treated as “short duration” crops.
The crop season for each crop, which means the period up to harvesting of the crops
raised, would be as determined by the State Level Bankers’ Committee in each State.
The following NPA norms would apply to agricultural advances (including Crop Term
Loans):
• A loan granted for short duration crops will be treated as NPA, if the
instalment of principal or interest thereon remains overdue for two crop
seasons and,
• A loan granted for long duration crops will be treated as NPA, if the instalment
of principal or interest thereon remains overdue for one crop season.

14. COMPUTATION OF DRAWING POWER

• All accounts should be kept within both the drawing power and the sanctioned limit at
all times.
• The accounts which exceed the sanctioned limit or drawing power or are against
unapproved securities or are otherwise irregular should be brought to the notice of the
Management / Head Office regularly.
• Banks should ensure that drawings in the working capital account are covered by the
adequacy of the current assets.
• Drawing power is required to be arrived at based on current stock statement.
• However, considering the difficulties of large borrowers, stock statements relied upon by
the banks for determining drawing power should not be older than three months.
• The outstanding in the account based on drawing power calculated from stock statements
older than three months is deemed as irregular.
• The stock statements, quarterly returns and other statements submitted by the borrower
to the bank should be scrutinized in detail.
• The audited Annual Report submitted by the borrower should be scrutinized properly.
• The monthly stock statement of the month for which the audited accounts are prepared
and submitted should be compared and the reasons for deviations, if any, should be
ascertained.
• It needs to be ensured that the drawing power is calculated as per the extant guidelines
formulated by the Board of Directors of the respective bank and agreed upon by the
concerned statutory auditors.
• Special consideration should be given to proper reporting of sundry creditors for the
purposes of calculating drawing power.

12.24
• The stock audit should be carried out by the bank for all accounts having funded exposure
of more than ` 5 crores.
• Auditors can also advise for stock audit in other cases if the situation warrants the same.
• Branches should obtain the stock audit reports from lead bank in the cases where the
Bank is not leader of the consortium of working capital.
• The report submitted by the stock auditors should be reviewed during the course of the
audit and special focus should be given to the comments made by the stock auditors on
valuation of security and calculation of drawing power.
• The drawing power needs to be calculated carefully in case of working capital advances
to companies engaged in construction business.
• The valuation of work in progress should be ensured in consistent and proper manner.
• It also needs to be ensured that mobilization advance being received by the contractors
is reduced while calculating drawing power.

Particulars of Current Assets DP

(A) Stocks
Stocks at realizable value 1000
Less: Unpaid Stocks:
- Sundry creditors 300
- Acceptances / LCs etc. 300 600
Paid for stocks 400
Margin @ 25% 100 300

(B) Debtors:
Total Debtors 1000
Less: Ineligible debtors 200
Eligible debtors 800
Margin @ 40% 320 480
Total DP 780

15. AUDIT OF ADVANCES

• Advances generally constitute the major part of the assets of the bank.
• There are large number of borrowers to whom variety of advances are granted.
• The audit of advances requires the major attention from the auditors.

In carrying out audit of advances, the auditor is primarily concerned with obtaining
evidence about the following:

12.25
 ✓ Amounts included in balance sheet in respect of advances are outstanding at the
date of the balance sheet.
✓ Advances represent amount due to the bank.
✓ Amounts due to the bank are appropriately supported by Loan documents and
other documents as applicable to the nature of advances.
✓ There are no unrecorded advances.
✓ The stated basis of valuation of advances is appropriate and properly applied,
and that the recoverability of advances is recognised in their valuation.
✓ The advances are disclosed, classified and described in accordance with
recognised accounting policies and practices and relevant statutory and
regulatory requirements.
✓ Appropriate provisions towards advances have been made as per the RBI norms,
Accounting Standards and generally accepted accounting practices.

• The auditor can obtain sufficient appropriate audit evidence about advances by study
and evaluation of internal controls relating to advances, and by:
✓ examining the validity of the recorded amounts;
✓ examining loan documentation;
✓ reviewing the operation of the accounts;
✓ examining the existence, enforceability and valuation of the security;
✓ checking compliance with RBI norms including appropriate classification and
provisioning; and
✓ carrying out appropriate analytical procedures.
• In carrying out his substantive procedures, the auditor should examine all large
advances while other advances may be examined on a sampling basis. The accounts
identified to be problem accounts however need to be examined in detail unless t h e
amount involved is insignificant.
• Advances which are sanctioned during the year or which are adversely commented by
RBI inspection team, concurrent auditors, bank’s internal inspection, etc. should
generally be included in the auditor’s review.

Evaluation of Internal Controls over Advances: The auditor should examine the efficacy of
various internal controls over advances to determine the nature, timing and extent of his
substantive procedures. In general, the internal controls over advances should include,
inter alia, the following:
• The bank should make an advance only after satisfying itself as to the credit worthiness
of the borrower and after obtaining sanction from the appropriate authorities of the bank.
• All the necessary documents (e.g., agreements, demand promissory notes, letters of
hypothecation, etc.) should be executed by the parties before advances are made.

12.26
• The compliance with the terms of sanction and end use of funds should be ensured.
• Sufficient margin as specified in the sanction letter should be kept against securities
taken so as to cover for any decline in the value thereof. The availability of sufficient margin
needs to be ensured at regular intervals.
• If the securities taken are in the nature of shares, debentures, etc., the ownership of the
same should be transferred in the name of the bank and the effective control of such
securities be retained as a part of documentation.
• All securities requiring registration should be registered in the name of the bank or
otherwise accompanied by documents sufficient to give title to the bank.
• In the case of goods in the possession of the bank, contents of the packages should
be test checked at the time of receipt. The godown should be frequently inspected by
responsible officers of the branch concerned, in addition to the inspectors of the bank.
• Drawing Power Register should be updated every month to record the value of securities
hypothecated. These entries should be checked by an officer.
• The accounts should be kept within both the drawing power and the sanctioned limit.
• All the accounts which exceed the sanctioned limit or drawing power or are otherwise
irregular should be brought to the notice of the controlling authority regularly.
• The operation of each advance account should be reviewed at least once a year, and at
more frequent intervals in the case of large advances.

12.27
 16. AUDIT OF REVENUE ITEMS
• Profit and Loss Account: Sub–section (1) of section 29 of the Banking Regulation Act, 1949,
requires the preparation of Profit and Loss Account in Form B of Third Schedule to the
Act or as near thereto as the circumstances admit.

12.28
16.1 Income:
The following items are included under this head:

Interest Earned Other Income

• Interest / Discount on • Commission, Exchange and Brokerage: This
Advances / Bills: item comprises of the following:
• Interest Income on ✓ Commission on bills for collection.
Investments: ✓ Commission / exchange on remittances and
• Interest on Balances transfers, e.g. demand drafts, NEFT, RTGS, etc.
with RBI and Other ✓ Commission on letters of credit and
Inter–bank Funds: guarantees, letter of comforts.
• Others: This includes ✓ Loan processing, arranger and syndication
any other fees.
interest/discount
✓ Mobile banking fees.
income not included in
✓ Credit / Debit card fee income including
the above heads
annual fee income, merchant acquiring
income, interchange fees, etc.
✓ Rent from letting out of lockers
✓ Commission on Government business.
✓ Commission on other permitted agency
business including consultancy and other
services.
✓ Brokerage on securities.
✓ Fee on insurance referral.
✓ Commission on referral of mutual fund clients.
✓ Service / transaction banking charges
including charges levied for transaction at
other branches.
✓ Income from rendering other services like
custodian, de-mat, investment advisory, cash
management and other fee-based services.
• Profit on Sale of Investments
• Profit/Loss on Revaluation of Investments
• Profit on sale of Land, Buildings and Other
Assets:
✓ Profit / Loss on Revaluation of Fixed Assets
✓ Profit on exchange transactions: This includes

12.29
 revaluation gains/losses on forward exchange
contracts and other derivative contracts,
premium income/expenses on options, etc.
✓ Income earned by way of dividends, etc., from
subsidiaries and joint ventures abroad/in
India.
✓ Miscellaneous income.

Audit Approach and Procedures

• In carrying out an audit of income, the auditor is primarily concerned with obtaining
reasonable assurance that the recorded income arose from transactions, which took place
during the relevant period and pertain to the bank, that there is no unrecorded income,
and that income is recorded at appropriate amount.
• RBI has advised that in respect of any income which exceeds one percent of the total
income of the bank if the income is reckoned on a gross basis or one percent of the net
profit before taxes if the income is reckoned net of costs, should be considered on
accrual as per AS-9.
• If any item of income is not considered to be material as per the above norms, it may
be recognised when received and the auditors need not qualify the statements in that
situation.
• Banks recognize income (such as interest, fees and commission) on accrual basis, i.e., as
it is earned. It is an essential condition for accrual of income that it should not be
unreasonable to expect its ultimate collection.
• In modern day banking, the entries for interest income on advances are automatically
generated through a batch process in the CBS system.
• In view of the significant uncertainty regarding ultimate collection of income arising in
respect of non-performing assets, the guidelines require that banks should not recognize
income on non-performing assets until it is actually realised.
• When a credit facility is classified as non-performing for the first time, interest accrued
and credited to the income account in the corresponding previous year which has
not been realized should be reversed or provided for.
• This will apply to Government guaranteed accounts also.
• Interest on advances against Term Deposits, National Savings Certificates (NSCs), Indira
Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and Life policies may be taken to income
account on the due date, provided adequate margin is available in the accounts.
• In the case of bills purchased outstanding at the close of the year the discount received
thereon should be properly apportioned between the two years. [The Unexpired
discount / rebate on bills discounted i.e., where part of receipt comprising discount
charges on bills purchased relate to the period beyond the year-end, should be recorded as
“Other Liabilities”].

12.30
• Interest (discount) component paid by Bank/Branch on rediscount of bills from other
financial institutions, is not to be netted off from the discount earned on bills discounted.
• In the case of bills for collection, the auditor should also examine the procedure for
crediting the party on whose behalf the bill has been collected.
• The procedure is usually such that the customer’s account is credited only after the bill
has actually been collected from the drawee either by the bank itself or through its
agents, etc.
• This procedure is in consonance with the nature of obligations of the bank in respect of
bills for collection. The commission of the branch becomes due only when the bill has been
collected.
• Fees and commissions earned by the banks as a result of re-negotiations or
rescheduling of outstanding debts should be recognised on an accrual basis over the
period of time covered by the re-negotiated or rescheduled extension of credit.
• Test checks the Interest earned by the banks for the sample selected.
• Test check the Fees and commissions earned by the banks made for commission on Bills
for collection; Letters of credit; Bank Guarantees.

Customer Code: 28XXXXXXXXXX Customer Name: ABCD

Account No.: 015XXXXXXXXX1367
Date Date No. of Rate of Amount Total Interest Applied
From To Days Interest Base Product Amount on

02-06-20XX 03-06-20XX 2 6.86 39,96,21,793 79,92,43,586 1,50,214 02-07-20XX

04-06-20XX 29-06-20XX 26 6.86 39,96,23,225 10,39,02,02,992 19,52,789 02-07-20XX

30-06-20XX 01-07-20XX 2 6.86 39,94,70,153 79,89,41,704 1,50,157 02-07-20XX

02-08-20XX 02-08-20XX 1 6.86 40,19,52,259 40,19,52,334 75,545 02-09-20XX

03-08-20XX 05-08-20XX 3 6.86 39,96,21,793 1,19,88,65,439 2,25,321 02-09-20XX

06-08-20XX 30-08-20XX 25 6.86 39,96,19,026 9,99,05,79,800 18,77,662 02-09-20XX

07-09-20XX 29-09-20XX 23 6.86 39,96,22,256 9,19,13,13,291 17,27,463 02-10-20XX

30-09-20XX 30-09-20XX 1 6.86 40,17,23,469 40,17,25,314 75,502 02-10-20XX

01-10-20XX 01-10-20XX 1 6.86 39,94,67,493 39,94,69,972 75,078 02-10-20XX

Reversal of Income:
• If any advance, including bills purchased and discounted, becomes NPA as at the close of
any year, the entire interest accrued and credited to income account in the past
periods, should be reversed or provided for if the same is not realised. This will
apply to Government guaranteed accounts also.

12.31
 • In respect of NPAs, fees, commission and similar income that have accrued should
cease to accrue in the current period and should be reversed or provided for with
respect to past periods, if uncollected.
• Further, in case of banks which have wrongly recognised income in the past should
reverse the interest if it was recognised as income during the current year or make a
provision for an equivalent amount if it was recognized as income in the previous year(s).
• Furthermore, the auditor should enquire if there are any large debits in the Interest
Income account that have not been explained. It should be enquired is there are any
communications from borrowers pointing out differences in Interest charge, and whether
action as justified has been taken in this regard.

On Leased Assets:
• The finance charge component of finance income (as defined in AS 19 – Leases) on the
leased asset which has accrued and was credited to income account before the asset
became non-performing, and remaining unrealized, should be reversed or provided
for in the current accounting period.

On Take-out Finance:
• In the case of take-out finance, if based on record of recovery, the account is classified by
the lending bank as NPA, it should not recognize income unless realised from the
borrower/taking-over institution (if the arrangement so provides).

On Partial Recoveries in NPAs:

• In the absence of a clear agreement between the bank and the borrower for the purpose
of appropriation of recoveries in NPAs (i.e., towards principal or interest due), banks are
required to adopt an accounting policy and exercise the right of appropriation of
recoveries in a uniform and consistent manner.
• The appropriate policy to be followed is to recognize income as per AS 9 when certainty
attaches to realisation and accordingly amount reversed/derecognized or not recognised
in the past should be accounted.
• Interest partly / fully realised in NPAs can be taken to income.
• However, it should be ensured that the credits towards interest in the relevant accounts
are not out of fresh/additional credit facilities sanctioned to the borrowers
concerned.

Memorandum Account:
• On an account turning NPA, banks should reverse the interest already charged and not
collected by debiting Profit and Loss account and stop further application of interest.

12.32
• However, banks may continue to record such accrued interest in a Memorandum
account in their books for control purposes.
• For the purpose of computing Gross Advances, interest recorded in the Memorandum
account should not be taken into account.

Income from Investments:

• Interest Income on Investments: This includes all income derived from Government
securities, bonds and debentures of corporates and other investments by way of interest
and dividend, except income earned by way of dividends, etc., from subsidiaries and joint
ventures abroad/in India. Broken period interest paid on securities purchased and
amortization of premium on SLR investments is net off from the interest income on
investments.
• Profit on Sale of Investments: Investments are dealt in the course of banking activity and
hence the net profit or loss on sale of investments is taken to profit and loss account.
• Profit/Loss on Revaluation of Investments: In terms of guidelines issued by RBI,
investments are to be valued at periodical intervals and depreciation or appreciation
in valuation should be recognised and taken to profit and loss account.

16.2 Expenses:
Expenditure is to be shown under three broad heads
(1) Interest expended;
(2) Operating expenses; and
(3) Provisions and contingencies.
The following items are included under this head:

Provisions and
Interest Expended Operating Expenses
Contingencies
• Interest on Deposits • Payments to and • Provisions made in
• Interest on Reserve Provisions for respect of the Non-
Bank of India / Inter- Employees performing assets.
Bank Borrowings • Rent, Taxes and • Provisions for Taxation
• Others Lighting • Provisions for
• Printing and Diminution in the value
Stationery of investments
• Advertisement and • Provisions for
Publicity contingencies
• Depreciation on
Bank’s Property
• Directors’ Fees,

12.33
 Allowances and
Expenses
• Auditors’ Fees and
Expenses
• Law Charges
• Postage, Telegrams,
Telephones, etc.
• Repairs and
Maintenance
• Insurance
• Direct Marketing
Expenses
• Other Expenditure

Audit Approach and Procedures

• In carrying out an audit of Interest expended, the auditor is primarily concerned with
assessing the overall reasonableness of the amount of interest expense by analyzing
ratios of interest paid on different types of deposits and borrowings to the average
quantum of the respective liabilities during the year.
• In modern day banking, the entries for interest expended are automatically generated
through a batch process in the CBS system.
• The auditor should obtain from the bank an analysis of various types of deposits
outstanding at the end of each quarter.
• From such information, the auditor may work out a weighted average interest rate.
• The auditor may then compare this rate with the actual average rate of interest paid
on the relevant deposits as per the annual accounts and enquire into the difference, if
material.
• The auditor should also compare the average rate of interest paid on the relevant
deposits with the corresponding figures for the previous years and analyze any material
differences.
• The auditor should obtain general ledger break-up for the interest expense incurred on
deposits (savings and term deposits) and borrowing each month/quarter.
• The auditor should analyze month on month (or quarter) cost analysis and document
the reasons for the variances as per the benchmark stated.
• He should examine whether the interest expense considered in the cost analysis agrees
with the general ledger.

12.34
• The auditor should understand the process of computation of the average balance and
re-compute the same on sample basis.
• The auditor should, on a test check basis, verify the calculation of interest and satisfy
himself that:
✓ Interest has been provided on all deposits upto the date of the balance sheet; and
verify whether there is any excess or short credit of material amount.
✓ Interest rates are in accordance with the bank’s internal regulations, of the RBI
directives, and agreements with the respective depositors;
✓ Interest on savings accounts are in accordance with the rules framed by the
bank/RBI in this behalf.
✓ Interest on inter–branch balances has been provided at the rates prescribed by
the head office/RBI.
• The auditor should ascertain whether there are any changes in interest rate on saving
deposits and term deposits during the period.
• The auditor should obtain the interest rate card for various types of term deposits and
analyze the interest cost for the period.
• The auditor should examine the completeness that interest has been accrued on the
entire borrowing portfolio and the same should agree with the general ledgers.
• The auditor should re-compute the interest accrual i.e., by referring to the parameters
like frequency of payment of interest amount, rate of interest, period elapsed till the date
of balance sheet, etc. from the term sheet, deal ticket, agreements, etc. and ensure that
the recomputed amount is tallying with the amount as per books of accounts without any
significant difference.

For audit of Operating Expenses:

• The auditor should study and evaluate the system of internal control relating to
expenses, including authorization procedures in order to determine the nature, timing and
extent of his other audit procedures.
• The auditor should examine whether there are any Divergent Trends in respect of major
items of Expenses.
• The auditor should perform an substantive analytical procedures (proforma given
below for reference) in respect of these expenses. E.g. assess the reasonableness of
expenses by working out their ratio to total operating expenses and comparing it with the
corresponding figures for previous years.
• The auditor should verify expenses with reference to documents evidencing purchase /
debit note received, wherever required.

12.35
 For audit of Provisions and Contingencies:
• The auditor should ensure that the compliances for various regulatory requirements
for provisioning as contained in the various circulars have been fulfilled.
• The auditor should obtain an understanding as to how the bank computes provision
on standard assets and non- performing assets.
• It will primarily include checking the basis of classification of loans and receivables into
standard, sub-standard, doubtful, loss and non- performing assets.
• The auditor may verify the loan classification on a sample basis.
• The auditor should obtain the detailed break up of standard loans, non-performing loans
and agree the outstanding balances with the general ledger.
• The auditor should obtain the tax provision computation from the bank’s management
and verify the nature of items debited and credited to profit and loss account to ascertain
that the same are appropriately considered in the tax provision computation.
• The other provisions for expenses should be examined vis-a-vis the circumstances
warranting the provisioning and the adequacy of the same by discussing and obtaining
the explanations from the bank’s management.

16.3 Disclosure of the prior period items:

Since the format of the profit and loss accounts of banks prescribed in Form B under
Third Schedule to the Banking Regulation Act, 1949 does not specifically provide for
disclosure of the impact of prior period items on the current year’s profit and loss, such
disclosures, wherever warranted, may be given.
Proforma for Analytical Procedure:
Analytical – Profit & Loss items
Balances as at Variation
March 13
Particulars 31-03-13 30-09-13 31-12-13 31-03-14 to %
March 14

Interest 4,43,09,706 2,40,11,555 3,50,56,870 4,73,74,798 30,65,092 6.5%

Expended

General 1,16,02,373 56,70,073 82,78,307 1,11,87,055 -4,15,318 -

Charges 3.7%

Interest 3,62,69,39,756 1,73,51,72,054 2,53,33,51,198 3,42,34,94,462 - -

Collected 20,34,45,294 5.9%

Commission, 6,87,76,134 3,35,16,929 4,89,34,716 6,61,28,900 -26,47,234 -

Exchange, 4.0%
Brokerage &
Other Income

Net Profit 3,63,98,03,811 1,73,90,07,354 2,53,89,50,737 3,43,10,61,509

12.36
 AUDIT OF
DIFFERENT TYPE
OF ENTITIES

13A.1
 1. STEPS INVOLVED IN SP ECIAL AUDIT

1. Provisions of 2. Examine Trust deed /

3. Minutes of meetings
applicable statute as partnership deed /
of governing
per legal status of the MOA or any other
body/trustee.
institute regulation.

5. List of accounting
4. Inrenal Control
records and accounting 6. Receipts.
System
policy adopted.

8. Verification of Assets
7. Payments. 9. Audit Report
and Liabilities

2. AUDIT OF LOCAL BO DIES

Background
• A municipality can be defined as a unit of local self-government in an urban area.
• 'local self-government' ordinarily means the administration of a locality - a village, a
town, a city or any other area smaller than a state.
• It raises its revenue through local taxation and spends its income on local services.
• These bodies generally follow the cash basis of accounting.
• Municipal authorities are endowed with specific local functions covering
✓ regulatory,
✓ maintenance and
✓ development activities.
• Expenditure incurred by the municipalities and corporations can be broadly classified
under the following heads:
✓ general administration and revenue collection,
✓ public health,
✓ public safety,

13A.2
 ✓ education,
✓ public works, and
✓ others such as interest payments, etc.
• Property taxes and octroi are the major sources of revenue of the municipal authorities;
other municipal taxes are profession tax, non-mechanised vehicles tax, taxes on
advertisements, taxes on animals and boats, tolls, show-tax, etc.

Revenue Grants
Local bodies may receive different types of grants from the state administration as well.
Broadly, the revenue grants are of three categories:
• General purpose grants: These are primarily intended to substantially bridge the gap
between the needs and resources of the local bodies.
• Specific purpose grants: These grants which are tied to the provision of certain services
or performance of certain tasks.
• Statutory and compensatory grants: These grants, under various enactments, are given
to local bodies as compensation on account of loss of any revenue on taking over a tax
by state government from local government.

Financial Administration
Budgetary • The objectives of local bodies budgetary procedure are:
Procedure ✓ Financial Accountability,
✓ Control of expenditure, and
• The main objective is to ensure that funds are raised and
moneys are spent by the executive departments in accordance
with the rules and regulations and within the limits of sanction
and authorisation by appropriate authority.
• Budget preparation is usually the occasion for determining the levels
of taxation and rates and the ceilings on expenditure.
• One important feature of the municipal budgets is that there is no
strict separation between revenue and capital items; usually
there is a ‘head’ called extraordinary items which cover most of the
capital transactions.
• There are, however, a number of special funds (e.g. roads) or in
some cases separate budgets for specific municipal functions (e.g.
education) or enterprise activities (e.g., water supply and sanitation,
transport, electricity, etc.)

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 Expenditure • Matters of regular revenues and expenditures are generally
Control delegated to the executives for example, commissioners.
• External audit by state government is the only instrument of
controlling municipal expenditure.
• Thus, it should be seen whether expenditure is within limits.

Accounting • Municipal accounting and budget format have been criticised as

System neither simple nor comprehensible, sometimes providing inadequate
information and at other times a surfeit of information.
• Both these situations are not conducive to a proper system of
management information.
• Municipal accounting system is usually kept as per the cash system.

Audit Programme for Local Bodies

• The Local Fund Audit Wing of the State Govt. is generally in-charge of the audit of
municipal accounts. Sometimes bigger municipal corporations e.g. Delhi, Mumbai etc.
have power to appoint their own auditors for regular external audit. So, the auditor
should ensure his appointment.
• The auditor while auditing the local bodies should report on the fairness of the contents
and presentation of financial statements, the strengths and weaknesses of system of
financial control, the adherence to legal and/or administrative requirements; whether
value is being fully received on money spent. His objective should be to detect errors
and fraud and misuse of resources.
• The auditor should ensure that the expenditure incurred conforms to the relevant
provisions of the law and is in accordance with the financial rules and regulations
framed by the competent authority
• He should ensure that all types of sanctions, either special or general, accorded by
the competent authority.
• He should ensure that there is a provision of funds and the expenditure is incurred
from the provision and the same has been authorized by the competent authority.
• The auditor should check that the different schemes, programmes and projects, where
large financial expenditure has been incurred, are running economically and getting
the expected results.

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 Objective of Audit of Local Bodies
The important objectives of audit are:
• reporting on the fairness of the content and presentation of financial statements;
• reporting upon the strengths and weaknesses of systems of financial control;
• reporting on the adherence to legal and/or administrative requirements;
• reporting upon whether value is being fully received on money spent; and
• detection and prevention of error, fraud and misuse of resources.

Audit procedure
Preliminary Auditor should obtain basic information about the constitution,
functions and financial status of the local body.
Understand financial • Obtain sufficient knowledge about their budget and
administration accounting system.
• The auditor should obtain complete knowledge about the
budget as it is an important tool of financial planning and
control for urban local bodies.

Vouch income and • The revenue items may include property tax, collection from
expenditure public places, grants, etc.
• The expenditure may include salary and wages, allowances
to employees, rent, printing and stationery, repairs and
maintenance, etc.
• He should vouch income and expenditure account in the
usual manner.
Verification of assets • Assets may consist of land, buildings, plant and machinery,
and liabilities vehicles, office equipment, furniture and fittings, etc.
• Reserves, long-term and short-term loans and unutilized
grants are included in the liabilities side.
• Verification of assets and liabilities should also be carried
out in usual manner.

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 3. AUDIT OF NON-GOVERNMENTAL ORGANIZATION
(NGO’S)

Background
• NGOs can be defined as non-profit making organizations which raise funds from
members, donors or contributors apart from receiving donation of time, energy and
skills for achieving their social objectives like imparting education, providing medical
facilities, economic assistance to poor, managing disasters and emergent situation.
• Therefore, this definition of NGO would include religious organizations, voluntary health
and welfare agencies, charitable organizations, hospitals, old age homes, research
foundations etc. The scope of services rendered by NGOs is extremely wide and as such
cannot be covered in a small definition.
• Some examples of NGOs operating in India include Child Relief and You (CRY),
NORAD, UNICEF, Godhuli, Vidya, Concern India Foundation., etc.
• NGOs can be incorporated as a company under section 8 of the Companies Act, 2013.
• NGOs registered under the Companies Act, 2013 must maintain their books of account
under the accrual basis as required by the provisions of section 128 of the said Act. If
the accounts are not maintained on accrual basis, it would amount to non-
compliance of the provision of the Companies Act, 2013.
• The NGOs which are not registered under the Companies Act, 2013 are allowed to
maintain accounts either an accrual basis or cash basis.

Sources and Applications of Funds

• The main sources of funds include grants and donations, fund raising programmes,
advertisements, fees from the members, technical assistance fees / fee for services
rendered, subscriptions, gifts, sale of produce or publications, etc.
• Donations and grants received in the nature of promoter’s contribution are in the
nature of capital receipts and shown as liabilities in the Balance Sheet of NGO.
These may either be in the form of corpus contribution or a contribution towards
revolving fund. A contribution made towards the capital or the corpus of an NGO is
known as corpus contribution.
• The objective of a contribution or grant towards a Revolving Fund is to rotate the
amount by giving temporary loans from the fund to other NGO or beneficiaries for
their projects and then recover the loan so as to give temporary loans again and so on.
• However, any interest earned from the beneficiary on such temporary loans from the
revolving fund could be either added back to the fund or credited to the Income and
Expenditure Account depending on restrictions laid down by the authority providing
the contribution (for the revolving fund) or by the rules and regulations laid down by the
concerned NGO in this regard.

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• Donations and grants received for acquisition of specific fixed assets are those grants
whose primary condition is that an NGO accepting them should purchase, construct or
otherwise acquire the assets for which the grant is given.
• Many a times NGOs receive contributions in kind. These contributions include assets such
as land, buildings, vehicles, office equipment, etc. and articles related to programmes /
projects such as food, books, building materials, clothes, beds, and raw material for
training purposes, e.g., Wool, reeds, cloth, etc.
• The areas of application of funds for an NGO include Establishment Costs, Office and
Administrative Expenses, Maintenance Expenses, Programme / Project Expenses, Charity,
Donations and Contributions given, etc.

Provisions Relating to Audit

• The auditors of an NGO registered under the Societies Registration Act, 1860 (or
under any law corresponding to this Act, in force in any part of India) or the Indian Trusts
Act 1882 are normally appointed by the Management of the Society or Trust.
• The auditors of NGO registered under section 8 of the Companies Act, 2013 are
appointed by the members of the company.
• Some of the statues such as the Companies Act, 2013, Foreign Contribution (Regulation)
Act 1976, Income Tax Act 1961 required that the accounts of the NGO be audited and
submitted to the prescribed authorities and failure to do so could lead to forfeiture of
certain exemptions and benefits. In the case of NGO/PDA’s different statutes have
specified certain audit reports.
• The Foreign Contribution (Regulation) Act 1976 has prescribed the format and requires
that the same be furnished to the Ministry of Home Affairs within 60 days from the
close of the financial year i.e. by May 30 each year.

While planning the audit, the auditor may concentrate on the following:
• Knowledge of the NGO’s work, its mission and vision, areas of operations and
environment in which it operates.
• Updating knowledge of relevant statutes especially with regard to recent
amendments, circulars, judicial decisions viz. Foreign Contribution (Regulation) Act 1976,
Societies Registration Act, 1860, Income Tax Act 1961 etc. and the Rules related to the
statutes.
• Reviewing the legal form of the Organization and its Memorandum of Association,
Articles of Association, Rules and Regulations.
• Reviewing the NGO’s Organization chart, then Financial and Administrative Manuals,
Project and Programme Guidelines, Funding Agencies Requirements and formats,
budgetary policies if any.
• Examination of minutes of the Board/Managing Committee/Governing Body/
Management and Committees thereof to ascertain the impact of any decisions on the

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 financial records.
• Study the accounting system, procedures, internal controls and internal checks
existing for the NGO and verify their applicability.
• Setting of materiality levels for audit purposes.
• The nature and timing of reports or other communications.
• The involvement of experts and their reports.
• Review the previous year’s Audit Report.

The audit programme should include in a sequential order all assets, liabilities, income and
expenditure ensuring that no material item is omitted.
• Corpus Fund: The contributions / grants received towards corpus be vouched with
special reference to the letters from the donor(s). The interest income be checked
with Investment Register and Physical Investments in hand.
• Reserves: Vouch transfers from projects / programmes with donor’s letters and board
resolutions of NGO. Also check transfer of gross value of asset sold from capital reserve
to general reserve and adjustments during the year.
• Ear-marked Funds: Check requirements of donor’s institutions, board resolution of
NGO, rules and regulations of the schemes of the ear-marked funds.
• Project / Agency Balances: Vouch disbursements and expenditure as per agreements
with donors for each of the balances.
• Loans: Vouch loans with loan agreements, counterfoil of receipt issued.
• Fixed Assets: Vouch all acquisitions / sale or disposal of assets including depreciation
and the authorisations for the same. Also check donor’s letters/ agreements for the grant.
In the case of immovable property check title, etc.
• Investments: Check Investment Register and the investments physically ensuring that
investments are in the name of the NGO. Verify further investments and dis- investments
for approval by the appropriate authority and reference in the bank accounts for the
principal amount and interest.
• Cash in Hand: Physically verify the cash in hand and imprest balances, at the close of
the year and whether it tallies with the books of account.
• Bank Balance: Check the bank reconciliation statements and ascertain details for old
outstanding and unadjusted amounts.
• Inventory: Verify inventory in hand and obtain certificate from the management for the
quantities and valuation of the same.
• Programme and Project Expenses: Verify agreement with donor / contributor(s)
supporting the particular programme or project to ascertain the conditions with
respect to undertaking the programme/project and accordingly, in the case of
programmes / projects involving contracts, ensure that income tax is deducted,

13A.8
 deposited and returns filed and verify the terms of the contract.
• Establishment Expenses: Verify that provident fund, life insurance premium, employees
state insurance and their administrative charges are deducted, contributed and deposited
within the prescribed time. Also check other office and administrative expenses such as
postage, stationery, travelling, etc.

The receipt of income of NGO may be checked on the following lines:

• Contributions and Grants for projects and programmes: Check agreements with
donors and grants letters to ensure that funds received have been accounted for. Check
that all foreign contribution receipts are deposited in the foreign contribution bank
account as notified under the Foreign Contribution (Regulation) Act, 1976.
• Receipts from fund raising programmes: Verify in detail the internal control system
and ascertain who are the persons responsible for collection of funds and mode of
receipt. Ensure that collections are counted and deposited in the bank daily.
• Membership Fees: Check fees received with Membership Register. Ensure proper
classification is made between entrance and annual fees and life membership fees.
Reconcile fees received with fees to be received during the year.
• Subscriptions: Check with subscription register and receipts issued. Reconcile
subscription received with printing and dispatch of corresponding magazine / circulars /
periodicals. Check the receipts with subscription rate schedule.
• Interest and Dividends: Check the interest and dividends received and receivable
with investments held during the year.

4. AUDIT OF SOLE TRADER

• A sole trader is under no legal obligation to have his accounts audited. However,
many such individuals get their financial statement audited due to regulatory
requirements, such as inventory brokers or on a specific instructions of the bank for
approval of loans, etc.
• Appointment of Auditor: Auditors of sole- proprietary concern shall be appointed by
the sole proprietor himself. In case of change of auditor, it would be duty of incoming
auditor to communicate with the previous auditor. As such, sole proprietor can
determine the scope of the audit as well as the conditions under which it will be carried
out.
• On these considerations, it is desirable that the contract of appointment of auditor in
such a case should be in writing; also, that it should clearly define the scope of the
work which the auditor is expected to carry out. This helps to prevent misunderstanding.
• If the appointment of the auditor is not in writing, the auditor should write to his
client explaining the scope of his duties. While doing so, he should state the

13A.9
 limitations, if any, placed upon his work to obtain the client’s confirmation.
• The advantages and audit procedure discussed in following paragraphs of audit in case
of partnership firm would be similar in case of proprietorship.

5. AUDIT OF FIRM
• Appointment of Auditors
✓ The auditor to a firm is usually appointed by the partners either on the basis of a
decision taken by them or to comply with a condition in the partnership agreement.
✓ His remuneration is also fixed by the partners.
✓ It is important that the letter of appointment should clearly state the nature and
scope of audit which is to be carried out and particulars of limitations, if any, under
which he would have to function.
✓ In case of change of auditor, it would be duty of incoming auditor to
communicate with the previous auditor.
• The auditor may, particularly, ensure application of accounting standards prescribed
by the Institute.
• In case the firm is required to get its accounts audited under the requirements of any
statute, the auditor will have to qualify the report in case of non-compliance with
the accounting standards.
• Alternatively, only disclosure of non-compliance with the accounting standards,
would be sufficient without making it a subject matter of qualification.
• Matters to be considered before starting audit
Also, before starting the audit, he should examine the partnership agreement and note
the provisions therein as regards the following matters:
✓ The name and style under which the business shall be conducted.
✓ The duration of the partnership, if any, that has been agreed upon.
✓ The amount of capital that shall be contributed by each partner - whether it will be
fixed or could be varied from year to year.
✓ The period at the end of which the accounts of the partnership will be closed
periodically and the proportions in which the profit shall be divided among the
partners or losses shall have to be contributed by them; whether the losses shall be
borne by the partners or whether any of the partners will not be required to do so.
✓ The provisions as regards maintenance of books of account and the matters which
must be taken into account for determining the profits of the firm available for
division among the partners e.g., creation of reserves, provision for depreciation,
etc. also the period within which accounts can be reopened for correcting a

13A.10
 manifest error.
✓ Borrowing capacity of the partnership (when it is not implied as in the case of non-
trading firms).
✓ The rate at which interest will be allowed on the capitals and loans provided by
partners and the rate at which it will be charged on their drawings and current
accounts.
✓ Whether any salaries are payable to the partners or withdrawals are permitted
against shares of profits and, if so, to what extent?
✓ Duties of the partners as regards the management of business of the firm; also, the
partners who shall act as managing partners.
✓ Who shall operate the bank account of the firm? How will the surplus funds of the
partnership be invested?
✓ Limitations and restrictions that have been agreed upon, the rights and powers of
partners and on their implied authority to pledge the firm’s credit or to render it
liable.

Advantages of Audit of a Partnership Firm

On broad considerations, the advantages of audit of accounts of a partnership could be
stated as follows:
✓ Audited accounts provide a convenient and reliable means of settling accounts
between the partners and, thereby, the possibility of occurrence of a dispute
among them is mitigated. On this consideration, it is usually provided in and
accepted by the partners, shall be binding upon them, unless some manifest error
is brought to light within a specified period subsequent to the accounts having
been signed.
✓ On the retirement or death of a partner, audited accounts, which have been
accepted by the partners, constitute a reliable evidence for computing the
amounts due to the retiring partner or to the representative of the deceased
partner in respect of his share of capital, profits and goodwill.
✓ Audited statement of accounts are relied upon by the banks when advancing
loans, as well as by prospective purchasers of the business, as evidence of the
profitability of the concern and its financial position.
✓ Audited statements of account can be helpful in the negotiations to admit a
person as a partner, especially when they are available for a number of past years.
✓ An audit is an effective safeguard against any undue advantage being taken by
a working partner or partners especially in the case of those partners who are not
actively associated with the working of the firm.

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 Matters which should be specially considered in the audit of accounts of a
partnership:
✓ Confirming that the letters of appointment, signed by a partner, duly
authorised, clearly states the nature and scope of audit contemplated by the
partners, specially the limitation, if any, under which the auditor shall have to
function.
✓ Studying the minute book, if any, maintained to record the policy decision taken
by partners specially the minutes relating to authorisation of extraordinary and
capital expenditure, raising of loans; purchase of assets, extraordinary contracts
entered into and other such matters as are not of a routine nature.
✓ Verifying that the business in which the partnership is engaged is authorised
by the partnership agreement; or by any extension or modification thereof
agreed to subsequently.
✓ Examining whether books of account appear to be reasonable and are
considered adequate in relation to the nature of the business of the partnership.
✓ Verifying generally that the interest of no partner has suffered prejudicially by
an activity engaged in by the partnership which, it was not authorised to do under
the partnership deed or by any violation of a provision in the partnership
agreements.
✓ Confirming that a provision for the firm’s tax payable by the partnership has
been made in the accounts before arriving at the amount of profit divisible among
the partners.
✓ Verifying that the profits and losses have been divided among the partners in
their agreed profit-sharing ratio

• From the foregoing steps involved in the audit of a partnership it would be observed that
like the audit of every other commercial undertaking, it culminates in the verification of
the Balance Sheet and the Statement of Profit and Loss to ensure that these exhibit a true
and fair state of affairs of the firm.
• The object of examining the partnership agreement, which is an important feature of
such an audit, is that the auditor may be able to report to the partners if the interest
of any partner has been prejudicially affected, on account of the firm having engaged
itself in an activity which it was not authorised to do or violation of any provision of the
partnership agreement.

Basics of Limited Liability Partnerships (LLP) Audit

• An LLP shall be under obligation to maintain annual accounts reflecting true and fair

13A.12
 view of its state of affairs. A “Statement of Accounts and Solvency” in prescribed form
shall be filed by every LLP with the Registrar every year.
• Rules provides that any LLP, whose turnover does not exceed, in any financial year,
forty lakh rupees, or whose contribution does not exceed twenty five lakh rupees, is
not required to get its accounts audited.
• However, if the partners of such limited liability partnership decide to get the accounts of
such LLP audited, the accounts shall be audited.
• Every LLP would be required to file annual return in Form 11 with ROC within 60
days of closer of financial year. The annual return will be available for public
inspection on payment of prescribed fees to Registrar.
• Every LLP is also required to submit Statement of Account and Solvency in Form 8 which
shall be filed within a period of thirty days from the end of six months the financial year
to which the Statement of Account and Solvency relates.

Appointment of Auditor
The auditor may be appointed by the designated partners of the LLP –
• At any time for the first financial year but before the end of first financial year,
• At least thirty days prior to the end of each financial year (other than the first
financial year),
• To fill the causal vacancy in the office of auditor,
• To fill the casual vacancy caused by removal of auditor.
The partners may appoint the auditors if the designated partners have failed to appoint them.

LLP’s are required to maintain books of accounts which

shall contain
• Particulars of all sums of money received and expended by the LLP and the matters
in respect of which the receipt and expenditure takes place,
• A record of the assets and liabilities of the LLP,
• Statements of costs of goods purchased, inventories, work-in-progress, finished
goods and costs of goods sold,
• Any other particulars which the partners may decide.

Advantages / Purpose / Need of Audit

• Auditing the accounts of a LLP helps in detecting errors & frauds & verification of
financial statements.
• Disputes, if any between any partners in the matter of accounts can be settled with the

13A.13
 help of audited accounts.
• Banks & financial institutions lend money to the firms only on the basis of audited
accounts.
• Periodical visits & suggestions by the auditor will be helpful in improving the
management of the LLP.
• For settling accounts between partners at the time of admission, death, retirement,
insolvency, insanity, etc. audited accounts are accepted by those concerned who have
dealings with the LLP.

Auditor’s Duty Regarding Audit of LLP

• The auditor should get definite instructions writing as to the work to be performed by
him.
• The auditor should mention
✓ Whether the records of the firm appear to be correct & reliable.
✓ Whether he was able to obtain all information & explanation necessary for his
work.
✓ Whether any restriction was imposed upon him.
• The auditor should read the LLP agreement & note the following provisions
✓ Nature of the business of the LLP.
✓ Amount of capital contributed by each partner.
✓ Interest – in respect of additional capital contributed.
✓ Duration of partnership.
✓ Drawings allowed to the partners.
✓ Salaries, commission etc. payable to partners.
✓ Borrowing powers of the LLP.
✓ Rights & duties of partners.
✓ Method of settlement of accounts between partners at the time of admission,
retirement, admission etc.
✓ Any loans advanced by the partners.
✓ Profit sharing ratio
• If partners maintain minute book he shall refer it for any resolution passed regarding the
accounts.

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 6. AUDIT OF CHARITABLE INSTITUTION
In the case of audit of a charitable institution, attention should be paid to the following
matters-
1. General
• Studying the constitution under which the charitable institution has been set up.
• Verifying whether the institution is being managed in the manner contemplated by
the law under which it has been set up.
• Examining the system of internal check, especially as regards accounting of
amounts collected.
• Verifying in detail the income and confirming that the amounts received have been
deposited in the bank regularly and promptly.

2. Subscriptions and donations

Ascertaining, if any, the changes made in amount of annual or life membership
subscription during the year.
Whether official receipts are issued;
• confirming that adequate control is imposed over unused receipt books;
• obtaining all receipt books covering the period under review;
• test checking the counterfoils with the cash book; any cancelled receipts being
specially looked into;
• obtaining the printed list of subscriptions and donations and agreeing them with
the total collections shown in the accounts;
• examining the system of internal check regarding moneys received from box
collections, flag days, etc. and checking the amount received from representatives,
with the correspondence and the official receipts issued; paying special attention to
the system of control exercised over collections and the steps taken to ensure that
all collections made have been accounted for; and
• verifying the total subscriptions and donations received with any figures published
in reports, etc. issued by the charity.

3. Legacies
Verifying the amounts received by reference to correspondence with any figures and
other available information.

4. Grants
• Vouching the amount received with the relevant correspondence, receipts and
minute books.
• Obtaining a certificate from a responsible official showing the amount of grants
received.

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 5. Investments Income
• Vouching the amounts received with the dividend and interest counterfoils.
• Checking the calculations of interest received on securities bearing fixed rates of
interest.
• Checking that the appropriate dividend has been received where any investment
has been sold ex-dividend or purchased cum-dividend.
• Comparing the amounts of dividend received with schedule of investments making
special enquiries into any investments held for which no dividend has been
received.

6. Rents
Examining the rent roll and inspecting tenancy agreements, noting in each case:
• the amounts of the rents, and
• the due dates.
Vouching the rents on to the rent roll from the counterfoils of receipt books and
checking the totals of the cash book.

7. Special function, etc.

Vouching gross receipts and outgoings in respect of any special functions, e.g. concerts,
dramatic performance, etc., held in aid of the charity with such vouchers and cash
statements as are necessary. In particular, verifying that the proceeds of all tickets issued
have been accounted for, after making the allowance for returns.

8. Income Tax Refunds

Where income-tax has been deducted from the Investment income, it should be seen
that a refund thereof has been obtained since charitable institutions are exempt from
payment of Income-tax. This involves:
• vouching the Income-tax refund with the correspondence with the Income-
tax Department; and
• checking the calculation of the repayment of claims.

9. Expenditure
• Vouching payment of grants, also verifying that the grants have been paid only for
a charitable purpose or purposes falling within the purview of the objects for which
the charitable institution has been set up and that no trustee, director or member
of the Managing Committee has benefited there from either directly or indirectly.
• Verifying the schedules of securities held, as well as inventories of properties both
movable and immovable by inspecting the securities and title deeds of property
and by physical verification of the movable properties on a test- basis.

13A.16
 • Verifying the cash and bank balances.
• Ascertaining that any funds contributed for a special purpose have been
utilised for the purpose.

7. AUDIT OF EDUCATION I NSTITUTION (SCHOOL, COLLEGE

& UNIVERSITY)
The special steps involved in their audit are the following -
• Examine the Trust Deed or Regulations, in the case of school or college and note all
the provisions affecting accounts. In the case of a university, refer to the Act of
Legislature and the Regulation framed thereunder.
• Read through the minutes of the meetings of the Managing Committee or
Governing Body, noting resolutions affecting accounts to see that these have been
duly complied with, specially the decisions as regards the operation of bank accounts
and sanctioning of expenditure.
• Check names entered in the Students Fee Register for each month or term, with the
respective Class Registers, showing names of students on rolls and test amount of fees
charged; and verify that there operates a system of internal check which ensures
that demands against the students are properly raised.
• Check fees received by comparing counterfoils of receipts granted with entries in the
Cash Book and tracing the collections in the Fee Register to confirm that the revenue
from this source has been duly accounted for.
• Total up the various columns of the Fees Register for each month or term to
ascertain that fees paid in advance have been carried forward and that the arrears that
are irrecoverable have been written off under the sanction of an appropriate authority.
• Check admission fees with admission slips signed by the head of the institution and
confirm that the amount has been credited to a Capital fund, unless the Managing
Committee has taken a decision to the contrary.
• See that free studentship and concessions have been granted by a person
authorised to do so, having regard to the Rules prepared by the Managing Committee.
• Confirm that fines for late payment or absence, etc. have been either collected or
remitted under proper authority.
• Confirm that hostel dues were recovered before student’s accounts were closed and
their deposits of caution money refunded.
• Verify rental income from landed property with the rent rolls, etc.
• Vouch income from endowments and legacies, as well as interest and dividends from
investment; also inspect the securities in respect of investments held.
• Verify any Government or local authority grant with the memo of grant. If any

13A.17
 expense has been disallowed for purposes of grant, ascertain the reasons thereof.
• Report any old heavy arrears on account of fees, dormitory rents, etc. to the Managing
Committee.
• Confirm that caution money and other deposits paid by students on admission, have
been shown as liability in the balance sheet not transferred to revenue, unless they are
not refundable.
• See that the investments representing endowment funds for prizes are kept
separate and any income in excess of the prizes has been accumulated and invested
along with the corpus.
• Verify that the Provident Fund money of the staff has been invested in appropriate
securities.
• Vouch donations, if any with the list published with the annual report. If some donations
were meant for any specific purpose, see that the money was utilised for the purpose.
• Vouch, all capital expenditure in the usual way and verify the same with the sanction
for the Committee as contained in the minute book.
• Vouch, in the usual manner, all establishment expenses and enquire into any unduly
heavy expenditure under any head. If there was any annual budget prepared, see that
any excess under any head over the budgeted amount was duly sanctioned by the
Managing Committee. If not, bring it to the Committee’s notice in your report.
• See that increase in the salaries of the staff have been sanctioned and noted by the
Committee.
• Ascertain that the system ordering inspection on receipt and issue of provisions,
foodstuffs, clothing and other equipment is efficient and all bills are duly authorised
and passed before payment.
• Verify the inventories of furniture, stationery, clothing, provision and all equipment etc.
These should be checked by reference to Inventory Register or corresponding
inventories of the previous year and values applied to various items should be test
checked.
• Confirm that the refund of taxes deducted from the income from investment
(interest on securities etc.) has been claimed and recovered since the institutions are
generally exempted from the payment of income-tax.
• Finally, verify the annual statements of account and, while doing so see that separate
statements of account have been prepared as regards Poor Boys Fund, Games Fund,
Hostel and Provident Fund of staff, etc.

13A.18
 8. AUDIT OF HOSPITAL
The special steps involved in such an audit are stated below -
• Register of Patients: Vouch the Register of patients with copies of bills issued to them.
Verify bills for a selected period with the patients’ attendance record to see that the bills
have been correctly prepared. Also see that bills have been issued to all patients from
whom an amount was recoverable according to the rules of the hospital.
• Collection of Cash: Check cash collections as entered in the Cash Book with the receipts,
counterfoils and other evidence for example, copies of patient’s bill, counterfoils of
dividend and other interest warrants, copies of rent bills, etc.
• Income from Investments, Rent etc.: See by reference to the property and Investment
Register that all income that should have been received by way of rent on properties,
dividends, and interest on securities have been collected.
• Legacies and Donations: Ascertain that legacies and donations received for a specific
purpose have been applied in the manner agreed upon.
• Reconciliation of Subscriptions: Trace all collections of subscription and donations
from the Cash Book to the respective Registers. Reconcile the total subscriptions due (as
shown by the Subscription Register and the amount collected and that still outstanding).
• Authorisation and Sanctions: Vouch all purchases and expenses and verify that the
capital expenditure was incurred only with the prior sanction of the Trustees or the
Managing Committee and that appointments and increments to staff have been duly
authorised.
• Grants and TDS: Verify that grants, if any, received from Government or local authority
has been duly accounted for. Also, that refund in respect of taxes deducted at source has
been claimed.
• Budgets: Compare the totals of various items of expenditure and income with the
amount budgeted for them and report to the Trustees or the Managing Committee,
significant variations which have taken place.
• Internal Check: Examine the internal check as regards the receipt and issue of stores;
medicines, linen, apparatus, clothing, instruments, etc. so as to ensure that purchases
have been properly recorded in the Inventory Register and that issues have been made
only against proper authorisation.
• Depreciation: See that depreciation has been written off against all the assets at the
appropriate rates.
• Registers: Inspect the bonds, share scrips, title deeds of properties and compare their
particulars with those entered in the property and Investment Registers.
• Inventories: Obtain inventories, especially of stocks and stores as at the end of the year
and check a percentage of the items physically; also compare their total values with
respective ledger balances.

13A.19
 • Management Representation and Certificate: Get proper Management Representation
and Certificate with respect to various aspects covered during the course of audit.

9. AUDIT OF CLUB
The special steps involved in such an audit are stated below -
• Vouch the receipt on account of entrance fees with members’ applications,
counterfoils issued to them, as well as on a reference to minutes of the Managing
Committee.
• Vouch members’ subscriptions with the counterfoils of receipt issued to them, trace
receipts for a selected period to the Register of Members; also reconcile the amount of
total subscriptions due with the amount collected and that outstanding.
• Ensure that arrears of subscriptions for the previous year have been correctly
brought over and arrears for the year under audit and subscriptions received in
advance have been correctly adjusted.
• Check totals of various columns of the Register of members and tally them across.
• See the Register of Members to ascertain the Member’s dues which are in arrear and
enquire whether necessary steps have been taken for their recovery; the amount
considered irrecoverable should be mentioned in the Audit Report.
• Verify the internal check as regards members being charged with the price of
foodstuffs and drinks provided to them and their guests, as well as, with the fees
chargeable for the special services rendered, such as billiards, tennis, etc.
• Trace debits for a selected period from subsidiary registers maintained in respect of
supplies and services to members to confirm that the account of every member has been
debited with amounts recoverable from him.
• Vouch purchase of sports items, furniture, crockery, etc. and trace their entries into the
respective inventory registers.
• Vouch purchases of foodstuffs, cigars, wines, etc., and test their sale price so as to
confirm that the normal rates of gross profit have been earned on their sales. The
inventory of unsold provisions and stores, at the end of year, should be verified
physically and its valuation checked.
• Check the inventory of furniture, sports material and other assets physically with the
respective inventory registers or inventories prepared at the end of the year.
• Inspect the share scrips and bonds in respect of investments, check their current
values for disclosure in final accounts; also ascertain that the arrangements for their
safe custody are satisfactory.
• Examine the financial powers of the secretary and, if these have been exceeded,
report specific case for confirmation by the Managing Committee.

13A.20
 10. AUDIT OF CINEMA HALL
The special steps involved in its audit are stated below -
• Verify the internal control mechanism-
a) that entrance to the cinema-hall during show is only through printed tickets;
b) that they are serially numbered and bound into books;
c) that the number of tickets issued for each show and class, are different though
the numbers of the same class for the show on the same day, each week, run
serially;
d) that for advance booking a separate series of tickets is issued; and
e) that the inventory of tickets is kept in the custody of a responsible official.
• Confirm that at the end of show, a statement of tickets sold is prepared and cash
collected is agreed with it.
• Verify that a record is kept of the ‘free passes’ and that these are issued under proper
authority.
• Reconcile the amount of Entertainment Tax collected with the total number of tickets
issued for each class and vouch and verify the entertainment tax returns filed each
month.
• Vouch the entries in the Cash Book in respect of cash collected on sale of tickets for
different shows on a reference to Daily Statements which have been test checked as
aforementioned with record of tickets issued for the different shows held.
• Verify the charges collected for advertisement slides and shorts by reference to the
Register of Slides and Shorts Exhibited kept at the cinema as well with the agreements,
entered into with advertisers in this regard.
• Vouch the expenditure incurred on advertisement, repairs and maintenance. No part of
such expenditure should be capitalized.
• Confirm that depreciation on machinery and furniture has been charged at an
appropriate rate.
• Vouch payments on account of film hire with bills of distributors and in the process,
the agreements concerned should be referred to.
• Examine unadjusted balance out of advance paid to the distributors against film hire
contracts to see that they are good and recoverable. If any film in respect of which an
advance was paid has already run, it should be enquired as to why the advance has not
been adjusted. The management should be asked to make a provision in respect of
advances that are considered irrecoverable.
• The arrangement for collection of the share in the restaurant income should be enquired
into either a fixed sum or a fixed percentage of the taking may be receivable annually. In
case the restaurant is run by the Cinema, its accounts should be checked. The audit
should cover sale of various items of foodstuffs, purchase of foodstuffs, cold drink, etc. as
in the case of club.

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 11. AUDIT OF HIRE PURCHA SE & LEASING COMPANI ES
• Hire-purchase agreement means an agreement under which goods are let on hire and
under which the hirer has an option to purchase them in accordance with the terms of
the agreement and includes an agreement under which-
✓ possession of goods is delivered by the owner thereof to a person on
condition that such person pays the agreed amount in periodical instalments,
✓ the property in the goods is to pass to such person on the payment of the last
of such instalments, and
✓ such person has a right to terminate the agreement at any time before the
property so passes.
• Thus, hirer means the person who obtains or has obtained possession of goods from
an owner under a hire- purchase agreement and owner means the person who lets or
has let, delivers or has delivered possession of goods to a hirer under a hire-purchase
agreement in order to complete the purchase of, or the acquisition of property in the
goods of which the agreement relates; and includes any sum so payable by the hirer
under the hire- purchase agreement by way of a deposit or other initial payment.
• While checking the hire- purchase transaction, the auditor may examine the following:
✓ Hire purchase agreement is in writing and is signed by all parties.
✓ Hire purchase agreement specifies clearly-
▪ The hire-purchase price of the goods to which the agreement relates;
▪ The cash price of the goods, that is to say, the price at which the goods
may be purchased by the hirer for cash;
▪ The date on which the agreement shall be deemed to have commenced;
▪ The number of instalments by which the hire- purchase price is to be
paid, the amount of each of those instalments, and the date, or the
mode of determining the date, upon which it is payable, and the person
to whom and the place where it is payable; and
▪ The goods to which the agreement relates, in a manner sufficient to
identify them.
• Ensure that instalment payments are being received regularly as per the agreement.

13A.22
 Lease
• In a lease agreement, a party (called ‘lessee’) acquires the right to use an asset for an
agreed period of time in consideration of payment of rent to another party (called
‘lessor’). In certain lease agreements, the legal ownership of the asset remains with
the lessor (the leasing company), but in substance, all the risks and rewards of
ownership of the asset are transferred to the lessee.
• In other words, the lease is, in effect, a financing arrangement. Such leases are termed as
finance leases. An operating lease, on the other hand, is a simple arrangement where,
in return for rent, the lessor allows the lessee to use the asset for a certain period.
• A normal financial lease transaction usually goes through the following modality:
▪ The lessee will select the equipment, and satisfy himself about its functional fitness
and specifications, the lessor has no participation at this stage.
▪ Having chosen the equipment, the lessee approaches a lessor, either directly or
through a lease-broking agency.
▪ The lease agreement is broadly negotiated and the rates are finalised. The lessor
places an order on the manufacturer as chosen by the lessee.
▪ The manufacturer delivers the equipment at the site of the lessee, and the latter gives
notice of acceptance to the lessor.
▪ The lease agreement giving detailed terms of contract is signed between the parties.
Leases will normally be full pay-out, with term varying as per requirements.
• During the lease period, the lessee:
✓ Will pay rentals regularly at periods agreed-upon, which are usually each calendar
month;
✓ Will keep the equipment in good repair and working condition, etc.
✓ Will be entitled to any manufacturer’s warranties or after-sales services.
• At the end of the lease period, the equipment shall retreat to the lessor. The lessee
may, however, be given a renewal right, or may be allowed to participate in purchase of
the equipment when the lessor intends to sell it. No purchase option shall be given to
the lessee in the lease agreement itself.

In respect of leasing transaction entered into by the leasing company, the following
procedures may be adopted by the auditor:
• The object clause of leasing company to see that the goods like capital goods,
consumer durables etc. in respect of which the company can undertake such activities.
Further, to ensure that whether company can undertake financing activities or not.
• Whether there exists a procedure to ascertain the credit analysis of lessee like
lessee’s ability to meet the commitment under lease, past credit record, capital strength,
availability of collateral security, etc.

13A.23
 • The lease agreement should be examined and the following points may be noted:
i. the description of the lessor, the lessee, the equipment and the location where
the equipment is to be installed. (The stipulation that the equipment shall not be
removed from the described location except for repairs. For the sake of
identification, the lessor may also require plates or markings to be attached to the
equipment).
ii. the amount of tenure of lease, dates of payment, late charges, deposits or
advances etc. should be noted.
iii. whether the equipment shall be returned to the lessor on termination of the
agreement and the cost shall be borne by the lessee.
iv. whether the agreement prohibits the lessee from assigning the subletting the
equipment and authorises the lessor to do so.
• Examine the lease proposal form submitted by the lessee requesting the lessor to
provide him the equipment on lease.
• Ensure that the invoice is retained safely as the lease is a long-term contract.
• Examine the acceptance letter obtained from the lessee indicating that the equipment
has been received in order and is acceptable to the lessee.
• See the Board resolution authorising a particular director to execute the lease
agreement has been passed by the lessee.
• See that the copies of the insurance policies have been obtained by the lessor for his
records.

Students need to pay attention that AS-19/ Ind-AS 17 define that lease arrangements
could be of 2 types i.e. Finance Lease and Operating Lease.

Finance Lease
An arrangement with the following attributes qualifies as a Finance Lease:
• The lease arrangement transfers ownership of the asset to the lessee at the end of the
lease term;
• The lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable for it to
be reasonably certain, at the inception of the lease, that the option will be exercised;
• The lease term is for the major part of the economic life of the asset even if title is
not transferred;
• At the inception of the lease, the present value of the minimum lease payments
amounts to at least substantially all of the fair value of the leased asset; and
• the leased assets are of such a specialized nature that only the lessee can use them
without major modifications.

13A.24
 Operating Lease
• An arrangement that does not transfer substantially all the risks and rewards
incidental to ownership qualifies as an Operating Lease. In other words, an operating
lease is a lease arrangement “Other than finance lease”.
• The below table captures the broad differences under both the above said types of lease
arrangements:

Operating Lease Financial Lease

Ownership Ownership of the asset remains Ownership transfer option at the
with the lessor for the entire end of the lease period is with
period of lease. the lessee. Title may or may not
be eventually transferred.

Accounting Operating lease is generally Financial lease is treated like loan

treatment treated like a renting arrangement. Hence, the asset
arrangement. That means, the ownership is considered of that of
lease payments are treated as the lessee and thus appears on
operating expenses and the asset the balance sheet of the lessee.
does not appear as an asset on
lessee’s balance sheet.

Purchase Under operating lease, the lessee Financial lease allows the lessee
Option does not have any option to buy to have a purchase option at less
the asset during the lease period. than the fair market value of the
asset.
Lease Term Lease term generally extends to Lease term is generally more than
less than 75% of the projected or equal to estimated economic
useful life of the leased asset. life of the asset under the lease
arrangement.

Operating/ Lessee pays only the monthly Lessee generally bears insurance,
running lease payments. No running or maintenance and taxes.
expenses administration costs are to be
borne for example: registration,
repairs etc. since it gives only
right to use the asset.

Tax benefit Since operating lease is as good Lessee can claim both interest and
as renting, lease payment is depreciation expense as financial
considered as expense. No lease is treated like a loan.
depreciation can be claimed by
the lessee.

13A.25
 12. AUDIT OF HOTELS
• There are many problems involved in any hotel audit, some of which are peculiar to the
hotel industry such as control of cash assumes greater proportions.
• Almost all sales points in a hotel make both cash and credit sales. The auditor should
reconcile the total sales reported with the total of the bills issued by the sales point;
this total may take the form of a bill roll or a series of numerically controlled bills. This
numerical control must be checked to ensure that all bills are included in the total.
The cash element of the sales must then be checked to the cash records and the credit
sales in total and detail to the guest’s bills.
• The special considerations in a hotel audit can be summarised as follows:
✓ Internal Controls
Pilfering is one of the greatest problems in any hotel and the importance of
internal control cannot be undermined. It is the responsibility of management to
introduce controls which will minimise the leakage as far as possible. Evidence of
their success is provided by the preparation of regular perhaps weekly, trading
accounts for each sales point and a detailed scrutiny of the resulting profit
percentages, with any deviation from the anticipated form being investigated. The
auditor should obtain these regular trading accounts for the period under
review, examine them and obtain explanations for any apparent deviations.
If the internal control in a hotel is weak or perhaps breaks down, then a very
serious problem exists for the auditor. As a result of the transient nature of many
of his clients’ records, the auditor must rely to a very large extent on the gross
margin shown by the accounts. As a result, the scope of his audit tests will
necessarily be increased and, in the event of a material margin discrepancy
being unexplained, he will have to consider qualifying his audit report.
✓ Room Sales
The charge for room sales is normally posted to guest bills by the receptionist/
front office or in the case of large hotels by the night auditor. The source of these
entries is invariably the guest register and audit tests should be carried out to
ensure that the correct numbers of guests are charged for the correct period.
Any difference between the charged rates used on the guests’ bills and the
standard room rate should be investigated to ensure that they have been properly
authorised.
In many hotels, the housekeeper prepares a daily report of the rooms which
were occupied the previous night and the number of beds kept in each room.
This report tends not to be permanently retained and the auditor should ensure
that a sufficient number of reports are available for him to test both with the guest
register and with the individual guest’s bill.’

13A.26
✓ Inventories
The inventories in any hotel are both readily portable and saleable particularly
the food and beverage inventories. It is therefore extremely important that all
movements and transfers of such inventories should be properly documented to
enable control to be exercised over each individual stores areas and sales point.
The auditor should carry out tests to ensure that all such documentation is
accurately processed.
✓ Areas where large quantities of inventory are held should be kept locked, the key
being retained by the departmental manager. The key should be released only to
trusted personnel and unauthorised persons should not be permitted in the
stores areas except under constant supervision. In particular, any movement of
goods in or out of the stores should be checked. Many hotels use specialised
professional valuers to take and value the inventories on a continuous basis
throughout the year.
✓ Such a valuation is then almost invariably used as the basis of the balance sheet
inventory figure at the year end. Although such valuers are independent of the
audit client, it is important that the auditor satisfies himself that the amounts
included for such inventories are reasonable.
✓ In order to satisfy himself of this, the auditor should consider attending the
physical inventory taking and carrying out certain pricing and calculation
tests. The extent of such tests could well be limited since the figures will have been
prepared independently of the hotel.
✓ Fixed Assets
The accounting policies for fixed assets of individual hotels are likely to differ.
However, many hotels account for certain quasi-fixed assets such as silver and
cutlery on inventory basis. This can lead to confusion between each inventory items
and similar assets which are accounted for on a more normal fixed assets basis.
In such cases, it is important that very detailed definitions of inventory items exist
and the auditor should carry out tests to ensure that the definitions have been
closely followed.
✓ Casual Labour
The hotel trade operates to very large extent on casual labour. The records
maintained of such wage payments are frequently inadequate. The auditor should
ensure that defalcation on this account does not take place by suggesting
proper controls to the management.
✓ Other points –
▪ For ledgers coming through travel agents or other booking agencies the bills
are usually made on the travel agents or booking agencies. The auditor
should ensure that money is recovered from the travel agents or booking
agencies as per the terms of credit allowed.

13A.27
 ▪ Commission, if any, paid to travel agents or booking agents should be
checked by reference to the agreement on that behalf.
▪ The auditor should ensure that proper records re-maintained for booking
of halls and other premises for special parties and recovered on the basis of
the tariff.
▪ The auditor should verify a few restaurants bills by reference to K.O.T.s
(Kitchen Order Tickets) or basic record. This would enable the auditor to
ensure that controls regarding revenue cycle are in order.
▪ The auditor should see that costs of repairs and minor renovation and
redecoration are treated as revenue expenditure, whereas costs of major
alterations and additions to the hotel building and facilities capitalised.
▪ The auditor should ensure that proper valuation of occupancy-in-progress
at the balance sheet date is made and included in the accounts.
▪ The auditor should satisfy himself that all taxes collected from
occupants on food and occupation have been paid over to the proper
authorities.

The Dayal Singh College an institution managed by Dayal Trust, has received a grant
of 2 crore from Government nodal agencies for funding a project of research on rural
health systems in India.
Draft an audit programme for auditing this fund in the accounts of the college.
Answer:
1. The auditors should obtain preliminary knowledge about the college & the trust.
2. He should carefully study the grant letter to understand the conditions relating to
grant.
3. He should examine the bank statement & trace the receipt of grant therein.
4. He should enquire the management about budgeted project expenditure & actual
expenditure so far.
5. He should ascertain the progress of the project from minutes book.
6. It should also be ensured that project fund is actually being used for the intended
purpose only.
7. Examine whether purchase of capital assets have been appropriately capitalized.
8. He should ensure that physical verification of the assets relating to fund is carried out
by the management.
9. The revenue expenditures from the grant must be checked to ensure their proper
accounting. He should also examine relevant vouchers.
10. Finally, he should examine whether fund account has been shown as a liability
separately in the balance sheet.

13A.28
GOVERNMENT
AUDIT

13B.1
 1. INTRODUCTION
• Government audit means
✓ The objective, systematic, professional and independent examination,
✓ of financial, administrative and other operations of a Public Entity,
✓ For the purpose of evaluating and verifying them
✓ Presenting a report with comments on audit findings together with conclusions
& recommendations for future actions and
✓ In case of examination of financial statements expressing the appropriate
professional opinion regarding the fairness of the presentation.
• Its objective is to ensure the accountability of the government entity in respect of
public revenue and expenditure.
• Auditor presents a report containing audit findings along with recommendations for
future actions.
• In India, the function of government audit is performed by Comptroller and Auditor
General.

2. COMPTROLLER & AUDIT GENERAL OF INDIA

Appointment
• The President of India shall appoint CAG.

Removal or resignation
• He can be removed from the office only on the ground of proven mis-behaviour or
incapacity.
• Moreover, he can be removed from office only when each house of parliament
decides to do so by a majority of at least two third of the members present and
voting.
• He can resign any time through a resignation letter addressed to the President of
India.

Remuneration
• He shall be paid a salary equivalent to that of a Judge of the Supreme Court.
• The parliament is competent to make laws to determine salary and other conditions of
service.

13B.2
 Terms
• He shall hold office for six years or up to age of 65 years, whichever is earlier.

3. DUTIES OF COMPTRO LLER & AUDITOR GENERAL

1. Compilation He shall compile the accounts of the Union/State/Union Territory
and and submit those accounts to the President / Governor /
Submission of Administrator respectively.
Accounts
2. Audit of He shall audit and report on all receipts and expenditure of any
Receipts and body, which has been substantially financed from the Consolidated
Expenditure Fund of India/State/Union Territory.
Note: A body or authority shall be treated as substantially financed
if the amount of grant or loan in one year is not less than;
i) Rs. 25 lakhs, and
ii) 75% of the total expenditure of that body or authority.
3. Audit of Where any grant or loan is given for any specific purpose from the
Grants or ✓ Consolidated Fund of India or
Loans
✓ of any State or
✓ of any Union Territory having a Legislative Assembly to any
authority or body,
not being a foreign State or international organization.
The Comptroller and Auditor General shall scrutinize the procedures
by which the sanctioning authority satisfies itself as to the
fulfillment of the conditions subject to which such grants or loans
were given and shall for this purpose have right of access, after
giving reasonable previous notice, to the books and accounts of
that authority or body.
4. Audit of The CAG shall review rules and procedures designed to secure an
receipts of effective check on assessment, collection and proper allocation
Union or States of revenue, for all receipts into Consolidated fund of
India/Sate/Union Territory.

5. Audit of The CAG shall have the authority to audit and report on the
Accounts of accounts of stores and stock kept in any office or department of
Stores and the union or state.

13B.3
 Stock
6. Audit of CAG shall exercise powers and observe duties as per the provisions
Government of the Companies Act, 2013 in relation to the Government
Companies & Companies or Corporations.
Corporations
7. General It shall be the duty of the Comptroller and Auditor General -
provisions • to audit and report on all expenditure from the Consolidated
related to
Fund of India and of each State and of each Union Territory
Audit
having a Legislative Assembly and to ascertain whether the
moneys shown in the accounts as having been disbursed
were legally available for and applicable to the service or
purpose to which they have been applied or charged and
whether the expenditure conforms to the authority which
governs it;
• to audit and report all transactions of the Union and of the
States relating to Contingency Funds and Public Accounts;
• to audit and report on all trading, manufacturing and profit and
loss accounts and balance-sheets and other subsidiary accounts
kept in any department of the Union or of a State.

4. POWERS OF COMPTRO LLER & AUDITOR GENER AL

Inspection He can inspect any office of accounts under the control of the Union
or State Government.

Transmission He may require that any accounts, books, papers and other
documents, which are relevant to the transactions under audit, be
sent to specified places.

Inquiry and Call for He can put such questions, as he may consider necessary, to the
Information person in charge and to call for such information as he may require
for the preparation of any account or report.
Sample check In carrying out the audit, the Comptroller and Auditor General has
the power
• to dispense with any part of detailed audit of any accounts
or class of transactions and
• to apply such limited checks in relation to such accounts or
transactions as he may determine.

13B.4
13B.5
 5. AUDIT OF VARIOUS ITEMS

Expenditure Audit
The auditor examines the fulfilment of conditions for government expenditure. It involves
examination of following:
a) Audit of rules and orders
b) Audit of sanctions
c) Audit against provision of funds
d) Propriety audit
e) Performance audit

Audit against 1. Its objective is to ensure whether the expenditure is in accordance

Rules and Orders with:
(Regularity Audit)
• relevant provisions of the Constitution and of the laws
and rules.
• the Financial rules, regulations issued by CAG.
• the orders of, or rules made by, any competent authority.
2. These rules, regulations and orders against which regularity audit
is conducted mainly fall under the following categories:
• Rules and orders regulating the powers to incur and
sanction expenditure from the Consolidated Fund of India
or of a State (and the Contingency Fund of India or of a
State);
• Rules and orders dealing with the mode of presentation of
claims against government, withdrawing moneys from the
Consolidated Fund, Contingency Fund and Public Accounts of
the Government of the India and of the States, and in general
the Financial rules prescribing the detailed procedure to be
followed by government servants in dealing with government
transactions; and
• Rules and orders regulating the conditions of service, pay
and allowances, and pensions of government servants.
3. Aspects of Regularity Audit:
• they are not inconsistent with any provisions of the
Constitution or any laws made thereunder;
• they are consistent with the essential requirements of
audit and accounts as determined by the C&AG;

13B.6
 • they do not come in conflict with the orders of, or rules
made by, any higher authority; and
• in case they have not been separately approved by
competent authority, the issuing authority possesses the
necessary rule-making power.

1. The auditor has to ensure whether the expenditure is:

• Properly covered by a sanction, either general or special.
• Sanctioned by authority, which is authorized to do so.
2. Thus, auditor should consider following:
Audit of • He should have knowledge of the sanctioning powers of
Sanctions various authorities.
• He should examine whether all sanctions are adequately
noted in the prescribed register.
• For petty expenditure, the signature of the competent
authority on a bill can be regarded as a sanction.
Audit against Its objective is to ensure whether the expenditure:
Provision of • Is made for the purpose to which the grant and appropriation
Funds has been provided.
• Does not exceed the appropriation made.
Audit of Propriety 1. Propriety audit stands for verification of transactions on the tests
of
• Public interest,
• Commonly accepted customs and
• Standards of conduct
2. According to propriety audit, the auditor examines the cases of
improper or wasteful expenditure even though the expenditure
has been incurred in conformity with the existing rules and
regulations.
3. A transaction may satisfy all the requirements of regular audit but
may still be highly wasteful.
4. For e.g. a building may be constructed for running a school but
may not be used for the same purpose, resulting in wasteful
expenditure.
5. Auditor should try to examine public financial morality by
looking in to the wisdom, faithfulness and economy of
transactions.
6. No hard and fast rules can be laid down regarding the standards
of financial propriety.

13B.7
 7. Here, the auditor should examine that:
• The authorities have made the expenditure with same
degree of vigilance, as a person of ordinary prudence would
exercise in respect of his own money.
• The expenditure is not prima facie more than the occasion
demands.
• No authority exercises its power of sanctioning expenditure
to pass an order, which will directly or indirectly accrue to its
own advantage.
• Public money is not utilised for the benefit of a particular
person or section of the community unless:
✓ the amount of expenditure involved is insignificant; or
✓ a claim for the amount could not be enforced in a Court
of law; or
✓ the expenditure is in pursuance of a recognised policy
or custom;
✓ the amount of allowances, such as travelling
allowances, granted to meet expenditure of a particular
type should be so regulated that the allowances are not,
on the whole, sources of profit to the recipients.

Audit of 1. Here, auditor tries to ensure that government programmes have

Performance achieved the desired objectives at the lowest cost and given the
intended benefits.
2. Performance audit includes efficiency, economy and
effectiveness audit.
3. Performance audit is an objective examination of the financial and
operational performance. It seeks to identify opportunities for
greater economy and effectiveness.
4. Efficiency Audit
It examines whether:
• The various schemes/projects are executed, and
• Their operations are carried out in efficient manner, and
• They are yielding the expected results.

5. Economy Audit
It examines whether:
• The government has acquired the financial, human and

13B.8
 physical resources in an economical manner, and
• The sanctioning and spending authority have observed
economy in spending.
6. Effectiveness Audit
It examines whether:
• Programmes and projects are performing well.
• Overall targeted objectives are being achieved in an
optimal manner.

6. AUDIT OF COMMERCIAL ACCOUNTS

• Public enterprises are required to maintain commercial accounts and are generally
classified under three categories:
✓ departmental enterprises engaged in commercial and trading operations, which
are subject to the same laws, financial and other regulations as other government
departments and agencies;
✓ statutory bodies, corporations, created by specific statutes mostly financed by
government in the form of loans, grants, etc. and
✓ government companies set up under the Companies Act, 2013.
• Government companies have their own auditors under the statute appointed by C&AG.
• In addition, the C&AG conducts a supplementary test audit of the accounts, as well as
periodical financial audit and appraisal of performance.
• The C&AG also issues direction to the company auditors for reporting on specific
aspects of their audit work.
• These are reviewed and condensed in the audit reports to government/legislatures.
• C&AG has adopted the mechanism of an Audit Board-comprising of representatives of
the audit and nominees of government including functional specialists to process reviews
or appraisals on performance.
Important Note: Refer Role of C&AG prescribed under sub section (5), (6) and (7) of
section 143 of the Companies Act, 2013 in Chapter – 10 “The Company Audit”.

13B.9
 7. AUDIT OF STORES AND INVENTORIES
• Auditor should ascertain whether the internal controls over purchase, receipt, and issue
of stores are well designed and properly carried out during the year.
• He should bring to the notice of the government any deficiencies in the system of
control.
• The audit of purchase of stores is conducted in the same manner as audit of expenditure.
• The auditor has to ensure that the prices paid are reasonable.
• Cases of uneconomical purchase of stores and losses due to defective or inferior
quality of stores are specifically examined.
• The certificates of quality and quantity given by expert should be examined.
• Accounts of receipts, issues and balances are checked regarding accuracy,
correctness and reasonableness of balances in stocks.
• Any excess or idle stocks should be specifically mentioned in the report.
• Auditor should ensure their existence by attending physical verification of stock.
• The valuation of the stocks is also examined properly.

8. AUDIT OF RECEIPTS
The government audit also covers receipts payable in to the Consolidated Fund of India and of
each State/Union Territory. The auditor examines whether:
• Whether all revenues or other debts due to government have been correctly assessed,
realised and credited to government account by the designated authorities;
• Whether adequate regulations and procedures have been framed by the
department/agency concerned to secure an effective check on assessment, collection
and proper allocation of cases;
• Whether such regulations and procedures are actually being carried out;
• Whether adequate checks imposed to ensure the prompt detection and investigation
of irregularities, double refunds, fraudulent or forged refund vouchers or other loss of
revenue through fraud or willful omission or negligence to levy or collect taxes or to
issue refunds; and
• Review of systems and procedures to see that the internal procedures adequately secure
correct and regular ac-counting of demands collection and refunds and pursuant of
dues up to final settlement and to suggest improvement.

13B.10
 AUDIT OF
CO-OPERATIVE
SOCIETY

13C.1
 1. INTRODUCTION
Co-operative society is a business organization with a special mode of doing business, by
pulling together all the means of production co-operatively, elimination of middlemen and
exploitation from outside forces.
Apart from audit, some other professional services could be rendered by chartered accountants
in the development of Co-operative organisations such as -
• Guidance in accounts writing,
• Installation of accounting system,
• Internal audit,
• Management accounting services,
• Taxation etc.

2. AUDIT AS PER SECT ION 17 OF CO-OPERATIVE

SOCIETIES ACT, 1912
• The Registrar shall audit or cause to be audited by some person authorised by him
by general or special order in writing in this behalf the accounts of every registered
society once at least in every year.
• The audit under sub-section (1) shall include an examination of overdue debts, if any,
and a valuation of the assets and liabilities of the society.
• The Registrar, the Collector or any person authorised by general or special order in
writing in this behalf by the Registrar shall at all times have access to all the books,
accounts, papers and securities of a society, and every officer of the society shall
furnish such information in regard to the transactions and working of the society as
the person making such inspection may require.

3. IMPORTANT POINTS IN CO-OPERATIVE SOCIETY AUDIT

The following points should be kept in mind in connection with the audit of a co- operative
society:
1. Qualifications of Auditors
Apart from a chartered accountant within the meaning of the Chartered Accountants Act,
1949, some of the State Co-operative Acts have permitted persons holding a
government diploma in co-operative accounts or in co-operation and accountancy
and also a person who has served as an auditor in the co-operative department of a
government to act as an auditor.

13C.2
2. Appointment of the Auditor
An auditor of a co-operative society is appointed by the Registrar of Co-operative
Societies and the auditor so appointed conducts the audit on behalf of the Registrar
and submits his report to him as also to the society. The audit fees are paid by the
society on the basis of statutory scale of fees prescribed by the Registrar, according
to the category of the society audited.

3. Books, Accounts and other records of Co-operative Societies

Under section 43(h) of the Central Act, a state government can frame rules prescribing
the books and accounts to be kept by a co-operative society.
For example, in Maharashtra, the co-operative societies are required to maintain books
of account in terms of the instructions of the Registrar as following:
• All sums of money received and expended by the society and the matters in
respect of which receipts and expenditure take place.
• All sales and purchases of goods by the society.
• Assets and liabilities of the society.
Depending upon the nature and object of the society, different kinds of books and
registers will be maintained, so as to disclose a proper and fair picture of financial
transactions. In case of large scale co-operative organisation, different subsidiary books
and registers shall be maintained and the daily summary totals will be transferred to
main Cash Book.
For example:
• Daily cash sales summary register.
• A register of collection from debtors if credit sales are allowed by bye-laws of
society.
• A register of recovery of loans from salaries and directly by receipts from members
in case of credit society.
• Loan disbursement register in case of credit society.
• Any other columnar subsidiaries depending upon the nature and functions of
society.

4. Restrictions on share holdings

According to section 5 of the Central Act, in the case of a society where the liability of a
member of the society is limited, no member of a society other than a registered
society can hold such portion of the share capital of the society as would exceed a
maximum of twenty percent of the total number of shares or of the value of
shareholding to ` 1,000/-. The auditor of a co-operative society will be concerned with
this provision so as to watch any breach relating to holding of shares.

13C.3
 5. Restrictions on loans
Section 29 of the Central Act puts restriction on loan. It states that a registered society
shall not make a loan to any person other than a member. However, with the special
sanction of the Registrar, a registered society may make a loan to another registered
society.

6. Restrictions on borrowings
Section 30 of the Central Act further puts restriction on borrowings. According to this
section, a registered society shall accept loans and deposits from persons who are
not members subject to the restrictions and limits of the bye-laws of the society.
The auditor will have to examine the bye-laws in this respect.

7. Investment of funds
According to section 32 of the Central Act, a society may invest its funds in any one or
more of the following:
• In the Central or State Co-operative Bank.
• In any of the securities specified in section 20 of the Indian Trusts Act, 1882.
• In the shares, securities, bonds or debentures of any other society with limited
liability.
• In any co-operative bank, other than a Central or State co-operative bank, as
approved by the Registrar on specified terms and conditions.
• In any other moneys permitted by the Central or State Government.

8. Appropriation of profits
According to section 33 of the Central Act, a prescribed percentage of the profits
should be transferred to Reserve Fund, before distribution as dividends or bonus to
members.

9. Contributions to Charitable Purposes

According to section 34, a registered society may, with the sanction of the Registrar,
contribute an amount not exceeding 10% of the net profits remaining after the
compulsory transfer to the reserve fund for any charitable purpose as defined in section
2 of the Charitable Endowments Act, 1890.

10. Investment of Reserve Fund outside the business or utilisation as working capital
Some of the State Acts provide that a society may use the Reserve Fund:
a) in the business of a society, as working capital (subject to the rules made in
this behalf).
b) may invest as per provisions of the Act.

13C.4
 c) may be used for some public purposes likely to promote the object of the
society. The auditor should ensure strict compliance with the State Act and
Rules in this regard.
11. Contribution to Education Fund
Some of the State Acts provide that every society shall contribute annually towards
the Education Fund of the State Federal Society, at the appropriate rate as per the
class of the society. Contribution to Education Fund is a charge on profits and not an
appropriation.
Further, it may be noted that necessary accounting entries for the appropriation of
profits must be passed after the date of approval by the General Body. Here there is a
departure from corporate accounting practice, where entries are passed for
proposed appropriations, subject to approval of Annual General Meeting.

12. Special features of Co-operative Society:

Examination of • Overdue debts for a period from six months to five
overdue debts: years and more than five years will have to be
classified and shall have to be reported by an auditor.
• Overdue debts have far reaching consequences on
the working of a credit society. It affects its working
capital position.
• A further analysis of these overdue debts from the
viewpoint of chances of recovery will have to be
made, and they will have to be classified as good or
bad.
• The auditor will have to ascertain whether proper
provisions for doubtful debts are made and
whether the same is satisfactory.

Overdue Interest • Overdue interest should be excluded from interest

outstanding and accrued due while calculating profit.
• Overdue interest is interest accrued or accruing in
accounts, the amount of which the principal is
overdue.
• In practice an overdue interest reserve is created
and the credit of overdue interest credited to
interest account is reduced.
Certification of Bad • A peculiar feature regarding the writing off of the
Debts bad debts in case of Co-operative societies is that
bad debts can be written off only when they are
certified as bad by the auditor or managing

13C.5
 committee (When no such requirement of approval
by auditor is required).
• Bad debts and irrecoverable losses before being
written off against Bad Debts Funds, Reserve Fund
etc. should be certified as bad debts or irrecoverable
losses as discussed above.
Valuation of Assets • The auditor will have to ascertain existence,
and Liabilities: ownership and valuation of assets.
• Fixed assets should be valued at cost less adequate
provision for depreciation.
• The current assets should be valued at cost or
market price, whichever is lower.
• All the known liabilities are brought into the account,
and the contingent liabilities are stated by way of
a note.

Observations of the • An auditor of a co-operative society is required to

Provisions of the Act point out the infringement (Non-Compliance) with
and Rules: the provisions of Co-operative Societies Act and
Rules and bye-laws.
• The financial implications of such infringements
should be properly assessed by the auditor and
they should be reported.
• Some of the State Acts contain restrictions on
payment of dividends, which should be noted by
the auditor.
Verification of • Examination of entries in members pass books
Members’ Register regarding the loan given and its repayments,
and examination of apply SA 505 for obtaining the confirmation of
their pass books: loan balances.
• Apply SA 505 wherever required.

Special report to the During the course of audit, if the auditor notices that there
Registrar: are some serious irregularities in the working of the
society, he may report these special matters to the
Registrar, drawing his specific attention to the points.
The Registrar on receipt of such a special report may take
necessary action against the society. In the following cases,
for instance a special report may become necessary:
• Personal profiteering by members of managing
committee in transactions of the society

13C.6
 • Detection of fraud relating to expenses, purchases,
property and stores of the society.
• Specific examples of mis-management like
decisions of management against co- operative
principles.
• In the case of urban co-operative banks,
disproportionate advances to vested interest
groups, such as relatives of management, and
deliberate negligence about the recovery thereof.
Cases of reckless advancing, where the
management is negligent about taking adequate
security and proper safeguards for judging the credit
worthiness of the party.
Audit classification of • After a judgement of an overall performance of the
society: society, the auditor has to award a class to the
society.
• It may be noted here that if the management of the
society is not satisfied about the award of audit
class, it can make an appeal to the Registrar, and
the Registrar may direct to review the audit
classification.

Discussion of draft The audit report should never be finalized without

audit report with discussion with the managing committee. Minor
managing committee: irregularities may be got settled and rectified.

Distribution of Profit • 25% of profit should be transferred to Reserve Fund

before distribution to members.
• Registrar may reduce it but at least 10% is even
then required. Society may use Reserve fund in
business of a society or some other public purpose.

13. Rights & Duties of Co-operative Auditors:

According to the present prescribed form in some of the States, the auditor has to
state:
• Whether he has obtained all the necessary information and explanations which
to the best of his knowledge and belief were necessary for the purpose of audit.
• Whether in his opinion and to the best of his information and according to the
explanations given to him, the said accounts give all the information required
by the Act.

13C.7
 • Whether the Profit and Loss Account of the society gives a true and fair view
of the Profit and Loss made by the society.
• Whether the Balance Sheet drawn up as at the end of the year gives a true
and fair view of the state of affairs of the society as on the given date.
• Whether in his opinion, proper books of account as required by the Act, the Rules
and the bye-laws of the society have been properly maintained.
• Whether the Balance Sheet and the Profit and Loss Account examined by him
are in agreement with the books of account and returns of the society.
The auditor will have to give qualifying observations, if any of the answers to the
above-mentioned matters are negative.

14. Forms of Audit Report:

The form of the audit report to be submitted by the auditor, as prescribed in various
states, contains many matters which the auditor has to state or comment upon. The
auditor will have to attach schedules to the report regarding the following information:
• All transactions which appear to be contrary to the provisions of the Act, the rules
and bye-laws of the society.
• All sums, which ought to have been, but have not been brought into account by
the society.
• Any material, or property belonging to society which appears to the auditor to be
bad or doubtful of recovery.
• Any material irregularity or impropriety in expenditure or in the realization or
monies due to society.
• Any other matters specified by the Registrar in this behalf.

15. Multistate Co-operative Society Act, 2002:

Books of Accounts: Every auditor of a multi – State Co-operative Society shall keep
books of accounts for:
• all sum of money received and expended and the matters in respect of which the
receipt and expenditure took place.
• all sales and purchases of goods.
• the assets and liabilities of the society.
• in the case of Multi State Co-operative Society engaged in production, processing
and manufacturing particulars relating to utilization of materials or labor or
other term of cost as may be specified in the bye laws of such a society.

16. Audit of Multistate Co-operative Society:

1. Qualification of Auditors - Section 72 of the Multi-State Co-operative Societies
Act, 2002 states that a person who is a Chartered Accountant within the meaning

13C.8
 of the Chartered Accountants Act, 1949 can only be appointed as auditor of
Multi-State co-operative society.
However, the following persons are not eligible for appointment as auditors of a
Multi- State co-operative society-
• A body corporate.
• An officer or employee of the Multi-State co-operative society.
• A person who is a member or who is in the employment, of an officer or
employee of the Multi-State co-operative society.
• A person who is indebted to the Multi-State co-operative society or who
has given any guarantee or provided any security in connection with the
indebtedness of any third person to the Multi-State co-operative society for
an amount exceeding one thousand rupees.
If an auditor becomes subject, after his appointment, to any, of the disqualifications
specified above, he shall be deemed to have vacated his office as such.

2. Appointment of Auditors –
• Section 70 of the Multi-State Co-operative Societies Act, 2002 provides that the
first auditor or auditors of a Multi-State co-operative society shall be
appointed by the board within one month of the date of registration of
such society and the auditor or auditors so appointed shall hold office until
the conclusion of the first annual general meeting.
• If the board fails to exercise its powers under this sub-section, the Multi-State
co-operative society in the general meeting may appoint the first auditor
or auditors.
• The subsequent auditor or auditors are appointed by Multi-State co-operative
society, at each annual general meeting.
• The auditor or auditors so appointed shall hold office from the conclusion
of that meeting until the conclusion of the next annual general meeting.

3. Power and duties of Auditors –

• Section 73 of the Multi-State Co-operative Societies Act, 2002 discusses the
powers and duties of auditors.
• According to this, every auditor of a Multi-State co-operative society shall have
a right of access at all times to the books accounts and vouchers of the
Multi-State co-operative society, whether kept at the head office of the Multi-
State co-operative society or elsewhere, and shall be entitled to require from
the officers or other employees of the Multi- State co-operative society such
information and explanation as the auditor may think necessary for the
performance of his duties as an auditor.
• As per Section 73(2), the auditor shall make following inquiries:

13C.9
 ✓ Whether loans and advances made by the Multi-State co-operative society
on the basis of security have been properly secured and whether the terms
on which they have been made are not prejudicial to the interests of the
Multi-State co- operative society or its members,
✓ Whether transactions of the Multi-State co-operative society which are
represented merely by book entries are not prejudicial to the interests of
the Multi-State co-operative society.
✓ Whether personal expenses have been charged to revenue account, and
✓ Where it is Stated in the books and papers of the Multi-State co-operative
society that any shares have been allotted for cash, 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 as correct regular and not misleading.

4. Content of Auditor’s Report - As per sub-section (3) & (4) of section 73 of Multi-
state Co-operative Societies Act, 2002, the auditor shall make a report to the
members of the Multi-State co-operative society on the accounts examined by
him and on every balance-sheet and profit and loss account and on every
other document required to be part of or annexed to the balance-sheet or profit
and loss account, which are laid before the Multi-State co-operative society in
general meeting during his tenure of office, and the report shall state whether, in
his opinion and to the best of his information and according to the explanation
given to him, the said account give the information required by this act in the
manner so required, and give a true and fair view:
• In the case of the balance-sheet, of the state of the Multi-State co-operative
society’s affairs as at the end of its financial year; and
• In the case of the profit and loss account, of the profit or loss for its financial
year.

The auditor’s report shall also state:

• Whether he has obtained all the information and explanation which to the
best of his knowledge and belief were necessary for the purpose of his audit.
• Whether, in his opinion, proper books of account have been kept by the
Multi- State co-operative society so far as appears from his examination of
these books and proper returns adequate for the purpose of his audit have
been received from branches or offices of the Multi-State co-operative
society not visited by him.
• Whether the report on the accounts of any branch office audited by a
person other than the Multi-State co-operative society’s auditor has been
forwarded to him and how he has dealt with the same in preparing the
auditor’s report.

13C.10
 • Whether the Multi-State co-operative society’s balance sheet and profit and
loss account dealt with by the report are in agreement with the books of
account and return.
Where any of the matters referred to in sub-section (3) or (4) is answered in the
negative or with a qualification, the auditor’s report shall state the reason for the
answer.

5. POWER OF CENTRAL GOV ERNMENT TO DIRECT SP ECIAL

AUDIT IN CERTAIN CAS ES (SECTION 77)
• If Central Government is of opinion that:
✓ Affairs of MSCOS aren't being managed in accordance with self-help & Co-
operative principles or sound business principles or:
✓ MSCOS is managed in manner likely to cause serious injury / damage to interest
of trade industry or business to which it pertains or
✓ The financial position of any MSCOS is such as to endanger its solvency.
• The Central Government may at any time by order direct that a special audit of the Multi-
State co-operative society’s accounts for such period or periods as may be specified in
the order, shall be conducted and appoint either a chartered accountant or the Multi-
State co-operative society’s auditor himself to conduct the special audit.
• However, Central Government shall order for special audit only if that Government or the
State Government either by itself or both hold fifty-one percent or more of the paid-
up share capital in such Multi-State co-operative society.
• The special auditor shall have the same powers and duties in relation to the special audit
as an auditor of a Multi-State co-operative society has under section 73.
• However, the special auditor shall instead of making his report to the members of the
Multi-State co-operative society make the report to the Central Government.
• The report of the special auditor shall, include all the matters required to be included in
the auditor’s report under section 73 and any other matter as directed by the Central
Government.
• On receipts of the report of the special auditor the Central Government may take such
action on the report as it considers necessary in accordance with the provision of the Act
or any law for the time being in force.
• However, if the Central Government does not take any action on the report within
four months from the date of its receipt, that Government shall send to the Multi-State
Co- operative society either a copy of, or relevant extract from, the report with its
comments thereon and require the Multi-State Co-operative society either to circulate
that copy or those extracts to the members or to have such copy or extracts read before
the Multi-State Co-operative society at its next general meeting.

13C.11
 • The expenses of, and incidental to, any special audit under this section (including the
remuneration of the special auditor) shall be determined by the Central Government
which determination shall be final and paid by the Multi-State Co-operative society
and in default of such payment, shall be recoverable from the Multi-State Co-operative
society as an arrear of land revenue.

6. INQUIRY BY CENTRAL REGISTRAR UNDER SECTION 78

• The Central Registrar may, on a request from
✓ a federal co-operative to which a Multi- State Co-operative society is affiliated or
✓ a creditor or
✓ not less than one-third of the members of the board or
✓ not less than one-fifth of the total number of members of a Multi-state co-operative
society,
Hold an inquiry or direct some person authorized by him by order in writing in his behalf
to hold an inquiry into the constitutions, working and financial condition of a Multi-State
Co-operative society.
• However, before holding such inquiry fifteen days’ notice must be given to the Multi-State
co-operative society.

The Central Registrar or the person authorized by him shall have the following powers,
namely:
• He shall at all reasonable times have free access to the books, accounts, documents,
securities, cash and other properties belonging to or in the custody of the Multi-State
co-operative society and may summon any person in possession or responsible for the
custody of any such books, accounts, documents securities, cash or other properties to
produce the same at any place specified by him.
• He may, notwithstanding any bye-law specifying the period of notice for a general
meeting of the Multi-State co-operative society, require the officers of the society to
call a general meeting of the society by giving notice of not less than seven days at
such time and place at the headquarters of the society to consider such matters as may
be directed to him, and where the officers of the society refuse or fail to call such a
meeting, he shall have power to call it himself.
• he may summon any person who is reasonably believed by him to have any
knowledge of the affairs of the Multi-State co-operative society to appear before him at
any place at the headquarters of the society or any branch thereof and may examine
such person on oath.
Note: The Central Registrar shall, within a period of three months of the date of receipt
of the report, communicate the report of inquiry to the Multi-State co-operative society,

13C.12
the financial institutions, if any, to which the society is affiliated, and to the person or
authority, if any at whose instance the inquiry is needed.

7. INSPECTION OF MULTIS TATE CO-OPERATIVE SOCIETIES

UNDER SECTION 79
• The Central Registrar may, on a request from
✓ federal co-operative to which a Multi- State Co-operative society is affiliated or
✓ a creditor or
✓ not less than one-third of the members of the board or
✓ not less than one-fifth of the total number of members of a Multi-State co-operative
society
by general or special order in writing in this behalf inspect or direct any person authorized
by him by order in writing in this behalf to make an inspection into the constitution,
working and financial condition of a Multi- State co-operative society.
• However, no inspection shall be made unless a notice of not less than fifteen days has
been given to the multi-state co-operative society.

The Central Registrar or the person authorized by him shall have the following powers:
• He shall at all times have access to all books, accounts, papers, vouchers, securities,
stock and other property of that society and may, in the event of serious irregularities
discovered during inspection, take them into custody and shall have power to verify
the cash balance of the society and subject to the general or special order of the
central registrar to call a meeting of the society where such general meeting is, in his
opinion necessary.
• Every officer or member of a Multi-State Co-operative society shall furnish such
information with regard to the working of the society as the central registrar or the
person making such inspection may require.

A copy of the report of inspection under this section shall be communicated to the Multi-
State Co-operative society within a period of three months from the date of completion of
such inspection.

13C.13
 Notes:

13C.14